SEC Release: "Form PF" Reporting Requirements |
Proposed "Form PF" Reporting Requirements
Today, April 12, 2011, the SEC enters the final stage of its rulemaking process for new reporting requirements on registered private fund advisers—the “Form PF” Rule 204(b)-1 under the Investment Advisers Act of 1940. As directed by the Dodd-Frank Act, the SEC and CFTC jointly proposed this new reporting obligation for all registered advisers that advise private funds. As proposed, Form PF is unprecedented in scope and detail: it is 44 pages long in its entirety. All registered private fund advisers would be required to file Form PF at least annually, and large private fund advisers would be required to file quarterly. Currently, the SEC intends to implement a compliance date of December 15, 2011.
The purpose of the new reporting requirement is to assist the Financial Stability Oversight Council (FSOC) and the Office of Financial Research (OFR) in monitoring the financial industry for sources of systemic risk. The agencies will continue to refine this rule over the coming months—factoring in, we hope, comments received from the industry. The statute prescribes that a final rule be issued by July 21, 2011, the anniversary of Dodd-Frank’s enactment.
Who Would Have to File Form PF?
All registered advisers that advise private funds would have to file Form PF. A “private fund adviser” is any investment adviser registered or required to register with the SEC that advises one or more private funds. A “private fund” is as an issuer that would be an investment company under the Investment Company Act of 1940 but for Section 3(c)(1) or 3(c)(7) of that Act. Form PF requirements would not apply to: (i) advisers that are exempt from SEC registration, such as advisers to venture capital funds; (ii) advisers to private funds with less than $150 million in assets under management in the U.S.; and (iii) foreign private advisers. Under the CFTC’s companion rule, all commodity pool operators and commodity trading advisers that are registered with the CFTC would also have to file Form PF.
Large private fund advisers that have at least $1 billion in assets under management to hedge funds, private equity funds, or liquidity funds would have a much more comprehensive reporting obligation, as outlined below.
As the industry has pointed out in its comments in response to the proposed rule, the definitions used by the SEC for purposes of this rule are ambiguous, and if this issue is left unaddressed in the final rules, it may lead to unintended consequences. For example, hedge funds are defined as private funds that: (i) have a performance fee calculated by taking into account unrealized gains; (ii) may borrow an amount in excess of one-half of its net asset value or may have gross notional exposure in excess of twice its net asset value; and (iii) may sell securities short. This simplistic definition may capture private equity funds in many cases. Moreover, private equity funds are defined by what they are not: private equity funds are private funds that are not hedge funds, liquidity funds, real estate funds, securitized asset funds, or venture capital funds and that do not provide investors with redemption rights. Note that by the nature of this definition—it is a series of negations—the definition of a “private equity fund” may expand or contract in accordance with the definitions of hedge funds and liquidity funds.
Information Required to be Reported on Form PF
While the specific information required by Form PF may change between its proposed and final versions, the purpose and conceptual theme of Form PF is to identify potential sources of systemic risk. Thus, broadly speaking, the questions reflect a concern with the extent of private funds’ interconnectedness within the financial system and the possibility of contagion, or one adviser’s distress and failure spreading to other advisers. For this reason, the reporting obligation would be tiered according to the amount of an investment adviser’s assets under management.
The proposed Form PF is made up of 4 sections. All registered private fund advisers would have to file Section 1, which requires disclosure of an adviser’s total and net assets under management and the amount of those assets that are attributable to certain types of private funds, including hedge funds, private equity funds, and liquidity funds. For each private fund advised, Section 1 seeks disclosure of the fund’s gross and net asset value, the aggregate notional amount of derivative positions, significant counterparty credit exposure, monthly and quarterly fund performance, information about the fund’s borrowings, and basic information about the concentration of the fund’s investor base. In addition, advisers to hedge funds would have to disclose, for each hedge fund advised, investment strategies and information about the fund’s use of trading and clearing mechanisms. The SEC is looking for information about how certain kinds of private funds perform under different market conditions to allow the FSOC to monitor borrowing practices of the broader private fund industry, which might in the aggregate significantly impacts banks and the financial system as a whole.
The additional sections of the form apply only to large private fund advisers that manage $1 billion or more of hedge fund assets, private equity fund assets, or liquidity fund assets. Sections 2 through 4 focus on these types of funds.
