On June 28, 2016, the Securities and Exchange Commission (SEC) proposed a rule that would require all SEC-registered investment advisers to adopt and implement written business continuity and transition plans to address operational risks related to significant disruptions.

The proposal seeks to address an investment adviser’s fundamental operational risks that are caused by internal and external business continuity events. Such risks could impact the ability of an adviser to continue operations, provide services to his or her clients, and potentially transition the management of accounts to another advisor. It is the SEC’s view that “as part of their fiduciary duty, advisers are obligated to take steps to protect client interests from being placed at risk as a result of the adviser’s inability to provide advisory services.” While many advisers have already taken steps to address and mitigate the risks of business disruptions, the SEC seeks to enhance this process with this proposal.

Under the proposed rule, the written business continuity and transition plans would, at a minimum, include policies and procedures concerning the following:

• Maintenance of critical operations and systems, and the protection, backup, and recovery of data;
• Pre-arranged alternate physical location(s) of the adviser’s office(s) and/or employees;
• Communications with clients, employees, service providers, and regulators;
• Identification and assessment of third-party services critical to the operation of the adviser; and
• Plan of transition that accounts for the possible winding down of the adviser’s business, or the transition of the adviser’s business to others in the event the adviser is unable to continue providing advisory service.

While the plans should meet this established criteria, advisers would be permitted to tailor the details of their plans based on the risks associated with their particular business model, including size, technological infrastructure, nature, and complexity of operations.

SEC-registered investment advisers would also be required to retain copies of plans that are in effect or were in effect for the past five years while also implementing an annual review on the adequacy and effectiveness of their plans. During this time, they would be expected to consider any changes to the adviser’s strategic, operational, and regulatory environment that might suggest a need to revise the plan. A formal record documenting this review would also need to be maintained.

The proposed rule is still in the review period and is open for public comment. Overall, the SEC is seeking input on various aspects of the proposal, such as scope, clarification, cost, and benefit of implementation.

Some specific topics that the SEC is looking for feedback on are as follows:

• Instead of all SEC-registered advisers, should the SEC identify only a subset of SEC-registered advisers that must implement such plans? If so, which advisers should be in such a subset and why?
• Should all applicable advisers be required to include each of the proposed components in a business continuity and transition plan, or should certain advisers be exempt from including certain components? If so, why?
• Will the proposed rule have any other implications for investment advisers that are also subject to other regulatory requirements regarding business continuity and/or transition planning (e.g., FINRA or CFTC rules)?

Comments are due by September 6, 2016.

We would be pleased to provide further information related to this subject. Contact us at 215.441.4600 with questions or for more information.

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In the first quarter of 2015, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No 2015-02, Consolidation (Topic 810) – Amendments to the Consolidation Analysis. This ASU was issued to respond to concerns surrounding the current generally accepted accounting principles (GAAP) that may require a general partner to consolidate an investment fund in which the general partner has little equity, but directs the activities of the fund on behalf of the limited partners. Financial statement users felt that deconsolidated statements were needed to better analyze a reporting entity’s economic and operational results, and this ASU was adopted in response to these concerns.

Overall, the amendments in the ASU are considered an improvement because they simplify existing GAAP and provide more meaningful information to the financial statement users, specifically:

• The number of consolidation models will be reduced through the elimination of a prior statement (the indefinite deferral of 167)
• More emphasis will be placed on risk of loss when determining a controlling financial interest
• There will no longer be a sole focus to consolidate due to a fee arrangement with another entity
• Should result in fewer consolidations of limited partners, making general partner financial statements more meaningful to the users

As a reminder, the criteria to consolidate under the new consolidation model are focused on the Variable Interest Entity (VIE) model, or the Voting model. Under this model, entities must consider:

• Whether there is a variable interest, or whether the value of an ownership interest, a contract, or other relationship changes as the fair value of the related asset changes. Specifically, consider fee arrangements where there are management and incentive fees that change as the underlying net assets of a fund change. The fee contract is considered a variable interest, unless exempted, as noted below.
• Whether there is a VIE that focuses on the kick-out rights of the limited partners. Where a simple majority of limited partners have kick out rights, consolidation is not required.
• Identification of the primary beneficiary includes the power to direct the VIE, and the obligation to absorb losses and receive benefits of the VIE that could potentially be significant to the VIE. The new consolidation model exempts fees received from the VIE if those fees are commensurate with the level of effort required to provide those services, and the contract for those fees includes only terms that are normally found in arrangements for similar services. This change will often result in the analysis for primary beneficiary being entirely based on the equity investment by the GP in the limited partnership.

In regards to the Voting model for consolidation, the ASU eliminates the presumption that a general partner controls a limited partnership, and a general partner will not consolidate a partnership based on the voting model.

The new consolidation model will be applied to public entities for fiscal years beginning after December 15, 2015, and for all other entities, for fiscal years beginning after December 15, 2016. Early adoption is permitted, and the effect of adoption is reflected as a cumulative-effect adjustment to beginning equity in the year of adoption.

While it is anticipated that the changes to the FASB consolidation model will result in fewer consolidations, entities will be required to re-evaluate their consolidation considerations. With the effective dates drawing closer, entities may want to consider preparing for the changes that will be required to their accounting policies and documentation surrounding their consolidation considerations and conclusions. Entities may wish to begin considering the following:

• Determining the population of entities that require consideration: The revised consolidation model applies to all legal entities, and there are specific examples in the ASU regarding series funds / trusts that will likely result in each series being evaluated.
• Reviewing the rights of the limited partners: Under the new consolidation model, the rights of the limited partners (specifically kick-out rights) are an important factor in determining whether an entity should be consolidated. Those entities where limited partners have substantive kick-out rights would not be required to consolidate.
• Revisiting fee arrangements: As noted above, fee arrangements can represent variable interests, and analysis of whether these fees are normally found in arrangement for similar services is required in order to exclude these fee arrangements from the consolidation analysis.
• Revising accounting policies and related supporting documentation regarding consolidation under the new consolidation model.

Evaluating and planning for these items now should help reduce the burden on accounting departments and eliminate surprises in the year of adoption.

We will be happy to provide further information relating to this subject. For more information, contact Frank L. Varanavage at fvaranavage@kmco.com or 215.441.4600.

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