Wayne Cohen, 43, is President and Chief Operating Officer of Oz Management and is a member of Oz Management’s Partner Management Committee. Prior to joining Oz Management in 2005, Mr. Cohen was an Associate at Schulte Roth & Zabel. Mr. Cohen holds a B.A. in International Relations from Tulane University and a J.D. from New York University School of Law.
David M. Levine, 50, is Chief Legal Officer of Oz Management and is a member of Oz Management’s Partner Management Committee. Prior to joining Oz Management in 2017, Mr. Levine spent 15 years at Deutsche Bank in various positions with increasing responsibilities, most recently, Global Head of Litigation and Regulatory Enforcement. Prior to that, he spent eight years in various roles at the SEC including as Chief of Staff. Mr. Levine holds a B.S. from the State University of New York at Albany and a J.D. from Hofstra University.
Item 1A. Risk Factors
Risks Related to Our Business
In the course of conducting our business operations, we are exposed to a variety of risks that are inherent to or otherwise impact the alternative asset management business. Any of the risk factors we describe below have affected or could materially adversely affect our business, results of operations, financial condition and liquidity. The market price of our Class A Shares could decline, possibly significantly or permanently, if one or more of these risks and uncertainties occur. Certain statements in “Risk Factors” are forward-looking statements. See “Forward-Looking Statements.”
•Difficult global market, economic or geopolitical conditions may materially adversely affect our business and cause significant volatility in equity and debt prices, interest rates, exchange rates, commodity prices and credit spreads. These factors can materially adversely affect our business in many ways, including by reducing
•Fiscal challenges facing the value or performance of the investments made by our funds and by reducing the ability of our funds to raise or deploy capital, each of whichU.S. government could materially adversely affect our financial condition and results of operations.
The success and growth of our business are highly dependent upon conditions in the global financial markets and economic and geopolitical conditions throughout the world that are outside of our control and difficult to predict. Factors such as equity prices, equity market volatility, asset or market correlations, interest rates, counterparty risks, availability of credit, inflation rates, economic uncertainty, changes in laws or regulation (including laws relating to the financial markets generally or the taxation or regulation of the hedge fund industry), trade barriers, commodity prices, currency exchange rates and controls, and national and international political circumstances (including governmental instability or dysfunction, wars, terrorist acts or security operations) can have a material impact on the value of our funds’ portfolio investments or our general ability to conduct business. Difficult market, economic and geopolitical conditions can negatively impact those valuations and our ability to conduct business,financial markets which, in turn, would reduce or even eliminate our revenues and profitability, thereby having a materialcould have an adverse effect on our business, financial conditionposition or results of operations. As a global alternative asset manager, we seek to generate consistent, positive, absolute returns across all market cycles for the investors in our funds. Our ability to do this has been, and in the future
•We may be materially impacted by conditions in the global financial markets and economic and geopolitical conditions worldwide.
Interest rates have been at historically low levels in recent years. However, from December 2015 through 2017, the Federal Reserve raised its benchmark interest rate five separate times, in each case by a quarter of a percentage point. The Federal Reserve has indicated it may continue raising interest rates in the coming twelve months. Interest rates could have an adverse impact on our business, financial condition or results of operations.
Unpredictable or unstable market, economic or geopolitical conditions have resulted and may in the future result in reduced opportunities to find suitable risk-adjusted investments to deploy capital and make it more difficult to exit and realize value from our existing investments, which could materially adversely affect our ability to raise new funds and increase our assets under management and, therefore, may have a material adverse effect on our business, financial condition or results of operations. In addition, during such periods, financing and merger and acquisition activity may be greatly reduced, making it harder and more competitive for asset managers to find suitable investment opportunities and to obtain funding for such opportunities. If we fail to react appropriately to difficult market, economic and geopolitical conditions, our funds could incur material losses.
Potential impact of the United Kingdom’s decision to leave the European Union.
On June 23, 2016, the UK held an advisory referendum in which UK voters approved the UK’s exit from the European Union (the “EU”), commonly referred to as “Brexit.” On March 29, 2017 the UK government gave formal notice to the
European Council under Article 50(2) of the Treaty on European Union of the UK’s intention to withdraw from the EU. This notice began a period of negotiation between the EU and the UK ahead of the UK’s exit from the EU which is currently expected to take place on March 30, 2019. The negotiations are expected to focus on an agreement for the terms of the UK’s withdrawal from the EU, the terms of a potential transitional period from March 30, 2019, and a framework for the UK’s future relationship with the EU after the UK’s exit. Nevertheless, the timing and the outcome of those negotiations remain highly uncertain and information regarding the long-term consequences of the UK’s withdrawal is expected to become clearer over time. The announcement of the result of the Brexit referendum and news concerning the progress of the EU’s and UK’s Brexit negotiations has caused significant volatility in global financial and foreign exchange markets, including volatility in the value of the Euro and the British Pound, which may impair the investment performance of our funds. In addition, Brexit could lead to political, legal and economic uncertainty and potentially divergent national laws and regulations, particularly from a tax perspective, as the UK determines which EU laws to replace or replicate. Changes madeaffected by the UK to its domestic or international tax system and its implementation after the UK has withdrawn from the EU could have a material adverse effect on our business, financial condition or resultseffects of operations.inflation.
An investment in our Class A Shares is not an alternative to an investment in any of our funds, and the returns of our funds should not be considered as indicative of any returns expected on our Class A Shares, although poor•Poor investment performance of, or lack of capital flows into, the funds we manage could have a materially adverse impact on our revenues and, therefore, the returns on our Class A Shares.revenues.
The returns on our Class A Shares are not directly linked to the historical or future performance of the funds we manage or the manager of those funds. Even if our funds experience positive performance and our assets under management increase, holders of our Class A Shares may not experience a corresponding positive return on their Class A Shares.
However, poor performance of the funds we manage will cause a decline in our revenues from such funds, and may therefore have a negative effect on our performance and the returns on our Class A Shares. If we fail to meet the expectations of our fund investors or otherwise experience poor investment performance, whether due to difficult economic and financial conditions or otherwise, our ability to retain existing assets under management and attract new investors and capital flows could be materially adversely affected. In turn, the management fees and incentive income that we would earn would be reduced and our business, financial condition or results of operations would suffer, thus negatively impacting the price of our Class A Shares. Furthermore, even if the investment performance of our funds is positive, our business, financial condition or results of operations and the price of our Class A Shares could be materially adversely affected if we are unable to attract and retain additional assets under management consistent with our past experience, industry trends or investor and market expectations.
•Investors in our funds have the right to redeem their investments in our funds on a regular basis and have in the past and could in the future redeem a significant amount of assets under managementAssets Under Management during any given quarterly period, which would result in significantly decreased revenues.period.
Subject to any specific redemption provisions applicable to a fund, investors in our multi-strategy hedge funds may generally redeem their investments in our funds on an annual or quarterly basis following the expiration of a specified period of time (typically between one and three years), although certain investors generally may redeem capital during such specified period upon the payment of a redemption fee and upon giving proper notice. In a declining market, during periods when the hedge fund industry generally experiences outflows, or in response to specific events that occur at the Company (including any uncertainty related to our recently announced succession plans), we could experience increased redemptions and a consequent reduction in our assets under management. Recently, our assets under management have declined and we believe this trend will likely continue to some extent for some period of time following the settlement of the FCPA investigation. Furthermore, investors in our funds may also invest in funds managed by other alternative asset managers that have restricted or suspended redemptions or may in the future do so. Such investors may redeem capital from our funds, even if our performance is superior to such other alternative asset managers’ performance if they are restricted or prevented from redeeming capital from those other managers.
The decrease in revenues that would result from significant redemptions in our funds could have a material adverse effect on our business, financial condition or results of operations. During 2017, we experienced redemptions of approximately $10.5 billion from our funds. We may continue to experience elevated redemption levels and, if economic and market conditions remain uncertain or worsen, we may once again experience significant redemptions.
•Our business financial condition or results of operations may be materially adversely impacted by the highly variable nature of our revenues, results of operations and cash flows. In a typical year, a substantial portion of our incentive income and a large portion of our annual discretionary cash bonus expense is determined and recorded in the fourth quarter each year, which means that our interim results are not expected to be indicative of our results for a full year, causing increased volatility in the price of our Class A Shares.
Our revenues are influenced by the combination of the amount of assets under management and the investment performance of our funds. Asset flows, whether inflows or outflows, can be highly variable from month-to-month and quarter-to-quarter. Furthermore, our funds’ investment performance, which affects the amount of assets under management and the amount of incentive income we may earn in a given year, can be volatile due to, among other things, general market and economic conditions. Accordingly, our revenues, results of operations and cash flows are all highly variable. This variability is exacerbated during the fourth quarter of each year, primarily due to the fact that a substantial portion of our revenues historically has been and we expect will continue to be derived from incentive income from our funds. Such incentive income is contingent on the investment performance of the funds as of the relevant commitment period, which generally is as of the end of each calendar year; however, as of December 31, 2017, with respect to 54% of assets under management, the initial commitment period can be three years or longer depending on how the assets are invested. The expiration of these commitment periods may occur on dates other than December 31, which, in certain circumstances, may cause increased volatility in our results. Moreover, in a typical year, we determine a large portion of our annual discretionary cash bonus during the fourth quarter based on fund performance for the year. Because this bonus is variable and discretionary, it can exacerbate the volatility of our results. We may also experience fluctuations in our results from quarter to quarter due to a number of other factors, including changes in management fees resulting from changes in the management fee rates we charge our fund investors or due to changes in the values of our funds’ investments, as well as capital inflows or outflows. Changes in our operating expenses, unexpected business developments and initiatives and, as discussed above, general economic and market conditions may also cause fluctuations in our results from quarter to quarter. Such variability and unpredictability may lead to volatility or declines in the price of our Class A Shares and cause our results for a particular period not to be indicative of our performance in a future period or particularly meaningful as a basis of comparison against results for a prior period. Note, on the other hand, as of December 31, 2017, 31% of our assets under management are in Institutional Credit Strategies, which includes our CLOs, and have not historically generated a material amount of incentive income.
The amount of incentive income that may be generated by our funds is uncertain until it is actually crystallized. The commitment period for most of our multi-strategy assets under management is for a period of one year on a calendar-year basis, and therefore we generally crystallize incentive income annually on December 31. We may also recognize incentive income related to fund investor redemptions at other times during the year, as well as on assets under management subject to commitment periods that are longer than one year. We may also recognize incentive income from tax distributions relating to assets with longer-term commitment periods. As a result of these and other factors, our interim results may not be indicative of historical performance or any results that may be expected for a full year.
In addition, all of our hedge funds have “perpetual high-water marks.” This means that if a fund investor experiences losses in a given year, we will not be able to earn incentive income with respect to such investor’s investment unless and until our investment performance surpasses the perpetual high-water mark. For example, the incentive income we earn is dependent on the net asset value of each fund investor’s investment in the fund. However, failure to earn incentive income as a result of any high-water marks that do arise may adversely impact our business, financial condition or results of operations and our ability to make distributions to our Class A Shareholders. In addition, incentive income distributions from our real estate and certain other funds is subject to clawback obligations generally measured as of the end of the life of a fund, and therefore we currently defer this revenue until we are no longer required to repay amounts to a fund to the extent we have received excess incentive income distributions during the life of the fund relative to the aggregate performance of the fund. Beginning in 2018, as a result of the adoption of new revenue recognition accounting guidance, we will recognize incentive income when such amounts are probable of not significantly reversing. We cannot predict when realization events will occur or whether, upon occurrence, these investments will be profitable.
As a result of quarterly fluctuations in, and the related unpredictability of, our revenues and profits, the price of our Class A Shares can be significantly volatile.
•Competitive pressures in the asset management business could materially adversely affect our business, financial condition or results of operations.business.
The asset management business remains intensely competitive, with competition based on a variety of factors, including investment performance, the quality of service and level of desired information provided to fund investors, brand recognition and business reputation. We compete for fund investors, highly qualified talent, including investment professionals, and for investment opportunities with a number of hedge funds, private equity firms, specialized funds, traditional asset managers, commercial banks, investment banks and other financial institutions.
A number of factors create competitive risks for us:
We compete in an international arena and, to remain competitive, we may need to further expand our business into new geographic regions or new business areas where our competitors may have a more established presence or greater experience and expertise.
A number of our competitors have greater financial, technical, marketing and other resources and more personnel than we do.
Several of our competitors have raised and continue to raise significant amounts of capital, and many of them have or may pursue investment objectives that are similar to ours, which would create additional competition for investment opportunities and may reduce the size and duration of pricing inefficiencies that many alternative investment strategies seek to exploit.
Some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and to bid more aggressively than us for investments that we may want to make.
Some of our competitors may be subject to less extensive regulation and thus may be better positioned to pursue certain investment objectives and/or be subject to lower expenses related to compliance and regulatory investigations than us.
Other industry participants will from time to time seek to recruit our active executive managing directors, investment professionals and other professional talent away from us.
We may lose fund investors in the future if we do not match or provide more attractive management fees, incentive income arrangements, structures and terms than those offered by competitors. However, we may experience decreased revenues if we match or provide more attractive management fees, incentive income arrangements, structures and terms offered by competitors. In addition, changes in the global capital markets could diminish the attractiveness of our funds relative to investments in other investment products. This competitive pressure could materially adversely affect our ability to make successful investments and limit our ability to raise future successful funds, either of which would materially adversely impact our business, financial condition or results of operations.
If our investment performance, including the level and consistency of returns or other performance criteria, does not meet the expectations of our fund investors, it will be difficult for our funds to retain or raise capital and for us to grow our business. Additionally, even if our fund performance is strong, it is possible that we will not be able to attract additional capital. Further, the allocation of increasing amounts of capital to alternative investment strategies over the long term by institutional and individual investors may lead to a reduction in profitable investment opportunities, including by driving prices for investments higher and increasing the difficulty of achieving consistent, positive, absolute returns.
Competition for fund investors is based on a variety of factors, including:
Investment performance.
Investor liquidity and willingness to invest.
Investor perception of investment managers’ ability, drive, focus and alignment of interest with them.
Investor perception of robustness of business infrastructure and financial controls.
Transparency with regard to portfolio composition.
Investment and risk management processes.
Quality of service provided to and duration of relationship with investors.
Business reputation, including the reputation of a firm’s investment professionals.
Level of fees and incentive income charged for services.
If we are not able to compete successfully based on these and other factors, our assets under management, earnings and revenues may be significantly reduced and our business, financial condition or results of operations may be materially adversely affected. Furthermore, if we are forced to compete with other alternative asset managers on the basis of fees, we may not be able to maintain our current management fee and incentive income structures, which drive our revenues and earnings. We have historically competed for fund investors primarily on the investment performance of our funds and our reputation, and not on the level of our fees or incentive income relative to those of our competitors. However, as the alternative asset management sector continues to mature and addresses current market and competitive conditions, there is increasing downward pressure on management fees and a risk that incentive income rates will decline, without regard to the historical performance of a manager. Management fee or incentive income rate reductions on existing or future funds, particularly without corresponding increases in assets under management or decreases in our operating costs, could materially adversely affect our business, financial condition or results of operations.
In addition to the competitive pressures described above, as we diversify by offering new or enhanced products and investment platforms, the average management fee rate we earn on our assets under management may fall as a result of a larger proportion of our assets under management being invested in products that earn lower management fee rates. For example, our average management fee rate has fallen during the period 2015 to 2017 from 1.39% to 0.93% of weighted-average assets under management. The rate decline was driven primarily by lower assets under management in our multi-strategy funds as a percentage of our total assets under management. Additionally, effective October 1, 2016, we reduced the management fee rate for existing fund investors in virtually all of our multi-strategy assets under management further contributing to the decline in our management fee income. Our average management fee will vary from period to period based on the mix of products that comprise our assets under management.
Even if we are able to compete successfully based on the factors noted above, it is possible we could lose assets under management to our competitors. It is possible that similar circumstances could cause us to experience unusually high redemptions or a decrease in inflows, even if our investment performance and other business attributes are otherwise competitive or superior.
•Damage to our reputation could harm our business.
Our business is highly competitive•The founder and we benefitformer Chief Executive Officer of Och-Ziff has taken certain actions that have had an adverse impact on our business.
•The uncertainty surrounding the ongoing COVID-19 pandemic, including the length and severity of its impact on global economic activity could adversely affect our business.
•The United Kingdom’s withdrawal from being highly regarded inthe European Union could adversely affect our industry. Maintaining our reputation is critical to attracting and retaining fund investors and for maintaining our relationships with our regulators. Negative publicity regarding our company or actual, alleged or perceived issues regarding our recently announced succession plan could give rise to reputational risk which could significantly harm our existing business and business prospects.business.
•Our indebtedness and Preferred Units may restrict our current and future operations, particularly our ability to respond to certain changes or to take future actions.operations.
On November 20, 2014, OZ Management LP, as borrower, and certain•The replacement of our other subsidiaries, as guarantors (collectively,LIBOR with certain of their respective subsidiaries, the “Oz Operating Group Credit Parties”), entered into a $150 million unsecured revolving credit and guaranty agreement which was subsequently amended on December 29, 2015 (as amended, the “Revolving Credit Facility”), with certain financial institutions, as lenders, JPMorgan Chase Bank, N.A., as administrative agent, and certain other parties party thereto. On November 20, 2014, Och-Ziff Finance Co. LLC (“Oz Finance”), an indirect subsidiary of the Company, issued $400 million in aggregate principal amount of its 4.50% Senior Notes due 2019 (the “Senior Notes”) pursuant to an indenture (as supplemented by a supplemental indenture, the “Indenture”) among Oz Finance and the Oz Operating Partnerships (excluding Oz Finance, collectively, the “Senior Notes Guarantors”) and Wilmington Trust, National Association, as trustee. Also, pursuant to a securities purchase agreement, dated September 29, 2016 (the “Purchase Agreement”), the Company completed a $250.0 million issuance and sale of 250,000 Preferred Units on October 5, 2016, and an additional $150.0 million issuance and sale of 150,000 Preferred Units on January 23, 2017.
The Revolving Credit Facility provides for a revolving credit facility with a maturity of five years and contains a number of restrictive covenants that collectively impose significant operating and financial restrictions on the Oz Operating Group Credit Parties, including restrictions thatalternative reference rate, may limit their ability to engage in acts that may be in our long-term best interests.
The restrictions in the Revolving Credit Facility include, among other things, limitations on the ability of the Oz Operating Group Credit Parties to:
Incur certain additional indebtedness or issue certain equity interests.
Create liens.
Pay dividends or make other restricted payments.
Merge, consolidate, or sell or otherwise dispose of all or any part of their assets.
Engage in certain transactions with shareholders or affiliates.
Engage in substantially different lines of business.
Amend their organizational documents in a manner materially adverse to the lenders.
Additionally, our Revolving Credit Facility includes two financial maintenance covenants relating to assets under management and an economic income leverage ratio.
The Indenture includes certain covenants, including limitations on Oz Finance’s and the Senior Notes Guarantors’ ability to, subject to exceptions, incur indebtedness secured by liens on voting stock or profit participating equity interests of their respective subsidiaries or merge, consolidate or sell, transfer or lease all or substantially all assets.
The Revolving Credit Facility also identifies a number of events that, if they occur or are continuing, would constitute an event of default under this agreement. The events of default include a change of control, which would occur if any person or group, other than certain permitted holders (including, but not limited to, Daniel S. Och, our other executive managing directors, and each of their respective related entities), becomes the beneficial owner, directly or indirectly, of at least 50% (on a fully diluted basis) of the voting interests in the Oz Operating Group. Similarly, the Indenture provides for customary events of default and, if a change of control repurchase event occurs, Oz Finance will be required to offer to repurchase the Senior Notes at a price in cash equal to 101% of the aggregate principal amount of the Senior Notes, plus any accrued and unpaid interest to, but excluding, the repurchase date.
The terms of the Preferred Units contain certain operational limitations, a change in control provision and other mandatory repurchase provisions. Without the consent of the holders’ committee, which initially consists of Daniel S. Och as sole member, the Operating Group entities, their respective subsidiaries and the other subsidiaries of the Company may not, subject to limited exceptions, sell or otherwise dispose of any businesses, business lines or divisions, or any significant assets thereof. Under the terms of the Preferred Units, the Company, the Operating Group entities, their respective subsidiaries and the funds are also prohibited from any transaction with any Designated Officer (as defined in the exhibit to the Purchase Agreement), any holder of at least 10% of the outstanding equity of the Company, the Operating Group entities, their respective subsidiaries or their respective affiliates (other than Daniel S. Och or his related parties) other than transactions in the ordinary course of business with any person (other than a Designated Officer) relating to such person’s service to any Operating Group entity or consistent with past practice as of the date of the initial closing, including in connection with granting any direct or indirect carry or capital interest in the funds to such Person, which matters shall be determined by the Company’s board of directors or compensation committee.
Pursuant to the terms of the Preferred Units, distributions on the Preferred Units will be payable on the liquidation preference amount on a cumulative basis at an initial distribution rate of 0% per annum until the Step Up Date of February 19, 2020, after which the distribution rate will increase in stages thereafter to a maximum of 10% per annum on and after the eighth anniversary of the Step Up Date. In addition, following the occurrence of a change of control event, the Operating Group entities will redeem the Preferred Units as a redemption price equal to the liquidation preference plus all accumulated but unpaid distributions (collectively, the “liquidation value”). For so long as the Operating Group entities do not redeem all of the outstanding Preferred Units, the distribution rate will increase by 7.00% per annum, beginning on the 31st day
following such event. If we do not have sufficient cash to make such distributions or to repurchase the Preferred Units when required, we may be forced to sell assets, borrow additional funds or enter into new debt facilities. No assurance can be given that we would be able to complete such transactions on favorable terms, or at all, or that our borrowing costs would not increase.
A failure by any of the Oz Operating Group Credit Parties, Oz Finance or the Senior Notes Guarantors, as applicable, to comply with the covenants and other obligations—or upon the occurrence of other defaults—specified in the Revolving Credit Facility, or the Indenture, as the case may be, could result in an event of default under the Revolving Credit Facility, or the Indenture, as the case may be, which would give the lenders under the Revolving Credit Facility, or the holders of the Senior Notes, the right to declare all indebtedness and other obligations outstanding under the Revolving Credit Facility, if any, or the Senior Notes, as the case may be, together with accrued and unpaid interest and fees, to be immediately due and payable. If the indebtedness outstanding under the Revolving Credit Facility, if any, or the Senior Notes were to be accelerated, the Oz Operating Group Credit Parties, Oz Finance or the Senior Notes Guarantors, as applicable, may not have sufficient cash on hand or be able to sell sufficient assets to repay this indebtedness, which may have an immediate material adverse effect on our business, results of operations and financial condition. For more detail about risks relating to any refinancing, repurchasing or repayment of our Revolving Credit Facility and the Senior Notes, see “—Changes in the credit markets may negatively impact our ability to refinance our outstanding indebtedness or our ability to otherwise obtain attractive financing for our business, and may increase the cost of such financing if it is obtained, which would lead to higher interest expense or, with respect to our funds, lower-yielding investments, either of which would decrease our earnings. An increase in our borrowing costs may materially adversely affect our business, financial condition or results of operations.” For more detail regarding the Revolving Credit Facility, and Senior Notes, their respective terms and the current status of compliance with the Revolving Credit Facility by the Oz Operating Group Credit Parties, please see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” and “—Debt Obligations.”collateralized loan obligation transactions.
•Our business and financial condition may be materially adversely impacted by the loss of any of our key executive managing directors, particularly certain members of our Partner Management Committee.
The success of our business depends on the efforts, judgment and personal reputations of our key executive managing directors, particularly certain members of our Partner Management Committee. Our key executive managing directors’ reputations, expertise in investing and risk management, relationships with investors in our funds and third parties on which our funds depend for investment opportunities and financing are each critical elements in operating and expanding our business. The loss of any of these individuals could harm our business and jeopardize our relationships with our fund investors and members of the business community. We believe our performance is highly correlated to the performance of these individuals. Accordingly, the retention of our key executive managing directors is crucial to our success, but none of them is obligated to remain actively involved with us. In addition, if any of our key executive managing directors were to join or form a competitor, some of our fund investors could choose to invest with that competitor rather than in our funds. The loss of the services of any of our key executive managing directors could have a material adverse effect on our business, financial condition or results of operations, including on the performance of our funds, our ability to retain and attract fund investors and highly qualified employees and our ability to raise new funds. We do not carry any “key man” insurance that would provide us with proceeds in the event of the death or disability of any of our key executive managing directors.
In addition, investors in most of our funds have one-time special redemption rights that are triggered upon the loss of services of Mr. Och. See “—Most of our funds have special withdrawal provisions pursuant to which the failure of Daniel S. Och to be actively involved in the business provides investors with the right to redeem from such funds. The loss of the services of Mr. Och would have a material adverse effect on each of such funds and on our business, financial condition or results of operations” for additional information. Further, we negotiate other key man provisions in certain of our funds, which could provide for earlier redemption rights, in the event that one or more of certain of our key executive managing directors cease to provide services to such funds. Accordingly, the loss of such key executive managing directors could also result in significant or earlier redemptions from our funds, which could have a material adverse impact on our business, financial condition or results of operations.
Mr. Och resigned as CEO of the Company effective February 5, 2018. Mr. Och will remain Chairman of the Board until March 31, 2019, at which time he will resign and be replaced by a successor non-executive Chairman of the Board selected from the existing Board members and mutually agreed upon by the Nominating, Corporate Governance and Conflicts Committee and the Class B Shareholder Committee.
As Chairman of the Board, Mr. Och will oversee and be involved with the overall direction and vision of the Company. Following Mr. Och’s resignation as Chairman of the Board, Mr. Och will have the right to continue to serve as a director on the Board for so long as he continues to own interests in Oz Management representing at least 33% of either his current Preferred Units or current common equity units in the Oz Operating Partnerships.
Mr. Och will continue to serve as the (i) sole member of the Class B Shareholder Committee and (ii) Chairman of the Exchange Committee relating to the Group A Units until each is disbanded (which will coincide with the termination of the Class B Shareholders Agreement), which will occur on the Transition Date (as defined in the following sentence). The “Transition Date” will be December 31, 2019, subject to extension if either (i) the Company has advised Mr. Och that he may not withdraw any capital that he may request to withdraw or (ii) Mr. Och is advised by counsel that he is prohibited by law from withdrawing any capital he has requested to withdraw. We will develop a transition plan with respect to Mr. Och’s other roles and responsibilities and, to the extent necessary, we will seek consents or waivers with respect to certain of Mr. Och’s roles in order to effect such transition. As part of the transition, Mr. Och expects to continue to support Oz Management in its initiatives and remain involved with Oz Management to ensure its future success. After the Committee Dissolutions, Mr. Och will generally resign from other officer positions and from the boards of directors of our subsidiaries and will not become director of any future funds.
•Our ability to retain and attract executive managing directors, managing directors and other investment professionals is critical to the success and growth of our business.
Our investment performance and ability to successfully manage and expand our business, including into new geographic areas, is largely dependent on the talents and efforts of highly skilled individuals, including our active executive managing directors, managing directors and other investment professionals. Accordingly, our future success and growth depend on our ability to retain and motivate our active executive managing directors and other key personnel and to strategically recruit, retain and motivate new talent. We may not be successful in our efforts to recruit, retain and motivate the required personnel as the global market for qualified investment professionals is extremely competitive, particularly in cases where we are competing for qualified personnel in geographic or business areas where our competitors have a significantly greater presence or more extensive experience. We compete intensely with businesses both within and outside the alternative asset management industry for highly talented and qualified personnel. Accordingly, in order to retain and attract talent, our total compensation and benefits expense could increase to a level that may materially adversely affect our profitability and reduce our cash available for distribution to our executive managing directors and Class A Shareholders.
It may be difficult for us to retain and motivate our active executive managing directors after their interests in our business are fully vested and they are permitted to exchange their interests for Class A Shares that they can sell. The Group A Units granted to our executive managing directors who were executive managing directors before our IPO (our “Pre-IPO Partners”) in connection with the Reorganization have now generally become fully vested. Many of the Group A and Group D Units granted to executive managing directors since then are now also fully vested. Oz Operating Group Units otherwise granted to our executive managing directors, including awards granted under our Incentive Program established in 2017 (the “2017 Incentive Program”), continue to vest over time. See Note 10 to our consolidated financial statements included in this report for additional information on the 2017 Incentive Program.
If we are unable to retain the services of any of our active executive managing directors, the loss of their services could have a material adverse effect on our business, financial condition or results of operations, including by harming our ability to maintain or grow assets under management in existing funds or raise additional funds in the future.
In any year where our funds experience losses and we do not earn incentive income, bonuses for that year (and in subsequent years until such losses are recouped) may be significantly reduced. Reduced bonuses, particularly during subsequent years, could have a material adverse impact on our ability to motivate and retain our investment professionals and other employees.
Furthermore, our active executive managing directors and investment professionals possess substantial experience and expertise in investing, are responsible for locating and executing our funds’ investments, have significant relationships with the institutions that are the source of many of our funds’ investment opportunities, and in certain cases have strong relationships with our fund investors. Therefore, if our active executive managing directors or investment professionals join competitors or
form competing businesses, we could experience a loss of investment opportunities and existing fund investor relationships, which if significant, would have a material adverse effect on our business, financial condition or results of operations.
The Oz Operating Partnerships’ limited partnership agreements and other agreements entered into with our executive managing directors provide that the ownership interests in our business that are held by our executive managing directors are subject to various transfer restrictions and vesting and forfeiture conditions. In addition, the RSUs that have been awarded to our managing directors, certain executive managing directors and certain other employees are also subject to certain vesting and forfeiture requirements. Further, all of our active executive managing directors and managing directors are subject to certain restrictions with respect to competing with us, soliciting our employees and fund investors and disclosing confidential information about our business. These restrictions, however, may not be enforceable in all cases and can be waived by us at any time. There is no guarantee that these requirements and agreements, or the forfeiture provisions of the Oz Operating Partnerships’ limited partnership agreements (which are relevant to our executive managing directors) or the agreements we have with our managing directors will prevent any of these professionals from leaving us, joining our competitors or otherwise competing with us. Any of these events could have a material adverse effect on our business, financial condition or results of operations.
Most of our assets under management are in funds that have special withdrawal provisions pursuant to which the failure of Daniel S. Och to be actively involved in the business provides investors with the right to redeem from such funds. The loss of the services of Mr. Och could have a material adverse effect on each of such funds and on our business, financial condition or results of operations.
Most of our assets under management are in funds that give investors a one-time special redemption right (not subject to redemption fees) if Daniel S. Och dies or ceases to perform his duties with respect to the fund for 90 consecutive days or otherwise ceases to be involved in the activities of the Oz Operating Group. The death or inability of Mr. Och to perform his duties with respect to any of our funds for 90 consecutive days, or termination of Mr. Och’s involvement in the activities of the Oz Operating Group for any reason, could result in substantial redemption requests from investors in certain of our funds. Any such event would have a direct material adverse effect on our revenues and earnings, and would likely harm our ability to maintain or grow assets under management in existing funds or raise additional funds in the future. Such withdrawals could lead to a liquidation of certain funds and a corresponding elimination of our management fees and potential to earn incentive income. The loss of Mr. Och could, therefore, ultimately have a material adverse effect on our business, financial condition or results of operations, including a loss of substantially all of our revenues and earnings.
Mr. Och resigned as CEO of the Company effective February 5, 2018, but will remain Chairman of the Board. See “—Our business and financial condition may be materially adversely impacted by the loss of any of our key executive managing directors, particularly certain members of our Partner Management Committee.” above for additional details regarding Mr. Och’s transition.
•We have experienced and may again experience periods of rapid growth and significant declines in assets under management,Assets Under Management, which place significant demands on our legal, compliance, accounting, risk management, administrative and operational resources.
Rapid changes in our assets under management may impose substantial demands on our legal, compliance, accounting, risk management, administrative and operational infrastructures. The complexity of these demands, and the time and expense required to address them, is a function not simply of the size of the increase or decrease, but also of significant differences in the investing strategies employed within our funds and the time periods during which these changes occur. For example, expanding our product offerings and entering into new lines of business places additional demands on our infrastructure. Furthermore, our future growth will depend on, among other things, our ability to maintain and develop highly reliable operating platforms, management systems and financial reporting and compliance infrastructures that are also sufficiently flexible to promptly and appropriately address our business needs, applicable legal and regulatory requirements and relevant market and other operating conditions, all of which can change rapidly.
Addressing the matters described above may require us to incur significant additional expenses and to commit additional senior management and operational resources, even if we are experiencing declines in assets under management.
There can be no assurance that we will be able to manage our operations effectively without incurring substantial additional expense or that we will be able to grow our business and assets under management, and any failure to do so could materially adversely affect our ability to generate revenues and control our expenses.
•We are highly dependent on information systems and other technology, including those used or maintained by third parties with which we do business. Any failure or breach in any such systems or infrastructure or breach of the same,(including from a cyberattack) could materially impair our business, financial condition or results of operations.
Our business is highly dependent on information systems and technology. We rely heavily on our financial, accounting, trading, risk management and other data processing and information systems to, among other things, execute, confirm, settle and record a very large number of transactions, which can be highly complex and involve multiple parties across multiple financial markets and geographies, and to facilitate financial reporting and legal and regulatory compliance all in an extremely time-sensitive, efficient and accurate manner. We must continually update these systems to properly support our operations and growth, which creates risks associated with implementing new systems and integrating them into existing ones. We also use and rely upon third-party information systems and technology to perform certain business functions. Such third-party technology may be integrated with our own. Therefore, we face additional significant risks that would arise from the failure, disruption, termination or constraints in the information systems and technology of such third parties, including financial intermediaries such as exchanges and other service providers whose information systems and technology we use. Any of these information systems or technology infrastructures could fail, become disrupted (including by unauthorized security breaches) or otherwise not operate properly or as intended. In addition, our systems may be subject to cyberattacks. Breaches of our network security systems could involve attacks that are intended to obtain unauthorized access to our proprietary information, destroy data or disable, degrade or sabotage our systems, often through the introduction of computer malware, cyberattacks and other means and could originate from a wide variety of sources, including unknown third parties outside the firm. Although we take various measures to ensure the integrity of our systems, there can be no assurance that these measures will always provide sufficient protection. If any of these failures occur, particularly those that directly affect our New York headquarters, we could suffer a disruption or cessation in our business operations, an interception of confidential or proprietary information, liability to our funds, regulatory intervention, legal action or reputational damage, any or all of which could materially impair our business, financial condition or results of operations. We could also be significantly affected if the information systems and technology of third parties with whom we conduct business are subject to unauthorized security breaches or other tampering.
We depend on our headquarters in New York and our London and Hong Kong offices, where most of our personnel are located. Although, we have taken important precautions to limit the impact of failures or disruptions in the information systems and technology infrastructures that we use, as well as the impact of physical disruptions to our New York headquarters, London and Hong Kong offices, these precautions, including our disaster recovery programs, may not be sufficient to adequately mitigate the harm that may result from such a disaster or disruption. In addition, insurance and other safeguards might only partially reimburse us for any losses, if at all.
We are subject to third-party•Private litigation that could result in significant legal and other liabilities and reputational harm, which could materially adversely affect our business, financial condition or results of operations.harm.
We face significant risks in our business that subject us to third-party litigation and legal liability. In general, we will be exposed to litigation risk in connection with any allegations of misconduct, negligence, dishonesty or bad faith arising from our management of any fund. We may also be subject to litigation arising from investor dissatisfaction with the performance of our funds, including certain losses due to the failure of a particular investment strategy or improper trading activity, if we violate restrictions in our funds’ organizational documents or from allegations that we improperly exercised control or influence over companies in which our funds have large investments. In addition, we are exposed to risks of litigation relating to claims that we have not properly addressed conflicts of interest. Any litigation arising in such circumstances is likely to be protracted, expensive and surrounded by circumstances that could be materially damaging to our reputation and our business. Moreover, in such cases, we would be obligated to bear legal, settlement and other costs, which may be in excess of any available insurance coverage. In addition, although we are indemnified by our funds, our rights to indemnification may be challenged. If we are required to incur all or a portion of the costs arising out of any litigation or investigation as a result of inadequate insurance proceeds, if any, or fail to obtain indemnification from our funds, our business, financial condition or results of operations could be materially adversely affected.
Now that the FCPA investigation has been settled, it is possible that we will be exposed to increased civil litigation risk arising out of the events investigated by the SEC and DOJ as part of the FCPA matter.
It is possible that we would be made a party to any lawsuit involving any of the fund-related litigation described above. As with the funds, while we maintain insurance, there can be no assurance that our insurance will prove to be adequate. If we are required to incur all or a portion of the costs arising out of litigation, our business, financial condition or results of operations could be materially adversely affected. Furthermore, any such litigation could be protracted, expensive and highly damaging to our reputation, which could result in a significant decline in our assets under management and revenues, even if the underlying claims are without merit. In addition, we may participate in transactions that involve litigation (including the enforcement of property rights) from time to time, and such transactions may expose us to reputational risk and increased risk from countersuits.
•Extensive regulation of our business affects our activities and creates the potential for significant liabilities and penalties. Our reputation, business, financial condition or results of operations could be materially affected by regulatory issues.
Our business is subject to extensive and complex regulation, including periodic examinations and regulatory investigations, by governmental and self-regulatory organizations in the jurisdictions in which we operate and trade around the world. As an investment adviser registered under the Advisers Act and a company subject to the registration and reporting provisions of the Exchange Act, we are subject to regulation and oversight by the SEC. As a company with a class of securities listed on the NYSE, we are subject to the rules and regulations of the NYSE. As a registered commodity pool operator and a registered commodity trading advisor, we are subject to regulation and oversight by the United States Commodity Futures Trading Commission (“CFTC”) and the National Futures Association. In addition, we are subject to regulation by the Department of Labor under ERISA. In the UK, our UK sub-adviser is subject to regulation by the UK Financial Conduct Authority. Our Asian operations, and our investment activities around the globe, are subject to a variety of other regulatory regimes that vary country by country, including the Securities and Futures Commission in Hong Kong, and the Securities and Exchange Board of India.
The regulatory bodies with jurisdiction over us have the authority to grant, and in specific circumstances to cancel, permissions to carry on our business and the authority to conduct investigations and administrative proceedings. Such investigations and administrative proceedings can result in fines, suspensions of personnel or other sanctions, including censure, the issuance of cease-and-desist orders or the suspension or expulsion of an investment adviser from registration or memberships. For example, a failure to comply with the obligations imposed by the Exchange Act or Advisers Act, including recordkeeping, advertising and operating requirements, disclosure obligations and prohibitions on fraudulent activities, or a failure to maintain our funds’ exemption from compliance with the 1940 Act could result in investigations, sanctions and reputational damage, which could adversely affect our business, financial condition or results of operations. Our funds are involved regularly in trading activities that implicate a broad number of U.S. and foreign securities law regimes, including laws governing trading on inside information, market manipulation, anti-corruption, including the FCPA, and a broad number of technical trading requirements that implicate fundamental market regulation policies. Even if an investigation or proceeding does not result in a sanction or the sanction imposed against us or our personnel by a regulator were small in monetary amount, the adverse publicity relating to the investigation, proceeding or imposition of these sanctions could harm our reputation and cause us to lose existing investors or to fail to gain new investors. Furthermore, the legal, technology and other costs associated with regulatory investigations could increase to such a level that they could have a material impact on our business, financial condition or results of operations.
These global financial services regulators affect us not only with their regulations, but also with their examination, inspection and enforcement functions as well. We are routinely subject to examination and inspection and, although we make reasonable efforts to maintain effective compliance programs, there can be no assurances that any such inquiry would not result in a finding or sanction that would adversely affect our business, financial condition or results of operations. Likewise, enforcement investigations and administrative inquiries can be sweeping in nature. Cooperating with these investigations, as is our practice, can be expensive and time-consuming and could distract us from our business operations. In particular, U.S. regulators routinely investigate potentially serious matters such as possible insider trading, market manipulation, misleading disclosure, conflicts of interest, fraud, foreign corruption, including under the FCPA; lesser potential violations, such as books and records inaccuracies, weaknesses in internal controls; and compliance with general reporting and advertising regulations. For the past several years, we have cooperated with a number of ongoing regulatory investigations and examinations, both domestically and internationally, and we expect to be the subject of investigations and examinations in the future. There can be no assurances that ongoing or future investigations will not adversely affect our business, financial condition or results of operations. Enforcement actions and
administrative proceedings can result in fines, or other sanctions, including censure, the issuance of a cease-and-desist order, suspension or expulsion of persons or firms from the industry. Such sanctions can harm our reputation and cause us to lose existing investors or fail to gain new investors, which could adversely affect our business, financial condition or results of operations.
On September 29, 2016, we reached settlements with the DOJ and the SEC, resolving their investigations into our former private investment business in Africa and a 2007 investment by the Libyan Investment Authority in certain of our funds. As part of the settlements, we entered into a Deferred Prosecution Agreement with the DOJ, and our subsidiary, OZ Africa, agreed to plead guilty to one count of conspiracy to violate the anti-bribery provisions of the FCPA. We also agreed to settle an administrative proceeding with the SEC involving violations of the FCPA and the Advisers Act.
Pursuant to the settlement agreements with the regulators, we agreed to pay $412.1 million in settlement charges and to implement enhanced internal accounting controls and policies, to separate the chief compliance officer from other officer positions, and to engage an independent compliance monitor for three years, subject to early termination or extension. The settlements could have a material adverse effect on our business, financial condition or results of operations as described below in “-The FCPA settlements could have a material adverse effect on our ability to raise capital for our funds.”
In addition, we regularly rely on exemptions or exclusions from various requirements of the Securities Act, the Exchange Act, the 1940 Act, the Commodity Exchange Act and ERISA in conducting our asset management activities. These exemptions or exclusions are sometimes highly complex and may, in certain circumstances, depend on compliance by third parties whom we do not control. If for any reason these exemptions or exclusions were to become unavailable to us, we could become subject to regulatory action or third-party claims and our business, financial condition or results of operations could be materially adversely affected. Certain of the requirements imposed under the 1940 Act, the Advisers Act, ERISA and by non-U.S. regulatory authorities are designed primarily to ensure the integrity of the financial markets and to protect investors in our funds and are not designed to protect holders of our Class A Shares. At any time, the regulations applicable to us may be amended or expanded by the relevant regulatory authorities. If we are unable to correctly interpret and timely comply with any amended or expanded regulatory requirements, our business, financial condition or results of operations could be adversely impacted in a material way.
We may also be adversely affected if additional legislation or regulations are enacted, or by changes in the interpretation or enforcement of existing rules and regulations imposed by the SEC, other U.S. or foreign governmental regulatory authorities or self-regulatory organizations that supervise the financial markets and their participants. See “—Increased regulatory focus in the United States could result in additional burdens on our business” and “—Regulatory changes in jurisdictions outside the United States could adversely affect our business” for additional information. It is impossible to determine the extent of the impact of any new laws, regulations or initiatives that may be proposed, or whether any of the proposals will become law. Compliance with additional new laws or regulations could be difficult and expensive and affect the manner in which we conduct business, and we may be unable to correctly interpret and timely comply with any amended or expanded regulatory requirements, which could have adverse impacts on our business, financial condition or results of operations.
•The FCPA settlements could have a material adverse effect on our ability to raise capital for our funds.
As described above under “-Extensive regulation of our business affects our activities and creates the potential for significant liabilities and penalties. Our reputation, business, financial condition or results of operations could be materially affected by regulatory issues,” we recently settled investigations by the SEC and the DOJ concerning violations of the FCPA and other laws, which could have a material adverse effect on our business, financial condition or results of operations. In addition to the financial cost of the settlements, the investigation and settlements may harm our reputation and cause us to lose existing investors or fail to gain new investors, which could further adversely affect our business, financial condition or results of operations. Prior to the settlements, many of our funds raised capital relying on the exemption from registration provided by Rule 506 of Regulation D under the Securities Act (“Rule 506”) in connection with a securities offering structured as a private placement. As a consequence of the settlements, many of our funds are currently disqualified from raising capital using Rule 506 offerings. This could negatively affect our ability to raise capital for these funds, and our ability to offer and sell fund interests to certain investors in certain U.S. states may be impaired. The inability of many of our funds to raise capital in Rule 506 offerings may also result in additional expenses. The potential negative impact of the FCPA settlements on our ability to raise or retain capital for our funds could adversely affect our business, financial condition or results of operations.
•Increased regulatory focus in the United StatesU.S. could result in additional burdens on our business.
The financial industry has become more highly regulated. Legislation has been introduced in recent years in the U.S. relating to financial markets and institutions, including alternative asset management firms, which would result in increased oversight and taxation. There has been, and may continue to be, a related increase in regulatory investigations of the trading and other investment activities of alternative investment funds, including our funds. Such investigations may impose additional expenses on us, may require the attention of senior management and may result in fines if any of our funds are deemed to have violated any regulations.
We are subject to numerous•Risk retention regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). Title VII of the Dodd-Frank Act (the “Derivatives Title”) imposes a comprehensive regulatory regime on over-the-counter (“OTC”) derivatives and the operations of the markets for, and the activities of the dealers in and users of, OTC derivatives. The Derivatives Title, among other things: (i) could require certain OTC derivatives, including “swaps” (such as rate, credit, equity and commodity swaps) and “security-based swaps” (swaps and security-based swaps, collectively, “Swaps”), to be traded on a regulated exchange and cleared through a regulated clearing entity, potentially increasing significantly the collateral costs associated with such activities; (ii) imposes initial and variation margin requirements on certain entities whose derivatives are not cleared through a regulated clearing entity; (iii) creates several new classes of CFTC and SEC registrants, including “swap dealers,” “security-based swap dealers,” “major swap participants” and “major security-based swap participants,” that are subject to comprehensive regulation, including minimum net capital, margin, disclosure, reporting and recordkeeping requirements, conflicts of interest policies and procedures, new business conduct standards and other regulatory requirements; and (iv) expands the CFTC’s authority to impose speculative position limits with respect to derivative instruments, including Swaps on certain physical commodities (such as Swaps based on oil, gas, precious metals and agricultural commodities) and aggregate position limits for those instruments (including futures and options contracts and other listed instruments that are economically equivalent to such contracts) based on the same underlying physical commodity.
We are and may be directly and indirectly affected by the Derivatives Title and its rules, including but not limited to potential results such as increased clearing and margin costs and decreased liquidity. Although many of the regulations under the Derivative Title have been adopted, certain issues under the Derivatives Title that were to be addressed by the regulators have not yet been addressed in final form. At this time we still cannot fully predict what impact the Derivatives Title will have on us, the funds we manage, our counterparties, the financial services industry or the markets, although we have already seen meaningful impacts on the financial services industry and the markets, both positive and negative.
On December 18, 2014, the Financial Stability Oversight Council (the “Council”) released a notice seeking public comment regarding potential risks to U.S. financial stability from asset management products and activities and on February 4, 2015, the Council approved supplemental procedures for reviewing nonbank financial companies for potential designation as systematically important financial institutions (“SIFI”). If we or any of our funds were to be designated as a SIFI, or otherwise designated by the Council as presenting systemic risk, we would be subject to limitations on our ability to conduct certain activities, along with increased costs of doing business in the form of fees and assessments associated with such designation as
well as by virtue of increased regulatory compliance costs, all of which would be likely to adversely affect our competitive position.business.
On December 10, 2013, U.S. financial regulators adopted final regulations to implement the statutory mandate of the “Volcker Rule” contained in Section 619 of the Dodd-Frank Act. Under the Volcker Rule, the ability of certain banking entities to acquire as principal, directly or indirectly, ownership interests in certain private investment funds (referred to•A downturn in the Volcker Rule as “covered funds”) will be limited. As a result, banking entities and their affiliates that would otherwise invest in our funds may choose not to invest in our funds, or to invest less capital in our funds. In addition, banking entities that are invested in our funds may be required to reduce or eliminate such investments due to the requirements of the Volcker Rule. The Volcker Rule also includes a general prohibition on banking entities engaging in activities defined as “proprietary trading.” The effectiveness of the Volcker Rule could negatively impact our business, financial condition or results of operations.
The Dodd-Frank Act also requires increased disclosure of executive compensation and provides shareholders with the right to a non-binding vote on executive compensation. In addition, the Dodd-Frank Act empowers federal regulators to prescribe regulations or guidelines to prohibit any incentive-based payment arrangements that the regulators determine encourage covered financial institutions to take inappropriate risks by providing officers, employees, directors or principal shareholders with excessive compensation or that could lead to a material financial loss by such financial institutions. Until all of the relevant regulations and guidelines have been established, we cannot predict what effect, if any, these developments may have on our business or theglobal credit markets in which we operate.
Furthermore, the Dodd-Frank Act required the SEC and the CFTC to implement more expansive regulations concerning whistleblowers. The SEC and the CFTC have each adopted rules under this requirement, establishing reward programs for persons who bring information to the SEC or the CFTC. To receive a reward under these programs, the information must lead to the successful enforcement or resolution of a judicial or administrative action brought by the SEC or CFTC that results in a monetary sanction of more than $1 million for a violation of the securities laws or the Commodity Exchange Act, respectively. These rules may result in increased regulatory inquiries or investigations by the SEC or the CFTC. Such inquiries or investigations could impose significant additional expense on us, require the attention of senior management and result in negative publicity and harm to our reputation.
Effective September 23, 2013, and pursuant to a mandate under the Dodd-Frank Act, the SEC adopted amendments to Rule 506 that disqualify issuers, such as our funds, from relying on the exemption from registration provided by Rule 506 in connection with a securities offering structured as a private placement if any “covered persons” are deemed to be “bad actors.” Specifically, an issuer generally will be precluded from conducting offerings that rely on the registration exemption provided by Rule 506 if a “covered person” has been subject to a relevant criminal conviction, regulatory or court order or other disqualifying event that occurred on or after September 23, 2013. For these purposes, the “covered persons” of an issuer include directors, certain officers, various entities related to the issuer, solicitors and promoters of the issuer and 20% beneficial owners of the issuer’s voting securities. For more detail about risks relating to the FCPA settlement and the related disqualification event which prevents many of our funds from raising capital using Rule 506, see “—The FCPA settlements could have a material adverse effect on our ability to raise capital for our funds.”
These and other outstanding rulemakings mandated by the Dodd-Frank Act will be completed by various regulatory bodies and other groups over the next several years, and the Dodd-Frank Act mandates multiple agency reports and studies (which could result in additional legislative or regulatory action). As a result of the regulatory and other action yet to be taken, we do not know what the remaining final regulations under the Dodd-Frank Act will require and it is difficult to predict how significantly the Dodd-Frank Act will affect us. The Dodd-Frank Act will likely increase our administrative costs and could impose additional restrictions on our business.
In early February 2017, the new Trump administration issued an executive order calling for a review of laws and regulations affecting the U.S. financial industry in order to determine their consistency with a set of core principles identified in the executive order. Several bills are pending in Congress that, if enacted, would amend the Dodd-Frank Act, including the Financial CHOICE Act (the “CHOICE Act”), which was approved by the House of Representatives and the Economic Growth, Regulatory Relief and Consumer Protection Act which is awaiting consideration in the Senate. The Administration has expressed support for these proposals and encouraged the House and Senate to work together to present legislation to the President as quickly as possible. The House and Senate legislation, while different, could change the process and criteria for designating
systemically important financial institutions, modify the Volcker Rule and make reforms to the Consumer Financial Protection Bureau, among other amendments to the Dodd-Frank Act. The CHOICE Act would also significantly enhance the SEC’s enforcement capabilities and increase the maximum civil penalties and criminal sanctions under federal securities laws, including under the Investment Company Act (the “1940 Act”) and the Advisers Act. Both the House and Senate proposals are still subject to amendment and possible reconciliation into a single proposal, the scope of which is not possible to determine at this time nor is it possible to determine if and when such a proposal may be presented to the President for enactment.
Recently enacted tax legislation commonly known as the Tax Cuts and Jobs Act of 2017 (the “TCJA”) made significant changes to the taxation of U.S. business entities, including by reducing the corporate income tax rate from 35% to 21%, eliminating the corporate alternative minimum tax, restricting deductions allowed for net operating losses to 80% of current year taxable income, permitting net operating losses to be carried forward indefinitely, and limiting the deductibility of business interest, among other changes. In addition, the TCJA changed the treatment of certain carried interests held by us by denying long-term capital gain treatment for gains recognized with respect to assets held for three years or less. We have not yet fully determined the effect the TCJA will have on us. See Note 11 for additional information regarding the effects of the TCJA on our consolidated financial statements.
Risk retention rules could adversely affect our CLO management business.investments.
On October 21•Increasing ESG-related requirements and October 22, 2014, the U.S. federal interagency credit risk retention rules codified at 17 CFR Part 246 (the “U.S. Risk Retention Rules”) were issued. Effective as of December 24, 2015 (in the case of securitizations collateralized by residential mortgages) or December 24, 2016 (the “Risk Retention Compliance Date”), the U.S. Risk Retention Rules promulgated by U.S. federal regulators under the Dodd-Frank Act generally require a “sponsor” of a “securitization transaction” to retain either directly or through a “majority-owned affiliate” an economic interest in the “credit risk” of “securitized assets” (as such terms are defined in the U.S. Risk Retention Rules), in one or more prescribed forms.
The U.S. Risk Retention Rules provide that “sponsor” means “a person who organizes and initiates a securitization transaction by selling or transferring assets, either directly or indirectly, including through an affiliate, to the issuing entity”. For purposes of CLO transactions, the preamble to the rule text in the U.S. Risk Retention Rules states that the agencies believe that the U.S. Risk Retention Rules apply to CLOs and managers of CLOs. Thus, to the extent required by applicable law, subject to further developments relating to the LSTA Risk Retention Decision described below and other changes in circumstances, any CLO transaction that issues securities after such Risk Retention Compliance Date (including as a result of “deemed” issuances of securities resulting from refinancing, re-pricings or material amendments) will typically be required to satisfy the U.S. Risk Retention Rules. At this time, however, there is uncertainty with respect to what is required to comply with the U.S. Risk Retention Rules in certain circumstances. In addition, there are a number of future uncertainties surrounding the U.S. Risk Retention Rules, particularly for certain collateral managers in certain CLO transactions, including: (i) as discussed in greater detail below, the ultimate results of litigation currently in process brought by the Loan Syndications and Trading Association (the “LSTA”), a major industry trade association, challenging, among other things, the regulators’ application of U.S. Risk Retention Rules to certain collateral managers of certain CLOs, (ii) proposed legislation designed to exclude from U.S. Risk Retention Rules qualified CLOs that meet certain criteria and (iii) future directives and interpretations by governmental authorities with respect to the U.S. Risk Retention Rules.
On February 9, 2018, the United States Court of Appeals for the District of Columbia (the “DC Circuit Court”) ruled in favor of an appeal brought by the LSTA and reversed a lower court decision in favor of the Securities and Exchange Commission and the Board of Governors of the Federal Reserve System (the “Applicable Governmental Agencies”) with instructions to grant summary judgment in favor of the LSTA on the issue of whether the U.S. Risk Retention Rules apply to certain collateral managers of certain CLOs under Section 941 of the Dodd-Frank Act (the “LSTA Risk Retention Decision”). If this decision stands and is implemented, certain CLO managers of certain CLOs will no longer be required to comply with the risk retention requirements of the U.S. Risk Retention Rules.
Subject to further developments relating to the LSTA Risk Retention Decision and other changes in circumstances, the U.S. Risk Retention Rules have caused, and may continue to cause, significant and potentially adverse changes to the CLO management business generally, and to our business specifically. Since the applicable Risk Retention Compliance Date, we have retained an “eligible vertical interest” (as such term is defined in the U.S. Risk Retention Rules) in a number of CLOs (the “Risk
Retention Interests” and each a “Risk Retention Interest”) directly through a standalone, self-managed collateral manager entity that is a wholly owned subsidiary of OZ Management LP, OZ CLO Management LLC (the “Retention Holder”). The Retention Holder has financed its acquisition of each Risk Retention Interest through a third party financing arrangement which provides for the Retention Holder to make additional borrowings to finance its purchase of notes issued by other CLO issuers for which the Retention Holder may become the collateral manager in the future. Subject to further developments relating to the LSTA Risk Retention Decision and other changes in circumstances, we may seek to retain additional risk retention interests directly through the Retention Holder, Och-Ziff Loan Management LP or through any other majority-owned affiliate. We may also seek to establish an additional standalone, self-managed collateral manager entity that will manage CLOs and retain risk retention interests directly or through a majority-owned affiliate. There can be no assurance that applicable regulatory or governmental authorities will agree that any of the approaches we adopt in order to comply with the requirements of the U.S. Risk Retention Rules satisfy such requirements. In addition, subject to further developments relating to the LSTA Risk Retention Decision and other changes in circumstances, in the event that the Retention Holder determines that it is no longer required to retain the Retention Interests under applicable law, and subject to any financing arrangements then in place, it may dispose of such Retention Interests.
Our efforts to undertake compliance with the U.S. Risk Retention Rules have required, and, subject to further developments relating to the LSTA Risk Retention Decision and other changes in circumstances, will continue to require additional costs and expenses, which may be significant, and are further expected to require tying up capital thatexpectations could potentially be deployed in another manner in order to generate better risk-adjusted returns. In addition, in the event applicable regulatory or governmental authorities disagree that any of our adopted compliance approaches satisfy any applicable requirements of the U.S. Risk Retention Rules, this may expose us to additional costs and expenses, in addition to potential liability. Furthermore, we may be required to agree to certain undertakings and covenants in connection with complying with the U.S. Risk Retention Rules, breaches of which may cause us to incur liability. The Retention Holder’s third party recourse financing arrangement has imposed, and such financing arrangement, together with any additional third party recourse financing arrangement obtained in connection with retaining any future risk retention interest, may continue to impose, additional limitations or restrictions on our business that could adversely alter the way in our business is operated, reduce the value of our managing CLOs to us and to our shareholders, or otherwise adversely affect our business and operations generally, or the value of our shares. Generally, managing CLOs following the Risk Retention Compliance Date may be less valuable to us and our shareholders relative to managing CLOs prior to the Risk Retention Compliance Date.business.
The U.S. Risk Retention Rules are subject to varying interpretations, and one or more regulatory or governmental authorities could take positions with respect to the U.S. Risk Retention Rules that conflict with, or are inconsistent with, the U.S. Risk Retention Rules as understood or interpreted by us, the CLO management industry generally, or past or current regulatory or governmental authorities. Subject to further developments relating to the LSTA Risk Retention Decision and other•Regulatory changes in circumstances, available interpretive authority to date addressingjurisdictions outside the U.S. Risk Retention Rules applicable to CLOs is limited. Accordingly, no assurance can be made that the U.S. Risk Retention Rules, as understood or interpreted by us, by the CLO management industry generally, or by past or current regulatory or governmental authorities, will not be interpreted differently by applicable regulatory or governmental authorities, now or in the future, or that there will not be a change in applicable law or rules and regulations in the future that could adversely affect us or the CLOs we manage, including by making any structural changes or financing arrangements undertaken to facilitate compliance with the U.S. Risk Retention Rules obsolete, unnecessarily burdensome or otherwise economically or administratively disadvantageous.our business.
In addition to any potential direct effects on us or the CLOs we manage, the U.S. Risk Retention Rules also may have an adverse effect on the leveraged loan markets or credit markets generally, which may in turn adversely affect the CLOs we manage or our business generally.
No assurance can be given that the U.S. Risk Retention Rules will not have a material adverse effect on our business and operations.
Regulatory changes•National policies in jurisdictions outside the United States could adversely affectnegatively impact our business.
Similar to the United States, jurisdictions outside the United States in which we operate, in particular Europe, have become subject to further regulation. Governmental regulators and other authorities in Europe have proposed or implemented a number of initiatives and additional rules and regulations that could adversely affect our business.
The EU’s Alternative Investment Fund Managers Directive (2011/61/EU) (the “AIFMD”) became effective on July 21, 2011, but with implementation taking place between July 22, 2013 and July 22, 2014. As of January 1, 2017, all EU Member States had transposed the AIFMD into their domestic law. The AIFMD is complex and key aspects of it remain subject to further consultation and interpretation.
The AIFMD imposes significant regulatory requirements on alternative investment fund managers (“AIFMs”), operating within the EU, as well as prescribing certain conditions with regard to regulatory standards, cooperation and transparency that need to be satisfied for non-EU AIFMs to market alternative investment funds (“AIFs”) into EU Member States. Should any member of our group be treated as an AIFM operating within the EU, AIFMD rules would impose significant additional costs on the operation of our business in the EU and limit our operating flexibility. In any event, in order to market one of our AIFs to investors in the EU, the non-EU investment adviser of that AIF will be required to comply with the marketing conditions in the AIFMD and any additional national restrictions, assuming that national private placement is available. The AIFMD conditions are that the AIFM complies with specific notification or registration requirements and certain additional transparency requirements requiring disclosures to investors in the AIF and to EU regulators; the AIFM also complies with requirements relating to the acquisition of substantial stakes in EU companies; and the jurisdictions in which the non-EU AIFM and the relevant AIF are organized satisfy certain conditions with regard to regulatory standards, cooperation and transparency.
If the AIFMD’s marketing passport is made available to non-EU AIFMs, it is possible that national private placement regimes will be phased out, in which case such persons would, thereafter, need to comply with the AIFMD in full in order to be able to continue to market their AIFs within the EU. Again, such rules could, if they start to apply in full to our business, potentially impose significant additional costs on the operation of our business in the EU and could limit our operating flexibility and our ability to raise funds within the EU. There is also no requirement for EU Member States to make the private placement regimes available to non-EU AIFMs and consequently, individual EU Member States could, theoretically, seek to apply the rules set out in the AIFMD in full to non-EU AIFMs at any time, even before the marketing passport is made available to such non-EU AIFMs.
Separately to the AIFMD, the EU has also introduced significant changes to its regulation of EU securities and derivatives markets through new legislation known as “MiFID II” which came into force on January 3, 2018. MiFID II replaces the original MiFID I regime which had been in force since November 2007. MiFID II, which is comprised of the Markets in Financial Instruments Directive (2014/65/EU), the Markets in Financial Instruments Regulation ((EU)600/2014) and a number of regulatory and implementing technical standards that take the form of EU Delegated Acts, is the foundational legislation for investment firms operating in the EU, including our UK affiliates Och-Ziff Management Europe Limited (“OZME”) and Och-Ziff Europe Loan Management Limited (“OZELM”), both of which are authorized and regulated in the UK as MiFID investment firms.
MiFID II has imposed significant new organizational, conduct, governance, operational and reporting requirements on OZME and OZELM, including new requirements around the receipt of inducements and the use of soft dollars / dealing commissions, enhanced transaction reporting and pre and post-trade transparency requirements, formal telephone taping requirements, and new best execution rules. Further, new MiFID II rules may restrict the ability of other Oz entities domiciled outside of the EU (known as “third-country firms”) to provide investment services to clients domiciled in the EU. Other changes resulting from MiFID II may have an impact (indirectly) on any Oz entity or client that trades on EU markets or trading venues, or does business with EU-regulated banks or brokers. These impacts may include venue trading requirements for certain categories of shares and derivatives, restrictions on so-called “dark pool” trading, product banning powers, algorithmic trading restrictions, and enhanced requirements around the provision of direct market access / direct electronic access services.
In addition to the AIFMD and MiFID II, the EU has implemented, or is in the process of implementing, a number of measures in response to the financial crisis or as part of an ongoing program of legislative change. These include, but are not limited to:
The European Markets Infrastructure Regulation ((EU) No 648/2012) (known as EMIR), which, together with EU Delegated Acts, imposes clearing, risk mitigation, margining and trade reporting requirements on OTC derivatives counterparties.
