SEC Provides Additional Guidance on Performance Presentation and Subscription Facilities

On February 6, 2024, the SEC updated its Marketing Compliance Frequently Asked Questions to provide additional guidance with respect to performance presentations in advertisements under the SEC’s marketing rule. Specifically, this latest update to the marketing rule FAQs addresses whether gross and net performance must always be calculated using the same methodology over the same time period. The answer is “yes,” and as we discuss below, the staff at the SEC also took this opportunity to address the presentation of performance when managers use subscription facilities for a private fund. 

In this latest update to the marketing rule FAQs, the staff acknowledged that the marketing rule does not require any particular methodology for calculating performance. However, the staff also reminded readers that the marketing rule does require that presentations of gross performance also must present net performance that is calculated over the same time period using the same methodology and in a format that facilitates comparison of net performance with gross performance.

The staff also focused on the use of subscription facilities and a desire by certain investment advisers to private funds to present a gross internal rate of return (“Gross IRR”) calculated from the time an investment is made, excluding the effects of subscription facilities, while simultaneously presenting a net internal rate of return (“Net IRR”) that is calculated from the time that capital has been called to repay such borrowing. The staff stated that presenting Gross IRR and Net IRR in this manner would violate the marketing rule. 

First, the staff concluded that investment advisers presenting investment performance in this manner are calculating Gross IRR and Net IRR over different time periods. Specifically, the Gross IRR is calculated from when the private fund utilizes its subscription facility or other borrowing to acquire investments, while Net IRR is calculated from when capital contributions are called from fund investors and the subscription facility or other borrowing is repaid. 

Second, the staff concluded that investment advisers presenting investment performance in this manner are using different methodologies for calculating Gross IRR and Net IRR. Specifically, Gross IRR is being calculated without the impact of fund-level subscription facilities or other borrowings, and Net IRR is being calculated with the impact of fund-level subscription facilities. 

Third, the staff concluded that investment advisers presenting investment performance in this manner are not presenting net performance in a format that facilitates comparison with gross performance. The staff also stated that if an investment adviser desires to show Gross IRR that is calculated from before capital commitments are called, then it must also include Net IRR that is calculated from the same time period. Under that method, both Gross IRR and Net IRR would include the effect of subscription facilities.

Notably, the staff also concluded that presenting only Net IRR from before capital commitments are called (thereby including the impact of the subscription facility) would violate the marketing rule’s general prohibitions because such a presentation could mislead investors by suggesting that the fund’s performance is similar to the performance that the investor has achieved from its investment in the fund. The staff stated that if an investment adviser presents Net IRR in this manner, it must either also present Net IRR without factoring in the impact of the subscription facility or provide appropriate disclosures that describe the impact of the subscription facility on the Net IRR presented. 

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It is important for registered investment advisers to comply with the marketing rule. We also remind our clients that the SEC’s Division of Examinations has made marketing rule compliance an area of focus for its examinations.

If you have any questions about this most recent FAQ or the marketing rule in general, please do not hesitate to contact the below authors or any member of the Winston & Strawn LLP Financial Services practice group.