Publication - 07/14/2014

The SEC Provides Guidance on Custody Rule Compliance for Private Fund SPVs and Escrow Accounts

Investment Management Alert

In June 2014, the staff of the Securities and Exchange Commission’s (SEC’s) Division of Investment Management provided guidance (the Guidance Update) on how private fund managers using special purpose vehicles (SPVs) and escrow accounts may comply with Advisers Act Rule 206(4)-2 (the Custody Rule) [1] with respect to such vehicles and accounts.

Under the Custody Rule, registered investment advisers have custody of the assets of each private fund for which they or their affiliates serve as general partner or managing member or where they otherwise act in a “control” capacity.[2]  Such registered investment advisers (or private fund managers) generally comply with the Custody Rule by delivering audited financial statements for the fund to each beneficial owner within 120 days of the end of each fund’s fiscal year.[3]

The Guidance Update clarifies how the audit provision of the Custody Rule applies to private fund managers whose funds utilize SPVs and/or escrow accounts.  Depending on the circumstances, the private fund manager may be required to obtain a separate audit for SPVs and/or escrow accounts utilized by a private fund. 

The Guidance Update provides that a separate audit of a SPV is not required if:

(1) The SPV’s assets are included in the scope of the audited financial statements of one or more private funds advised by the private fund manager; and
(2) The SPV is not owned by any parties other than the private fund manager, the private fund manager’s related persons and private funds advised by the private fund manager.  
 
The Guidance Update clarifies that a separate audit is required for any SPV that does not meet the above requirements. This clarification could potentially be problematic for private fund managers who utilize SPVs such as liquidating trusts for the purposes of segregating their funds’ illiquid assets and making in-kind distributions to funds’ investors once any portion of the SPV is so distributed.

The Guidance Update with respect to escrow accounts is limited to a fairly narrow set of circumstances. With regard to escrow accounts, the Guidance Update states that the Division of Investment Management would not object if an adviser maintains assets owned by a private fund in an escrow account so long as:

(1) The portion of the escrow account owned by the private fund is included in the private fund’s audited financial statements;
(2) The escrow account is for the sale or merger of a portfolio company owned by the private fund;
(3) The amount of money held in the escrow account was negotiated by the buyer and seller of the portfolio company;
(4) The duration of the escrow account was negotiated by the buyer and seller;
(5) The escrow account is maintained at a qualified custodian; and
(6) The sellers’ representative is contractually obligated to promptly distribute the funds remaining in the escrow account at the end of the escrow period on a predetermined formula to the sellers, including the private funds.

If you have any questions or concerns, please contact your regular Drinker Biddle lawyer and we will be happy to assist you.


 

[1] See IM Guidance Update No. 2014-07 (June 2014), available here.

[2] For a more complete history of the Custody Rule and its impact on private fund managers see Joshua Deringer and Andrew Raby, “Custody Rule Developments Affecting Private Funds,” Investment Lawyer, Dec. 2013, available here.

[3] See section 206(4)-2(b)(4) of the Custody rule (often referred to as the “audit provision”).

The Viability of the Equitable Mootness Doctrine in the Third Circuit: A Moot Point?

Client Alert
Marita S. Erbeck

By Marita S. Erbeck and Jennifer M. Roussil In the bankruptcy context, effectively appealing an order confirming a debtor’s plan of reorganization is not always a sure bet, as a court may refuse to entertain the appeal in the name of equitable mootness.  Equitable mootness – “a judge-made abstention doctrine that allows a court to avoid hearing the merits of a bankruptcy appeal because implementing the requested relief would cause havoc”[1] – empowers a ...

What Does the Supreme Court's Same-Sex Marriage Ruling Mean for Employee Benefit Plans?

Client Alert
Summer Conley, Robert L. Jensen, Sarah Bassler Millar

On June 26, 2015, the U.S. Supreme Court ruled in Obergefell v. Hodges that states must license and recognize a marriage between two people of the same sex.

WTO Members Agree to Cut Tariffs on IT Products

Client Alert
Kathleen M. Murphy, Mollie D. Sitkowski

On Friday, July 24, 2015, the World Trade Organization (WTO) announced that more than 50 of its member countries had agreed to cut tariffs on hundreds of information technology (IT) products.

Something Old, Something New: Accounting for Accountable Care in Antitrust Analysis

Health Law Handbook
Robert W. McCann

In this chapter, Rob illustrates the tension between antitrust enforcement and clinical collaboration models under the Affordable Care Act, discusses the St. Luke’s decision, and explores the intersection between health care delivery reform and antitrust law.

Senate Passes Another Criminal Antitrust Anti-Retaliation Act July 30, 2015

Client Alert
Todd N. Hutchison, Paul H. Saint-Antoine, Ronald A. Sarachan, James J. Williamson II

The Senate recently passed with unanimous consent the Criminal Antitrust Anti-Retaliation Act of 2015 (“CAARA”) after minor tweaks to two definitions. CAARA provides anti-retaliation protection to whistleblowers who give information to their employer or the federal government concerning criminal violations of antitrust laws.