Tentative Disclosures about Investments in Another Investment Company Operationality Feedback Summary

Transcription

1 Financial Accounting Standards Board Investment Companies Project Tentative Disclosures about Investments in Another Investment Company Operationality Feedback Summary Introduction 1. In October 2011, the FASB issued proposed Accounting Standards Update, Financial Services Investment Companies (Topic 946): Amendments to the Scope, Measurement, and Disclosure Requirements, which would have required an investment company parent to consolidate an investment company subsidiary in a fund-of-funds structure. The Board reasoned that consolidation would provide transparency into an investee fund s risks and expenses. 2. In light of feedback received, during redeliberations the Board decided not to retain the consolidation requirement in the proposed Update. Instead, to address the Board s concerns about transparency into investee funds, the Board decided that an investment company should provide certain disclosures about its investments in another investment company. At its January 23, 2013 meeting, the Board directed the staff to perform outreach on the operationality of those disclosures. The tentative disclosure requirements discussed in this document are summarized in Appendix A. 3. Board members and staff participated in 15 conference calls with preparers and auditors to obtain feedback about the operationality and auditability of the tentative disclosures for an investment in another investment company. To obtain views from the various aspects of the investment company industry, the participants on the calls included the following stakeholder groups: (a) (b) Accounting firms the Big 4 firms and one smaller firm Industry groups representing both the views of funds regulated under the SEC s Investment Company Act of 1940 (1940 Act) and nonregulated funds 1

2 (c) Asset managers those that manage both funds regulated under the 1940 Act and nonregulated funds (hedge funds, private equity funds, and venture capital funds). 4. The purpose of this document is to provide a summary of significant feedback received on the tentative disclosure requirements and is organized as follows: (a) (b) (c) (d) (e) (f) (g) (h) (i) (j) Overall Comments Confidentiality Decision Usefulness Scope Availability of Information Concerns Raised About Specific Items Required to Be Disclosed Threshold As of Date for the Disclosure Requirements Cost Concerns Other Comments. Overall Comments 5. Many constituents urged the Board to conduct additional outreach before finalizing the tentative disclosure requirements. Some stated that an Exposure Draft for the disclosures would be the most efficient way to obtain the necessary feedback. Furthermore, some of those constituents raised concerns that deliberations on the disclosures could further delay final guidance on the assessment of investment company status. Those constituents urged the Board to discuss issues relevant to the disclosures separate from finalizing the Board s other decisions. 6. Most constituents raised significant operational and audit concerns with the tentative disclosure requirements. Many of those constituents stated that although the information for complying with the disclosures may be available, (a) it may not be received by the 2

3 reporting investment company in a timely manner or (b) the reporting investment company could be restricted by confidentiality agreements from including the information in their financial statements. Many constituents agreed that information about investee funds would provide useful information but questioned the threshold and relevance of specific components of the tentative disclosure requirements. Furthermore, constituents stated that the relevance and usefulness of the disclosure requirements also depends on the structure of the reporting investment company and the investee fund. The details of constituent concerns are provided in the sections below. 7. Two constituents were supportive of the Board s tentative disclosure requirements, stating that they are useful and not overly burdensome. Although not as significant as the concerns described in the paragraph above, these constituents did raise a few operational issues, which are included in the details summarized below. Confidentiality 8. Many constituents cited preexisting confidentiality agreements between the reporting investment company and investee funds as a significant obstacle in complying with the tentative disclosure requirements. Constituents stated that those agreements prohibit the investor fund from disclosing the required information in their financial statements. Some of those constituents were particularly concerned about confidentiality when a 1940 Act fund invests in a private fund because details about the private fund were never intended to be publicly available. Some constituents also stated that the disclosures may create a competitive disadvantage for those reporting under U.S. GAAP because they could be precluded from investing in funds that require confidentiality agreements. Some constituents stated that confidentiality agreements also could prohibit the reporting investment company from obtaining information about investments held by an investee fund. Furthermore, constituents stated that the disclosures would require them to renegotiate confidentiality agreements, if possible, which could be costly. 9. Some constituents recommended that the Board provide a practicability exception when information is not available or when specific items cannot be disclosed because of confidentiality restrictions. Some recommended a practicability exception that 3

