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News May 2, 2011 Issue

New Custody Rule FAQ Gives Certain Private Fund Advisers A Break

New Custody Rule FAQ Gives Certain Private Fund Advisers A Break

Advisers to pooled investment vehicles often use the custody rule’s "audit provision" to avoid the need for periodic client statementing and surprise audits of the pool’s assets. The audit provision excepts advisers from these requirements provided the pool is audited annually and the financial statements are distributed to investors within certain periods of time.

Pools generally have 120 days after the end of their fiscal year to deliver financial statements. If the pool is a fund of funds, it has 180 days after the end of its fiscal year to deliver financial statements to allow for receipt and processing of the underlying funds’ audited financial statements.

What if the pool is not a fund of funds, but invests a portion of its assets in one or more funds of funds?

A year ago, the SEC released custody rule FAQ VI.8 that said pools investing ten percent or more of their assets in affiliated funds of funds may also take up to 180 days to deliver financial statements to investors. Pools investing ten percent or more of their assets in unrelated funds of funds, however, were not addressed.

Last month, the SEC provided guidance to those pools investing in unrelated funds of funds. New FAQ VI.8B states that a pooled investment vehicle investing ten percent or more of its total assets in one or more unrelated funds of funds will have an additional 80 days after the fund of funds delivery deadline, or 260 days after the end of its fiscal year, to deliver audited financial statements to investors.

The FAQ for these "top tier" pooled investment vehicles notes that the relief follows certain guidance given in an August 2006 letter to the American Bar Association regarding the treatment of pooled investment vehicles. Specifically, ‘unrelated’ means that the fund of funds investment is not a related person of the top tier pool, its general partner, or its adviser. Nor is the fund of funds advised by a related person of the top tier pool, its general partner, or its adviser.

"An audit of the top tier pool cannot be completed prior to the completion of the audits of the funds of funds in which it invests, whose advisers have up to 180 days after the end of their fiscal year to distribute audited financial statements," says the FAQ. As a result, the staff of the Division of Investment Management allowed additional time for the completion and delivery of financial statements to these top tier pool investors.