SEC Clarifies Performance Representation Rules When Using a Subscription Line of Credit

On February 6, 2024, the Securities and Exchange Commission (“SEC”) updated the Frequently Asked Questions regarding the SEC’s Marketing Rule.
The new FAQ addresses net and gross private equity returns presentation when advisers use a subscription line of credit (“LOC”).

Presenting gross returns without the impact of an LOC while presenting net returns with the impact of an LOC is viewed as a violation of the Marketing Rule.
- Reasoning:
  i. The Marketing Rule requires net and gross returns to be calculated over the same time period and because an LOC changes the timing of cash flows, the presentation of gross returns without an LOC and net returns with an LOC violates the rule.
  ii. Such a presentation would violate the provision requiring presentations of performance in a format designed to facilitate comparison between net and gross performance and accordingly violate the general prohibitions of the rule.
  iii. This applies primarily to the calculation of Internal Rate of Return but it can also affect net Multiple of Invested Capital calculations if LOCs are still outstanding at the time of performance calculation.
  iv. Any presentation of a levered return without appropriate footnotes can be deemed misleading. However, in our experience, most managers already properly footnote their returns.
- Remedial Action:
  - Managers who use this performance presentation can remediate their calculations in one of three ways:
    1. Show only the net returns with or without the impact of the LOC without presenting gross returns.
    2. Include gross returns without the LOC and show net returns with and without the LOC; and
    3. Present gross and net returns with the LOC.

New Private Fund Advisers Rule Performance Reporting: Illiquid funds must present the performance of funds with and without the impact of any fund-level subscription facilities. The Private Fund Advisers Rule will require all fees and expenses associated with fund-level subscription facilities to be excluded from the calculation and managers may want to consider aligning calculation methodologies.
Gross and Net with Equal Prominence: The Marketing Rule requires gross and net returns to be shown in equal prominence. Many managers include unlevered net returns in the footnotes or endnotes. The SEC’s focus on presenting returns in a format designed to facilitate comparison indicates that this practice may violate the provisions of the Marketing Rule.