The regulation of private fund investment advisors has been under the scanner for a long time now, and recently the U.S. Securities and Exchange Commission (SEC) has adopted rules to enhance and update these regulations and compliance rules that govern all private fund advisors.
Increased transparency, competition and marketplace efficiency are viewed largely as the pillars through which the private fund investors are going to be protected by the newly laid out rules of the SEC.
The Private Fund Advisor Rules consist of five sets of regulations and prohibitions referred to as the Restricted Activities Rule, Preferential Treatment Rule, Quarterly Statement Rule, Audit Rule, Books and Records Rule, Compliance Rule and Advisor-Led Secondary Rule.
When do the new rules go into effect?
- Larger private fund advisors (AuM $1.5 billion or more) have a compliance date of 18 months after publication in the federal register for the quarterly statement and audit rules, but 12 months after publication in the federal register for the advisor-led secondaries, preferential treatment, and restricted activities rules.
- Smaller private fund advisors (AuM less than $1.5 billion) have a compliance date of 18 months after publication in the federal register for all new rules.
Under the Quarterly Statement Rule, the fund’s investors are expected to receive quarterly statements from their advisors that include critical information regarding expenses, performance and fees for any private fund that it advises.
Quarterly Statement Rule
- Timing – 45 days after the end of each of the first three fiscal quarters of each fiscal year of the fund and 90 days after the end of each fiscal year of the fund is the timeline within which private fund investors must receive quarterly statements from SEC-registered private fund advisors. For funds of funds, these deadlines are 75 days and 120 days
- It is expected that the quarterly statement must be written in clear, concise and plain English, and also in a format that facilitates review from one quarterly statement to the next.
The quarterly statement must contain the following detailed information:
Advisor compensation: All compensation, fees and other amounts allocated or paid to the advisor during the quarter.
Fees and Expenses: All fees and expenses allocated to or paid by the private fund during the quarter, including, but not limited to, organizational, accounting, legal, administration, audit, tax, due diligence, and travel fees and expenses.
Offsets, Rebates and Waivers: The amount of any credits or deductions retained from the current quarter and applied in future periods to lower forthcoming payments or distributions to the advisor or individuals associated with them.
Portfolio Investment Table: The quarterly report should include details that outline the fees or any other form of compensation paid or allocated to the advisor and their related persons stemming from a portfolio investment, both prior to and following the implementation of any deductions, reimbursements or exemptions.
Calculations and Cross-References: The quarterly statement must disclose the manner in which all expenses, payments, allocations, rebates, waivers and offsets are calculated, including cross-references to the applicable sections of the private fund’s organizational and offering documents.
Performance: Starting from the first quarterly report, the statement should include comprehensive performance data, with the specific details differing depending on whether the private fund is liquid or not.
Details on the requirements for Quarterly Statement Rules
Detailed breakdown of all the compensation, charges and any other amounts allocated or disbursed to the advisor by the fund during the reporting period.
Compensation includes, but is not limited to, management, advisory, sub-advisory or similar fees or payments and performance-based compensation.
Also includes any compensation, fees or other amounts allocated or paid to the advisor for non-advisory services they provide to the private fund such as consulting, legal or back-office services.
Fees and Expenses
Detailed accounting of all fees and expenses allocated to or paid by the fund during the reporting period.
Fund fees and expenses include, but are not limited to, organizational, accounting, legal, administration, audit, tax, due diligence and travel expenses.
Also includes start-up and organizational fees of the fund if they were paid during the reporting period.
Does not permit the exclusion of de minimis expenses, the general grouping of smaller expenses into broad categories or the labeling of expenses as miscellaneous.
Requires fees and expenses to be listed as separate line items by total dollar amount per specific category.
Portfolio Investment Level Disclosure on Compensation
Mandates the disclosure of a comprehensive breakdown of all compensation stemming from portfolio investments that have been assigned or disbursed by each "covered portfolio investment" during the reporting period, specifically in relation to a private fund's stake in a covered portfolio investment.
Includes holding companies, special purpose vehicles, subsidiaries and other entities.
Also includes, but is not limited to, origination, management, consulting, monitoring, servicing, transaction, administrative, advisory, closing, disposition, directors, trustees, or similar fees or payments.
The rule requires an advisor to show:
Annual net total return for each fiscal year over the past 10 fiscal years or since inception (whichever is shorter).
Average annual net total returns over the one-, five- and 10- fiscal-year periods.
Cumulative net total return for the current fiscal year as of the end of the most recent fiscal quarter covered by the quarterly statement.
The rule requires an advisor to show:
Gross/Net IRR and MOIC (Multiple on invested capital) since inception through the end of the quarter covered by the quarterly statement.
Gross/Net IRR and MOIC (Multiple on invested capital) for the realized and unrealized portions of the illiquid fund’s portfolio
A statement of contributions and distributions.
Performance measures with and without the impact of fund-level subscription facilities.
What should managers be doing now?
The changes in the new private funds rules are significant. Managers should be considering several factors in assessing their ability to comply with this new set of rules. While these new rules are significant and compliance is essential, managers must look ahead to assess their overall compliance strategy.
Managers need to be asking themselves the following questions:
- What are the data requirements for the new quarterly statement rule?
- How can that data be accessed?
- How do I develop processes and controls for creation, review and distribution of quarterly statements?
- What resources are required to ensure compliance?
- Do I need to reevaluate methodologies used to allocate shared expenses across private funds?
- How do I assess data and assumptions utilized to calculate net total returns of liquid funds and calculate performance measures of illiquid funds?
- Do I build in-house or outsource?
- What changes might I need to make to future-proof my compliance strategy?
With this new set of rules, managers need to make decisions now to minimize disruption, strengthen capabilities and ensure compliance. SS&C GlobeOp provides an end-to-end regulatory solution that includes the preparation of the quarterly statements required by the new quarterly statement rule.
Written by Richard Clark
Managing Director, Regulatory Solutions SS&C