4 grandfathers preexisting confidentiality agreements and only requires disclosures for new investments in another investment company. One constituent recommended that the Board expand paragraph to apply to all the disclosure requirements. That paragraph currently applies to the disclosure about investments held by an investee fund and states that if the information about an investee s portfolio is not available, that fact shall be disclosed. However, one industry group challenged any practicability exception, noting that it would be applied mostly by private funds, which is where the transparency is needed most. Decision Usefulness 10. Many asset managers stated that the demand for information about investee funds depends on the type of investor and their level of sophistication. Some stated that investors in alternative fund of funds must be qualified or accredited investors and have an understanding about the structure and nature of the fund s operations. Those investors generally request information about investee funds on a regular and more timely basis outside the financial statements. In contrast, retail investors, pension plans, and endowment funds generally focus on the total return of the investment and rely on the investment manager to perform due diligence when selecting investee funds. Those investors generally do not request information about investee funds. Some asset managers stated that the tentative disclosure requirements would result in disclosure overload and could be confusing for less sophisticated investors. 11. Some constituents stated that the usefulness of the disclosures depends on the type of investment structure or the purpose of the investee fund. Some noted that it is very common for a private equity fund to establish an intermediary investment company. That intermediary investment company invests in portfolio companies and may have significant leverage. However, private equity asset managers view that intermediary investment company as part of managing portfolio companies rather than as an extension of the reporting investment company s activities. For example, the debt held by the intermediary investment company could be to facilitate a portfolio company s operations. Those constituents questioned why the disclosures are relevant for an intermediary 4

5 investment company but not for the investments in portfolio companies. Some private equity asset managers stated that they currently disclose leverage, investments held by the intermediary investment company, and their ownership percentage of the intermediary investment company. 12. Some constituents noted that blocker entities are used for a different purpose by 1940 Act funds in which they are viewed as an extension of the fund Act funds generally consolidate or attach the financial statements for blocker entities that are wholly owned. 13. Some constituents stated that for investments in 1940 Act funds (that is, the investee fund is a public entity), the tentative disclosure requirements would not provide additional useful information. Those constituents stated that the SEC restricts the amount of leverage held by a 1940 Act fund and annual audited financial statements are publicly available on the fund s or the SEC s website. Semiannual financial statements and quarterly portfolio holdings required by the SEC are also publicly available. Those constituents stated that providing a link to where the information is publicly available would be more cost effective and provide the most up-to-date information. In addition, the SEC requires 1940 funds to disclose in the prospectus their proportionate share of expenses of investee funds (that is, a weighted average expense ratio for all investments in other funds). 14. One accounting firm stated that information about investee funds is useful only for controlled funds or in master-feeder structures because of the close relationship between the master fund and feeder fund. 15. Because of the various types of investment company structures, one accounting firm suggested a principles-based approach that considers the purpose of the investee fund to determine whether and what additional disclosures about the investee fund should be included in the financial statements. Scope 16. Several constituents questioned the scope of investments held by an investment company that would be subject to the disclosure requirements. A few constituents stated that certain investments (such as blocker entities, special purpose vehicles, and securitization 5

6 vehicles) may not be investment companies under the revised investment company assessment. Therefore, transparency would not be provided for investments in such entities because the tentative disclosures require information only about investments in another investment company. 17. A few constituents questioned whether the disclosures would be required for investments in another investment company held by the investee fund. That is, they questioned how many levels of funds the disclosures would apply to. Those constituents stated that if the disclosures are only required for the first level (direct investments in investee funds), an intermediary investment company could be established by the reporting investment company to avoid the disclosure requirements. Those constituents suggested that the Board consider an anti-abuse provision to achieve its objective of transparency and to minimize structuring opportunities. 18. An industry group requested that investments in money market funds be exempt from the disclosure requirements because those investments are used to hold cash, may be because of capital transactions rather than investment strategy, and are temporary in nature. Availability of Information 19. Many constituents raised various operational concerns with obtaining the information to comply with the disclosures. Constituents stated that the following could be barriers to gathering the information needed: (a) (b) (c) The investee fund is a private fund or unaffiliated with the reporting investment company and, therefore, the reporting investment company does not have access to the information. The investee fund may not prepare audited financial statements because it is a seed fund, blocker entity, or intermediary fund. The investee fund uses a different basis of accounting such as IFRS, tax basis, etc. Total assets and total liabilities could include different items under a different basis of accounting (for example, because of different offsetting 6

