|
|
|
|
|
|
|
REGULATORY CHANGES BRING INCREASED OPPORTUNITY - PLUS A FEW NEW OPERATIONAL WRINKLES
By Christine Egan and Keith Diamond
Kaufman Rossin Fund Services
Private investment funds may now accept greater participation from Benefit Plan Investors, thanks to The Pension Protection Act of 2006 (The Act).
The Act, which amends the Internal Revenue Code and the Employee Retirement Income Security Act of 1974 (ERISA), is designed to bring federal pension laws up-to-date with today's marketplace and economy.
Two significant changes will now allow fund managers to accept investments that previously would have subjected them to ERISA's fiduciary rules. These favorable regulatory changes add complexity to the operations side, requiring both immediate recalculations and ongoing procedural changes to address the challenges within the new rules.
The 25% Rule Remains - with changes
Private investment managers have long been subject to the "significant percentage" determination: if 25% or more of the value of any class of equity interests comes from Benefit Plan Investors, and the class of equity interests has plan money subject to Title I of ERISA, the entire fund is classified as a "plan asset fund," required to comply with ERISA's fiduciary and prohibited transactions rules. Managers sought exemption from the ERISA rules by limiting investment from Benefit Plan Investors.
The rule remains in place, but two major changes will affect Investment Managers, Investors, and service providers. These changes affect the significant percentage determination and should result in funds being able to provide certain Employee Benefit Plan Investors with more capacity in their vehicles.
BPI Redefined
The first change is in the definition of a Benefit Plan Investor (BPI). Government employee plans and non-U.S. employee plans are now excluded from the definition of a BPI, opening the significant opportunity for their investment in private funds without triggering the 25% cap.
Fund of Funds Calculation Change
The second change affecting the 25% test relates to fund of funds. Prior to the Act, 100% of an underlying fund would be deemed "plan assets" if an investing fund of funds has been classified as plan assets. A new "proportionality rule" requires the underlying fund into which a plan asset fund of funds invests to know the percentage of the fund of funds' investment made up of plan assets. Only this percentage will be counted toward the underlying fund's 25% test. For example, an underlying fund with a $10,000,000 fund of funds investment which is made up of 30% BPI, would now only include $3,000,000 as BPI money in it's own 25% calculation instead of the full $10,000,000.
Operational Impact
The first order of business for managers and their service providers is to determine if the BPI status of existing investors has changed as a result of the Act and make re-classifications accordingly. Also, the fund's subscription documents will need to be amended by the fund's counsel to reflect the new definitions and declarations. On an ongoing basis, managers and their outsourced service providers are required to calculate the 25% test immediately after the most recent acquisition or disposition of any equity interest in the entity. This now becomes more complex - at every fund of funds subscription into or redemption from an underlying fund, it is necessary to know the proportion or percentage of the fund of funds' investment which is made up of plan assets.
The challenge for administrators
The "25 test" has been and continues to be a standard procedurefor fund administrators, and these outsourced service providers willneed to accept the added challenges posed by the new rules. The creation of the "proportionality rule" magnifies the same timing concerns that exist in the accounting and valuation of fund of funds. In order to evaluate an underlying fund's plan asset status, the administrator will need to ascertain the percentage of investing fund of funds' assets which are classified as plan assets. Coordinating this dependent information will be a timing challenge, particularly if several fund of funds investors are participating. Underlying funds will need to monitor this closely, "leaving room" for anyadjustments that may occur.
"The impact of these favorable regulatory changes equates to more complexity on the operations side. The complexity stems from the inherent timing challenges with fund of funds," notes Keith Sharkey, Principal of Kaufman Rossin Fund Services, LLC. "Immediately at the time of any capital activity (when the 25% test needs to be calculated), the value of the fund of funds is an estimate and their BPI percentage is not yet known. While these estimates closely approximate the actual values, a cushion or margin should be provided."
As an example, when an underlying fund is contemplating accepting additional plan capital from a fund of funds on subscription date 9/1, the BPI percentage number from the fund of funds is not available and may not be available until the following month. For funds with a number of BPI fund of fund investors which are reporting revised BPI percentages upward, the impact may be that an even larger 'buffer' is required. So whereas in the past funds might have tried to keep their target percentage to 20%, to be conservative certain funds may want to push their target even lower. Similarly to address the administrative burden of tracking month by month changes, fund of funds may be asked to 'round up' to a higher percentage so that they do not have to update the funds they are invested in every month when their percentage goes from 32% to 36%, for example. Instead they would initially report 40% and only update funds when their percentage either goes above 40% or below 30%.
While the new Act allows for more BPI money to be accepted certain plans now excluded and underlying BPI funds will have only a portion of their assets counted) the administrative burden may create larger, more conservative buffers that will have an opposite effect, albeit a lesser one.
Kaufman Rossin Fund Services, LLC is working closely with clients, legal counsel, and internal ERISA proficient professionals to implement these changes and refine best practices.
About Kaufman Rossin Fund Services
Kaufman Rossin Fund Services is a full-service fund administrator. Born out of one of the nation's top CPA firms, KRFS maintains the technical skills and quality control of public accounting, using paperless technology for better communication and data security. Funds worldwide rely on us for startup, accounting and valuation, back-office out-sourcing, investor services, tax services, and corporate services for offshore and onshore funds. We take our clients through the last mile, providing complete financial reporting including K-1s and signed tax returns.
Christine Egan is Business Development Manager and Keith Diamond is Compliance Officer for Kaufman Rossin Fund Services.
|
|
|
|
©2008 Kaufman Rossin Fund Services. Sitemap | Privacy