Just before the holiday break, a new accounting rule was written that should end up being an important win for private investment firms – although it didn’t look like one at first glance.
For years now, CFOs of non-public entities have been complaining that Generally Accepted Accounting Principles (GAAP) – the common set of financial reporting standards followed by US companies – were too complex, having been primarily designed with large public companies in mind.
The good news is that US accounting watchdogs are in the process of tailoring their standards for private entities. For instance, disclosure notes are one area where private entities – which tend to have small ownership bases, with direct access to management – would certainly benefit from some bespoke accounting rules.
The biggest question for private funds, however, has been whether or not they would actually count as a private entity.
Last year, the Financial Accounting Standards Board (FASB) struggled to define private entities, opting instead to define public entities (so any entity that fell outside that definition would be private by default). In doing so, it introduced some specific tests that private equity and venture capital firms – as well as their portfolio companies – must meet in order to benefit from simpler private accounting rules.
One of those tests seemed particularly troubling for private fund advisors: the rule that any entity which has to file or furnish their financial statements with the US Securities and Exchange Commission (or an overseas regulator) counts as a public entity.
On the face of it, that would appear to include any investment advisors that has to show SEC examiners their financial records upon request, or any GP that provides European regulators with a copy of their financial records in order to comply with the Alternative Investment Fund Managers Directive.
However, market sources close to the rulemaking process tell PE Manager that FASB would only consider this to be applicable if the regulator specifically requires the entity to furnish financial statements in accordance with US GAAP. And that’s not a requirement either for SEC-registered advisors or firms seeking capital in Europe under AIFMD.
The caveat, of course, is that the interpretation of this provision will ultimately be left up to SEC inspectors and industry auditors. But this is unlikely to differ substantially from FASB’s, given their participation in the project.
In other words: despite the inexact wording of the new rule, it looks as though it will allow GPs to enjoy less burdensome financial reporting requirements – which should benefit both preparers (GPs) and users (LPs) of financial statements.
The FASB recently assembled a body called the Private Company Council to recommend changes to accounting rules for private entities, which is expected to begin significant work in 2014. So news that funds look likely to benefit from these changes is particularly timely.
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