7 guidance). The expense ratio also may not be required under a different basis of accounting. (d) (e) The investment is in a side pocket that invests in illiquid investments. If the side pocket is not a separate class, the financial statements of the investee fund would not disaggregate amounts for the side pocket investments. If the side pocket is a separate class, one asset manager stated that some investee funds only provide information about side pocket class rather than the entire fund. The investee fund provides a statement of net assets and does not provide total assets. 20. Constituents stated that although the items required to be disclosed are components of fair value, they do not specifically perform due diligence or audit total assets, total debt, net assets, and expenses to determine the fair value of their investment in the investee fund. They stated that they focus on the net asset value (NAV) per share for their investment class rather than the overall fair value of the investee fund. Management and auditors typically perform a roll forward of NAV per share from the last audited financial statements received from the investee fund, adjusting for contributions, redemptions, and gains and losses. Management also visits investee fund managers periodically and performs due diligence around the investee s internal controls, particularly their valuation process. Auditors typically also send confirmations to investee fund managers to substantiate NAVs and other amounts disclosed in the reporting investment company s financial statements. 21. One accounting firm stated that the audit procedures for fund of funds are tailored depending on a number of factors such as how the investee reports information to investors on a regular basis, whether the investee has audited financial statements, the types of investments held by the investee, etc. The accounting firm stated they develop their own estimate of fair value if other audit procedures cannot be performed or if the investee fund invests in Level 1 assets (such as an index fund). One asset manager stated that it does obtain and become comfortable with the items required to be disclosed. 7

8 22. Accounting firms stated that additional audit procedures would need to be performed to comply with the disclosure requirements. Those procedures could result in independence issues or principal auditor concerns. Concerns Raised About Specific Items Required to Be Disclosed 23. Aside from general operational concerns described in other sections of this summary, constituents also raised concerns specific to the following items required to be disclosed about an investee fund: (a) (b) (c) Total debt outstanding and leverage Expense ratio Proportionate ownership interest. Total Debt Outstanding and Leverage 24. Most constituents requested a definition of debt outstanding. Constituents questioned whether debt outstanding included derivatives and short sales. Some stated that leverage strategies of hedge funds are typically focused on the use of derivatives. 25. Some constituents questioned the Board s need for transparency about leverage held by an investee fund. Many stated that the fair value of an investment reflects the leverage held by the investee. A few constituents stated that a private equity firm could easily move the debt down to the portfolio company level to avoid disclosure. 26. One asset manager stated that the debt of an investee fund may not be attributable to all limited partners. For example, in private equity, limited partners commit to a certain amount of capital but they may not have provided all the capital upon start up. When a private equity fund identifies a suitable investment, it calls for additional capital. However, to expedite the investment purchase, the fund may draw on a margin account until funds are received from a limited partner. In that scenario, the debt held by the fund is temporary and may only be relevant to the investors of the one limited partner that provided funds. Disclosing the funds drawn from the margin account in the financial 8

9 statements of other limited partners may confuse and mislead investors in those investor funds. 27. To address the Board s concerns about leverage held within an investee fund, one accounting firm suggested that the Board require a brief narrative disclosure about how an investee fund employs leverage to achieve its investment strategy. One other constituent stated that a leverage ratio may provide more useful and comparable information, provided that it is clearly defined. Expense Ratio 28. Some constituents stated the expense ratio disclosure requirement would provide useful information because investors often make investment decisions based on the expense ratio. Those constituents stated that investors currently may not be fully aware of the total fees paid throughout the fund-of-funds structure. However, several constituents stated that the expense ratio is not a factor considered when making investment decisions in the alternative funds industry. Those fund of funds are more focused on the total return of the underlying funds. 29. Many constituents raised operational and audit concerns with disclosing the expense ratio for an investee fund that uses a different basis of accounting because under U.S. GAAP, the expense ratio is calculated based on periodic average net assets. The reporting investment company may not be able to obtain periodic information to comply with the disclosure requirement. Furthermore, a few constituents stated that expense ratios are provided for each class in a fund rather than at an overall fund level. An expense ratio for the overall fund may not be representative of the individual investor s expense ratio because the investor may be receiving a discount or fee waiver Act funds currently provide in their prospectus a weighted average expense ratio for all investments in other funds. However, the prospectus is required to be filed 120 days after year end compared to the 60-day deadline for filing financial statements. Those constituents stated that additional time is required to compile expense ratios for underlying funds that are unaffiliated with the reporting investment company. 9

10 31. Two accounting firms stated that transparency into expenses of investee funds is more important when the investee fund is within the same fund complex or is affiliated with the investment manager. That is to ensure that an asset manager is not charging multiple fees by creating a fund-of-funds structure. Two asset managers of 1940 Act funds stated that they currently disclose in their financial statements an adjusted expense ratio that includes the proportionate share of expenses for affiliated funds. Proportionate Ownership Percentage 32. Some constituents stated that investors are more concerned about the significance of an investment to the reporting investment company s net assets rather than the percentage owned of an investee. For example, a fund could own 80 percent of an investee fund, but the investee may represent only 2 percent of the fund s net assets. Some of those constituents also stated that a fund could own a larger percentage of an investee fund when the investee fund is in its start-up phase or wind-down phase because of the timing of contributions and redemptions. 33. A few constituents questioned how the proportionate ownership percentage would be calculated. An asset manager asked if the calculation would be based on committed capital, profit share, or the capital account balance compared to the net assets of the investee fund. Threshold 34. Almost all constituents stated that the tentative threshold of five percent of the reporting investment company s net assets is too low. Some constituents questioned the Board s reasons for the threshold because it would increase the population of investee funds for which disclosures would be provided compared to the Board s consolidation proposal in its proposed Update. 35. Some suggested raising the threshold to percent of the reporting investment company s net assets. Those constituents stated that the industry views percent of net assets as significant investments and, therefore, disclosures at that level would 10