The Solvency II directive, which applies capital charges on insurers in respect of their fund investments.
The Market Abuse Regulation ((EU) No. 596/2014) (known as MAR) and a directive designed to harmonize criminal sanctions for market abuse (called CSMAD) which came into force in July 2016 and which extended the EU’s market abuse regime to behavior in respect of financial instruments traded on a wider variety of trading venues and EU emission allowances, refined the definition of inside information, introduced a new offense of “attempted market manipulation” and strengthened regulatory authorities’ investigative and sanctioning powers.
A European Commission proposed Directive and Regulation on regulatory capital requirements for non-systemically important investment firms which, if implemented as planned in 2020, may result in OZME and OZELM needing to increase the amount of regulatory capital that they are currently required to set aside.
The General Data Protection Regulation ((EU) 2016/679) (the “GDPR”), which will come into effect on May 25, 2018, replacing the EU existing data protection regime, will introduce new enhanced requirements in respect of the processing of personal data (that will include amongst other things investor and employee data). The GDPR is expected to have a significant impact on those who act as data controllers and processors and those who intend to send personal data outside the EU.
Each or all of these measures could have direct and indirect effects on our business.
In the U.K., the Financial Conduct Authority (the “FCA”) is expected in the latter half of 2018 to formally extend the Senior Managers and Certification Regime (the “SMCR”) to “solo-regulated” firms such as OZME and OZELM. The SMCR will replace the existing FCA approved person regime and is expected to result in a significant increase in the requirements that will apply to certain OZME and OZELM staff and in the documentation and record-keeping needed to demonstrate compliance with the new regime.
In addition, the UK introduced a tax on “diverted profits,” effective April 1, 2015. The tax requirement remains controversial and, in some parts, unclear as to its operation. According to the UK government’s publications, the rules are intended to counteract “contrived arrangements” to divert profits from the UK by avoiding a UK taxable presence or by other contrived arrangements between connected entities. A 25% rate of tax will apply to diverted profits relating to UK activity, targeting foreign companies that are perceived as exploiting the UK’s permanent establishment rules or creating other tax advantages by using transactions or entities that lack economic substance. Credit will be available in some circumstances for foreign taxes incurred on the same profits. Statements by the UK government indicate that the legislation was not primarily focused on investment funds such as our funds, or non-UK investment managers of such funds such as Oz Management. While it is not possible to reach a definitive conclusion that the funds or the management entities will not be affected, we consider there to be sufficiently strong arguments as to why neither our funds nor the management entities should self-report for this tax. It is worth noting in this regard that the UK government is of the view that the tax is not within the terms of the U.S.-UK double taxation treaty, potentially limiting the availability of credit in the U.S., as well as treaty-based dispute resolution procedures.
If third-party•Third-party investors in our funds could exercise their right to remove us as investment manager or general partner of the funds, we would lose the assets under management in such funds, which would eliminate our management fees and incentive income derived from such funds.
The governing agreements of most of our funds provide that, subject to certain conditions, third-party investors in those funds have the right, without cause, to vote to remove us as investment manager or general partner of the fund by a simple majority vote, resulting in the elimination of the assets under management by those funds and the management fees and incentive income derived from those funds. In addition to having a significant negative impact on our business, financial condition or results of operations, the occurrence of such an event would likely result in significant reputational damage to us.
In addition, because our funds generally have an adviser that is registered under the Advisers Act, the management agreements of all of our funds would be terminated upon an “assignment” of these agreements without investor consent, which assignment may be deemed to occur in the event these advisers were to experience a change of control. We cannot be certain that consents required to assignments of our investment management agreements will be obtained if a change of control occurs. “Assignment” of these agreements without investor consent could cause us to lose the fees we earn from such funds.
Our failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business, financial condition or results of operations.
The Sarbanes-Oxley Act and the related rules require our management to conduct annual assessments of the effectiveness of our internal control over financial reporting and require a report by our independent registered public accounting firm, as well as an independent audit of our internal control over financial reporting. If our independent registered public accounting firm is unable to opine on the effectiveness of our internal control over financial reporting for any reason or we are unable to report our financial information on a timely basis due to matters impacting our internal controls, as has occurred in the past, we may become subject to adverse regulatory or other consequences, including sanctions or investigations by the SEC, and some of these consequences could have a material adverse effect on our business, financial condition or results of operations.
•Our failure to deal appropriately with conflicts of interest could damage our reputation and materially adversely affect our business, financial condition or results of operations.reputation.
As we expand the scope of our business, we increasingly confront potential conflicts of interest relating to our funds’ investment activities. Certain of our funds have overlapping investment objectives and potential conflicts may arise with respect to our decisions regarding how to allocate investment opportunities among or even within those funds. For example, a decision to acquire material non-public information about a company while pursuing an investment opportunity for a particular fund gives rise to a potential conflict of interest when it results in our having to restrict the ability of other funds to buy or sell securities in the public markets. In addition, fund investors and holders of our Class A Shares may perceive conflicts of interest regarding investment decisions for funds in which our executive managing directors and employees, who have and may continue to make significant personal investments, are personally invested.
It is possible that actual, potential or perceived conflicts could give rise to investor dissatisfaction or litigation or regulatory enforcement actions. Appropriately dealing with conflicts of interest is complex and difficult and our reputation could be damaged if we fail, or appear to fail, to deal appropriately with one or more potential or actual conflicts of interest. Regulatory scrutiny of, or litigation in connection with, conflicts of interest would have a material adverse effect on our reputation, which would materially adversely affect our business, financial condition or results of operations in a number of ways, including an inability to raise additional funds and a reluctance of counterparties to do business with us.
•Misconduct by our executive managing directors, employees or agents could harm us by impairing our ability to attract and retain investors and subjecting us to significant legal liability, regulatory scrutiny and reputational harm.
There is a risk that our executive managing directors, employees, joint venture partners, consultants or agents could engage in misconduct that materially adversely affects our business. We are subject to a number of obligations and standards arising from our asset management business and our authority over the assets we manage, as well as our status as a public company with securities listed on the NYSE. The violation of these obligations and standards by any of our executive managing directors, employees, joint venture partners, consultants or agents could materially adversely affect our investors, both in our funds and in our Class A Shares, and us. In addition to these numerous and complex obligations, our business requires that we properly deal with confidential matters of great significance to companies in which we may invest or with which we otherwise do business. If our executive managing directors, employees, joint venture partners, consultants or agents were improperly to use or disclose confidential information, we could be subject to litigation, regulatory investigations or sanctions and suffer serious harm to our reputation, financial position and current and future business relationships. Furthermore, there have been a number of recent highly publicized cases involving fraud or other misconduct by employees in the financial services industry generally and there can be no assurance that we will not suffer from similar employee misconduct. It is not always possible to detect or deter employee misconduct, and the precautions we take to detect and prevent this activity have not been and may not be effective in all cases. If one of our executive managing directors, employees, joint venture partners, consultants or agents were to engage in misconduct or were to be accused of such misconduct, even if such allegations were unsubstantiated, our reputation and our business, financial condition or results of operations could be materially adversely affected.
In recent years, the DOJ and the SEC have devoted greater resources to enforcement of the FCPA. In addition, the UK has recently significantly expanded the reach of its anti-bribery laws. While we have developed and implemented policies and procedures designed to ensure strict compliance by us and our personnel with the FCPA, such policies and procedures previously have not been, and in the future may not be effective in all instances to prevent violations. Any determination that we have
violated the FCPA or other applicable anti-bribery laws could subject us to, among other things, civil and criminal penalties, material fines, profit disgorgement, injunctions on future conduct, securities litigation and a general loss of investor confidence, any one of which could adversely affect our business, financial condition or results of operations.
•We may enter into new businesses, make future strategic investments or acquisitions or enter into joint ventures, each of which may result in additional risks and uncertainties in our business.
We intend, to the extent that market conditions warrant, to grow our business by increasing assets under management and creating new investment platforms and businesses. Accordingly, we may pursue growth through strategic investments, acquisitions or joint ventures, which may include entering into new lines of business in which we may not have extensive experience, including sponsoring business development companies. It is also possible that, from time to time, we may need to make payments in order to resolve commercial disputes. In addition, we expect opportunities will arise to acquire, or enter into joint ventures with, other alternative or traditional asset managers. To the extent we make strategic investments or acquisitions, enter into joint ventures, or enter into a new line of business, we will face numerous risks and uncertainties, including risks associated with the required investment of capital and other resources, the possibility that we have insufficient expertise to engage in such activities profitably or without incurring inappropriate amounts of risk, combining or integrating operational and management systems and controls, or loss of investors in our funds due to the perception that we are no longer focusing on our core fund management duties. Entry into certain lines of business may subject us to more complex or extensive new laws and regulations with which we may not be familiar, or from which we are currently exempt, and may lead to increased litigation and regulatory risk. If a new business that we enter into generates insufficient revenues or if we are unable to efficiently manage any expansion of our operations, our business, financial condition or results of operations could be materially adversely affected. In the case of joint ventures, we are subject to additional risks and uncertainties in that we may be dependent upon, and subject to liability, losses or reputational damage relating to, systems, controls and personnel that are not under our control.
Changes in the credit markets may negatively impact our ability to refinance our outstanding indebtedness or our ability to otherwise obtain attractive financing for our business, and may increase the cost of such financing if it is obtained, which would lead to higher interest expense or, with respect to our funds, lower-yielding investments, either of which would decrease our earnings. An increase in our borrowing costs may materially adversely affect our business, financial condition or results of operations.
In November 2019, our Revolving Credit Facility will expire and our Senior Notes will mature. At those times, we will be required to either refinance or replace any outstanding indebtedness under the Revolving Credit Facility (or to obtain a new revolving line of credit), and the Senior Notes, as applicable, by entering into one or more new credit facilities or issuing debt securities, which could result in higher borrowing costs, or issuing equity, which would dilute existing shareholders. We could also repay any outstanding loans under the Revolving Credit Facility, or the Senior Notes, by using cash on hand or cash from the sale of our assets, which would reduce amounts available for compensation of our employees or distribution to our Class A Shareholders and our executive managing directors. No assurance can be given that we will be able to enter into new credit facilities, issue debt securities or issue equity in the future on attractive terms, or at all. Loans under the Revolving Credit Facility may be subject to a base rate plus a margin or a LIBOR-based floating rate plus a margin, and the interest expense we incur may vary with changes in the applicable LIBOR reference rate. See “Item 7A. Qualitative and Quantitative Disclosures about Market Risk—Interest Rate Risk,” for additional information regarding the impact that a change in LIBOR would have on our annual interest expense associated with our debt obligations.
As our Revolving Credit Facility, the Senior Notes and, with respect to our funds, other committed secured credit facilities expire, or if our lenders fail, we will need to replace them by entering into new facilities or finding other sources of liquidity. Furthermore, to the extent that the debt financing markets make it difficult or impossible for us to refinance or replace our Revolving Credit Facility or the Senior Notes, we may be unable to repay the loans outstanding under the Revolving Credit Facility, if any, or the aggregate principal amount of the Senior Notes upon maturity, our liquidity may be reduced in a manner that may restrict or otherwise prevent us from funding or operating our general business affairs. We may be forced to sell assets, undergo a recapitalization or seek bankruptcy protection, and substantial doubt may be raised as to our status as a going concern. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” and “—Debt Obligations” for a discussion of our Revolving Credit Facility and overall liquidity position.
Furthermore, depending on the facts and circumstances, we may want to use significant borrowings to finance our business operations or growth. If we incur additional substantial indebtedness, we will be exposed to risks associated with the use of substantial borrowings, including those discussed below under “—Risks Related to Our Funds—Our funds may determine to use leverage in investments, which could materially adversely affect our ability to achieve positive rates of return on those investments.”
Risks Related to Our Funds
Our results of operations are dependent on the performance of our funds. Poor performance of our funds will result in reduced revenues and earnings and make it difficult for us to retain or attract investors to our funds, retain and increase assets under management and grow our business. The performance of each fund we manage is subject to some or all of the following risks.
•Difficult market conditions can adversely affect our funds in many ways, including by negatively impacting their performance and reducing their ability to raise or deploy capital, which could materially reduce our revenues and adversely affect our business, financial condition or results of operations.funds.
A recurrence of significant disruption and volatility in the global financial markets and economies could impair the investment performance of our funds. Additionally, we may not be able to raise capital for existing or new funds during, or even following, periods of market instability. Although we seek to generate consistent, positive, absolute returns across all market cycles, our funds have been and may be materially affected by conditions in the global financial markets and economic conditions. The global market and economic climate may become increasingly uncertain due to numerous factors beyond our control, including but not limited to, concerns related to unpredictable global market and economic factors, regulatory uncertainty, rising interest rates, inflation or deflation, the availability of credit, performance of financial markets, terrorism or political uncertainty.
A general market downturn, a specific market dislocation or deteriorating economic conditions may cause a material reduction in our revenues and adversely affect our business, financial condition or results of operations by causing:
A decline in assets under management, resulting in lower management fees and incentive income.
An increase in the cost of financial instruments, executing transactions or otherwise doing business.
Lower or negative investment returns, which may reduce assets under management and potential incentive income.
Reduced demand for assets held by our funds, which would negatively affect our funds’ ability to realize value from such assets.
Increased investor redemptions or greater demands for enhanced liquidity or other terms, resulting in a reduction in assets under management, lower revenues and potential increased difficulty in raising new capital.
Furthermore, while difficult market and economic conditions and other factors can potentially increase investment opportunities over the long term, including with respect to the competitive landscape for the hedge fund industry, such conditions and factors also increase the risk of increased investment losses and additional regulation, which may impair our business model and operations. Our funds may also be materially adversely affected by difficult market conditions if our investment professionals fail to assess the adverse effect of such conditions on our investments, resulting in a significant reduction in the value of those investments. Moreover, challenging market conditions may prompt alternative asset managers to reduce the management fee and incentive income rates they charge in order to retain assets. In response to competitive pressures or for any other reason, we may reduce or change the fee structures of our funds, which could reduce the amount of fees and income that we may earn relative to assets under management.
Most of our funds utilize investment strategies that depend on our ability to appropriately react to, or accurately assess, the occurrence of, certain events, including market and corporate events. If we fail to do so, our funds’ investment performance could be adversely affected in a material way.
•The historical returns attributable to our funds should not be considered as indicative of the future results of our funds or any future funds we may raise.
We have presented throughout this report the net composite returns relating to the historical performance of our most significant funds, and we have also referred to other metrics associated with historical returns, such as risk and correlation measures. The returns are relevant to us primarily insofar as they are indicative of incentive income we have earned in prior periods and are not indicative of any future fund returns.
Moreover, with respect to the historical returns of our funds:
The historical returns of our funds should not be considered indicative of the future results that should be expected from such funds or from any future funds we may raise.
Our funds’ returns, particularly during periods of more extreme market and economic conditions, have benefited from or been impaired by the existence or lack of investment opportunities and such general market and economic conditions, which may not repeat themselves, and there can be no assurance that our current or future funds will be able to avail themselves of profitable investment opportunities.
The historical rates of return of our funds reflect such funds’ historical expenses, which may vary in the future due to factors beyond our control, including changes in laws or regulations.
•We are subject to counterparty default risks.
Our funds enter into numerous types of financial arrangements with a wide array of counterparties around the world, including loans, swaps, repurchase agreements, securities lending agreements and other derivative and non-derivative contracts. The terms of these contracts are often customized and complex and these arrangements may occur in markets or relate to products that are not currently subject to experienced regulatory oversight. In particular, certain of our funds utilize prime brokerage arrangements with a relatively limited number of counterparties, which has the effect of concentrating the transaction volume (and related counterparty default risk) of these funds with these counterparties.
Our funds are subject to the risk that the counterparty to one or more of these contracts defaults, either voluntarily or involuntarily, under the contract. Any such default may occur rapidly and without prior notice to us. Moreover, if a counterparty defaults, we may be unable to take action to recover our assets or any amounts due to us, either because we lack the contractual ability or because market conditions make it difficult to take effective action. This inability could occur at any time, but particularly in times of market stress, which are precisely the times when defaults may be most likely to occur.
In addition, our risk-management assessments may not accurately anticipate the impact of market stress or counterparty financial condition and, as a result, we may not take sufficient action to reduce our risks effectively. Although each of our funds regularly monitors its credit exposures, default risk may arise from events or circumstances that are difficult to detect, foresee or evaluate. In addition, concerns about, or a default by, one large participant could lead to significant liquidity problems for other participants, which may in turn expose us to significant losses.
In the event of a counterparty default, particularly a default by a major commercial bank or other financial institution, one or more of our funds could incur material losses, and the resulting market impact of a major counterparty default could harm our business, results of operation and financial condition. In the event that one of our counterparties becomes insolvent or files for bankruptcy, our ability to eventually recover any losses suffered as a result of that counterparty’s default may be limited by the liquidity of the counterparty or the applicable legal regime governing the bankruptcy proceeding.
The counterparty risks that we face have increased in complexity and magnitude as a result of the financial crisis, including the sovereign debt crisis in Europe, and resulting impairment or insolvency of a number of major financial institutions that serve as counterparties for derivative contracts and other financial instruments with our funds. The consolidation or elimination of counterparties may also result in concentration of counterparty risk. In addition, counterparties have generally reacted to the ongoing market volatility by tightening their underwriting standards and increasing their margin requirements for all categories of financing, which has the result of decreasing the overall amount of leverage available to our funds and increasing the costs of borrowing.
•Poor performance of our funds would cause a decline in our revenues, results of operations and cash flows and could materially adversely affect our ability to retain capital or attract additional capital.
If our funds perform poorly, our revenues, results of operations and cash flows decline because the value of our assets under management decreases, which in turn results in a reduction in management fees. To the extent that our funds perform poorly and such performance is continuing at the end of a relevant commitment period, we would experience a reduction in incentive income and, if such reduction was substantial, could result in the elimination of incentive income for a given year and future years until that decrease has been surpassed by positive performance. Poor performance of our funds would make it more difficult for us to raise new capital and may cause investors in our funds to redeem their investments. Investors and potential investors in our funds continually assess our funds’ performance, as well as our ability to raise capital for existing and future funds. Our ability to avoid excessive redemption levels will depend in part on our funds’ continued satisfactory performance. Moreover, poor performance, particularly in our most significant funds, would harm our reputation and competitive standing, which would further impair our ability to retain or attract fund capital. These factors may cause us to reduce or change the fee structure of our funds in order to retain or continue to attract assets under management, which could further reduce the amounts of management fees and incentive income that we may earn relative to assets under management.
•Our funds may determine to use leverage in investments, which could materially adversely affect our ability to achieve positive rates of return on those investments.
Our funds use or may choose to use leverage, either directly or through the use of derivative instruments, to increase the yield on certain of their investments. The use of leverage poses a significant degree of risk, most notably by significantly increasing the risk of loss associated with leveraged investments that decline in value, and enhances the possibility of a significant loss in the value of the investments in our funds. Our funds may borrow money from time to time to purchase or carry securities. The interest expense and other costs incurred in connection with such borrowing may not be recovered by appreciation in the securities purchased or carried, and will be lost—and the timing and magnitude of such losses may be accelerated or exacerbated—in the event of a decline in the market value of such securities. Volatility in the credit markets increases the degree of risk associated with such borrowing. Gains realized with borrowed funds may cause a fund’s net asset value to increase at a faster rate than would be the case without borrowings. If investment results fail to cover the cost of borrowings, the fund’s net asset value could also decrease faster than if there had been no borrowings. Increases in interest rates could also decrease the value of fixed-rate debt investments made by our funds. To the extent our funds determine to significantly increase their use of leverage, any of the foregoing circumstances could have a material adverse effect on our financial condition, results of operations and cash flows.
•The due diligence process that we undertake in connection with investments by our funds may not reveal all facts that may be relevant in connection with making an investment.
Before investments are made by our funds, particularly investments in securities that are not publicly traded, we conduct due diligence that we deem reasonable and appropriate based on the facts and circumstances applicable to each investment. When conducting due diligence, we may be required to evaluate important and complex business, financial, tax, accounting, environmental and legal issues. Outside consultants, legal advisors, accountants and investment bankers may be involved in the due diligence process in varying degrees depending on the type of investment. Nevertheless, when conducting due diligence and making an assessment regarding an investment, we rely on the resources available to us, including information provided by the target of the investment and, in some circumstances, third-party investigations. The due diligence that we carry out with respect to any investment opportunity may not reveal or highlight all relevant facts that may be necessary or helpful in evaluating such investment opportunity, and such an evaluation will not necessarily result in the investment being successful. Moreover, the level of due diligence conducted with respect to a particular investment will vary and we may not properly assess the appropriate amount of diligence for each investment, which may result in losses.
•Our funds may invest in relatively high-risk, illiquid assets, including structured products, and may fail to realize any profits from these activities for a considerable period of time or lose some or all of the principal investments.
Our funds invest in securities that are not publicly traded or that are otherwise illiquid, including complex structured products. There may be no readily available liquidity in these securities, particularly at times of market stress or where many participants may be seeking liquidity at the same time. In many cases, our funds may be prohibited, whether by contract, by applicable securities laws or by the lack of a liquid market, from selling such securities for a period of time. Moreover, even if the
securities are publicly traded, large holdings of securities can often be disposed of only over a substantial length of time, exposing the investment returns to risks of downward movement in market prices during the required holding period. Accordingly, under certain conditions, our funds may be forced to either sell securities at lower prices than they had expected to realize or defer, potentially for a considerable period of time, sales that they had planned to make. Investment in illiquid assets involves considerable risk and our funds may lose some or all of the principal amount of such investments.
•Valuation methodologies for certain assets in our funds are subject to significant subjectivity and the values established pursuant to such methodologies may never be realized, which could result in significant losses for our funds.
There are no readily ascertainable market prices for the large number of the illiquid investments held by our funds. The fair value of the investments of our funds is determined periodically by us using a number of methodologies permitted by our funds’ valuation policies. These methodologies involve a significant degree of judgment and are based on a number of factors, which may include, without limitations, the nature of the investment, the expected cash flows from the investment, bid or ask prices provided by third parties for the investment, the length of time the investment has been held, the trading price of securities (in the case of publicly traded securities), restrictions on transfer and other recognized valuation methodologies. In addition, because certain of the illiquid investments held by our funds may be in industries or sectors that are under distress or undergoing some uncertainty, such investments may be subject to rapid changes in value caused by sudden company-specific or industry-specific developments.
Because valuations, and in particular valuations of investments for which market quotations are not readily available, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, determinations of fair value may differ materially from the values that would have resulted if a ready market had existed. Even if market quotations are available for our investments, such quotations may not reflect the value that may actually be realized because of various factors, including the possible illiquidity associated with a large ownership position, subsequent illiquidity in the market for a company’s securities, future market price volatility or the potential for a future loss in market value based on poor industry conditions or the market’s view of overall company and management performance.
Because there is significant uncertainty in the valuation of and in the stability of the value of illiquid investments, the fair values of such investments as reflected in a fund’s net asset value do not necessarily reflect the prices that might actually be obtained when such investments are sold. Realizations at values significantly lower than the values at which investments have been reflected in fund net asset values would result in losses for the applicable fund, a decline in management fees and the loss of potential incentive income. Also, a situation where asset values turn out to be materially different from values reflected in fund net asset values may cause investors to lose confidence in us, which could, in turn, result in redemptions from our funds, difficulties in our ability to raise additional capital or an increased risk of litigation by investors or governmental or self-regulatory organizations. These issues could result in regulatory scrutiny of our valuation methodologies, polices and related disclosures.
•Our funds make investments in companies that we do not control, exposing us to the risk of decisions made by others with whom we may not agree.
Investments by our funds will include investments in debt or equity of companies that we do not control. Such investments may be acquired by our funds through trading activities or through purchases of securities from the issuer. Those investments will be subject to the risk that the company in which the investment is made may make business, financial or management decisions contrary to our expectations, with which we do not agree or that the majority stakeholders or the management of the company may take risks or otherwise act in a manner that does not serve our interests. In addition, we may make investments in which we share control over the investment with co-investors, which may make it more difficult for us to implement our investment approach or exit the investment when we otherwise would. If any of the foregoing were to occur with respect to one or more significant investments, the values of such investments by our funds could decrease and our business, financial condition or results of operations could suffer as a result.
•Our funds make investments in companies that are based outside of the United States, exposing us to additional risks not typically associated with investing in companies that are based inU.S.
•Tariffs, sanctions and other restrictions imposed by the United States.
Many of our fundsU.S. government, and potential for further regulatory reform, may invest a significant portion of their assets in the equity, debt, loans or other securities of issuers located outside the United States. Investments in non-U.S. securities involve certain factors not typically associated with investing in U.S. securities, including risks relating to the following:
Currency exchange matters, including fluctuations in currency exchange ratescreate regulatory uncertainty and costs associated with conversion of investment principal and income from one currency into another.
Less developed or efficient financial markets than in the United States, which may not enable or permit appropriate hedging techniques or other developed trading activities, leading to potential price volatility and relative illiquidity.
The absence of uniform accounting, auditing and financial reporting standards, practices and disclosure requirements and less government supervision and regulation.
Differences in the legal and regulatory environment, including less-developed or less-comprehensive bankruptcy laws.
Fewer investor protections and less stringent requirements relating to fiduciary duties.
Difficulties in enforcing contracts and filing claims under foreign legal systems.
Less publicly available information in respect of companies in non-U.S. markets.
Certain economic and political risks, including potential exchange control regulations and restrictions on our non-U.S. investments and repatriation of profits on investments or of capital invested, the risks of political, economic or social instability, the possibility of expropriation or confiscatory taxation and adverse economic and political developments.
The possible imposition of non-U.S. taxes or withholding on income and gains recognized with respect to such securities.
There can be no assurance that adverse developments with respect to such risks will not materially adversely affect our funds’ investments that are held in certain countries orinvestment strategies and the returns from these investments.profitability of our funds.
•Risk management activities may materially adversely affect the return on our funds’ investments.
When managing our funds’ exposure to market risks, we may from time to time use hedging strategies and various forms of derivative instruments to limit the funds’ exposure to changes in the relative values of investments that may result from market developments, including changes in prevailing interest rates, currency exchange rates and commodity prices. The success of any hedging transactions generally will depend on our ability to correctly assess the degree of correlation between price movements of the hedging instrument, the position being hedged, the creditworthiness of the counterparty and other factors. As a result, while we may enter into a transaction in order to reduce our exposure to market risks, the transaction may result in poorer overall investment performance than if it had not been executed. Such transactions may also limit the opportunity for gain if the value of a hedged position increases. In addition, the degree of correlation between price movements of the instruments used in connection with hedging activities and price movements in a position being hedged may vary. For a variety of reasons, we may not seek or be successful in establishing a perfect correlation between the instruments used in a hedging or other derivative transaction and the position being hedged. An imperfect correlation could prevent us from achieving the intended result and could give rise to a loss. In addition, it may not be possible to fully or perfectly limit our exposure against all changes in the value of our investment because the value of investments is likely to fluctuate as a result of a number of factors, some of which will be beyond our control or ability to hedge.
•If our risk management processes and systems are ineffective, we may be exposed to material unanticipated losses.
We continue to refine•Our and implement our risk management techniques, strategiesfunds’ investments in special purpose acquisition companies, or SPACs, may expose us and assessment methods, such as the use of statistical and other quantitative and qualitative tools to identify, observe, measure and analyze the risks to which our funds are exposed. These methods, even if properly implemented, may not allow us to fully mitigate the risk exposure of our funds in all economic or market environments, or against all types of risk, including risks that we might fail to identify or anticipate. Some
of our strategies for anticipating and managing risk in our funds are based upon our use of historical market behavior statistics, which may not be an accurate predictor of current or future market risks. We apply statistical and other tools to these observations to measure and analyze the risks to which our funds are exposed. Any failure in our risk management systems, whether in design or implementation, to accurately identify and quantify such risk exposure could limit our ability to manage risks in the funds, identify appropriate investment opportunities or realize positive, risk-adjusted returns. Because neither our quantitative nor qualitative risk management processes can anticipate for every investment the economic and financial outcome or timing and other specifics of the outcome, we will, in the course of our activities, incur losses.
Our funds’ investments are subject to numerous additional risks.
Our funds’ investments are subject to numerous additional risks, including the following:
The funds may engage in short selling, which is subject to the theoretically unlimited risk of loss because there is no limit on how much the price of a security may appreciate before the short position is closed out. A fund may be subject to losses if a security lender demands return of the lent securities and an alternative lending source cannot be found or if the fund is otherwise unable to borrow securities that are necessary to hedge its positions.
Our funds may be limited in their ability to engage in short selling or other activities as a result of regulatory mandates. Such regulatory actions may limit our ability to engage in hedging activities and therefore impair our investment strategies. In addition, our funds may invest in securities and other assets for which appropriate market hedges do not exist or cannot be acquired on attractive terms.
Our funds may invest in companies with weak financial conditions, poor operating results, substantial financial needs, negative net worth and/or special competitive problems or that are involved in bankruptcy or reorganization proceedings. In such “distressed” situations, it may be difficult to obtain full information as to the exact financial and operating condition of the issuer. Depending on the specific fund’s investment profile, a fund’s exposure to distressed investments may be substantial in relation to the market for those investments and the investments may be illiquid and difficult to transfer. As a result, it may take a number of years for the fair value of our funds’ distressed investments to reflect their intrinsic value as perceived by us.
Distressed investments may be involved in work-outs, liquidations, spin-offs, reorganizations, bankruptcies and similar transactions and may purchase high-risk receivables. Additionally, the fair values of such investments may be subject to abrupt and erratic market movements and significant price volatility if they are widely traded securities and significant uncertainty in general if they are not widely traded securities or have no recognized market. Moreover, a major economic recession could have a materially adverse impact on the value of such securities. An investment in such business enterprises entails the risk that the transaction in which such business enterprise is involved either will be unsuccessful, will take considerable time or will result in a distribution of cash or a new security the value of which will be less than the purchase price to the fund of the security or other financial instrument in respect of which such distribution is received. In addition, if an anticipated transaction does not in fact occur, the fund may be required to sell its investment at a loss. Because there is substantial uncertainty concerning the outcome of transactions involving financially troubled companies, there is a potential risk of loss by a fund of its entire investment in each such company.
Investments in troubled companies may also be adversely affected by U.S. federal and state laws relating to, among other things, fraudulent conveyances, voidable preferences, lender liability and a bankruptcy court’s discretionary power to disallow, subordinate or disenfranchise particular claims. Investments in securities and private claims of troubled companies made in connection with an attempt to influence a restructuring proposal or plan of reorganization in a bankruptcy case may also involve substantial litigation. Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may also decrease the value and liquidity of securities rated below investment grade or otherwise adversely affect our reputation.
Credit risk may be exacerbated by a default by any one of several large institutions that are dependent on one another to meet their liquidity or operational needs, so that a default by one institution causes a series of defaults by the other institutions. This “systemic risk” could have a further material adverse effect on the financial intermediaries (such as prime brokers, clearing agencies, clearing houses, banks, securities firms and exchanges) with which the funds transact on a daily basis. Although the U.S. government, including the U.S. Treasury Department
and the Federal Reserve, has taken significant actions to prevent a systemic collapse, no assurance can be given that such actions will be sufficient or successful in all cases.
The effectiveness of investment and trading strategies depends largely on the ability to establish and maintain an overall market position in a combination of financial instruments. A fund’s trading orders may not be executed in a timely and efficient manner due to various circumstances, including systems failures or human error. In such event, the funds may only be able to acquire some but not all of the components of the position, or if the overall position were to need adjustment, the funds might not be able to make such adjustment. As a result, the funds would not be able to achieve the market position selected by the investment manager or general partner of such funds, and might incur a loss in liquidating their position.
Fund investments are subject to risks relating to investments in commodities, futures, options and other derivatives, the prices of which are highly volatile and may be subject to the theoretically unlimited risk of loss in certain circumstances, including if the fund writes a call option. Price movements of commodities, futures and options contracts and payments pursuant to swap agreements are influenced by, among other things, interest rates; changing supply and demand relationships; trade, fiscal, monetary and exchange control programs; and policies of governments and national and international political and economic events and policies. The value of futures, options and swap agreements also depends upon the price of the securities underlying them. In addition, the funds’ assets are subject to the risk of the failure of any of the exchanges on which their positions trade or of their clearinghouses or counterparties.
Our funds may make real estate investments, including, without limitation, the acquisition of real estate assets, the purchase of loans secured directly or indirectly by real estate and the purchase of securities backed by mortgage loans secured by real estate, which will be subject to the risks incident to the lending, ownership and operation of commercial and residential real estate, including (i) risks associated with both the domestic and international general economic climate; (ii) local real estate conditions; (iii) risks due to dependence on cash flow; (iv) risks relating to the decline in value of the real estate properties in question; (v)increased risks and operating problems arising out of the absence of certain construction materials; (vi) changes in supply of, or demand for, competing properties in an area (as a result, for instance, of over-building); (vii) the financial condition of tenants, buyers and sellers of properties; (viii) risks relating to the absence of debt financing or changes in its availability; (ix) energy and supply shortages; (x) laws assigning liability to the owners of real estate properties for environmental hazards existing on such properties; (xi) laws relating to real estate lending, management and/or ownership that are complex or unclear or otherwise difficult to comply with; (xii) changes in the tax, real estate, environmental and zoning laws and regulations; (xiii) various uninsured or uninsurable risks; (xiv) natural disasters; and (xv) the ability of the fund or third party borrowers to develop and manage the real properties. With respect to investments in equity or debt securities, the fund will in large part be dependent on the ability of third parties to successfully manage the underlying real estate assets. In addition, the fund may invest in mortgage loans that are structured so that all or a substantial portion of the principal will not be paid until maturity, which increases the risk of default at that time. The fund’s investment strategy, which may involve the acquisition of distressed or underperforming assets in a leveraged capital structure, will involve a high degree of legal and financial risk, and there can be no assurance that the fund’s rate of return objectives will be realized or that there will be any return of capital. There is no assurance that there will be a ready market for resale of investments because investments in real estate generally are not liquid.liabilities.
Risks Related to Our Organization and Structure
Control by Mr. Och of the•Our current and former executive managing directors’ total combined voting power of our shares could cause or prevent us from engaging in certain transactions, whichinfluence major corporate decisions that could materially adversely affectconflict with the market price of the Class A Shares or deprive our Class A Shareholders of an opportunity to receive a premium as part of a sale of our Company.
As of December 31, 2017, our executive managing directors control approximately 65.7% of the total combined voting powerinterests of our Class A SharesShareholders.
•Our Certificate of Incorporation and Class B Shares through their ownership of 100% of our Class B Shares and Mr. Och’s and certain other executive managing directors’ ownership of Class A Shares purchased on the open market. Our executive managing directors will receive additional Class B Shares resulting in additional control upon the conversion of any Group D Units into Group A Units. In addition, our executive managing directors received Class B Shares in connection with the grant of Group P Units under the 2017 Incentive Program. See Note 10 to our consolidated financial statements included in this report for additional information on the 2017 Incentive Program.
Each of our executive managing directors that owns Class B Shares has granted to the Class B Shareholder Committee, the sole member of which is currently our founder, Mr. Och, an irrevocable proxy to vote all of their Class B Shares as the Committee may determine in its sole discretion. Mr. Och will continue to serve as the sole member of the Class B Shareholder Committee until it is disbanded upon the termination of the Class B Shareholders Agreement, which will occur on the Transition Date. If the Class B Shareholders Agreement has not already been terminated as described above, this proxy will terminate upon the later of Mr. Och’s withdrawal, death or disability, or such time as our executive managing directors hold less than 40% of our total combined voting power.
Accordingly, Mr. Och currently has the ability to elect all of the members of our Board of Directors and thereby control our management and affairs. In addition, he currently is able to determine the outcome of all matters requiring shareholder approval and will be able to cause or prevent a change of control of our Company or a change in the composition of our Board of Directors, and could preclude any unsolicited acquisition of our Company. Mr. Och’s current control of voting power could deprive Class A Shareholders of an opportunity to receive a premium for their Class A Shares as part of a sale of our Company, and might ultimately affect the market price of the Class A Shares. If the Class B Shareholders Agreement has not already been terminated as described above, upon Mr. Och’s withdrawal, death or disability, the Class B Shareholder Committee will consist of either the remaining members of the Partner Management Committee, who shall act by majority vote in such capacity, or an executive managing director elected by majority vote of the remaining members of the Partner Management Committee to serve as the sole member of the Class B Shareholder Committee until the Transition Date.
In addition, the Class B Shareholders Agreement provides the Class B Shareholder Committee, so long as our executive managing directors and their permitted transferees continue to hold more than 40% of the total combined voting power of our outstanding Class A Shares and Class B Shares and prior to the Transition Date, with approval rights over a variety of significant Board actions, including:
Any incurrence of indebtedness, other than intercompany indebtedness, in one transaction or a series of related transactions, by us or any of our subsidiaries or controlled affiliates in an amount in excess of approximately 10% of the then existing long-term indebtedness of us and our subsidiaries.
Any issuance by us or any of our subsidiaries or controlled affiliates, in any transaction or series of related transactions, of equity or equity-related shares which would represent, after such issuance, or upon conversion, exchange or exercise, as the case may be, at least 10% of the total combined voting power of our outstanding Class A Shares and Class B Shares other than (i) pursuant to transactions solely among us and our wholly owned subsidiaries, (ii) upon issuances of securities pursuant to the Plan, (iii) upon the exchange by our executive managing directors of Group A Units for our Class A Shares pursuant to the exchange agreement or (iv) upon conversion of any convertible securities or upon exercise of warrants or options, which convertible securities, warrants or options may be issued and are either outstanding on the date of, or issued in compliance with, the shareholders’ agreement.
Any equity or debt commitment or investment or series of related equity or debt commitments or investments by us or any of our subsidiaries or controlled affiliates in an unaffiliated entity or related group of entities in an amount greater than $250 million.
Any entry by us, any subsidiary or controlled affiliate into a new line of business that does not involve investment management and that requires a principal investment in excess of $100 million.
The adoption of a shareholder rights plan.
Any appointment or removal of a chief executive officer or co-chief executive officer.
The termination of the employment of an executive officer or the active involvement of an executive managing director with us or any of our subsidiaries or controlled affiliates without cause.
In addition, until the Transition Date, our operating agreement requires that we obtain the consent of the Class B Shareholder Committee for specified actions primarily relating to our structure so long as any Class B Shares are outstanding. Our structure is intended to ensure that we maintain exchangeability of Group A Units for Class A Shares on a one-for-one basis. Accordingly, until the Transition Date, the Class B Shareholder Committee will have the right to approve or consent to actions that could result in an economic disparity between holders of our Class A Shares and other classes of equity, such as the issuance
of certain securities, making certain capital contributions, owning or disposing of certain assets, incurring certain indebtedness and conducting business outside of the Oz Operating Group.
Our operating agreement contains provisions that reduce fiduciary duties of our directors and officers with respect to potential conflicts of interest against such individuals and limit remedies available to our Class A Shareholders against such individuals for actions that might otherwise constitute a breach of duty.
Our operating agreement provides that in the event a potential conflict of interest exists or arises between any of our executive managing directors, our officers, our directors or their respective affiliates, on the one hand, and us, any of our subsidiaries or any of our shareholders, on the other hand, a resolution or course of action by our Board of Directors shall be deemed approved by all of our shareholders, and shall not constitute a breach of the fiduciary duties of members of the Board to us or our shareholders, if such resolution or course of action is: (i) approved by our Nominating, Corporate Governance and Conflicts Committee, which is composed of independent directors; (ii) approved by shareholders holding a majority of our shares that are disinterested parties; (iii) on terms no less favorable than those generally provided to or available from unrelated third parties; or (iv) fair and reasonable to us. Accordingly, if such a resolution or course of action is approved by our Nominating, Corporate Governance and Conflicts Committee or otherwise meets one or more of the above criteria, shareholders will not be able to successfully assert a claim that such resolution or course of action constituted a breach of fiduciary duties owed to our shareholders by our officers, directors and their respective affiliates. Under the Delaware General Corporation Law, which we refer to as the “DGCL,” in contrast, a corporation is not permitted to automatically exempt Board members from claims of breach of fiduciary duty under such circumstances.
Our operating agreement containsBy-Laws contain provisions limiting the liability of our officers and directors to us, which also reduces remedies available to our Class A Shareholders for certain acts by such persons.us.
Our operating agreement also provides that to the fullest extent permitted by applicable law our directors or officers will not be liable to us other than in instances of fraud, gross negligence and willful misconduct. Accordingly, unless our officers or directors commit acts of fraud, gross negligence or willful misconduct, our shareholders may not have remedies available against such individuals under applicable law. Under the DGCL, in contrast, a director or officer would be liable to us for: (i) breach of duty of loyalty to us or our shareholders; (ii) intentional misconduct or knowing violations of the law that are not done in good faith; (iii) improper redemption of stock or declaration of a dividend; or (iv) a transaction from which the director derived an improper personal benefit.
Our operating agreement also provides that we will indemnify our directors and officers for acts or omissions to the fullest extent permitted by law other than in instances of fraud, gross negligence and willful misconduct, against all expenses and liabilities (including judgments, fines, penalties, interest, amounts paid in settlement with the approval of the Company and counsel fees and disbursements) arising from the performance of any of their obligations or duties in connection with their service to us or the operating agreement, including in connection with any civil, criminal, administrative, investigative or other action, suit or proceeding to which any such person may hereafter be made party by reason of being or having been one of our directors or officers. Under the DGCL, in contrast, a corporation can only indemnify directors and officers for acts or omissions if the director or officer acted in good faith, in a manner he reasonably believed to be in the best interests of the corporation, and, in a criminal action, if the officer or director had no reasonable cause to believe his conduct was unlawful.
In the future, we may elect to rely on exceptions from certain corporate governance and other requirements under the rules of the NYSE.
Our executive managing directors control more than 50% of our voting power. We are therefore eligible for the “controlled company” exception from NYSE requirements that our Board of Directors be comprised of a majority of independent directors and that our Compensation Committee and Nominating, Corporate Governance and Conflicts Committee consist solely of independent directors. Although we do not currently intend to utilize this exception, we may in the future determine to do so.
•Because our executive managing directors hold their economic interest in our business directly in the OzSculptor Operating Group, conflicts of interest may arise between them and holders of our Class A Shares, particularly with respect to tax considerations.Shares.
As of December 31, 2017, our executive managing directors held 58.5% of the equity in the Oz Operating Group directly through Group A Units, rather than through ownership of our Class A Shares. In addition, as of December 31, 2017, our executive managing directors held a 14.5% interest in the Oz Operating Group in the form of Group D Units, which are non-equity profit interests. Because they hold their economic interests in our business directly through the Oz Operating Group, our executive managing directors may have conflicting interests with holders of Class A Shares or with us. For example, our executive managing directors will have different tax positions from holders of our Class A Shares which could influence decisions of the Class B Shareholder Committee (until disbanded effective as of the Transition Date) and also our Board of Directors regarding whether and when to dispose of assets, and whether and when to incur new or refinance existing indebtedness, especially in light of the existence of the tax receivable agreement. Decisions with respect to these and other operational matters could affect the timing and amounts of payments due to our executive managing directors and the Ziffs under the tax receivable agreement. In addition, the structuring of future transactions and investments may take into consideration our executive managing directors’ tax considerations even where no similar benefit would accrue to us or the holders of Class A Shares.
We intend•Our ability to pay regular quarterly distributions but our ability to do soClass A Shareholders may be limited by our holding company structure, as we are dependent on distributions from the Oz Operating Group to make distributions and to pay taxes and other expenses.structure.
As a holding company, our ability to make distributions or to pay taxes and other expenses is subject to the ability of our subsidiaries to provide cash to us. We intend to make quarterly distributions to our Class A Shareholders. Accordingly, we expect to cause the Oz Operating Group to make distributions to the direct owners of Oz Operating Group Units, currently our intermediate holding companies, and our executive managing directors, pro rata in an amount sufficient to enable us to pay corresponding distributions to our Class A Shareholders and make required tax payments and payments under the tax receivable agreement; however, no assurance can be given that such distributions will or can be made. Our Board of Directors can change our distribution policy or reduce or eliminate our distributions at any time, in its discretion. In addition, the Oz Operating Group is required to make minimum tax distributions to its direct unit holders, to which our Class A Shareholders may not be entitled, as distributions on Group B Units to our intermediate holding companies may be used to settle tax liabilities, if any, or other obligations. In addition, the Oz Operating Group may make distributions to our executive managing directors in respect of their Class C Non-Equity Interests with respect to cash awards granted to them from time to time. As a result, Class A Shareholders may not receive any distributions at a time when our executive managing directors are receiving distributions on their ownership interests. If the Oz Operating Group has insufficient funds to make such distributions, we may have to borrow additional funds or sell assets, which could have a material adverse effect on our business, financial condition or results of operations.
Furthermore, by paying cash distributions rather than investing that cash in our business, we might risk slowing the pace of our growth, or not having a sufficient amount of cash to fund our operations, new investments or unanticipated capital expenditures, should the need arise.
There may be circumstances under which we are restricted from making distributions under applicable law or regulation (for example, due to Delaware limited partnership act or limited liability company act limitations on making distributions if liabilities of the entity after the distribution would exceed the fair value of the entity’s assets) or under our Revolving Credit Facility.
•The declaration and payment of any future distributions will be at the sole discretion of our Board of Directors, which may change our distribution policy or reduce or eliminate our distributions at any time, in its discretion.Directors.
Because we have historically earned and recognized most of our incentive income in the fourth quarter of each year, we anticipate that quarterly distributions in respect of the first three calendar quarters•We will be disproportionaterequired to distributions in respect of the last calendar quarter, which will typically be paid in the first calendar quarter of the following year. Our Board of Directors will take into account such factors as it may deem relevant, including general economic and business conditions; our strategic plans and prospects; our business and investment opportunities; our financial condition and operating results; working capital requirements and anticipated cash needs; contractual restrictions and obligations, including payment obligations pursuant to the tax receivable agreement and restrictions pursuant to our Revolving Credit Facility; legal, tax and regulatory restrictions; and other restrictions and implications on the payment of distributions by us to our Class A Shareholders or by our subsidiaries to us
and such other factors as our Board of Directors may deem relevant. Any compensatory payments made to our employees, as well as payments that Oz Corp makespay amounts under the tax receivable agreementagreement.
•Our board of directors has publicly disclosed that it has formed a special committee to explore potential interest from third parties in a transaction that maximizes value for shareholders, and distributions to holders of ownership interests in respect of their tax liabilities arising from their direct ownership of ownership interests, will reduce amounts that would otherwise be available for distribution on our Class A Shares. In addition, discretionary income allocations on Class C Non-Equity Interests as determined by the Chairman of the Partner Management Committee (or, in the event there is no Chairman, the full Partner Management Committee acting by majority vote) in conjunction with our Compensation Committee, relating to cash awards granted to our executive managing directors will also reduce amounts available for distribution to our Class A Shareholders. We have granted RSUs that may settle in Class A Shares to certain of our executive managing directors, managing directors and other employees, and to independent members of our Board of Directors. All of these RSUs accrue distributions to be paid if and when the underlying RSUs vest. Distributions may be paid in cash or in additional RSUs that accrue additional distributions and will be settled at the same time the underlying RSUs vest.
The declaration and payment of any distribution may be subject to legal, contractual or other restrictions. For example, as a Delaware limited liability company, we are not permitted to make distributions if and to the extent that after giving effect to such distributions, our liabilities would exceed the fair value of our assets. In addition, we may not be permitted to make certain distributions if we are in default under our Revolving Credit Facility. Our cash needs and payment obligations may fluctuate significantly from quarterunable to quarter, and we may have material unexpected expenses in any period. This may cause amounts available for distribution to significantly fluctuate from quarter to quarter or may reduce or eliminate such amounts.
There areconsummate a number of risks involving the tax receivable agreement we are party to, including the risk that the Internal Revenue Service may challenge all or part of the tax basis increases and related increased deductions, and a court could sustain such a challenge, even with respect to amounts for which we have made payments pursuant to the tax receivable agreement.
The actual increase in tax basis of the Oz Operating Group assets resulting from an exchange or from payments under the tax receivable agreement, as well as the amortization thereof and the timing and amount of payments under the tax receivable agreement, will vary based upon a number of factors including the law in effecttransaction at the timeconclusion of an exchange or a payment under the tax receivable agreement, the timing of future exchanges, the timing and amount of prior payments under the tax receivable agreement, the price of our Class A Shares at the time of any exchange, the composition of the Oz Operating Group’s assets at the time of any exchange, the extent to which such exchanges are taxable and the amount and timing of the income of Oz Corp and our other intermediate corporate taxpayers that hold Group B Units in connection with an exchange, if any. Depending upon the outcome of these factors, payments that we may be obligated to make to our executive managing directors and the Ziffs under the tax receivable agreement in respect of exchanges are likely to be substantial. In light of the numerous factors affecting our obligation to make payments under the tax receivable agreement, however, the timing and amounts of any such actual payments are not reasonably ascertainable. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Tax Receivable Agreement.”
The Internal Revenue Service (“IRS”) may challenge all or part of increased deductions and tax basis increase, and a court could sustain such a challenge, which could result in a substantial increase in our tax liabilities. Were the IRS to challenge a tax basis increase, our executive managing directors and the Ziffs who have received payments under the tax receivable agreement will not reimburse the corporate taxpayers for any such payments that have been previously made. As a result, in certain circumstances, paymentsprocess, there could be made to our executive managing directors and the Ziffs under the tax receivable agreement in excess of the corporate taxpayers’ cash tax savings. The corporate taxpayers’ ability to achieve benefits from any tax basis increase, and the payments to be made under this agreement, will depend upon a number of factors, including the timing and amount of our future income.
Decisions made by our executive managing directors in the course of runningan adverse effect on our business, in particular decisions made with respect to the sale or dispositionfinancial condition and results of assets or change of control, may influence the timing and amount of payments that are payable to an exchanging or selling executive managing director or the Ziffs under the tax receivable agreement. In general, earlier disposition of assets following an exchange or acquisition transaction will tend to accelerate such payments and increase the present value of the tax receivable agreement, and disposition of assets before an exchange or acquisition transaction will tend to increase the tax liability of our executive managing directors or the Ziffs without giving rise to any rights to receive payments under the tax receivable agreement.operations.
In addition, the tax receivable agreement provides that, upon a merger, asset sale or other form of business combination or certain other changes of control, the corporate taxpayers’ (or their successors’) obligations with respect to exchanged or acquired units (whether exchanged or acquired before or after such change of control) would be based on certain prescribed assumptions, including that the corporate taxpayers would have sufficient taxable income to fully utilize the deductions arising from the increased tax deductions and tax basis and other benefits related to entering into the tax receivable agreement. Accordingly, obligations under the tax receivable agreement may make it more expensive for third parties to acquire control of us and make it more difficult for the holders of Class A Shares to recognize a premium in connection with any such transaction. Finally, we may need to incur debt to finance payments under the tax receivable agreement to the extent our cash resources are insufficient to meet our obligations under the tax receivable agreement, which may or may not be available on favorable terms, if at all.
•If we are deemed an investment company under the 1940 Act the applicable restrictions could make it impracticable for us to continue our business as contemplated and would have a material adverse impact on the market price of our Class A Shares.business.
We do not believe that we are an “investment company” under the 1940 Act because the nature of our assets and the sources of our income exclude us from the definition of an investment company under the 1940 Act. In addition, we believe our Company is not an investment company under Section 3(b)(1) of the 1940 Act because we are primarily engaged in a non-investment company business. We intend to continue to conduct our operations so that we will not be deemed an investment company. If we were to be deemed an investment company, restrictions imposed by the 1940 Act, including limitations on our capital structure and our ability to transact with affiliates, could make it impractical for us to continue our business as contemplated. In addition, we would no longer be treated, for U.S. federal income tax purposes, as a partnership and our earnings would become taxable as a corporation, which could have a material adverse effect on our business, financial condition or results of operations and the price of our Class A Shares.
Risks Related to Our Shares
•The market price and trading volume of our Class A Shares hashave been and may continue to be highly volatile, which could result in rapid and substantial losses for our shareholders.volatile.
The market price of our Class A Shares has been and may continue to be highly volatile and subject to wide fluctuations. In addition, the trading volume in our Class A Shares can be highly variable, which has caused and may continue to cause significant price variations to occur. The market price of our Class A Shares may fluctuate or decline significantly in the future.
Some of the primary factors that could negatively affect the price of our Class A Shares or result in fluctuations in the price or trading volume of our Class A Shares include:
Reductions or lack of growth in our assets under management, whether due to poor investment performance by our funds or redemptions by investors in our funds.
Difficult global market and economic conditions.
Loss of investor confidence in the global financial markets and investing in general and in alternative asset managers in particular.
Competitively adverse actions taken by other hedge fund managers with respect to pricing, fund structure, redemptions, employee recruiting and compensation.
Inability to attract, retain or motivate our active executive managing directors, investment professionals, managing directors or other key personnel.
Inability to refinance or replace our Revolving Credit Facility or the Senior Notes either on acceptable terms or at all.
Public or other offerings of additional Class A Shares.
Inability to develop or successfully execute on business strategies or plans.
Unanticipated variations in our quarterly operating results or dividends.
Failure to meet analysts’ earnings estimates.
Publication of negative or inaccurate research reports about us or the asset management industry or the failure of securities analysts to provide adequate coverage of our Class A Shares in the future.
Adverse market reaction to any indebtedness we may incur, Oz Operating Group Units or cash awards we may grant under our 2017 Incentive Program or otherwise, or any other securities we may issue in the future.
Changes in market valuations of similar companies.
Speculation in the press or investment community about our business.
Additional or unexpected changes or proposed changes in laws or regulations or differing interpretations thereof affecting our business or enforcement of these laws and regulations, or announcements relating to these matters.
Increases in compliance or enforcement inquiries and investigations by regulatory authorities, including as a result of regulations mandated by the Dodd-Frank Act and other initiatives of various regulators that have jurisdiction over us related to the alternative asset management industry.
Adverse publicity about the asset management industry generally or scandals involving hedge funds specifically.
•The price of our Class A Shares may decline due to the large number of shares eligible for future sale and for exchange into Class A Shares.
The market price of our Class A Shares could decline as a result of sales of a large number of our Class A Shares or the perception that such sales could occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time•Our current and price that we deem appropriate. As of December 31, 2017, 189,573,210 Class A Shares were outstanding and 30,724,645 interests were outstanding pursuant to our Amended and Restated 2007 Equity Incentive Plan, with approximately 6,209,679 Class A Shares and other plan interests that remain available for future grant under that plan. The Class A Shares reserved under the Amended and Restated 2007 Equity Incentive Plan are increased on the first day of each fiscal year during the plan’s term by the positive difference, if any, of (i) 15% of the number of outstanding Class A Shares (assuming the exchange of all outstanding Group A Units for Class A Shares) on the last day of the immediately preceding fiscal year over (ii) the number of shares reserved for issuance under the plan as of such date. As of December 31, 2017, 164,475,461 interests were outstanding pursuant to our 2013 Incentive Plan, and approximately 58,406,776 Class A Shares and other plan interests remain available for future grant under that plan. The Class A Shares reserved under our 2013 Incentive Plan are increased on the first day of each fiscal year during the plan’s term by 15% of any increase in the number of outstanding Class A Shares (assuming the exchange of all outstanding Oz Operating Group Units (other than Group B Units) for Class A Shares) from the number outstanding on the first day of the immediately preceding fiscal year.
As of December 31, 2017, our executive managing directors owned an aggregate of 345,222,691 Group A and D Units. The holder of any Group A Units generally has the right to exchange each of its Group A Units for one of our Class A Shares (or, at our option, a cash equivalent), subject to vesting, minimum retained ownership requirements and transfer restrictions. The Group D Units convert into Group A Units to the extent we determine that they have become economically equivalent to Group A Units. Promptly following the Transition Date, the Exchange Committee will be disbanded and the Exchange Agreement relating to the Group A Units will be terminated. Thereafter, any of our executive managing directors, including any Class B Shareholders, may exchange his or her vested Group A Units over a period of two years in three equal installments.
As of December 31, 2017, our executive managing directors owned an aggregate of 71,850,000 Group P Units. The holder of any Group P Unit generally has the right to exchange each of its Group P Units for one of our Class A Shares (or, at our option, a cash equivalent), subject to service and performance criteria, and only to the extent that we determine that they have become economically equivalent to Group A Units. See Note 10 to our consolidated financial statements included in this report for additional information regarding the terms of the Group P Units.
We are party to a registration rights agreement, as amended, with our executive managing directors pursuant to which we granted them certain demand and “piggyback” registration rights with respect to the resale of all Class A Shares delivered in exchange for Group A Units or otherwise held from time to time by executive managing directors that would be deemed affiliates (as such term is defined in Rule 144 of the Securities Act) of the Company, including after an exchange of Group P Units.
RSUs may be settled at the election of a majority of our Board of Directors in Class A Shares or cash. Subject to continued employment over the vesting period, the underlying Class A Shares will be issued, or cash in lieu thereof will be paid, as such RSUs vest. We filed registration statements on Form S-8 to register an aggregate of 67,188,267 Class A Shares reserved for issuance under our Amended and Restated 2007 Equity Incentive Plan and registration statements on Form S-8 to register an aggregate of 231,250,788 Class A Shares reserved for issuance under our 2013 Incentive Plan (in each case, not including automatic annual increases thereto). As a result, any Class A Shares issued in respect of the RSUs will be freely transferable by non-affiliates upon issuance and by affiliates under Rule 144, without regard to holding period limitations.
As of December 31, 2017, DIC Sahir Limited (“DIC”) owned 29,953,094 of our Class A Shares, which it purchased from us concurrent with the consummation of our IPO pursuant to a Securities Purchase and Investment Agreement. The transfer restrictions originally imposed by such agreement no longer apply to any of DIC’s Class A Shares, and DIC will be able to sell these Class A Shares.
Ourformer executive managing directors’ beneficial ownership of Class B Shares, our shareholders’ agreement, the tax receivable agreement and anti-takeover provisions in our charter documents and Delaware law could delay or prevent a change in control.
Our executive managing directors own all of our Class B Shares, which as of December 31, 2017, represent approximately 64.2% of the total combined voting power of our Company. In addition, our executive managing directors have granted an irrevocable proxy to vote all of such shares to the Class B Shareholder Committee (the sole member of which is currently Mr. Och) as it may determine in its sole discretion. As a result, Mr. Och is currently able to control all matters requiring the approval of shareholders and will be able to prevent a change in control of our Company. In addition, under the Class B Shareholders Agreement, the Class B Shareholder Committee has approval rights with respect to certain actions of our Board of Directors, including actions relating to a potential change in control, so long as our executive managing directors continue to hold at least 40% of our total combined voting power, and has the ability to initially designate five of the seven nominees to our Board of Directors, and, under our operating agreement, the Class B Shareholder Committee will have certain consent rights with respect to structural and other changes involving our Company. The Class B Shareholder Committee will be disbanded and the Class B Shareholders Agreement will be terminated on the Transition Date and, until such date, Mr. Och will remain the sole member of the Class B Shareholder Committee. See “—Risks Related to Our Organization and Structure—Control by Mr. Och of the total combined voting power of our shares could cause or prevent us from engaging in certain transactions, which could materially adversely affect the market price of the Class A Shares or deprive our Class A Shareholders of an opportunity to receive a premium as part of a sale of our Company.”
In addition, the tax receivable agreement provides that, upon a merger, asset sale or other form of business combination or certain other changes of control, the corporate taxpayers’ (or any successors’) obligations with respect to exchanged or acquired units (whether exchanged or acquired before or after such change of control) would be based on certain prescribed assumptions, including that the corporate taxpayers would have sufficient taxable income to fully utilize the deductions arising from the increased tax deductions and tax basis and other benefits related to entering into the tax receivable agreement. The provisions may make it more difficult and expensive for a third party to acquire control of us even if a change of control would be beneficial to the interests of our shareholders.
Further, provisions in our operating agreement may make it more difficult and expensive for a third party to acquire control of us even if a change of control would be beneficial to the interests of our shareholders. For example, our operating agreement provides for a staggered board of directors, requires advance notice for proposals by shareholders and nominations, places limitations on convening shareholder meetings, and authorizes the issuance of preferred shares that could be issued by our Board of Directors to thwart a takeover attempt. The market price of our Class A Shares could be materially adversely affected to the extent that Mr. Och’s control over us, as well as provisions of our operating agreement, discourage potential takeover attempts that our shareholders may favor.
Finally, some provisions of Delaware law may delay or prevent a transaction that would cause a change in our control. In this regard, Section 203 of the DGCL restricts certain business combinations with interested stockholders in certain situations. In general, this statute prohibits a publicly held Delaware corporation from engaging in a business combination with an interested stockholder for a period of three years after the date of the transaction by which that person became an interested stockholder, unless the business combination is approved in a prescribed manner. For purposes of Section 203, a business combination includes a merger, asset sale or other transaction resulting in a financial benefit to the interested stockholder, and an interested
stockholder is a person who, together with affiliates and associates, owns, or within three years prior, did own, 15% or more of voting stock. While Section 203 does not apply to limited liability companies, such companies may elect to utilize it. Although we currently have elected not to utilize Section 203, we may in the future determine to do so.
Risks Related to Taxation
•Our structure involves complex provisions of U.S. federal income tax law for which no clear precedent or authority may be available.
•We expect to pay more corporate income taxes and may be required to make accelerated payments under the tax receivable agreement as a result of the Corporate Classification Change.
•U.S. federal income tax reform could have uncertain effects.
•Our structure is subject to other potential legislative, judicial or administrative changes and differing interpretations, possibly on a retroactive basis.
•Tax gain or loss on disposition of our Class A Shares could be more or less than expected.
•New rules regarding U.S. federal income tax liability arising from IRS audits of partnerships could adversely affect shareholders.
•Our ability to use net operating loss carryforwards to offset future taxable income may be subject to limitations.
PART I
Item 1. Business
Business Description
Sculptor Capital is a leading institutional alternative asset manager, with approximately $35.9 billion in Assets Under Management as of February 1, 2023 and a global presence with offices in New York, London, Hong Kong, and Shanghai. We provide asset management services and investment products across Multi-Strategy, Credit, and Real Estate. We serve our global client base through our commingled funds, separate accounts, and specialized products. Our capabilities span all major geographies and asset classes. Our approach to asset management is based on the same fundamental elements that we have employed since Sculptor Capital was founded in 1994. Our distinctive investment process seeks to generate attractive and consistent risk-adjusted returns across market cycles through a combination of fundamental bottom-up research, a high degree of flexibility, a collaborative team, and integrated risk management. We currently serve a diverse global investor base with investment solutions across core capabilities in multi-strategy funds, dedicated credit funds, including opportunistic credit funds and Institutional Credit Strategies products and real estate funds. We also create value by expanding our product offering and enhancing our distribution channels.
Multi-Strategy - Our multi-strategy funds invest globally in high-conviction investment ideas across the depth and breadth of global equity, credit and convertible securities and derivatives markets with a mandate to generate strong and consistent risk-adjusted returns across market cycles with a focus on risk management and capital preservation. Our investment strategy benefits from flexible and dynamic capital allocations to the most attractive individual investment opportunities. The strategy primarily focuses on idiosyncratic opportunities where return drivers are less sensitive to the direction of broader financial markets. Through detailed, bottoms-up fundamental analysis and due diligence, we aim to identify investment opportunities where intermediate or long-term value is obscured by attributes such as complexity, corporate events, technical dislocations, or market misunderstandings. Our multi-strategy funds allocate capital across strategies and geographies opportunistically based on market conditions, with no predetermined capital allocations by strategy or asset class. Our investment strategies include Corporate Credit, Structured Credit, Convertible & Derivative Arbitrage, Merger Arbitrage, and Fundamental Equities.
