“Bill Kouser, a partner at the Philadelphia firm BBD, LLP, says hedge fund advisors need to address a number of tax issues as well.

For instance, managers have to ensure that the conversion from the hedge fund format to the mutual fund format is accomplished via a tax-free transaction, so that the former limited partners of the hedge fund are not taxed on their share of the unrealized appreciation tied to the hedge fund’s investment portfolio.

This means meeting certain technical requirements in the tax regulations for a tax-free transfer.  This could involve either getting a letter ruling from the IRS, an expensive and lengthy process, or getting a tax opinion from a fund attorney, which is less expensive but can be less iron-clad.”

The full column is available to “Money Management Executive” subscribers on the publication’s Web site.

“Bill Kouser, a partner at the Philadelphia firm BBD, LLP, says hedge fund advisors need to address a number of tax issues as well.

For instance, managers have to ensure that the conversion from the hedge fund format to the mutual fund format is accomplished via a tax-free transaction, so that the former limited partners of the hedge fund are not taxed on their share of the unrealized appreciation tied to the hedge fund’s investment portfolio.

This means meeting certain technical requirements in the tax regulations for a tax-free transfer.  This could involve either getting a letter ruling from the IRS, an expensive and lengthy process, or getting a tax opinion from a fund attorney, which is less expensive but can be less iron-clad.”

The full column is available to “Money Management Executive” subscribers on the publication’s Web site.

The video replay is available on the Gemini Fund Services Web site.

The video replay is available on the Gemini Fund Services Web site.

The trip to Kentucky is the fourth-annual week of service sponsored by the firm and now is an established BBD tradition. Mike Boyle, the firm’s managing partner, established the idea of a week of service at BBD in 2009 and has been the champion of the trip each year.

“We have been very fortunate at BBD,” said managing partnerMike Boyle.  “Because we have been so fortunate, it is our responsibility to reach out where help is needed, not just with monetary support but also with our hands and hearts.”

This year, BBD will work with the Low-Income Housing Coalition of East Kentucky, Inc.  Eastern Kentucky is an area of great need— seven counties in Eastern Kentucky are part of the U.S. Census Bureau’s list of the 50 poorest counties in the country.

Planning to attend the ICI’s 2012 General Membership Meeting?  Don’t miss BBD in Booth 708!

Despite the regulator’s focus on the Dodd-Frank Act’s new and pending regulations, I have not seen the SEC deemphasizing SOX.  I believe that complying with 38a-1, SOX and new regulations does present a strain for small and midsize firms.  One of the ways that small firms can combat this is to launch their fund via a shared trust.  Under this model, funds from different advisors operate as separate series of the same trust.  This allows them to share certain overhead costs, such as compliance.  We have seen this model grow in popularity in recent years.

The full column is available to “Ignites” subscribers on the publication’s Web site.

Recently the Securities and Exchange Commission (“SEC”) has been conducting “information gathering” with respect to how management understands the process behind the prices.  This information gathering has not been isolated to just the mutual fund world but rather has included all entities within the public company universe.  With respect to mutual funds, the information is being sought as part of the financial statement review conducted by the SEC every three years under regulations defined by Sarbanes-Oxley.  Below are some of the questions being asked of management.  These questions and apparently the SEC’s concern and focus primarily relate to Level 2 pricing, which requires the use of observable inputs.

• What are the vendor controls over their pricing process?
• Has management reviewed those controls and have they documented their understanding?
• Does the vendor have a SAS 70 or more recently a SSAE 16 document?
• Are there any exceptions detailed in the SAS 70 or SSAE 16, and if so what has management done to satisfy themselves that such exceptions do not impact their fund(s) pricing?
• Does management drill down into the data and understand the inputs being used?
• Are such inputs consistent with developing prices which meet GAAP standards?
• What does management do to gain comfort with the accuracy of the prices supplied? 
• Are there price tolerance and change parameters in place? 
• Is there a price challenge mechanism available to fund management? 
• What are the internal controls surrounding the price challenge mechanism? 
• What have been the results of price challenges and is there back testing in place to support the results of the price challenges?