11 provide more meaningful information. Some constituents noted that a threshold of percent is consistent with other guidance such as significant influence for equity method of accounting investment and SEC rules for attachment of financial statements. Those constituents also noted that a higher threshold would reduce the population of funds that would require disclosure, resulting in reduced costs for complying with the requirement. Two constituents suggested raising the threshold to 10 percent of the reporting investment company s net assets as a middle ground. 36. Some constituents stated it is common for a private fund to invest in another fund that represents percent of their net assets. A nondiversified 1940 Act fund also may have investments that represent percent of its net assets. Some constituents stated that the significance of an investment to a reporting investment company s net assets may be a result of the fund s investment strategy. For example, if a fund s strategy is to invest a portion of its net assets in emerging markets, a limited number of investee funds may be available in the marketplace in that category. Also, an investment may be significant to an investment company s net assets during the start-up phase or wind-down phase because the investment company is not fully invested during those phases. Some constituents stated that these phases could last up to three years. 37. One asset manager agreed with the 5-percent threshold because it is consistent with the guidance for the schedule of investments. Moreover, that asset manager stated that when determining whether the threshold has been met, the reporting investment company should: (a) (b) Combine both debt and equity investments in one issuer because of the exposure to the same credit risk Aggregate investments in one company that are held through different funds 38. A few constituents suggested a two part threshold based on (a) the significance of the investee fund to the reporting investment company s net assets and (b) the proportionate ownership percentage in the investee fund. Under a 2-part threshold, part (a) could remain at 5 percent of net assets with part (b) based on 20 percent ownership (significant influence) or 50 percent ownership (control). Those constituents stated that the second part of the threshold would mitigate concerns about access to information and 11

12 confidentiality because the reporting investment company would have more power to obtain the information to comply with the disclosure requirements. As of Date for the Disclosure Requirements 39. The Board tentatively decided that the disclosures should be provided as of the investee fund s most recently audited financial statements, including a disclosure of that date. The Board and staff obtained feedback about the operationality of providing disclosures as of both the investee fund s most recently audited financial statements and as of the reporting investment company s reporting date. Overall, less operational concerns were raised when providing the disclosures as of the most recently audited financial statements. However, constituents stated that the disclosures would be more useful and timely as of the reporting date. As of the Most Recently Audited Financial Statements 40. The most significant issue raised about providing the disclosures as of the most recently audited financial statements was that the information provided could be up to 18 months old depending on the year end of the investee fund and when the investee fund issues audited financial statements. Many constituents stated the disclosures would not provide meaningful information if that information is stale because the items required to be disclosed could fluctuate significantly from month to month. Additionally, many stated that the information would not be comparable across investee funds because the amounts could be as of different year ends. 41. A few constituents also noted that the reporting investment company may not have invested in the investee as of its most recently audited financial statements. In that scenario, the reporting investment company may not receive audited financial statements or, if they do receive the financial statements, the information would not be relevant. 42. Constituents expressed the following additional concerns or questions when providing the disclosures as of the most recently audited financial statements of the investee fund: 12

13 (a) (b) (c) (d) Constituents noted that subsequent events may cause the information from the most recently audited financial statements to no longer be representative. Several questioned how to account for and audit subsequent events. Several auditors noted that an investee fund s financial statements could have qualified opinions, and raised concerns about disclosing such information in the reporting investment company s financial statements. A few constituents stated that although the investee fund s financial statements are audited, the auditors may still need to perform additional audit procedures to opine on the amounts disclosed. In determining whether an investment meets the 5 percent of net assets threshold, a few constituents questioned whether the threshold is based on the significance of the investment at the reporting date or as of the investee fund s most recently audited financial statements. Constituents stated that there would be a disconnect between the amounts disclosed and the threshold for both the schedule of investments and the disclosure requirements. As of the Reporting Investment Company s Reporting Date 43. Many constituents stated that providing the disclosures as of the reporting investment company s reporting date would be more decision useful and aligned with other reporting requirements, such as the schedule of investments. However, constituents stated that it would be more operationally complex to provide the disclosures as of the reporting investment company s year end. 44. Constituents raised concerns with gathering the necessary information in a timely manner, particularly when the investee fund is unaffiliated with the reporting investment company. Also, if the investee fund and the reporting investment company have the same year end, constituents questioned whether the reporting investment company must wait for the investee fund to issue its financial statements before it issues its financial statements. Those constituents noted that waiting for the investee fund s current-year-auditedfinancial statements could result in a significant delay and may risk meeting filing deadlines. 13