Credit - Our credit platform comprises both opportunistic credit and Institutional Credit Strategies. Opportunistic credit focuses on global corporate, structured and private credit markets, with the ability to source both undervalued and dislocated assets in times of market distress and pursue more complex process-driven opportunities during periods of relative calm. This includes investments in distressed businesses, restructurings and bankruptcies. Our investment proposition is a result of our disciplined underwriting of credit fundamentals, a value creation process generally focused on idiosyncratic situations that are less correlated to markets and having a thorough understanding of the market environment that permits the nimble flow of capital across security types dependent on the spread environment. Institutional Credit Strategies invests in performing credit via leveraged loans, high yield bonds, private financing and investment-grade credit and serves clients through CLOs, collateralized bond obligations (“CBOs”), aviation securitizations, commingled products and customized solutions.
Real Estate - Our real estate funds invest in opportunistic real estate private equity and real estate credit in both North America and Europe. Our opportunistic investment approach generates attractive risk-adjusted returns relative to positioning within the capital structure. Our Real Estate business adopts a broader investment mandate than most fund managers, having invested in 28 different traditional and non-traditional asset classes across the debt / equity spectrum. Our business emphasizes preservation of capital and downside protection by seeking to generate attractive current returns through interest income and fees. The real estate funds focus on proprietary sourcing, discretion in deal selection, thorough due diligence, intensive asset management, multiple defined exit strategies and structured downside protection to seek and manage investments.
Our Assets Under Management
Our primary sources of revenues are management fees, which are primarily based on the amount of our Assets Under Management, and incentive income, which is based on the investment performance of our funds. Accordingly, for any given
period, our revenues will be driven by the combination of Assets Under Management and the investment performance of our funds. Our Assets Under Management are a function of the capital that is allocated to us by the investors in our funds and the investment performance of our funds. For additional information regarding Assets Under Management, please see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Managing Business Performance”
Overview of Our Funds
Multi-Strategy
As of December 31, 2022, Assets Under Management in our multi-strategy funds totaled approximately $9.2 billion, or 25% of our total Assets Under Management. These funds seek to consistently generate strong risk-adjusted returns across market cycles with a focus on risk management and capital preservation. We aim to achieve these objectives by investing in high-conviction investment ideas across asset classes, regions and strategies, with a primary focus on idiosyncratic opportunities where return drivers are less sensitive to direction of broader financial markets. Our investment strategy seeks to benefit from flexible and dynamic capital allocations to the most attractive individual investment opportunities. Sculptor’s investment process combines expert bottom-up fundamental analysis, a dynamic approach to portfolio construction, and a sophisticated and fully integrated risk management effort. The primary investment strategies we employ in our multi-strategy funds include the following:
•Corporate Credit takes an opportunistic approach to corporate credit investing and includes investments in undervalued or dislocated securities and pursuing process-driven investments including investments in complex distressed businesses, restructurings and bankruptcies. We take a fundamental investment approach to identify investments that may be undervalued due to complexity, market inefficiencies or other investors’ lack of scale, capability or mandate to pursue these investments. Our ability to participate in many of these types of investments is a direct function of our presence in the markets, scale, experience and reputation as a counterparty.
•Structured Credit invests in a wide breadth of structured products, with a primary focus in several credit categories, including residential, commercial, corporate, and consumer credit, among others. This strategy aims to provide idiosyncratic and highly differentiated returns through process-driven investments in which value can be extracted through active rights enforcement, litigation, liquidation or restructuring. Our scale, propriety sourcing, collateral underwriting, and ability to analyze complex structures provides a competitive advantage. The strategy also invests in opportunities in areas such as CLO mezzanine debt, CMBS and ABS, pursuing positions that exploit market inefficiencies, misunderstandings and technical factors.
•Convertible and Derivative Arbitrage seeks to exploit the price discrepancies between certain convertible bonds and derivative securities and the underlying equity or other securities to generate strong, stable, and uncorrelated returns. We explore opportunities in traditional convertible arbitrage, mandatory convertible investments, short convertible strategies and relative value opportunities. Within this strategy, we also opportunistically invest in third party SPACs.
•Merger Arbitrage pursues a wide array of event-driven situations, with a focus on mergers and acquisitions in the U.S. and Europe. In addition to more-traditional merger arbitrage, the strategy also invests in favorably skewed risk/ reward opportunities in less-followed corporate actions, including exchange offers, unannounced deals, spin-offs, split-offs and hostile cross-border situations with regulatory and geopolitical complexity. Our flexible approach allows us to pursue strategies on a risk-adjusted basis and size them accordingly.
•Fundamental Equities seeks to generate returns through concentrated positions, both long and short, across global equity markets. The strategy employs a rigorous fundamental research process that draws on resources and knowledge from across the firm to generate investment ideas with medium to long-term time horizons. Our primary focus for long investments is situations where value is being obscured for an attributable reason with a path to value realization. Short positions generally focus on overvalued companies where earnings expectations in the future will be reduced as a result of secular challenges, cyclical headwinds, or a misjudgment of the fundamental earnings power of a business. The strategy’s best-ideas framework is complemented with dynamic hedging at the portfolio level to allow few constraints on net directional exposure.
The Sculptor Master Fund, our global multi-strategy fund, invests in high-conviction investment ideas across asset classes, regions and strategies, with a primary focus on idiosyncratic opportunities where return drivers are less sensitive to the direction of broader financial markets. The key limitations we consider when selecting and sizing investments are related to our fundamental and quantitative view on the risk/reward, liquidity and availability of the specific investment under evaluation. Sculptor Master Fund generally employs every strategy and geography in which our funds invest and constituted approximately 25% of our Assets Under Management as of December 31, 2022. The investment performance for our other funds may vary from those of the Sculptor Master Fund, and that variance may be material.
The table below sets forth, as of December 31, 2022, the net annualized return, volatility and Sharpe Ratio of the Sculptor Multi-Strategy Composite (as defined below), the HFRI Fund Weighted Composite Index, MSCI World Index and Balanced US 60/40 Index.
Past performance is no indication or guarantee of future results. | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net Annualized Return through December 31, 2022 | | 1 Year | | 3 Years | | 5 Years | | 10 Years | | Since Sculptor Multi-Strategy Composite Inception (April 1, 1994) |
Sculptor Multi-Strategy Composite(1) | | (12.9)% | | 3.0% | | 4.5% | | 5.6% | | 10.5% |
HFRI Fund Weighted Composite Index(2) | | (4.2)% | | 5.7% | | 4.4% | | 4.7% | | 7.4% |
MSCI World Index(2) | | (15.6)% | | 6.3% | | 7.4% | | 10.6% | | 7.7% |
Balanced U.S. 60/40 Index(2) | | (19.1)% | | 0.4% | | 2.7% | | 5.3% | | 4.8% |
Volatility - Standard Deviation (Annualized)(3) | | | | | | | | | | |
Sculptor Multi-Strategy Composite(1) | | 7.9% | | 10.5% | | 9.2% | | 7.3% | | 6.3% |
HFRI Fund Weighted Composite Index(2) | | 5.3% | | 9.0% | | 7.8% | | 6.0% | | 6.8% |
MSCI World Index(2) | | 20.4% | | 19.4% | | 17.0% | | 13.6% | | 14.2% |
Balanced U.S. 60/40 Index(2) | | 16.6% | | 14.6% | | 12.6% | | 9.9% | | 9.7% |
Sharpe Ratio(4) | | | | | | | | | | |
Sculptor Multi-Strategy Composite(1) | | (1.94) | | 0.20 | | 0.33 | | 0.63 | | 1.28 |
HFRI Fund Weighted Composite Index(2) | | (1.22) | | 0.52 | | 0.38 | | 0.62 | | 0.72 |
MSCI World Index(2) | | (0.87) | | 0.28 | | 0.35 | | 0.71 | | 0.36 |
Balanced U.S. 60/40 Index(2) | | (1.29) | | (0.04) | | 0.10 | | 0.44 | | 0.22 |
_______________
(1)The returns shown represent the composite performance of all feeder funds that comprise the Sculptor Master Fund since the inception of the Sculptor Master Fund on January 1, 1998, and are calculated using the total return of all feeder funds net of all fees and expenses and include the reinvestment of all dividends and other income. Since our inception on April 1, 1994 through December 31, 1997, we managed other accounts in a substantially similar manner to the Sculptor Master Fund, and in accordance with our same multi-strategy mandate that was not subject to portfolio investment restrictions or other factors that limited our investment discretion (the “Multi-Strategy Accounts”). The presentation of historical performance information in this table includes the performance of the Multi-Strategy Accounts for those periods prior to January 1, 1998. Performance is calculated using the total return of all such Multi-Strategy Accounts net of all investment fees and expenses of such accounts and include the reinvestment of all dividends and other income. For the period from April 1, 1994 through December 31, 1997, the returns are gross of certain overhead expenses that were reimbursed by the Multi-Strategy Accounts. Such reimbursement arrangements were terminated at the inception of the Sculptor Master Fund. The size of the accounts comprising the composite during the time period shown vary materially. Such differences impacted our investment decisions and the diversity of the investment strategies we followed. Furthermore, the composition of the investment strategies we follow is subject to our discretion and has varied materially since inception and is expected to vary materially in the future. We refer collectively to the combined returns of the Sculptor Master Fund and Multi-Strategy Accounts as the “Sculptor Multi-Strategy Composite.” We believe that the inclusion of the historical performance of the Multi-Strategy Accounts provides a more complete representation of our historical multi-strategy performance. The returns exclude realized and unrealized gains and losses attributable to currency hedging specific to certain investors investing in Sculptor Master Fund in currencies other than the U.S. dollar. The returns for the Sculptor Multi-Strategy Composite exclude Special Investments. Special Investments in the Sculptor Master Fund are held by investors representing a small percentage of Assets Under Management in the fund. Inclusive of these Special Investments, the net returns of the Sculptor Multi-Strategy Composite were (13.3)%, 2.8%, 4.1%, and 5.3% for the trailing one, three, five, and ten year periods, respectively; and 10.4% since the Sculptor Multi-Strategy Composite inception.
(2)These comparisons show the returns of the HFRI Fund Weighted Composite Index (HFRIFWI), the MSCI World Index (GDDLWI) and the Balanced US 60/40 Index (VBINX US Equity) and (collectively, the “Broader Market Indices”) against the Sculptor Multi-Strategy Composite. These comparisons are intended solely for illustrative purposes to show a historical comparison of the Sculptor Multi-Strategy Composite to the broader equity markets, as represented by the Broader Market Indices, and should not be considered as an indication of how the Sculptor Master Fund or the feeder funds will perform relative to the Broader Market Indices in the future. The Broader Market Indices are not performance benchmarks of the Sculptor Master Fund or the feeder
funds. Neither the Sculptor Master Fund nor the feeder funds are managed to correlate in any way with the returns or composition of the Broader Market Indices, which are unmanaged. It is not possible to invest in an unmanaged index. You should not assume that there is any material overlap between the securities underlying the Sculptor Multi-Strategy Composite and those that comprise the Broader Market Indices. The HFRI Fund Weighted Composite Index is a global equal-weighted index of over 2,000 single-manager funds that report to the HFR Database. Constituent funds report monthly, net of all fees, performance in U.S. dollar and have a minimum of $50.0 million under management or a twelve (12) month track record of active performance. The HFRI Fund Weighted Composite Index does not include Funds of Hedge Funds. The MSCI World Index is a free float-adjusted market capitalization weighted index owned and maintained by MSCI Inc. that is designed to measure the equity market performance of developed markets. The Balanced US 60/40 Index is a Vanguard Fund weighted index that invests roughly 60% in stocks and 40% in bonds by tracking the performance of the CRSP U.S. Total Market Index and Bloomberg Barclays U.S. Aggregate Float Adjusted Index. Returns of the Broader Market Indices have not been reduced by fees and expenses associated with investing in securities and include the reinvestment of dividends.
(3)Standard Deviation is a statistical measure of volatility that measures the fluctuation of the monthly rates of return against the average return.
(4)Sharpe Ratio represents a measure of the risk-adjusted return of the composite returns, or benchmark returns, as applicable. The Sharpe Ratio is calculated by subtracting the risk-free rate from the composite returns, or benchmark returns, as applicable, and dividing that amount by the standard deviation of the applicable returns. The risk-free rate of return used in computing the Sharpe Ratio is the one-month U.S. dollar London Interbank Offered Rate compounded monthly throughout the periods presented.
Credit
As of December 31, 2022, we managed approximately $22.3 billion of Assets Under Management in our dedicated credit funds, or 62% of our total Assets Under Management. Our dedicated credit funds comprise our opportunistic credit funds and Institutional Credit Strategies products.
The tables below present returns for our flagship credit funds:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net Annualized Return through December 31, 2022 | | 1 Year | | 3 Years | | 5 Years | | 10 Years | | Since Sculptor Credit Opportunities Master Fund Inception (November 1, 2011) |
Sculptor Credit Opportunities Master Fund(1) | | (4.1)% | | 3.4% | | 3.7% | | 6.8% | | 8.8% |
BAML Global High Yield(3) | | (13.2)% | | (1.7)% | | 0.9% | | 3.2% | | 4.3% |
HFRX Fixed Income Credit Index(3) | | (11.6)% | | (0.1)% | | 0.7% | | 1.2% | | 1.7% |
Volatility - Standard Deviation (Annualized)(3) | | | | | | | | | | |
Sculptor Credit Opportunities Master Fund(1) | | 5.4% | | 14.3% | | 11.3% | | 8.7% | | 8.5% |
BAML Global High Yield(3) | | 12.4% | | 12.2% | | 9.9% | | 8.1% | | 8.0% |
HFRX Fixed Income Credit Index(3) | | 6.9% | | 7.3% | | 5.9% | | 4.7% | | 4.6% |
Sharpe Ratio(4) | | | | | | | | | | |
Sculptor Credit Opportunities Master Fund(1) | | (1.14) | | 0.17 | | 0.20 | | 0.67 | | 0.92 |
BAML Global High Yield(3) | | (1.26) | | (0.21) | | (0.05) | | 0.28 | | 0.43 |
HFRX Fixed Income Credit Index(3) | | (2.07) | | (0.13) | | (0.13) | | 0.06 | | 0.18 |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Net Annualized Return through December 31, 2022 | | 1 Year | | 3 Years | | 5 Years | | 10 Years | | Since Customized Credit Focused Platform Inception (April 6, 2010) |
Customized Credit Focused Platform (weighted average returns)(2) | | (2.0)% | | 7.9% | | 7.0% | | 9.8% | | 11.3% |
BAML Global High Yield(3) | | (13.2)% | | (1.7)% | | 0.9% | | 3.2% | | 4.8% |
HFRX Fixed Income Credit Index(3) | | (11.6)% | | (0.1)% | | 0.7% | | 1.2% | | 1.5% |
Volatility - Standard Deviation (Annualized)(3) | | | | | | | | | | |
| Customized Credit Focused Platform | | 5.0% | | 11.0% | | 8.9% | | 6.9% | | 6.8% |
BAML Global High Yield(3) | | 12.4% | | 12.2% | | 9.9% | | 8.1% | | 8.4% |
HFRX Fixed Income Credit Index(3) | | 6.9% | | 7.3% | | 5.9% | | 4.7% | | 4.7% |
Sharpe Ratio(4) | | | | | | | | | | |
| Customized Credit Focused Platform | | (0.82) | | 0.50 | | 0.50 | | 1.14 | | 1.52 |
BAML Global High Yield(3) | | (1.26) | | (0.21) | | (0.05) | | 0.28 | | 0.48 |
HFRX Fixed Income Credit Index(3) | | (2.07) | | (0.13) | | (0.13) | | 0.06 | | 0.15 |
(1)The returns for the Sculptor Credit Opportunities Master Fund exclude Special Investments. Special Investments in the Sculptor Credit Opportunities Master Fund are held by investors representing a small percentage of Assets Under Management in the fund. Inclusive of these Special Investments, the net returns of the Sculptor Credit Opportunities Master Fund were (3.8)%, 3.5%, 3.6%, and 6.7% for the trailing one, three, five, and ten year periods, respectively; and 8.6% since the fund inception.
(2)Performance presented is for the opportunistic credit strategies in the Customized Credit Focused Platform. As of December 31, 2022, approximately 94% of the invested capital in the Customized Credit Focused Platform is invested in the Platform’s opportunistic credit strategies. Weighted Average Returns reflect the total profit & loss divided by the weighted average capital base, which represents net asset value plus net contributions (distributions) for the period.
(3)These comparisons show the returns of the BAML Global High Yield (“HW00”) and HFRX Fixed Income Credit Index (“HFRXFIC”). The BAML Global High Yield Index tracks the performance of USD, CAD, GBP and EUR denominated below investment grade corporate debt publicly issued in the major domestic or Eurobond markets. The HFRX Fixed Income Credit Index is a credit Index which includes strategies with exposure to credit across a broad continuum of credit sub-strategies, including Corporate, Sovereign, Distressed, Convertible, Asset Backed, Capital Structure Arbitrage, Multi-Strategy and other Relative Value and Event Driven sub-strategies. Investment thesis across all strategies is predicated on realization of a valuation discrepancy between the related credit instruments. Strategies may also include and utilize equity securities, credit derivatives, government fixed income, commodities, currencies or other hybrid securities. The methodology is based on defined and predetermined rules and objective criteria to select and rebalance components to maximize representation of the Hedge Fund Universe.
(4)Standard Deviation is a statistical measure of volatility that measures the fluctuation of the monthly rates of return against the average return.
(5)Sharpe Ratio represents a measure of the risk-adjusted return of the composite returns, or benchmark returns, as applicable. The Sharpe Ratio is calculated by subtracting the risk-free rate from the composite returns, or benchmark returns, as applicable, and dividing that amount by the standard deviation of the applicable returns. The risk-free rate of return used in computing the Sharpe Ratio is the one-month U.S. dollar London Interbank Offered Rate compounded monthly throughout the periods presented.
Opportunistic Credit Funds
As of December 31, 2022, we managed approximately $6.0 billion of Assets Under Management in our opportunistic credit funds. These products seek to generate risk-adjusted returns by capturing value in mispriced investments across disrupted, dislocated and distressed corporate, structured and private credit markets globally. As of December 31, 2022, Assets Under Management in the Sculptor Credit Opportunities Master Fund, our global opportunistic credit fund, totaled $1.7 billion, and Assets Under Management in the Customized Credit Focused Platform totaled $3.8 billion. The remainder of the Assets Under Management in our opportunistic credit products was made up of various open-end andclosed-end funds, as well as customized solutions structured to meet our fund investors’ needs.
Institutional Credit Strategies
As of December 31, 2022, we managed approximately $16.3 billion of Assets Under Management in our Institutional Credit Strategies products. Institutional Credit Strategies is our asset management platform that invests in performing credits, including leveraged loans, high-yield bonds, private credit/bespoke financing and investment grade credit via CLOs, aircraft securitization vehicles, CBOs, structured alternative investment solutions, commingled products and other customized solutions for clients. The Institutional Credit Strategies platform’s fundamental approach is built on capital preservation and rigorous assessment of relative value, proactive portfolio management combined with diversification, cross asset collaboration and integrated risk management.
Real Estate
As of December 31, 2022, we managed approximately $4.5 billion of Assets Under Management in our real estate funds, or 13% of our total Assets Under Management. Our real estate funds generally make investments in commercial and residential real estate, including real property, multi-property portfolios, real estate-related joint ventures, real estate operating companies and other real estate-related assets. We seek to build portfolios that are balanced between traditional and non-traditional asset classes, employing moderate leverage, using creative structures and targeting high cash-on-cash returns. Our opportunistic investment approach generates attractive risk-adjusted returns relative to positioning within the capital structure combined with a disciplined risk assessment process. These funds seek to diversify investments across geography, asset types and transaction structures to actively balance the portfolios within each of the funds. Our Real Estate business adopts a broader investment mandate than most fund managers, having invested in 28 different traditional and non-traditional asset classes across the debt/equity spectrum. Our two primary fund series are equity and credit opportunity funds (Sculptor Real Estate and Sculptor Real Estate Credit, respectively), and we also manage a SPAC. As of December 31, 2022, our real estate funds have invested across 28 different real estate asset classes with 72% of the capital deployed in non-traditional asset classes.
Over time, and in response to changing investment environments, asset pricing bubbles, and significant capital flows driving valuations past peak levels for the traditional asset classes in the major real estate markets, we developed significant experience and capabilities in more non-traditional asset classes. As a result we adopted a broad investment mandate, investing across traditional and niche asset classes along the entire real estate and real estate debt spectrum. Our real estate credit strategy is focused on distressed debt recapitalizations, certain construction lending opportunities, inefficiencies in non-traditional asset classes and attractive risk-adjusted returns in certain sectors with strong fundamentals.
The below table presents returns for select real estate funds:
| | | | | | | | | | | | | | |
Life-to-Date Performance (as of December 31, 2022) | Fund I | Fund II | Fund III | Credit Fund I |
| Gross | 25.5% | 32.9% | 30.3% | 18.3% |
| Net | 16.1% | 21.7% | 21.0% | 12.9% |
The performance tables provided throughout this “Overview of Our Funds” section are for illustrative purposes only and are not necessarily indicative of the future results of our funds. There can be no assurance that any fund will achieve comparable results. An investment in our Class A Shares is not an investment in any of our funds. See “Item 1A. Risk Factors—Risks Related to Our Business—An investment in our Class A Shares is not an alternative to an investment in any of our funds, and the returns of our funds should not be considered as indicative of any returns expected on our Class A Shares, although poor investment performance of, or lack of capital flows into, the funds we manage could have a materially adverse impact on our revenues and, therefore, the returns on our Class A Shares.”
Investment and Risk Management Process
Our extensive experience and consistent approach to investing and risk management are an essential part of our strong performance history. Risk management is a core element of our investment philosophy and process and plays a crucial role in the strategy and operations of our business. Our investment and risk management processes benefit from our dedicated and experienced teams operating out of our offices worldwide.
Our approach to investing and managing risk is defined by certain common elements:
•Proactive risk management is built on the principles of constant vigilance, frequent dialogue, and continuous improvement. We constantly monitor risk and have instituted a formal and consistent process to disseminate information, conduct informed debate, and take proactive or responsive action across our portfolios. Technology is at the core of Sculptor’s risk management efforts, and we leverage our broad capabilities to develop proprietary solutions that fit the exact specifications of our investment approach. In addition to our formalized process, we conduct custom studies and optimizations for various groups on an as-needed, ad hoc basis such as bespoke hedge solutions, pre-trade what-if analysis, and portfolio rebalance alternatives.
•Preservation of capital. Preservation of capital is our top priority and guiding factor in our effort to deliver attractive returns to fund investors. Our goal is to preserve capital during periods of market decline and generate competitive investment performance in rising markets. We use sophisticated risk tools and active portfolio management to govern exposures to market and other risk factors. We adhere strictly to each fund’s mandate and provisions with respect to leverage. We are knowledgeable about the risks of fund leverage, respectful of its limits, and judicious in our application.
•Dynamic capital allocation. We allocate to individual investments based on a thorough analysis of the risk/reward for each opportunity under consideration and the investment objectives for each of our funds. This results in an overall capital allocation that is constantly fine-tuned based on our best ideas at each point in time.
•Expertise across strategies and geographies. The considerable expertise, tenure and collaboration among our diverse interdisciplinary investment team forms the basis of our ability to generate attractive risk-adjusted returns for our fund investors. We have fostered a culture that allows us to analyze and scrutinize investment opportunities on a firm-wide basis, focusing on the best ideas and opportunities available.
Our Fund Investors
We focus on developing and maintaining long-term relationships with a global base of institutional investors, which includes many of the largest, most sophisticated investors in the world. Excluding our securitization vehicles within Institutional Credit Strategies products, we currently have over 1,300 investors in our funds, including pensions, sovereign wealth and corporates, high net worth and family office, fund-of-funds, and foundations and endowments. Over 70% of our clients have been partnering with us for over a decade. We build transparent, thoughtful, and enduring partnerships with our investors that are grounded in a deep understanding of their objectives and expectations. Our investors value our funds’ consistent performance history, our global investing expertise, our diverse investment strategies and our ability to develop investment capabilities in areas where we see opportunities evolve. As a result, a number of our fund investors invest in more than one of our funds.
Investments by our executive managing directors and employees collectively comprised approximately 2% of our total Assets Under Management as of January 1, 2023. The single largest unaffiliated investor in our funds accounted for approximately 19% of our total Assets Under Management as of January 1, 2023, and the top five unaffiliated fund investors accounted for approximately 43%. Approximately 28% of our Assets Under Management were from investors from outside North America as of January 1, 2023. These percentages, as well as those presented in the chart below, exclude Assets Under Management in our securitization vehicles, which are held by various types of investors.
The following chart presents the composition of our fund investors by type across our funds as of January 1, 2023:
Competitive Environment
The asset management industry is intensely competitive, and we expect that it will remain so. We compete globally and regionally with other investment managers, including hedge funds, public and private investment firms, distressed debt funds, mezzanine funds and other CLO issuers, real estate development companies, business development companies, investment banks and other financial institutions worldwide. We compete for both investors in our funds and attractive investment opportunities based on a number of factors, including investment performance, brand recognition, business reputation, pricing, innovation, the quality of services we provide to the investors in our funds, the range of products we offer, and our ability to attract and retain qualified professionals in all aspects of our business while managing our operating costs. We face competitors that are larger than we are and have greater financial, technical and marketing resources. Certain of our competitors may continue to raise capital to pursue investment strategies that may be similar to ours, which may create additional competition for investment opportunities. In addition, some of these competitors may have higher risk tolerances or make different risk assessments than we do, or may have lower return thresholds, allowing them to consider a wider variety of investments and establish broader networks of business relationships. They may also be subject to different regulatory requirements, which may give them greater flexibility to pursue investment opportunities or attract new capital to their funds. For additional information regarding the competitive risks that we face, see “Item 1A. Risk Factors—Risks Related to Our Business—Competitive pressures in the asset management business could materially adversely affect our business, financial condition or results of operations.”
Competitive Strengths
Sculptor Capital is built on certain distinct fundamental elements that we believe are differentiating competitive strengths. We view these elements as a crucial part of our efforts to generate attractive and consistent long-term investment performance and to retain and attract new Assets Under Management.
•Performance. Our funds have continued to deliver strong investment performance compared to relevant benchmarks and compound capital for our clients.
•Resilience. We have strengthened the balance sheet providing the firm with stability to weather potential downturns and opportunistically invest in our business to drive future returns for shareholders. We have increased our longer-duration AUM, creating longevity in our asset base and more stable earnings.
•Alignment of interests. Sculptor Capital’s structure is designed to motivate and align the interests of our executive managing directors and employees with those of investors in our funds and our Class A Shareholders. Our 25 active executive managing directors and 60 managing directors (as of December 31, 2022) have a compensation structure that focuses on both individual and firm-wide performance. This structure includes granting a portion of bonus compensation in a combination of equity and deferred cash interests that vest over time.
•One-firm philosophy. Our “one-firm” philosophy promotes a collaborative environment that encourages internal cooperation and cross-functional sharing of information, expertise and transaction experience gained over our 28-year history. We believe this strong collaborative approach is a key differentiator that enhances the success of our firm as a whole and brings to bear our diverse resources and perspectives.
•Synergies among investment strategies. Our investment model is built off of and benefits from full collaboration among our investment team, fostering trust, diverse viewpoints, cross-disciplinary development and critical self-examination. Sculptor’s investment team leadership comprises a group of 17 investment partners who have worked together for an average of over 15 years. We believe this approach and the tenure of our investment partners is a central factor in our ability to identify, evaluate and pursue opportunities across a broad range of geographies and capital structures.
•Global presence. We are a global organization with an investment philosophy that opportunistically pursues “best ideas” investment opportunities wherever they arise. Our ability to invest worldwide allows us to evaluate the fullest range of investments by employing both on-the-ground expertise and the support of our global team and infrastructure. Our investment professionals in the U.S., Europe and Asia are seamlessly integrated with the global team and have a long history of investing on an international scale.
•Experience. Sculptor’s one-firm philosophy and collaborative investment style is enabled by the long tenure and shared experience of our investment and executive teams. We have a history of hiring highly talented employees and developing them into senior roles as managing directors and executive managing directors across the firm.
•Focus on infrastructure. Since inception, Sculptor has been highly committed to building and maintaining a robust infrastructure with an emphasis on strong financial, operational and compliance controls. As of December 31, 2022, of our total 343 professionals, 209 were dedicated to global infrastructure, illustrating our commitment to this important part of our business.
•Transparency. We believe that our fund investors should be provided with qualitative and quantitative information about our investment process, operational procedures and portfolio exposures in order to fully understand and evaluate their partnership with Sculptor. We provide fund investors with comprehensive and transparent reporting on a regular basis, and our senior management and investment staff regularly meet with investors to provide updates and address questions.
Our Structure
Sculptor Capital Management, Inc.
Sculptor Capital Management, Inc. is a publicly traded holding company, and its primary assets are ownership interests in the Sculptor Operating Group entities, which are held indirectly through Sculptor Corp. We conduct our business through the Sculptor Operating Group. Sculptor Capital Management, Inc. currently has two classes of shares outstanding: Class A Shares and Class B Shares.
Class A Shares. Class A Shares represent Class A common stock in Sculptor Capital Management, Inc. The holders of Class A Shares are entitled to one vote per share held of record on all matters submitted to a vote of our shareholders and, as of December 31, 2022, represent 37.9% of our total combined voting power. The holders of Class A Shares are entitled to any distribution declared by our Board of Directors, subject to any statutory or contractual restrictions on the payment of distributions and to any restrictions on the payment of distributions imposed by the terms of any outstanding preferred shares we may issue in the future. Additional Class A Shares are issuable upon the exercise of warrants, as well as exchange of Partner Equity Units, subject to certain vesting and other conditions as discussed below, and upon vesting of equity awards granted under
our Amended and Restated 2007 Equity Incentive Plan, 2013 Incentive Plan or 2022 Incentive Plan. As of December 31, 2022, we have warrants outstanding to issue an additional 4,338,015 of Class A Shares. See Note 8 for additional details on warrants.
We have also issued RSAs to certain active executive managing directors. RSAs are restricted Class A shares that are not transferable, and are subject to forfeiture, until vesting conditions are met. The RSAs entitle the holders of record to one vote per share on all matters submitted to a vote of our shareholders and, as of December 31, 2022, the RSAs represent 8.3% of our total combined voting power. The RSAs are held solely by executive managing directors and have no economic rights until they vest upon satisfying a service condition and, where applicable, certain market performance conditions based on achievement of targeted total shareholder return on Class A Shares. Unvested RSAs without market performance vesting conditions accrue dividend equivalents in the form of additional RSAs, and RSAs with market performance vesting conditions that have not yet met the service condition do not begin to accrue dividend equivalents until the market performance conditions have been achieved.
Class B Shares. Class B Shares have no economic rights and are not publicly traded, but rather entitle the holders of record to one vote per share on all matters submitted to a vote of our shareholders and, as of December 31, 2022, the Class B Shares represent 53.7% of our total combined voting power. The Class B Shares are held solely by current and former executive managing directors and provide them with a voting interest in Sculptor Capital Management, Inc. commensurate with their economic interest in the Sculptor Operating Group in the form of Group A Units, Group A-1 Units (until a corresponding number of Group E Units (other than Group E-2 Units) have vested), Group E Units (once such Group E Units have vested) and Group P Units (assuming such Group P Units are participating). Each executive managing director holding Group A Units, Group A-1 Units (until a corresponding number of Group E Units (other than Group E-2 Units) have vested), vested Group E Units or Group P Units holds an equal number of Class B Shares. Upon an issuance of Group A Units or Group P Units to an executive managing director or the vesting of such executive managing director’s Group E Units, an equal number of Class B Shares is also issued to such executive managing director. Upon the exchange by an executive managing director of a Partner Equity Unit for a Class A Share as further discussed below, the corresponding Class B Share is canceled. Class B Shares that relate to our Group A-1 Units will be voted pro rata in accordance with the vote of the Class A Shares until a corresponding Group E Unit has vested.
Sculptor Operating Group Entities
We conduct our business through the Sculptor Operating Group. Historically, we have used more than one Sculptor Operating Group entity to segregate our operations for business, financial, tax and other reasons. We may increase or decrease the number of our Sculptor Operating Group entities and intermediate holding companies based on our views as to the appropriate balance between administrative convenience and business, financial, tax and other considerations.
The Sculptor Operating Group currently consists of Sculptor Capital LP, Sculptor Capital Advisors LP and Sculptor Capital Advisors II LP, and each of their consolidated subsidiaries (collectively, the “Sculptor Operating Partnerships” and collectively with their consolidated subsidiaries, the “Sculptor Operating Group”). Sculptor Capital Management, Inc. holds its interests in the Sculptor Operating Group indirectly through Sculptor Capital Holding Corporation (“Sculptor Corp”), a wholly owned subsidiary of Sculptor Capital Management, Inc. Sculptor Corp is the sole general partner of each of the Sculptor Operating Partnerships and, therefore, generally controls the business and affairs of such entities. The Sculptor Operating Group currently has the following units outstanding: Group A Units, Group A-1 Units, Group B Units, Group E Units and Group P Units.
The Group A Units and Group B Units have no preference or priority over other securities of the Sculptor Operating Group (other than the Group E Units and Group P Units to the extent described below) and, upon liquidation, dissolution or winding up, will be entitled to any assets remaining after payment of all debts and liabilities of the Sculptor Operating Group.
Group A Units. Our current and former executive managing directors own 100% of the Group A Units, which as of December 31, 2022, represent a 29.0% equity interest in the Sculptor Operating Group. Currently, Group A Units are exchangeable for our Class A Shares at the discretion of the Exchange Committee (which consists of the Chief Executive Officer and the Chief Financial Officer of Sculptor Capital Management, Inc.) (or the cash equivalent thereof), on a one-for-one basis, subject to vesting requirements by our executive managing directors, book-up requirements, transfer restrictions and certain exchange rate adjustments for splits, unit distributions and reclassifications. In connection with the Recapitalization, the Sculptor Operating Partnerships initiated a distribution holiday (the “Distribution Holiday”). Holders of Group A Units do not receive
distributions on such units during the Distribution Holiday. Each of our executive managing directors may exchange his or her vested and booked-up Group A Units over a period of two years in three equal installments commencing upon the final day of the Distribution Holiday and on each of the first and second anniversary thereof (or, for units that become vested and booked-up Group A Units after the final day of the Distribution Holiday, from the later of the date on which they would have been exchangeable in accordance with the foregoing and the date on which they become vested and booked-up Group A Units) (and thereafter such units will remain exchangeable), in each case, subject to certain restrictions (including, among other things, in connection with our insider trading policy in respect of affiliate holders and in certain circumstances where the exchange would be likely to impact our ability to use net operating losses). On the date of the Recapitalization, each Group A Unit then outstanding was recapitalized into 0.65 Group A Units and 0.35 Group A-1 Units. See Note 3 to our consolidated financial statements included in this report for additional information.
Group A-1 Units. Group A-1 Units are interests into which 0.35 of each Group A Unit then outstanding was recapitalized in connection with the Recapitalization. The Group A-1 Units will be canceled at such time and to the extent that the Group E Units granted in connection with the Recapitalization and associated with such Group A-1 Units vest and achieve a book-up. Group A-1 Units are not eligible to receive distributions at any time. However, the holders of Group A-1 Units shall participate in any sale, change of control or other liquidity event. In the Recapitalization, the holders of the 2016 Preferred Units forfeited 749,813 Group A Units, which were also recapitalized into Group A-1 Units.
Group B Units. Sculptor Corp holds a general partner interest and Group B Units in each Sculptor Operating Partnership that it controls. Group B Units are issued in respect to Class A Shares and Sculptor Corp owns 100% of the Group B Units, which, as of December 31, 2022, represent a 45.8% equity interest in the Sculptor Operating Group. Except during the Distribution Holiday, the Group B Units are economically identical to the Group A Units and represent common equity interests in our business, but are not exchangeable for Class A Shares and are not subject to vesting, forfeiture or minimum retained ownership requirements.
Group E Units.Group E Units are limited partner profits interests issued to certain executive managing directors that are only entitled to future profits and gains. Each Group E Unit converts into a Group A Unit and becomes exchangeable for one Class A Share (or the cash equivalent thereof) to the extent there has been a sufficient amount of appreciation for a Group E Unit to achieve a book-up target and, subject to other conditions contained in the limited partnership agreements of the Sculptor Operating Partnerships, the Distribution Holiday has ended (or an earlier exchange date is established by the Exchange Committee). The Group E Units are entitled to share in residual assets upon liquidation, dissolution or winding up and become eligible to participate in any tag along right, in a change of control transaction or other liquidity event only to the extent of their relative positive capital accounts (if any). One Class B Share will be issued to each holder of Group E Units upon the vesting of each such holder’s Group E Unit, at which time, with respect to all Group E Units (other than Group E-2 Units), a corresponding number of Class B Shares held by holders of Group A-1 Units will be canceled. The general partner of the Sculptor Operating Partnerships may conditionally issue additional Group E Units to active executive managing directors, in an aggregate number not to exceed the amount described in the Sculptor Operating Partnerships’ limited partnership agreements. The Group E Units convert into Group A Units to the extent they become economically equivalent to Group A Units. As part of the Recapitalization, holders of Group E Units will not receive distributions during the Distribution Holiday. See Note 3 to our consolidated financial statements included in this report for additional information.
Group P Units. On March 1, 2017, we issued Group P Units to certain executive managing directors. In December 2021, we issued additional Group P Units to certain executive managing directors and many Group P Units that were previously held by executive managing directors were forfeited. Group P Units entitle holders to receive distributions of future profits of the Sculptor Operating Group, and each Group P Unit becomes exchangeable for one Class A Share (or the cash equivalent thereof), in each case upon satisfaction of certain service and market performance conditions at such time and, with respect to exchanges, to the extent there has been sufficient appreciation for a Group P Unit to achieve a book-up target and, subject to other conditions contained in the limited partnership agreements of the Sculptor Operating Partnerships, the Distribution Holiday has ended (or an earlier exchange date is established by the Exchange Committee). The Group P Units are entitled to share in residual assets upon liquidation, dissolution or winding up and become eligible to participate in any tag along right, in a change of control transaction or other liquidity event only to the extent that certain market performance conditions are met and to the extent of their relative positive capital accounts (if any).
The terms of the Group P Units may be varied for certain executive managing directors. See Note 13 to our consolidated financial statements included in this report for additional information regarding the terms of the Group P Units.
Restricted Share Units
We grant RSUs as a form of compensation to our employees and executive managing directors. An RSU entitles the holder to receive a Class A Share, or cash equal to the fair value of a Class A Share at the election of the Board of Directors, upon completion of the requisite service period. We may grant, from time to time, RSUs that entitle the holder to receive cash equal to fair value of a Class A Share upon completion of the requisite service period. All of the RSUs granted to date accrue dividend equivalents equal to the dividend amounts paid on our Class A Shares. To date, these dividend equivalents have been awarded in the form of additional RSUs that also accrue additional dividend equivalents. Delivery of dividend equivalents on outstanding RSUs is contingent upon the vesting of the underlying RSUs. As part of the Recapitalization, certain RSUs held by directors and certain executive managing directors are limited in the amount of dividend equivalents they may receive during the Distribution Holiday. See Note 3 to our consolidated financial statements included in this report for additional information.
In 2018, we began granting PSUs. A PSU entitles the holder to receive a Class A Share, or cash equal to the fair value of a Class A Share at the election of the Board of Directors, upon completion of the requisite service period, as well as satisfying certain performance conditions based on achievement of targeted total shareholder return on Class A Shares. PSUs do not accrue dividend equivalents. See Note 13 to our consolidated financial statements included in this report for additional information regarding RSUs and PSUs.
The diagram below depicts our organizational structure as of December 31, 2022:
This diagram does not give effect to 4,338,015 Class A Shares that would be issued if all of our outstanding warrants were exercised. In addition, this diagram does not give effect to 3,893,011 RSUs that were outstanding as of December 31, 2022, which were granted to our executive managing directors, managing directors, other employees and the independent members of our Board of Directors. Also not presented in the diagram above are 5,348,572 Group P Units and 912,500 PSUs. The Group P Units and PSUs are not participating in the economics of Sculptor Operating Group, as the applicable Market Conditions (as defined in Note 13 to our consolidated financial statements) have not yet been met as of December 31, 2022. However, certain PSUs vested in the second quarter of 2021 at which time they were converted into Class A Shares. Further, not presented in the diagram above are Class C Non-Equity Interests, which are non-equity interests in the Sculptor Operating Group entities held by our executive managing directors in which they receive distributions in regards to annual discretionary cash bonus. No holder of Class C Non-Equity Interests will have any right to receive distributions on such interests. Our executive managing directors hold all of the Class C Non-Equity Interests, which may be used for discretionary income allocations, including the cash element of any discretionary annual performance awards paid to our executive managing directors. References to bonuses throughout this annual report include any Class C Non-Equity Interests distributions.
Human Capital
As of December 31, 2022, our worldwide headcount was 343, including 25 active executive managing directors and 60 managing directors, consisting of 106 investment professionals, 209 global infrastructure professionals and 28 client partner group professionals. We have built an experienced cross-functional team with a well-established presence in the United States, Europe and Asia.
Diversity, Equity and Inclusion
Sculptor is strongly committed to cultivating and growing a culture of diversity and inclusion. We believe that a breadth of backgrounds, experiences and knowledge is a competitive advantage and enhances the well-being and effectiveness of our employees. Sculptor’s diversity, equity and inclusion initiatives aim to recruit, retain, and promote diverse talent, as well as to engage and train employees with these goals in mind. We encourage employees to participate in and support one another through our affinity networks. Our current networks include affinity groups for Women, LGBTQ, Black & African American, Asian, and Hispanic & Latino employees. These groups assist in fostering diverse recruiting and retention efforts.
Recruiting and developing diverse talent is an ongoing focus for Sculptor. Sculptor targets a diverse candidate population through its recruiting efforts and partnerships with relevant organizations. Sculptor’s developmental efforts include day-to-day mentoring, training and firm-wide events. We also seek to promote diverse talent, including into senior leadership roles, wherever appropriate, which supports retention of diverse employees.
Sculptor’s annual employee performance review process is essential to establishing an equitable environment and to retaining our employees. The process ensures that employees receive detailed feedback on their performance on a formal basis at least once a year. Because compliance and ethics are a fundamental component of our firm’s culture, compliance with these key principles is part of our performance review process. Our review process also includes an evaluation of employees’ participation in promoting an inclusive firm culture. In connection with our goal to retain diverse talent and ensure an equitable environment, we regularly conduct pay equity reviews across all levels and groups within the firm.
Compensation and Benefits
We believe that equitable compensation and incentive programs are critical to hiring and retaining highly qualified people. We seek to provide a pay and benefits package that is competitive within the local marketplace for our industry to reward and retain our employees and attract new talent.
Our annual discretionary performance-based cash bonus program is a significant component of our compensation program and rewards employees based in part on firm performance which directly aligns our employees with our financial performance and strategic goals. To further align the interests of our employees and to cultivate a strong sense of ownership and commitment to our firm, certain employees are also eligible to receive awards of restricted stock units or participate in our other long-term incentive programs.
Additionally, we provide our employees with a comprehensive benefits package which includes, among other benefits, support and coverage for physical and mental wellness. These offerings are consistent with our commitment to the health, safety and well-being of our employees.
Environmental, Social and Governance (“ESG”)
As part of our investment approach, we view ESG integration as a key component of our underwriting and risk monitoring across all investment disciplines. We believe our approach to ESG integration contributes to acting in the best interests of our clients. We are a signatory, and seek to align our ESG investment practices with the tenets set out by the United Nations Principles for Responsible Investment (“UN PRI”). We recognize that industry guidelines and best practices for ESG management will continue to evolve over time. As such, we regularly review our publicly-available ESG policy and expect to adapt accordingly.
Our ESG policy covers all of our investment strategies and assets. This approach is rooted in our belief that ESG considerations can have important implications in investment decision-making. We see ESG integration as a complementary step in information processing that can improve investment outcomes: whereas traditional investment due diligence is focused on identifying and analyzing mostly financial and economic information, the additional step of proactively considering a broad range of non-financial risks and their materiality may enhance investment returns and optimize risk management.
Our investment professionals have primary responsibility for identifying ESG risks and opportunities as part of investment idea origination, and material issues are escalated for consideration by the relevant strategy head or investment committee, as appropriate. Similarly, all of our engagement activities are the responsibility of investment professionals and are not delegated to dedicated stewardship specialists. Strategy heads and the Partner Management Committee maintain ongoing oversight and monitoring of salient ESG matters across the portfolio through formal quarterly reporting, and informally as material ad-hoc considerations are escalated by investment professionals.
Regulatory Matters
Our business is subject to extensive regulation, including periodic examinations and regulatory investigations, by governmental and self-regulatory organizations in the jurisdictions in which we operate around the world. Since 1999, we have been registered with the SEC as an investment adviser under the Advisers Act. We are also a company subject to the registration and reporting provisions of the Exchange Act, and therefore subject to regulation and oversight by the SEC. As a company with a class of securities listed on the NYSE, we are subject to the rules and regulations of the NYSE. In addition, among other rules and regulations, we are subject to regulation by the Department of Labor under the U.S. Employee Retirement Income Security Act of 1974, which we refer to as “ERISA.” As a registered commodity pool operator and a registered commodity trading advisor, we are subject to regulation and oversight by the Commodity Futures Trading Commission, which we refer to as the “CFTC.” We are also subject to regulation and oversight by the National Futures Association in the U.S., as well as other regulatory bodies.
Our European and Asian operations, and our investment activities around the globe, are subject to a variety of regulatory regimes that vary country by country, including the U.K. Financial Conduct Authority, and the Securities and Futures Commission in Hong Kong. Currently, governmental authorities in the U.S. and in the other countries in which we operate have proposed additional disclosure requirements and regulation of hedge funds and other alternative asset managers.
See “Item 1A. Risk Factors—Risks Related to Our Business—Extensive regulation of our business affects our activities and creates the potential for significant liabilities and penalties. Our reputation, business, financial condition or results of operations could be materially affected by regulatory issues,” “—Increased regulatory focus in the U.S. could result in additional burdens on our business,” and “—Regulatory changes in jurisdictions outside the U.S. could adversely affect our business”.
Global Compliance Program
We have implemented a global compliance program to address the legal and regulatory requirements that apply to our company-wide operations. We have structured our global compliance program to address the requirements of each of our
regulators, as described above, as well as the requirements necessary to support our global securities, futures, swaps, commodities and loan trading operations.
Our compliance program includes comprehensive policies and procedures that have been designed and implemented to monitor compliance with these requirements. All employees are required to complete certain annual trainings to ensure that they have the information and skills necessary to perform their duties in accordance with all applicable laws and regulations and Sculptor’s requirements for the workplace. Mandatory annual compliance trainings are designed to reinforce our policies and procedures related to matters such as the handling of material non-public information, conflicts of interest and employee securities trading. Annual training specifically targeted at ensuring the understanding of and compliance with the FCPA and, as applicable, other foreign anti-corruption laws and regulations is mandatory for employees and executives responsible for structuring, supervising, ensuring compliance of and executing accounting functions for private deals, as well as for employees who interact with or provide reporting to investors. Annual trainings also cover areas relating to information security, as well as harassment prevention. In addition to a robust internal compliance framework, we have strong relationships with a global network of local attorneys specializing in compliance matters to help us quickly identify regulatory changes and address compliance issues as they arise.
Information about our Executive Officers
Set forth below is certain information regarding our executive officers as of the date of this filing.
James S. Levin, 40, is the Chief Investment Officer and Chief Executive Officer for Sculptor Capital. He is also a member of the Company’s Partner Management Committee, a member of the Company’s Board of Directors, an Executive Managing Director and a member of the Portfolio Committee. Prior to joining Sculptor Capital in 2006, Mr. Levin was an Associate at Dune Capital Management LP. Prior to that, Mr. Levin was an analyst at Sagamore Hill Capital Management, L.P. Mr. Levin holds a B.A. in Computer Science from Harvard University.
Dava Ritchea, 38, is the Chief Financial Officer of Sculptor Capital. She is also an Executive Managing Director and a member of the Company’s Partner Management Committee. Prior to joining Sculptor Capital in 2021, Ms. Ritchea served as Chief Financial Officer at Assured Investment Management (formerly known as BlueMountain Capital Management) from January 2017, and vice president of business management and strategy from October 2013 to January 2017. Prior to joining Assured Investment Management in 2013, Ms. Ritchea worked at Barclays Capital, Credit Suisse and Lehman Brothers in several investment banking and strategy roles. Ms. Ritchea received a B.S. in Business Administration with a minor in Mathematics from Carnegie Mellon University.
Wayne Cohen, 48, is the President and Chief Operating Officer for Sculptor Capital. He is also an Executive Managing Director, a member of the Company’s Partner Management Committee and a member of the Company’s Board of Directors. In this role, Mr. Cohen has a broad scope of responsibilities managing day-to-day operations of Sculptor Capital, including overseeing non-investment functions and leading strategic initiatives. Mr. Cohen joined the Company in 2005 working as an Attorney and General Counsel. Prior to joining Sculptor Capital, he was an Attorney at Schulte Roth & Zabel LLP. Mr. Cohen holds a B.A. in International Relations from Tulane University and a J.D. from New York University School of Law.
David M. Levine, 55, is the Chief Legal Officer for Sculptor Capital. He is also an Executive Managing Director and a member of the Company’s Partner Management Committee. In this role, Mr. Levine oversees the Company’s legal team and the management of its legal affairs. Mr. Levine has over 20 years practicing securities law. Prior to joining Sculptor Capital in January 2017, Mr. Levine spent 15 years at Deutsche Bank AG, where he served as Global Head of Litigation and Regulatory Enforcement. From 1993 through 2001, Mr. Levine worked at the SEC in both New York and in the Washington D.C. headquarters. During this time he served in a variety of roles including as the agency’s Chief of Staff, as well as Senior Adviser to the Director of Enforcement. Mr. Levine holds a B.S. from SUNY Albany, and a J.D. Degree from Hofstra University School of Law where he was valedictorian and an editor of the law review.
HapPollard, 44, is an Executive Managing Director and Chief Accounting Officer for Sculptor Capital. In this role, Mr. Pollard oversees the Public Entity, Corporate Finance and Accounting teams. He is responsible for the global corporate accounting function, which includes fund accounting, monthly and quarterly close processes, SEC filings, management reporting, expense management, treasury, compensation and regulatory reporting. Prior to joining Sculptor Capital in 2007, Mr. Pollard was
a Senior Manager of Financial Accounting and Control within the Asset Management Division at Morgan Stanley. Prior to that, he was an Auditor at KPMG and McGladrey & Pullen. Mr. Pollard holds a Bachelor of Science in Accounting from the University of Richmond. He is a Certified Public Accountant certified in the State of Virginia.
Item 1A. Risk Factors
In the course of conducting our business operations, we are exposed to a variety of risks that are inherent to or otherwise impact the alternative asset management business. Any of the risk factors we describe below have affected or could materially adversely affect our business, results of operations, financial condition and liquidity. The market price of our Class A Shares could decline, possibly significantly or permanently, if one or more of these risks and uncertainties occur. Certain statements in “Risk Factors” are forward-looking statements. See “Forward-Looking Statements.”
Risks Related to Our Business
Difficult global market, economic or geopolitical conditions may materially adversely affect our business and cause significant volatility in equity and debt prices, interest rates, exchange rates, commodity prices and credit spreads. These factors can materially adversely affect our business in many ways, including by reducing the value or performance of the investments made by our funds and by reducing the ability of our funds to raise or deploy capital, each of which could materially adversely affect our financial condition and results of operations.
The success and growth of our business are highly dependent upon conditions in the global financial markets and economic and geopolitical conditions throughout the world that are outside of our control and difficult to predict. Factors such as equity prices, equity market volatility, asset or market correlations, interest rates, counterparty risks, availability of credit, increasing inflation rates, economic uncertainty, changes in laws or regulation (including laws relating to the financial markets generally or the taxation or regulation of the hedge fund industry), trade barriers and tariffs, disease, commodity prices, currency exchange rates and controls, and national and international political circumstances (including governmental instability or dysfunction, wars, terrorist acts, security operations and the ongoing conflict between Russia and Ukraine) can have a material impact on the value of our funds’ portfolio investments or our general ability to conduct business. Difficult market, economic and geopolitical conditions can negatively impact those valuations and our ability to conduct business, which in turn would reduce or even eliminate our revenues and profitability, thereby having a material adverse effect on our business, financial condition or results of operations. As a global alternative asset manager, we seek to generate consistent, positive, absolute returns across all market cycles for the investors in our funds. Our ability to do this has been, and in the future may be, materially impacted by conditions in the global credit or equity financial markets and economic and geopolitical conditions worldwide.
Unpredictable or unstable market, economic or geopolitical conditions have resulted and may in the future result in reduced opportunities to find suitable risk-adjusted investments to deploy capital and make it more difficult to exit and realize value from our existing investments, which could materially adversely affect our ability to raise new funds and increase our Assets Under Management and, therefore, may have a material adverse effect on our business, financial condition or results of operations. In addition, during such periods, financing and merger and acquisition activity may be greatly reduced, making it harder and more competitive for asset managers to find suitable investment opportunities and to obtain funding for such opportunities. If we fail to react appropriately to difficult market, economic and geopolitical conditions, our funds could incur material losses.
Fiscal challenges facing the U.S. government could negatively impact financial markets which, in turn, could have an adverse effect on our financial position or results of operations.
Recent federal budget deficit concerns and political conflict over legislation to raise the U.S. government’s debt limit have increased the possibility of a default by the U.S. government on its debt obligations, related credit-rating downgrades, or an economic recession in the United States. As a result of uncertain domestic political conditions, including the possibility of the federal government defaulting on its obligations for a period of time due to debt ceiling limitations, investments in financial instruments issued or guaranteed by the federal government pose liquidity risks. A possible sovereign credit rating downgrade in response to current political dynamics, as well as sovereign debt issues facing the governments of other countries, could have a material adverse impact on financial markets and economic conditions in the U.S. and worldwide.
We may be adversely affected by the effects of inflation.
General inflation in the United States, Europe and other geographies has risen to levels not experienced in recent decades. Inflation has the potential to adversely affect our liquidity, business, financial condition and results of operations by increasing our overall cost structure, particularly increased prices will increase our costs and may lead to our clients requesting fewer services or decreased investment in our funds. The existence of inflation in the economy has resulted in, and may continue to result in, higher interest rates and capital costs, increased costs of labor, and other similar effects. Although we may take measures in an effort to mitigate the impact of this inflation, if these measures are not effective our business, financial condition, results of operations and liquidity could be materially adversely affected. Even if such measures are effective, there could be a difference between the timing of when such actions impact our results of operations and when the cost inflation is incurred.
An investment in our Class A Shares is not an alternative to an investment in any of our funds, and the returns of our funds should not be considered as indicative of any returns expected on our Class A Shares, although poor investment performance of, or lack of capital flows into, the funds we manage could have a materially adverse impact on our revenues and, therefore, the returns on our Class A Shares.
The returns on our Class A Shares are not directly linked to the historical or future performance of the funds we manage or the manager of those funds. Even if our funds experience positive performance and our Assets Under Management increase, holders of our Class A Shares may not experience a corresponding positive return on their Class A Shares.
However, poor performance of the funds we manage will cause a decline in our revenues from such funds, and may therefore have a negative effect on our performance and the returns on our Class A Shares. If we fail to meet the expectations of our fund investors or otherwise experience poor investment performance, whether due to difficult economic and financial conditions or otherwise, our ability to retain existing Assets Under Management and attract new investors and capital flows could be materially adversely affected. In turn, the management fees and incentive income that we would earn would be reduced and our business, financial condition or results of operations would suffer, thus negatively impacting the price of our Class A Shares. Furthermore, even if the investment performance of our funds is positive, our business, financial condition or results of operations and the price of our Class A Shares could be materially adversely affected if we are unable to attract and retain additional Assets Under Management consistent with our past experience, industry trends or investor and market expectations.
Investors in our funds have the right to redeem their investments in our funds on a regular basis and have in the past and could in the future redeem a significant amount of Assets Under Management during any given quarterly period. In addition, market or idiosyncratic factors may make it difficult to raise new capital from investors into our funds. Either or both of these circumstances could result in significantly decreased revenues and have a material adverse effect on our business, financial condition and results of operations.
Subject to any specific redemption provisions applicable to a fund, investors in our multi-strategy and opportunistic credit funds may generally redeem their investments in our funds on an annual or quarterly basis following the expiration of a specified period of time (typically between one and three years), although certain investors generally may redeem capital during such specified period upon giving proper notice. Investors in our funds have in the past and could in the future redeem a significant amount of Assets Under Management driven by a variety of factors, primarily the uncertainty and perceived instability created by recent public actions taken by the founder and former Chief Executive Officer of Och-Ziff, as well as market factors impacting investor allocations, idiosyncratic factors related to one or more investors (e.g., rebalancing), idiosyncratic factors related to one or more of our funds (e.g., fund performance) and other factors. These factors may also prevent us from raising new capital from investors into our funds. See separate Risk Factor in this Form 10-K entitled, “The founder and former Chief Executive Officer of Och-Ziff has taken certain actions that have had an adverse impact on our business.” If we are unable to replace redeemed amounts with new capital commitments or if additional investors seek significant redemptions of their investments in the future, our Assets Under Management will decline, which will reduce our revenues and could materially adversely affect our business, financial condition and results of operations. The decrease in revenues that would result from significant redemptions in our funds could have a material adverse effect on our business, financial condition or results of operations.
Our business, financial condition or results of operations may be materially adversely impacted by the highly variable nature of our revenues, results of operations and cash flows. In a typical year, a substantial portion of our incentive income and a large portion of our annual discretionary cash bonus expense is determined and recorded in the fourth quarter each year, which means that our interim results are not expected to be indicative of our results for a full year, which can cause increased volatility in the price of our Class A Shares.
Our revenues are influenced by the combination of the amount of Assets Under Management and the investment performance of our funds. Asset flows, whether inflows or outflows, can be highly variable from month-to-month and quarter-to-quarter. Furthermore, our funds’ investment performance, which affects the amount of Assets Under Management and the amount of incentive income we may earn in a given year, can be volatile due to, among other things, general market and economic conditions. Accordingly, our revenues, results of operations and cash flows are all highly variable. This variability is exacerbated during the fourth quarter of each year, primarily due to the fact that a substantial portion of our revenues historically has been and we expect will continue to be derived from incentive income from our funds. Such incentive income is contingent on the investment performance of the funds as of the relevant incentive period, which generally is as of the end of each calendar year; however, as of December 31, 2022, with respect to 72% of Assets Under Management, the initial commitment period can be three years or longer depending on how the assets are invested. The expiration of these commitment periods may occur on dates other than December 31, which, in certain circumstances, may cause increased volatility in our results. Moreover, in a typical year, we determine a large portion of our annual discretionary cash bonus during the fourth quarter largely based on current year fund performance regardless of the year in which incentive income is recognized. As a result, there may be differences in the timing of when bonuses are accrued and when the corresponding incentive income is recognized, particularly for performance generated on our longer-term AUM and AUM that have annual incentive income crystallization dates other than at year-end. Because the bonus is variable and discretionary, and may not necessarily be recognized in the year the related incentive income is recognized, this mismatch can exacerbate the volatility of our results. We may also experience fluctuations in our results from quarter to quarter due to a number of other factors, including changes in management fees resulting from changes in the management fee rates we charge our fund investors or due to changes in the values of our funds’ investments, as well as capital inflows or outflows. Changes in our operating expenses, unexpected business developments and initiatives and, as discussed above, general economic and market conditions may also cause fluctuations in our results from quarter to quarter. Such variability and unpredictability may lead to volatility or declines in the price of our Class A Shares and cause our results for a particular period not to be indicative of our performance in a future period or particularly meaningful as a basis of comparison against results for a prior period.
The amount of incentive income that may be generated by our funds is uncertain until it is actually crystallized. The commitment period for most of our multi-strategy Assets Under Management is for a period of one year on a calendar-year basis, and therefore we generally crystallize incentive income annually on December 31. We may also recognize incentive income related to fund investor redemptions at other times during the year, as well as on Assets Under Management subject to commitment periods that are longer than one year. We may also recognize incentive income from tax distributions relating to assets with longer-term commitment periods. As a result of these and other factors, our interim results may not be indicative of historical performance or any results that may be expected for a full year.
In addition, all of our hedge funds have “perpetual high-water marks.” This means that if a fund investor experiences losses in a given year, we will not be able to earn incentive income with respect to such investor’s investment unless and until our investment performance surpasses the perpetual high-water mark. For example, the incentive income we earn is dependent on the net asset value of each fund investor’s investment in the fund. However, failure to earn incentive income as a result of any high-water marks that do arise may adversely impact our business, financial condition or results of operations and our ability to make distributions to our Class A Shareholders. Our bonus expense may be recognized even when we do not recognize the related incentive income due to high-watermarks, resulting in additional earnings volatility.
As a result of quarterly fluctuations in, and the related unpredictability of, our revenues and profits, the price of our Class A Shares can experience significant volatility.
Competitive pressures in the asset management business could materially adversely affect our business, financial condition or results of operations.
The asset management business remains intensely competitive, with competition based on a variety of factors, including investment performance, the quality of service and level of desired information provided to fund investors, brand recognition and business reputation. We compete for fund investors, highly qualified talent, including investment professionals, and for investment opportunities with a number of hedge funds, private equity firms, specialized funds, traditional asset managers, commercial banks, investment banks and other financial institutions.
A number of factors create competitive risks for us:
•We compete in an international arena and, to remain competitive, we may need to further expand our business into new geographic regions or new business areas where our competitors may have a more established presence or greater experience and expertise.
•A number of our competitors have greater financial, technical, marketing and other resources and more personnel than we do.
•Several of our competitors have raised and continue to raise significant amounts of capital, and many of them have or may pursue investment objectives that are similar to ours, which would create additional competition for investment opportunities and may reduce the size and duration of pricing inefficiencies that many alternative investment strategies seek to exploit.
•Some of our competitors may have higher risk tolerances or different risk assessments, which could allow them to consider a wider variety of investments and to bid more aggressively than us for investments that we may want to make.
•Some of our competitors may be subject to less extensive regulation and thus may be better positioned to pursue certain investment objectives and/or be subject to lower expenses related to compliance than us.
•Other industry participants will from time to time seek to recruit our active executive managing directors, investment professionals and other professional talent away from us.
We may lose fund investors in the future if we do not match or provide more attractive management fees, incentive income arrangements, structures and terms than those offered by competitors. However, we may experience decreased revenues if we match or provide more attractive management fees, incentive income arrangements, structures and terms offered by competitors. In addition, changes in the global capital markets could diminish the attractiveness of our funds relative to investments in other investment products. This competitive pressure could materially adversely affect our ability to make successful investments and limit our ability to raise future successful funds, either of which would materially adversely impact our business, financial condition or results of operations.
