The Chief Accountant’s Office of the SEC’s Division of Investment Management issued an IM Guidance Update in October regarding the presentation of consolidated financial statements for master-feeder funds, funds-of-funds and business development companies (“BDCs”) under Regulation S-X, which governs the form and content of financial statements filed pursuant to the Securities Act of 1933, as amended (the “Securities Act”), and the 1940 Act.

Regulation S-X, in relevant part, provides that “[t]here is a presumption that consolidated statements are more meaningful than separate statements and that they are usually necessary for a fair presentation when one entity directly or indirectly has a controlling financial interest in another entity.” In this regard, the Staff commented that an investment company that is a feeder fund in a master-feeder structure or an investment company that is a fund-of-funds in the same group of investment companies may have “a controlling financial interest in another entity” for purposes of Regulation S-X, which would generally require consolidated financial statements. The Staff noted, however, that, subject to certain qualifications, the most meaningful financial presentation for these investment companies is generally unconsolidated. Because a feeder fund is one of several investors in a master fund, the Staff stated that unconsolidated disclosure provides a meaningful and appropriately transparent presentation of the financial position and results of operations of the feeder fund. According to the Guidance, instead of consolidating financial statements, a feeder fund should attach the financial statements of the master fund to its financial statements. Additionally, because a fund-of-funds invests in multiple underlying funds with varying levels of interest over time, consolidated financial statements may not be meaningful and may be confusing to the fund-of-funds’ investors. A fund-of-funds, however, should consider whether its investment in an underlying fund is so significant that it should present its financials in a manner similar to a master-feeder fund.

The Staff also commented that it has observed a number of BDCs that have wholly-owned subsidiaries designed to act as an extension of the BDC’s investment operations and to facilitate the execution of the BDC’s investment strategy that do not consolidate such subsidiary’s financial statements with the BDC’s. The Staff commented that a BDC should generally consolidate its financial statements with such subsidiaries to provide investors with the most meaningful financial presentation. Additionally, in the Staff’s view, a registered investment company in similar circumstances should consolidate its financial statements with those of any wholly-owned subsidiaries (e.g., a wholly-owned subsidiary used as a “tax blocker”).