Although the SEC has not stated the objective of this information gathering, it is clear that they consider it a necessity for public registrants to have effective internal control procedures and processes surrounding the independent third party pricing agent.  The pricing agent will be the first to tell their clients that they are only the initial step in the pricing process.  Management maintains all responsibility with respect to the accuracy and classification of prices received.  If management feels that they properly address the questions being posed, then they are probably in good stead.  Management that has always relied on the third party pricing agent and that has given little thought to how these prices are developed should reassess pricing policy overview. 

Additionally, if not already being done, it would be prudent to educate the Funds’ Board of Directors on pricing methodology.  This education should include a presentation by the third party pricing agent, as well as management’s presentation on the internal processes and procedures surrounding the pricing vendor.

With a fund merger, two or more funds consolidate into one surviving entity. While the legal survivor and the accounting survivor are often the same entity, there are situations based on the below criteria where they differ. The accounting survivor should be based on consistency with the pre-merger entity of the following:

• Portfolio management
• Portfolio composition
• Investment policies, objective, and restrictions
• Expense structures and ratios
• Asset size

Shares of the surviving fund are typically exchanged for all the shares of the acquired fund at an exchange ratio that usually reflects the surviving fund’s net asset value per share divided by the net asset value per share of the fund being acquired. This serves to maintain a consistent value of the investment for the shareholder, while reflecting the true dilutive effect of the combined entity. Since each fund’s assets are at fair market value, there should not be any significant adjustments once merged, however to the extent that the funds taking part in the merger have different valuation policies, adjustments may be necessary to get value in line.

As one would expect, there are certain expenses related to a merger including legal costs, auditor fees, proxy solicitation, mailing costs, etc. The responsibility for these costs is usually addressed in the plan of reorganization, but are often paid by the fund incurring the expense. Certain advisors also absorb the costs of the merger. There are also transactional costs which result from the advisor re-aligning the portfolio post-merger. These expenses are accounted for in the period in which they are incurred.

Due to tax requirements, the acquired fund must ensure that all distributable earnings have been distributed prior to the merger, ensuring that the fund qualifies as a regulated investment company. The surviving fund may also decide to make a pre-merger distribution, although not required, for purposes of avoiding the dilutive effect of distributions to the combined entity’s shareholders reflective of pre-merger earnings.

A Form N-14 filing is required as part of any fund merger. Form N-14 is a proxy statement soliciting a vote from the acquired fund’s shareholders to approve the transaction. It is also a prospectus because it registers the surviving fund’s shares to be issued as part of the transaction. Pro-forma financial statements are usually included in this filing meant to show the potential effects of the merger. Pro-forma expenses are also presented to show the impact the merger will have on fund expenses highlighting one of management’s likely considerations in going through with the merger, that of gained cost efficiencies.

The above was meant to skim the surface of some of the significant operational issues that can be faced when going through with a merger. Please contact BBD with further concerns/considerations.

The RIC Modernization Act of 2010 raised the excise capital gains distribution requirement from 98% to 98.2% for calendar years beginning after the date of the enactment. For excise period 2011, the regulations weren’t clear regarding when the new capital gains distributions requirement will apply, since the capital gains measurement timeframe for the 2011 excise period starts on November 1, 2010, which is before the date of the enactment. As of the end of February 2012, Form 8613 has not yet been updated to reflect the new capital gains requirement.  Although we have heard that the IRS intends to revise Form 8613, we do not expect it to be ready if you file 2011 forms by March 15.  Until that form is released, we suggest that you cross out 98% on line 2b on Form 8613 and insert 98.2%.

The unrevised form also does not provide for the new elective deferral of late year ordinary losses.  We recommend taxpayers who made such an election for 2011, and intend to use the unrevised form, to attach a statement to their tax return with respect to the election made.