If our investment performance, including the level and consistency of returns or other performance criteria, does not meet the expectations of our fund investors, it will be difficult for our funds to retain or raise capital and for us to grow our business. Additionally, even if our fund performance is strong, it is possible that we will not be able to attract additional capital. Further, the allocation of increasing amounts of capital to alternative investment strategies over the long term by institutional and individual investors may lead to a reduction in profitable investment opportunities, including by driving prices for investments higher and increasing the difficulty of achieving consistent, positive, absolute returns.
Competition for fund investors is based on a variety of factors, including:
•Investment performance.
•Investor liquidity and willingness to invest.
•Investor perception of investment managers’ ability, drive, focus and alignment of interest with them.
•Investor perception of robustness of business infrastructure and financial controls.
•Transparency with regard to portfolio composition.
•Investment and risk management processes.
•Quality of service provided to and duration of relationship with investors.
•Business reputation, including the reputation of a firm’s investment professionals.
•Level of fees and incentive income charged for services.
If we are not able to compete successfully based on these and other factors, our Assets Under Management, earnings and revenues may be significantly reduced and our business, financial condition or results of operations may be materially adversely affected. Furthermore, if we are forced to compete with other alternative asset managers on the basis of fees, we may not be able to maintain our current management fee and incentive income structures, which drive our revenues and earnings. We have historically competed for fund investors primarily on the investment performance of our funds and our reputation, and not on the level of our fees or incentive income relative to those of our competitors. However, as the alternative asset management sector continues to mature and addresses current market and competitive conditions, there is increasing downward pressure on management fees and a risk that incentive income rates will decline, without regard to the historical performance of a manager. Management fee or incentive income rate reductions on existing or future funds, particularly without corresponding increases in Assets Under Management or decreases in our operating costs, could materially adversely affect our business, financial condition or results of operations. In addition to the competitive pressures described above, as we diversify by offering new or enhanced products and investment platforms, the average management fee rate we earn on our Assets Under Management may fall as a result of a larger proportion of our Assets Under Management being invested in products that earn lower management fee rates. Our average management fee will vary from period to period based on the mix of products that comprise our Assets Under Management.
Even if we are able to compete successfully based on the factors noted above, it is possible we could lose Assets Under Management to our competitors. It is possible that similar circumstances could cause us to experience unusually high redemptions or a decrease in inflows, even if our investment performance and other business attributes are otherwise competitive or superior.
Damage to our reputation could harm our business.
Our business is highly competitive and we benefit from being highly regarded in our industry. Maintaining our reputation is critical to attracting and retaining fund investors and for maintaining our relationships with our regulators. Negative publicity regarding our company could give rise to reputational risk which could significantly harm our existing business and business prospects.
The founder and former Chief Executive Officer of Och-Ziff has taken certain actions that have had an adverse impact on our business.
The founder and former Chief Executive Officer (the “Founder”) of Och-Ziff, has taken certain public actions that have had an adverse impact on our business, including commencement of a Section 220 legal proceeding on August 24, 2022 in Delaware Chancery Court, October 4, 2022 and November 3, 2022 letters to Sculptor’s Board of Directors, simultaneously filed publicly with the SEC, and a January 27, 2023 Form 13D filing, See “Part II, Item 1. Legal Proceedings” for additional information. In each action, the Founder makes what we believe are inaccurate assertions with respect to our Board of Directors and our management team. Should such actions or similar actions persist, there will be a continuation of adverse impacts to our business, which include affecting our ability to retain and attract fund investors and highly qualified employees and our ability to raise new funds.
The uncertainty surrounding the ongoing COVID-19 pandemic, including the length and severity of its impact on global economic activity, caused a substantial disruption to many benchmark market indices and significantly increased volatility in equity and debt prices, interest and exchange rates, commodity prices and the ratings and cash flows of collateral in the CLOs that we manage. These factors may adversely impact our business in the future, which could adversely impact our business, financial condition, results of operations and liquidity. Additionally, we face various potential operational challenges due to the ongoing COVID-19 pandemic.
The degree to which COVID-19 may continue to impact our business, results of operations, financial condition and liquidity will depend on future developments, which are highly uncertain, difficult to predict and outside of our control, including the continued global spread of COVID-19 and spikes in infection rates, the severity and the duration of the pandemic, the efficacy employment and success of the COVID-19 vaccine, and further actions that may be taken by governmental authorities, businesses or individuals and how quickly and to what extent normal economic and operating conditions can resume. Risks that could be brought by the continuation of the COVID-19 pandemic include, but are not limited to, dislocations in market prices for investments in our funds, substantial market uncertainty which could lead to a decline in Assets Under Management and other negative effects that could flow from an overall economic downturn. As a result, the further impact on our business, results of operations, financial condition and liquidity cannot be reasonably estimated at this time, but the impact could be significant.
In the wake of the COVID-19 pandemic, certain of our employees are working remotely to mitigate the risks associated with COVID-19. While we have been successful in operating our business remotely, unexpected operational challenges may arise in the future and the use of remote work environments and virtual platforms may increase our risk of cyberattack or data security breaches. If we or any of our key service providers were to experience material disruptions in the ability for our or their employees to work remotely, our ability to operate our business could be materially adversely impacted. If our employees, including our executive managing directors and key investment professionals, were to become seriously ill, our ability to operate our business could be materially disrupted. Any such disruptions to our business operations could have a material adverse impact on our business, results of operation, financial condition or liquidity.
In addition, a resurgence of the COVID-19 pandemic could heighten many other risks described in this annual report.
The United Kingdom’s withdrawal from the European Union and the implications thereof on United Kingdom, European and global macroeconomics conditions could adversely affect our business.
The United Kingdom (the “UK”) left the European Union (the “EU”) on January 31, 2020 (commonly referred to as “Brexit”). The UK and the EU agreed to a Trade and Cooperation Agreement which sets out the agreement for certain parts of the future relationship between the EU and the UK from January 1, 2021. The Trade and Cooperation Agreement does not provide the UK with the same level of rights or access to all goods and services in the EU as the UK previously maintained as a member of the EU and during the transition period. As of January 1, 2021, our UK FCA-authorized affiliate, Sculptor Capital Management Europe Limited (“SCME”), ceased to be entitled to exercise single market passport rights to provide investment services in or into the EEA on a cross-border services basis.
From January 1, 2021, EU laws ceased to apply in the UK. However, many EU laws have been transposed into English law and these transposed laws will continue to apply until such time that they are repealed, replaced or amended. Depending on the terms of any future agreement between the EU and the UK on financial services, substantial amendments to English law may occur, and it is impossible to predict the consequences on our funds, their investments, and our business. Such changes could be materially detrimental to investors.
Although one cannot predict the full effect of Brexit, it could continue to have a significant adverse impact on the UK, European and global macroeconomic conditions and could lead to prolonged political, legal, regulatory, tax and economic uncertainty. This uncertainty may impact opportunities, pricing, availability and cost of bank financing, regulation, values or exit opportunities of companies or assets based, doing business, or having service or other significant relationships in, the UK or the EU, which may negatively impact our business, including companies or assets held or considered for prospective investment by our funds.
Brexit may result in an adverse effect on the management of market risk and, in particular, asset and liability management due in part to an adverse effect on our ability, and the ability of our affiliates to manage, operate and invest in our
funds and increased legal, regulatory or compliance burden for us, our affiliates and/or our funds, each of which may have a negative impact on the operations, financial condition, returns or prospects of our funds, which may have a negative impact on our business.
Areas where the uncertainty created by the UK’s withdrawal from the EU is relevant include, but are not limited to, trade within Europe, foreign direct investment in Europe, the scope and functioning of European regulatory frameworks (including with respect to the regulation of alternative investment fund managers and the distribution and marketing of alternative investment funds), industrial policy pursued within European countries, immigration policy pursued within European countries, the regulation of the provision of financial services within and to persons in Europe and trade policy within European countries and internationally. The uncertainty caused by the withdrawal may adversely affect the value of our funds’ investments and the ability to achieve the investment objective of our funds, as well as the investment objectives of our business.
Our indebtedness may restrict our current and future operations, particularly our ability to respond to certain changes or to take future actions.
On September 25, 2020, Sculptor Capital LP, as borrower, (the “Borrower”), and certain other subsidiaries of the Company, as guarantors, entered into a credit and guaranty agreement (the “2020 Credit Agreement”), consisting of (i) a senior secured term loan facility in an initial aggregate principal amount of $320.0 million (the “2020 Term Loan”) and (ii) a senior secured revolving credit facility in an initial aggregate principal amount of $25.0 million (the “2020 Revolving Credit Facility”). The funding of the 2020 Term Loan occurred on November 13, 2020 (the “Closing Date”). The 2020 Term Loan and the 2020 Revolving Credit Facility mature on the seventh and sixth anniversary of the Closing Date, respectively. Through the year ended December 31, 2022, we have repaid $225.0 million of the 2020 Term Loan, leaving a balance of $95.0 million. The 2020 Revolving Credit Facility remains undrawn.
The 2020 Credit Agreement contains a number of restrictive covenants that collectively impose operating and financial restrictions on the Sculptor Operating Group, including restrictions that may limit their ability to engage in acts that may be in our long-term best interests, including but not limited to:
•Incur certain additional indebtedness or issue certain equity interests.
•Create liens.
•Pay dividends or make other restricted payments.
•Make payments on, or redeem, repurchase or retire, subordinated debt.
•Merge, consolidate, or sell or otherwise dispose of all or any part of their assets.
•Engage in certain transactions with shareholders or affiliates.
•Engage in substantially different lines of business.
•Amend their organizational documents in a manner materially adverse to the lenders.
If we are unable to repay or refinance the debt at or prior to maturity, our business, financial condition and liquidity could be adversely effected.
In addition, the 2020 Credit Agreement requires us to comply with a minimum fee-paying Assets Under Management covenant. A failure to comply with the covenants and other obligations specified in the 2020 Credit Agreement could result in an event of default under 2020 Credit Agreement, which would give the lenders under the 2020 Credit Agreement the right to declare all amounts outstanding under the 2020 Credit Agreement, including accrued and unpaid interest and fees, to be immediately due and payable. If the indebtedness outstanding under 2020 Credit Agreement were to be accelerated, we may not have sufficient cash on hand or be able to sell sufficient assets to repay this indebtedness at such time, which may have a material adverse effect on our business, results of operations and financial condition.
For adescription of the 2020 Credit Agreement, please see Note 8 to our consolidated financial statements included in this annual report
The replacement of LIBOR with an alternative reference rate, may adversely affect our collateralized loan obligation transactions.
LIBOR and certain other “benchmarks” in recent years have been the subject of national, international, and other regulatory guidance and proposals for reform. Given these reforms, LIBOR will cease to exist in the future and its benchmark settings may perform differently than in the past or have other consequences which cannot be predicted.
In July 2017, the UK Financial Conduct Authority (the “FCA”) announced that it would phase out LIBOR as a benchmark by the end of 2021. The U.S. Federal Reserve, in conjunction with the Alternative Reference Rates Committee (“ARRC”), a steering committee comprised of large U.S. financial institutions, proposed replacing U.S. dollar LIBOR with a new index calculated by short-term repurchase agreements, backed by Treasury securities called the Secured Overnight Financing Rate (“SOFR”). The first publication of SOFR was released in April 2018. The Bank of England followed suit on April 23, 2018 by publishing its proposed alternative rate, the Sterling Overnight Index Average (“SONIA”).
On November 30, 2020, ICE Benchmark Administration Limited (“IBA”) announced its intention to cease the publication of (i) all GBP, EUR, CHF and JPY LIBOR settings, and the 1 Week and 2 Month USD LIBOR settings immediately following the LIBOR publication on December 31, 2021, and (ii) the Overnight and 1, 3, 6 and 12 Month USD LIBOR settings immediately following the LIBOR publication on June 30, 2023, subject to any rights of the FCA to compel IBA to continue publication. On March 5, 2021, the FCA released an announcement confirming that such LIBOR settings would cease to be provided by any administrator and would no longer be representative as of the dates specified in the IBA proposal, and confirmed that the FCA did not expect any LIBOR setting to become unrepresentative before such dates. Concurrent with the announcement made by the IBA, the Federal Reserve Board, the Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation released a statement that (i) encouraged banks to cease entering into new contracts that use U.S. dollar LIBOR as a reference rate as soon as practicable and in any event by December 31, 2021, (ii) indicated that new contracts entered into before December 31, 2021 should either utilize a reference rate other than U.S. dollar LIBOR or have robust fallback language that includes a clearly defined alternative reference rate after U.S. dollar LIBOR’s discontinuation and (iii) explained that extending the publication of certain U.S. dollar LIBOR tenors until June 30, 2023 would allow most legacy US dollar LIBOR contracts to mature before LIBOR experiences disruptions. The FCA subsequently confirmed that U.S. Dollar LIBOR tenors would either cease to exist or no longer be representative following June 30, 2023. On July 29, 2021, ARRC announced that it recommended Term SOFR, a similar forward-looking term rate which is based on SOFR, for business loans.
On April 6, 2021, the state of New York enacted legislation (the “New York LIBOR Legislation”) addressing the phase-out of LIBOR as a benchmark rate in contracts governed by New York law. The New York LIBOR Legislation provides a statutory remedy for contracts that reference USD LIBOR as a benchmark interest rate but do not include effective fallback provisions that address or operate adequately through a permanent cessation of LIBOR. Under the New York LIBOR Legislation, LIBOR references in such contracts would be replaced with SOFR plus any applicable spread adjustment and any conforming changes selected or recommended by the Federal Reserve Board, the Federal Reserve Bank of New York or by the ARRC. The New York LIBOR Legislation also establishes a safe harbor from liability for the selection and use of the recommended benchmark interest rate.
These announcements mean that LIBOR referencing contracts maturing after June 30, 2023, will need to be amended to reference alternative rates unless they are otherwise subject to contemplated regulatory or legislative remediation. These developments and uncertainties around further legislative or regulatory developments may adversely affect the market for LIBOR-based financial instruments, including interest rates on certain of our floating rate loans, deposits, derivatives, and other financial instruments tied to LIBOR rates, as well as the revenue and expenses associated with those financial instruments.
We commenced an enterprise-wide initiative to identify and help mitigate risks associated with the expected discontinuance of LIBOR. An internal LIBOR transition working group meets regularly, engages with industry working groups, and leverages regulatory best practice guidelines to help effectuate the transition. As of December 31, 2022, we had direct exposure to U.S. Dollar LIBOR-linked interest rate settings through certain CLO Investments Loans. For our latest generation of CLOs, we have been incorporating provisions to address a potential transition from LIBOR, however certain older CLOs may
not currently have been amended to contain clear LIBOR transition procedures. For these older CLOs, legislative remedy such as outlined by the New York LIBOR Legislation may be relied upon.
At this point in time, it remains unclear if there will be further legislative or regulatory developments that might impact LIBOR’s replacement in certain contracts. Given characteristic differences between LIBOR and the regulatory endorsed alternative reference rates, there is no guarantee that said reference rates will behave or perform in a manner similar to LIBOR in the future. Given this, it is not possible to predict the effect of LIBOR cessation and adoption of alternative reference rates, including any impact on our LIBOR-linked CLOs. There is no guarantee that a transition from LIBOR to an alternative will not result in broader financial market disruptions, significant increases in benchmark rates, or borrowing costs to borrowers, any of which could have a material adverse effect on our business, result of operations, financial condition, and price of our Class A Shares. Please see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Risks to Our Liquidity” for additional information.
Our business and financial condition may be materially adversely impacted by the loss of any of our key executive managing directors, particularly certain members of our Partner Management Committee, or other employees.
The success of our business depends on the efforts, judgment and personal reputations of our key executive managing directors, particularly certain members of our Partner Management Committee. Our key executive managing directors’ reputations, expertise in investing and risk management, relationships with investors in our funds and third parties on which our funds depend for investment opportunities and financing are each critical elements in operating and expanding our business. The loss of any of these individuals – including James Levin, who assumed the role of our Chief Executive Officer and Chief Investment Officer – could harm our business and jeopardize our relationships with our fund investors and members of the business community. We believe our performance is highly correlated to the performance of these individuals. Accordingly, the retention of our key executive managing directors is crucial to our success, but none of them is obligated to remain actively involved with us. In addition, if any of our key executive managing directors were to join or form a competitor, some of our fund investors could choose to invest with that competitor rather than in our funds. The loss of the services of any of our key executive managing directors could have a material adverse effect on our business, financial condition or results of operations, including on the performance of our funds, our ability to retain and attract fund investors and highly qualified employees and our ability to raise new funds.
In addition, investors in most of our funds have certain key person provisions that are triggered upon the loss of services of one or more key investment professionals and could, upon the occurrence of such event, provide the investors in the funds with certain rights such as earlier redemption rights (including by conversion to interests providing for more frequent liquidity) or rights providing for the termination or suspension of the funds’ investment periods and/or wind-down of the funds. Accordingly, the loss of such key investment professionals could result in significant or earlier redemptions from our funds or disruption of the funds’ investment activities, which could have a material adverse impact on our business, financial condition or results of operations, and could harm our ability to maintain or grow our Assets Under Management in existing funds or raise additional funds in the future. Withdrawals exercised pursuant to key person provisions could lead to a liquidation of certain funds and a corresponding elimination of our management fees and potential to earn incentive income beyond the withdrawal dates with respect to such funds. This risk is somewhat mitigated by the fact that our executive managing directors and managing directors are subject to certain restrictions with respect to competing with us, soliciting our employees and fund investors and disclosing confidential information about our business.
Our ability to retain and attract executive managing directors, managing directors and other investment professionals is critical to the success and growth of our business.
Our investment performance and ability to successfully manage and expand our business, including into new geographic areas, is largely dependent on the talents and efforts of highly skilled individuals, including our active executive managing directors, managing directors and other investment professionals. Accordingly, our future success and growth depend on our ability to retain and motivate our active executive managing directors and other key personnel and to strategically recruit, retain and motivate new talent. We may not be successful in our efforts to recruit, retain and motivate the required personnel as the global market for qualified investment professionals is extremely competitive, particularly in cases where we are competing for qualified personnel in geographic or business areas where our competitors have a significantly greater presence or more extensive experience. Further, in January 2023, the U.S. Federal Trade Commission published a proposed rule that, if finally issued, would
generally prohibit post-employment non-compete clauses (or other clauses with comparable effect) in agreements between employers and their employees. We are monitoring the proposed rule and the impact it may have on our ability to recruit and retain our professionals. We compete intensely with businesses both within and outside the alternative asset management industry for highly talented and qualified personnel. Accordingly, in order to retain and attract talent, our total compensation and benefits expense could increase to a level that may materially adversely affect our profitability and reduce our cash available for distribution to our executive managing directors and Class A Shareholders.
It may be difficult for us to retain and motivate our active executive managing directors after their interests in our business are fully vested and they are permitted to exchange their interests for Class A Shares that they can sell. All of the Group A Units and the majority of the Group E Units granted to executive managing directors in connection with the Recapitalization are now fully vested. Sculptor Operating Group common units otherwise granted to our executive managing directors, including awards granted under our Incentive Program established in 2017 (the “2017 Incentive Program”), continue to vest over time. The holder of any Group A Units generally has the right to exchange each of his or her Group A Units for one of our Class A Shares (or, at our option, the cash equivalent thereof), subject to vesting and book-up requirements and transfer restrictions under the Sculptor Operating Partnerships’ limited partnership agreements and the Class A Unit Exchange Agreement (as defined below). Beginning on the final day of the Distribution Holiday, each of our executive managing directors may exchange his or her vested and booked-up Group A Units over a period of two years in three equal installments commencing upon the final day of the Distribution Holiday and on each of the first and second anniversary thereof (or, for units that become vested and booked-up Group A Units after the final day of the Distribution Holiday, from the later of the date on which they would have been exchangeable in accordance with the foregoing and the date on which they become vested and booked-up Group A Units) (and thereafter such units will remain exchangeable), in each case, subject to certain restrictions. For more detail regarding exchange rights of our active executive managing directors, see “—The price of our Class A Shares may decline due to the large number of shares eligible for future sale and for exchange into Class A Shares.” See Note 13 to our consolidated financial statements included in this report for additional information on the 2017 Incentive Program and Note 3 to our consolidated financial statements included in this report for additional information on the Recapitalization.
If we are unable to retain the services of any of our active executive managing directors, the loss of their services could have a material adverse effect on our business, financial condition or results of operations, including by harming our ability to maintain or grow Assets Under Management in existing funds or raise additional funds in the future.
In any year where our funds experience losses and we do not earn incentive income, bonuses for that year (and in subsequent years until such losses are recouped) may be significantly reduced. Reduced bonuses, particularly during subsequent years, could have a material adverse impact on our ability to motivate and retain our investment professionals and other employees.
Furthermore, our active executive managing directors and investment professionals possess substantial experience and expertise in investing, are responsible for locating and executing our funds’ investments, have significant relationships with the institutions that are the source of many of our funds’ investment opportunities, and in certain cases have strong relationships with our fund investors. Therefore, if our active executive managing directors or investment professionals join competitors or form competing businesses, we could experience a loss of investment opportunities and existing fund investor relationships, which if significant, would have a material adverse effect on our business, financial condition or results of operations.
The Sculptor Operating Partnerships’ limited partnership agreements and other agreements entered into with our executive managing directors provide that the ownership interests in our business that are held by our executive managing directors are subject to various transfer restrictions and vesting and forfeiture conditions. In addition, the RSUs that have been awarded to our managing directors, certain executive managing directors and certain other employees are also subject to certain vesting and forfeiture requirements. Further, all of our active executive managing directors and managing directors are subject to certain restrictions with respect to competing with us, soliciting our employees and fund investors and disclosing confidential information about our business. These restrictions, however, may not be enforceable in all cases and can be waived by us at any time. There is no guarantee that these requirements and agreements, or the forfeiture provisions of the Sculptor Operating Partnerships’ limited partnership agreements (which are relevant to our executive managing directors) or the agreements we have with our managing directors will prevent any of these professionals from leaving us, joining our competitors or otherwise competing with us. Any of these events could have a material adverse effect on our business, financial condition or results of operations.
We have experienced and may again experience periods of rapid growth and significant declines in Assets Under Management, which place significant demands on our legal, compliance, accounting, risk management, administrative and operational resources.
Rapid changes in our Assets Under Management may impose substantial demands on our legal, compliance, accounting, risk management, administrative and operational infrastructures. The complexity of these demands, and the time and expense required to address them, is a function not simply of the size of the increase or decrease, but also of significant differences in the investing strategies employed within our funds and the time periods during which these changes occur. For example, expanding our product offerings and entering into new lines of business places additional demands on our infrastructure. Furthermore, our future growth will depend on, among other things, our ability to maintain and develop highly reliable operating platforms, management systems and financial reporting and compliance infrastructures that are also sufficiently flexible to promptly and appropriately address our business needs, applicable legal and regulatory requirements and relevant market and other operating conditions, all of which can change rapidly.
Addressing the matters described above may require us to incur significant additional expenses and to commit additional senior management and operational resources, even if we are experiencing declines in Assets Under Management.
There can be no assurance that we will be able to manage our operations effectively without incurring substantial additional expense or that we will be able to grow our business and Assets Under Management, and any failure to do so could materially adversely affect our ability to generate revenues and control our expenses.
We are highly dependent on information systems and other technology, including those used or maintained by third parties with which we do business. Any failure or breach in any such systems or infrastructure (including from a cyberattack) could materially impair our business, financial condition or results of operations.
Our business is highly dependent on information systems and technology. We rely heavily on our financial, accounting, trading, risk management and other data processing and information systems to, among other things, execute, confirm, settle and record a very large number of transactions, which can be highly complex and involve multiple parties across multiple financial markets and geographies, and to facilitate financial reporting and legal and regulatory compliance all in an extremely time-sensitive, efficient and accurate manner. We must continually update these systems to properly support our operations and growth, which creates risks associated with implementing new systems and integrating them into existing ones. We also use and rely upon third-party information systems and technology to perform certain business functions. Such third-party technology may be integrated with our own. Therefore, we face additional significant risks that would arise from the failure, disruption, termination or constraints (including, in all respects, via a security breach or other tampering) in the information systems and technology of such third parties, including financial intermediaries such as exchanges and other service providers whose information systems and technology we use. Any of these information systems or technology infrastructures could fail, become disrupted (including by unauthorized security breaches) or otherwise not operate properly or as intended.
In addition, our systems may be subject to cyberattacks. Breaches of our network security systems could involve attacks that are intended to obtain unauthorized access to our proprietary information, destroy data or disable, degrade or sabotage our systems, often through the introduction of computer malware, cyberattacks and other means and could originate from a wide variety of sources, including employees, foreign governments and other unknown third parties outside the firm. The increased use of mobile technology can heighten these and other operational risks. Further, the use of remote work environments and virtual platforms, geopolitical tensions or conflicts, such as the ongoing conflict between Russia and Ukraine, may create a heightened risk of cyberattacks or other data security breaches. Although we take various measures to ensure the integrity of our systems, there can be no assurance that these measures will always provide sufficient protection. The costs related to cyber or other security threats or disruptions may not be fully insured or indemnified by other means. In addition, cybersecurity has become a top priority for regulators around the world. Many jurisdictions in which we operate have laws and regulations relating to data privacy, cybersecurity and protection of personal information, including, in the EU, the General Data Protection Regulation ((EU) 2016/679) (the “GDPR”), which came into effect on May 25, 2018, as supplemented by various national laws, and further implemented through binding guidance from the European Data Protection Board, and the UK Data Protection Act of 2018 (the “UK Data Protection Act”). The California Consumer Privacy Act (the “CCPA”), which came into operation on January 1, 2020, provides enhanced consumer protections for California residents, including a private right of action for some data breaches, and imposes civil penalties for violations. The California Privacy Rights Enforcement Act (the “CCPRA”) further expanded the
privacy rights of California residents as of January 1, 2023. Virginia and other states either have comprehensive laws similar to the CCPA and CDPRA going into operation this year, in the case of Colorado, Connecticut and Utah, or are considering similar laws. Some jurisdictions, including all 50 U.S. states, have also enacted laws requiring companies to notify individuals of data security breaches involving certain types of personal data. Breaches in security could potentially jeopardize our, our employees’ or our fund investors’ or counterparties’ confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our, our employees’, our fund investors’, our counterparties’ or third parties’ operations, which could result in significant losses, increased costs, disruption of our business, liability to our fund investors and other counterparties, regulatory intervention or reputational damage. Furthermore, if we fail to comply with the relevant laws and regulations, it could result in regulatory investigations and penalties, which could lead to negative publicity and may cause our fund investors and clients to lose confidence in the effectiveness of our security measures. Any of these failures, particularly those that directly affect us, could materially impair our business, financial condition or results of operations.
Traditionally we have depended on our headquarters in New York and our London and Hong Kong offices, where most of our personnel are located. Although, we have taken important precautions to limit the impact of failures or disruptions in the information systems and technology infrastructures that we use, as well as the impact of physical disruptions to our New York headquarters, London and Hong Kong offices, these precautions, including our disaster recovery programs, may not be sufficient to adequately mitigate the harm that may result from such a disaster or disruption. While we believe we have been successful in operating our business remotely, unexpected operational challenges may arise in the future. If we or any of our key service providers were to experience material disruptions in the ability for our or their employees to work remotely, our ability to operate our business could be materially adversely impacted. In addition, insurance and other safeguards might only partially reimburse us for any losses, if at all.
Private litigation could result in significant legal and other liabilities and reputational harm, which could materially adversely affect our business, financial condition or results of operations.
We face significant risks in our business that may subject us to private litigation and legal liability. In general, we will be exposed to litigation risk in connection with any allegations of misconduct, negligence, dishonesty or bad faith arising from our management of any fund or by actions taken in the running of our parent company or operating partnerships. See, e.g., —Part I, Item 3. Legal Proceedings for additional information on a complaint under Section 220 filed by Dan S. Och and four former Och-Ziff executive managing directors. We may also be subject to litigation arising from investor dissatisfaction with the performance of our funds, including certain losses due to the failure of a particular investment strategy or improper trading activity, if we violate restrictions in our funds’ organizational documents or from allegations that we improperly exercised control or influence over companies in which our funds have large investments. In addition, we are exposed to risks of litigation relating to claims that we have not properly addressed conflicts of interest. Any litigation arising in such circumstances is likely to be protracted, expensive and surrounded by circumstances that could be materially damaging to our reputation and our business. Moreover, in such cases, we would be obligated to bear legal, settlement and other costs, which may be in excess of any available insurance coverage. In addition, although we are indemnified by our funds, our rights to indemnification may be challenged. If we are required to incur all or a portion of the costs arising out of any litigation or investigation as a result of inadequate insurance proceeds, if any, or fail to obtain indemnification from our funds, our business, financial condition or results of operations could be materially adversely affected. In the event any fund-related litigation scenarios described above materialize, it is possible we are made a party to any such litigation. As with the funds, while we maintain insurance, there can be no assurance that our insurance will prove to be adequate. If we are required to incur all or a portion of the costs arising out of litigation, our business, financial condition or results of operations could be materially adversely affected. Furthermore, any such litigation could be protracted, expensive and highly damaging to our reputation, which could result in a significant decline in our Assets Under Management and revenues, even if the underlying claims are without merit. See —Part II, Item 3. Legal Proceedings for additional information. In addition, we may participate in transactions that involve litigation (including the enforcement of property rights) from time to time, and such transactions may expose us to reputational risk and increased risk from countersuits.
Extensive regulation of our business affects our activities and creates the potential for significant liabilities and penalties. Our reputation, business, financial condition or results of operations could be materially affected by regulatory issues.
Our business is subject to extensive and complex regulation, including periodic examinations and regulatory investigations, by governmental and self-regulatory organizations in the jurisdictions in which we operate and trade around the
world. As an investment adviser registered under the Advisers Act and a company subject to the registration and reporting provisions of the Exchange Act, we are subject to regulation and oversight by the SEC. As a company with a class of securities listed on the NYSE, we are subject to the rules and regulations of the NYSE. As a registered commodity pool operator and a registered commodity trading advisor, we are subject to regulation and oversight by the U.S. Commodity Futures Trading Commission (“CFTC”) and the National Futures Association. In addition, we are subject to regulation by the Department of Labor under ERISA. In the UK, our UK sub-adviser is subject to regulation by the FCA. Our Asian operations, and our investment activities around the globe, are subject to a variety of other regulatory regimes that vary country by country, including the Securities and Futures Commission in Hong Kong.
The regulatory bodies with jurisdiction over us have the authority to grant, and in specific circumstances to cancel, permissions to carry on our business and the authority to conduct investigations and administrative proceedings. Such investigations and administrative proceedings can result in fines, suspensions of personnel or other sanctions, including censure, the issuance of cease-and-desist orders or the suspension or expulsion of an investment adviser from registration or memberships. For example, a failure to comply with the obligations imposed by the Exchange Act or Advisers Act, including recordkeeping, advertising and operating requirements, disclosure obligations and prohibitions on fraudulent activities, or a failure to maintain our funds’ exemption from compliance with the Investment Company Act of 1940 (the “1940 Act”) could result in investigations, sanctions and reputational damage, which could adversely affect our business, financial condition or results of operations. Our funds are involved regularly in trading activities that implicate a broad number of U.S. and foreign securities law regimes, including laws governing trading on inside information, market manipulation, anti-corruption, including the FCPA, and a broad number of technical trading requirements that implicate fundamental market regulation policies. Even if an investigation or proceeding does not result in a sanction or the sanction imposed against us or our personnel by a regulator were small in monetary amount, the adverse publicity relating to the investigation, proceeding or imposition of these sanctions could harm our reputation and cause us to lose existing investors or to fail to gain new investors. Furthermore, the legal, technology and other costs associated with regulatory investigations could increase to such a level that they could have a material impact on our business, financial condition or results of operations.
These global financial services regulators affect us not only with their regulations, but also with their examination, inspection and enforcement functions. We are routinely subject to examination and inspection and, although we make reasonable efforts to maintain effective compliance programs, there can be no assurances that any such inquiry would not result in a finding or sanction that would adversely affect our business, financial condition or results of operations. Likewise, enforcement investigations and administrative inquiries can be sweeping in nature. Cooperating with these investigations, as is our practice, can be expensive and time-consuming and could distract us from our business operations. In particular, U.S. regulators routinely investigate potentially serious matters such as possible insider trading, market manipulation, misleading disclosure, conflicts of interest, fraud, foreign corruption, including under the FCPA; lesser potential violations, such as books and records inaccuracies, weaknesses in internal controls; and compliance with general reporting and advertising regulations. For the past several years, we have cooperated with a number of regulatory investigations and examinations, both domestically and internationally, and we expect to be the subject of investigations and examinations in the future. There can be no assurances that ongoing or future investigations will not adversely affect our business, financial condition or results of operations. Enforcement actions and administrative proceedings can result in fines, or other sanctions, including censure, the issuance of a cease-and-desist order, suspension or expulsion of persons or firms from the industry. Such sanctions can harm our reputation and cause us to lose existing investors or fail to gain new investors, which could adversely affect our business, financial condition or results of operations and related fines and settlements could have a material adverse effect on our business, financial condition or results of operations as described below in “—The FCPA settlements could have a material adverse effect on our ability to raise capital for our funds.”
In addition, we regularly rely on exemptions or exclusions from various requirements of the Securities Act, the Exchange Act, the 1940 Act, the Commodity Exchange Act and ERISA in conducting our asset management activities. These exemptions or exclusions are sometimes highly complex and may, in certain circumstances, depend on compliance by third parties whom we do not control. If for any reason these exemptions or exclusions were to become unavailable to us, we could become subject to regulatory action or third-party claims and our business, financial condition or results of operations could be materially adversely affected. Certain of the requirements imposed under the 1940 Act, the Advisers Act, ERISA and by non-U.S. regulatory authorities are designed primarily to ensure the integrity of the financial markets and to protect investors in our funds and are not designed to protect holders of our Class A Shares. At any time, the regulations applicable to us may be amended or expanded by
the relevant regulatory authorities. If we are unable to correctly interpret and timely comply with any amended or expanded regulatory requirements, our business, financial condition or results of operations could be adversely impacted in a material way.
We may also be adversely affected if additional legislation or regulations are enacted, or by changes in the interpretation or enforcement of existing rules and regulations imposed by the SEC, other U.S. or foreign governmental regulatory authorities or self-regulatory organizations that supervise the financial markets and their participants. See “—Increased regulatory focus in the U.S. could result in additional burdens on our business” and “—Regulatory changes in jurisdictions outside the U.S. could adversely affect our business” for additional information. It is impossible to determine the extent of the impact of any new laws, regulations or initiatives that may be proposed, or whether any of the proposals will become law. Compliance with additional new laws or regulations could be difficult and expensive and affect the manner in which we conduct business, and we may be unable to correctly interpret and timely comply with any amended or expanded regulatory requirements, which could have adverse impacts on our business, financial condition or results of operations.
The FCPA settlements could have a material adverse effect on our ability to raise capital for our funds.
In September 2016, we reached settlements with the DOJ and the SEC, resolving their investigations into our former private investment business in Africa and a 2007 investment by the Libyan Investment Authority in certain of our funds. As part of the settlements, we entered into a Deferred Prosecution Agreement (“DPA”) with the DOJ, and our subsidiary, OZ Africa, agreed to plead guilty to one count of conspiracy to violate the anti-bribery provisions of the FCPA. In November 2020, Oz Africa paid approximately $138.0 million to former shareholders of Africo Resources Ltd. to settle the matter of U.S. v. Oz Africa Management GP, LLC, Cr. No. 16-515 (NGG) (EDNY) and the DPA was terminated shortly thereafter.
Any potential continuing negative impact of the FCPA settlements on our ability to raise or retain capital for our funds could adversely affect our business, financial condition or results of operations.
Increased regulatory focus in the U.S. could result in additional burdens on our business.
The financial industry has become more highly regulated. Legislation has been introduced in recent years in the U.S. relating to financial markets and institutions, including alternative asset management firms, which would result in increased oversight and taxation. There has been, and may continue to be, a related increase in regulatory investigations of the trading and other investment activities of alternative investment funds, including our funds. Such investigations may impose additional expenses on us, may require the attention of senior management and may result in fines if any of our funds are deemed to have violated any regulations.
We are subject to numerous regulations under the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). Title VII of the Dodd-Frank Act (the “Derivatives Title”) has imposed and will impose a comprehensive regulatory regime on over-the-counter (“OTC”) derivatives and the operations of the markets for, and the activities of the dealers in and users of, OTC derivatives. The Derivatives Title, among other things: (i) could require certain OTC derivatives, including “swaps” (such as rate, credit, equity and commodity swaps) and “security-based swaps” (swaps and security-based swaps, collectively, “Swaps”), to be traded on a regulated exchange and cleared through a regulated clearing entity, potentially increasing significantly the collateral costs associated with such activities; (ii) imposes initial and variation margin requirements on certain entities whose derivatives are not cleared through a regulated clearing entity; (iii) creates several new classes of CFTC and SEC registrants, including “swap dealers,” “security-based swap dealers,” “major swap participants” and “major security-based swap participants,” that are subject to comprehensive regulation, including minimum net capital, margin, disclosure, reporting and recordkeeping requirements, conflicts of interest policies and procedures, new business conduct standards and other regulatory requirements; and (iv) expands the CFTC’s authority to impose speculative position limits with respect to derivative instruments, including Swaps on certain physical commodities (such as Swaps based on oil, gas, precious metals and agricultural commodities) and aggregate position limits for those instruments (including futures and options contracts and other listed instruments that are economically equivalent to such contracts) based on the same underlying physical commodity.
We are and may be directly and indirectly affected by the Derivatives Title and its rules, including but not limited to potential results such as increased clearing and margin costs and decreasing liquidity. The SEC requirements have largely yet to be made effective, but the CFTC requirements are largely in place. The regulatory requirements under the Derivatives Title continue to be developed and there may be further modifications that could impact materially and adversely the funds we manage, the
markets in which these funds trade and the counterparties with which these funds engage in transactions. At this time we still cannot fully predict what impact the Derivatives Title will have on us, the funds we manage, our counterparties, the financial services industry or the markets, although we have already seen meaningful impacts on the financial services industry and the markets, both positive and negative.
The Financial Stability Oversight Council (the “Council”) has the authority under the Dodd-Frank Act to review nonbank financial companies predominantly engaged in financial activities for potential designation as systematically important financial institutions (“SIFI”). In December 2019, the Council voted to change its methodology for assessing financial stability from its previous entity-specific approach to designation to a products and activities-based approach to designation. This reduces the risk of an entity-level designation, however it remains too early to predict the direction of the forthcoming regulatory environment and the Council retains the authority to designate an entity if an activities-based approach does not adequately address potential risks. If we or any of our funds were to be designated as a SIFI, or otherwise designated by the Council as presenting systemic risk, we would be subject to limitations on our ability to conduct certain activities, along with increased costs of doing business in the form of fees and assessments associated with such designation as well as by virtue of increased regulatory compliance costs, all of which would be likely to adversely affect our competitive position.
On December 10, 2013, U.S. financial regulators adopted final regulations to implement the statutory mandate of the “Volcker Rule” contained in Section 619 of the Dodd-Frank Act. The Volcker Rule limits the ability of certain banking entities to acquire as principal, directly or indirectly, ownership interests in certain private investment funds (referred to in the Volcker Rule as “covered funds”). As a result, the Volcker Rule may cause banking entities and their affiliates that would otherwise invest in our funds to not invest in our funds or CLOs, to invest less capital in our funds or CLOs, reduce or eliminate such investments, or require modifications to the documents governing our funds or CLOs that may adversely affect their performance or attractiveness to other investors or that otherwise may be adverse to our business and the value of our Class A Shares. The Volcker Rule also includes a general prohibition on certain banking entities engaging in activities defined as “proprietary trading.” Applicable regulators have proposed amendments and invited comments to the Volcker Rule and the requirements of the Volcker Rule may change over time. The Volcker Rule (including any changes thereto) and its effects could negatively impact our business, financial condition or results of operations.
The Dodd-Frank Act also requires increased disclosure of executive compensation and provides shareholders with the right to a non-binding vote on executive compensation. In October 2022, the SEC adopted final rules, as mandated by the Dodd-Frank Act, requiring companies to develop and enforce recovery policies that in the event of an accounting restatement, “claw back” from current and former executive officers’ incentive-based compensation they would not have received based on the restatement.
Furthermore, the Dodd-Frank Act required the SEC and the CFTC to implement more expansive regulations concerning whistleblowers. The SEC and the CFTC have each adopted rules under this requirement, establishing reward programs for persons who bring information to the SEC or the CFTC. To receive a reward under these programs, the information must lead to the successful enforcement or resolution of a judicial or administrative action brought by the SEC or CFTC that results in a monetary sanction of more than $1.0 million for a violation of the securities laws or the Commodity Exchange Act, respectively. These rules may result in increased regulatory inquiries or investigations by the SEC or the CFTC. Such inquiries or investigations could impose significant additional expense on us, require the attention of senior management and result in negative publicity and harm to our reputation.
Effective September 23, 2013, and pursuant to a mandate under the Dodd-Frank Act, the SEC adopted amendments to Rule 506 that disqualify issuers, such as our funds, from relying on the exemption from registration provided by Rule 506 in connection with a securities offering structured as a private placement if any “covered persons” are deemed to be “bad actors.” Specifically, an issuer generally will be precluded from conducting offerings that rely on the registration exemption provided by Rule 506 if a “covered person” has been subject to a relevant criminal conviction, regulatory or court order or other disqualifying event that occurred on or after September 23, 2013. For these purposes, the “covered persons” of an issuer include directors, certain officers, various entities related to the issuer, solicitors and promoters of the issuer and 20% beneficial owners of the issuer’s voting securities. Risk to the business would be created should a Rule 506 disqualifying event take place in the future.
These and other outstanding rulemakings mandated by the Dodd-Frank Act will be completed by various regulatory bodies and other groups over the next several years, and the Dodd-Frank Act mandates multiple agency reports and studies
(which could result in additional legislative or regulatory action). As a result of the regulatory and other action yet to be taken, we do not know what the remaining final regulations under the Dodd-Frank Act will require and it is difficult to predict how significantly the Dodd-Frank Act will affect us. The Dodd-Frank Act will likely increase our administrative costs and could impose additional restrictions on our business.
The Foreign Investment Risk Review Modernization Act (“FIRRMA”) and related regulations significantly expanded the types of transactions that are subject to the jurisdiction of the Committee on Foreign Investment in the United States (“CFIUS”). Under FIRRMA, CFIUS has the authority to review and potentially block or impose conditions on certain foreign investments in U.S. companies and real estate, which may reduce our ability to raise capital from certain types of investors.
Risk retention regulations could adversely affect our business.
Jurisdictions including the U.S., the EU and UK have adopted risk retention regulations applicable to securitizations and similar transactions, including CLOs and other transactions that we manage or may manage in the future. As a result of these regulations, we may be required to retain, and historically have retained, a portion of the securities or other interests issued in some of these CLOs and other transactions, whether in order to satisfy compliance obligations directly applicable to us or in response to investor demands based on regulatory requirements imposed on such investors. Accordingly, this has required us to utilize capital that could otherwise be deployed in another manner, and we expect that we will need to continue to do so in the future for certain CLOs and other transactions that we may manage in the future. In addition, retaining interests in these transactions increases our exposure to the performance of these transactions and changes in the value of those interests. We have also incurred, and expect to continue to incur, costs and expenses in connection with our efforts to comply with these regulations or related investor demands. We have historically financed the majority of the interests we retain as a result of these regulations, and expect to continue to do so. Such financing arrangements may impose limitations or restrictions on our business that could adversely affect our business and the price of our Class A Shares.
These risk retention regulations have changed and may continue to change over time, and may be introduced in other jurisdictions, and their interpretation and applicability at any given point in time may be uncertain. For example, as of January 1, 2019, new EU and UK risk retention regulations replaced previously existing EU and UK risk retention regulations for applicable transactions that issue securities on or after January 1, 2019. In addition, in the U.S., a court has held that certain regulators exceeded their statutory authority by requiring managers of “open-market” CLOs to hold risk retention interests in those CLOs under U.S. risk retention regulations. Regulatory uncertainty of this nature may cause us to continue to incur costs and expenses in our efforts to comply with risk retention regulations or in response to the efforts of others to comply with risk retention regulations, and there can be no assurance that those costs and expenses, or the amount of capital we invest in connection with these risk retention regulations, will not increase in the future. Nor can there be any assurance that applicable governmental or regulatory authorities agree with our compliance approaches to these risk retention regulations, which may expose us to liability, including to third parties to whom we have made representations, warranties or covenants regarding such compliance. In the event that we adopt compliance approaches that are subsequently determined to not be required (such as with U.S. “open-market” CLOs), or are less capital-efficient than other approaches subsequently determined to be possible under applicable law, there can be no assurance that we will be able to recover or redeploy capital that we’ve previously committed (and we may be contractually prohibited from disposing of the related risk retention interests), and we will generally not be able to recover any costs or expenses that we have already incurred.
In addition to any direct effects on us, risk retention regulations may adversely affect markets relevant to our business, such as leveraged loan markets or credit markets generally, which may in turn adversely affect the transactions we manage and our business generally. There can be no assurance that risk retention regulations will not materially and adversely affect our business and operations, and the price of our Class A Shares.
A downturn in the global credit markets could adversely affect our CLO investments.
CLOs are subject to credit, liquidity, interest rate and other risks. From time to time, liquidity in the credit markets is reduced, sometimes significantly, resulting in an increase in credit spreads and a decline in ratings, performance and market values for leveraged loans. We have exposure to these markets through our investments in our CLOs. In some cases, we may be required to maintain such exposure as a result of applicable risk retention regulations. CLOs invest on a leveraged basis in loans or securities that are themselves highly leveraged investments in the underlying collateral, which increases both the opportunity for
higher returns as well as the magnitude of losses when compared to unlevered investments. As a result of CLOs’ leveraged position, CLOs and their investors are at greater risk of suffering losses. Any failure by our CLOs to meet certain overcollateralization and interest coverage tests will result in reduced cash flows that may have been otherwise available for distribution to us. This could reduce the value of our investment. There can be no assurance that market conditions giving rise to these types of consequences will not occur, subsist or become more acute in the future.
Increasing ESG-related requirements and expectations, including with respect to climate impact, could adversely affect our business and results of operations.
Regulation relating to the consideration of environmental, social and governance (“ESG”) factors by investment managers and related disclosure requirements is rapidly evolving in many countries in which we do business. Compliance with these requirements will increase our compliance costs and could require changes to our investment policies and processes, which could adversely affect our business and results of operations.
New U.S. regulations may be adopted that require specified ESG-related disclosures by investment managers or public companies, which could increase our compliance costs. For example, in 2022, the SEC proposed rules that will require public companies to disclose information related to their direct and indirect greenhouse gas emissions. In addition to our own required disclosures, portfolio companies in which our funds invest may become subject to heightened disclosure and compliance obligations related to climate impact. Compliance by these companies may require capital expenditures and changes to operations and supply chains. Non-compliance with climate-related disclosure obligations could create business risks for companies in which our funds invest, which could negatively impact the returns in our funds.
In addition, asset owner expectations and requirements concerning managers’ integration of ESG factors, including with respect to climate impact, into investment decisions and ongoing engagement are increasing, including due to requirements in some jurisdictions that asset owners integrate consideration of ESG factors into their investment decisions. Asset owner expectations, at both the manager and fund level, concerning voluntary ESG disclosures and membership and participation in and adherence to voluntary standards, codes, principles and initiatives also are increasing. In the U.S. the Biden administration has included rules adopted by the Department of Labor (the “DOL”) in its list of agency actions required to be reviewed by agency heads for a potential conflict with the administration’s environmental policies. These DOL rules require investments by ERISA funds to be made based solely on appropriately weighted pecuniary factors, which are certain material financial factors. Some of our investors are ERISA funds, and their investment processes may differ from our other funds as a result of these rules. If these rules are repealed or modified, it may change how some of our investors allocate capital. Compliance with these expectations and requirements may increase our costs and in some cases limit our investment options. Asset owner expectations concerning how managers manage ESG factors at the firm level also are increasing. Failure to meet any of the foregoing ESG-related expectations or requirements of investors and prospective investors, either at the fund or firm level, may adversely impact our ability to raise new funds and result in redemptions by existing investors, or may limit the types of investment opportunities that are available to our funds.
Additionally, the European Union’s Regulation (EU) 2019/2088 on sustainability-related disclosures in the financial services sector (as amended from time to time, the “SFDR”) sets out certain ESG and sustainability disclosure requirements for alternative investment fund managers undertaking fund management activities, or marketing fund interests, to investors within the EEA, such as Sculptor Capital LP. To the extent applicable, the SFDR will require both manager level and pre-contractual product-specific disclosures, including among other things on how managers integrate sustainability risks into their investment decision-making process and remuneration decisions and the results of the assessment of the likely impacts of sustainability risks. In some situations, managers may be required to undertake a periodic assessment of the principal adverse impacts of a fund’s impact on sustainability factors. Additional requirements, including ongoing disclosure requirements, also apply for products which promote environmental or social characteristics or have a sustainable investment objective.These requirements may result in additional compliance costs, disclosure obligations or other implications or restrictions on our funds and our investment advisers, including the requirement to capture information or data about our funds or their investments. Additionally, an investment adviser may be required to classify itself or the funds it manages against certain ESG criteria, some of which can be open to subjective interpretation. Our view on the appropriate classification may develop over time, including in response to statutory or regulatory guidance or changes in industry approach to classification. A change to the relevant classification may require further actions to be taken, for example it may require further disclosures by an investment adviser or the fund or it may require new processes to be set up to capture data about the fund or its investments, which may lead to additional cost to be
borne by the fund. Additionally, the classification of a fund into a certain ESG category may make it more difficult for the fund to raise its targeted amount of capital commitments as such classification may not reflect the beliefs or values of a particular investor in the manner of which another classification otherwise would.
Further, the FCA has introduced a new regulatory framework focused on implementing the recommendations of the Financial Stability Board Taskforce on Climate-related Financial Disclosures (“TCFD”) and, in particular, by introducing mandatory TCFD-aligned disclosure for certain FCA authorized firms. The rules capture certain asset managers and is a phased approach to the implementation of these rules. These new and changing rules and regulations are likely to result in increased general and administrative expenses and increased management time and attention spent complying with or meeting such regulations.
Finally, the significant physical effects of climate change including extreme weather events can also have an adverse impact on certain of our real estate portfolio investments, especially any real asset investments that may rely on physical property and equipment located in affected areas. As the effects of climate change increase, we expect the frequency and impact of weather and climate related events and conditions to increase as well.
Regulatory changes in jurisdictions outside the U.S. could adversely affect our business.
Similar to the U.S., jurisdictions outside the U.S. in which we operate, in particular the EU and the UK, have become subject to further regulation. Regulators and other governmental authorities in the EU and the UK have proposed or implemented a number of initiatives and additional rules and regulations that could adversely affect our business. While we have developed and implemented policies and procedures designed to ensure compliance with these rules and regulations, such policies and procedures may not be effective in all instances to prevent violations. Any such violations could subject us to, among other things, civil and criminal penalties, material fines, profit disgorgement, injunctions on future conduct, securities litigation and a general loss of investor confidence, any one of which could adversely affect our business, financial condition or results of operation.
The EU’s Alternative Investment Fund Managers Directive (2011/61/EU) (including all national, implementing or supplementary measures, laws and regulations the “AIFMD”) and the UK Alternative Investment Fund Managers Regulations 2013 as amended from time to time, including by the Alternative Investment Fund Managers (Amendment etc.) (EU Exit) Regulations 2019, (the “AIFM Law”) may have an adverse effect on the continued operation of our funds where interests are offered to or placed with investors in the European Economic Area (the “EEA”) and the UK. The AIFMD and the AIFM Law are complex and key aspects of it remain subject to further consultation and interpretation.
The AIFMD and the AIFM Law impose significant regulatory requirements on alternative investment fund managers (“AIFMs”), operating within the EEA and the UK, as well as prescribing certain conditions with regard to regulatory standards, cooperation and transparency that need to be satisfied for non-EU and non-UK AIFMs to market alternative investment funds (“AIFs”) into EEA Member States and the UK. Should any member of our group be treated as an AIFM operating within the EEA or the UK, AIFMD and the AIFM Law may impose additional costs on the operation of our business in the EEA and the UK and limit our operating flexibility. In any event, in order to market one of our AIFs to investors in the EEA or the UK, the non-EEA and non-UK investment adviser of that AIF will be required to comply with the marketing conditions in the AIFMD or the AIFM Law and any additional national restrictions (such as a requirement to appoint a depositary), assuming that national private placement is available. In addition, the AIFM will be required to comply specific notification or registration requirements and certain additional transparency requirements requiring disclosures to investors in the AIF and to EEA or UK regulators, such as annual reporting and regulatory filing requirements; requirements relating to the acquisition of substantial stakes in EEA or UK companies; and the jurisdictions in which the non-EEA or non-UK AIFM and the relevant AIF are organized satisfy certain conditions with regard to regulatory standards, cooperation and transparency. Compliance with these requirements may result in additional costs to our funds reducing the returns for investors. The need to comply with the registration requirements may also delay the capital raising process for our funds, in turn reducing the speed with which an investment manager could deploy the capital raised.
Furthermore, the extent to which an investment adviser of an AIF or any person acting on their behalf can market a fund in an EEA Member State or the UK may be more restricted than was the case before the AIFMD or the AIFM Law came into force. This could limit a fund’s ability to attract investors based in those EEA Member States or the UK, resulting in a
reduction in the overall amount of capital raised by a fund which limits, in turn, the range of investment strategies and investments that a fund is able to pursue and make.
There is a risk that an investment adviser may breach the requirements imposed by the AIFMD or the AIFM Law as a result of the differing manner and way in which the AIFMD or the AIFM Law have been implemented in various EEA Member States and the UK, respectively. Such a breach may result in a regulatory authority or court in that or another EEA Member State or the UK requiring an investment adviser to return any capital or other funds to investors or otherwise seeking to take other enforcement or remedial action against an investment adviser or our funds. This may result in a reduction in the overall amount of capital available to our funds, which limits, in turn, the range of investment strategies and investments that our funds are able to pursue and make or otherwise result in a loss to our funds. Furthermore, there is a risk that the AIFMD or the AIFM Law will be interpreted differently by each EEA Member State or the UK. This may have an adverse effect on the marketing and/or operation of our funds and may result in additional costs, reducing the returns for investors.
A non-EEA or non-UK investment adviser, such as Sculptor Capital LP, is not required to comply with all of the requirements set out in the AIFMD or the AIFM Law. Accordingly, and subject to the below, investors in our funds may not receive the full protections or benefits available under AIFMD or the AIFM Law, which would otherwise be available to investors in an AIF managed by an EEA AIFM or UK AIFM.
Notwithstanding the above, in certain or all EEA Member States and the UK, we may choose not to market our funds at our own initiative or otherwise take any action that would result in the AIFMD or the AIFM Law applying to our investment advisers or our funds. In this respect, an investment adviser will only accept investors where an investment adviser concludes that such investors approached the investment adviser, our funds or someone acting on their behalf at their own initiative or that AIFMD or the AIFM Law would not otherwise apply to the investment adviser, our funds or any persons acting on their behalf. There is a risk that an EEA Member State or UK regulatory or governmental authority may reach a different conclusion than the investment adviser and find that the relevant measures taken in order to give effect to or supplement the AIFMD or the AIFM Law in one or more EEA Member States or the UK do apply to the investment adviser or our funds. Such a finding may result in a regulatory or governmental authority or court in one or more EEA Member States or the UK requiring an investment adviser or our funds to return any capital or other funds to investors or otherwise seeking to take other enforcement or remedial action against an investment adviser or our funds. This may result in a reduction in the overall amount of capital available to our funds, which limits, in turn, the range of investment strategies and investments that our funds are able to pursue and make or otherwise result in a loss to our funds. If an investor approaches an investment adviser or someone acting on their behalf at the investor’s own initiative, a non-EEA or non-UK investment adviser will not be required to comply with any of the requirements of the AIFMD or the AIFM Law with which a non-EEA or a non-UK manager registered under the AIFMD or the AIFM Law is otherwise required to comply, and investors will not receive the protections or benefits available under the AIFMD or the AIFM Law, including initial disclosure requirements and periodic reporting on illiquid assets and leverage.
The European Commission recently published a proposed directive (known as “AIFMD II”) to amend the AIFMD as it applies in the EEA. AIFMD II (which is not expected to come into force before 2024 at the earliest) includes significant proposals in respect of, among other things, delegation, loan origination, liquidity risk management, data reporting, depositaries and public disclosure via the European Single Access Point. At this stage, it cannot be ruled that the changes currently set out in AIFMD II will not change further or that new changes will not be introduced (each of which could again have a material impact upon the operation of our business in the EEA and could limit our operating flexibility and our ability to raise funds within the EEA) as the proposals are considered by the European Parliament and the European Council as part of the EU legislative process.
Separately to the AIFMD, the EU has also introduced significant changes to its regulation of EU securities and derivatives markets through “MiFID II” which came into force on January 3, 2018. MiFID II replaces the original MiFID I regime which had been in force since November 2007. MiFID II, which is comprised of the Markets in Financial Instruments Directive (2014/65/EU), the Markets in Financial Instruments Regulation ((EU)600/2014) and a number of regulatory and implementing technical standards that take the form of EU Delegated Acts, is the foundational legislation for investment firms operating in the EU. MiFID II forms part of UK law by virtue of national implementing legislation, sections 2 and 3 of the European Union (Withdrawal) Act 2018, the Markets in Financial Instruments (Amendment) (EU Exit) Regulations 2018 and a number of regulators’ EU Exit Instruments (“UK MiFID II”) and will apply to investment firms operating in the UK, including
our UK affiliates SCME and Sculptor Europe Loan Management Limited (“SELM”), both of which are authorized and regulated in the UK as MiFID investment firms.
MiFID II and UK MiFID II have imposed significant organizational, conduct, governance, operational and reporting requirements on SCME and SELM, including requirements around the receipt of inducements and the use of soft dollars / dealing commissions, enhanced transaction reporting and pre- and post-trade transparency requirements, formal telephone taping requirements, and best execution rules. Further, MiFID II and UK MiFID II rules may restrict the ability of other Sculptor entities domiciled outside of the EEA or the UK (known as “third-country firms”) to provide investment services to clients domiciled in the EEA or the UK, respectively. Other changes resulting from MiFID II and UK MiFID II may have an impact on any Sculptor entity or client that trades on EEA or UK markets or trading venues, or does business with EEA of UK-regulated banks or brokers. These impacts may include venue trading requirements for certain categories of shares and derivatives, restrictions on so-called “dark pool” trading, product banning powers, algorithmic trading restrictions, and enhanced requirements around the provision of direct market access / direct electronic access services.
In addition to the AIFMD and MiFID II, the EU has implemented, or is in the process of implementing, a number of measures in response to the financial crisis or as part of an ongoing program of legislative change, which may or may not form part of the UK law. These include, but are not limited to:
•The European Markets Infrastructure Regulation ((EU) No 648/2012) (known as EMIR), which, together with EU Delegated Acts (including the Regulation and EU Delegated Acts as they form part of UK law by virtue of section 3 of the European Union (Withdrawal) Act 2018, the Over the Counter Derivatives, Central Counterparties and Trade Repositories (Amendment, etc., and Transitional Provision) (EU Exit) Regulations 2019 and a number of regulators’ EU Exit Instruments), imposes clearing, risk mitigation, margining and trade reporting requirements on derivatives counterparties.
•The Solvency II directive (including the directive as it forms part of UK law by virtue of national implementing legislation, section 2 of the European Union (Withdrawal) Act 2018 and the Solvency 2 and Insurance (Amendment etc.) (EU Exit) Regulations 2019), which applies capital charges on insurers in respect of their fund investments.
•The Market Abuse Regulation ((EU) No. 596/2014) (known as MAR) (including the regulation as it forms part of UK law by virtue of section 3 of the European Union (Withdrawal) Act 2018 and the Market Abuse (Amendment) (EU Exit) Regulations 2019) and a directive (including the directive as it forms part of UK law by virtue of national implementing legislation and section 2 of the European Union (Withdrawal) Act 2018) designed to harmonize criminal sanctions for market abuse (called CSMAD). MAR came into force in July 2016 and extended the EU’s and UK’s market abuse regime to behavior in respect of financial instruments traded on a wider variety of trading venues and EU and UK emission allowances, refined the definition of inside information, introduced a new offense of “attempted market manipulation” and strengthened regulatory authorities’ investigative and sanctioning powers.
•The Securitisation Regulation ((EU) 2017/2402) (known as the Securitisation Regulation) (including the regulation as it forms part of UK law by virtue of section 3 of the European Union (Withdrawal) Act 2018 and the Securitisation (Amendment) (EU Exit) Regulations 2019) establishes due diligence, risk retention and transparency requirements for parties involved in securitisations. Among other requirements, the Securitisation Regulation imposes a duty on “institutional investors”, which includes AIFMs investing in securitisations on behalf of their funds, to ensure that any investment in a “securitization” position is only undertaken following due diligence sufficient to verify, amongst other matters, that (i) the credit assets being securitised were originated on the basis of sound and well-defined criteria and (ii) the originator, sponsor or original lender retains on an ongoing basis a material net economic interest of at least 5% in the securitisation. The definition of “securitisation” is broadwithin the meaning of the Securitisation Regulation and includes structures which may not be “commercially” considered a securitisation but have the relevant characteristics.
•The Sustainable Finance Disclosure Regulation ((EU 2019/2088) (known as SFDR) establishes requirements on a broad range of investment firms, including certain of our affiliates, and firms providing investment advice to publish certain disclosures related to sustainability matters on their website and in pre-contractual disclosure documents
provided to investors. Additional requirements may apply to firms that promote funds or financial products with sustainable objectives or that promote environmental or social characteristics.
•The EU Cross-border Distribution of Funds Directive (EU 2019/1160) and Regulation (EU2019/1156) (known as the CBDF) have introduced new rules on pre-marketing and marketing within the EEA. There is uncertainty as to the manner in and extent to which the CBDF is being implemented in various EEA Member States and how it applies to third country managers. This uncertainty increases the risk of a breach by an investment adviser of the requirements imposed by the CBDF. Such a breach may result in a regulatory authority or court in that or another EEA Member State seeking to take enforcement or remedial action against an investment adviser or our funds. This may result in a reduction in the overall amount of capital available to our funds, which limits, in turn, the range of investment strategies and investments that our funds are able to pursue and make or otherwise result in a loss to our funds. Furthermore, there is a risk that the CBDF will be interpreted differently by each EEA Member State. This may have an adverse effect on the marketing and/or operation of our funds and may result in additional costs, reducing the returns for investors and may also limit our ability to raise funds within the EEA.
•The General Data Protection Regulation (EU) 2016/679 (including the regulation as it forms part of UK law by virtue of section 3 of the European Union (Withdrawal) Act 2018 and the Data Protection Privacy and Electronic Communications (Amendments etc) (EU Exit) Regulations 2019 and 2020) (together, the “GDPR”) and the UK Data Protection Act expanded the scope of the EU and UK data protection laws, include, in certain cases, to foreign companies processing personal data of EEA or UK individuals (e.g., investor and employee data), imposed a more stringent data protection compliance regime, and included new data subject rights (e.g., the right to erasure, commonly known as “the right to be forgotten”). The GDPR and the UK Data Protection Act may have a significant impact on those who act as data controllers and processors and those who intend to transfer personal data outside the EEA or the UK, including the introduction of severe administrative fines of up to the greater of 4% of total worldwide annual turnover or €20.0 million/£17.5 million (as well as the right to compensation for financial or non-financial damages claimed by any individuals under Article 82 GDPR). Additionally, non-compliance may lead to reputational damages and a loss of confidence in our security and privacy or data protection measures as well as the right to compensation for financial or non-financial damages claimed by individuals under Article 82 GDPR. Enforcement of the GDPR is designed to be harmonized across the EU, and the UK’s data protection regulator, the Information Commissioner’s Office, has indicated that it will continue to enforce the UK Data Protection Act in line with the GDPR. However, the UK government recently announced its intention to adopt a more flexible approach to the regulation of data, and as a result there remains a risk of future divergence between the data protection regimes in the EU and the UK.
