“The Securities and Exchange Commission in recent years has instructed mutual funds to estimate the value of stocks or bonds in their portfolios when the true worth of the securities has changed from their last trading prices. But it appears that many funds haven’t bothered to do so,” writes Ian McDonald in today’s Wall Street Journal.

“So the SEC found when it surveyed funds last fall in the wake of the share-trading scandal. Much of the scandal has involved market-timing, or the rapid buying and selling of fund shares at ‘stale’ prices that don’t reflect events affecting the value of securities in funds’ portfolios since they last traded. To help offset market-timing, which particularly affects U.S. funds holding foreign stocks and bonds, the SEC has required funds to have procedures in place to perform ‘fair-valuation’ pricing to estimate updated values for their portfolio securities when accurate market prices aren’t ‘readily available.’ “

“Releasing its findings for the first time, the SEC said this week that nearly a third of the more than 960 funds surveyed hadn’t done any fair-value pricing in the volatile 20 months ended in September, when the SEC mailed out its questionnaire. More than half of the funds questioned, all of which held half or more of their assets in foreign securities, said they had only used fair-value techniques five times or less during that period.”

“Because they didn’t update their portfolio values, the SEC estimated that investors in about 15% of the funds surveyed saw their assets reduced by 2% or more through market-timing. Another 10% had losses, or ‘dilution,’ at the hands of market-timers amounting to between 1% and 2% of their holdings, according to the SEC.”

“Such survey results, said Douglas Scheidt, chief counsel of the SEC’s division of investment management, are ‘not pretty.’ Speaking at a mutual-fund industry conference this week in Palm Desert, Calif., Mr. Scheidt said, ‘It’s one thing to have policies and procedures. It’s another thing to use them.’ “

“But while the SEC — seemingly with limited success — has waged a campaign to get mutual funds to adopt fair valuation, a closer look at the practice shows that it has limitations. For example, valuation techniques that don’t use market prices are only estimates and therefore can easily produce varying numbers. The result: Different funds can value the same security at different prices on the same day.”

“Take Toyota Motor Corp. shares, which on Oct. 31 closed in Tokyo at 3,130 yen — equivalent to $28.49, according to stock quotes provided by Reuters. But on that same day, the Toyota shares were valued by one U.S. mutual fund at $28.41, at $28.74 by another fund and at $29.01 by a third fund, a price range of some 2%, according to the funds’ portfolio reports.”

“In another example, shares of Japanese wireless outfit NTT DoCoMo Inc. closed at $2,070.01 in Tokyo on April 30, according to Reuters. But ING International Fund valued its shares of NTT DoCoMo at $2,062.72 and Putnam Utilities Growth & Income Fund valued its shares at $2,063.07, according to their shareholder reports.”

“Fair valuation ‘chips away at one of the perceived foundations of mutual funds — that there’s pricing parity of securities among different funds,’ says Geoff Bobroff, a fund consultant and former SEC attorney based in East Greenwich, R.I.”