Trillium

Final rule 211(h)(1)-2 (the “Quarterly Statement Rule”) requires an investment adviser registered with the United States Securities and Exchange Commission (“SEC”) to prepare a quarterly statement that includes certain standardized disclosures regarding the cost of investing in the private fund and the private fund’s performance and distribute the quarterly statement to the private fund’s investors. The quarterly statement must be distributed within 45 days after the end of each of the first three fiscal quarters of each fiscal year and 90 days after the end of each fiscal year (fund of funds timeframes are 75 days and 120 days, respectively).

The Quarterly Statement Rule requires the disclosure of three distinct areas.

1. Fund-level information
2. Portfolio-level information
3. Performance reporting

Fund-level Information

Private fund advisers are required to present a table detailing the following information for each private fund.

• All forms of compensation paid or allocated to the adviser or any of its related persons from the private fund;
• All fees and expenses paid by the private fund; and 
• The amount of any offsets, rebates or waivers carried forward to subsequent periods.

Any private fund expense that could also be characterized as adviser compensation must be shown as adviser compensation in the quarterly statement rather than shown as a fee or expense. For example, back-office, in-house legal, accounting or administration or other services provided by the adviser or its related persons would be disclosed as adviser compensation, even is such services fall under categories defined as “partnership expenses” in a private fund’s governing documents.

In the Adopting Release the SEC provided examples of “adviser compensation” including management, advisory, sub-advisory or similar payments, and performance-based compensation (carried interest, incentive fees and incentive or profit allocations.)

Advisers are required to show each compensation or category of fees and expenses as a separate line item and cannot exclude de minimis expenses. Further, advisers are instructed to not group small expenses or use a “miscellaneous” category. The table must show each category of expense before and after any offset, rebate or waiver provisions are applied.

Portfolio-level Information

Advisers must disclose all portfolio investment compensation paid by any entity or issuer in which the private fund has directly or indirectly invested. Portfolio investment compensation is defined as any compensation, fees or other amounts allocated or paid to the adviser or its related persons by the portfolio investment and attributable to the private fund’s interest in such portfolio investment. The portfolio investment compensation disclosure requirement is intended to capture potentially or actually conflicted compensation arrangements including the following examples of portfolio investment compensation:

• Origination
• Management
• Consulting
• Monitoring
• Servicing
• Transaction
• Administrative
• Advisory
• Closing
• Disposition
• Directors
• Trustees
• Similar fees or payments paid by a portfolio investment

The rule requires each form of compensation to be shown as a separate line item detailing the amount allocated or paid and must be presented both before and after the application of any offsets, rebates or waivers. 

The SEC specifically declined to provide an exception for fund of funds to this requirements saying advisers to fund of funds should be in a position to determine whether an entity paying the adviser (or a related person) is a portfolio investment of the fund of funds. The SEC believes that the adviser can request (i) a list of investments from the underlying funds to determine whether any of those underlying portfolio investments have business relationships with the adviser (or its related persons).

Performance Reporting

Finally, the rule requires advisers to present standardized performance in each quarterly statement calculated as of the most recent practicable date. The information required varies based on whether the private fund is “liquid” or “illiquid.” 

Illiquid private funds are funds that (i) do not offer to redeem upon an investor’s request and (ii) provide limited opportunities for investors to withdraw their interests before termination of the fund, other than in exceptional circumstances, such as in response to regulatory events. Private funds that fall into the “illiquid” fund definition are generally closed-end funds that do not offer periodic redemption/withdrawal options. According to the SEC, most private equity and venture capital funds will likely fall under the illiquid fund definition.

Advisers to illiquid funds must show:

• Gross and net internal rate of return (“IRR”) and gross and net multiple of invested capital (“MOIC”) for the full fund portfolio since inception with and without the use of fund-level subscription facilities;
• Gross IRR and gross MOIC for the realized and unrealized, shown separately, portions of fund’s portfolio since inception with and without the use of fund-level subscription facilities; and 
• A statement of aggregate contributions and distributions since the fund’s inception, including the value and date of each inflow and outflow, along with a statement of the fund’s net asset value as of the end of the relevant reporting period.

It is important to note computing performance without the impact of fund-level subscription facilities requires advisers to exclude fees and expenses associated with the subscription facility, such as interest expense, when calculating the net performance figures and preparing the statement of contributions and distributions.

Additionally, recycled capital should be treated as additional contributions for the purposes of any performance calculations under the rule.

Performance Disclosure Requirements

In addition to the aforementioned performance information, the rule requires advisers to include prominent disclosure of the criteria used and assumptions made in calculating the performance within the quarterly statement. The SEC expects quarterly statements to provide sufficient detail to enable investors to verify that the categories of fees and expenses charged conform to the private funds governing documents and to understand and evaluate the performance calculations. Therefore, quarterly statements should include prominent

• Disclosure regarding the manner in which expenses, payments, allocations, rebates, waivers and offsets are calculated;
• Descriptions of the structure of, and the method used to determine, any performance-based compensation (such as the distribution waterfall) and the criteria on which each type of compensation is based; and
• Cross-references to the relevant section(s) of the fund’s governing documents that set forth the applicable calculation methodology.

Recordkeeping

The SEC is amending rule 204-2 (the “Recordkeeping Rule”) alongside the adoption of the Quarterly Statement Rule. As amended, the Recordkeeping Rule will require advisers to make and retain a copy of any quarterly statement distributed to fund investors, as well as a record of each addressee and the date(s) the statement was sent. Additionally, the SEC is requiring advisers make and retain all records evidencing the calculation method for all expenses, payments, allocations rebates, offsets, waivers and performance listed on any quarterly statement. Finally, advisers are required to make and keep books and records substantiating the adviser’s determination that a private fund is a liquid or illiquid fund.