•In July 2020, the Court of Justice of the European Union (the “CJEU”) issued a ruling regarding the validity of the primary mechanism that investors, suppliers and other third parties use to safeguard transfers of personal data to us, namely, the European Commission-approved standard contractual clauses. Following the CJEU’s ruling, those parties may be unable in certain cases to transfer personal data outside of the EEA and UK without a defined lawful mechanism under the GDPR or UK Data Protection Act, or may require Sculptor Capital LP to demonstrate that it has appropriate technical measures in place to ensure the legality of such transfers. It currently is unclear how data protection regulators, courts and counterparties of Sculptor Capital LP will view or enforce such potential non-compliance or any failure on our part to demonstrate such measures.
•The EU has proposed to replace the European e-Privacy Directive (Directive 2002/58/EC as amended by Directive 2009/136/EC), which obliges the EU member states to introduce certain national laws regulating privacy in the electronic communications sector, with a new e-Privacy Regulation. The text of the proposal for the e-Privacy Regulation is not yet final and the formal EU legislative process in relation to the e-Privacy Regulation has not yet begun. As the text of the e-Privacy Regulation is still under development and in draft form, and as further guidance is issued and interpretations of both the e-Privacy Regulation and the GDPR develop, it is difficult to assess the impact of the proposed e-Privacy Regulation on our business or operations, but it may require us to modify our data practices and policies (e.g. in relation to the management of cookies and marketing messages sent through different media) and we could incur substantial costs as a result. Each or all of these measures could have direct and indirect effects on our business.
In the UK, the Senior Managers and Certification Regime (the “SMCR”) was extended on December 9, 2019 to “solo-regulated” firms (i.e. those firms that are only regulated by the FCA and not jointly by the FCA and the Prudential Regulation Authority) such as SCME and SELM. The SMCR replaces the existing FCA approved person regime and imposes new, more burdensome requirements on certain SCME and SELM staff as well as increasing the documentation and record-keeping needed to demonstrate compliance with the new regime.
The U.S. Congress, the Organization for Economic Co-operation and Development (the “OECD”) and other government agencies in jurisdictions in which we and our affiliates invest or do business have maintained a focus on issues related to the taxation of multinational companies, such as Sculptor. The OECD has made changes to numerous long-standing tax principles through its base erosion and profit shifting (“BEPS”) project, which looks at various different ways in which domestic tax rules around the world, and the bilateral double tax treaties that govern the interplay between them, could be amended to address perceived profit shifting among affiliated entities. Several of the proposed measures under the BEPS project, including measures covering treaty abuse (including an anti-abuse "principal purpose" test that would deny treaty benefits to the extent that obtaining such benefit was one of the principal purposes of any arrangement or transaction that resulted directly or indirectly in such benefit), the deductibility of interest expense, local nexus requirements, transfer pricing and hybrid mismatch arrangements are potentially relevant to some of our structures and could have an adverse tax impact on our funds, investors and/or our portfolio companies. Some member countries have been moving forward on the BEPS agenda but, because timing of implementation and the specific measures adopted will vary among participating states, significant uncertainty remains regarding the impact of the BEPS proposals project. In addition to national implementation of the BEPS project, the European Council has adopted Anti-Tax Avoidance Directives that address many of the same issues. These and other proposals could result in increased taxes on our funds and/or management entities. Such implementation may also give rise to additional reporting and disclosure obligations for our funds and/or management entities.
National policies in jurisdictions outside the United States could negatively impact our business.
On June 30, 2020, the National People’s Congress of China passed a national security law (the “National Security Law”), which criminalizes certain offenses related to the Chinese government. Although the extra-territorial reach of the National Security Law remains unclear, there is a risk that its application to conduct outside the Hong Kong Special Administrative Region of the People Republic of China (“Hong Kong”) by non-permanent residents of Hong Kong could limit the activities of or negatively impact us or our funds. The United States, the United Kingdom and several EU countries have expressed concerns regarding the National Security Law and the implementation of the National Security Law has created additional U.S.-China tensions and could potentially increase the risks associated with the business and operations of U.S.-based companies in China and Hong Kong. Any alterations to our business strategy or operations made in order to adapt to or comply with any such changes would be time-consuming and expensive, and certain of our competitors may be better suited to withstand or react to these changes. The aforementioned risks, including an expansionary application of the National Security Law in unpredictable circumstances by the Chinese authorities, and any downturn in Hong Kong’s economy could negatively impact the industries in which we participate, negatively impact our, our funds’ operations and have a material adverse effect on our results of operations, financial condition and cash flow.
If third-party investors in our funds exercise their right to remove us as investment manager or general partner of our funds, we would lose the Assets Under Management in such funds, which would eliminate our management fees and incentive income derived from such funds.
The governing agreements of most of our funds provide that, subject to certain conditions, third-party investors in those funds have the right, without cause, to vote to remove us as investment manager or general partner of the fund by a simple majority vote, resulting in the elimination of the Assets Under Management by those funds and the management fees and incentive income derived from those funds. In addition to having a significant negative impact on our business, financial condition or results of operations, the occurrence of such an event would likely result in significant reputational damage to us.
In addition, because our funds generally have an adviser that is registered under the Advisers Act, the management agreements of all of our funds would be terminated upon an “assignment” of these agreements without investor consent, which assignment may be deemed to occur in the event these advisers were to experience a change of control. We cannot be certain that consents required to assignments of our investment management agreements will be obtained if a change of control occurs. “Assignment” of these agreements without investor consent could cause us to lose the fees we earn from such funds.
Our failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business, financial condition or results of operations.
The Sarbanes-Oxley Act and the related rules require our management to conduct annual assessments of the effectiveness of our internal control over financial reporting and require a report by our independent registered public accounting firm, as well as an independent audit of our internal control over financial reporting. While we believe we maintain an effective system of controls, if our independent registered public accounting firm is unable to opine on the effectiveness of our internal control over financial reporting for any reason or we are unable to report our financial information on a timely basis due to matters impacting our internal controls, as has occurred in the past, we may become subject to adverse regulatory or other consequences, including sanctions or investigations by the SEC, and some of these consequences could have a material adverse effect on our business, financial condition or results of operations.
Our failure to deal appropriately with conflicts of interest could damage our reputation and materially adversely affect our business, financial condition or results of operations.
As we expand the scope of our business, we increasingly confront potential conflicts of interest relating to our funds’ investment activities. Certain of our funds have overlapping investment objectives and potential conflicts may arise with respect to our decisions regarding how to allocate investment opportunities among or even within those funds. For example, a decision to acquire material non-public information about a company while pursuing an investment opportunity for a particular fund gives rise to a potential conflict of interest when it results in our having to restrict the ability of other funds to buy or sell securities in the public markets. In addition, fund investors and holders of our Class A Shares may perceive conflicts of interest regarding investment decisions for funds in which our executive managing directors and employees, who have and may continue to make significant personal investments, are personally invested.
It is possible that actual, potential or perceived conflicts could give rise to investor dissatisfaction or litigation or regulatory enforcement actions. While we believe we have appropriate policies and procedures in place to manage conflicts of interest, this process is complex and difficult and our reputation could be damaged if we fail, or appear to fail, to deal appropriately with one or more potential or actual conflicts of interest. Regulatory scrutiny of, or litigation in connection with, conflicts of interest would have a material adverse effect on our reputation, which would materially adversely affect our business, financial condition or results of operations in a number of ways, including an inability to raise additional funds and a reluctance of counterparties to do business with us.
Misconduct by our executive managing directors, employees or agents could harm us by impairing our ability to attract and retain investors and subjecting us to significant legal liability, regulatory scrutiny and reputational harm.
There is a risk that our executive managing directors, employees, joint venture partners, consultants or agents could engage in misconduct that materially adversely affects our business. We are subject to a number of obligations and standards arising from our asset management business and our authority over the assets we manage, as well as our status as a public company with securities listed on the NYSE. The violation of these obligations and standards by any of our executive managing directors, employees, joint venture partners, consultants or agents could materially adversely affect our investors, both in our funds and in our Class A Shares, and us. In addition to these numerous and complex obligations, our business requires that we properly deal with confidential matters of great significance to companies in which we may invest or with which we otherwise do business. If our executive managing directors, employees, joint venture partners, consultants or agents were improperly to use or disclose confidential information, we could be subject to litigation, regulatory investigations or sanctions and suffer serious harm to our reputation, financial position and current and future business relationships. Furthermore, there have been a number of recent highly publicized cases involving fraud or other misconduct by employees (including in the workplace via inappropriate or unlawful behavior or actions directed to other employees) in the financial services industry generally and there can be no assurance that we will not suffer from similar employee misconduct. It is not always possible to detect or deter employee misconduct, and the precautions we take to detect and prevent this activity have not been and may not be effective in all cases. While we believe we have effective policies and procedures in place designed to deter and detect employee misconduct, the steps we have taken have not been and may not be effective in all cases. If one of our executive managing directors, employees, joint venture partners, consultants or agents were to engage in misconduct or were to be accused of such misconduct, even if such allegations were unsubstantiated, our reputation and our business, financial condition or results of operations could be materially adversely affected.
In recent years, the DOJ and the SEC have devoted significant resources to enforcement of the FCPA. In addition, the UK has significantly expanded the reach of its anti-bribery laws. While we have developed and implemented policies and procedures designed to ensure strict compliance by us and our personnel with the FCPA, such policies and procedures previously have not been, and in the future may not be effective in all instances to prevent violations. Any determination that we have violated the FCPA or other applicable anti-bribery laws could subject us to, among other things, civil and criminal penalties, material fines, profit disgorgement, injunctions on future conduct, securities litigation and a general loss of investor confidence, any one of which could adversely affect our business, financial condition or results of operations, see “—The FCPA settlements could have a material adverse effect on our ability to raise capital for our funds.”
We may enter into new businesses, make future strategic investments or acquisitions or enter into joint ventures, each of which may result in additional risks and uncertainties in our business.
We intend, to the extent that market conditions warrant, to grow our business by increasing Assets Under Management and creating new investment platforms and businesses. Accordingly, we may pursue growth through strategic investments, acquisitions or joint ventures, which may include entering into new lines of business in which we may not have extensive experience, including sponsoring business development companies and special purpose acquisition companies. It is also possible that, from time to time, we may need to make payments in order to resolve commercial disputes. In addition, we expect opportunities will arise to acquire, or enter into joint ventures with, other alternative or traditional asset managers. To the extent we make strategic investments or acquisitions, enter into joint ventures, or enter into a new line of business, we will face numerous risks and uncertainties, including risks associated with the required investment of capital and other resources, the possibility that we have insufficient expertise to engage in such activities profitably or without incurring inappropriate amounts of risk, combining or integrating operational and management systems and controls, or loss of investors in our funds due to the perception that we are no longer focusing on our core fund management duties. Entry into certain lines of business may subject us to more complex or extensive new laws and regulations with which we may not be familiar, or from which we are currently exempt, and may lead to increased litigation and regulatory risk. If a new business that we enter into generates insufficient revenues or if we are unable to efficiently manage any expansion of our operations, our business, financial condition or results of operations could be materially adversely affected. In the case of joint ventures, we are subject to additional risks and uncertainties in that we may be dependent upon, and subject to liability, losses or reputational damage relating to, systems, controls and personnel that are not under our control.
Risks Related to Our Funds
Our results of operations are dependent on the performance of our funds. Poor performance of our funds will result in reduced revenues and earnings and make it difficult for us to retain or attract investors to our funds, retain and increase Assets Under Management and grow our business. The performance of each fund we manage is subject to some or all of the following risks.
Difficult market conditions can adversely affect our funds in many ways, including by negatively impacting their performance and reducing their ability to raise or deploy capital, which could materially reduce our revenues and adversely affect our business, financial condition or results of operations.
Significant disruptions and volatility in the global financial markets and economies could impair the investment performance of our funds. Additionally, we may not be able to raise capital for existing or new funds during, or even following, periods of market instability. Although we seek to generate consistent, positive, absolute returns across all market cycles, our funds have been and may be materially affected by conditions in the global financial markets and economic conditions. The global market and economic climate may become increasingly uncertain due to numerous factors beyond our control, including but not limited to, concerns related to unpredictable global market and economic factors, uncertainty in U.S. federal fiscal, tax, trade or regulatory policy and the fiscal, tax, trade or regulatory policy of foreign governments, rising interest rates, inflation or deflation and rapid fluctuations in inflation rates, the availability of credit, performance of financial markets, terrorism and other armed conflicts, cyberterrorism, major or prolonged power outages or network interruptions, political uncertainty or public health crises, including infectious disease outbreaks, epidemics and pandemics or the possibility of U.S. sovereign debt default.
A general market downturn, a specific market dislocation or deteriorating economic conditions may cause a material reduction in our revenues and adversely affect our business, financial condition or results of operations by causing:
•A decline in Assets Under Management, resulting in lower management fees and incentive income.
•An increase in the cost of financial instruments, executing transactions or otherwise doing business.
•Lower or negative investment returns, which may reduce Assets Under Management and potential incentive income.
•Reduced demand for assets held by our funds, which would negatively affect our funds’ ability to realize value from such assets.
•Increased investor redemptions or greater demands for enhanced liquidity or other terms, resulting in a reduction in Assets Under Management, lower revenues and potential increased difficulty in raising new capital.
Furthermore, while difficult market and economic conditions and other factors can potentially increase investment opportunities over the long term, including with respect to the competitive landscape for the hedge fund industry, such conditions and factors also increase the risk of increased investment losses and additional regulation, which may impair our business model and operations. Our funds may also be materially adversely affected by difficult market conditions if our investment professionals fail to assess the adverse effect of such conditions on our investments, resulting in a significant reduction in the value of those investments. Moreover, challenging market conditions may prompt alternative asset managers to reduce the management fee and incentive income rates they charge in order to retain assets. In response to competitive pressures or for any other reason, we may reduce or change the compensation structures of our funds, which could reduce the amount of fees and income that we may earn relative to Assets Under Management.
Most of our funds utilize investment strategies that depend on our ability to appropriately react to, or accurately assess, the occurrence of certain events, including market and corporate events. If we fail to do so, our funds’ investment performance could be adversely affected in a material way.
The historical returns attributable to our funds should not be considered as indicative of the future results of our funds or any future funds we may raise.
We have presented throughout this report the net composite returns relating to the historical performance of our most significant funds, and we have also referred to other metrics associated with historical returns, such as risk and correlation measures. The returns are relevant to us primarily insofar as they are indicative of incentive income we have earned in prior periods and are not indicative of any future fund returns.
Moreover, with respect to the historical returns of our funds:
•The historical returns of our funds should not be considered indicative of the future results that should be expected from such funds or from any future funds we may raise.
•Our funds’ returns, particularly during periods of more extreme market and economic conditions, have benefited from or been impaired by the existence or lack of investment opportunities and such general market and economic conditions, which may not repeat themselves, and there can be no assurance that our current or future funds will be able to avail themselves of profitable investment opportunities.
•The historical rates of return of our funds reflect such funds’ historical expenses, which may vary in the future due to factors beyond our control, including changes in laws or regulations.
We are subject to counterparty default risks.
Our funds enter into numerous types of financial arrangements with a wide array of counterparties around the world, including loans, swaps, repurchase agreements, securities lending agreements and other derivative and non-derivative contracts. The terms of these contracts are often customized and complex and these arrangements may occur in markets or relate to products that are not currently subject to experienced regulatory oversight although the Dodd-Frank Act provides certain regulation in the derivatives market. In particular, certain of our funds utilize prime brokerage arrangements with a relatively limited number of counterparties, which has the effect of concentrating the transaction volume (and related counterparty default risk) of these funds with these counterparties.
Our funds are subject to the risk that the counterparty to one or more of these contracts defaults, either voluntarily or involuntarily, under the contract. Any such default may occur rapidly and without prior notice to us. Moreover, if a counterparty defaults, we may be unable to take action to recover our assets or any amounts due to us, either because we lack the contractual ability or because market conditions make it difficult to take effective action. This inability could occur at any time, but particularly in times of market stress, which are precisely the times when defaults may be most likely to occur.
In addition, our risk-management assessments may not accurately anticipate the impact of market stress or counterparty financial condition and, as a result, we may not take sufficient action to reduce our risks effectively. Although each of our funds regularly monitors its credit exposures, default risk may arise from events or circumstances that are difficult to detect, foresee or evaluate. In addition, concerns about, or a default by, one large participant could lead to significant liquidity problems for other participants, which may in turn expose us to significant losses.
In the event of a counterparty default, particularly a default by a major investment or commercial bank or other financial institution, one or more of our funds could incur material losses, and the resulting market impact of a major counterparty default could harm our business, results of operation and financial condition. In the event that one of our counterparties becomes insolvent or files for bankruptcy, our ability to eventually recover any losses suffered as a result of that counterparty’s default may be limited by the liquidity of the counterparty or the applicable legal regime governing the bankruptcy proceeding.
The counterparty risks that we face have increased in complexity and magnitude as a result of major disruptions in the financial markets in recent years. Further, the consolidation or elimination of counterparties has increased our concentration of counterparty risk. In addition, counterparties have generally reacted to the ongoing market volatility by tightening their underwriting standards and increasing their margin requirements for all categories of financing, which has the result of decreasing the overall amount of leverage available to our funds and increasing the costs of borrowing.
Poor performance of our funds would cause a decline in our revenues, results of operations and cash flows and could materially adversely affect our ability to retain capital or attract additional capital.
If our funds perform poorly, our revenues, results of operations and cash flows decline because the value of our Assets Under Management decreases, which in turn results in a reduction in management fees. To the extent that our funds perform poorly and such performance is continuing at the end of a relevant incentive period, we would experience a reduction in incentive income and total revenues, and if such reduction was substantial, could result in the elimination of incentive income for a given year and future years until that decrease has been surpassed by positive performance. Poor performance of our funds would make it more difficult for us to raise new capital and may cause investors in our funds to redeem their investments. Investors and potential investors in our funds continually assess our funds’ performance, as well as our ability to raise capital for existing and future funds. Our ability to avoid excessive redemption levels will depend in part on our funds’ continued satisfactory performance. Moreover, poor performance, particularly in our most significant funds, would harm our reputation and competitive standing, which would further impair our ability to retain or attract fund capital. These factors may cause us to reduce or change the compensation structure of our funds in order to retain or continue to attract Assets Under Management, which could further reduce the amounts of management fees and incentive income that we may earn relative to Assets Under Management.
Our funds may determine to use leverage in investments, which could materially adversely affect our ability to achieve positive rates of return on those investments.
Our funds use or may choose to use leverage, either directly or through the use of derivative instruments, to increase the yield on certain of their investments. The use of leverage poses a significant degree of risk, most notably by significantly increasing the risk of loss associated with leveraged investments that decline in value, and enhances the possibility of a significant loss in the value of the investments in our funds. Our funds may borrow money from time to time to purchase or carry securities. The interest expense and other costs incurred in connection with such borrowing may not be recovered by appreciation in the securities purchased or carried, and will be lost—and the timing and magnitude of such losses may be accelerated or exacerbated—in the event of a decline in the market value of such securities. Volatility in the credit markets increases the degree of risk associated with such borrowing. Gains realized with borrowed funds may cause a fund’s net asset value to increase at a faster rate than would be the case without borrowings. If investment results fail to cover the cost of borrowings, the fund’s applicable net asset value could also decrease faster than if there had been no borrowings. Increases in interest rates could also decrease the value of fixed-rate debt investments made by our funds. To the extent our funds determine to significantly increase their use of leverage, any of the foregoing circumstances could have a material adverse effect on our financial condition, results of operations and cash flows.
The due diligence process that we undertake in connection with investments by our funds may not reveal all facts that may be relevant in connection with making an investment.
Before investments are made by our funds, particularly investments in financial instruments that are not publicly traded, we conduct due diligence that we deem reasonable and appropriate based on the facts and circumstances applicable to each investment. When conducting due diligence, we may be required to evaluate important and complex business, financial, tax, accounting, ESG and legal issues. Outside consultants, legal advisors, accountants and investment bankers may be involved in the due diligence process in varying degrees depending on the type of investment. Nevertheless, when conducting due diligence and making an assessment regarding an investment, we rely on the resources available to us, including information provided by the target of the investment and, in some circumstances, third-party investigations. In some cases, whether or not known to us at the time, such resources may not be sufficient, accurate, complete or reliable. The due diligence that we carry out with respect to any investment opportunity may not reveal or highlight all relevant facts that may be necessary or helpful in evaluating such investment opportunity, and such an evaluation will not necessarily result in the investment being successful. Moreover, the level of due diligence conducted with respect to a particular investment will vary and we may not properly assess the appropriate amount of diligence for each investment, which may result in losses.
Our funds may invest in relatively high-risk, illiquid assets, including structured products, and may fail to realize any profits from these activities for a considerable period of time or lose some or all of the principal investments.
Our funds invest in financial instruments that are not publicly traded or that are otherwise illiquid, including complex structured products. There may be no readily available liquidity in these financial instruments, particularly at times of market stress or where many participants may be seeking liquidity at the same time. In many cases, our funds may be prohibited, whether by contract, by applicable securities laws or by the lack of a liquid market, from selling such financial instruments for a period of time. Moreover, even if the financial instruments are publicly traded, large holdings of financial instruments can often be disposed of only over a substantial length of time, exposing the investment returns to risks of downward movement in market prices during the required holding period. Accordingly, under certain conditions, our funds may be forced to either sell financial instruments at lower prices than they had expected to realize or defer, potentially for a considerable period of time, sales that they had planned to make. Investment in illiquid assets involves considerable risk and our funds may lose some or all of the principal amount of such investments.
Valuation methodologies for certain assets in our funds are subject to significant subjectivity and the values established pursuant to such methodologies may never be realized, which could result in significant losses for our funds.
While we believe we have effective policies and procedures in place governing valuation of illiquid investments, risk exists that these policies and procedures may not always function effectively. There are no readily ascertainable market prices for the large number of the illiquid investments held by our funds. The fair value of the investments of our funds is determined periodically by us using a number of methodologies permitted by our funds’ valuation policies. These methodologies involve a
significant degree of judgment and are based on a number of factors, which may include, without limitations, the nature of the investment, the expected cash flows from the investment, bid or ask prices provided by third parties for the investment, the length of time the investment has been held, the trading price of financial instruments (in the case of publicly traded financial instruments), restrictions on transfer and other recognized valuation methodologies. In addition, because certain of the illiquid investments held by our funds may be in industries or sectors that are under distress or undergoing some uncertainty, such investments may be subject to rapid changes in value caused by sudden company-specific or industry-specific developments.
Because valuations, and in particular valuations of investments for which market quotations are not readily available, are inherently uncertain, may fluctuate over short periods of time and may be based on estimates, determinations of fair value may differ materially from the values that would have resulted if a ready market had existed. Even if market quotations are available for our investments, such quotations may not reflect the value that may actually be realized because of various factors, including the possible illiquidity associated with a large ownership position, subsequent illiquidity in the market for a company’s financial instruments, future market price volatility or the potential for a future loss in market value based on poor industry conditions or the market’s view of overall company and management performance.
Because there is significant uncertainty in the valuation of and in the stability of the value of illiquid investments, the fair values of such investments as reflected in a fund’s net asset value do not necessarily reflect the prices that might actually be obtained when such investments are sold. Realizations at values significantly lower than the values at which investments have been reflected in fund net asset values would result in losses for the applicable funds, a decline in management fees and the loss of potential incentive income. Also, a situation where asset values turn out to be materially different from values reflected in fund net asset values may cause investors to lose confidence in us, which could, in turn, result in redemptions from our funds, difficulties in our ability to raise additional capital or an increased risk of litigation by investors or governmental or self-regulatory organizations. These issues could result in regulatory scrutiny of our valuation methodologies, polices and related disclosures.
Our funds make investments in companies that we do not control, exposing us to the risk of decisions made by others with whom we may not agree.
Investments by our funds will include investments in debt or equity of companies that we do not control. Such investments may be acquired by our funds through trading activities or through purchases of financial instruments from the issuer. Those investments will be subject to the risk that the company in which the investment is made may make business, financial or management decisions contrary to our expectations, with which we do not agree or that the majority stakeholders or the management of the company may take risks or otherwise act in a manner that does not serve our interests. In addition, we may make investments in which we share control over the investment with co-investors, which may make it more difficult for us to implement our investment approach or exit the investment when we otherwise would. If any of the foregoing were to occur with respect to one or more significant investments, the values of such investments by our funds could decrease and our business, financial condition or results of operations could suffer as a result.
Our funds make investments in companies that are based outside of the U.S., exposing us to additional risks not typically associated with investing in companies that are based in the U.S.
Many of our funds may invest a significant portion of their assets in the equity, debt, loans or other financial instruments of issuers located outside the U.S. Investments in non-U.S. financial instruments involve certain factors not typically associated with investing in U.S. financial instruments, including risks relating to the following:
•Currency exchange matters, including fluctuations in currency exchange rates and costs associated with conversion of investment principal and income from one currency into another.
•Less developed or efficient financial markets than in the U.S., which may not enable or permit appropriate hedging techniques or other developed trading activities, leading to potential price volatility and relative illiquidity.
•The absence of uniform accounting, auditing and financial reporting standards, practices and disclosure requirements and less government supervision and regulation.
•Differences in the legal and regulatory environment, including less-developed or less-comprehensive bankruptcy laws.
•Fewer investor protections and less stringent requirements relating to fiduciary duties.
•Difficulties in enforcing contracts and filing claims under foreign legal systems.
•Less publicly available information in respect of companies in non-U.S. markets.
•Higher rates of inflation.
•Heightened exposure to corruption risk in non-U.S. markets.
•Certain economic and political risks, including potential exchange control regulations and restrictions on our non-U.S. investments and repatriation of profits on investments or of capital invested, the risks of political, economic or social instability, the possibility of expropriation or confiscatory taxation, unexpected, additional and/ or costly changes in trade policies, tariffs or other barriers and adverse economic and political developments.
•The possible imposition of non-U.S. taxes or withholding on income and gains recognized with respect to such financial instruments.
There can be no assurance that adverse developments with respect to such risks will not materially adversely affect our funds’ investments that are held in certain countries or the returns from these investments.
Tariffs, sanctions and other restrictions imposed by the U.S. government, and potential for further regulatory reform, may create regulatory uncertainty and adversely affect our investment strategies and the profitability of our funds.
The U.S. has imposed new or increased tariffs on certain goods and materials, such as steel products imported into the U.S. from certain jurisdictions, including China and Russia. Similarly, the U.S. government has expanded economic sanctions laws and regulations to target an increasingly broad range of non-U.S. parties, including in response to the ongoing conflict between Russia and Ukraine. These tariffs, sanctions and other changes in U.S. trade policy, have resulted in, and may continue to trigger, retaliatory actions by affected countries. Certain foreign governments have instituted or are considering imposing tariffs on certain U.S. goods, or restrictions that will deny U.S. companies access to critical raw materials. A “trade war” of this nature or other governmental action related to tariffs or international trade agreements or policies has the potential to further increase uncertainty and costs, decrease margins, reduce the competitiveness of products and services offered by companies where our funds have current or future investments and adversely affect the revenues and profitability of companies whose businesses rely on goods imported from outside of the U.S. and could reduce the value of our current or future investments in such companies. In addition, tariff increases may have a similar impact to suppliers and certain other customers of companies where our funds have current or future investments, which could increase the negative impact on our operating results or future cash flows. Similarly, the proliferation of U.S. economic sanctions and similar trade-related restrictions, and countersanctions imposed by foreign governments, may increase the regulatory burden on our funds, and the compliance considerations for the companies where our funds have current or future investments if our funds were to violate or be deemed in violation of any such sanction, such funds could face significant legal and monetary penalties.
Furthermore, sanctions may negatively impact our funds’ ability to effectively implement their respective investment strategies and have a material adverse impact on the funds’ investment programs. Sanctions may adversely affect our funds in various ways, including by preventing or inhibiting our funds from making certain investments or by forcing our funds to divest from investments previously made.
Risk management activities may materially adversely affect the return on our funds’ investments.
When managing our funds’ exposure to market risks, we may from time to time use hedging strategies and various forms of derivative instruments to limit the funds’ exposure to changes in the relative values of investments that may result from market developments, including changes in prevailing interest rates, currency exchange rates and commodity prices. The success of any
hedging transactions generally will depend on our ability to correctly assess the degree of correlation between price movements of the hedging instrument, the position being hedged, the creditworthiness of the counterparty and other factors. As a result, while we may enter into a transaction in order to reduce our exposure to market risks, the transaction may result in poorer overall investment performance than if it had not been executed, such as by limiting the opportunity for gain if the value of a hedged position increases, and in some cases, the hedging or derivative transaction may not perform as anticipated. In addition, the degree of correlation between price movements of the instruments used in connection with hedging activities and price movements in a position being hedged may vary. For a variety of reasons, we may not seek or be successful in establishing a perfect correlation between the instruments used in a hedging or other derivative transaction and the position being hedged. An imperfect correlation could prevent us from achieving the intended result and could give rise to a loss. In addition, it may not be possible to fully or perfectly limit our exposure against all changes in the value of our investment because the value of investments is likely to fluctuate as a result of a number of factors, some of which will be beyond our control or ability to hedge.
If our risk management processes and systems are ineffective, we may be exposed to material unanticipated losses.
We continue to refine and implement our risk management techniques, strategies and assessment methods, such as the use of statistical and other quantitative and qualitative tools to identify, observe, measure and analyze the risks to which our funds are exposed. These methods, even if properly implemented, may not allow us to fully mitigate the risk exposure of our funds in all economic or market environments, or against all types of risk, including risks that we might fail to identify or anticipate. Some of our strategies for anticipating and managing risk in our funds are based upon our use of historical market behavior statistics, which may not be an accurate predictor of current or future market risks. Any failure in our risk management systems, whether in design or implementation, to accurately identify and quantify such risk exposure could limit our ability to manage risks in the funds, identify appropriate investment opportunities or realize positive, risk-adjusted returns. Because neither our quantitative nor qualitative risk management processes can anticipate for every investment the economic and financial outcome or timing and other specifics of the outcome, we will, in the course of our activities, incur losses.
Our funds’ investments are subject to numerous additional risks.
Our funds’ investments are subject to numerous additional risks, including the following:
•The funds may engage in short selling, which is subject to the theoretically unlimited risk of loss because there is no limit on how much the price of a security may appreciate before the short position is closed out. A fund may be subject to losses if a security lender demands return of the lent securities and an alternative lending source cannot be found or if such fund is otherwise unable to borrow securities that are necessary to hedge its positions.
•Our funds may be limited in their ability to engage in short selling or other activities as a result of regulatory mandates. Such regulatory actions may limit our ability to engage in hedging activities and therefore impair our investment strategies. In addition, our funds may invest in securities and other assets for which appropriate market hedges do not exist or cannot be acquired on attractive terms.
•Our funds may invest in companies with weak financial conditions, poor operating results, substantial financial needs, negative net worth and/or special competitive problems or that are involved in bankruptcy or reorganization proceedings. In such “distressed” situations, it may be difficult to obtain full information as to the exact financial and operating condition of the issuer. Depending on the specific fund’s investment profile, a fund’s exposure to distressed investments may be substantial in relation to the market for those investments and the investments may be illiquid and difficult to transfer. As a result, it may take a number of years for the fair value of our funds’ distressed investments to reflect their intrinsic value as perceived by us.
•Distressed investments may be involved in work-outs, liquidations, spin-offs, reorganizations, bankruptcies and similar transactions and may purchase high-risk receivables. Additionally, the fair values of such investments may be subject to abrupt and erratic market movements and significant price volatility if they are widely traded financial instruments and significant uncertainty in general if they are not widely traded financial instruments, have no recognized market or if transactions or events in related markets, such as related derivatives markets, have the effect of increasing the economic significance or importance of a price or value determined as of a particular time of timeframe. Moreover, a major economic recession could have a materially adverse impact on the value of such
financial instruments. An investment in such business enterprises entails the risk that the transaction in which such business enterprise is involved either will be unsuccessful, will take considerable time or will result in a distribution of cash or a new security, the value of which will be less than the purchase price to the funds of the security or other financial instrument in respect of which such distribution is received. In addition, if an anticipated transaction does not in fact occur, the funds may be required to sell their investment at a loss. Because there is substantial uncertainty concerning the outcome of transactions involving financially troubled companies, there is a potential risk of loss by a fund of its entire investment in each such company.
•Investments in troubled companies may also be adversely affected by U.S. federal and state laws relating to, among other things, fraudulent conveyances, voidable preferences, lender liability and a bankruptcy court’s discretionary power to disallow, subordinate or disenfranchise particular claims. Investments in financial instruments and private claims of troubled companies made in connection with an attempt to influence a restructuring proposal or plan of reorganization in a bankruptcy case may also involve substantial litigation. Adverse publicity and investor perceptions, whether or not based on fundamental analysis, may also decrease the value and liquidity of financial instruments rated below investment grade or otherwise adversely affect our reputation.
•Credit risk may be exacerbated through a default by or because of one of several large institutions that are dependent on one another fail to meet their liquidity or operational needs, so that a default by one institution causes a series of defaults by the other institutions. This “systemic risk” could have a further material adverse effect on the financial intermediaries (such as prime brokers, clearing agencies, clearing houses, banks, securities firms and exchanges) with which the funds transact on a daily basis. Although the U.S. government, including the U.S. Treasury Department and the Federal Reserve, has taken significant actions to prevent a systemic collapse, no assurance can be given that such actions will be sufficient or successful in all cases.
•The effectiveness of investment and trading strategies depends largely on the ability to establish and maintain an overall market position in a combination of financial instruments. A fund’s trading orders may not be executed in a timely and efficient manner due to various circumstances, including systems failures or human error. In such event, the funds may only be able to acquire some but not all of the components of the position, or if the overall position were to need adjustment, the funds might not be able to make such adjustment. As a result, the funds would not be able to achieve the market position selected by the investment manager or general partner of such funds, and might incur a loss in liquidating their position.
•Fund investments are subject to risks relating to investments in commodities, futures, options and other derivatives, the prices of which are highly volatile and may be subject to the theoretically unlimited risk of loss in certain circumstances, including if the funds write a call option. Price movements of commodities, futures and options contracts and payments pursuant to swap agreements are influenced by, among other things, interest rates; changing supply and demand relationships; trade, fiscal, monetary and exchange control programs; and policies of governments and national and international political and economic events and policies. The value of futures, options and swap agreements also depends upon the price of the securities underlying them. In addition, the funds’ assets are subject to the risk of the failure of any of the exchanges on which their positions trade or of their clearinghouses or counterparties.
•Our funds may make real estate investments, including, without limitation, the acquisition of real estate assets, the purchase of loans secured directly or indirectly by real estate and the purchase of public and private market securities backed by real estate assets or mortgage loans secured by real estate, which will be subject to the risks incident to the lending, ownership and operation of commercial and residential real estate, including (i) risks associated with both the domestic and international general economic climate; (ii) local real estate conditions; (iii) risks due to dependence on cash flow; (iv) risks relating to the decline in value of the real estate properties in question; (v) risks and operating problems arising out of the absence of certain construction materials; (vi) changes in supply of, or demand for, competing properties in an area (as a result, for instance, of over-building); (vii) the financial condition of tenants, buyers and sellers of properties; (viii) risks relating to the absence of debt financing or changes in its availability; (ix) energy and supply shortages; (x) laws assigning liability to the owners of real estate properties for environmental hazards existing on such properties; (xi) laws relating to real estate lending, management and/or ownership that are complex or unclear or otherwise difficult to comply with; (xii) changes in
the tax, real estate, environmental and zoning laws and regulations; (xiii) various uninsured or uninsurable risks; (xiv) natural disasters and disease, including COVID-19; and (xv) the ability of the funds or third-party borrowers to develop and manage the real properties. With respect to investments in equity or debt securities, the funds will in large part be dependent on the ability of third parties to successfully manage the underlying real estate assets. In addition, the funds may invest in mortgage loans that are structured so that all or a substantial portion of the principal will not be paid until maturity, which increases the risk of default at that time. The funds’ investment strategy, which may involve the acquisition of distressed or underperforming assets in a leveraged capital structure, will involve a high degree of legal and financial risk, and there can be no assurance that the funds’ rate of return objectives will be realized or that there will be any return of capital. There is no assurance that there will be a ready market for resale of investments because investments in real estate generally are not liquid.
•Our funds may make investments in Bitcoin, Ethereum and other digital assets and cryptocurrencies (collectively, “Digital Assets”). The investment characteristics of Digital Assets differ from those of many traditional currencies, commodities and securities. Digital Assets are not backed by a central bank or a national, supra-national or quasi-national organization, any hard assets, human capital, or other form of credit. Banks and other established financial institutions may refuse to process funds for Digital Asset transactions, process wire transfers to or from Digital Asset exchanges, cryptocurrency-related companies or service providers, or maintain accounts for persons or entities transacting in Digital Assets. Market capitalization for Digital Assets is as a medium of exchange and payment method may always be low. Further, any Digital Asset’s use as an international currency may be hindered by the fact that it may not be considered as a legitimate means of payment or legal tender in some jurisdictions and governments may curtail or outlaw the acquisition, use or redemption of Digital Assets. In certain cases, ownership of, holding or trading in Digital Assets may then be considered illegal, subject to sanction and subject us and our funds to heightened regulatory scrutiny. While all investments entail risk of loss of capital, investments in Digital Assets should be considered substantially more speculative and significantly more likely to result in total loss of capital than many other investments. The market prices of many Digital Assets have experienced extreme volatility in recent periods and may continue to do so. Digital Assets can be traded on virtual currency exchanges and held by companies providing Digital Asset custodial services. Such electronic exchanges and third-party custodians are subject to their own risks such as cyber-attacks.
Our and our funds’ investments in special purpose acquisition companies, or SPACs, may expose us and our funds to increased risks and liabilities.
We and our funds have, continue to, sponsor or otherwise make investments in, or facilitate the acquisition of companies by, special purpose acquisition vehicles (“SPACs”), including our investment into our subsidiary that is the sponsor of Sculptor Acquisition Corp I (NYSE: SCUA) in December 2021. There are a number of risks associated with investing in SPACs, including: (i) because a SPAC is raised without a specifically-identified acquisition target, it may never, or only after an extended period of time, be able to find and execute a suitable business combination, during which period the capital invested in or committed to the SPAC will not be available for other uses: (ii) investments made by us and our funds in a SPAC may be entirely lost, or otherwise decline in value in the case of investments in third-party SPACs, if the SPAC does not execute a business combination during the finite period of time that is permitted for the related SPAC; (iii) SPACs typically invest in single assets and not diversified portfolios, and investments therein are therefore subject to significant concentration risk; (iv) SPACs incur substantial fees, costs and expenses related to their initial public offerings, being a public company and in connection with pursuing a business combination (in some cases, regardless of whether, or when, the SPAC ultimately consummates a transaction); and (v) potential litigation risks associated with transactions executed by SPACs and compliance with regulatory, tax or other policies relating to SPACs and SPAC investing. In addition, SPACs can raise capital through offering securities, each of which is subject to the risks associated with such instruments. Furthermore, sponsoring SPACs or otherwise making investments in SPACs increases the likelihood that potential conflicts of interest relating to us and our funds’ investment activities may arise. Management may also determine that our internal controls over financial reporting have material weaknesses or significant deficiencies if there are changes to accounting policies for SPACs that would require a restatement of the financial statements of any SPAC that we consolidate for financial reporting.
Sculptor Acquisition Corp I has until June 13, 2023 to complete a business combination transaction. If Sculptor Acquisition Corp I does not complete a business combination transaction by this date and chooses to extend its deadline to
complete a business combination transaction, we may be required to contribute additional amounts to Sculptor Acquisition Corp I’s trust account. Further investment in Sculptor Acquisition Corp I by us may heighten the impact of the risks described above.
In addition, litigation related to acquisitions by SPACs has increased in recent years. Litigation has also arisen asserting that SPACs are violating federal securities laws by operating as unregistered investment companies. Any liabilities arising from these developments could harm our professional reputation as the sponsor of Sculptor Acquisition Corp I. Moreover, we may lose all or a portion of our investment in Sculptor Acquisition Corp I if a business combination is not completed.
Risks Related to Our Organization and Structure
Our current and former executive managing directors’ total combined voting power could influence major corporate decisions that could conflict with the interests of our Class A Shareholders and materially adversely affect the market price of the Class A Shares.
As of December 31, 2022, our current and former executive managing directors control approximately 66.6% of the total combined voting power of our Class A Shares and Class B Shares, excluding the voting power of the Class B Shares that relate to our Group A-1 Units, which represent 0.7% of our total combined voting power, and are voted pro rata in accordance with the vote of our Class A Shares until such time as the relevant Group E Units become vested or are forfeited. Our executive managing directors will receive additional Class B Shares resulting in additional control in connection with the vesting of Group E Units.
As of December 31, 2022, Mr. Och controls approximately 12.5% of the total combined voting power of our Class A Shares and Class B Shares after excluding the Class B Shares owned by Mr. Och that relate to Group A-1 Units that will be voted pro rata in accordance with the vote of the Class A Shares. As of May 29, 2019, (the “Transition Date”), Mr. Och no longer has an irrevocable proxy to vote all of our executive managing director’s Class B Shares. In addition, pursuant to the governance agreement, dated as of February 7, 2019, (the “Governance Agreement”), Mr. Och has the right to designate a director to serve in his place as a director on the Board of Directors for as long as Mr. Och continues to own a number of common equity units (on an as-converted basis) of the Company not less than 33% of the number of common equity units (on an as-converted basis) of the Company owned by Mr. Och immediately after the Recapitalization.
Our Certificate of Incorporation and By-Laws contain provisions limiting the liability of our officers and directors to us, which also reduces remedies available to our Class A Shareholders for certain acts by such persons.
Under our Certificate of Incorporation and By-Laws, in most circumstances the Company will indemnify the following persons (the “Indemnified Persons”), to the fullest extent authorized or permitted by applicable law, if such indemnified persons acted in a manner not constituting fraud, gross negligence or willful misconduct: (a) any person who is or was a director, officer or tax matters partner of the Company or its predecessor, (b) any person who is or was serving at the request of the Company or its predecessor as an officer, director, member, manager, partner, tax matters partner, fiduciary or trustee of another person (including any subsidiary); provided, that a person shall not be an Indemnified Person by reason of providing, on a fee-for-services basis, trustee, fiduciary or custodial services, and (c) any person the Board of Directors designates as an “Indemnified Person” for purposes of the Certificate of Incorporation or the By-Laws. In addition to rights to indemnification, the Certificate of Incorporation also contains a provision eliminating personal liability of directors of the Company for monetary damages for breach of fiduciary duties, except for personal liability for fraud, gross negligence or willful misconduct and except that personal liability may not be eliminated for:
•any breach of the director’s duty of loyalty to the Company or its stockholders;
•any act or omission not in good faith or which involved intentional misconduct or a knowing violation of law;
•unlawful payments of dividends or unlawful stock repurchases or redemptions as provided in Section 174 of the Delaware General Corporation Law, which we refer to as the “DGCL”; and
•any transaction from which the director derived an improper personal benefit.
The Company has agreed to provide this indemnification unless there has been a final and non-appealable judgment by a court of competent jurisdiction determining that these persons are not entitled to indemnification. The Company has also agreed to provide this indemnification for criminal proceedings. The Company may purchase insurance against these liabilities asserted against and expenses incurred by persons in connection with its activities, regardless of whether the Company would have the power to indemnify the person against liabilities under the Certificate of Incorporation and By-Laws.
In connection with the Recapitalization, we agreed to indemnify losses, and advance expenses, of each active and former executive managing director and trust that executed a consent agreement (and their applicable related parties and representatives) arising out of, relating to, based upon or resulting from the Recapitalization or any act or omission with respect to the planning for, or otherwise arising out of or relating to, the Recapitalization (including, without limitation, losses relating to taxes) solely in respect of the period beginning on May 17, 2018 and subject to and in accordance with the terms and conditions of the consent agreements (and excluding any intended effects of the Recapitalization).
Additionally, we have entered into an indemnification agreement with each of our directors and executive officers. The indemnification agreements provide for, among other things, indemnification to the fullest extent permitted by law against: (i) any and all expenses and liabilities, including judgments, fines, penalties, interest and amounts paid in settlement of any claim with our approval, and counsel fees and disbursements; (ii) any liability pursuant to a loan guarantee, or otherwise, for any of our indebtedness; and (iii) any liabilities incurred as a result of acting on our behalf (as a fiduciary or otherwise) in connection with an employee benefit plan. The indemnification agreements provide for the advancement or payment of all expenses to the director or executive officer and for reimbursement to us if it is found that such director or executive officer is not entitled to such indemnification under applicable law. The Sculptor Operating Partnerships’ limited partnership agreements also require the Sculptor Operating Group entities to indemnify and exculpate our executive managing directors, including those who are our executive officers.
Because our executive managing directors hold their economic interest in our business directly in the Sculptor Operating Group, conflicts of interest may arise between them and holders of our Class A Shares, particularly with respect to tax considerations.
As of December 31, 2022, our executive managing directors held 54.2% of the outstanding interests in the Sculptor Operating Group in the form of Group A Units and Group E Units. In addition, as of December 31, 2022, our executive managing directors held 5,348,572 Group P Units. Because they hold their economic interests in our business directly through the Sculptor Operating Group, our executive managing directors may have conflicting interests with holders of Class A Shares or with us. For example, our executive managing directors will have different tax positions from holders of our Class A Shares which could influence decisions of the Partner Management Committee and also our Board of Directors regarding whether and when to dispose of assets, and whether and when to incur new or refinance existing indebtedness, especially in light of the existence of the tax receivable agreement. Decisions with respect to these and other operational matters could affect the timing and amounts of payments due to our executive managing directors and Ziff Investors Partnership, L.P. II and certain of its affiliates and control persons (the “Ziffs”) under the tax receivable agreement. In addition, the structuring of future transactions and investments may take into consideration our executive managing directors’ tax considerations even where no similar benefit would accrue to us or the holders of Class A Shares.
We intend to pay regular quarterly distributions to Class A Shareholders but our ability to do so may be limited by our holding company structure, as we are dependent on distributions from the Sculptor Operating Group to make distributions and to pay taxes and other expenses, and may be limited by contractual restrictions and obligations.
As a holding company, our ability to make distributions or to pay taxes and other expenses is subject to the ability of our subsidiaries to provide cash to us. We intend to make quarterly distributions to our Class A Shareholders. Accordingly, we expect to cause the Sculptor Operating Group to make distributions to Sculptor Corp in an amount sufficient to enable us to pay distributions to our Class A Shareholders and make required tax payments and payments under the tax receivable agreement; however, no assurance can be given that such distributions will or can be made. The members of the Sculptor Operating Group are subject to certain restrictions under the 2020 Credit Agreement that limit their ability to make distributions. Consequently, no assurance can be given that the Sculptor Operating Group will or can make such distributions to Sculptor Corp. Our Board of Directors can change our distribution policy or reduce or eliminate our distributions at any time, in its discretion. The Sculptor Operating Group may make minimum tax distributions to its direct unit holders, to which our Class A Shareholders may not be entitled, as distributions on Group B Units to Sculptor Corp that may be used to settle tax liabilities, if any, and make payments
under the tax receivable agreement or settle other obligations. In addition, the Sculptor Operating Group may make distributions to our executive managing directors in respect of their Class C Non-Equity Interests with respect to cash awards granted to them from time to time. As a result, Class A Shareholders may not receive any distributions at a time when our executive managing directors are receiving distributions on their Class C Non-Equity Interests or their other ownership interests. If the Sculptor Operating Group has insufficient funds to make such distributions, we may have to borrow additional funds or sell assets, which could have a material adverse effect on our business, financial condition or results of operations.
Furthermore, by paying cash distributions rather than investing that cash in our business, we might risk slowing the pace of our growth, or not having a sufficient amount of cash to fund our operations, new investments or unanticipated capital expenditures, should the need arise.
There may be circumstances under which we are restricted from making distributions under applicable law or regulation (for example, our Board of Directors may only declare and pay dividends either out of our surplus (as defined in DGCL) or in case there is no such surplus, out of our net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year) or under our 2020 Credit Agreement.
The declaration and payment of any future distributions will be at the sole discretion of our Board of Directors, which may change our distribution policy or reduce or eliminate our distributions at any time, in its discretion, and may be subject to contractual obligations and restrictions under Delaware law.
Because we have historically earned and recognized most of our incentive income in the fourth quarter of each year, we anticipate that quarterly distributions in respect of the first three calendar quarters will be disproportionate to distributions in respect of the last calendar quarter, which will typically be paid in the first calendar quarter of the following year. Our Board of Directors will take into account such factors as it may deem relevant, including general economic and business conditions; our strategic plans and prospects; our business and investment opportunities; our financial condition and operating results; working capital requirements and anticipated cash needs; contractual restrictions and obligations, including payment obligations pursuant to the tax receivable agreement and restrictions pursuant to our 2020 Credit Agreement; legal, tax and regulatory restrictions; and other restrictions and implications on the payment of distributions by us to our Class A Shareholders or by our subsidiaries to us and such other factors as our Board of Directors may deem relevant. Any compensatory payments made to our employees, as well as payments that Sculptor Corp makes under the tax receivable agreement and distributions to holders of ownership interests in respect of their tax liabilities arising from their direct ownership of ownership interests, will reduce amounts that would otherwise be available for distribution on our Class A Shares. In addition, discretionary income allocations on Class C Non-Equity Interests as determined by the Chairman of the Partner Management Committee (or, in the event there is no Chairman, the full Partner Management Committee acting by majority vote) in conjunction with our Compensation Committee with respect to our executive officers, relating to cash awards granted to our executive managing directors will also reduce amounts available for distribution to our Class A Shareholders. We have granted RSUs and restricted shares that may settle in Class A Shares to certain of our executive managing directors, managing directors and other employees, and to certain independent members of our Board of Directors. All of these RSUs accrue distributions (except with respect to certain RSUs, during the Distribution Holiday) to be paid if and when the underlying RSUs vest. Distributions may be paid in cash or in additional RSUs that accrue additional distributions and will be settled at the same time the underlying RSUs vest . Restricted shares have the same rights to distributions as Class A Shares, provided that any distributions payable with respect to unvested restricted shares are payable only in restricted Class A Shares.
The declaration and payment of any distribution may be subject to legal, contractual or other restrictions. For example, as a Delaware corporation, our Board of Directors may only declare and pay dividends either out of our surplus (as defined in DGCL) or in case there is no such surplus, out of our net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year. In addition, we may not be permitted to make certain distributions if we are in default under our 2020 Credit Agreement. Our cash needs and payment obligations may fluctuate significantly from quarter to quarter, and we may have material unexpected expenses in any period. This may cause amounts available for distribution to significantly fluctuate from quarter to quarter or may reduce or eliminate such amounts.
We will be required to pay amounts under the tax receivable agreement we are party to for most of the actual tax benefits we realize as a result of the tax basis step-up we receive in connection with an exchange of common units in the Sculptor Operating Group for Class A Shares (or cash). In certain circumstances, payments under the tax receivable agreement may be accelerated and/or could exceed the actual tax benefits we realize.
We generally receive a tax benefit when common units in the Sculptor Operating Group are acquired or exchanged because our tax basis in our distributive share of the Sculptor Operating Group assets generally increases as a result of these acquisitions or exchanges. We are a party to a tax receivable agreement with active and former executive managing directors and the Ziffs, that requires us to pay 75% of the amount of cash savings in U.S. federal, state and local income tax that we actually realize as a result of such an increase in tax basis.
The actual increase in tax basis of the Sculptor Operating Group assets resulting from an exchange or from payments under the tax receivable agreement, as well as the amortization thereof and the timing and amount of payments under the tax receivable agreement, will vary based upon a number of factors including the law in effect at the time of an exchange or a payment under the tax receivable agreement, the timing of future exchanges, the timing and amount of prior payments under the tax receivable agreement, the price of our Class A Shares at the time of any exchange, the composition of the Sculptor Operating Group’s assets at the time of any exchange, the extent to which such exchanges are taxable and the amount and timing of the income of Sculptor Corp and our other intermediate corporate taxpayers that hold Group B Units in connection with an exchange, if any. Depending upon the outcome of these factors, payments that we may be obligated to make to our executive managing directors and the Ziffs under the tax receivable agreement in respect of exchanges are likely to be substantial. In light of the numerous factors affecting our obligation to make payments under the tax receivable agreement, however, the timing and amounts of any such actual payments are not reasonably ascertainable. See “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Tax Receivable Agreement.”
Were the Internal Revenue Service (“IRS”) to successfully challenge all or a part of increased deductions and a tax basis increase, our executive managing directors and the Ziffs who have received payments under the tax receivable agreement will not reimburse the corporate taxpayers for any such payments that have been previously made. As a result, in certain circumstances, payments could be made to our executive managing directors and the Ziffs under the tax receivable agreement in excess of the corporate taxpayers’ cash tax savings. The corporate taxpayers’ ability to achieve benefits from any tax basis increase, and the payments to be made under this agreement, will depend upon a number of factors, including the timing and amount of our future income.
Decisions made by our executive managing directors in the course of running our business, in particular decisions made with respect to the sale or disposition of assets or change of control, may influence the timing and amount of payments that are payable to an exchanging or selling executive managing director or the Ziffs under the tax receivable agreement. In general, earlier disposition of assets following an exchange or acquisition transaction will tend to accelerate such payments and increase the present value of the tax receivable agreement, and disposition of assets before an exchange or acquisition transaction will tend to increase the tax liability of our executive managing directors or the Ziffs without giving rise to any rights to receive payments under the tax receivable agreement.
In addition, the tax receivable agreement provides that, upon a merger, asset sale or other form of business combination or certain other changes of control, the corporate taxpayers’ (or their successors’) obligations with respect to exchanged or acquired units (whether exchanged or acquired before or after such change of control) would be based on certain prescribed assumptions, including that the corporate taxpayers would have sufficient taxable income to fully utilize the deductions arising from the increased tax deductions and tax basis and other benefits related to entering into the tax receivable agreement. Accordingly, obligations under the tax receivable agreement may make it more expensive for third parties to acquire control of us and make it more difficult for the holders of Class A Shares to recognize a premium in connection with any such transaction. Finally, we may need to incur debt to finance payments under the tax receivable agreement to the extent our cash resources are insufficient to meet our obligations under the tax receivable agreement, which may or may not be available on favorable terms, if at all.
Our board of directors has publicly disclosed that it has formed a special committee to explore potential interest from third parties in a transaction that maximizes value for shareholders, and if we are unable to consummate a transaction at the conclusion of that process, there could be an adverse effect on our business, financial condition and results of operations.
On November 18, 2022, we issued a press release announcing the formation by of our board of directors of a special committee comprised solely of independent directors (the “Special Committee”) to explore potential interest from third parties in a transaction with the Company that maximizes value for shareholders. As of the filing date of this Annual Report on Form 10-K, no transaction has been announced, and there can be no assurance that the Special Committee process will result in any transaction in the future. If we are unable to consummate a strategic transaction at the conclusion of the Special Committee process, there could be an adverse effect on our business, financial condition or results of operations, including that the price of our Class A Shares may decline or become more volatile.
If we are deemed an investment company under the 1940 Act, the applicable restrictions could make it impracticable for us to continue our business as contemplated and would have a material adverse impact on the market price of our Class A Shares.
We do not believe that we are an “investment company” under the 1940 Act because the nature of our assets and the sources of our income exclude us from the definition of an investment company under the 1940 Act. In addition, we believe our Company is not an investment company under Section 3(b)(1) of the 1940 Act because we are primarily engaged in a non-investment company business. We intend to continue to conduct our operations so that we will not be deemed an investment company. If we were to be deemed an investment company, including in connection with our sponsorship of Sculptor Acquisition Corp I, restrictions imposed by the 1940 Act, including limitations on our capital structure and our ability to transact with affiliates, could make it impractical for us to continue our business as contemplated.
Risks Related to Our Shares
The market price and trading volume of our Class A Shares have been and may continue to be highly volatile, which could result in rapid and substantial losses for our shareholders.
The market price of our Class A Shares has been and may continue to be highly volatile and subject to wide fluctuations. In addition, the trading volume in our Class A Shares can be highly variable, which has caused and may continue to cause significant price variations to occur. The market price of our Class A Shares may fluctuate or decline significantly in the future.
Some of the primary factors that could negatively affect the price of our Class A Shares or result in fluctuations in the price or trading volume of our Class A Shares include:
•Reductions or lack of growth in our Assets Under Management, whether due to poor investment performance by our funds or redemptions by investors in our funds.
•Difficult global market and economic conditions.
•Loss of investor confidence in the global financial markets and investing in general and in alternative asset managers in particular.
•Competitively adverse actions taken by other hedge fund managers with respect to pricing, fund structure, redemptions, employee recruiting and compensation.
•Inability to attract, retain or motivate our active executive managing directors, investment professionals, managing directors or other key personnel.
•Public or other offerings of additional Class A Shares.
•Inability to develop or successfully execute on business strategies or plans.
•Unanticipated variations in our quarterly operating results or dividends.
•Failure to meet analysts’ earnings estimates.
•Publication of negative or inaccurate research reports about us or the asset management industry or the failure of securities analysts to provide adequate coverage of our Class A Shares in the future.
•Adverse market reaction to any indebtedness we may incur, Sculptor Operating Group common units or cash awards we may grant under our 2013 Incentive Plan and 2022 Incentive Plan or otherwise, or any other securities we may issue in the future.
•Changes in market valuations of similar companies.
•Speculation in the press or investment community about our business.
•Additional or unexpected changes or proposed changes in laws or regulations or differing interpretations thereof affecting our business or enforcement of these laws and regulations, or announcements relating to these matters.
•Increases in compliance or enforcement inquiries and investigations by regulatory authorities, including as a result of regulations mandated by the Dodd-Frank Act and other initiatives of various regulators that have jurisdiction over us related to the alternative asset management industry.
•Adverse publicity about the asset management industry generally or scandals involving hedge funds specifically.
•Negative publicity or unfavorable or downgraded reports published by analysts who cover our securities.
The price of our Class A Shares may decline due to the large number of shares eligible for future sale and for exchange into Class A Shares.
The market price of our Class A Shares could decline as a result of sales of a large number of our Class A Shares or the perception that such sales could occur. These sales, or the possibility that these sales may occur, also might make it more difficult for us to sell equity securities in the future at a time and price that we deem appropriate. As of December 31, 2022, 23,707,228 Class A Shares were outstanding and 3,163,667 interests were outstanding pursuant to our Amended and Restated 2007 Equity Incentive Plan. The Amended and Restated 2007 Equity Incentive Plan expired on November 11, 2017, and no new awards may be granted thereunder on or after that date. As of December 31, 2022, 35,153,361 interests were outstanding pursuant to our 2013 Incentive Plan, and approximately 674,870 Class A Shares and other plan interests remain available for future grant under that plan. The Class A Shares reserved under our 2013 Incentive Plan are increased on the first day of each fiscal year during the plan’s term by 15% of any increase in the number of outstanding Class A Shares (assuming the exchange of all outstanding Sculptor Operating Group common units (other than Group B Units) for Class A Shares) from the number outstanding on the first day of the immediately preceding fiscal year. As of December 31, 2022, 5,500,000 interests were outstanding pursuant to our 2022 Incentive Plan, and all plan interests remain available for future grant under that plan.
As of December 31, 2022, our executive managing directors owned an aggregate of 28,040,152 Group A and E Units. The holder of any Group A Units generally has the right to exchange each of his or her Group A Units for one of our Class A Shares (or, at our option, the cash equivalent thereof), subject to vesting and transfer restrictions under the Sculptor Operating Partnerships’ limited partnership agreements and the Class A Unit Exchange Agreement. The Group E Units convert into Group A Units to the extent they have become economically equivalent to Group A Units. Prior to the expiration of the Distribution Holiday, the Exchange Committee (comprised of our Chief Executive Officer and the Chief Financial Officer), in consultation with the Board of Directors, shall have the authority to permit exchanges of vested and booked-up Group A Units, which exchanges shall be made available to all holders of such vested and booked-up Group A Units on a pro rata basis. Beginning on the final day of the Distribution Holiday, each of our executive managing directors may exchange his or her vested Group A Units over a period of two years in three equal installments commencing upon the final day of the Distribution Holiday and on each of the first and second anniversary thereof (or, for units that become vested and booked-up Group A Units after the final day of the Distribution Holiday, from the later of the date on which they would have been exchangeable in accordance with the foregoing and the date on which they become vested and booked-up Group A Units) (and thereafter such units will remain exchangeable), in each case, subject to certain restrictions (including, among other things, in connection with our insider trading
policy in respect of affiliate holders and in certain circumstances where the exchange would be likely to impact our ability to use net operating losses).
As of December 31, 2022, our executive managing directors owned an aggregate of 5,348,572 Group P Units. The holder of any Group P Unit generally has the right to exchange each of his or her Group P Units for one of our Class A Shares (or cash), subject to service and performance criteria. See Note 13 to our consolidated financial statements included in this report for additional information regarding the terms of the Group P Units.
We are party to a registration rights agreement, as amended, with our executive managing directors pursuant to which we granted them certain “piggyback” registration rights with respect to the resale of all Class A Shares delivered in exchange for Group A Units or otherwise held from time to time by our executive managing directors, including after an exchange of Group P Units. We will agree to file with the SEC a shelf registration statement or a prospectus supplement or other supplemental materials to an existing shelf registration statement, no later than the first “established exchange date” under the Class A Unit Exchange Agreement, providing for registration and resale of the Class A Shares that may be delivered in exchange for Operating Group Units (as provided for in the registration rights agreement) or otherwise held from time to time by the executive managing directors.
RSUs may be settled at the election of a majority of our Board of Directors in Class A Shares or cash. Subject to continued employment over the vesting period, the underlying Class A Shares will be issued, or cash in lieu thereof will be paid, as such RSUs vest. We filed registration statements on Form S-8 to register an aggregate of 6,718,827 Class A Shares reserved for issuance under our Amended and Restated 2007 Equity Incentive Plan (which expired on November 11, 2017) and registration statements on Form S-8 to register an aggregate of 32,904,525 Class A Shares reserved for issuance under our 2013 Incentive Plan (not including automatic annual increases thereto), as well as a registration statement on Form S-8 to register an aggregate of 5,500,000 Class A Shares reserved for issuance under our 2022 Incentive Plan. As a result, any Class A Shares issued in respect of the RSUs will be freely transferable by non-affiliates upon issuance and by affiliates under Rule 144, without regard to holding period limitations.
Our current and former executive managing directors’ beneficial ownership of Class B Shares, the tax receivable agreement and anti-takeover provisions in our charter documents and Delaware law could delay or prevent a change in control.
