Whose track record is it anyway?

One of the stickiest parts of a spin-out is track record.

As one fund administrator recently warned: If LPs reach out to someone’s previous firm to check the validity of their track record, the firm may not hand it over. They simply don’t want that information out there.

And that’s not the only unknown element. Scrutiny from the Securities and Exchange Commission can be intense. The commission focuses on performance advertising rules: ie, whether the past performance you are touting is justifiably yours, is relevant and is the complete picture.

One New York-based attorney is currently dealing with a case from a firm that spun out over a decade ago.

“The SEC has actually asked for the agreement between my client and the prior firm where he negotiated for certain rights in respect to attribution of the track record,” says the attorney.

“We have to find the agreement from a dozen years ago. We need to produce the agreement to them and then they’re going to look at it as part of their evaluation on whether or not he fairly presented performance with respect to his prior professional activity.”

Generally, the SEC sees an investment advisory firm’s performance data as belonging to the firm and not investment professionals. However, the departing employee can negotiate with their firm and, according to a 1996 case involving Horizon Asset Management, the SEC will accept the performance from a previous firm only if the following conditions are met:

• The founder of the new firm was primarily responsible for achieving the prior performance results.
• The investments managed at the predecessor firm are so similar to those currently under management that the performance results would provide relevant information to prospective clients.
• All investments that were managed in a substantially similar manner are included, unless the ones left out don’t materially affect performance.
• The performance disclosed is consistent with the SEC interpretations pertaining to rules on the advertisement of performance results, which include those outlined in the Clover Capital Management case.
• The advertisement includes all relevant disclosures, including that the performance results were from investments managed at another entity.

Raising a first-time fund can be hard enough. Emerging managers should make a point of not only following closely the SEC’s rules on the portability of their track record, but documenting everything and keeping it on file ready for inspection.

Write to the author: marine.c@peimedia.com