SEC Guidance on Consolidating Investment Company Financial Statements

Investment Management Update

Date: November 13, 2014

In October 2014, the Chief Accountant’s Office of the SEC’s Division of Investment Management issued a Guidance Update regarding the presentation of consolidated financial statements for registered investment companies that are feeder funds, funds of funds or business development companies.

Investment companies present their financial statements in accordance with the provisions of Regulation S-X, which provides for the presumptions that consolidated financial statements are more meaningful than separate statements and are necessary for a fair presentation when one investment company directly or indirectly has a controlling financial interest in another entity.

Feeder Funds

The SEC staff noted that feeder funds may have a controlling financial interest in certain master funds for the purposes of financial reporting under Regulation S-X. In such instances, however, the staff’s position has been that unconsolidated financial statements may be more meaningful when, among other things:

  • The feeder fund attaches the master fund’s financial statements to its financial statements
  • The feeder fund separately discloses on its statement of operations the net investment income, net realized gain or loss, and net change in unrealized gain or loss allocated from the master fund if the master fund is organized as a partnership
  • The feeder fund includes the net investment income and expenses allocated from the master fund in its net investment income and expense ratios in its financial highlights if the master fund is organized as a partnership

It is the staff’s view that such unconsolidated disclosure is more appropriate because the feeder fund is usually one of several investors in the master fund. The staff does encourage feeder funds to consult with the staff on whether consolidated financial statements would be more meaningful in instances where the master fund is wholly owned by the feeder fund.

Funds of Funds

The staff also has taken the position that unconsolidated financial statements are generally the more meaningful disclosure for funds of funds. A typical fund of funds invests in several underlying funds, and whether its level of ownership in any one fund can be considered a controlling financial interest may change from time to time. Accordingly, the staff has stated that unconsolidated financial statements may be more appropriate, noting that a fund of funds should consider whether its investment in any one underlying fund is so significant that its financial statements should be presented in a manner similar to a master-feeder fund.

Business Development Companies

After reviewing business development companies’ financial statements, the staff noted a number of the companies did not consolidate their wholly owned subsidiaries’ financial statements, even though such subsidiaries are an extension of the business development company’s investment operations and strategy. In such instances, the staff suggests that the subsidiaries’ financial statements be consolidated with the parent business development company’s financial statements.

FOR MORE INFORMATION

For more information, please contact:

Andrew J. Davalla
614.469.3353
Andrew.Davalla@ThompsonHine.com

Michael V. Wible
614.469.3297
Michael.Wible@ThompsonHine.com

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