Our current and former executive managing directors own all of our Class B Shares, which as of December 31, 2022, represent approximately 53.0% of the total combined voting power of our Company, excluding the voting power of the Class B Shares that relate to our Group A-1 Units, which represent 0.7% of our total combined voting power, and are voted pro rata in accordance with the vote of our Class A Shares until such time as the relevant Group E Units become vested, or are forfeited.
In addition, the tax receivable agreement provides that, upon a merger, asset sale or other form of business combination or certain other changes of control, the corporate taxpayers’ (or any successors’) obligations with respect to exchanged or acquired units (whether exchanged or acquired before or after such change of control) would be based on certain prescribed assumptions, including that the corporate taxpayers would have sufficient taxable income to fully utilize the deductions arising from the increased tax deductions and tax basis and other benefits related to entering into the tax receivable agreement. The provisions may make it more difficult and expensive for a third party to acquire control of us even if a change of control would be beneficial to the interests of our shareholders.
Further, provisions in our Certificate of Incorporation and By-laws may make it more difficult and expensive for a third party to acquire control of us even if a change of control would be beneficial to the interests of our shareholders. For example, our Certificate of Incorporation and By-laws provide for a staggered Board of Directors, require advance notice for proposals by shareholders and nominations, place limitations on convening shareholder meetings, and authorize the issuance of preferred shares that could be issued by our Board of Directors to thwart a takeover attempt. The market price of our Class A Shares could be materially adversely affected to the extent that our current and former executive managing directors’ influence over us, as well as provisions of our Certificate of Incorporation and By-laws, discourage potential takeover attempts that our shareholders may favor.
Finally, some provisions of Delaware law may delay or prevent a transaction that would cause a change in our control. In this regard, Section 203 of the DGCL restricts certain business combinations with interested stockholders in certain situations. In
general, this statute prohibits a publicly held Delaware corporation from engaging in a business combination with an interested stockholder for a period of three years after the date of the transaction by which that person became an interested stockholder, unless the business combination is approved in a prescribed manner. For purposes of Section 203, a business combination includes a merger, asset sale or other transaction resulting in a financial benefit to the interested stockholder, and an interested stockholder is a person who, together with affiliates and associates, owns, or within three years prior, did own, 15% or more of voting stock.
Risks Related to Taxation
Our structure involves complex provisions of U.S. federal income tax law for which no clear precedent or authority may be available. Our structure also is subject to potential legislative, judicial or administrative change and differing interpretations, possibly on a retroactive basis.
The U.S. federal income tax treatment of holders of the Class A Shares depends in some instances on determinations of fact and interpretations of complex provisions of U.S. federal income tax law for which no clear precedent or authority may be available. You should be aware that the U.S. federal income tax rules are constantly under review by persons involved in the legislative process, the IRS, and the U.S. Treasury Department, frequently resulting in revised interpretations of established concepts, statutory changes, revisions to regulations and other modifications and interpretations. The IRS pays close attention to the proper application of tax laws to partnerships. The present U.S. federal income tax treatment of an investment in the Class A Shares may be modified by administrative, legislative or judicial interpretation at any time, possibly on a retroactive basis, and any such action may affect investments and commitments previously made. For example, changes to the U.S. federal tax laws and interpretations thereof could make it more difficult or impossible to meet the qualifying income exception for us to be treated as a partnership for U.S. federal income tax purposes that is not taxable as a corporation, affect or cause us to change our investments and commitments, change the character or treatment of portions of our income, (including, for instance, treating carried interest income as entirely ordinary income), affect the tax considerations of an investment in us and adversely affect an investment in our Class A Shares. “Carried interest” is
As a term often used inresult of the marketplace asRecapitalization and the Corporate Classification Change, we expect to pay more corporate income taxes and may be required to make accelerated payments under the tax receivable agreement compared to under our prior structure. In addition, we may fail to realize some or all of the benefits of the Corporate Classification Change, or those benefits could take longer to materialize than expected, which could have a general referencematerial and adverse effect on the trading price of the Class A Shares.
We converted from a partnership to describe a general partner’s right to receive its incentive income in the form of a profit allocation eligible for capital gains tax treatment (to the extent that the carried interest consists of capital gains). See “—Legislation changing the treatment of carried interest has been considered that would, if enacted, preclude us from qualifying for treatment as a partnershipcorporation for U.S. federal income tax purposes, effective April 1, 2019 (the “Corporate Classification Change”). Following the Corporate Classification Change, all of our net income has become subject to U.S. federal (and state and local) corporate income taxes, which reduces the amount of cash available for distributions or for reinvestment in our business. The maximum U.S. federal corporate income tax rate is currently 21%, but this rate may increase in the future, which would cause us to pay more corporate income taxes than currently anticipated.
We generally receive a tax benefit when common units in the Sculptor Operating Group are acquired or exchanged because our tax basis in our distributive share of the Sculptor Operating Group assets generally increases as a result of these acquisitions or exchanges. We are a party to a tax receivable agreement with active and former executive managing directors and the Ziffs, that requires us to pay 75% of the amount of cash savings in U.S. federal, state and local income tax that we actually realize as a result of such an increase in tax basis. We expect corporate-entity-level taxes and payments under the publicly traded partnership rules. Our structure also is subject to other potential legislative, judicial or administrative changes and differing interpretations, possibly ontax receivable agreement will accelerate as a retroactive basis.”
Our organizational documents and agreements permit the Board of Directors to modify our operating agreement from time to time, without the consentresult of the holdersRecapitalization and the Corporate Classification Change.
During the Distribution Holiday, net income and distributions of Class A Shares,the Sculptor Operating Group that previously would have been allocated and distributed pro rata among the Sculptor Operating Group Units will be allocated and distributed solely to the Group B Units. This will result in order to address certain changesincreased corporate income taxes and acceleration of the utilization of our deferred tax assets, and may result in accelerated payments under the tax receivable agreement.
For U.S. federal income tax regulations, legislationpurposes, any distributions we pay following the Corporate Classification Change generally will be treated as qualified dividend income (generally subject to tax in the hands of U.S. individual shareholders at capital gain rates under current law) paid by a domestic corporation to the extent paid out of our current or interpretation. In some circumstances, such revisions could have a material adverse impact on someaccumulated earnings and profits, as determined for U.S. federal income tax purposes. Since the Corporate Classification Change, no income, gains, losses, deductions or allcredits of the holdersSculptor Operating Partnerships flow through to the shareholders for U.S. federal income tax purposes.
Although we believe that the Corporate Classification Change will, among other things, simplify our tax reporting for shareholders, expand our shareholder base, and increase the liquidity of our Class A Shares.Shares, we may fail to realize all or some of the anticipated benefits of the Corporate Classification Change, or those benefits may take longer to realize than we expected, which could contribute to a decline in the trading price of our shares. Moreover, we will apply certain assumptions and conventions in an attempt to comply with applicable rules and to report income, gain, deduction, loss and credit to holders in a manner that reflects such holders’ beneficial ownership of partnership items, taking into account variation in ownership interests during each taxable year because of trading activity. However, these assumptions and conventions may notthere can be in compliance with all aspects of applicable tax requirements. It is possibleno assurance that the IRS will assert successfully that the conventions and assumptions used by us do not satisfy the technical requirementsanticipated benefits of the Internal Revenue CodeCorporate Classification Change will over time offset the cost of 1986, as amended (the “Code”), and/or Treasury regulations and could require that items of income, gain, deductions, loss or credit, including interest deductions, be adjusted, reallocated, or disallowed, in a manner that adversely affects holders of the Class A Shares.these transactions.
U.S. federal income tax reform could have uncertain effects.
The TCJA made significant changes to the taxation of U.S. business entities, including reducing the corporate income tax rate from 35% to 21%, eliminating the corporate alternative minimum tax, restricting deductions allowed for net operating losses beginning in 2018 to 80% of current year taxable income, permitting those net operating losses to be carried forward indefinitely, and limiting the deductibility of business interest to 30% of “adjusted taxable income” (which is similar to EBITDA before 2022 and EBIT beginning in 2022), and making certain modifications to section 162(m) of the Internal Revenue Code of 1986, as amended (the “Code”), among other changes. Under the regulations issued by the U.S. Treasury (the “Treasury Regulations”), partnership guaranteed payments for the use of capital may under certain circumstances be characterized as interest for purposes of the aforementioned limitation on the deductibility of business interest. In addition, the TCJA changed the treatment of certain carried interests by denying long-term capital gain treatment for gains recognized with respect to assets held for three years or less. We have not yet fully determined the effects the TCJA will have on us. See Note 11 for additional information regarding the effectsrecently finalized Treasury Regulations under section 162(m) of the TCJA.
Code would limit deductions for compensation paid by a partnership for services performed for it by covered employees of a corporation that is a partner in the partnership. The aforementioned limitation on the deductibility of business interest and the final Treasury Regulations under section 162(m) could reduce deductions available to us. Other changes to the tax laws may be enacted in the future. For example, the Biden Administration proposed various changes in the Build Back Better Act passed by the House of Representatives. The likelihood that any of these or other changes are enacted, and, if so, the consequences to us, are uncertain.
Our structure is subject to other potential legislative, judicial or administrative changes and differing interpretations, possibly on a retroactive basis.
As described above, the TCJA made significant changes to the taxation of U.S. business entities includingand changes to the treatment of certain carried interests by denying long-term capital gain treatment for gains recognized with respect to assets held for three years or less. A number of more sweeping legislative proposals have been consideredtax laws may be enacted in the past that would have precluded us from qualifying for treatment as a partnership for U.S. federal income tax purposes but such proposals were not included in the TCJA. States, including New York, have also considered legislation to increase taxes with respect to carried interests and, as a result of widespread budget deficits, several states have evaluated proposals to subject partnerships to entity level taxation through the imposition of state income, franchise or other forms of taxation.future. If any change in the tax laws, rules, regulations or interpretations were to preclude us from qualifying for treatment as a partnership for U.S. federal income tax purposes under the publicly traded partnership rules or otherwise impose additional taxes or limitations, Class A Shareholders could be negatively affected because we could incur a material increase in our tax liability as a public company from the date any such changes applied to us, which could result in a reduction in the value of our Class A Shares.
You may be subject to U.S. federal income tax on your share of our taxable income, regardless of whether you receive any cash distributions from us.
So long as we are not required to register as an investment company under the 1940 Act and 90% of our gross income for each taxable year constitutes “qualifying income” within the meaning of the Code on a continuing basis, we will be treated, under current law, as a partnership for U.S. federal income tax purposes and not as an association or a publicly traded partnership taxable as a corporation. You may be subject to U.S. federal, state, local and possibly, in some cases, foreign income taxation on your allocable share of our items of income, gain, loss, deduction and credit (including our allocable share of those items of any entity in which we invest that is treated as a partnership or is otherwise subject to tax on a flow-through basis) for each of our taxable years ending with or within your taxable year, regardless of whether or not you receive cash distributions from us. You may not receive cash distributions equal to your allocable share of our net taxable income or even the tax liability that results from that income. Even in cases where we make cash distributions, our taxable income and losses will be apportioned among Class A Shareholders in a manner that may not correspond with the timing of cash distributions. In addition, certain of our holdings, including holdings, if any, in a Controlled Foreign Corporation, which we refer to as “CFC,” and a Passive Foreign Investment Company, which we refer to as “PFIC,” may produce taxable income prior to the receipt of cash relating to such income, and holders of our Class A Shares that are United States persons will be required to take such income into account in determining their taxable income. Under our operating agreement, in the event of an inadvertent partnership termination in which the IRS has granted us limited relief, each holder of our Class A Shares also is obligated to make such adjustments as are required by the IRS to maintain our status as a partnership. Such adjustments may require persons who hold our Class A Shares to recognize additional amounts in income during the years in which they hold such shares. We may also be required to make payments to the IRS.
There can be no assurance that amounts paid as distributions on Class A Shares will be sufficient to cover the tax liability arising from ownership of Class A Shares.
Any distributions paid on Class A Shares will not take into account your particular tax situation (including the possible application of the alternative minimum tax) and, therefore, because of the foregoing as well as other possible reasons, may not be sufficient to pay your full amount of tax based upon your share of our net taxable income. In addition, the actual amount and timing of distributions will always be subject to the discretion of our Board of Directors and we cannot assure you that we will in fact pay cash distributions as currently intended. In particular, the amount and timing of distributions will depend upon a number of factors, including, among others:
General business and economic conditions and our strategic plans and prospects.
Amounts necessary or appropriate to provide for the conduct of our business, including to pay operating and other expenses.
Amounts necessary to make appropriate investments in our business and our funds and the timing of such investments.
Our actual results of operations and financial condition.
Restrictions imposed by our operating agreement and Delaware law.
Contractual restrictions, including restrictions imposed by our Revolving Credit Facility and payment obligations under our tax receivable agreement.
Cash payments to our executive managing directors, including distributions in respect of their Class C Non-Equity Interests, and compensatory payments made to our employees.
The amount of cash that is generated by our investments.
Cash needed to fund liquidity requirements.
Contingent liabilities.
Other factors that our Board of Directors deems relevant.
Even if we do not distribute cash in an amount that is sufficient to fund your tax liabilities, you will still be required to pay income taxes on your share of our taxable income.
If we were to be treated as a corporation for U.S. federal income tax purposes, the value of the Class A Shares may be materially adversely affected.
We have not requested, and do not plan to request, a ruling from the IRS on our treatment as a partnership for U.S. federal income tax purposes, or on any other matter affecting us. Under current law and assuming full compliance with the terms of our operating agreement (and other relevant documents), we believe that we would be treated as a partnership, and not as an association or a publicly traded partnership taxable as a corporation for U.S. federal income tax purposes.
In general, if an entity that would otherwise be classified as a partnership for U.S. federal income tax purposes is a “publicly traded partnership” (as defined in the Code) it will be nonetheless treated as a corporation for U.S. federal income tax purposes, unless the exception described below, and upon which we intend to rely, applies. A publicly traded partnership will, however, be treated as a partnership, and not as a corporation for U.S. federal income tax purposes, so long as 90% or more of its gross income for each taxable year constitutes “qualifying income” within the meaning of the Code and it is not required to register as an investment company under the 1940 Act. We refer to this exception as the “qualifying income exception.”
Qualifying income generally includes dividends, interest, capital gains from the sale or other disposition of stocks and securities and certain other forms of investment income. We expect that our income generally will consist of interest and dividends (including dividends from Oz Corp), capital gains and other types of qualifying income, such as income from notional principal contracts, securities loans, options, forward contracts and future contracts. No assurance can be given as to the types of income that will be earned in any given year. If we fail to satisfy the qualifying income exception described above, items of income and deduction would not pass through to holders of the Class A Shares and holders of the Class A Shares would be treated for U.S. federal (and certain state and local) income tax purposes as shareholders in a corporation. In such a case, we would be required to pay income tax at regular corporate rates on all of our income. In addition, we would likely be liable for state and local income and/or franchise taxes on all of such income. Moreover, dividends to holders of the Class A Shares would constitute ordinary dividend income taxable to such holders to the extent of our earnings and profits, and the payment of these dividends would not be deductible by us. Taxation of us as a publicly traded partnership taxable as a corporation could result in a material adverse effect on our cash flows and the after-tax returns for holders of Class A Shares and thus could result in a substantial reduction in the value of the Class A Shares.
Tax gain or loss on disposition of our Class A Shares could be more or less than expected.
If you sell your Class A Shares, you will generally recognize a gain or loss equal to the difference between the amount realized and the adjusted tax basis in those Class A Shares. Prior distributions to you for periods prior to the Corporate Classification Change in excess of the total net taxable income allocated to you for such periods, if any, which decreased the tax basis in your Class A Shares, will in effect become taxable income to you if the Class A Shares are sold in a taxable disposition at a price greater than your tax basis in those Class A Shares, even if the price is less than the original cost.
We cannot match transferors and transferees of our Class A Shares, and we have therefore adopted certain income tax accounting positions that may not conform with all aspects of applicable tax requirements. The IRS may challenge this treatment, which could materially adversely affect the value of our Class A Shares.
Because we cannot match transferors and transferees of Class A Shares, we have adopted depreciation, amortization and other tax accounting positions that may not conform with all aspects of existing Treasury regulations. A successful IRS challenge to those positions could materially adversely affect the amount of tax benefits available to our holders. It also could affect the timing of these tax benefits or the amount of gain on the sale of Class A Shares and could have a negative impact on the value of our Class A Shares or result in audits of and adjustments to our Class A Shareholders’ tax returns.
New rules regarding U.S. federal income tax liability arising from IRS audits of partnerships could adversely affect shareholders.
For taxable years of the Companyentities treated as partnerships for U.S. federal income tax purposes beginning on or after January 1, 2018, U.S. federal income tax liability arising from an IRS audit will be borne by the Company,entity, unless certain alternative methods are available and the Companyentity elects to utilize them. Under the new rules, it is possible that shareholdersholders or the Companyentity itself may bear responsibility for taxes attributable to adjustments to the taxable income of the Companyentity with respect to tax years that closed before the shareholderholder owned sharesan interest in the Company.entity. Accordingly, this new legislation may adversely affect certain of our shareholders for periods prior to the Corporate Classification Change in certain cases.cases and could affect the Sculptor Operating Partnerships, which will continue to be classified as partnerships for U.S. federal income tax purposes. These new rules differ from the prior rules, which generally provided that tax adjustments only affected the persons who were shareholderspartners in the partnership in the tax year in which the item was reported on the Company’spartnership’s tax return. The changes created by these new rules are uncertain and in many respects depend on the promulgation of future regulations or other guidance by the IRS or the U.S. Treasury.
As we currently do not intend
Our ability to make, or causeuse net operating loss carryforwards to offset future taxable income may be made, an otherwise available election undersubject to limitations.
Our ability to use our federal net operating losses and built-in losses (“NOLs”) to offset potential future taxable income and related income taxes may be limited. Section 754382 of the Internal Revenue Code, to adjustimposes an annual limitation on the amount of taxable income that may be offset by loss carryforwards of a “loss corporation” if the corporation experiences an “ownership change” as defined in Section 382 (generally, a cumulative change in ownership that exceeds 50% of the value of a corporation’s stock over a rolling three-year period). We may experience an ownership change as a result of issuances or other changes in ownership of our asset basis or the asset basisshares, including as a result of OZ Advisors II LP, a holderissuances of Class A Shares could be allocated more taxable income in respect of those shares prior to disposition than if such an election were made.
We have not made and currently do not intend to make, or cause to be made, an election to adjust asset basis under Section 754 of the Code with respect to the Registrant or OZ Advisors II LP. Without such an election, there will generally be no adjustment to the basis of the assets of OZ Advisors II LP upon our acquisition of interests in OZ Advisors II LP in connection with an exchangefuture exchanges of Group A Units for Class A Shares, or to the assetsGroup P Units by active and former executive managing directors. In addition, Section 382 of the Registrant or of OZ Advisors II LP upon a subsequent transferee’s acquisition of Class A Shares from a prior holder of such shares, even if the purchase price for those interests or shares, as applicable, is greater than the share of the aggregate tax basis of the assets of the Registrant or OZ Advisors II LP attributable to those interests or units immediately prior to the acquisition. Consequently, upon a sale of an asset by the Registrant or OZ Advisors II LP, gain allocable to a holder of Class A SharesCode contains certain anti-avoidance rules that could include built-in gainresult in the asset existing at the time the Registrant acquired those interests, or such holder acquired such shares, which built-in gain would otherwise generally be eliminated if a Section 754 election had been made.
Complying with certain tax-related requirements may cause us to forego otherwise attractive business or investment opportunities or enter into acquisitions, borrowings, financings or arrangements we may not have otherwise entered into.
In order for us to be treated as a partnership for U.S. federal income tax purposes, and not as an association or publicly traded partnership taxable as a corporation, we must meet the qualifying income exception discussed aboveapplication of similar limitations on a continuing basis and we must not be required to register as an investment company under the 1940 Act. In order to effect such treatment, we (or our subsidiaries) may be required to invest through foreign or domestic corporations, forego attractive business or investment opportunities or enter into borrowings or financings we may not have otherwise entered into. This may materially adversely affect our ability to operate solely to maximizeuse our cash flows. Our structure also may impede our ability to engage in certain corporate acquisitive transactions because we generally intend to hold all of our assets through the Oz Operating Group. In addition, we may be unable to participate in certain corporate reorganization transactions that would be tax free to our holders if we were a corporation.NOLs. To the extent we hold assets other than through the Oz Operating Group, we will make appropriate adjustments to the Oz Operating Group agreements so that distributions to our executive managing directors and us would be the same as if such assets were heldexperience an ownership change at that level.
We may not be able to invest in certain assets, other than through a taxable corporation.
In certain circumstances, we or one of our subsidiaries may have an opportunity to invest in certain assets through an entity that is characterized as a partnership for U.S. federal income tax purposes, where the income of such entity may not be “qualifying income” for purposes of the publicly traded partnership rules. In order to manage our affairs so that we will meet the qualifying income exception, we may either refrain from investing in such entities or, alternatively, we may structure our investment through an entity classified as a corporation for U.S. federal income tax purposes. If the entity were a U.S. corporation, it would be subject to U.S. federal income tax on its operating income, including any gain recognized on its disposal of its interest in the entity in which the opportunistic investment has been made, as the case may be, and such income taxes would reduce the return on that investment.
The IRS could assert thattime when we are engaged in a U.S. tradeloss corporation, or business and that some portion of our income is properly treated as effectively connected income, which we refer to as “ECI,” with respect to non-U.S. holders of Class A Shares. Moreover, certain REIT dividends and other stock gains may be treated as effectively connected income with respect to non-U.S. holders of Class A Shares.
While we expect that our method of operation will not result in a determination that we are engaged in a U.S. trade or business, there can be no assurance that the IRS will not assert successfully that we are engaged in a U.S. trade or business and that some portion of our income is properly treated as ECI with respect to non-U.S. holders. Moreover, dividends paid by an investment that we make in a Real Estate Investment Trust, which we refer to as a “REIT,” that is attributable to gains from the sale of U.S. real property interests will, subject to certain exceptions, and sales of certain investments in the stock of U.S. corporations owning significant U.S. real property may, be treated as effectively connected income with respect to non-U.S. holders. In addition, certain income of non-U.S. holders from U.S. sources not connected to any such U.S. trade or business conducted by us could be treated as ECI. To the extent our income is treated as ECI, non-U.S. holders generally would be subject to withholding tax on their allocable shares of such income and would be required to file a U.S. federal income tax return for such year reporting their allocable shares of income effectively connected with such trade or business and any other income treated as ECI, and would be subject to U.S. federal income tax at regular U.S. tax rates on any such income (state and local income taxes and filings may also apply in that event). Non-U.S. holders that are treated as corporations for U.S. federal income tax purposes may also be subject to a 30% branch profits tax on such income.
Class A Shareholders may be subject to foreign, state and local taxes and return filing requirements as a result of investing in our Class A Shares.
While it is expected that our method of operation will not result in a determination that the holders of our Class A Shares, solely on account of their ownership of Class A Shares, are engaged in trade or business so as to be taxed on any part of their allocable shares of our income or subjected to tax return filing requirements in any jurisdiction in which we conduct activities or own property, there can be no assurance that the Class A Shareholders, on account of owning Class A Shares, will not be subject to certain taxes, including foreign, state and local income taxes, unincorporated business taxes and estate, inheritance or intangible taxes, imposed by the various jurisdictions in which we conduct activities or own property now or in the future, even if the Class A Shareholders do not reside, or are not otherwise subject to such taxes, in any of those jurisdictions. Consequently, Class A Shareholders also may be required to file foreign, state and local income tax returns in some or all of these jurisdictions. Furthermore, Class A Shareholders may be subject to penalties for failure to comply with those requirements. It is the responsibility of each Class A Shareholder to file all United States federal, foreign, state and local tax returns that may be required of such Class A Shareholder.
Our delivery of required tax information for a taxable year may be subject to delay, which may require a Class A Shareholder to request an extension of the due date for their income tax returns.
We have agreed to use reasonable efforts to furnish to you tax information (including Schedule K-1) which describes your allocable share of our income, gains, losses and deductions for our preceding taxable year. Delivery of this information by us will be subject to delay in the event of, among other reasons, the late receipt of any necessary tax information from lower-tier entities. It is therefore possible that, in any taxable year, our shareholders will need to apply for extensions of time to file their tax returns.
An investment in Class A Shares will give rise to UBTI to certain tax-exempt holders of Class A Shares.
Due to ownership interests we will hold in entities that are treated as partnerships, or are otherwise subject to tax on a flow-through basis, which will incur indebtedness or may engage in a trade or business, we will derive unrelated business taxable income, which we refer to as “UBTI,” from “debt-financed” property or from such trade or business, as applicable, and, thus, an investment in Class A Shares will give rise to UBTI to certain tax-exempt holders of Class A Shares. Och-Ziff Holding may borrow funds from Oz Corp or third parties from time to time to make investments. These investments will give rise to UBTI from “debt-financed” property.
We may hold or acquire certain investments through an entity classified as a PFIC or CFC for U.S. federal income tax purposes.
Certain of our investments may be in foreign corporations or may be acquired through a foreign subsidiary that would be classified as a corporation for U.S. federal income tax purposes. Such an entity may be a PFIC or a CFC for U.S. federal income tax purposes. U.S. holders of Class A Shares indirectly owning an interest in a PFIC or a CFC may experience adverse U.S. tax consequences.
Special tax considerations may apply to mutual fund investors.
U.S. mutual funds that are treated as regulated investment companies, or RICs, for U.S. federal income tax purposes are required, among other things, to meet an annual 90% gross income and a quarterly 50% asset value test under Section 851(b)382 of the Code otherwise applies under such rules, our ability to maintain their favorable U.S. federal income tax status. The treatment of an investment by a RIC in Class A Shares for purposes of these tests will depend on whetherutilize our partnership willNOLs could be treated as a “qualified publicly traded partnership.” If our partnership is so treated, thensignificantly limited, and similar limitations may apply at the Class A Shares themselves are the relevant assets for purposes of the 50% asset value test and the net income from the Class A Shares is the relevant gross income for purposes of the 90% gross income test. If, however, our partnership is not so treated, then the relevant assets are the RIC’s allocable share of the underlying assets held by our partnership and the relevant gross income is the RIC’s allocable share of the underlying gross income earned by our partnership. Whether our partnership will qualify as a “qualified publicly traded partnership” depends on the exact nature of its future investments, but we believe our partnership is not a “qualified publicly traded partnership.” We expect, however, that at least 90% of our annual gross income from the underlying assets held by our partnership will consist of dividends, interest and gains from the sale of securities or other income that qualifies for the RIC gross income test described above. As discussed above under “—You may be subject to U.S. federal income tax on your share of our taxable income, regardless of whether you receive any cash distributions from us,” RICs investing in Class A Shares may recognize income for U.S. federal income tax purposes without receiving a corresponding cash distribution. RICs should consult their own tax advisors about the U.S. tax consequences of an investment in Class A Shares.state level.
Item 1B. Unresolved Staff Comments
None.
Item 2. Properties
Our principal executive offices are located in leased office space in New York. We also lease space for our operations in London, Hong Kong Mumbai, Beijing, Shanghai and Houston.Shanghai. We believe that our existing facilities are adequate to meet our current requirements and we anticipate that suitable additional or substitute space will be available, as necessary, upon favorable terms. See Note 157 to our consolidated financial statements included in this report for additional information regarding our leases.
Item 3. Legal Proceedings
We are from time to time involved in litigation, investigations, inquiries, disputes, and other potential claims incidental to the conduct of our business. Like other businesses in our industry, we are subject to extensive scrutiny by regulatory agencies globally that have, or may in the future have, regulatory authority over us and our business activities. This has resulted in, or may in the future result in, regulatory agency investigations, litigation and subpoenas, and related sanctions and costs.
On August 24, 2022, a complaint under Section 220 of Delaware’s general corporation law, which allows shareholders to inspect corporate books and records, was filed by Daniel S. Och, the founder and former Chief Executive Officer (the “Founder”) of Och-Ziff Capital Management LLC and its consolidated subsidiaries (“Och-Ziff”) and four former Och-Ziff executive managing directors. In April 2022, the Founder and these former executive managing directors made a demand to inspect books and records relating to alleged corporate governance concerns in connection with the promotion of James S. Levin to Chief Executive Officer, a new executive compensation plan approved by the Board of Directors in December 2021, and other matters related to the Board’s exercise of its duties. Despite the voluntary production by the Company of extensive documentation in response to that demand, the Founder and the former executive managing directors filed the Section 220 complaint to compel additional production. On November 18, 2022, the parties announced a settlement of the matter whereby the Founder and the former executive managing directors dismissed the Section 220 complaint with prejudice and in return, among other things, the Company agreed to produce certain additional books and records as well as to issue a press release announcing the formation of a Special Committee of the Board, as discussed in additional detail in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview—Recent Developments – Formation of Special Committee to Explore Potential Transactions.
See “Item 1A. Risk Factors—Risks Related to Our Business—Business—Extensive regulation of our business affects our activities and creates the potential
for significant liabilities and penalties. Our reputation, business, financial condition or results of operations could be materially affected by regulatory issues,issues.,” “—Increased regulatory focus in the United StatesU.S. could result in additional burdens on our business”business,” and “—Regulatory changes in jurisdictions outside the United StatesU.S. could adversely affect our business.” See Note 1518 to our consolidated financial statements included in this report for additional information.
Item 4. Mine Safety Disclosures
None.
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market for Registrant’s Common Equity
Our Class A Shares are listed and traded on the NYSE under the symbol “OZM.“SCU.” The following table presents information on the high and low last reported sales prices, as reported on the NYSE for our Class A Shares for the periods presented:
|
| | | | | | | |
| | Price Range of Our Class A Shares |
| | High | | Low |
| 2017 | | | |
| First quarter | $ | 3.63 |
| | $ | 2.20 |
|
| Second quarter | $ | 2.56 |
| | $ | 2.16 |
|
| Third quarter | $ | 3.22 |
| | $ | 2.82 |
|
| Fourth quarter | $ | 3.92 |
| | $ | 2.50 |
|
| 2016 | | | |
| First quarter | $ | 6.45 |
| | $ | 3.48 |
|
| Second quarter | $ | 4.24 |
| | $ | 3.30 |
|
| Third quarter | $ | 4.49 |
| | $ | 3.29 |
|
| Fourth quarter | $ | 4.08 |
| | $ | 2.84 |
|
Our Class B Shares are not listed on the NYSE and there is no, and we do not expect there would be any, other established trading market for these shares. All of our Class B Shares are owned by our current and former executive managing directors and have no economic rights, but entitle holders to one vote per share on all matters submitted to a vote of our Class A Shareholders.
As of February 16, 2018,27, 2023, there were 918 holders of record of our Class A Shares. A substantially greater number of holders of our Class A Shares are “street name” or beneficial holders, whose shares are held of record by banks, brokers and other financial institutions.
DividendsRecent Sales of Unregistered Securities
Issuer Purchases of Equity Securities
The following table summarizes our Class A Share repurchase activity under our 2022 Share Repurchase Program during the fourth quarter of 2022.
| | | | | | | | | | | | | | | | | | | | | | | |
| Period | Total Number of Shares Purchased | | Average Price Paid per Share | | Total Number of Shares Purchased Publicly as part of Publicly Announced Programs | | Approximate Dollar Value of Shares That May Yet Be Purchased Under Our Programs ($ in millions) |
| October 2022 | 112,133 | | | $ | 9.99 | | | 112,133 | | | $ | 70.6 | |
| November 2022 | 175,486 | | | 9.60 | | | 175,486 | | | 69.0 | |
| December 2022 | 157,156 | | | 9.28 | | | 157,156 | | | 67.5 | |
| Total | 444,775 | | | $ | 9.58 | | | 444,775 | | | $ | 67.5 | |
In February 2022, our Board of Directors authorized us to repurchase up to $100.0 million of our outstanding common stock. The repurchase program has no expiration date. In the quarter ended December 31, 2022, we repurchased 444,775 Class A Shares at a cost of $4.3 million, for an average price of $9.58 per share through open market purchase transactions. As of December 31, 2022, $67.5 million remained available for repurchase of our common stock under the share repurchase program. All of the repurchased shares are classified as treasury stock in our consolidated balance sheets. Please see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Dividends and Distributions”Share Repurchase Program” for information regarding dividends paid on our Class A Shares, as well as information on the declaration and payment of future dividends.
Recent Sales of Unregistered Securities
None.
additional information.
OZMSCU Stock Performance
The line graph and table below compares the cumulative total return on our Class A Shares with the cumulative total return of the Standard & Poor’s (“S&P”) 500 Index (“SPX”) and the S&P 500 Financials Index (“SPF”) for the period of December 31, 20122017 through December 31, 2017.2022. The graph and table assume that $100 was invested simultaneously on December 31, 20122017 in our Class A Shares, the S&P 500 IndexSPX and the S&P 500 Financials Index,SPF, respectively, that these investments were held until December 31, 2017,2022, and that all dividends were reinvested. The past performance of our Class A Shares is not an indication of future performance.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Period Ended December 31, |
| 2017 | | 2018 | | 2019 | | 2020 | | 2021 | | 2022 |
| Sculptor Capital Management, Inc. | $ | 100.00 | | | $ | 39.25 | | | $ | 99.07 | | | $ | 69.57 | | | $ | 113.42 | | | $ | 47.14 | |
| S&P 500 Index | $ | 100.00 | | | $ | 93.76 | | | $ | 120.84 | | | $ | 140.49 | | | $ | 178.27 | | | $ | 143.61 | |
| S&P 500 Financials Index | $ | 100.00 | | | $ | 85.33 | | | $ | 110.23 | | | $ | 105.71 | | | $ | 140.11 | | | $ | 122.80 | |
|
| | | | | | | | | | | | | | | | | | | | | | | |
| | Period Ended December 31, |
| | 2012 | | 2013 | | 2014 | | 2015 | | 2016 | | 2017 |
| | | | | | | | | | | | |
| Och-Ziff Capital Management Group LLC | $ | 100.00 |
| | $ | 177.79 |
| | $ | 159.11 |
| | $ | 91.48 |
| | $ | 48.60 |
| | $ | 37.62 |
|
| S&P 500 Index | $ | 100.00 |
| | $ | 132.37 |
| | $ | 150.48 |
| | $ | 152.55 |
| | $ | 170.78 |
| | $ | 208.05 |
|
| S&P 500 Financials Index | $ | 100.00 |
| | $ | 135.59 |
| | $ | 156.17 |
| | $ | 153.73 |
| | $ | 188.69 |
| | $ | 230.47 |
|
Item 6. Selected Financial Data
Not Applicable.
|
| | | | | | | | | | | | | | | | | | | |
| | As of and for the Year Ended December 31, |
| | 2017 | | 2016 | | 2015 | | 2014 | | 2013 |
| | | | | | | | | | |
| | (dollars in thousands) |
| Selected Operating Statement Data | | | | | | | | | |
| Total revenues | $ | 858,337 |
| | $ | 770,364 |
| | $ | 1,322,981 |
| | $ | 1,542,284 |
| | $ | 1,895,923 |
|
| Total expenses | 621,202 |
| | 1,080,477 |
| | 1,009,792 |
| | 876,032 |
| | 835,393 |
|
| Total other income | 234,796 |
| | 5,012 |
| | (13,652 | ) | | 184,108 |
| | 290,982 |
|
| Income taxes | 317,559 |
| | 10,886 |
| | 132,224 |
| | 139,048 |
| | 95,687 |
|
| Consolidated and Comprehensive Net Income (Loss) | 154,372 |
| | (315,987 | ) | | 167,313 |
| | 711,312 |
| | 1,255,825 |
|
| Less: (Income) loss attributable to noncontrolling interests | (131,630 | ) | | 193,757 |
| | (191,177 | ) | | (535,288 | ) | | (985,823 | ) |
| Less: (Income) loss attributable to redeemable noncontrolling interests | (1,667 | ) | | (2,450 | ) | | 49,604 |
| | (33,579 | ) | | (8,235 | ) |
| Net Income (Loss) Attributable to Och-Ziff Capital Management Group LLC—GAAP | 21,075 |
| | (124,680 | ) | | 25,740 |
| | 142,445 |
| | 261,767 |
|
| Less: Change in redemption value of Preferred Units | (2,853 | ) | | (6,082 | ) | | — |
| | — |
| | — |
|
| Net Income (Loss) Attributable to Class A Shareholders | $ | 18,222 |
| | $ | (130,762 | ) | | $ | 25,740 |
| | $ | 142,445 |
| | $ | 261,767 |
|
| | | | | | | | | | |
| Earnings (Loss) per Class A Share | | | | | | | | | |
| Income (Loss) per Class A Share - basic | $ | 0.10 |
| | $ | (0.72 | ) | | $ | 0.14 |
| | $ | 0.82 |
| | $ | 1.68 |
|
| Income (Loss) per Class A Share - diluted | $ | 0.10 |
| | $ | (0.73 | ) | | $ | 0.14 |
| | $ | 0.80 |
| | $ | 1.62 |
|
| Weighted-average Class A Shares outstanding - basic | 186,423,793 |
| | 182,670,173 |
| | 177,935,977 |
| | 172,843,926 |
| | 155,994,389 |
|
| Weighted-average Class A Shares outstanding - diluted | 187,181,760 |
| | 479,987,268 |
| | 180,893,947 |
| | 178,179,112 |
| | 468,442,690 |
|
| | | | | | | | | | |
| Dividends Paid per Class A Share | $ | 0.07 |
| | $ | — |
| | $ | 0.87 |
| | $ | 1.72 |
| | $ | 1.42 |
|
| | | | | | | | | | |
| Selected Balance Sheet Data | | | | | | | | | |
| Cash and cash equivalents | $ | 469,513 |
| | $ | 329,813 |
| | $ | 254,070 |
| | $ | 250,603 |
| | $ | 189,974 |
|
| Investments | 238,974 |
| | 37,980 |
| | 24,750 |
| | 40,822 |
| | 9,938 |
|
| Assets of consolidated funds | 56,697 |
| | 55,205 |
| | 9,416,702 |
| | 7,559,180 |
| | 4,711,189 |
|
| Total assets | 1,639,433 |
| | 1,485,555 |
| | 10,685,643 |
| | 9,295,696 |
| | 6,868,426 |
|
| Debt obligations | 569,379 |
| | 577,128 |
| | 443,069 |
| | 440,697 |
| | 383,329 |
|
| Liabilities of consolidated funds | 11,340 |
| | 15,197 |
| | 7,315,917 |
| | 5,580,010 |
| | 3,042,395 |
|
| Total liabilities | 1,289,745 |
| | 1,495,526 |
| | 8,612,791 |
| | 7,057,848 |
| | 4,576,819 |
|
| Redeemable noncontrolling interests | 445,617 |
| | 284,121 |
| | 832,284 |
| | 545,771 |
| | 76,583 |
|
| Shareholders’ deficit attributable to Class A Shareholders | (453,831 | ) | | (466,021 | ) | | (415,830 | ) | | (290,759 | ) | | (133,721 | ) |
| Shareholders’ equity attributable to noncontrolling interests | 357,902 |
| | 171,929 |
| | 1,656,398 |
| | 1,982,836 |
| | 2,348,745 |
|
| Total shareholders’ (deficit) equity | (95,929 | ) | | (294,092 | ) | | 1,240,568 |
| | 1,692,077 |
| | 2,215,024 |
|
| | | | | | | | | | |
| Economic Income Data | | | | | | | | | |
| Economic Income Revenues— Non-GAAP | $ | 832,987 |
| | $ | 730,178 |
| | $ | 849,276 |
| | $ | 1,209,756 |
| | $ | 1,630,487 |
|
| Economic Income—Non-GAAP | 337,735 |
| | (211,575 | ) | | 345,216 |
| | 729,943 |
| | 1,098,696 |
|
| | | | | | | | | | |
| Assets Under Management | | | | | | | | | |
| Balance—beginning of period | $ | 37,880,303 |
| | $ | 45,494,861 |
| | $ | 47,534,415 |
| | $ | 40,238,812 |
| | $ | 32,603,930 |
|
| Inflows / (outflows) | (7,612,108 | ) | | (7,993,589 | ) | | (1,176,435 | ) | | 6,134,745 |
| | 3,380,622 |
|
| Distributions / other reductions | (273,315 | ) | | (888,265 | ) | | (907,879 | ) | | (943,997 | ) | | (277,111 | ) |
| Appreciation / (depreciation) | 2,433,682 |
| | 1,267,296 |
| | 44,760 |
| | 2,104,855 |
| | 4,531,371 |
|
| Balance—End of Period | $ | 32,428,562 |
| | $ | 37,880,303 |
| | $ | 45,494,861 |
| | $ | 47,534,415 |
| | $ | 40,238,812 |
|
As a result of the adoption of ASU 2015-02 in 2016, we deconsolidated the majority of our previously consolidated funds. This resulted in a substantial decrease as compared to prior periods in assets of consolidated funds, liabilities of
consolidated funds, redeemable noncontrolling interests, appropriated retained deficit and shareholders’ equity attributable to non-controlling interests in our consolidated balance sheet. Please see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Year Ended December 31, 2016 Compared to Year Ended December 31, 2015”.
Our non-GAAP financial measures supplement, and should not be considered alternatives to, revenues, net income (loss) or cash flow from operations that have been prepared in accordance with GAAP, and are not necessarily indicative of liquidity or the cash available to fund operations. Please see “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Economic Income Analysis” for important information about these non-GAAP measures.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in “Part I—Item 1A. Risk Factors” of this report. Actual results may differ materially from those contained in any forward-looking statements. This MD&A should be read in conjunction with the consolidated financial statements and related notes included elsewhere in this annual report. An investment in our Class A Shares is not an investment in any of our funds.
Overview
General
2022 was one of the most volatile years on record for the markets. We were pleased with our ability to protect clients’ capital and deliver relative outperformance versus relevant benchmarks and indices, especially in our opportunistic credit and real estate strategies. Our focus is to make attractive investments for our clients and be stewards of their capital, showcasing the value of our investment capabilities to both fund investors and shareholders.
The Sculptor Credit Opportunities Master Fund and Customized Credit Focused Platform were down 3.2% and 1.9% gross, respectively, for the full year 2022, both of which delivered exceptional relative outperformance as compared to the BAML Global High Yield Index which was down 13.2%. Our real estate funds continued to perform strongly, and show the benefits of our investments in non-traditional asset classes with attractive risk and return profiles not correlated to broader markets. Our Real Estate Fund III was up 15% while real estate indices were down for the year. The Sculptor Master Fund was down 11.6% gross for the full year 2022, compared to the MSCI World Index and the Balanced US 60/40 Index which were down 15.6% and 19.1%, respectively. The fund is not market-neutral and is expected to have some downside capture in a challenging market. However, this represents an outlier year of more than expected downside capture for the fund. The strategy maintains an attractive long term track record with a 15.4% gross return since inception, with less than half the volatility of equity markets. While markets may continue to remain volatile, we believe both our funds, through their unconstrained investment style, and our platform, from our business diversification and strong balance sheet, are well position to navigate these challenging market conditions.
In 2022 we furthered our expansion into credit and real estate. In 2022, we held first closes for our Real Estate Credit Fund II, Tactical Credit Fund (“STAX”), the latest vintage in our series of seven closed-end opportunistic credit funds and closed a $350.0 million structured alternative investment solution, which was tailored to meet the needs of insurance investors. We also launched an additional real estate investment vehicle. Lastly, we launched two additional CLOs during 2022. These new launches further diversify our business by product, channel and vintage, continuing the trend of raising long term capital, as we grew our long-term AUM to 72% of our total AUM as of December 31, 2022.
Additionally, our balance sheet remains strong as a result of the actions we have taken over the past several years. This gives us the stability to weather challenging market conditions and allows us to pursue attractive uses of our capital. During 2022, our Board of Directors authorized a share repurchase plan, allowing us a pathway complimentary to our dividend distributions to return capital to our shareholders, as a result during the year we repurchased approximately 3.0 million Class A Shares for a total of $32.5 million.
While the business fundamentals are sound, the earnings for any given year can have volatility due to annual performance or incentive fee recognition timing. Over time, we created greater consistency in management fees as our longer-term AUM grew. With that also comes volatility in overall earnings due to the impact of longer-term AUM on incentive fee recognition and associated variable bonus expense timing. There is a timing difference between when we can recognize incentive income and when we accrue our discretionary bonus expense, which is dependent upon a variety of factors, including fund performance for the full calendar year. Incentive income for this longer-term AUM is typically recognized near the end of a multi-year period, which can create year-over-year volatility in incentive income.
Finally, when we evaluate our business, we look to the underlying earnings drivers of the organization which will drive future returns to shareholders. These key indicators include fund performance in line with or exceeding investor expectations, the compounding of our asset base through net flows and new products, continuing to be cognizant of our cost framework, and growing and utilizing our balance sheet to invest in the growth of the business.
Recent Developments – Formation of Special Committee to Explore Potential Transactions
On November 18, 2022, we issued a press release announcing the formation by of our board of directors of the Special Committee to explore potential interest from third parties in a transaction with the Company that maximizes value for shareholders. As of the filing date of this Annual Report on Form 10-K, no transaction has been announced, and there can be no assurance that the Special Committee process will result in any transaction in the future.
Overview of Our Business
Sculptor Capital is a leading institutional alternative asset manager, with approximately $35.9 billion in Assets Under Management as of February 1, 2023 and a global presence with offices in New York, London, Hong Kong, and Shanghai. We provide asset management services and investment products across Credit, Real Estate, and Multi-Strategy. We serve our global client base through our commingled funds, separate accounts, specialized products, and the SPAC. Our capabilities span all major geographies and asset classes. Our approach to asset management is based on the same fundamental elements that we have employed since Sculptor Capital was founded in 1994. Our distinct investment process seeks to generate attractive and consistent risk-adjusted returns across market cycles through a combination of bottom-up fundamental analysis, a high degree of flexibility, a collaborative team and integrated risk management. Our capabilities span all major geographies and asset classes, including fundamental equities, corporate credit, real estate debt and equity, merger arbitrage, structured credit, and convertible and derivative arbitrage.
We manage multi-strategy funds, dedicated credit funds, including opportunistic credit funds and Institutional Credit Strategies products, real estate funds, and other alternative investment vehicles. Through Institutional Credit Strategies, our asset management platform that invests in performing credits, we manage CLOs, aircraft securitization vehicles, collateralized bond obligations (“CBOs”), structured alternative investment solutions, commingled products and other customized solutions for clients.
COVID-19 Pandemic
As the COVID-19 pandemic evolved, we continued to focus on the health and well-being of our employees and the uninterrupted service to investors in our funds and our shareholders. We have returned to the office with safety protocols in place consistent with government guidelines. We continue to monitor government guidelines and maintain the effectiveness of our information technology infrastructure and other controls to remain agile should the situation change.
Due to the uncertainty over the timing and extent of any possible global economic recovery, we cannot readily estimate or determine the effects that the ongoing COVID-19 pandemic will ultimately have on our future business and financial results, as well as on our liquidity and capital resources. Please see the COVID-19 commentary included throughout this MD&A, including “—Liquidity and Capital Resources”, and “Part I—Item 1A. Risk Factors” included in this annual report for additional information.
War in Ukraine
We are monitoring the developments in Ukraine resulting from the Russian invasion and the economic sanctions and restrictions imposed as a result. As of December 31, 2022, our funds had no material investments that would cause us or any of our funds to be in violation of the current international sanctions, and we believe the direct or indirect exposure of our funds’ investments to Russia, Belarus and Ukraine is immaterial. We have appropriate controls in place and we continue to monitor any new exposure including any investments that may be in violation of current international sanctions.
Overview of Our Financial Results
As a global alternative asset manager, our results of operations are impacted by a variety of factors, including conditions in the global financial markets and economic and political environments. Global risk assets fell under pressure this year as financial conditions tightened at a velocity not witnessed since COVID and the global financial crisis in 2008. As a result, both global equities and bonds declined and had their worst year since 2008 by a wide margin. Sculptor Credit Opportunities Master Fund delivered exceptional relative outperformance in 2022, exceeding the returns of the BAML Global High Yield by 10.0% on a gross basis. Our Multi-Strategy funds had an outlier year of downside capture, but outperformed the Balanced US 60/40 Index by 7.5% on a gross basis. Negative absolute performance impacted our ability to generate incentive income for the year in these strategies. Our real estate funds continued to perform strongly and show the benefits of our strategic investment in non-traditional and traditional asset classes with limited correlation to broader markets. We continued to deploy and realize investments, leading to incentive income for the year. Market conditions remain challenged and we believe both our funds, through their unconstrained investment style, and our platform, from our business diversification and strong balance sheet, are well positioned to navigate these challenging conditions.
As of December 31, 2022, our AUM was $36.0 billion, a decrease of $2.1 billion from the prior year. Our AUM decreased primarily due to: (i) performance-related depreciation in multi-strategy and credit funds and (ii) distributions and other reductions in Institutional Credit Strategies and real estate funds, which led to recognition of incentive income in the year, as well as reductions due to the effects of foreign currency translation adjustments on our European CLOs. These decreases were partially offset by net inflows in Institutional Credit Strategies and real estate funds. In 2022, we held first closes for our Real Estate Credit Fund II, Tactical Credit Fund (“STAX”), the latest vintage in our series of seven closed-end opportunistic credit funds, and another real estate investment vehicle. Additionally, in the current year, we closed a $350.0 million structured alternative investment solution, which was tailored to meet the needs of insurance investors. Lastly, we launched two additional CLOs in 2022. These new launches further diversify our business by product, channel and vintage, continuing the trend of raising long term capital, as we grew our long-term AUM to 72% of our total AUM as of December 31, 2022.
We reported a GAAP net income attributable to Class A Shareholders of $18.2 million for the full year 2017, compared to net loss of $130.8$12.0 million in 2022, compared to a GAAP net loss of $8.6 million in 2021.
Management fees were $278.4 million in 2022, a decrease of $23.6 million compared to 2021. Our management fees fell primarily due to Institutional Credit Strategies and multi-strategy funds. The decrease year-over-year in Institutional Credit Strategies was driven by the one-time recovery of previously deferred subordinated management fees in the prior year as well as lower weighted-average management fee rates. We continue to issue new CLOs and reset older CLO vintages, which extends the duration of our AUM in Institutional Credit Strategies, but we have seen our average fee rate decline in these vehicles, bringing down management fees. The decrease in multi-strategy funds was driven primarily by lower average assets under management, primarily as a result of negative fund performance in 2022 as well as redemptions. Please see “—Managing Business Performance—Multi-Strategy Funds” for additional information regarding the 2016 full year.performance of the Sculptor Master Fund.
Incentive income was $123.4 million in 2022 driven primarily by realizations in Sculptor Real Estate Fund III, Customized Credit Focused Platform, and Sculptor Credit Opportunities Master Fund. The year-over-year improvement$189.0 million decrease from 2021 was driven primarily by negative fund performance in multi-strategy and credit funds, compared to strong performance in 2021, this decrease was partially offset by higher realizations from our real estate funds in 2022.
Expenses were $458.2 million in 2022, down $92.8 million from 2021 due to lower compensation and benefits expense driven by lower bonus expense, as well as lower general, administrative and other expenses due to a decrease in occupancy expense due to a right-of-use asset impairment loss in the prior year period.
Other loss in 2022 decreased by $55.5 million from 2021, primarily as a result of lower fair value of warrant liabilities and losses incurred on early retirement of debt in the prior year, partially offset by losses on our equity-method investments and risk retention investments in our CLOs.
Please see the “Results of Operations” section of this MD&A for commentary regarding changes in net loss attributable to noncontrolling interests and changes in the redemption value of redeemable noncontrolling interests.
Economic Income was $69.9 million in 2022, compared to $119.4 million in 2021. The decrease was primarily due to settlements expense of $412.1 million taken in 2016, as well aslower revenues and higher incentive income, lower non-compensationgeneral, administrative and other expenses, lower salaries and benefits, and a reduction in the tax receivable agreement liability. These improvements were partially offset by lower management fees, highercompensation and benefits expenses, driven by lower bonus expense and higher income tax expense due to a reduction of our deferred tax assets as a result of the TCJA.
We reported Economic Income of $337.7 million for the full year 2017, compared to net loss of $211.6 million for the 2016 full year. The increase was mainly driven by the settlements expense of $412.1 million takennegative fund performance, which resulted in 2016, as well as higher incentive income, lower non-compensation expenses, and lower salaries and benefits. These improvements were partially offset by lower management fees and higher bonus expense.performance related bonuses.
Economic Income is a non-GAAP measure. For additional information regarding non-GAAP measures, as well as for a discussion of the drivers of the year over yearyear-over-year change in Economic Income, please see “—Economic Income Analysis.”
Overview of Assets Under Management and Fund Performance
Assets under management totaled $32.4 billion as of December 31, 2017. Longer-dated assets under management, which are those subject to initial commitment periods of three years or longer, were $17.4 billion, comprising 54% of our total assets under management as of December 31, 2017. Assets under management in our dedicated credit, real estate and other strategy-specific funds were $18.7 billion, comprising 58% of assets under management as of December 31, 2017.
Assets under management in our multi-strategy funds totaled $13.7 billion as of December 31, 2017, decreasing $7.4 billion, or 35%, year-over-year. This change was driven by net capital outflows of $9.2 billion, primarily in the Oz Master Fund, our largest multi-strategy fund, partially offset by performance-related appreciation of $1.8 billion. Our multi-strategy funds experienced elevated redemptions and reduced inflows during 2017, which were driven in-part by the investigation matter and the related inability to rely on Regulation D.
Our assets under management increased to $33.3 billion as of February 1, 2018, an increase of 3% since December 31, 2017, as capital net outflows from our multi-strategy funds were offset by launches of two CLOs in January 2018, as well as positive fund performance in January 2018.
Oz Master Fund generated a gross return of 15.0% and a net return of 10.4% year-to-date through December 31, 2017. The largest positive contributors to the fund’s performance by strategy were merger arbitrage, structured credit, corporate credit long/short equity special situations. Convertible and derivative arbitrage reported a modest loss in 2017. The fund also reported positive performance across all regions: the U.S., Europe and Asia. Please see “—Assets Under Management and Fund Performance—Multi-Strategy Funds” for additional information regarding the returns of the Oz Master Fund.
Assets under management in our dedicated credit products totaled $15.7 billion as of December 31, 2017, increasing $2.3 billion, or 17%, year-over-year. This change was driven by capital net inflows of $1.8 billion and performance-related appreciation of $535.8 million, partially offset by $58.0 million of distributions and other reductions in our closed-end opportunistic credit funds.
Assets under management in our opportunistic credit funds totaled $5.5 billion as of December 31, 2017, increasing $137.5 million, or 3%, year-over-year. Oz Credit Opportunities Master Fund, our global opportunistic credit fund, generated a
gross return of 16.9% and a net return of 11.0% year-to-date through December 31, 2017. Performance was broad-based with gains across both the structured and corporate credit strategies, and geographies. Similar to credit strategy performance in the Oz Master Fund, these returns were driven in part by realizations in structured credit and successful resolutions in various distressed situations in corporate credit. We continue to be focused on process-oriented and event-driven investments that are not correlated with the broader markets.Assets under management for the fund were $1.7 billion as of December 31, 2017.
Assets under management in Institutional Credit Strategies totaled $10.1 billion as of December 31, 2017, increasing $2.1 billion, or 26%, year-over-year. The increase was primarily driven by four new CLOs. 2017 was a strong year for Institutional Credit Strategies, which closed over $6.1 billion in CLOs, including refinancings.
Assets under management in our real estate funds totaled $2.5 billion as of December 31, 2017, increasing $281.8 million, or 13%, year-over-year. Since inception through December 31, 2017, the gross internal rate of return (“IRR”) was 33.2% and 21.8% net for Och-Ziff Real Estate Fund II (for which the investment period ended in 2014), and 25.1% gross and 15.7% net for Och-Ziff Real Estate Fund I (for which the investment period ended in 2010).
Assets Under Management and FundManaging Business Performance
Our financial results are primarily driven by the combination of our assets under managementAUM and the investment performance of our funds. Both of these factors directly affect the revenues we earn from management fees and incentive income. Growth in assets under management due to capital placed with us by investorsAUM in our funds and positive investment performance of our funds drive growth in our revenues and earnings. Conversely, poor investment performance slows our growth by decreasing our assets under managementAUM and increasing the potential for redemptions from our funds, which would have a negative effect on our revenues and earnings.
We typically accept capital from new and existing investors in our multi-strategy and certain open-end opportunistic credit funds on a monthly basis on the first day of each month. Investors in our multi-strategy and our open-end opportunistic creditthese funds (other than with respect to capital invested in Special Investments) typically have the right to redeem their interests in a fundeither following an initial lock-up period of one to three years.four years, or on a quarterly basis for certain multi-strategy fund investors. Following the expiration of these lock-up periods, subject to certain limitations, investors may redeem capital generally on a quarterly, annual or annualthree-year basis upon giving 30 to 90 days’days prior written notice. However, upon the payment of a redemption fee to the applicable fund and upon giving 30 days’ prior written notice, certain investors may redeem capital during the lock-up period. The lock-up requirements for our funds may generally be waived or modified at the sole discretion of each fund’sfunds’ general partner or board of directors, as applicable.
With respect to investors with quarterly redemption rights, requests for redemptions submitted during a quarter generally reduce assets under managementAUM on the first day of the following quarter. Accordingly, quarterly redemptions generally will have no impact on management fees during the quarter in which they are submitted. Instead, these redemptions will reduce management fees in the following quarter. With respect to investors with annual redemption rights, redemptions paid prior to the end of a quarter impact assets under managementAUM in the quarter in which they are paid, and therefore impact management fees for that quarter.
Investors in our closed-end credit funds, CLOs,securitization vehicles, real estate and certain other funds are not able to redeem their investments. In those funds, investors generally make a commitment that is funded over an investment period (or at launch for our CLOs)securitization vehicles). Upon the expiration of the investment period, the investments are then sold or realized over time, and distributions are made to the investors in the fund.
In a declining market, during periods when the hedge fund industry generally experiences outflows, or in response to specific company events, we could experience increased redemptions and a consequent reduction in our assets under management. Recently, our assets under management have declined and this trend may continue to some extent
for some period of time in light of the 2016 settlements and the related inability to rely on Regulation D. Throughout the latter part of 2017 and into early 2018, net outflows from our multi-strategy funds began to normalize and were partially offset by growth in our CLOs business, as well as positive fund performance. We believe that strong fund performance should translate to inflows, although we cannot pinpoint the timing.
Information with respect to our assets under managementAUM throughout this report, including the tables set forth below, includes investments by us, our executive managing directors, employees and certain other related parties. As of December 31, 2017,2022, approximately 8%3% of our assets under managementAUM represented investments by us, our executive managing directors, employees and certain other related parties in our funds. As of that date, approximately 71%43% of these affiliated assets under managementAUM are not charged management fees and are not subject to an incentive income calculation. Additionally, to the extent that a fund is an investor in another fund or vehicle, we waive or rebate a corresponding portion of the management fees charged to the fund.
As further discussed below in “—Understanding Our Results—Revenues,Revenues—Management Fees,” we generally calculate management fees based on assets under managementAUM as of the beginning of each quarter. The assets under managementAUM in the tables below are presented net of management fees and incentive income as of the end of the period. Accordingly, the assets under managementAUM presented in the tables below are not the amounts used to calculate management fees for the respective periods.
Appreciation (depreciation) in the tables below reflects the aggregate net capital appreciation (depreciation) for the entire period and is presented on a total return basis, net of all fees and expenses (except incentive income on Special Investments), and includes the reinvestment of all dividends and other income. Management fees and incentive income vary by product.
Summary of Changes in Assets Under ManagementAUM
The tables below present the changes to our assets under managementAUM for the respective periods based on the type of funds or investment vehicles we manage. During
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2022 |
| December 31, 2021 | | Inflows / (Outflows)(1) | | Distributions / Other Reductions | | Appreciation / (Depreciation) | | Other(2) | | December 31, 2022 |
| | | | | | | | | | | |
| (dollars in thousands) |
| Multi-strategy funds | $ | 11,112,445 | | | $ | (354,677) | | | $ | (5,494) | | | $ | (1,578,171) | | | $ | — | | | $ | 9,174,103 | |
| Credit | | | | | | | | | | | |
| Opportunistic credit funds | 6,350,474 | | | (30,623) | | | (182,496) | | | (166,393) | | | — | | | 5,970,962 | |
| Institutional Credit Strategies | 16,052,406 | | | 990,969 | | | (464,920) | | | 730 | | | (305,449) | | | 16,273,736 | |
| Real estate funds | 4,544,862 | | | 423,475 | | | (390,816) | | | 3,364 | | | (17,193) | | | 4,563,692 | |
| | | | | | | | | | | |
| Total | $ | 38,060,187 | | | $ | 1,029,144 | | | $ | (1,043,726) | | | $ | (1,740,470) | | | $ | (322,642) | | | $ | 35,982,493 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2021 |
| December 31, 2020 | | Inflows / (Outflows)(1) | | Distributions / Other Reductions | | Appreciation / (Depreciation) | | Other(2) | | December 31, 2021 |
| | | | | | | | | | | |
| (dollars in thousands) |
| Multi-strategy funds | $ | 10,504,024 | | | $ | 99,974 | | | $ | (5,301) | | | $ | 513,748 | | | $ | — | | | $ | 11,112,445 | |
| Credit | | | | | | | | | | | |
| Opportunistic credit funds | 6,287,777 | | | (799,744) | | | (38,545) | | | 900,986 | | | — | | | 6,350,474 | |
| Institutional Credit Strategies | 15,697,827 | | | 2,904,817 | | | (2,082,381) | | | 710 | | | (468,567) | | | 16,052,406 | |
| Real estate funds | 4,308,648 | | | 708,348 | | | (470,581) | | | (1,553) | | | — | | | 4,544,862 | |
| | | | | | | | | | | |
| Total | $ | 36,798,276 | | | $ | 2,913,395 | | | $ | (2,596,808) | | | $ | 1,413,891 | | | $ | (468,567) | | | $ | 38,060,187 | |
_______________(1)Includes transfers between Sculptor funds.
(2)Includes the effects of changes in the par value of the underlying collateral of the CLOs, foreign currency translation changes in the measurement of AUM of our European CLOs and other funds, and changes in the portfolio appraisal value for aircraft securitization vehicles. For FP AUM, this also includes movements in or out of FP AUM.
AUM totaled $36.0 billion as of December 31, 2022. In the year ended December 31, 2022, AUM decreased by $2.1 billion, driven by performance-related depreciation of $1.7 billion, primarily from multi-strategy funds, distributions and other reductions of $1.0 billion, driven primarily by Institutional Credit Strategies and real estate funds, and a decrease of $220.2 million due to the effects of foreign currency translation adjustments on our European CLOs. These decreases were partially offset by net inflows of $1.0 billion across Institutional Credit Strategies and real estate funds.
AUM net inflows of $1.0 billion in the year ended December 31, 2022, were comprised of (i) $2.4 billion of gross inflows, driven by $1.0 billion in Institutional Credit Strategies, from the launch of two additional CLOs, $698.9 million in multi-strategy funds, $423.5 million in real estate funds, driven by the launches of Real Estate Credit Fund II and another real estate investment vehicle, and $241.9 million in opportunistic credit funds due to the launch and additional closings of STAX; and (ii) $1.4 billion of gross outflows due to redemptions, primarily in our multi-strategy and opportunistic credit funds. In 2022, excluding securitization vehicles within Institutional Credit Strategies, our largest sources of gross inflows were from high net worth and family offices, sovereign wealth and corporates, and pensions, while pensions, high net worth and family offices, and fund-of-funds were the largest source of gross outflows.