14 45. Many constituents stated that auditors would need to perform additional procedures to roll forward the information as of the investee fund s most recently audited financial statements to the reporting investment company s reporting date. That could include additional internal controls testing. Constituents stated that the extent of the additional audit procedures depends upon the structure and strategy of the investee fund and the length of time between the investee s most recent year end and reporting investment company s reporting date. Cost Concerns 46. One asset manager stated that the disclosure requirements were not overly burdensome and would not result in significant costs. However, many other constituents stated that investment companies could incur significant costs to comply with the disclosure requirements. Some of those costs are one-time implementation costs while others are recurring costs for reporting the information. One-time implementation costs included updating current systems, creating processes to gather the data and test controls, and renegotiation of confidentiality agreements. Recurring costs included periodic costs for gathering and preparing the disclosures, additional audit procedures, and administrative costs such as printing and mailing. Asset managers noted that investors would ultimately bear these costs. Other Comments Additional Items to Disclose 47. A few constituents suggested that the Board consider the following additional items to be disclosed when an investment company invests in another investment company: (a) (b) (c) Total return many constituents stated that investors are most interested in total return when investing in an investment company. Portfolio turnover. Performance allocation or fee. 14

15 (d) Total commitments rather than total assets an asset manager stated that for private equity funds the more relevant information is total commitments rather than total assets. Required Supplementary Information 48. Some constituents suggested that the Board include the disclosures as part of required supplementary information rather than part of the basic financial statements. The AICPA s Statement on Auditing Standards AU Section 558, Required Supplementary Information, also adopted as a PCAOB interim standard, addresses an auditor's responsibility regarding information that a designated accounting standard setter requires as supplementary to an entity's basic financial statements. AU 558 reduces the level of responsibility placed on an external auditor. Auditors are required to perform certain limited procedures and report deficiencies in, or the omission of, information. Auditors would generally inquire of management about its procedures for gathering the information and obtain management representations for the disclosures. However, one constituent stated it may be difficult to obtain management representations because the reporting investment company is not responsible for the operations of the investee fund. Master-Feeder Structures 49. One accounting firm suggested that the Board define master funds and feeder funds. That accounting firm suggested that a feeder fund attach the master fund s financials if the master fund represents 25 percent or more of the feeder fund s net assets. If the master fund represents less than 25 percent of the feeder fund s net assets, the feeder fund should provide the Board s tentative disclosures in its financial statements if the master fund s financial statements are not available. That accounting firm also raised concerns with the Board s tentative requirement to attach the master fund s financial statements along with a feeder fund s financial statements when the feeder fund and master fund are not affiliated. 15

16 Appendix A A1. This appendix summarizes the Board s tentative decisions regarding disclosures about investments in another investment company. Disclosures about Investments in Another Investment Company A2. An investment company would be required to disclose the following about its investments in another investment company (investee fund) whose fair values exceed 5 percent of the reporting investment company s net assets at the reporting date: (a) A description of the investee fund (name and category) consistent with the requirements for the schedule of investments (b) The percentage of the reporting investment company s net assets invested in the investee fund (c) The total assets of the investee fund (d) The total debt outstanding of the investee fund (e) The net assets of the investee fund (f) The expense ratio of the investee fund (g) The proportionate ownership interest in the investee fund. A3. The items required to be disclosed above should be as of the investee fund s most recently audited financial statements, including a disclosure of that date. Investments Held by an Investee Fund A4. All investments companies (regulated and nonregulated) also would be required to disclose the name and category (consistent with the requirements for the schedule of investments) of each investment owned by an investee fund whose fair value exceeds 5 percent of the reporting investment company s net assets at the reporting date. 16

17 Attaching Investee Fund Financial Statements to Satisfy the Disclosure Requirements A5. In a master-feeder structure, a feeder fund would be required to attach the master fund s financial statements along with its financial statements, which would satisfy the disclosure requirements. For structures that are not master-feeder structures, an investment company would be permitted to attach the investee fund s financial statements along with its financial statements to satisfy the disclosure requirements. 17