The hot regulatory topic now – Rule 206(4)-2. The SEC issued yet another round of guidance last month.1 In its latest interpretation of the Rule for private fund advisers, the SEC provides valuable feedback to the private fund industry regarding two topics: (1) the use of Special Purpose Vehicles (SPVs) and (2) PE escrow accounts. The purpose of the guidance is to address industry concerns on how to treat SPVs and escrow accounts under the Custody Rule.
The SPV guidance relates to the audit exemption under Rule 206(4)-2(c). The new guidance provides relief to advisers that utilize various types of SPVs for special investment purposes. Specifically, the SEC will now allow private fund advisers (and their related persons) to treat certain SPVs as assets of the pooled investment vehicle for purposes of the audit provision, as long as certain conditions are met:
- The SPV must be a “single purpose vehicle,” a “multi-fund single purpose vehicle” or a “multi-purpose vehicle” in which the assets of the SPV are considered part of the pooled investment vehicle’s assets and included on the pooled investment vehicle’s financial statement audits.
- The owners of the SPV are the adviser, the adviser’s related persons or the pooled investment vehicle that is controlled by the adviser and/or its related persons.
- An Investment Fund that includes unrelated third party owners does not meet the definition of a SPV that qualifies for the relief and therefore, must have a separate audit of its financial statements delivered to its investors.
The relief provided for escrow accounts is specific to private equity advisers under Rule 206(4)- 2(a)(1) and allows for the commingling of client and non-client assets in a single escrow account under certain conditions:
- Client must be a pooled investment vehicle that relies upon the audit provision and the client portion of the escrow account is included in its financial statements.
- Escrow account is specifically for the sale or merger of a portfolio company holding of the client.
- Escrow account funds are equal to an agreed upon amount between the buyer and seller (of the portfolio company), as negotiated.
- Escrow account is temporary and exists only as long as agreed to by the buyer and seller.
- Escrow account is maintained at a qualified custodian (bank or broker-dealer).
- Seller is contractually obligated to distribute all monies (based upon a formula) in escrow to the sellers (including the pooled investment vehicle clients) upon expiration of escrow.