Also as to flows, following a strong fundraising start to 2022 in Q1 and continued momentum in Q2, inflows slowed in the second quarterhalf of 2017,the year, and we reclassifiedare experiencing elevated redemption requests for the coming year, driven by a variety of factors, primarily the uncertainty and perceived instability created by recent public actions taken by the founder and former Chief Executive Officer of Och-Ziff. Also relevant are market factors impacting investor allocations, idiosyncratic factors related to
one or more investors (e.g., rebalancing), idiosyncratic factors related to one or more of our funds (e.g., fund performance) and other factors. If the founder and former Chief Executive Officer of Och-Ziff takes actions of a similar nature going forward, there will be a continuation of adverse impacts to our business, including negative impact on our ability to attract and retain fund investors and our ability to raise new funds.
Distributions and other reductions of $1.0 billion in the year ended December 31, 2022, were driven primarily by: (i) $464.9 million of distributions from Institutional Credit Strategies as a result of a redemption and paydowns in certain fundof our CLOs; (ii) $390.8 million of distributions from otherour real estate funds as a result of realizations, primarily in Sculptor Real Estate Credit Fund I and Sculptor Real Estate Fund III; and (iii) a $182.5 million reduction in opportunistic credit funds, into real estate funds. Prior period amounts have been reclassified to conformprimarily related to the current presentation.expiration of the investment period of a closed-end fund.
|
| | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, 2017 |
| | December 31, 2016 | | Inflows / (Outflows) | | Distributions / Other Reductions | | Appreciation / (Depreciation) | | December 31, 2017 |
| | | | | | | | | | |
| | (dollars in thousands) |
| Multi-strategy funds | $ | 21,084,548 |
| | $ | (9,236,044 | ) | | $ | — |
| | $ | 1,846,536 |
| | $ | 13,695,040 |
|
| Credit | | | | | | | | | |
| Opportunistic credit funds | 5,376,080 |
| | (337,114 | ) | | (58,013 | ) | | 532,665 |
| | 5,513,618 |
|
| Institutional Credit Strategies | 8,019,510 |
| | 2,114,320 |
| | — |
| | 3,161 |
| | 10,136,991 |
|
| Real estate funds | 2,213,364 |
| | 462,862 |
| | (181,586 | ) | | 550 |
| | 2,495,190 |
|
| Other | 1,186,801 |
| | (616,132 | ) | | (33,716 | ) | | 50,770 |
| | 587,723 |
|
| Total | $ | 37,880,303 |
| | $ | (7,612,108 | ) | | $ | (273,315 | ) | | $ | 2,433,682 |
| | $ | 32,428,562 |
|
|
| | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, 2016 |
| | December 31, 2015 | | Inflows / (Outflows) | | Distributions / Other Reductions | | Appreciation / (Depreciation) | | December 31, 2016 |
| | | | | | | | | | |
| | (dollars in thousands) |
| Multi-strategy funds | $ | 29,510,248 |
| | $ | (8,962,296 | ) | | $ | — |
| | $ | 536,596 |
| | $ | 21,084,548 |
|
| Credit | | | | | | | | | |
| Opportunistic credit funds | 5,383,629 |
| | (81,612 | ) | | (685,327 | ) | | 759,390 |
| | 5,376,080 |
|
| Institutional Credit Strategies | 7,241,680 |
| | 784,165 |
| | — |
| | (6,335 | ) | | 8,019,510 |
|
| Real estate funds | 2,048,559 |
| | 324,826 |
| | (152,655 | ) | | (7,366 | ) | | 2,213,364 |
|
| Other | 1,310,745 |
| | (58,672 | ) | | (50,283 | ) | | (14,989 | ) | | 1,186,801 |
|
| Total | $ | 45,494,861 |
| | $ | (7,993,589 | ) | | $ | (888,265 | ) | | $ | 1,267,296 |
| | $ | 37,880,303 |
|
|
| | | | | | | | | | | | | | | | | | | |
| | Year Ended December 31, 2015 |
| | December 31, 2014 | | Inflows / (Outflows) | | Distributions / Other Reductions | | Appreciation / (Depreciation) | | December 31, 2015 |
| | | | | | | | | | |
| | (dollars in thousands) |
| Multi-strategy funds | $ | 34,100,390 |
| | $ | (4,719,269 | ) | | $ | — |
| | $ | 129,127 |
| | $ | 29,510,248 |
|
| Credit | | | | | | | | | |
| Opportunistic credit funds | 5,098,600 |
| | 1,121,104 |
| | (727,190 | ) | | (108,885 | ) | | 5,383,629 |
|
| Institutional Credit Strategies | 5,166,734 |
| | 2,077,404 |
| | — |
| | (2,458 | ) | | 7,241,680 |
|
| Real estate funds | 2,022,399 |
| | 197,887 |
| | (165,587 | ) | | (6,140 | ) | | 2,048,559 |
|
| Other | 1,146,292 |
| | 146,439 |
| | (15,102 | ) | | 33,116 |
| | 1,310,745 |
|
| Total | $ | 47,534,415 |
| | $ | (1,176,435 | ) | | $ | (907,879 | ) | | $ | 44,760 |
| | $ | 45,494,861 |
|
In the year ended December 31, 2017, our funds experienced2021, assets under management increased by $1.3 billion, driven by performance-related appreciation of $2.4$1.4 billion, net inflows of $2.9 billion, distributions and other reductions of $2.6 billion, and a decrease of $468.6 million primarily due to the effects of foreign currency translation adjustments and changes in par value of underlying collateral of the CLOs.
AUM net outflows of $7.6 billion, which wasinflows in the year ended December 31, 2021 were comprised of $2.9(i) $4.8 billion of gross inflows, driven by $2.9 billion in Institutional Credit Strategies, due to the launches of additional CLOs and $10.5an aircraft securitization vehicle, $1.2 billion in multi-strategy funds, primarily driven by inflows into the Sculptor Master Fund, which had the first positive net flows since 2014, and $708.3 million in real estate funds, primarily due to the launches of several Sculptor Real Estate Fund IV co-investment vehicles and our real estate SPAC; and (ii) $1.9 billion of gross outflows due to redemptions. We also had $273.3 millionredemptions, primarily in distributionsour multi-strategy and opportunistic credit funds.
Distributions and other reductions related to investorsof $2.6 billion in our real estate, closed-end opportunistic credit and other funds. We experienced elevated redemptions and reduced inflows in our multi-strategy funds during 2017the year ended December 31, 2021 were driven primarily by $2.1 billion of distributions from Institutional Credit Strategies as a result of the investigation matterwind down and the related inability to rely on Regulation D.redemption of certain of our CLOs, and $470.6 million of distributions from our real estate funds, as a result of realizations. In the full year 2017,2021, excluding CLOs, our largest source of gross inflows was from corporate, institutional and other, while pensions and foundations and endowments weresecuritization vehicles within Institutional Credit Strategies, our largest sources of gross outflows.
In 2016, our funds experienced performance-related appreciation of $1.3 billioninflows were from high net worth and net outflows of $8.0 billion, which was comprised of $1.6 billion of gross inflowsfamily offices, sovereign wealth and $9.6 billion of gross outflows due to redemptions. We also had $888.3 million in distributionscorporates, and other reductions, which were primarily related to investors in our closed-end opportunistic creditpensions, while pensions, fund-of-funds, and real estate funds. Our largest sources of gross inflows related primarily to two additional CLOs launched in Institutional Credit Strategies, as well as additional commitments to Och-Ziff Real Estate Credit Fund I. We experienced elevated redemptions in our multi-strategy funds during 2016 as a result of the settlements, as well as the overall redemption cycle currently affecting the hedge fund industry. Our capital net outflows continued to be elevated in early 2017, due to additional redemptions in our multi-strategy funds as a result of the same factors identified above, resulting in assets under management decreasing to an estimated $33.6 billion as of February 1, 2017. Excluding CLOs, pensionssovereign wealth and fund-of-funds were the largest sources of our gross inflows, while fund-of-funds, pensions and private banks were our largest sources of gross outflows during 2016.
In 2015, our funds experienced performance-related appreciation of $44.8 million and net outflows of $1.2 billion, which was comprised of $5.5 billion of gross inflows and $6.7 billion of gross outflows due to redemptions. Distributions and other reductions were $907.9 million, which was driven by $740.3 million in distributions to investors in our closed-end opportunistic credit and real estate funds, and a $152.4 million reduction in the Oz European Credit Opportunities Fund as a result of the expiration of the fund’s investment period. Our gross inflows included $2.4 billion within Institutional Credit Strategies primarily related to four CLOs that closed during 2015. Excluding CLOs, pension fundscorporates were the largest source of gross outflows.
Summary of Changes in FP AUM
The tables below present the changes to our gross inflowsFP AUM for the respective periods based on the type of funds or investment vehicles we manage. FP AUM represents the AUM on which we earn management fees and gross outflows during 2015./ or incentive income.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2022 |
| December 31, 2021 | | Inflows / (Outflows)(1) | | Distributions / Other Reductions | | Appreciation / (Depreciation) | | Other(2) | | December 31, 2022 |
| | | | | | | | | | | |
| (dollars in thousands) |
| Multi-strategy funds | $ | 10,877,541 | | | $ | (304,078) | | | $ | (3,038) | | | $ | (1,544,079) | | | $ | (5,357) | | | $ | 9,020,989 | |
| Credit | | | | | | | | | | | |
| Opportunistic credit funds | 5,742,605 | | | (158,322) | | | (104,269) | | | (163,533) | | | 71,009 | | | 5,387,491 | |
| Institutional Credit Strategies | 11,142,956 | | | 520,359 | | | (226,513) | | | 196 | | | (278,745) | | | 11,158,253 | |
| Real estate funds | 3,875,427 | | | 100,665 | | | (208,893) | | | — | | | (50,163) | | | 3,717,036 | |
| | | | | | | | | | | |
| Total | $ | 31,638,529 | | | $ | 158,624 | | | $ | (542,713) | | | $ | (1,707,416) | | | $ | (263,256) | | | $ | 29,283,768 | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Year Ended December 31, 2021 |
| December 31, 2020 | | Inflows / (Outflows)(1) | | Distributions / Other Reductions | | Appreciation / (Depreciation) | | Other(2) | | December 31, 2021 |
| | | | | | | | | | | |
| (dollars in thousands) |
| Multi-strategy funds | $ | 10,319,387 | | | $ | 50,992 | | | $ | (4,567) | | | $ | 508,098 | | | $ | 3,631 | | | $ | 10,877,541 | |
| Credit | | | | | | | | | | | |
| Opportunistic credit funds | 5,964,678 | | | (770,670) | | | (194,351) | | | 889,075 | | | (146,127) | | | 5,742,605 | |
| Institutional Credit Strategies | 12,694,258 | | | 1,327,575 | | | (1,578,062) | | | 143 | | | (1,300,958) | | | 11,142,956 | |
| Real estate funds | 3,575,828 | | | 643,577 | | | (342,428) | | | — | | | (1,550) | | | 3,875,427 | |
| | | | | | | | | | | |
| Total | $ | 32,554,151 | | | $ | 1,251,474 | | | $ | (2,119,408) | | | $ | 1,397,316 | | | $ | (1,445,004) | | | $ | 31,638,529 | |
_______________(1)Includes transfers between Sculptor funds.
(2)Includes the effects of changes in the par value of the underlying collateral of the CLOs, foreign currency translation changes in the measurement of AUM of our European CLOs and other funds, and changes in the portfolio appraisal value for aircraft securitization vehicles. For FP AUM, this also includes movements in or out of FP AUM.
FP AUM totaled $29.3 billion as of December 31, 2022. FP AUM is lower than AUM primarily due to:
•Amounts held by our employees or other related parties who do not pay fees in our multi-strategy funds, opportunistic credit funds, and real estate funds
•Uncalled capital for funds where we do not earn management fees until it is invested for our opportunistic credit funds and real estate funds; and
•Fee rebates when our funds invest in the equity of CLOs in Institutional Credit Strategies, in addition to the AUM associated with the structured alternative investment solution, which becomes FP AUM once it is invested in our funds. Refer to the “Institutional Credit Strategies” section below for further details.
In the year ended December 31, 2022, FP AUM decreased by $2.4 billion, driven largely by the drivers discussed in the Summary of Changes in AUM section above. FP AUM as a percentage of AUM decreased during the period due to the launch of a new real estate vehicle in December 2022, which increased AUM by $150.2 million, but did not begin charging fees until January 2023, as well as an increase in the amount of CLO equity held by our funds; the related management fee is rebated to the funds and the AUM is then treated as non-fee paying.
Weighted-Average Assets Under ManagementFP AUM and Average Management Fee Rates
The table below presents our weighted-average assets under managementFP AUM and average management fee rates.rates for our FP AUM. Weighted-average assets under managementFP AUM exclude the impact of fourth quarter investment performance for the periods presented, as these amounts generally do not impact management fees calculated for those periods. The average management fee rates presented below take into account the effect of non-fee paying assets under management. Please see the respective sections below for average management fee rates by fund type.
|
| | | | | | | | | | | |
| | Year Ended December 31, |
| | 2017 | | 2016 | | 2015 |
| | | | | | |
| | (dollars in thousands)
|
| Weighted-average assets under management | $ | 32,149,591 |
| | $ | 40,405,332 |
| | $ | 46,094,097 |
|
| Average management fee rates | 0.93 | % | | 1.22 | % | | 1.39 | % |
The decline in our average management fee rate for the periods presented occurred primarily because of a change in the mix of products that comprise our assets under management, as well as due to reductions in the management fee rates in certain of our multi-strategy assets under management that took effect during the fourth quarter of 2016. Our average management fee willmay vary from period to period based on the mix of products that comprise our assets under management.FP AUM. The average management fee rates below consider management fees on an Economic Income basis. For reconciliations of our non-GAAP measures to the respective GAAP measures, please see “—Economic Income Reconciliations” at the end of this MD&A.
| | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, |
| | | | | 2022 | | 2021 | | |
| | | | | | | | | |
| | | | | (dollars in thousands) |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| | | | | | | | | |
| Weighted-average fee-paying assets under management | | | | | $ | 30,605,283 | | | $ | 32,017,541 | | | |
| Average management fee rates | | | | | 0.84 | % | | 0.88 | % | | |
Fund Performance Information
The tables below present performance information for the funds we manage. AllThe return information presented represents, where applicable, the composite performance of ourall feeder funds that comprise each of the master funds presented. Gross return information is generally calculated using the total return of all feeder funds, net of all fees and expenses except management fees and incentive income of such feeder funds and master funds, and the returns of each feeder fund include the reinvestment of all dividends and other income. Net return information is generally calculated as the gross returns less management fees and incentive income. Return information that includes Special Investments excludes incentive income on unrealized gains attributable to such investments, which could reduce returns at the time of realization. Special Investments and initial public offering investments are managed bynot allocated to all investors in the Oz Funds segment with the exception of our real estate funds, which are managed by the real estate management business included in Other Operations.and investors that were not allocated Special Investments and initial public offering investments may experience materially different returns.
The performance information presented in this report“Fund Performance Information” section is not indicative of the performance of our Class A Shares and is not necessarily indicative of the future results of any particular fund, including the accrued unrecognized amounts of incentive income. An investment in our Class A Shares is not an investment in any of our funds. There can be no assurance that any of our existing or future funds will achieve similar results. The timing and amount of incentive income generated from our funds are inherently uncertain. Incentive income is a function of investment performance and realizations of investments, which vary period-to-period based on market conditions and other factors. We cannot predict when, or if, any realization of investments will occur. Incentive income recognized for any particular period is not a reliable indicator of incentive income that may be earned in subsequent periods.
TheMulti-Strategy Funds
Our multi-strategy funds invest globally in high-conviction investment ideas across asset classes, regions and investment strategies with a primary focus is on idiosyncratic opportunities where return information presented in this report represents, where applicable,drivers are less sensitive to direction of broader financial markets and which tend to arise when value is obscured by attributes such as complexity, corporate actions, market dislocations, or investor misunderstandings. Additionally, we have the composite performance of all feeder fundsflexibility to take on market-directional risk when we believe that comprise each of the master funds presented. Gross return information is generally calculated using the total return of all feeder funds, net of all fees and expenses except management fees and incentive income of such feeder funds and master funds and the returns of each feeder fund include the reinvestment of all dividends and other income. Net return information is generally calculated as the gross returns less management fees and incentive income (except incentive income on unrealized gains attributable to Special Investments in certain funds that could reduce returns on these investments at the time of realization). Return information also includes realized and unrealized gains and losses attributable to Special Investments and initial public offering investments that are not allocated to all investors in the feeder funds. Investors that were not allocated Special Investments and initial public offering investments may experience materially different returns.
Multi-Strategy Fundsbroad market dislocations have created asymmetric upside/downside potential.
The table below presents assets under managementAUM and investment performance for our multi-strategy funds. Assets under managementAUM are generally based on the net asset value of these products.funds plus any unfunded commitments, if applicable. Management fees generally range from 0.97%1.00% to 2.50%2.00% annually of assets under management.FP AUM. For the fourth quarter of 2017,2022, our multi-strategy funds had an average management fee rate of 1.26%.1.25% of FP AUM.
We generally crystallize incentive income from the majority of our multi-strategy funds on an annual basis. Incentive income is generally equal to 20% of the realized and unrealized profits attributable to each investor. A portion of the assets under
managementAUM in each of the OzSculptor Master Fund and our other multi-strategy funds is subject to initial commitment periods of three years, and for certain of these assets, we only earn incentive income once profits attributable to an investor exceed a preferential return, or “hurdle rate,” which is generally equal to the 3-month T-bill or LIBOR rate for our multi-strategy funds. Once the investment performance has exceeded the hurdle rate for these assets, we may receive a “catch-up” allocation, resulting in a potential recognition by us of a full 20% of the net profits attributable to investors in these assets.
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Assets Under Management as of December 31, | | Returns for the Year Ended December 31, | | Annualized Returns Since Inception Through December 31, 2017 | |
| | | | | | | | 2017 | | 2016 | | 2015 | | |
| | 2017 | | 2016 | | 2015 | | Gross | | Net | | Gross | | Net | | Gross | | Net | | Gross | | Net | |
| | | | | | | | | | | | | | | | | | | | | | | |
| Fund | (dollars in thousands) | | | | | | | | | | | | | | | | | |
Oz Master Fund(1) | $ | 11,386,541 |
| | $ | 17,671,856 |
| | $ | 24,297,106 |
| | 15.0 | % | | 10.4 | % | | 6.5 | % | | 3.8 | % | | 1.6 | % | | -0.4 | % | | 16.8 | % | (1) | 11.7 | % | (1) |
| Oz Asia Master Fund | 607,178 |
| | 937,232 |
| | 1,200,213 |
| | 30.7 | % | | 23.1 | % | | -3.8 | % | | -5.4 | % | | 13.8 | % | | 9.6 | % | | 10.5 | % | | 6.3 | % | |
| Oz Europe Master Fund | 245,179 |
| | 425,203 |
| | 899,388 |
| | 8.3 | % | | 4.8 | % | | 5.8 | % | | 3.7 | % | | 8.9 | % | | 5.8 | % | | 11.5 | % | | 7.5 | % | |
| Oz Enhanced Master Fund | 635,197 |
| | 817,971 |
| | 1,130,747 |
| | 27.8 | % | | 20.2 | % | | 10.2 | % | | 6.8 | % | | 0.9 | % | | -1.1 | % | | 15.1 | % | | 10.3 | % | |
| Other funds | 820,945 |
| | 1,232,286 |
| | 1,982,794 |
| | n/m |
| | n/m |
| | n/m |
| | n/m |
| | n/m |
| | n/m |
| | n/m |
| | n/m |
| |
| | $ | 13,695,040 |
| | $ | 21,084,548 |
| | $ | 29,510,248 |
| | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | Returns for the Year Ended December 31, | | | | | | Annualized Returns Since Inception Through December 31, 2022 | |
| Assets Under Management as of December 31, | | | | 2022 | | 2021 | | | | |
| 2022 | | 2021 | | | | Gross | | Net | | Gross | | Net | | | | | | Gross | | Net | |
| | | | | | | | | | | | | | | | | | | | | | |
| Fund | (dollars in thousands) | | | | | | | | | | | | | | | | | | | |
Sculptor Master Fund(1)(2) | $ | 9,165,632 | | | $ | 10,200,106 | | | | | -11.6 | % | | -12.9 | % | | 7.8 | % | | 5.0 | % | | | | | | 15.4 | % | (3) | 10.5 | % | (3) |
| | | | | | | | | | | | | | | | | | | | | | |
Other funds(2) | 8,471 | | | 912,339 | | | | | n/m | | n/m | | n/m | | n/m | | | | | | n/m | | n/m | |
| $ | 9,174,103 | | | $ | 11,112,445 | | | | | | | | | | | | | | | | | | | | |
_______________
n/m not meaningful
| |
(1) | The annualized returns since inception are those of the Oz Multi-Strategy Composite, which represents the composite performance of all accounts that were managed in accordance with our broad multi-strategy mandate that were not subject to portfolio investment restrictions or other factors that limited our investment discretion since inception on April 1, 1994. Performance is calculated using the total return of all such accounts net of all investment fees and expenses of such accounts, except incentive income on unrealized gains attributable to Special Investments that could reduce returns in these investments at the time of realization, and the returns include the reinvestment of all dividends and other income. The performance calculation for the Oz Master Fund excludes realized and unrealized gains and losses attributable to currency hedging specific to certain investors investing in Oz Master Fund in currencies other than the U.S. Dollar. For the period from April 1, 1994 through December 31, 1997, the returns are gross of certain overhead expenses that were reimbursed by the accounts. Such reimbursement arrangements were terminated at the inception of the Oz Master Fund on January 1, 1998. The size of the accounts comprising the composite during the time period shown vary materially. Such differences impacted our investment decisions and the diversity of the investment strategies followed. Furthermore, the composition of the investment strategies we follow is subject to our discretion, has varied materially since inception and is expected to vary materially in the future. As of December 31, 2017, the gross and net annualized returns since the Oz Master Fund’s inception on January 1, 1998 were 13.1% and 8.9%, respectively.
|
(1)The $7.4 billion,returns for the Sculptor Master Fund exclude Special Investments. Special Investments in the Sculptor Master Fund are held by investors representing a small percentage of AUM in the fund. Inclusive of these Special Investments, the returns of the Sculptor Master Fund for the year ended December 31, 2022 were -12.0% gross and -13.3% net, for the year ended December 31, 2021 were 8.5% gross and 5.7% net, and annualized since inception through December 31, 2022 were 15.1% gross and 10.4% net.
(2)In the third quarter of 2022, we consolidated Sculptor Enhanced Master Fund into the Sculptor Master Fund, as a result we show the related historical AUM in Other funds
(3)The annualized returns since inception are those of the Sculptor Multi-Strategy Composite, which represents the composite performance of all accounts that were managed in accordance with our broad multi-strategy mandate that were not subject to portfolio investment restrictions or 35%, year-over-year decreaseother factors that limited our investment discretion since inception on April 1, 1994. Performance is calculated using the total return of all such accounts net of all investment fees and expenses of such accounts, and the returns include the reinvestment of all dividends and other income. The performance calculation for the Sculptor Master Fund excludes realized and unrealized gains and losses attributable to currency hedging specific to certain investors investing in assets under managementSculptor Master Fund in currencies other than the U.S. dollar. For the period from April 1, 1994 through December 31, 1997, the returns are gross of certain overhead expenses that were reimbursed by the accounts. Such reimbursement arrangements were terminated at the inception of the Sculptor Master Fund on January 1, 1998. The size of the accounts comprising the composite during the time period shown vary materially. Such differences impacted our investment decisions and the diversity of the investment strategies followed. Furthermore, the composition of the investment strategies we follow is subject to our discretion, has varied materially since inception and is expected to vary materially in the future. As of December 31, 2022, the annualized returns since the Sculptor Master Fund’s inception on January 1, 1998 were 12.2% gross and 8.1% net excluding Special Investments and 11.9% gross and 7.9% net inclusive of Special Investments.
AUM in our multi-strategy funds decreased by $1.9 billion, or 17%, year-over-year. This was driven primarily due to capitalby $1.6 billion of performance-related depreciation, as well as $354.7 million of net outflowsoutflows. In 2022, the largest sources of $9.2 billion, primarilygross inflows into our multi-strategy funds were from the Oz Master Fund, our largest multi-strategy fund, partially offset by performance-related appreciation of $1.8 billion. We continued to experience redemptions in 2017 as a result of the investigation matterhigh net worth and the related inability to rely on Regulation D; however, our net outflows have begun to decrease over the latter part of 2017family offices and into 2018. In 2017,sovereign wealth and corporates, while the largest sources of gross outflows from our multi-strategy funds were attributable to pensions and private banks.high net worth and family offices.
ForThe Sculptor Master Fund was down 11.6% gross in the full year 2017,2022 as compared to the OzMSCI World Index and the Balanced US 60/40 Index which were down 15.6% and 19.1%, respectively. The fund is not market-neutral and is expected to have some downside capture in a challenging market. However, this represents an outlier year of more than expected downside capture for the fund. Equities was the largest detractor for the year, along with corporate credit, while the fund profited from positions in convertible and derivative arbitrage and structured credit.
As a result of the performance-related depreciation in our multi-strategy funds in 2022, we will not earn incentive income in future periods on the AUM of substantially all investors until such losses from 2022 have been recovered. As of December 31, 2022, we had $1.4 billion of losses at the fund level remaining to be recovered before we can earn incentive income in our multi-strategy funds.
In 2021, the Sculptor Master Fund generated a gross return of 15.0%7.8% and a net return of 10.4%5.0%. The largest positive contributors to the fund’s performance by strategy were merger arbitrage,fund profited predominately from positions within corporate credit, structured credit, corporate credit long/short equity special situations. Convertible and derivative arbitrage reported a modest loss in 2017. The fund also reported positive performance across all regions: the U.S., Europe and Asia.
Performance in merger arbitrage was strong in 2017 and driven by a wide range of positions. Structured credit delivered strong performance as our differentiated process-driven style of investing continued to deliver attractive and uncorrelated returns. In corporate credit, we experienced positive developments in a number of relatively long-held, late-stage restructuring positions. Losses in the convertible and derivative arbitrage strategy were primarily related to weakness in commodities positions. In long/short equity, a number of our largest positions played out according to plan, and we have meaningfully adjusted the portfolio to reflect our best ideas for 2018.
In 2016, the Oz Master Fund generated a gross return of 6.5% and a net return of 3.8%. These returns were driven by the fund’s merger arbitrage, credit-related and convertible and derivative arbitrage, strategies, partially offset by weaker performancelosses in long/short equity special situations due to losses during the first quarter.equities.
Despite a challenging start to 2016, Oz Master Fund saw the positive momentum that began in the second quarter carry through to the end of the year, generating positive performance in each of the last six months of the year. Oz Master Fund’s merger arbitrage, convertible and derivative arbitrage, corporate credit and structured credit investment strategies each generated strong year-to-date gains through December 31, 2016. In merger arbitrage, Oz Master Fund benefited from positive performance in a number of positions, contributing to the investment strategy’s year-to-date gross return of +2.0%. As we demonstrated throughout 2016, we are drawn to arbitrage situations where we have strong fundamental or industry views and where we have a differentiated view on the risk/reward dynamics. In general, while merger arbitrage spreads remain tight, deal activity is robust and we continue to find select situations that we think are materially mispriced.
Convertible and derivative arbitrage also performed well during the year, driven by profitable trades on certain core positions and positive performance in a handful of existing exposures. Year-to-date, convertible and derivative arbitrage has generated a gross return of +2.0%.
In Oz Master Fund’s credit strategies, we added selectively to high-conviction positions, capitalized on the strength of certain sectors and resolved a number of idiosyncratic situations over the course of 2016. Year-to-date, the corporate credit and structured credit strategies were both up +3.8% on a gross basis.
Oz Master Fund’s long/short equity special situations strategy recovered some of its first quarter losses during the second half of 2016, with gains being driven by a mix of situation-specific events and market factors. Year-to-date, performance in long/short equity special situations was -1.5%. While long/short equity special situations still detracted from Oz Master Fund’s performance for the year, the magnitude of the losses were reduced materially over the last few months of the year.
|
| | | | | | | | | | | |
| | Assets Under Management as of December 31, |
| | 2017 | | 2016 | | 2015 |
| | | | | | |
| | (dollars in thousands) |
| Opportunistic credit funds | $ | 5,513,618 |
| | $ | 5,376,080 |
| | $ | 5,383,629 |
|
| Institutional Credit Strategies | 10,136,991 |
| | 8,019,510 |
| | 7,241,680 |
|
| | $ | 15,650,609 |
| | $ | 13,395,590 |
| | $ | 12,625,309 |
|
| | | | | | | | | | | | | |
| Assets Under Management as of December 31, | | |
| 2022 | | 2021 | | |
| | | | | |
| (dollars in thousands) |
| Opportunistic credit funds | $ | 5,970,962 | | | $ | 6,350,474 | | | |
| Institutional Credit Strategies | 16,273,736 | | | 16,052,406 | | | |
| $ | 22,244,698 | | | $ | 22,402,880 | | | |
Opportunistic Credit Funds
Our opportunistic credit funds seek to generate risk-adjusted returns by capturing value in mispriced investments across disrupted, dislocated and distressed corporate, structured and private credit markets globally.
CertainWithin our Opportunistic Credit strategy, we manage open-ended and closed-ended funds on behalf of investors. In our opportunistic creditopen-ended funds, are open-end andwe allow for contributions and redemptions (subject to initial lock-up and notice periods) on a periodic basis similar tobasis. In our multi-strategy funds. Our remaining opportunistic creditclosed-ended funds, are closed-end, whereby investors make a commitmentcommit capital that is funded over an investment period. Upon the expiration of an investment period, theThe investments are then sold or realized over a period of time, and distributions are made to the investors in the fund.
AUM for our opportunistic credit funds are generally based on the net asset value of those funds plus any unfunded commitments.commitments, if applicable. Management fees for our opportunistic credit funds generally range from 0.75% to 1.75%2.25% annually of the net asset value of these funds. For the fourth quarter of 2017,2022, our opportunistic credit funds had an average management fee rate of 0.86%.0.96% of FP AUM.
The table below presents assets under managementAUM and investment performance information for certain of our opportunistic credit funds. Incentive income related to these funds (excluding the closed-end opportunistic fund, which is explained further below) is generally equal to 20% of realized and unrealized profits attributable to each investor, and a portion of these assets under managementAUM is subject to hurdle rates, which are generally 5% to 8% for our open-end opportunistic credit funds. Once the cumulative investment performance has exceeded the hurdle rate, we maytypically receive a “catch-up” allocation,
resulting in athe potential recognition by us of a full 20% of the net profits attributable to investors in these funds. The measurement periods for these assets under managementAUM generally range from one to five years.
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Assets Under Management as of December 31, | | Returns for the Year Ended December 31, | | Annualized Returns Since Inception Through December 31, 2017 |
| | 2017 | | 2016 | | 2015 | | 2017 | | 2016 | | 2015 | |
| | | | | | | | Gross | | Net | | Gross | | Net | | Gross | | Net | | Gross | | Net |
| | | | | | | | | | | | | | | | | | | | | | |
| Fund | (dollars in thousands) | | | | | | | | | | | | | | | | |
| Oz Credit Opportunities Master Fund | $ | 1,728,910 |
| | $ | 1,818,649 |
| | $ | 1,486,241 |
| | 16.9 | % | | 11.0 | % | | 21.1 | % | | 18.0 | % | | -4.4 | % | | -5.2 | % | | 17.4 | % | | 12.8 | % |
| Customized Credit Focused Platform | 3,001,740 |
| | 2,762,882 |
| | 2,460,716 |
| | 14.6 | % | | 10.9 | % | | 26.3 | % | | 19.8 | % | | — | % | | -0.6 | % | | 19.5 | % | | 14.7 | % |
| Closed-end opportunistic credit funds | 325,312 |
| | 316,360 |
| | 919,786 |
| | See below for return information on our closed-end opportunistic credit funds. |
| Other funds | 457,656 |
| | 478,189 |
| | 516,886 |
| | n/m |
| | n/m |
| | n/m |
| | n/m |
| | n/m |
| | n/m |
| | n/m |
| | n/m |
|
| | $ | 5,513,618 |
| | $ | 5,376,080 |
| | $ | 5,383,629 |
| | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | Returns for the Year Ended December 31, | | Annualized Returns Since Inception Through December 31, 2022 |
| Assets Under Management as of December 31, | | | | 2022 | | 2021 | | | |
| 2022 | | 2021 | | | | Gross | | Net | | Gross | | Net | | | | | | Gross | | Net |
| | | | | | | | | | | | | | | | | | | | | |
| Fund | (dollars in thousands) | | | | | | | | | | | | | | | | |
Sculptor Credit Opportunities Master Fund(1) | $ | 1,698,050 | | | $ | 2,069,005 | | | | | -3.2 | % | | -4.1 | % | | 22.2 | % | | 17.0 | % | | | | | | 12.5 | % | | 8.8 | % |
| Customized Credit Focused Platform | 3,816,248 | | | 3,968,064 | | | | | See below for return information on our Customized Credit Focused Platform. |
| Closed-end opportunistic credit funds | 456,664 | | | 313,405 | | | | | See below for return information on our closed-end opportunistic credit funds. |
| | | | | | | | | | | | | | | | | | | | | |
| $ | 5,970,962 | | | $ | 6,350,474 | | | | | | | | | | | | | | | | | | | |
_______________
n/m not meaningful(1)The returns for the Sculptor Credit Opportunities Master Fund exclude Special Investments, which are held by investors representing a small percentage of AUM in the fund. Inclusive of these Special Investments, the returns of the Sculptor Credit Opportunities Master Fund for the year ended December 31, 2022 were -2.9% gross and -3.8% net, for the year ended December 31, 2021 were 22.3% gross and 17.3% net, and annualized since inception through December 31, 2022 were 12.2% gross and 8.6% net.
Assets under managementAUM in our opportunistic credit funds increaseddecreased by $137.5$379.5 million, or 6%, year-over-year. This change was driven by $532.7primarily by: (i) distributions and other reductions of $182.5 million primarily related to the expiration of the investment period of a closed-end fund; (ii) $166.4 million of performance-related appreciation, partially offset by $337.1depreciation, primarily from our open-ended funds; and (iii) $30.6 million of net outflows and $58.0transfers, primarily driven by redemptions from the Sculptor Credit Opportunities Master Fund, partially offset by transfers into STAX. We continue to raise capital for STAX with total committed capital of $370.0 million to date, a portion of distributionswhich was transferred from the Sculptor Credit Opportunities Master Fund. We plan to continue to hold additional closes and have seen previous periods of market volatility act as a catalyst for capital raising in these types of strategies.
In 2022, the Company’s closed-endSculptor Credit Opportunities Master Fund, our global opportunistic credit funds.
Forfund, delivered strong results on a relative basis, generating significant outperformance as compared to relevant credit indices and benchmarks during the year, and extending their exceptional year-to-date returns relative to the overall market. The fund generated a gross return of -3.2% and a net return of -4.1%, as compared to BAML Global High Yield of -13.2% and HFRX Fixed Income Credit Index -11.6% for the full year 2017,2022. In 2022, the Ozfund experienced losses in corporate credit and experienced gains in structured credit.
As a result of the performance-related depreciation in the Sculptor Credit Opportunities Master Fund in 2022, we will not earn incentive income in future periods on the AUM of certain investors until such losses from 2022 have been recovered. As of December 31, 2022, we had $59 million of losses at the fund level remaining, however, not all investors were in a high watermark position which is dependent upon the timing and duration of their investments.
In 2021, the Sculptor Credit Opportunities Master Fund, our global opportunistic credit fund, generated a gross return of 16.9%22.2% and a net return of 11.0%17.0%. Performance was broad-based with gains acrossIn 2021 the fund saw positive contributions from both corporate credit and structured credit in both the structuredU.S. and corporateEurope, and the fund’s returns represented their largest annual excess return over high yield, continuing our successful track record of delivering excess returns to high yield, particularly in the years following material spread widening periods.
Our Customized Credit Focused Platform invests under a flexible credit mandate across the credit spectrum to allow timely investments as market conditions change and dislocate. The table below presents investment performance for the fund.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Weighted Average Return for the Year Ended December 31,(2) | | Inception to Date as of December 31, 2022 |
| 2022 | | 2021 | | IRR | | Net Invested Capital Multiple(5) |
| Customized Credit Focused Platform | Gross | | Net | | Gross | | Net | | Gross(3) | | Net(4) | |
Opportunistic Credit Performance(1) | -1.9 | % | | -2.0 | % | | 21.8 | % | | 17.2 | % | | 14.3 | % | | 10.8 | % | | 2.5x |
_______________
(1)Performance presented is for the opportunistic credit strategies and geographies. Similar to credit strategy performance in the Oz Master Fund, these returns were drivenCustomized Credit Focused Platform. As of December 31, 2022, approximately 94% of the invested capital in part by realizationsthe Customized Credit Focused Platform is invested in structured credit and successful resolutions in various distressed situations in corporate credit. We continue to be focused on process-oriented and event-driven investments that are not correlated with the broader markets.
In 2016, the assets under management in ourPlatform’s opportunistic credit funds decreasedstrategies.
(2)Weighted Average Returns reflect the total profit & loss divided by $7.5 million year over year, essentially flat year-over-year, as $759.4 millionthe weighted average capital base, which represents net asset value plus net contributions (distributions) for the period.
(3)Gross IRR represents estimated, unaudited, annualized pre-tax returns based on the timing of performance-related appreciation was mostly offset by $685.3 million of distributionscash inflows and other reductionsoutflows for each investment. It is calculated in the Company’s closed-end opportunisticsame manner as Net IRR, however, it does not reflect adjustments to cash flows related to incentive income, management fees and the applicable fund expenses. Gross IRR represents the estimated, unaudited, annualized pre-tax return based on the actual and/or projected timing of cash inflows from, and outflows to, investors for each investment (irrespective of any funding from a credit funds.facility or other third-party financing source used by the Customized Credit Focused Platform). In 2016,certain cases, funding from a credit facility or other third party financing source was initially used by the OzCustomized Credit Opportunities Master Fund, our global opportunistic credit fund, generatedFocused Platform to acquire an investment or pay certain expenses, which may have the effect of increasing the Gross IRR above that which would have been presented, had drawdowns from limited partners been initially used to acquire the investment or pay such expenses. Gross IRR includes the effect of investment hedges as determined by us. There can be no assurance that an appropriate hedge will be identified for each investment or that an appropriate hedge will be available for all investments.
(4)Net IRR is the Gross IRR adjusted to reflect actual management fees, incentive income and expenses incurred by the Customized Credit Focused Platform.
(5)Net invested capital multiple measures the current net asset value over the net invested capital, where net invested capital represents cumulative contributions less cumulative distributions. The Customized Credit Focused Platform has an active liquid investment program, a gross returnkey element of 21.1%which includes ramping up and a net returnramping down depending on market conditions. Much of 18.0%. These returns were driven in part by realizations in structured credit and successful resolutions in various distressed situations in corporate credit.the capital has recently been deployed.
The table below presents assets under management,AUM investment performance and other information for our closed-end opportunistic credit funds. Our closed-end opportunistic credit funds follow a European-style waterfall, whereby incentive income may be paid to us only after a fund investor receives distributions in excess of their total contributed capital and a preferential return, which is generally 6% to 8%. Incentive income related to these funds is generally equal to 20% of the cumulative realized profits in excess of the preferential return attributable to each investor over the life of the fund. Once the investment performance has exceeded the preferential return, we maytypically receive a “catch-up” allocation, resulting in a potential recognition by us of a full 20% of the net profits attributable to investors in these funds. These funds have concluded their investment periods, and therefore we expect AUM for these funds to decrease as investments are sold and the related proceeds are distributed to the investors in these funds.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Assets Under Management as of December 31, | | | | Inception to Date as of December 31, 2022 |
| 2022 | | 2021 | | | | Total Commitments | | Total Invested Capital(1) | | Gross IRR(2) | | Net IRR(3) | | Gross MOIC(4) |
| | | | | | | | | | | | | | | |
| Fund (Investment Period) | (dollars in thousands) | | | | | | |
Sculptor Tactical Credit Fund (2022 - 2025)(5) | 243,625 | | | — | | | | | 370,471 | | | 169,420 | | | n/m | | n/m | | n/m |
| Sculptor European Credit Opportunities Fund (2012-2015) | — | | | — | | | | | 459,600 | | | 305,487 | | | 15.7 | % | | 11.8 | % | | 1.5x |
| Sculptor Structured Products Domestic Fund II (2011-2014) | — | | | — | | | | | 326,850 | | | 326,850 | | | 19.2 | % | | 15.1 | % | | 2.1x |
| Sculptor Structured Products Offshore Fund II (2011-2014) | — | | | — | | | | | 304,531 | | | 304,531 | | | 16.5 | % | | 12.9 | % | | 1.9x |
| Sculptor Structured Products Offshore Fund I (2010-2013) | — | | | — | | | | | 155,098 | | | 155,098 | | | 23.7 | % | | 18.9 | % | | 2.1x |
| Sculptor Structured Products Domestic Fund I (2010-2013) | — | | | 4,537 | | | | | 99,986 | | | 99,986 | | | 22.4 | % | | 17.8 | % | | 2.0x |
| OZ Global Credit Master Fund I (2008-2009) | — | | | — | | | | | 214,141 | | | 214,141 | | | 5.5 | % | | 4.2 | % | | 1.1x |
| Other funds | 213,039 | | | 308,868 | | | | | 679,471 | | | 408,162 | | | n/m | | n/m | | n/m |
| $ | 456,664 | | | $ | 313,405 | | | | | $ | 2,610,148 | | | $ | 1,983,675 | | | | | | | |
_______________n/m not meaningful
(1)Represents funded capital commitments net of recallable distributions to collect incentive income frominvestors.
(2)Gross IRR for our closed-end opportunistic credit funds represents the estimated, unaudited, annualized return based on the timing of cash inflows and outflows for the fund as of December 31, 2022, including the fair value of unrealized investments as of such amounts are generallydate, together with any appreciation or depreciation from related hedging activity. Gross IRR does not subject to clawback,include the effects of management fees or incentive income, which would reduce the return, and are therefore recognizedincludes the reinvestment of all fund income.
(3)Net IRR is calculated as revenuedescribed in footnote (2), but is reduced by us when collected. Beginningall management fees, as well as paid incentive and accrued incentive income that will be payable upon the distribution of each fund’s capital in 2018, as a resultaccordance with the terms of the adoption of new revenue recognition accounting guidance, we will recognizerelevant fund. Accrued incentive income whenmay be higher or lower at such amounts are probabletime. The net IRR represents a composite rate of return for a fund and does not significantly reversing. As a result, beginning in 2018, we will generally recognizereflect the net IRR specific to any individual investor.
(4)Gross Multiple on Invested Capital (“MOIC”) for our closed-end opportunistic credit funds is calculated by dividing the sum of the net asset value of the fund, accrued incentive income, revenuelife-to-date incentive income and management fees paid and any non-recallable distributions made from certain funds earlier than under existing guidance.the fund by the invested capital.
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Assets Under Management as of December 31, | | Inception to Date as of December 31, 2017 |
| | | | | | | | | | | | IRR | | |
| | 2017 | | 2016 | | 2015 | | Total Commitments | | Total Invested Capital(1) | | Gross(2) | | Net(3) | | Gross MOIC(4) |
| | | | | | | | | | | | | | | | |
| Fund (Investment Period) | (dollars in thousands) | | | | | | |
Oz European Credit Opportunities Fund (2012-2015)(5) | $ | 46,116 |
| | $ | 79,760 |
| | $ | 230,662 |
| | $ | 459,600 |
| | $ | 305,487 |
| | 16.5 | % | | 12.5 | % | | 1.5x |
Oz Structured Products Domestic Fund II (2011-2014)(5) | 130,090 |
| | 110,538 |
| | 301,534 |
| | 326,850 |
| | 326,850 |
| | 20.1 | % | | 15.8 | % | | 2.0x |
Oz Structured Products Offshore Fund II (2011-2014)(5) | 136,687 |
| | 108,822 |
| | 267,429 |
| | 304,531 |
| | 304,531 |
| | 17.6 | % | | 13.7 | % | | 1.9x |
Oz Structured Products Offshore Fund I (2010-2013)(5) | 5,748 |
| | 6,033 |
| | 23,495 |
| | 155,098 |
| | 155,098 |
| | 24.0 | % | | 19.2 | % | | 2.1x |
Oz Structured Products Domestic Fund I (2010-2013)(5) | 5,187 |
| | 4,836 |
| | 14,621 |
| | 99,986 |
| | 99,986 |
| | 22.8 | % | | 18.2 | % | | 2.0x |
| Other funds | 1,484 |
| | 6,371 |
| | 82,045 |
| | 298,250 |
| | 298,250 |
| | n/m |
| | n/m |
| | n/m |
| | $ | 325,312 |
| | $ | 316,360 |
| | $ | 919,786 |
| | $ | 1,644,315 |
| | $ | 1,490,202 |
| | | | | | |
_______________
n/m(5)This fund is in the first year of deployment; therefore, IRR and MOIC information is not meaningfulpresented, as it is not meaningful.
| |
(1) | Represents funded capital commitments net of recallable distributions to investors. |
| |
(2) | Gross IRR for our closed-end opportunistic credit funds represents the estimated, unaudited, annualized return based on the timing of cash inflows and outflows for the fund as of December 31, 2017, including the fair value of unrealized investments as of such date, together with any appreciation or depreciation from related hedging activity. Gross IRR does not include the effects of management fees or incentive income, which would reduce the return, and includes the reinvestment of all fund income.
|
| |
(3) | Net IRR is calculated as described in footnote (2), but is reduced by all management fees, as well as paid incentive and accrued incentive income that will be payable upon the distribution of each fund’s capital in accordance with the terms of the relevant fund. Accrued incentive income may be higher or lower at such time. The net IRR represents a composite rate of return for a fund and does not reflect the net IRR specific to any individual investor. |
| |
(4) | Gross MOIC for our closed-end opportunistic credit funds is calculated by dividing the sum of the net asset value of the fund, accrued incentive income, life-to-date incentive income and management fees paid and any non-recallable distributions made from the fund by the invested capital. |
| |
(5) | These funds have concluded their investment periods, and therefore we expect assets under management for these funds to decrease as investments are sold and the related proceeds are distributed to the investors in these funds. |
Institutional Credit Strategies
Institutional Credit Strategies is our asset management platform that invests in performing credits, including leveraged loans, high-yield bonds, private credit/bespoke financing and investment grade credit via CLOs, aircraft securitization vehicles, CBOs, structured alternative investment solutions, commingled products and other customized solutions for clients.
Assets under managementAUM for our CLOsInstitutional Credit Strategies are generally based on the amount of equity outstanding for CLOs and CBOs (during the warehouse period), the par value of the collateral assets and cash held infor CLOs and CBOs (after the CLOs.warehouse period), and adjusted portfolio appraisal values for the aircraft collateral within the securitization vehicles. AUM also includes the net asset value of other investment vehicles within the strategy. However, assets under managementAUM are reduced for any investments in our CLOs and securitization vehicles held by our other funds in order to avoid double counting these assets.funds. Management fees for the CLOs areInstitutional Credit Strategies generally range from 0.43%0.25% to 0.50% annually of assets under management.AUM. For the fourth quarter of 2017, our2022, Institutional Credit Strategies products had an average management fee rate of 0.41%.0.46% net of rebates on cross-investments from other funds we manage.
Given market pressures, average fee rates in our Institutional Credit Strategies business decreased in line with the broader market trends. We continue to issue new CLOs and reset older CLO vintages, which extend the duration of our AUM and we believe may lead to enhanced returns to our investors.
Incentive income from our CLOs and CBO is generally equal to 20% of the excess cash flows due to the holders of the subordinated notes issued by the CLOs and CBO and is generally subject to a 12% hurdle rate. Because of the hurdle rate and structure of our CLOs and CBO, we do not expect to earn a meaningful amount of incentive income from these entities, and
therefore no return information is presented for these vehicles. We do not earn incentive income from our aircraft securitization vehicles.
During the first quarter of 2022, we closed on a $350.0 million structured alternative investment solution, which was tailored to meet the needs of insurance investors. The OZLM CLOs presented below are our U.S. CLOs, whereasfinancing vehicle issued senior and subordinated notes to investors and used those proceeds to invest in a diversified portfolio of funds managed by us. Prior to investing in the OZLME CLOs are our European CLOs.portfolio of funds, the AUM is included within Institutional Credit Strategies. Upon investment in the funds, which began during April 2022, we earn management and incentive fees based on the terms of the underlying funds in which the vehicle invests and the associated AUM is included in those funds.
| | | | | | | | | | | | | | | | | | | | | | | |
| Most Recent Launch or Refinancing Year | | | | Assets Under Management as of December 31, |
| | Deal Size | | 2022 | | 2021 |
| | | | | | | |
| | | (dollars in thousands) |
| | | | | | | |
| Collateralized loan obligations | 2017 | | $ | 1,658,282 | | | $ | 1,023,882 | | | $ | 1,022,807 | |
| 2018 | | 5,315,728 | | | 3,793,343 | | | 4,204,715 | |
| 2019 | | 653,250 | | | — | | | — | |
| 2020 | | 1,868,287 | | | 1,680,046 | | | 1,698,970 | |
| 2021 | | 8,174,069 | | | 7,000,959 | | | 7,150,793 | |
| 2022 | | 852,334 | | | 792,084 | | | 52,621 | |
| | | 18,521,950 | | | 14,290,314 | | | 14,129,906 | |
| | | | | | | |
| Aircraft securitization vehicles | 2018 | | 696,000 | | | 432,723 | | | 471,774 | |
| 2019 | | 1,128,000 | | | 292,667 | | | 339,981 | |
| 2020 | | 472,732 | | | 164,101 | | | 168,788 | |
| 2021 | | 821,529 | | | 569,253 | | | 641,778 | |
| | | 3,118,261 | | | 1,458,744 | | | 1,622,321 | |
| | | | | | | |
| Collateralized bond obligation | 2021 | | 367,050 | | | 286,218 | | | 285,845 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| Other funds | | | | | 238,460 | | | 14,334 | |
| | | $ | 22,007,261 | | | $ | 16,273,736 | | | $ | 16,052,406 | |
|
| | | | | | | | | | | | | | | | | |
| | | | | | Assets Under Management as of December 31, |
| | Initial Closing Date (Most Recent Refinance Date) | | Deal Size | | 2017 | | 2016 | | 2015 |
| | | | | | | | | | |
| | | | (dollars in thousands) |
| CLOs | | | | | | | | | |
| OZLM I | July 19, 2012 (July 24, 2017) | | $ | 523,550 |
| | $ | 496,283 |
| | $ | 497,633 |
| | $ | 499,344 |
|
| OZLM II | November 1, 2012 (October 31, 2016) | | 560,100 |
| | 508,533 |
| | 510,557 |
| | 517,301 |
|
| OZLM III | February 20, 2013 (December 15, 2016) | | 653,250 |
| | 608,383 |
| | 611,608 |
| | 613,827 |
|
| OZLM IV | June 27, 2013 (September 15, 2017) | | 615,500 |
| | 540,283 |
| | 540,979 |
| | 543,297 |
|
| OZLM V | December 17, 2013 (March 16, 2017) | | 501,250 |
| | 466,719 |
| | 468,465 |
| | 470,335 |
|
| OZLM VI | April 16, 2014 (January 17,2017) | | 621,250 |
| | 594,986 |
| | 597,161 |
| | 598,438 |
|
| OZLM VII | June 26, 2014 (April 17, 2017) | | 824,750 |
| | 792,776 |
| | 796,547 |
| | 798,289 |
|
| OZLM VIII | September 9, 2014 (May 30, 2017) | | 622,250 |
| | 595,096 |
| | 597,194 |
| | 597,988 |
|
| OZLM IX | December 22, 2014 (March 2, 2017) | | 510,208 |
| | 498,924 |
| | 495,532 |
| | 495,643 |
|
| OZLM XI | March 12, 2015 (August 18, 2017) | | 541,532 |
| | 515,782 |
| | 491,949 |
| | 491,366 |
|
| OZLM XII | May 28, 2015 | | 565,650 |
| | 548,606 |
| | 550,642 |
| | 548,452 |
|
| OZLM XIII | August 6, 2015 | | 511,600 |
| | 494,941 |
| | 496,758 |
| | 493,012 |
|
| OZLM XIV | December 21, 2015 | | 507,420 |
| | 502,130 |
| | 502,862 |
| | 495,798 |
|
| OZLM XV | December 20, 2016 | | 409,250 |
| | 395,864 |
| | 396,489 |
| | — |
|
| OZLME I | December 15, 2016 | | 430,490 |
| | 478,142 |
| | 422,982 |
| | — |
|
| OZLM XVI | June 8, 2017 | | 410,250 |
| | 401,172 |
| | — |
| | — |
|
| OZLM XVII | August 3, 2017 | | 512,000 |
| | 497,108 |
| | — |
| | — |
|
| OZLME II | September 14, 2017 | | 494,708 |
| | 476,090 |
| | — |
| | — |
|
| OZLM XIX | November 21, 2017 | | 610,800 |
| | 599,644 |
| | — |
| | — |
|
| | | | 10,425,808 |
| | 10,011,462 |
| | 7,977,358 |
| | 7,163,090 |
|
| Other funds | n/a | | n/a |
| | 125,529 |
| | 42,152 |
| | 78,590 |
|
| | | | $ | 10,425,808 |
| | $ | 10,136,991 |
| | $ | 8,019,510 |
| | $ | 7,241,680 |
|
AUM in Institutional Credit Strategies totaled $16.3 billion as of December 31, 2022, increasing $221.3 million, or 1%, year-over-year. The year-over-year increase in assets under managementAUM in Institutional Credit Strategies was driven primarily by the closinglaunches of four new CLOs. 2017two CLOs in 2022, which is below our historical levels, given the current market environment. This was partially offset by the redemption and amortization of certain of our CLOs, as a strong year for Institutional Credit Strategies, which closed over $6.1 billionresult of natural life-cycle events, as well as decreases driven by foreign currency translation adjustments in our European CLOs including refinancings.
In 2016, the year over year increase in assets under management was driven primarily by two new CLOs that closedand changes in the fourth quarter of 2016, includingportfolio appraisal value for our first European CLO. The Company also successfully refinanced two existing deals during the fourth quarter of 2016.aircraft securitization vehicles.
Real Estate Funds
Our real estate funds generally make investments in commercial and residential real estate, including real property, multi-property portfolios, real estate-related joint ventures, real estate operating companies and other real estate-related assets. We seek to build portfolios that are balanced between traditional and non-traditional asset classes, employing moderate leverage, using creative structures and targeting high cash-on-cash returns.
Assets under managementAUM for our real estate funds are generally based on the amount of capital committed by our fund investors during the investment period and the amount of actual capital invested for periods following the investment period. However, assets under managementAUM are reduced for unfunded commitments by our executive managing directors that will be funded through transfers from other fundsfunds. AUM for the SPAC sponsored by us includes the proceeds raised in order to avoid double counting these assets.the initial public offering that are currently invested in U.S. Treasury bills and held in a trust for use in a business combination. The SPAC AUM is non-fee paying, and our AUM will be reduced if and when the SPAC undergoes a
business combination or in the event of its liquidation. AUM for the real estate vehicle launched in December 2022 is based on net asset value. Management fees for our real estate funds, exclusive of co-investment vehicles, generally range from 0.75% to 1.50% annually of assets under management;FP AUM, however, management fees for Och-ZiffSculptor Real Estate Credit Fund I are based on invested capital.capital both during and after the investment period. For the fourth quarter of 2017,2022, our real estate funds, inclusive of co-investment vehicles, had an average management fee rate of 0.83%.
0.90% of FP AUM.
The tabletables below presents assets under management,present AUM, investment performance and other information for our real estate funds. The amounts included within “co-investment and other funds” below mainly relate to co-investment vehicles in which we partner with clients on investment opportunities, typically with lower fees.
Our real estate funds generally follow an American-style waterfall, whereby incentive income may be paid to us after a fund investment is realized if a fund investor receives distributions in excess of the capital contributed for such investment, as well as a preferential return on such investment, which is generally 6% to 10%. Upon each subsequent realization, incentive income, which is generally 20% of realized profits, is recalculated based on the cumulative realized profits in excess of the preferential return attributable to each investor over the life of the fund. Once the investment performance has exceeded the hurdlepreferential rate, we may receive a “catch-up” allocation, resulting in a potential recognition by us of a full 20% of the realized net profits attributable to investors in these funds.
In addition, we recognize incentive income on our real estate funds related to certain tax distributions on realizations at the fund level. Realizations at the fund level may give rise to tax liabilities for our investors and us. Funds distribute capital back to us to cover these tax liabilities and this in turn drives the recognition of tax distribution-related incentive income. In addition, incentive income is recognized as investments are sold and related distributions are made to investors and us. Due to the recalculation of cumulative realized profits upon each realization, the fund may clawback incentive income previously paid to us. As a result, we currently record incentive income paid to us by the real estate funds as unearned revenue in our consolidated balance sheets until such amounts are no longer subject to clawback. Beginning in 2018, as a result of the adoption of newcriteria for revenue recognition accounting guidance,has been met as we willhave received cash before we can recognize the revenue.
For additional information on incentive income when such amountsaccrued at fund level for our real estate, as well as other funds, see “Longer-Term AUM and Accrued Unrecognized Incentive Income” for additional information.
For funds that have concluded their investment periods, we expect AUM to decrease as investments are probable of not significantly reversing. As a result, beginningsold and the related proceeds are distributed to the investors in 2018, we will generally recognize incentive income revenue from certain funds earlier than under existing guidance.these funds. | | | | | | | | | | | | | |
| Assets Under Management as of December 31, | | |
| 2022 | | 2021 | | |
| | | | | |
| Fund (Investment Period) | (dollars in thousands) | | |
| Sculptor Real Estate Fund I (2005-2010) | $ | — | | | $ | — | | | |
| Sculptor Real Estate Fund II (2011-2014) | 20,413 | | | 24,676 | | | |
Sculptor Real Estate Fund III (2014-2019) | 242,964 | | | 308,970 | | | |
| Sculptor Real Estate Fund IV (2019-2023) | 2,594,933 | | | 2,593,402 | | | |
| Sculptor Real Estate Credit Fund I (2015-2020) | 192,941 | | | 368,442 | | | |
| Sculptor Real Estate Credit Fund II (2022-2025) | 154,118 | | | — | | | |
| Co-investment and other funds | 1,358,323 | | | 1,249,372 | | | |
| $ | 4,563,692 | | | $ | 4,544,862 | | | |
|
| | | | | | | | | | | |
| | Assets Under Management as of December 31, |
| | 2017 | | 2016 | | 2015 |
| | | | | | |
| Fund | (dollars in thousands) |
| Och-Ziff Real Estate Fund I | $ | 13,257 |
| | $ | 15,871 |
| | $ | 33,752 |
|
| Och-Ziff Real Estate Fund II | 184,639 |
| | 303,528 |
| | 343,679 |
|
| Och-Ziff Real Estate Fund III | 1,455,200 |
| | 1,457,722 |
| | 1,447,770 |
|
| Och-Ziff Real Estate Credit Fund I | 695,371 |
| | 288,344 |
| | 130,150 |
|
| Other funds | 146,723 |
| | 147,899 |
| | 93,208 |
|
| | $ | 2,495,190 |
| | $ | 2,213,364 |
| | $ | 2,048,559 |
|
82
|
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Inception to Date as of December 31, 2017 |
| | | | Total Investments | | Realized/Partially Realized Investments(1) |
| | Total Commitments | | Invested Capital(2) | | Total Value(3) | | Gross IRR(4) | | Net IRR(5) | | Gross MOIC(6) | | Invested Capital | | Total Value | | Gross IRR(4) | | Gross MOIC(6) |
| | | | | | | | | | | | | | | | | | | | |
| Fund (Investment Period) | (dollars in thousands) | | | | |
Och-Ziff Real Estate Fund I(7) (2005-2010) | $ | 408,081 |
| | $ | 385,977 |
| | $ | 814,152 |
| | 25.1 | % | | 15.7 | % | | 2.1x | | $ | 372,720 |
| | $ | 810,101 |
| | 26.6 | % | | 2.2x |
Och-Ziff Real Estate Fund II(7) (2011-2014) | 839,508 |
| | 762,588 |
| | 1,464,572 |
| | 33.2 | % | | 21.8 | % | | 1.9x | | 586,815 |
| | 1,234,065 |
| | 37.7 | % | | 2.1x |
Och-Ziff Real Estate Fund III(8) (2014-2019) | 1,500,000 |
| | 678,729 |
| | 1,020,848 |
| | n/m |
| | n/m |
| | n/m | | 209,984 |
| | 368,778 |
| | n/m |
| | n/m |
Och-Ziff Real Estate Credit Fund I(8) (2015-2019) | 736,225 |
| | 97,396 |
| | 118,100 |
| | n/m |
| | n/m |
| | n/m | | 48,771 |
| | 57,636 |
| | n/m |
| | n/m |
| Other funds | 293,003 |
| | 172,998 |
| | 235,717 |
| | n/m |
| | n/m |
| | n/m | | 59,030 |
| | 105,262 |
| | n/m |
| | n/m |
| | $ | 3,776,817 |
| | $ | 2,097,688 |
| | $ | 3,653,389 |
| | | | | | | | $ | 1,277,320 |
| | $ | 2,575,842 |
| | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Inception to Date as of December 31, 2022 |
| | | Total Investments | | Realized/Partially Realized Investments(1) |
| Total Commitments | | Invested Capital(2) | | Total Value(3) | | Gross IRR(4) | | Net IRR(5) | | Gross MOIC(6) | | Invested Capital | | Total
Value | | Gross IRR(4) | | Gross MOIC(6) |
| | | | | | | | | | | | | | | | | | | |
| Fund | (dollars in thousands) | | | | |
| Sculptor Real Estate Fund I | $ | 408,081 | | | $ | 386,298 | | | $ | 847,612 | | | 25.5 | % | | 16.1 | % | | 2.2x | | $ | 386,298 | | | $ | 847,612 | | | 25.5 | % | | 2.2x |
| Sculptor Real Estate Fund II | 839,508 | | | 762,588 | | | 1,614,894 | | | 32.9 | % | | 21.7 | % | | 2.1x | | 762,588 | | | 1,614,894 | | | 32.9 | % | | 2.1x |
| Sculptor Real Estate Fund III | 1,500,000 | | | 1,112,924 | | | 2,207,222 | | | 30.3 | % | | 21.0 | % | | 2.0x | | 951,783 | | | 1,909,781 | | | 32.2 | % | | 2.0x |
Sculptor Real Estate Fund IV(7) | 2,596,024 | | | 1,173,285 | | | 1,470,062 | | | n/m | | n/m | | n/m | | 293,006 | | | 440,851 | | | n/m | | n/m |
| Sculptor Real Estate Credit Fund I | 736,225 | | | 698,388 | | | 904,789 | | | 18.3 | % | | 12.9 | % | | 1.3x | | 502,029 | | | 660,683 | | | 19.1 | % | | 1.3x |
Sculptor Real Estate Credit Fund II(7) | 180,540 | | | 45,738 | | | 36,888 | | | n/m | | n/m | | n/m | | n/m | | n/m | | n/m | | n/m |
| Co-investment and other funds | 1,356,173 | | | 1,328,194 | | | 1,669,322 | | | n/m | | n/m | | n/m | | 196,791 | | | 353,355 | | | n/m | | n/m |
| $ | 7,616,550 | | | $ | 5,507,415 | | | $ | 8,750,789 | | | | | | | | | $ | 3,092,495 | | | $ | 5,827,176 | | | | | |
|
| | | | | | | | | |
| | Unrealized Investments as of December 31, 2017 |
| | Invested Capital | | Total Value | | Gross MOIC(6) |
| | | | | | |
| Fund (Investment Period) | (dollars in thousands) | | |
Och-Ziff Real Estate Fund I (2005-2010)(7) | $ | 13,257 |
| | $ | 4,051 |
| | 0.3x |
Och-Ziff Real Estate Fund II (2011-2014)(7) | 175,773 |
| | 230,506 |
| | 1.3x |
Och-Ziff Real Estate Fund III (2014-2019)(8) | 468,745 |
| | 652,071 |
| | n/m |
Och-Ziff Real Estate Credit Fund I (2015-2019)(8) | 48,625 |
| | 60,464 |
| | n/m |
| Other funds | 113,968 |
| | 130,455 |
| | n/m |
| | $ | 820,368 |
| | $ | 1,077,547 |
| | |
| | | | | | | | | | | | | | | | | |
| Unrealized Investments as of December 31, 2022 |
| Invested Capital | | Total
Value | | Gross MOIC(6) |
| | | | | |
| Fund | (dollars in thousands) | | |
| Sculptor Real Estate Fund I | $ | — | | | $ | — | | | — | |
| Sculptor Real Estate Fund II | — | | | — | | | — | |
| Sculptor Real Estate Fund III | 161,141 | | | 297,441 | | | 1.8x |
Sculptor Real Estate Fund IV(7) | 880,279 | | | 1,029,211 | | | n/m |
| Sculptor Real Estate Credit Fund I | 196,359 | | | 244,106 | | | 1.2x |
Sculptor Real Estate Credit Fund II(7) | 45,738 | | | 36,888 | | | n/m |
| Co-investment and other funds | 1,131,403 | | | 1,315,967 | | | n/m |
| $ | 2,414,920 | | | $ | 2,923,612 | | | |
_______________
n/m not meaningful
| |
(1) | An investment is considered partially realized when the total amount of proceeds received, including dividends, interest or other distributions of income and return of capital, represents at least 50% of invested capital. |
| |
(2) | Invested capital represents total aggregate contributions made for investments by the fund. |
| |
(3) | Total value represents the sum of realized distributions and the fair value of unrealized and partially realized investments as of December 31, 2017. Total value will be impacted (either positively or negatively) by future economic and other factors. Accordingly, the total value ultimately realized will likely be higher or lower than the amounts presented as of December 31, 2017.
|
| |
(4) | Gross IRR for our real estate funds represents the estimated, unaudited, annualized return based on the timing of cash inflows and outflows for the aggregated investments as of December 31, 2017, including the fair value of unrealized and partially realized investments as of such date, together with any unrealized appreciation or depreciation from related hedging activity. Gross IRR is not adjusted for estimated management fees, incentive income or other fees or expenses to be paid by the fund, which would reduce the return.
|
| |
(5) | (1)An investment is considered partially realized when the total amount of proceeds received, including dividends, interest or other distributions of income and return of capital, represents at least 50% of invested capital. (2)Invested capital represents total aggregate contributions made for investments by the fund. (3)Total value represents the sum of realized distributions and the fair value of unrealized and partially realized investments as of December 31, 2022. Total value will be impacted (either positively or negatively) by future economic and other factors. Accordingly, the total value ultimately realized will likely be higher or lower than the amounts presented as of December 31, 2022. (4)Gross IRR for our real estate funds represents the estimated, unaudited, annualized return based on the timing of cash inflows and outflows for the aggregated investments as of December 31, 2022, including the fair value of unrealized and partially realized investments as of such date, together with any unrealized appreciation or depreciation from related hedging activity. Gross IRR is not adjusted for estimated management fees, incentive income or other fees or expenses to be paid by the fund, which would reduce the return. (5)Net IRR is calculated as described in footnote (4), but is reduced by all management fees and other fund-level fees and expenses not adjusted for in the calculation of gross IRR. Net IRR is further reduced by paid incentive and accrued incentive income that will be payable upon the distribution of each fund’s capital in accordance with the terms of the relevant fund. Accrued incentive income may be higher or lower at such time. The net IRR represents a composite rate of return for a fund and does not reflect the net IRR specific to any individual investor. |
| |
(6) | Gross MOIC for our real estate funds is calculated by dividing the value of a fund’s investments by the invested capital, prior to adjustments for incentive income, management fees or other expenses to be paid by the fund. |
| |
(7) | These funds have concluded their investment periods, and therefore we expect assets under management for these funds to decrease as investments are sold and the related proceeds are distributed to the investors in these funds. |
| |
(8) | These funds recently launched and have only invested a small portion of their committed capital; therefore, IRR and MOIC information is not presented, as it is not meaningful. |
The $281.8net IRR represents a composite rate of return for a fund and does not reflect the net IRR specific to any individual investor.
