On October 31, 2014, the SEC’s Division of Investment Management issued a Guidance Update1 concerning the consolidation of financial statements filed by certain investment companies (“RICs”) registered under the Investment Company Act of 1940 (the “1940 Act”) and investment companies that have elected to be treated as business development companies (“BDCs”) under the 1940 Act that have wholly owned subsidiaries.

Regulation S-X governs the requirements of financial statements filed by RICs and BDCs pursuant to, among other statutes, the 1940 Act and the Securities Act of 1933, and addresses the issue of consolidated financial statements. Article 3A of Regulation S-X provides that in deciding upon consolidation, registrants should consider what presentation is “most meaningful” and clearly exhibits their financial positions.2There is a presumption for consolidation when “one entity directly or indirectly has a controlling financial interest in another entity”. Furthermore, RICs and BDCs are subject to an additional rule that their statements may be consolidated only with statements of subsidiaries that are investment companies.3

The Guidance Update highlights some situations where questions may arise in the application of these requirements. For example, a RIC that is a feeder fund may have a controlling financial interest in the master fund, and a RIC that is a fund of funds in the same group of investment companies may have a controlling financial interest in the underlying funds. The Guidance Update states the general positions the staff has taken in such situations, as listed here: 

  • In the circumstances of a RIC that is a feeder fund in a master-feeder structure, the staff generally suggests unconsolidated financial presentation, provided that the feeder fund supplies certain information on its financial statements as specified in the Guidance Update.4 The staff believes such presentation is appropriate since a feeder fund is typically one of several investors in the master fund.
  • In the circumstances of a RIC that is a fund of funds, the staff generally suggests unconsolidated financial presentation. The staff’s view is that since fund of funds typically invests in multiple underlying funds (its levels of interest in each fund fluctuating over time), consolidated financial statements may be confusing to investors.5
  • For a BDC that has wholly owned subsidiaries, the staff generally suggests consolidated financial presentation. Where the subsidiaries are designed to act as an extension of the BDC’s investment operations, the staff believes that consolidated financial presentation would be more meaningful.