Securities and Exchange Commission requirements that funds investing in pooled investment vehicles disclose associated fees may unintentionally cover derivatives-based investments and collateralized debt obligations. That would hit them with a raft of onerous book and record keeping.
The rule requires all new registrations and annual update statements after Jan. 2 to disclose the fees. Its aim is to improve transparency of hedge funds of funds and private equity funds. The regulation, however, includes entities issued through an exception to the Companies Act known as 3(c)7. Derivatives-based investments and collateralized debt obligations are often issued through this exception because it allows securities to be sold on a private placement basis to accredited investors without being registered as investment companies.
Under the fee disclosure rules this exception is in effect defunct and funds face the weighty administrative burden of disclosing fees for investment in these securities. Managers are also concerned they may face action from the SEC for failing to disclose the fees of any structured investment products they hold issued through the 3(c)7 exception. This has some officials predicting it could cause a drop off in interest from fund managers in investing in CDOs and structured notes.
The Investment Company Institute sent a memo to members late last month announcing it had verbal confirmation from SEC staff that CDOs and structured products--or any other investments not "traditionally thought of as pooled investment vehicles"--were not included in the fee disclosure rules. But that isn't satisfying everyone. Mara Schreck, assistant counsel at the ICI in Washington, D.C., admits, "This is just a band-aid and is not going to fly over the long term."
The ICI is working with the SEC to compose a workable distinction between investment vehicles and other securities for the purposes of the fee disclosure rules. Schreck, however, said it is going to be a complicated process. For example, there is the possibility a fund may invest in a structured note that references a hedge fund or private equity fund, and it is not obvious how this would be classed for disclosure purposes by the SEC.