(6)Gross MOIC for our real estate funds is calculated by dividing the value of a fund’s investments by the invested capital, prior to adjustments for incentive income, management fees or other expenses to be paid by the fund.
(7)These funds have invested less than half of their committed capital; therefore, IRR and MOIC information is not presented, as it is not meaningful. Sculptor Real Estate Credit Fund II total commitments include $34.3 million or 13%, increase year-over-year in assets under managementassociated with the structured alternative investment solution.
AUM in our real estate funds totaled $4.6 billion as of December 31, 2022, remaining relatively flat year-over-year. This was primarily due to net inflows of $423.5 million, driven by the first closings of Sculptor Real Estate Credit Fund II and another real estate investment vehicle. This was partially offset by $390.8 million of distributions and other reductions, primarily by additional commitmentsrelated to Och-ZiffSculptor Real Estate Credit Fund I, which had its final closing during the second quarter of 2017, and which was partially offset by distributions, primarily related to Och-Ziff Real Estate Fund II. We continue to deploy capital in our real estate funds, while also realizing investments. In 2017, the real estate funds invested over $200 million and had full or partial realizations of 21 investments at an average multiple of invested capital in excess of 2.2x. In total, we have committed approximately 60% of Och-ZiffSculptor Real Estate Fund III, and 18% of the recently closed Och-Ziffvarious other real estate funds, as these funds are
harvesting investments and making distributions. Our real estate funds continue to deploy capital and generate strong returns with a 30.3% annualized gross return in Sculptor Real Estate Fund III and an 18.3% annualized gross return in Sculptor Real Estate Credit Fund I.
In 2016, the $164.8 million year-over-year increase in assets under management in our real estate funds was driven primarily by additional closings in Och-Ziff Real Estate Credit Fund I, partially offset by distributions from Och-Ziff Real Estate Funds ILonger-Term AUM and II. Och-Ziff Real Estate Funds I and II continue to harvest investments, realizing six investments during 2016 at 2.2x of invested capital and a gross IRR of 23.6%.Accrued But Unrecognized Incentive Income (“ABURI”)
Other
Our other assets under management are comprised of funds that are generally strategy-specific, including our equity and energy funds. Management fees for these funds range from 0.75% to 1.50% of assets under management, generally based on the amount of capital committed to these platforms by our fund investors. For the fourth quarter of 2017, our other funds had an average management fee rate of 0.65%.
Incentive income for our equity funds is generally 20% of realized and unrealized annual profits attributable to each investor. Incentive income related to the energy funds is generally 20% of cumulative realized profits attributable to each investor,
and is subject to hurdle rates (generally 3% to 8%). Incentive income for the energy funds is currently not recognized as revenue until near the end of the life of the fund when it is no longer subject to clawback. Beginning in 2018, as a result of the adoption of new revenue recognition accounting guidance, we will recognize incentive income when such amounts are probable of not significantly reversing. As a result, beginning in 2018, we will generally recognize incentive income revenue from these funds earlier than under existing guidance.
Longer-Term Assets Under Management
As of December 31, 2017,2022, approximately 54%72% of our assets under management wereAUM was subject to initial commitment periods of three years or longer. We earn incentivelonger, excluding AUM that had initial commitment periods of three years or longer and subsequently moved to shorter commitment periods at the end of their initial commitment period. The table below presents the amount of these AUM. | | | | | | | | | | | |
| December 31, 2022 | | December 31, 2021 |
| (dollars in thousands) |
| Multi-strategy funds | $ | 408,171 | | | $ | 458,242 | |
| Credit | | | |
| Opportunistic credit funds | 4,742,929 | | | 4,773,980 | |
| Institutional Credit Strategies | 16,259,128 | | | 16,038,071 | |
| Real estate funds | 4,562,718 | | | 4,544,862 | |
| $ | 25,972,946 | | | $ | 25,815,155 | |
Incentive income on these assets, if any, is based on the cumulative investment performance generated over this commitment period. The table below presents the amount of these assets under management, as well as the gross amount of incentive income accrued at the fund level but for which the commitment period has not concluded. These amounts have not yet been recognized in our revenues, as we recognize incentive income at the end of the commitment period when amounts are no longer subject to clawback. Further, these amounts may ultimately not be recognized as revenue by us in the event of future losses in the respective funds. See “—Understanding Our Results—Revenues—Incentive Income” for additional information.
Our longer-term AUM has continued to increase over time, as our product mix continues to shift toward longer-duration products. Longer-term AUM has increased from 26% in 2013 to 45% in 2016 to 72% as of December 31, 2022, driven by growth in opportunistic credit, Institutional Credit Strategies and real estate funds. During the first quarter, longer-term AUM increased from the launch of a structured alternative investment solution, which was tailored to insurance investors and provides exposure to our funds across the platform in a long-dated format. Longer-term AUM creates stability in our platform and provides more consistency in our management fee earnings. |
| | | | | | | |
| | December 31, 2017 |
| | Longer-Term Assets Under Management | | Accrued Unrecognized Incentive Income |
| | | | |
| | (dollars in thousands) |
| Multi-strategy funds | $ | 547,291 |
| | $ | 11,547 |
|
| Credit | | | |
| Opportunistic credit funds | 4,010,757 |
| | 231,488 |
|
| Institutional Credit Strategies | 10,091,527 |
| | — |
|
| Real estate funds | 2,495,189 |
| | 192,767 |
|
| Other | 290,517 |
| | 1,620 |
|
| | $ | 17,435,281 |
| | $ | 437,422 |
|
We recognizeThe table below presents the changes in the amount of incentive income accrued at the fund level but that has not yet been recognized in our revenues (ABURI) during the year ended December 31, 2022: | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2021 | | Recognized Incentive Income | | Performance | | December 31, 2022 | | | | |
| (dollars in thousands) |
| Multi-strategy funds | $ | 5,246 | | | $ | (837) | | | $ | (4,050) | | | $ | 359 | | | | | |
| Credit | | | | | | | | | | | |
| Opportunistic credit funds | 98,674 | | | (37,339) | | | (24,007) | | | 37,328 | | | | | |
| | | | | | | | | | | |
| Real estate funds | 122,940 | | | (75,179) | | | 75,054 | | | 122,815 | | | | | |
| | | | | | | | | | | |
| $ | 226,860 | | | $ | (113,355) | | | $ | 46,997 | | | $ | 160,502 | | | | | |
Incentive income, if any, on our longer-term assets under managementAUM is based on the cumulative investment performance generated over the respective commitment period. As of December 31, 2022, our ABURI was $160.5 million, down $66.4 million in 2022 primarily from the crystallization of ABURI into incentive income in our multi-strategy fundsreal estate and open-end opportunistic credit funds. In real estate, we generated $75.1 million of performance for the year which was largely crystallized during the period. During the year, the opportunistic credit funds reversed $24.0 million of previously accrued ABURI due to performance.
Our ABURI from longer-term AUM generally comprise the following:
•Multi-strategy funds. Multi-strategy ABURI is derived from clients in the three-year liquidity tranche, where incentive income other than tax distributions will be recognized at the end of their respective commitment periods, which are generallyeach client’s three-year period.
•Opportunistic credit funds. Opportunistic credit funds ABURI is derived from three to five years. Incentivesources:
◦Clients in the three-year and four-year liquidity tranches of an open-end opportunistic credit fund, where incentive income related to assets under management in ourother than tax distributions will be recognized at the end of each client’s three-year or four-year period.
◦Long-dated closed-end opportunistic credit funds, where incentive income will be recognized during each fund’s harvest period after invested capital and a preferred return has been distributed to the clients, other than tax distributions.
◦The Customized Credit Focused Platform, where incentive income is recognized at the end of a multi-year term; previously crystallized on December 31, 2020, other than tax distributions.
•Real estate funds. Real Estate ABURI is derived from long-dated real estate funds, where incentive income will start to be recognized following the completion of each fund’s investment period as investments are realized and after invested capital and a preferred return has been distributed to the clients other than tax distributions.
Certain ABURI amounts will generally have compensation expense (on an Economic Income Basis) that will reduce the amount ultimately realized on a net basis. Compensation expense relating to ABURI from our real estate funds is generally recognized near the end of the life of each fund. These funds generally begin to make distributions after the conclusion of their respective investment period, as presented in the tables above. However, these investment periods may generally be extended for an additional one to two years.
Beginning in 2018, as a result of the adoption of new GAAP revenue recognition guidance, we will recognize incentive income when such amounts are probable of not significantly reversing. As a result, beginning in 2018, we will generally recognize incentive income revenue from certain funds earlier than under the existing guidance. On an Economic Income basis, the incentive income recognized on adoption will be partially offset by the related compensation and benefits. Compensation and benefits for incentive income profit-sharing arrangements are generally recognized at the same time as the related incentive income revenue is recognized for Economic Income. We doas the compensation is structured as carried interest in these vehicles. Compensation expense relating to ABURI generated from our multi-strategy funds and opportunistic credit funds is generally recognized in the fourth quarter of the year the underlying fund performance is generated which may not expect any impact to compensation and benefits on a GAAP basis, as such amounts have generally already been recognized as expense.occur at the same time that the related revenues are generated.
Understanding Our Results
Revenues
Our operations historically have been financed primarily by cash flows generated by our business. Our principal sources of revenues are management fees and incentive income. For any given period, our revenues are influenced by the amount of our assets under management,AUM, the investment performance of our funds and the timing of when we recognize incentive income for certain assets under managementAUM as discussed below.
The ability of investors to contribute capital to and redeem capital from our funds causes our assets under managementAUM to fluctuate from period to period. Fluctuations in assets under managementAUM also result from our funds’ investment performance. Both of these factors directly impact the revenues we earn from management fees and incentive income. For example, a $1$1.0 billion increase or decrease in assets under managementAUM subject to a 1% management fee would generally increase or decrease annual management fees by $10$10.0 million. If profits, net of management fees, attributable to a fee-paying fund investor were $10$10.0 million in a given year, we generally would earn incentive income equal to $2$2.0 million, assuming a 20% incentive income rate, a one-year commitment period, no hurdle rate and no high-water marks from prior years.
For any given quarter, our revenues are influenced by the combination of assets under managementAUM and the investment performance of our funds. For the first three quarters of each year, our revenues are primarily comprised of the management fees we have earned for each respective quarter. In addition, we may recognizeexample, incentive income for assets under management for which the measurement period expiredmajority of our multi-strategy AUM is recognized in that quarter, such as longer-term assets under management, or incentive income related to fund investor redemptions, and these amounts may be significant. In the fourth quarter our revenues are primarily comprised of the management fees we have earned for the quarter, as well as incentive income related to the full-yeareach year, based on full year investment performance generated on assets under management that are subject to one-year commitment periods, or for other assets under management for which the commitment period expired in that quarter.performance.
Management Fees. Management fees are generally calculated and paid to us on a quarterly basis in advance, based on the amount of assets under managementAUM at the beginning of the quarter. Management fees are prorated for capital inflows and redemptions during the quarter. Accordingly, changes in our management fee revenues from quarter to quarter are driven by changes in the quarterly opening balances of assets under management,AUM, the relative magnitude and timing of inflows and redemptions during the respective quarter, as well as the impact of differing management fee rates charged on those inflows and redemptions.redemptions, as well as the impact of the deferral of subordinated management fees from certain CLOs. See “—Weighted-Average Assets Under ManagementFP AUM and Average Management Fee Rates” for information on our average management fee rate.rate and Note 12 to our consolidated financial statements in this annual report for additional information regarding management fees.
Incentive Income. We earn incentive income based on the cumulative performance of our funds over a commitment period. Incentive income is typically equal to 20% of the realized and unrealized profits, net of management fees, attributable to each fund investor in our multi-strategy funds, open-end opportunistic credit funds and certain other funds, but it excludes unrealized gains and losses attributable to Special Investments. For our closed-end opportunistic credit funds, real estate funds and certain other funds, incentive income is typically equal to 20% of the realized profits, net of management fees, attributable to each fund investor. For our CLOs, incentive income is typically 20% of the excess cash flows available to the holders of the subordinated notes. Our ability to earn incentive income from some of our funds may be impacted by hurdle rates as further discussed below.
Currently, incentive income is generally recognized at the end of the applicable commitment period when the amounts are contractually payable, or “crystallized,” and when no longer subject to clawback. Beginning in 2018, as a result of the adoption of new revenue recognition accounting guidance, we willWe recognize incentive income when such amounts are probable of not significantly reversing. As a result, beginning in 2018, we will generally recognize incentive income revenue from certain funds earlier than under existing guidance.
All of our multi-strategy funds and open-end opportunistic credit funds are subject to a perpetual loss carry forward, or a perpetual “high-water mark,” meaning we would not be able to earn incentive income with respect to positive investment performance we generate for a fund investor in any year following negative investment performance until that loss is recouped, at which point a fund investor’s investment surpasses the high-water mark. We earn incentive income on any profits, net of management fees, in excess of the high-water mark.
The commitment period for most of our multi-strategy assets under management is for a period of one year on a calendar-year basis, and therefore we generally crystallize incentive income annually on December 31. We may also recognize incentive income related to fund investor redemptions at other times during the year, as well as on assets under management subject to commitment periods that are longer than one year. We may also recognize incentive income for tax distributions related to these assets. Tax distributions are amounts distributed to us to cover tax liabilities related to incentive income that has been accrued at the fund level but will not be recognized by us until the end of the relevant commitment period (if at all). These tax distributions are not subject to clawback once distributed to us.
Incentive income relatedSee Note 12 to our longer-term assets under management is based on the cumulative investment performance over a specified commitment period (in the case of CLOs, based on the excess cash flows available to the holders of the subordinated notes), and is not earned until it is no longer subject to repayment to the respective fund. Our ability to earnconsolidated financial statements in this annual report for additional information regarding incentive income on these longer-term assets is also subject to hurdle rates whereby we do not earn any incentive income until the investment returns exceed an agreed upon benchmark. However, for a portion of these assets subject to hurdle rates, once the investment performance has exceeded the hurdle rate, we may receive a preferential “catch-up” allocation, resulting in a potential recognition by us of a full 20% of the profits, net of management fees, attributable to investors in these assets.income.
Other Revenues. Other revenues consist primarily of interest income on investments in CLOs, cash equivalents and cash and cash equivalents.long-term U.S. government obligations, as well as subrental income. Interest income is recognized on an effective yield basis. Additionally, prior to the sale of our aircraft in the first half of 2017, revenue related to non-business use of the corporate aircraft by certain executive managing directors was also included within other revenues. Revenues earned from non-business use of the corporate aircraft wereSubrental income is recognized on an accruala straight-line basis based on actual flight hours.over the lease term.
Income of Consolidated Funds. Entities.Revenues recorded as income of consolidated fundsentities consist primarily of interest income, dividend income, fees and other miscellaneous items.income.
Expenses
Compensation and Benefits. Compensation and benefits consist of salaries, employee benefits, payroll taxes, and discretionary and guaranteed cash bonus expenses. We generally recognize compensation and benefits expenses over the related service period.
On an annual basis, compensation and benefits comprise a significant portion of total expenses, with discretionary cash bonuses generally comprising a significant portion of total compensation and benefits. We accrue minimum annual discretionary cash bonusbonuses on a straight-line basis during the year. The total amount of discretionary cash bonuses ultimately recognized for the full year, which is determined in the fourth quarter of each year, could differ materially from the minimum amount accrued, as the total discretionary cash bonus is dependent upon a variety of factors, including fund performance for the year. Prior
Due to 2017, annualmulti-year crystallizations in our credit and real estate funds, we may recognize discretionary bonus expense as incentive is generated at the fund level but before we recognize the related incentive income. As our discretionary cash bonuses wereare generally determined based on fund performance in a given year, there may be differences in the timing of when bonuses are accrued and expensed inwhen the corresponding incentive income is recognized, particularly for performance generated on our longer-term AUM and AUM that have annual incentive income crystallization dates other than at year-end. In the fourth quarter we recognize discretionary bonuses, which are largely based on current year fund performance regardless of each year.the year in which incentive income is recognized. It is best to look at our compensation ratio on incentive income over a multi-year period given the difference in timing of these line items. For additional information on incentive income recognized at fund level but not yet recognized by us see “—Longer-Term AUM and Accrued Unrecognized Incentive Income” for additional information. We generally pay our bonuses in January of the year following the year in which bonuses were accrued.
Note that expenses related to incentive income profit-sharing arrangements are generally recognized at the same time the related incentive income revenue is recognized, as management reviews the total compensation expense related to these arrangements in relation to any incentive income earned by the relevant fund.
Compensation and benefits also includesinclude equity-based compensation expense, which is primarily in the form of RSUs granted to our independent board members, employees and executive managing directors, as well as RSAs, PSUs and Partner Equity Units granted to executive managing directors. In February 2018, we also issued PSUs. See Note 10These awards are structured to create strong alignment of economic interest between our consolidated financial statements includedexecutives and shareholders, in this report for additional information regarding RSUs and Note 17 for additional information regarding PSUs.
We also issue Group D Unitsaddition to executive managing directors. Group D Units are not considered equity under GAAP, and therefore no equity-based compensation expense is recognized related to these units when they are granted. Distributions to holders of Group D Units are included within compensation and benefits in the consolidated statements of comprehensive income (loss). These distributions are accrued in the quarter in which the related income was earned and are paid out the following quarter at the same time distributions on the Group A Units and dividends on the Company’s Class A Shares are paid. A Group D Unit converts into a Group A Unit to the extent the Company determines that it has become economically equivalent to a Group A Unit, at which point it is considered a grant of equity-based compensation for GAAP purposes. Upon the conversion of Group D Units into Group A Units, we recognize a one-time charge for the grant-date fair value of the vested units and begin to amortize the grant-date fair value of the unvested units over the vesting period. As additional Group D Units are converted into Group A Units in the future, we may see increasing non-cash equity-based compensation expense related to these units.
Effective March 1, 2017, the Board of Directors approved amendments to the Limited Partnership Agreements of the Oz Operating Partnerships to adjust the measurement thresholds used in calculating the appreciation necessary to permit a determination that Group D Units issued prior to March 1, 2017 have become economically equivalent to Group A Units, making it more likely that outstanding Group D Units (and, due to the fact that economic equivalence is determined chronologically based on order of issuance, subsequently issued Group D Units) will convert to Group A Units. retaining key talent.
We also have profit-sharing arrangements whereby certain employees or executive managing directors are entitled to a share of incentive income distributed by certainthat we earn primarily from our real estate funds. This incentive income is typically paid to us and then we pay a portion is paid to the
profit-sharing participant as investments held by these funds are realized. We defer the recognition of any portion of this incentive income to the extent it is subject to clawback and relates to a fund that is not consolidated. See “—Incentive Income” above. To the extent that the payments to the employees or executive managing directors are probable and reasonably estimable, we accrue these payments as compensation expense for GAAP purposes, which may occur prior to the recognition of the related incentive income.
Deferred cash interestinterests (“DCIs”) are also granted to certain employees and executive managing directors as a form of compensation. DCIs reflect notional fund investments made by us on behalf of an employee or executive managing director. DCIs generally vest over a three yearthree-year period, subject to an employee’s or executive managing director’s continued service. Upon vesting, we pay the employee or executive managing director an amount in cash equal to the notional investment represented by
the DCIs, as adjusted for notional fund performance. Except as otherwise provided in the relevant deferred cash interestDCI plan or in an award agreement, in the event of a termination of the employee’s or executive managing director’s service, any portion of the DCIs that areis unvested as of the date of termination will be forfeited. These awards are designed to create strong alignment of economic interest between our executives and fund investors, in addition to retaining key talent.
Sculptor’s compensation structure is designed to align the interests of our executive managing directors and employees with those of investors in our funds and our Class A Shareholders. Our compensation structure focuses on both individual and firm-wide performance through bonus compensation in a combination of equity and deferred cash interests that vest over time.
Interest Expense. Amounts included within interest expense relate primarily to indebtedness outstanding under our Senior Notes, CLO Investments Loans, Revolving Credit Facility, and Aircraft Loan. See “—Liquidity and Capital Resources—Debt Obligations” for a summary of the terms related to these borrowings. We repaid the outstanding balance under our Revolving Credit Facility and our Aircraft Loan in the first quarter of 2017.outstanding.
General, Administrative and Other. General, administrative and other expenses are comprised of professional services, occupancy and equipment, information processing and communications, recurring placement and related service fees, business development, insurance, impairment of right-of-use lease assets, foreign currency transaction gains and losses, and other miscellaneous expenses. In addition, the settlements expense incurred in 2016 isLegal provisions are also included in this line item.within general, administrative and other.
Expenses of Consolidated Funds.Entities. Expenses recorded as expenses of consolidated fundsentities consist of interest expense, general, administrative and other miscellaneous expenses.
Other Income (Loss)Loss
Changes in Fair Value of Warrant Liabilities. Changes in fair value of warrant liabilities represent gains (losses) from changes in fair value of warrants.
Changes in Tax Receivable Agreement Liability. Changes in tax receivable agreement liability consists of changes in our estimate of the future payments related to the tax receivable agreement that result from changes in future income tax savings due to changes in tax rates. See Note 1518 to our consolidated financial statements included in this report for additional information.
Net Losses on Retirement of Debt. Net losses on retirement of debt consist of net losses realized upon the retirement of any indebtedness outstanding, and include the write-off of unamortized debt discounts and issuance costs, as well as other fees incurred in connection with the retirement of debt.
Net (Losses) Gains on Investments in Funds and Joint Ventures.Investments. Net (losses) gains on investments in funds and joint ventures primarily consist of realized and unrealized net gains and losses on investments in U.S. government obligations and investments in our funds, made by usincluding CLOs and net gains and losses on investments in joint ventures established to expand certain of our private investments platforms.other funds we manage.
Net Gains (Losses) of Consolidated Funds.Entities. Net gains (losses) of consolidated fundsentities primarily consist of net realizedchanges in the fair value of warrant liabilities related to our consolidated SPAC and unrealized gains (losses) on investments held by consolidated entities, as well as changes in the consolidated funds.fair value of the structured alternative investment solution’s assets and liabilities and related interest and other income.
Income Taxes
Income taxes consist of our provision for federal, state and local income taxes in the United StatesU.S. and foreign income taxes, including provisions for deferred income taxes resulting from temporary differences between the tax and GAAP bases. The computation of the provision requires certain estimates and significant judgment, including, but not limited to, the expected taxable income for the year, projections of the proportion of income earned and taxed in foreign jurisdictions, permanent differences between the tax and GAAP bases and the likelihood of being able to fully utilize deferred income tax assets existing as of the end of the period.
The Registrant and the OzSculptor Operating Partnerships are partnerships for U.S. federal income tax purposes and the Registrant is a corporation for U.S. federal income tax purposes. Due to our legal structure, only a portionGenerally all of the income we earn isallocated to the Registrant from the Sculptor
Operating Group will be subject to corporate-level income taxes in the United States and foreign jurisdictions. The amount of incentive income we earn in a given year, the resultant flow of revenues and expenses through our legal entity structure, the effect that changes in our Class A Share price may have on the ultimate deduction we are able to take
related to the settlement of RSUs, and any changes in future enacted income tax rates may have aU.S. See Note 14 for additional information regarding significant impact onitems impacting our income tax provision and effective income tax rate.
Net Income (Loss)Loss Attributable to Noncontrolling Interests and Redeemable Noncontrolling Interests
Noncontrolling interests represent ownership interests in our subsidiaries held by parties other than us and are primarily made up of GroupA Units and fund investors’ interests in the consolidated funds.Units. Increases or decreases in net (loss) income (loss) attributable to the GroupA Units are driven by the earnings of the Oz SculptorOperating Group. Increases or decreases in the net income attributable to fund investors’ interests in consolidated funds are driven by the earnings of those funds as allocated under the contractual terms of the relevant fund agreements.
See Note 34 for a description of factors that historically have, and in the future may, impactadditional information regarding our ownership interest in the Oz SculptorOperating Group.
We also consolidate certain ofIn 2021, we consolidated our opportunistic credit funds,SPAC, wherein investors are able to redeem their interests after an initial lock-up period of up to three years.Class A shares issued by the SPAC. Allocations of earnings to these interestsshares are reflected within net income (loss) attributable to redeemable noncontrolling interests in the consolidated statements of comprehensiveoperations. Increases or decreases in the net income (loss). attributable to SPAC investors’ interests in the SPAC is driven primarily by interest income generated on investments in U.S. Treasury bills, changes in fair value of warrant liabilities of the SPAC and various expenses related to legal costs, business development and insurance. Change in redemption value of Class A Shares of the consolidated SPAC is reflected within change in redemption value of redeemable noncontrolling interests in the consolidated statements of operations.
Additionally in 2020, change in redemption value of Preferred Units was reflected within change in redemption value of redeemable noncontrolling interests in the consolidated statements of operations. The Preferred Units were redeemed in the fourth quarter of 2020. Results of Operations
Year Ended December 31, 20172022 Compared to Year Ended December 31, 20162021
RevenuesNet Loss Attributable to Class A Shareholders | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | | Change |
| | | | | 2022 | | 2021 | | $ | | % |
| | | | | (dollars in thousands) | | |
| Net Loss Attributable to Class A Shareholders | | | | | $ | (12,008) | | | $ | (8,605) | | | $ | (3,403) | | | 40 | % |
Refer below for the discussion of the contributing factors to changes in net loss attributable to Class A Shareholders from the prior year. |
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | Change |
| | 2017 | | 2016 | | $ | | % |
| | | | | | | | |
| | (dollars in thousands) | | |
| Management fees | $ | 319,458 |
| | $ | 533,156 |
| | $ | (213,698 | ) | | -40 | % |
| Incentive income | 528,000 |
| | 233,440 |
| | 294,560 |
| | 126 | % |
| Other revenues | 6,777 |
| | 2,006 |
| | 4,771 |
| | 238 | % |
| Income of consolidated funds | 4,102 |
| | 1,762 |
| | 2,340 |
| | 133 | % |
| Total Revenues | $ | 858,337 |
| | $ | 770,364 |
| | $ | 87,973 |
| | 11 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Year Ended December 31, | | Change |
| | | | | | 2022 | | 2021 | | $ | | % |
| | | | | | | | | | | |
| | | | | | (dollars in thousands) | | |
| Management fees | | | | | $ | 278,374 | | | $ | 301,945 | | | $ | (23,571) | | | (8) | % |
| Incentive income | | | | | 123,434 | | | 312,432 | | | (188,998) | | | (60) | % |
| Other revenues | | | | | 14,014 | | | 7,351 | | | 6,663 | | | 91 | % |
| Income of consolidated entities | | | | | 3,180 | | | 4,340 | | | (1,160) | | | (27) | % |
| Total Revenues | | | | | $ | 419,002 | | | $ | 626,068 | | | $ | (207,066) | | | (33) | % |
Total revenues increased by a net $88.0in 2022 were $419.0 million, decreasing $207.1 million, primarily due to the following:
Management Fees
Management fees decreased by $23.6 million, primarily driven by the following:
•Multi-strategy funds.A $213.7$10.3 milliondecrease due to lower average assets under management, primarily as a result of negative fund performance in 2022 as well as redemptions. Please see “—Managing Business Performance—Multi-Strategy Funds” for additional information regarding the performance of the Sculptor Master Fund.
•Opportunistic credit funds. A $2.0 million decrease due to lower average assets under management in the Sculptor Credit Opportunities Master Fund due to outflows, as well as negative fund performance in 2022. Please see “—Managing Business Performance—Opportunistic Credit Funds” for additional information regarding the performance of the Sculptor Credit Opportunities Master Fund.
•Institutional Credit Strategies. A $10.4 million decrease due to the recovery of $5.6 million of previously deferred subordinated management fees in 2021, as well as natural life cycle events within our existing CLOs which drove down our average net fee rate. Such life cycle events include: (i) the redemptions of certain of our CLOs; (ii) a reduction in AUM in certain of our CLOs due to distributions; and (iii) new issuances and refinancing transactions priced at lower rates. These decreases were partially offset by an increase in management fees driven primarily by lower assets under management in our multi-strategy funds, as well as lower average management fee rates. the new launches of two CLOs.
•Real estate funds. Management fees remained relatively flat year-over-year.
See “Assets Under Management and Fund“—Managing Business Performance—Weighted-Average Assets Under ManagementFP AUM and Average Management Fee Rate”Rates” and “—Managing Business Performance—Summary of Changes in FP AUM” above for information regarding our average management fee rate.
rates and further detail on changes in FP AUM, respectively.Incentive Income
Incentive income decreased by $189.0 million, primarily driven by the following:
•Multi-strategy funds.A $294.6$177.0 million decrease driven by the Sculptor Master Fund which generated a gross return of -11.6% in 2022, as compared to a gross return of 7.8% in 2021. Please see “—Managing Business Performance—Multi-Strategy Funds” for additional information regarding the performance of the Sculptor Master Fund.
•Opportunistic credit funds. A $47.0 million decrease driven by: (i) a $42.5 million decrease from the Sculptor Credit Opportunities Master Fund which generated a gross return of -3.2% in 2022, as compared to a gross return of 22.2% in 2021; and (ii) a $6.6 million decrease driven by the liquidation of one of our closed-end funds in 2021. These decreases were partially offset by a $2.6 million increase in from the Customized Credit Focused Platform as a result of tax distributions taken to cover tax liabilities on accrued unrecognized incentive income, which represents incentive income at the fund level not yet recognized by us. Please see “—Managing Business Performance—Opportunistic Credit Funds” for additional information regarding the performance of the Sculptor Credit Opportunities Master Fund.
•Real estate funds. A$35.0 million increase driven overall by higher relativecrystallizations and realizations in Sculptor Real Estate Fund III, as the fund performance.
| |
◦ | Multi-strategy funds.A $271.6 million increase in incentive income from our multi-strategy funds, which was driven by: (i) an increase of $163.0 million driven by fund investors with annual commitment periods that matured during the period; (ii) an increase of $65.4 million related to fund investor redemptions; and (iii) an increase of $48.0 million related to longer-term assets under management.
|
| |
◦ | Opportunistic credit funds. A $22.0 million increase in incentive income from our opportunistic credit funds, primary due to: (i) an increase of $25.4 million related to fund investors with annual commitment periods that matured during the period; (ii) an increase of $3.7 million from tax distributions; and (iii) an increase of $1.7 million related to crystallization of incentive from fund investor redemptions. These increases were partially offset by a decrease of $8.8 million related to longer-term assets under management.
|
| |
◦ | Other funds. An $11.2 million increase due to higher incentive income from our equity funds.
|
is realizing investments during its harvest period. This increase was partially offset by decreases in realizations in Sculptor Real Estate Fund II, as well as decreases in tax distributions across several of our real estate funds. Realizations in our real estate funds will vary from period to period based on exit opportunities. Please see “—Managing Business Performance—Real Estate Funds” for information regarding incentive income recognized related to tax distributions in our real estate funds.
| |
◦ | Real estate funds. An offsetting $10.3 million decrease in incentive income from our real estate funds, primarily due to lower realizations in one of our real estate co-investment vehicles as compared to the prior year period.
|
A $4.8Other revenues increased $6.7 million, primarily driven by: (i) a $3.4 million increase in other revenues primarily interest income earned on cash and cash equivalents and longer-term treasury bills due to higher interest rates; (ii) a $1.9 million increase in interest income from our risk retention investments in CLOs.our CLOs primarily due to higher interest rates and new CLO issuances; and (iii) a $1.4 million increase in sublease income as a result of the subleasing of a portion of our office space in New York City in the third quarter of 2021.
ExpensesIncome of Consolidated Entities
Income of consolidated entities decreased $1.2 million, driven by a decrease in other fee income from our consolidated entities compared to the prior year, partially offset by an increase in interest income generated on the trust assets of our consolidated SPAC. |
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | Change |
| | 2017 | | 2016 | | $ | | % |
| | | | | | | | |
| | (dollars in thousands) | | |
| Compensation and benefits | $ | 436,549 |
| | $ | 409,883 |
| | $ | 26,666 |
| | 7 | % |
| Interest expense | 23,191 |
| | 23,776 |
| | (585 | ) | | -2 | % |
| General, administrative and other | 152,071 |
| | 646,468 |
| | (494,397 | ) | | -76 | % |
| Expenses of consolidated funds | 9,391 |
| | 350 |
| | 9,041 |
| | NM |
|
| Total Expenses | $ | 621,202 |
| | $ | 1,080,477 |
| | $ | (459,275 | ) | | -43 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | | Change |
| | | | | 2022 | | 2021 | | $ | | % |
| | | | | | | | | | | |
| | | | | (dollars in thousands) | | |
| Compensation and benefits | | | | | $ | 321,319 | | | $ | 411,463 | | | $ | (90,144) | | | (22) | % |
| Interest expense | | | | | 15,521 | | | 15,586 | | | (65) | | | 0 | % |
| General, administrative and other | | | | | 118,646 | | | 121,210 | | | (2,564) | | | (2) | % |
| Expenses of consolidated entities | | | | | 2,753 | | | 2,823 | | | (70) | | | (2) | % |
| Total Expenses | | | | | $ | 458,239 | | | $ | 551,082 | | | $ | (92,843) | | | (17) | % |
Total expenses decreased by $459.3were $458.2 million, decreasing $92.8 million, primarily due to the following:
Compensation and Benefits
A $26.7 millionincrease in compensationCompensation and benefits expensesdecreased $90.1 million, primarily driven by a $25.4the following:
•Equity-based compensation expenses increased by $25.1 million,increase in bonus expense which was primarily due to higher relative fund performance. Also contributingthe following: (i) a $46.6 million increase in amortization related to the increase was a $9.0 millionincrease in equity-based compensation expense primarily driven by a $20.8 millionincrease inRSAs and Group P Units, amortization, which units were granted in 2017, partially offset bythe fourth quarter of 2021 and the first quarter of 2022; (ii) a $12.5decrease in stock-based compensation related to RSUs and PSUs of $13.8 million,decrease in Group A Units amortization primarily due to the separation-related costs incurred in the prior year period for a lower numberdeparting executive; and (iii) a $7.7 million decrease in amounts related to Group E Units.
•Bonus expense decreased by $119.7 million, primarily as a result of unvested units outstanding. Further contributing to the increasea decrease in performance-based bonuses as a result of negative performance in our multi-strategy and credit funds in 2022, as well as separation-related compensation and benefits expenses wasincurred in 2021 for a $6.7 millionincrease in distributions accrued on the Group D Units.departing executive. These increasesdecreases were partially offset by a $14.4$17.1 milliondecrease increase in salariesreal estate profit sharing expense due to continued realizations and income generated by Sculptor Real Estate Fund III and Real Estate Credit Fund I.
•Salaries and benefits increased by $4.5 million, as our worldwide headcount decreasedincreased to 483343 as of December 31, 2017,2022, from 524337 as of December 31, 2016.
2021. Additionally, there was an $879 thousand decrease in the amount of capitalized salaries and benefits related to an internal use software implementation project.Interest Expense
Interest expense remained relatively flat year-over-year, primarily due to a lower average outstanding debt balance, as we repaid $224.4 million under the 2020 Term Loan in 2021, partially offset by higher interest expense as a result of higher interest rates.
General, Administrative and Other Expenses
A $494.4$2.6 milliondecrease in general, administrative and other expenses, driven primarily by $412.1 million of settlements expense incurred in 2016. Also contributingdue to the decline wasfollowing: (i) a $31.5$15.5 milliondecrease in professional services, driven by lower legal fees, an $18.3 milliondecrease in recurring placement and related service fees,occupancy expense primarily due to lower assets under management subjectthe recognition of an $11.2 million impairment loss on a right-of-use asset and a $2.3 million loss incurred on the write-off of leasehold improvements in the prior year related to these agreements, as well asthe sublease of a portion of our New York office space; (ii) a $1.2 million increase in foreign currency transaction gains; and (iii) reductions across various other operating expense categories. These decreases were partially offset by a $13.0 million increase in professional services expenses, primarily due to $11.1 million of elevated professional services fees, primarily legal costs, as well as a $1.4 million increase in recruiting costs, as a result of expense savings initiatives.the hiring activity during the year.
Expenses of Consolidated Entities
A $9.0 millionincrease inExpenses of consolidated entities remained relatively flat year-over-year, primarily due to lower general, administrative and other expenses of certain of our consolidated fundsentities, partially offset by the activity of the structured alternative investment solution that was consolidated in the first quarter of 2022, as well as expenses of our consolidated SPAC, which was consolidated in the fourth quarter of 2021.
Other Loss | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Year Ended December 31, | | Change |
| | | | | | 2022 | | 2021 | | $ | | % |
| | | | | | | | | | | |
| | | | | | (dollars in thousands) | | |
| Changes in fair value of warrant liabilities | | | | | $ | 41,124 | | | $ | (27,460) | | | $ | 68,584 | | | (250) | % |
| Changes in tax receivable agreement liability | | | | | (11,266) | | | (9,238) | | | (2,028) | | | 22 | % |
| Net losses on retirement of debt | | | | | — | | | (30,198) | | | 30,198 | | | (100) | % |
| Net (losses) gains on investments | | | | | (33,664) | | | 11,537 | | | (45,201) | | | (392) | % |
| Net gains (losses) of consolidated entities | | | | | 3,419 | | | (481) | | | 3,900 | | | n/m |
| Total Other Loss | | | | | $ | (387) | | | $ | (55,840) | | | $ | 55,453 | | | (99) | % |
Total other loss was $387 thousand, down from a loss of $55.8 million, which resulted from the following:
•Changes in fair value of warrant liabilities. These represent the change in the fair value of warrants to purchase our Class A Shares that were issued in connection with the 2020 Credit Agreement. The primary driver of the changes in fair value for both 2022 and 2021 was the change in our Class A Share price during each of the respective years. See Note 5 to our consolidated financial statements included in this report for additional details on warrants valuation inputs.
•Changes in tax receivable agreement liability. These are a result of changes in projected future tax rates impacting the anticipated liability under the tax receivable agreement.
•Net losses on retirement of debt. No losses on retirement of debt were incurred in 2022, while the amount in 2021 was primarily related to the $224.4 million prepayment of amounts outstanding under the 2020 Term Loan and a $19.9 million repayment of a CLO Investment Loan. The related losses on retirement of debt were comprised of unamortized discounts and deferred financing costs that were proportionately written-off in connection with these repayments.
•Net (losses) gains on investments. Investment income decreased by $45.2 million. This was primarily due to consolidationlosses on our equity method investments in our multi-strategy funds, risk retention investments in our CLOs, and U.S. government obligations, compared to the prior year in which all of a CLO in warehouse duringthese investments generated income. These losses were largely related to temporary mark-to-market movements, without impairments to the second and third quartersunderlying assets.
•Net gains (losses) of 2017. The CLO was deconsolidated at launch in Septemberconsolidated entities. Income of 2017.
Other Income
|
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | Change |
| | 2017 | | 2016 | | $ | | % |
| | | | | | | | |
| | (dollars in thousands) | | |
| Changes in tax receivable agreement liability | $ | 222,859 |
| | $ | (1,663 | ) | | $ | 224,522 |
| | NM |
|
| Net gains on investments in funds and joint ventures | 3,465 |
| | 3,760 |
| | (295 | ) | | -8 | % |
| Net gains of consolidated funds | 8,472 |
| | 2,915 |
| | 5,557 |
| | 191 | % |
| Total Other Income | $ | 234,796 |
| | $ | 5,012 |
| | $ | 229,784 |
| | NM |
|
Total other incomeconsolidated entities increased for the year-to-date period by $229.8$3.9 million, primarily due to agains on the change in the fair value of warrant liabilities of our consolidated SPAC, partially offset by losses incurred by our consolidated structured alternative investment solution.
Income Taxes | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31, | | Change |
| | | | | 2022 | | 2021 | | $ | | % |
| | | | | | | | | | | |
| | | | | (dollars in thousands) | | |
| Income taxes | | | | | $ | (6,968) | | | $ | 13,705 | | | $ | (20,673) | | | (151) | % |
Income tax receivable agreement liabilityexpense decreased by $20.7 million, primarily due to the decrease in future U.S. Federal corporate income tax rate pursuant toprofitability and the TCJA.
Income Taxes
|
| | | | | | | | | | | | | |
| | Year Ended December 31, | | Change |
| | 2017 | | 2016 | | $ | | % |
| | | | | | | | |
| | (dollars in thousands) | | |
| Income taxes | $ | 317,559 |
| | $ | 10,886 |
| | $ | 306,673 |
| | NM |
For the year-to-date period, income taxes increased by $306.7 million, primarily due to a $280.8 million reduction of deferred income tax assets as a result of the TCJA. The remaining increase in income taxes was primarily due to a change in state tax rates and an increasefair value of warrant liabilities, as these gains are not taxable, partially offset by the change in the valuation allowance related to foreign tax credits.disallowed expenses.
Net Income (Loss)Loss Attributable to Noncontrolling Interests
The following table presents the components of the net income (loss)loss attributable to noncontrolling interests and net income (loss) attributable to redeemable noncontrolling interests: | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Year Ended December 31, | | Change |
| | | | | | 2022 | | 2021 | | $ | | % |
| | | | | | | | | | | |
| | | | | | (dollars in thousands) | | |
| Group A Units | | | | | $ | (26,576) | | | $ | (14,299) | | | $ | (12,277) | | | 86 | % |
| | | | | | | | | | | |
| Other | | | | | 2,664 | | | 2,983 | | | (319) | | | (11) | % |
| Total | | | | | $ | (23,912) | | | $ | (11,316) | | | $ | (12,596) | | | 111 | % |
| | | | | | | | | | | |
| Redeemable noncontrolling interests | | | | | $ | 7,466 | | | $ | (562) | | | $ | 8,028 | | | n/m |
|
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | Change |
| | 2017 | | 2016 | | $ | | % |
| | | | | | | | |
| | (dollars in thousands) | | |
| Group A Units | $ | 130,730 |
| | $ | (195,087 | ) | | $ | 325,817 |
| | 167 | % |
| Consolidated funds | — |
| | 262 |
| | (262 | ) | | -100 | % |
| Other | 900 |
| | 1,068 |
| | (168 | ) | | -16 | % |
| Total | $ | 131,630 |
| | $ | (193,757 | ) | | $ | 325,387 |
| | 168 | % |
| | | | | | | | |
| Redeemable noncontrolling interests | $ | 1,667 |
| | $ | 2,450 |
| | $ | (783 | ) | | -32 | % |
Net income (loss) allocatedattributable to redeemable noncontrolling interests increased by $325.4 million.relates to the SPAC that we consolidated in 2021. The $8.0 million increase was primarily due to improved earningsgains on the change in fair value of the Oz Operating Group, a portion of which was allocable to the Group A Units. The improvement was driven by the settlements expense taken in 2016,SPAC’s warrant liabilities, as well as higher incentiveinterest income lower salaries and benefits, and lower non-compensation expenses, partially offset by lower management fees and higher bonus expense.
Net Income (Loss) Attributable to Class A Shareholders
|
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | Change |
| | 2017 | | 2016 | | $ | | % |
| | | | | | | | |
| | (dollars in thousands) | | |
| Net Income (Loss) Attributable to Class A Shareholders | $ | 18,222 |
| | $ | (130,762 | ) | | $ | 148,984 |
| | 114 | % |
Net income (loss) attributable to Class A Shareholders increased by $149.0 million. The year-over-year improvement was primarily due to investigation-related settlements expense of $412.1 million taken in 2016, as well as higher incentive income, lower non-compensation expenses, lower salaries and benefits, and a reduction in the tax receivable agreement liability. These improvements were partially offset by lower management fees, higher bonus expense, and higher income tax expense due to a reduction of our deferred tax assets as a result of the TCJA.
Year Ended December 31, 2016 Compared to Year Ended December 31, 2015
Deconsolidation on Adoption of ASU 2015-02
As a result of the adoption of ASU 2015-02, we deconsolidated the majority of our previously consolidated funds. This resulted in a substantial decrease in assets of consolidated funds, liabilities of consolidated funds, redeemable noncontrolling interests, appropriated retained deficit and shareholders’ equity attributable to non-controlling interests in our consolidated balance sheet. Additionally, the deconsolidation has caused a significant decrease in the amount of income of consolidated funds, expenses of consolidated funds, and net gains of consolidated funds in our consolidated statement of comprehensive income (loss). Management fees and incentive income from the previously consolidated funds are also no longer eliminated in consolidation.
We adopted ASU 2015-02 using the modified retrospective method of transition, which resulted in an effective date of adoption of January 1, 2016, and a cumulative effect adjustment to opening equity to reflect the impacts of adoption. We did not restate prior-period results. The impact to our opening retained earnings was driven by the cumulative effect of a change in incentive income recognition for the funds no longer consolidated as further discussed below.
The net impact on our results is that incentive income from these funds will now be recognized when such amounts are no longer subject to clawback. Prior to deconsolidation, incentive income from these previously consolidated funds was recognized by allocating a portion of the net income of these funds to us rather than to the fund investors (noncontrolling interests) basedearned on the contractual termsSPAC’s trust assets.
Change in Redemption Value of the relevant fund agreements. This resulted in incentive income being recognized that was subject to clawback in the event of future losses in the respective funds.
The adoption of ASU 2015-02 and the resulting deconsolidation of the majority of the previously consolidated funds had no impact on our Economic Income or other non-GAAP measures discussed throughout this MD&A.
Revenues
|
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | Change |
| | 2016 | | 2015 | | $ | | % |
| | | | | | | | |
| | (dollars in thousands) | | |
| Management fees | $ | 533,156 |
| | $ | 643,991 |
| | $ | (110,835 | ) | | -17 | % |
| Incentive income | 233,440 |
| | 187,563 |
| | 45,877 |
| | 24 | % |
| Other revenues | 2,006 |
| | 2,077 |
| | (71 | ) | | -3 | % |
| Income of consolidated funds | 1,762 |
| | 489,350 |
| | (487,588 | ) | | -100 | % |
| Total Revenues | $ | 770,364 |
| | $ | 1,322,981 |
| | $ | (552,617 | ) | | -42 | % |
Total revenues decreased by $552.6 million, primarily due to the following:
A $110.8 milliondecrease in management fees, primarily due to the following:
| |
◦ | Multi-strategy funds. A $154.0 million decrease in management fees due to increased redemptions, as well as due to a fee rate cut that went into effect on October 1, 2016, for existing fund investors in virtually all of our multi-strategy assets under management.
|
| |
◦ | Opportunistic credit funds. An $8.0 million increase in management fees, primarily due to the effects of deconsolidation of our funds, as fees in the prior year would have been eliminated in consolidation. See “—Economic Income Analysis” where we discuss management fees excluding the effects of consolidation for the comparative periods.
|
| |
◦ | Institutional Credit Strategies. A $35.6 million increase in management fees, primarily due to the effects of deconsolidation of our funds, as fees in the prior year would have been eliminated in consolidation. See “—Economic Income Analysis” where we discuss management fees excluding the effects of consolidation for the comparative periods.
|
| |
◦ | Real estate funds. Management fees in our real estate funds remained relatively flat year over year.
|
For information regarding our average assets under management and management fee rates, see “Assets Under Management and Fund Performance—Weighted-Average Assets Under Management and Average Management Fee Rates.”
A $487.6 million decrease in income of consolidated funds driven primarily by the deconsolidation of the majority of our funds during the first quarter of 2016.
This decrease in revenues was partially offset by a $45.9 millionincrease in incentive income, primarily due to the following:
| |
◦ | Multi-strategy funds. A $5.5 million decrease in incentive income from our multi-strategy funds, which was driven by a decrease of $32.5 million related to longer-term assets under management, a decrease of $27.8 million related to fund investor redemptions, and a decrease of $4.4 million related to lower tax distributions taken to cover tax liabilities on incentive income that has been accrued on certain longer-term assets under management, but that will not be realized until the end of the relevant commitment period. These decreases were partially offset by an increase of $59.2 million related to assets subject to annual crystallization which was driven by improved performance of the funds.
|
| |
◦ | Opportunistic credit funds. A $44.5 million increase in incentive income from our opportunistic credit funds, which was driven primarily by an increase of $29.1 million earned from our open-end funds due to higher fund performance and an increase of $15.4 million earned from our closed-end funds due to higher realizations from funds out of their investment period, as well as due to the deconsolidation of funds, as incentive income from these funds would have been eliminated in consolidation. See “—Economic Income Analysis” where we discuss incentive income excluding the effects of consolidation for the comparative periods.
|
| |
◦ | Real estate funds. A $14.6 million increase in incentive income from our real estate funds, primarily due to the effects of deconsolidation of funds, as incentive income in the prior year would have been eliminated in consolidation. See “—Economic Income Analysis” where we discuss incentive income excluding the effects of consolidation for the comparative periods.
|
| |
◦ | Other funds. An $8.6 million decrease due to lower incentive income from our equity funds.
|
Expenses
|
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | Change |
| | 2016 | | 2015 | | $ | | % |
| | | | | | | | |
| | (dollars in thousands) | | |
| Compensation and benefits | $ | 409,883 |
| | $ | 430,526 |
| | $ | (20,643 | ) | | -5 | % |
| Reorganization expenses | — |
| | 14,064 |
| | (14,064 | ) | | -100 | % |
| Interest expense | 23,776 |
| | 21,441 |
| | 2,335 |
| | 11 | % |
| General, administrative and other | 646,468 |
| | 239,991 |
| | 406,477 |
| | 169 | % |
| Expenses of consolidated funds | 350 |
| | 303,770 |
| | (303,420 | ) | | -100 | % |
| Total Expenses | $ | 1,080,477 |
| | $ | 1,009,792 |
| | $ | 70,685 |
| | 7 | % |
Total expenses increased by $70.7 million, primarily due to the following:
A $406.5 millionincrease in general, administrative and other expenses, driven by the $412.1 million settlements expense in 2016. The increase was partially offset by a decrease of $10.3 million in recurring placement and related service fees due to lower assets under management subject to these arrangements.
A $2.3 millionincrease in interest expense primarily due to the draw down on our Revolving Credit Facility in April 2016.
This increase was partially offset by certain decreases in expenses, primarily the following:
A $20.6 milliondecrease in compensation and benefits expenses, primarily due to the following: (i) a $37.4 million decrease in equity based compensation driven by lower average grant date fair values due to our lower stock price; (ii) a $12.7 million decrease in the allocation to Group D Units due to no Oz Operating Group distributions being declared in 2016; and (iii) a $2.8 million decrease in salary and benefits, as our worldwide headcount decreased to 524 as of December 31, 2016, compared to 659 as of December 31, 2015. These decreases were partially offset by a $32.2 million increase in bonus expense, which was due to improved fund performance.
A $14.1 milliondecrease in Reorganization expenses, as the amortization period for these IPO-related grants ended in 2015.As part of the Reorganization, interests in the Oz Operating Group held by our executive managing directors and the Ziffs were reclassified Group A Units, resulting in non-cash Reorganization expenses. Substantially all of those Group A Units were expensed on a straight-line basis over a five-year vesting period following the IPO, which concluded in November 2012. However, certain of these units had vesting periods through 2015.
A $303.4 milliondecrease in expenses of consolidated funds driven primarily by the deconsolidation of the majority of our funds during the first quarter of 2016.
Other Income (Loss)
|
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | Change |
| | 2016 | | 2015 | | $ | | % |
| | | | | | | | |
| | (dollars in thousands) | | |
| Changes in tax receivable agreement liability | $ | (1,663 | ) | | $ | 55,852 |
| | $ | (57,515 | ) | | -103 | % |
| Net gains on investments in funds and joint ventures | 3,760 |
| | 68 |
| | 3,692 |
| | NM |
|
| Net gains (losses) of consolidated funds | 2,915 |
| | (69,572 | ) | | 72,487 |
| | 104 | % |
| Total Other Income (Loss) | $ | 5,012 |
| | $ | (13,652 | ) | | $ | 18,664 |
| | 137 | % |
Total other income (loss) increased by $18.7 million, primarily due to the $57.5 million increase due to a change in tax receivable agreement liability, which resulted from updated estimated future income tax savings due to changes in state and local income apportionment factors that resulted in lower expenses in 2015 as compared to 2016, the increase was partially offset by a decrease in net gains of consolidated funds, which was driven primarily by the deconsolidation of the majority of our funds during the first quarter of 2016.
|
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | Change |
| | 2016 | | 2015 | | $ | | % |
| | | | | | | | |
| | (dollars in thousands) | | |
| Income taxes | $ | 10,886 |
| | $ | 132,224 |
| | $ | (121,338 | ) | | -92 | % |
Income tax expense decreased by $121.3 million, primarily driven by a $69.3 million decrease in deferred income tax expenses due to prior year changes in state and local income apportionment factors and a $38.8 million decrease due to lower profitability. The remaining variance was due to various miscellaneous items.
Net (Loss) Income Attributable toRedeemable Noncontrolling Interests
The following table presents the componentschange in redemption value of the net income attributable to noncontrolling interests and to redeemable noncontrolling interests:
|
| | | | | | | | | | | | | | |
| | Year Ended December 31, | | Change |
| | 2016 | | 2015 | | $ | | % |
| | | | | | | | |
| | (dollars in thousands) | | |
| Group A Units | $ | (195,087 | ) | | $ | 136,449 |
| | $ | (331,536 | ) | | -243 | % |
| Consolidated funds | 262 |
| | 54,357 |
| | (54,095 | ) | | -100 | % |
| Other | 1,068 |
| | 371 |
| | 697 |
| | 188 | % |
| Total | $ | (193,757 | ) | | $ | 191,177 |
| | $ | (384,934 | ) | | -201 | % |
| | | | | | | | |
| Redeemable noncontrolling interests | $ | 2,450 |
| | $ | (49,604 | ) | | $ | 52,054 |
| | 105 | % |
Net (loss) income attributable to noncontrolling interests decreased $384.9 million primarily due to the following:
A $331.5 milliondecrease in the amounts attributable to the Group A Units due lower profitability of the Oz Operating Group, which was driven by the settlements expense, as well as lower management fees, partially offset by higher incentive income and lower compensation and benefits expenses.
A $54.1 milliondecrease in the amounts attributable to the consolidated Oz funds was driven primarily by deconsolidation of the majority of our funds during the first quarter of 2016.
| | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Year Ended December 31, | | Change |
| | | | | | 2022 | | 2021 | | $ | | % |
| | | | | | | | | | | |
| | | | | | (dollars in thousands) | | |
| Change in redemption value of redeemable noncontrolling interests | | | | | $ | 4,202 | | | $ | (25,924) | | | $ | 30,126 | | | (116) | % |
The $52.1 million increasechange in amounts attributable toredemption value of redeemable noncontrolling interests in the year ended December 31, 2022 was driven primarilya gain of $4.2 million, increasing by $30.1 million from the deconsolidationprior year. These amounts represent the accretion to redemption value of the majority of our funds during the first quarter of 2016.
Net (Loss) Income Attributable to Class A Shareholders
|
| | | | | | | | | | | | | |
| | Year Ended December 31, | | Change |
| | 2016 | | 2015 | | $ | | % |
| | | | | | | | |
| | (dollars in thousands) | | |
| Net (loss) income attributable to Class A Shareholders | $ | (130,762 | ) | | $ | 25,740 |
| | $ | (156,502 | ) | | NM |
Net (loss) income attributableShares related to Class A Shareholders decreased by $156.5 million,our consolidated SPAC. The gain in the current year was primarily driven by the settlements expense, as well as lower management fees, partially offsetincrease in the SPAC’s earnings allocated to the SPAC’s Class A shareholders. The loss in the prior year period was primarily driven by higher incentive income, lower income tax expensean accretion of
the initial value of the SPAC’s Class A Shares to their redemption value.
For the discussion of results of operations for the year ended December 31, 2021 compared to year ended December 31, 2020, please see “Item 7. Management’s Discussion and lower compensationAnalysis of Financial Condition and benefits expenses.Results of Operations—December 31, 2021 Compared to December 31, 2020” in our annual report on Form 10-K for the year ended December 31, 2021, dated February 25, 2022 and filed with the SEC. Economic Income Analysis
In addition to analyzing our results on a GAAP basis, management also reviews our results on an “Economic Income” basis. Economic Income excludes the adjustments described below that are required for presentation of our results on a GAAP basis, but that management does not consider when evaluating operating performance in any given period. Management uses Economic Income as the basis on which it evaluates our financial performance and makes resource allocation and other operating decisions. Management considers it important that investors review the same operating information that it uses.
Economic Income is a measure of pre-tax operating performance that excludes the following from our results on a GAAP basis:
•Equity-based compensation expenses, net of cash settled RSUs. When the number of RSUs to be settled in cash is discretionary at the time of the grant, then the fair value of RSUs that are settled in cash is included as an expense at the time of settlement. When the number of RSUs to be settled in cash is certain on the grant date, then the expense is recognized during the performance period to which the award relates.
•Amounts related to non-cash interest expense accretion on term debt. The 2020 Term Loan and Debt Securities, which were issued in connection with the Recapitalization, were each recognized at a significant discount, as proceeds from each borrowing were allocated to warrant liabilities and the 2019 Preferred Units, respectively, resulting in non-cash accretion to par over time through interest expense for GAAP. The Debt Securities and the 2019 Preferred Units were fully redeemed in 2020. Management excludes this non-cash expense from Economic Income, as it does not consider it to be reflective of our economic borrowing costs.
•Depreciation and amortization expenses, changes in fair value of warrant liabilities, changes in the tax receivable agreement liability, net losses on retirement of debt, gains and losses on fixed assets, and gains and losses on investments in funds, as management does not consider these items to be reflective of operating performance.
•Impairment of right-of-use lease assets is excluded from Economic Income at the time the impairment is recognized for GAAP and the impact is then amortized over the lease term for Economic Income, as management evaluates impairment expenses over the life of the related lease asset and considers the impairment charge to be nonrecurring in nature. Additionally, rent expense is offset by subrental income as management evaluates rent expenses on a net basis.
•Income allocations to our executive managing directors on their direct interests in the OzSculptor Operating Group. Management reviews operating performance at the OzSculptor Operating Group level, where our operations are performed, prior to making any income allocations.
•Net income (loss) attributable to redeemable noncontrolling interests, which relates to our consolidated SPAC, is also eliminated as management does not consider this to be reflective of operating performance.
Equity-based compensation expenses, depreciation and amortization expenses, changes in the tax receivable agreement liability, gains and losses on fixed assets and investments in funds, and reorganization expenses•Amounts related to the IPO,consolidated entities, as management does not consider these itemsamounts to be reflectiverepresentative of our core operating performance. However, the fair value of RSUs that are settled in cash to employees or executive managing directors is included as an expense at the time of settlement.
For reconciliations of our non-GAAP measures to the respective GAAP measures, please see “—Economic Income Reconciliations” at the end of this MD&A.