As proposed, Section 2 applies to advisers with hedge fund assets under management of $1 billion or more. If an adviser has at least $1 billion of hedge fund assets under management on any day in the reporting period, even if only one day, the adviser would have to file Section 2. Section 2 asks for information about each hedge fund’s market value of assets invested in different types of securities and commodities on a short- and long-term basis, the duration of fixed-income portfolio holdings, interest rate sensitivities, the turnover rate of portfolios as an indication of the adviser’s frequency of trading, and a geographic breakdown of investments held by the hedge fund. The SEC seeks this information to assist the FSOC in examining large hedge fund advisers’ role as a source of liquidity in different asset classes. The SEC reasons that flow of funds information is an important tool for evaluating macroeconomic trends and risks in the financial system. If any hedge fund advised by the private adviser has a net asset value of at least $500 million on any day during the reporting period, the adviser would have to report additional information about the hedge fund. The SEC states that it imposes this intermediate threshold to prevent advisers from evading disclosure by restructuring its activities. The Financial Services Authority of the United Kingdom uses a similar threshold.
Section 3 would apply to private advisers advising a liquidity fund. Liquidity funds are essentially unregistered money market funds, or private funds that generate income by investing in a portfolio of short-term obligations in order to minimize principal volatility for investors. If an adviser to a liquidity fund has at least $1 billion of assets under management in liquidity funds and registered money market funds on any day in the reporting period, the adviser would have to file Section 3. The proposed Section 3 asks for information about the fund’s pricing method for computing net asset value per share, detailed information regarding the fund’s portfolio, broken down by instrument type and maturity profile, and information about the fund’s secured and unsecured borrowing, broken down by credit type and maturity profile. This aims to assess the fund’s susceptibility to runs and to monitor its leverage practices. Section 3 would also ask for information regarding the concentration of the fund’s investor base, gating and redemption policies, and investor liquidity, as well as a good faith estimate of the percentage of the fund purchased using securities lending collateral. The SEC believes this information is important to allow the FSOC to monitor the fund’s interconnectedness with securities lending programs.
Section 4 would require advisers that have private equity fund assets under management of at least $1 billion on any day during the reporting period to disclose each fund’s borrowings and guarantees, and the fund’s investments broken down by industry and by geography. Advisers would also have to report certain information about the portfolio companies in which each fund invests, such as the portfolio companies’ leverage, debt-to-equity ratios, and the maturity profile of their debt. Section 4 would also seek information about the institutions providing bridge financing to the adviser’s portfolio companies and the amount of that financing. The SEC states that this allows the FSOC to assess private equity funds’ use of leverage and to monitor private equity funds’ investments in companies that may be important to financial stability. However, many private equity firms will likely view this as a particularly onerous reporting requirement.
When Must Form PF Be Filed?
Currently, the SEC expects to implement a compliance date of December 15, 2011 for the Form PF rule. Most private advisers would be required to file Form PF annually, and they would have to file their first Form PF 90 days after the end of their first fiscal year occurring on or after December 15, 2011 (e.g., smaller private advisers with a December 31 fiscal year end would file their first Form PF by March 31, 2012). Large private fund advisers with $1 billion or more in assets under management to hedge funds, private equity funds, or liquidity funds would have to file quarterly. Large private fund advisers would have to file Form PF 15 days after the end of each quarter, and they would have to file their first Form PF by January 15, 2012.
Application
As firms assess the many changes to reporting requirements imposed by Dodd-Frank, including in the areas of risk management, derivatives, whistleblowers, and executive compensation, they should also be mindful of the pending new requirements of Form PF. As proposed, asset managers with many funds would face a large reporting burden, including procedures to make sure all necessary information is collected and updated, and procedures to monitor daily whether the $1 billion threshold has been crossed. Large private fund advisers that are subject to the 15-day quarterly reporting deadline would face the most onerous burden, given such a contracted deadline. Private equity funds may include dozens of portfolio companies, each with their own financial reporting schedules, and these companies typically prepare financial reports up to 60 days after the end of the quarter. Many of the funds formed during the past few years to target financial institution investments face even greater reporting challenges, depending on the size and composition of their holdings.
According to the SEC, Form PF is confidential “to the extent permitted by law,” meaning that Form PF information is not yet required to be made available to investors through Form ADV. But, Form PF information would be made available to the SEC and CFTC in examinations, investigations, and enforcement actions. However, unless the regulators adopt significant changes based on comments received from the industry, the greatest risk to private fund advisers is likely to be from compliance costs associated with the scope and hasty timetable for reporting.
| ---------------------------------------------------------------------------------------------- |
This information is not intended as legal advice. Readers should seek specific advice before acting with regard to the subjects mentioned herein.
Patomak Global Partners LLC is a financial services consultancy based in the Washington, DC area. Since early 2009, our firm's experienced consultants have provided an array of regulatory compliance services to private equity firms, hedge funds, mutual funds, and other investment advisors and investment companies. This communication is intended to highlight regulatory and compliance developments for these clients and other interested colleagues. If you would like to sign up for future emails or electronic alerts, please email info@patomak.com.