Financial Statement Presentation of Regulated Investment Company's Investment in Other Investment Companies

Posted by Investment Management Group on Nov 8, 2011 10:51:00 AM

There are different scenarios in which an investment company invests in another investment company (registered or unregistered)— master-feeder fund structures; funds of funds; investment companies that happen to be invested in another fund but aren’t necessarily funds of funds. Within each of these scenarios, a fund must consider the appropriate financial statement presentation relating to these investments considering the significance of the investment.

With master-feeder fund structures, management of the feeder funds are required to present the master fund’s financial statements as part of their financial statement package, as it is often the sole investment of the feeder fund.

With a fund of funds structure or a fund that may be invested in an investment company, there is no set requirement identified under Regulation SX or within the FASB Codification that mandates the presentation of an underlying fund’s financial statements with those of the fund of funds or fund. However, according to Rule 3-09 of Regulation SX, if there is a significant subsidiary then the company must include the audited financials. The basic definition of a subsidiary is an investment by a company whereby that company has control, directly or indirectly, of that investment entity. Significant is any investment greater than 10% of the company’s total assets, i.e. 10%. Most investments in investment companies outside a fund of funds structure are not in a controlling interest regardless of the size of that investment.

The FASB Codification Topic-Section 946-210-45-7 states that “fund management shall consider if an investment in a single underlying fund is so significant to the fund of funds as to make the presentation of financial statements in a manner similar to a master-feeder fund more appropriate.”

If consideration is given, then the question that arises is what is “so significant” and how is it determined? Rule 3-09 of Regulation SX defines significant as disclosed above. However, FASB Codification does not define what is significant. During the recent ICI Tax & Accounting Conference in September 2011, an SEC Chief Accountant for the Division of Investment Management mentioned this disclosure requirement on 25% positions in non-registered investment companies. A question was asked regarding the applicability of this disclosure requirement to registered investment companies. The response was that the SEC would be satisfied if there is, at a minimum, disclosure within the financial statements that references the location (SEC Web site) of the underlying regulated investment company’s financial statements.

Without a consistent definition of what is significant and with the FASB Codification stating that only consideration shall be given, our clients’ consideration of this issue has resulted in the following solutions:

  • Maintain investments in an underlying fund below the 25% threshold
  • Disclose in the Notes to Financial Statements of the underlying investment in investment companies
  • Inclusion of the underlying fund’s financial statements in the unaudited section of the their financial statements
  • Disclose in the unaudited section of the financial statements to the reference that the financial statements of the underlying fund are available on the SEC’s website.

As a result of the recent discussion and information received by the SEC Chief Accountant at the ICI Tax & Accounting Conference, we will recommend to our clients that face this situation to disclose the location of the underlying investment company’s financial statements only.

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