SEC Staff Provides Guidance on Custody Rule Compliance When Private Funds Use SPVs and Escrow Accounts

by Goodwin
Contact

The staff of the SEC’s Division of Investment Management issued IM Guidance Update No. 2014-7 (the “Guidance Update”) to provide guidance on how Rule 206(4)-2 under the Investment Advisers Act of 1940 (the “Custody Rule”) applies when private pooled investment vehicles (“private funds”) use special purpose vehicles (“SPVs”) to own one or more assets or use escrow accounts in connection with the sale of a portfolio company.

Four Scenarios for Special Purpose Vehicles

The Guidance Update elaborates on prior SEC statements regarding the alternatives available to an adviser delivering audited financial statements to private fund investors under the Custody rule (the “Audit Provision”) to either (1) treat an SPV as a separate fund client and comply with the audited financial statement requirements for the SPV separately from the owning private fund or (2) treat an SPV’s assets as assets of the owning private fund and include them within the scope of the owning private fund’s audit.  The Guidance Update addresses the following four scenarios:

  1. Single Purpose Vehicle:  a private fund client of the adviser invests in an SPV that makes a single investment.
  2. Multi-Fund, Single Purpose Vehicle:  two or more of the adviser’s private fund clients invest in an SPV that makes a single investment.
  3. Multi-Purpose Vehicle:  two or more of the adviser’s private fund clients invest in an SPV that makes more than one investment.

In these three scenarios, the staff advised that an audit of a private fund that includes the assets of the SPV will satisfy the Audit Provision as long as the SPV has no owners other than the adviser, the adviser’s related person(s) or private fund clients controlled by the adviser or the adviser’s related person(s).

  1. Investment Fund SPV:  one or more of an adviser’s private clients invest alongside third parties (such as pooled investment vehicles controlled by other advisers or persons that are not the adviser, the adviser’s related person(s) or pooled investment vehicles controlled by the adviser) in an SPV that makes one or more investments (an “Investment Fund SPV”).

In this scenario, the staff advised that the Investment Fund SPV should generally be treated as a separate client for purposes of the Custody Rule, which would mean, among other things, that the adviser would comply separately with the custody rule’s audited financial statement distribution requirements for the Investment Fund SPV.

Escrow Accounts

The staff noted that the sale of a portfolio company held by a private fund may involve the creation of an escrow account to serve certain limited purposes (such as to hold a percentage of sale proceeds for indemnification purposes or to provide for adjustments to the sale price of the portfolio company).  These accounts typically hold money that belongs to the adviser’s private fund client and to other sellers that are not clients of the adviser. In addition, these accounts are typically held in the name of a “seller’s representative” appointed by the sellers to act on their behalf with respect to the escrow.

The staff advised that it would not object if an adviser maintains client funds in an escrow account with other client and non-client assets, provided that: (1) the client is a private fund as to which the adviser relies on the Audit Provision, and the portion of the escrow attributable to the private fund is included in its financial statements; (2) the escrow is in connection with the sale or merger of a portfolio company owned by the client (i.e., for indemnification or to adjust the purchase price); (3) both the amount of money held in escrow and the length of time it is held are agreed upon as part of a bona fide negotiation between the buyer and the sellers; (4) the escrow is maintained at a qualified custodian; and (5) the seller’s representative is contractually obligated to promptly distribute, based on a predetermined formula, the money remaining in escrow at the end of the escrow period to the sellers, including the private fund clients.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Goodwin | Attorney Advertising

Written by:

Goodwin
Contact
more
less

Goodwin on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Privacy Policy (Updated: October 8, 2015):
hide

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.

Security

JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at info@jdsupra.com. In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at: info@jdsupra.com.

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.
Feedback? Tell us what you think of the new jdsupra.com!