Because of the investment adviser registration requirements and exempt reporting adviser filing requirements under the Investment Advisers Act 1940 as well as the enhanced reporting required of some private fund advisers to file Form PF, private fund advisers must make a yearly (or sometimes more frequent) calculation of their regulatory assets under management. Essentially this is a total tally of the assets over which the fund adviser provides investment advice, calculated using a method prescribed by the SEC.
When must regulatory assets under management be determined?
There are a number of instances where a fund adviser needs to make this determination:
- ADV Reporting. Private fund advisers that are registered with the SEC or a state securities regulator or which are exempt reporting advisers must file Form ADV. In each case, Form ADV requires that the fund adviser disclose its regulatory assets under management.
- Eligibility for an Exemption. Some fund advisers are exempt from registration with the SEC. Fund advisers that have less than $25 million under management are exempt completely if the fund adviser’s home state provides an exemption. In addition, fund advisers with less than $150 million under management may be exempt from registration with the SEC (though they must still submit Form ADV as an exempt reporting adviser). To make a determination whether a fund adviser qualifies for one of these exemptions, the fund adviser must calculate its regulatory assets under management.
- Division of Responsibility Between Federal or State Regulators. If a fund adviser must register, because it does not qualify for an exemption, there is a division of responsibility between the state securities divisions and the SEC. If a fund adviser has $100 million or less of regulatory assets under management, in most cases, it must register with its state securities division instead of with the SEC. Once again, the calculation of regulatory assets under management is used to make this determination.
- Form PF. Private fund advisers with $150 million or more of assets under management within private funds are required to file Form PF annually, which requires the fund adviser to disclose regulatory assets under management. In addition, certain large fund advisers are required to report quarterly. A determination of regulatory assets under management is used to determining whether a fund adviser qualifies for these requirements.
Therefore, being able to determine regulatory assets under management is important for a variety or reporting and compliance needs.
Calculating Regulatory Assets under Management
First, when counting assets, the fund adviser is required to include all gross assets without any deduction for debt or leverage. Therefore, if a fund has $30 million of assets and $20 million in debt, it is considered to have $30 million in regulatory assets under management, not $10 million.
Second, the fund adviser must also include uncalled capital commitments. This especially affects venture capital funds and private equity funds, who will often require investors to commit a certain amount of capital but not actually contribute cash to the fund until a later date. Therefore, if a fund adviser obtains a commitment from an investor to invest $1 million, and the investor has only actually contributed $200,000, the fund adviser must include the remaining $800,000 in its regulatory assets under management.
Finally, all assets must be valued at their market value or fair value. For assets that are publicly traded securities, this is relatively simple. The fund adviser can use the most recent trade price. But private funds often hold illiquid assets that are difficult to value. How does the fund adviser go about valuing those?
The SEC’s guidance offers a number of suggestions. First, for funds that issue financial statements for their investors that utilize GAAP or some other internationally recognized accounting standard, the values used in those statements can be used for calculating regulatory assets under management. However, there are funds that do not produce GAAP financial reporting (especially those which do not allow investors to enter or leave the fund over its lifespan). For these funds, the process of valuing assets becomes more complex. The SEC has explicitly said in its commentary to the final rule that the requirement for calculating fair value does not mandate a particular procedure nor require the use of a third-party pricing service or appraiser. Rather the fund adviser must act consistently and in good faith. This ambiguity will likely cause fund advisers a great number of headaches in the years to come. It will be crucial for them to adopt standards that are reasonable and consistently applied year in and year out across all illiquid assets and to document all decisions and methodologies used in determining asset values.
Fund advisers should consult an attorney familiar with securities laws in making any difficult determinations. Failure to do so could lead to a fund adviser failing to register when they should have, or reporting inaccurate information, both of which could lead to sanctions from securities regulators.