The ALTs investing landscape has grown more thorny with the recent implementation of the SEC’s new Private Funds Rule. Understanding these regulatory changes is crucial for navigating the evolving compliance landscape, yet the maze of new rules can feel like a complex mystery to unravel.

It’s easy to get bogged down in the minutiae. However, equipped with the right knowledge, ALTs investors can navigate the shifts underway, and adapt and thrive in this new environment. You can find a broader overview of the Private Funds Rule’s key’s changes in our previous article. Now, we’re going to take a closer look at one of the rules most impactful changes: the Quarterly Statement Rule.

Key Principles for Quarterly Statements

The goal of the Quarterly Statement Rule is to establish a baseline of reported information and frequency for ALTs investors. It is designed to ensure a level of transparency and detail that helps investors gain a clearer picture of the fund’s operations, how their money is being used, and the potential risks and returns involved.

As your firm prepares its quarterly reports, it’s important to keep the following principles in mind.

  • Prominently disclose your methodology and assumptions when calculating performance.
  • Present the information in a consistent format that is comparable quarter to quarter.
  • Keep additional non-required information clear and succinct.
  • Statements are required to be issued within 45 days of quarter-end for direct funds, and 75 days for fund-of-funds. At the fiscal year-end, the timelines change to 90 and 120 days, respectively.

Disclosing Expenses and Fees

The rule mandates a more granular breakdown of fees and expenses charged to the fund. This includes management fees, performance fees, carried interest, transaction fees, and other administrative expenses. It is important that firms are prepared to clearly categorize and disclose all fees.

For the prior quarterly period, the statement should provide, in a table format:

  • All amounts paid or allocated to the adviser (or related persons), before and after offsets, in a line-item format for each category.
  • Other fees and expenses allocated or paid by the fund. Grouping of smaller expenses into broader categories is not allowed.
  • Amounts of unused offsets of adviser fees that will be carried forward.
  • Disclosure of the manner which expenses, payments, allocations, etc. are calculated, with cross-reference to fund governing documents.
  • Fees paid to the adviser (or related persons) by the fund’s portfolio investments, by category by investment

Your Take-Action Checklist

The current transition period before the full implementation of the rule is a good time for private equity firms to adjust internal processes. Start by:

  • Adopting a robust internal reporting system to gather and compile data efficiently.
  • Thinking about what expense groupings look like.
  • Tracking information that may not currently live in the general ledger, such the fund’s portion of portfolio investment compensation paid to advisers.
  • Determine who are “related persons” to the advisers for whom payments must be disclosed.

Illiquid Fund Performance Metrics

The rule enhances disclosure of performance metrics to allow investors to better assess the liquidity risks associated with their investments. There are different requirements for liquid and illiquid funds, but most private equity and venture capital funds will meet the SEC’s definition of “illiquid funds.” Illiquid fund advisors are required to disclose performance metrics in quarterly statements containing data since the fund’s inception.

Each quarterly statement should include:

  • Gross and net IRR from inception to date, with and without the impact of fund-level subscription facilities.
  • Gross and net MOIC at report date, with and without the impact of fund-level subscription facilities.
  • Statement of contributions and distributions that supports the calculations.
  • Gross IRR and MOIC for realized and unrealized investments.

There are definitions worth noting here. Gross IRR is the internal rate of return that is calculated gross of all fees, expenses, and performance-based compensation. Fund-level subscription facilities means any subscription facilities, subscription line financing, capital call facilities, capital commitment facilities, bridge lines or other indebtedness incurred by the private fund that is secured by the unfunded capital commitments of the private fund’s investors.

Your Take-Action Checklist

To meet the rule’s goal of providing investors with a more detailed and nuanced understanding of the performance of illiquid funds, start thinking about:

  • Your methodology for calculating levered and unlevered gross metrics and unlevered net metrics.
  • Which borrowings qualify as fund-level subscription facilities.
  • Creating a policy to classify investments as realized and unrealized.

FinTech for Navigating the New Regulatory Landscape

The ALTs experts at Dynamo Software are well-versed in the new SEC rule, and have been engaged in ongoing discussions with PE clients about their evolving needs. Our new Dynamo Accounting template is now available to calculate the required SEC metrics and keep private investors compliant in the changing regulatory environment.

Like our other accounting reports, the new template is Excel-based. This makes it familiar and simple to verify formulas and calculation outputs, and make adjustments as needed. It can be easily customized to your fund’s specific requirements.

We’re keeping a close watch on how the market responds during this next period of implementation, and updates to the accounting template will be made as needed. Dynamo Software is uniquely positioned to help you navigate the complexities of the new SEC Private Funds Rule with confidence and efficiency.  For a more detailed look at the Quarterly Statement Rule and the Dynamo resources available help, view our webinar.

On-Demand Webinar | Navigating the New SEC Private Funds Rule

 

Mark Karchov is a Director with nearly 20 years of experience, having spent majority of his career in public accounting, servicing clients within the alternative investments space. Shortly before joining Dynamo, he oversaw the accounting, operations and investor relations teams at Wilshire Private Markets (division of Wilshire Associates, Inc). He holds a BSBA from Boston University with concentrations in Accounting and Finance and an MS in Taxation from Fordham University. He is a CPA licensed in the states of New York and Massachusetts and a CFA Charterholder. Connect with Mark on LinkedIn.