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SEC Amends Financial Reporting Rules for Investment Company Business Combination Transactions

On May 20, 2020, the SEC adopted amendments to the financial statement disclosure requirements under Regulation S-X related to acquisitions and dispositions involving investment companies.

First, the amendments streamline applicable significance tests under Regulation S-X to more closely align with significance tests under the Investment Company Act of 1940. Amended Rule 1-02(w)(2) of Regulation S-X creates a separate definition of “significant subsidiary” for investment companies using modified versions of the investment test and income test set forth in Rule 8b-2 under the Investment Company Act, as follows:

  • Investment Test. Under the amended investment test, an acquisition will be significant if the value of a fund’s investment in and advances to the tested subsidiary (i.e., the acquired fund) exceed 10 percent of the value of the fund’s total investments as of the most recently completed fiscal year.
  •  Income Test. Under the amended income test, an acquisition would be significant if the total investment income of the tested subsidiary for the most recently completed pre-acquisition fiscal year is greater than either (1) 80 percent of the total consolidated change in net assets resulting from the acquiring fund’s operations for the most recently completed fiscal year or (2) 10 percent of the total change in net assets resulting from the acquiring fund’s operations for the most recently completed fiscal year, if the investment test condition also exceeds 5 percent. The amended income test includes income from dividends, interest, other income, net realized gains and losses on investments and the net change in unrealized gains and losses on investments.
  •  Asset Test. Pursuant to the amendments, the asset test under Rule 1-02(w) has been eliminated for investment companies.

The amendments also address the financial statements required for acquiring and acquired investment funds, including registered investment companies and private funds relying on Sections 3(c)(1) or 3(c)(7) of the Investment Company Act. New Rule 6-11 of Regulation S-X applies a facts and circumstances evaluation to determine whether a fund acquisition has occurred. This facts and circumstances evaluation uses the significant subsidiary criteria of Rule 1-02(w)(2), as described above, modified to use the investment test at a 20 percent, rather than a 10 percent, significance threshold, and to exclude the 80 percent condition of the income test. If this significance test is met, one year of audited financial statements of an acquired fund would need to be provided. For private funds, the new rule allows financial statements to be filed in accordance with U.S. GAAP.

Additionally, the amendments eliminated the requirement for investment companies to provide pro forma financial statements in connection with business combination transactions. Instead, the amendments require investment companies to provide certain supplemental financial information about the combined fund post-acquisition, including, among other things, (1) a pro forma fee table; (2) a schedule of the acquired fund’s investments along with a related narrative discussion, if the acquisition causes material changes to the acquired fund’s investment portfolio resulting from applicable investment restrictions; and (3) narrative disclosure about material differences between the accounting policies of the acquired fund and those of the combined fund.

Lastly, the amendments modify certain financial disclosure requirements of Form N-14 to align those with the requirements of new Rule 6-11, as described above.

The SEC’s final rule is available here.

© 2020 Vedder PriceNational Law Review, Volume X, Number 189

TRENDING LEGAL ANALYSIS


About this Author

Legal, Business, John Marten, Investment Attorney, Vedder Price Law FIrm
Shareholder

John S. Marten, a Shareholder in the Chicago office of Vedder Price, has substantial experience representing clients in the investment management industry.

As a member of the firm’s Investment Services group, Mr. Marten counsels clients on a wide variety of matters involving the application of the federal securities laws to investment companies, investment advisers and broker-dealers. He has significant experience counseling investment company clients with respect to new products and was recently involved in the creation of two mutual funds...

(312) 609 7753
Nathaniel Segal, Investment Attorney, Vedder Price Law Firm
Associate

Nathaniel Segal is an Associate at Vedder Price and a member of the Investment Services group. He focuses his practice on investment companies and investment advisers in connection with the organization and operation of investment products and services, including traditional mutual funds, closed-end investment companies (including interval funds and listed closed-end funds), variable insurance products and registered hedge funds, as well as mutual funds utilizing complex hedging and absolute return strategies. Mr. Segal has experience in conducting transactional due diligence and drafting regulatory disclosures in connection with fund reorganizations and management acquisitions. He counsels clients on a wide variety of regulatory matters, including interpretive and no-action letter requests and SEC exemptive orders, as well as governance matters and internal compliance procedures in response to SEC examinations and inquiries.

(312) 609 7747
Jacob Tiedt, Vedder Price, investment services attorney
Shareholder

Jacob C. Tiedt is a Shareholder at Vedder Price and a member of the Investment Services group.

Mr. Tiedt’s practice includes the representation of registered mutual funds, closed-end funds and exchange-traded funds; private funds; investment advisers; and other financial institutions on a broad range of regulatory, governance and compliance matters. Mr. Tiedt regularly counsels clients on matters relating to SEC registration, disclosure and compliance; shareholder solicitation; NYSE, Nasdaq and FINRA regulation; corporate governance; and board administration. Mr....

312-609-7697
Tyrique Wilson Investment Attorney Vedder Price Law Firm
Associate

Tyrique J. Wilson is an Associate in the Chicago office of Vedder Price and a member of the firm’s Investment Services group.

Mr. Wilson received his law degree from the Washington University School of Law in St. Louis and his undergraduate degree from The George Washington University. While in law school, Mr. Wilson was Treasurer of the Black Law Students Association, received an award for Excellence in Oral Advocacy and earned a Certificate in Business Law.

312-609-7689