The Joint SEC and CFTC Form PF Proposal – a.k.a. the –They Really Expect Us to Tell Them EVERYTHING About Our Funds Via Their New Fancy Form' Proposal
By Gregory J. Nowak and Matthew R. Silver, Pepper Hamilton LLP, Attorneys at Law
As part of the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act), the Securities and Exchange Commission (SEC) and Commodity Futures Trading Commission (CFTC) have jointly proposed new rules under the Commodity Exchange Act, as amended (CEA) and the Investment Advisers Act of 1940, as amended (Advisors Act) to implement provisions of Title IV of the Dodd-Frank Act.
The proposed SEC rule would require all investment advisers registered (or required to be registered) with the SEC (but not unregistered or state-registered advisers)1 that advise2 one or more private funds3 to file a new “Form PF” with the SEC. The proposed CFTC rule also would require commodity pool operators (CPOs) and commodity trading advisors (CTAs) registered with the CFTC to satisfy certain proposed CFTC filing requirements by filing Form PF with the SEC, but only if those CPOs and CTAs are also registered with the SEC as investment advisers and advise one or more private funds. If adopted, advisers would file Form PF reports electronically, on a “confidential” basis.4 The required disclosures on Form PF are not directly connected to the current Form ADV required of registered investment advisers, but the two forms do bear certain basic similarities. Moreover, certain information required on Form PF (i.e., private fund identification numbers) can only be obtained by filing a Form ADV Part 1.
The official comment period on the joint rule proposal (the Proposal)5 ran through April 12, 2011. If adopted (and the Dodd-Frank Act does require something effectively similar to be adopted), the anticipated compliance date for “large” firms (i.e., a manager with $1 billion or more AUM in the hedge funds or private equity funds it manages) to file their initial Form PF is January 15, 2012. Smaller advisers with a fiscal year ending on December 31 would file their first Form PF by March 31, 2012.6 7
The proposed Form PF should be reviewed in detail. Depending on the size of the funds your firm manages, the level of detail you would be required to provide can be quite extensive and revealing. The level of specificity is based on AUM (large managers, especially those that manage any “qualifying hedge fund,” must disclose far more than smaller advisers).
If the proposal is adopted in its current form, the amount of work required of an adviser can be astonishing. If your firm is a smaller SEC-registered adviser with under $1 billion of AUM in hedge funds or private equity funds, the SEC thinks filing will take 10 hours of work the first year and 3 hours each subsequent year to prepare and update the filings. If your firm qualifies as a “large” fund adviser (meaning $1 billion or more of hedge fund AUM), the SEC estimate is a burden of 75 hours for an initial filing and 35 hours each quarter after that.8 For comparison, think how much time your firm spent preparing your new ADV Part 2 this year for the March 31 deadline; that form states that “estimated average burden hours” per initial filing is 10.6 hours.
Proposed Form PF will cause issues, in many cases, for your “related persons” due to the significant “related person” data collection requirements it imposes. If an adviser employs sub-advisers, there will be additional issues to work out.
Additionally, each private fund reported must have an identification number. Private fund identification numbers can only be obtained by filing Form ADV. If an adviser is not sure if the Regulation D filings for each of the funds it manages are current, such an adviser would be well advised to check (before requesting an identification number for the fund from the SEC).
Section 404 of the Dodd-Frank Act, which amends section 204(b) of the Advisers Act, directs the SEC to require private fund advisers to maintain records and file reports containing such information as the SEC deems necessary and appropriate in the public interest and for investor protection or for the assessment of systemic risk by the Financial Stability Oversight Council (FSOC), which was established by the Dodd-Frank Act and is comprised of the leaders of various financial regulators.9 The records and reports must include information about the private funds an adviser manages, such as the amount of assets under management,10 use of leverage, counterparty credit risk exposure, and trading and investment positions for each private fund advised by the adviser. Information collected about private funds on Form PF is expected to provide the SEC, the CFTC and FSOC with important information about the basic operations and strategies of private funds. Form PF will also assist the FSOC to obtain a baseline picture of potential systemic risk across the entire private fund industry and with respect to particular categories of private funds, such as hedge funds, private equity funds and liquidity funds.
Key Terms/Conditions in Form PF:
- any adviser that is registered or required to be registered with the SEC as an investment adviser and that advises at least one “private fund” (as defined in the Proposal, and regardless of the level of assets of the fund) will be required to complete Form PF, subject to the following exceptions:
- if an adviser’s principal office and place of business is outside the United States, for purposes of this Form PF, the adviser may disregard any private fund that during the adviser’s last fiscal year was neither a United States person nor offered to, or beneficially owned by, any United States person.
- “related persons”11 may (but are not required to) report on a single Form PF information with respect to all such related persons and the private funds they advise. An adviser must identify in its response to Question 1 on Form PF the related persons as to which it is reporting. This would allow affiliated entities that share reporting and risk management systems to report jointly while also permitting affiliated entities that operate separately to report separately, as well as prevent duplicative reporting with certain sub-advised funds. For reporting efficiency and to prevent duplicative reporting, the SEC has proposed that if an adviser completes information on Schedule D of Form ADV with respect to any private fund, the same adviser would be responsible for reporting on Form PF with respect to that fund.
- Form PF is far more intrusive if the adviser qualifies as a “Large Private Fund Adviser,” as such firms are required to complete numerous sections of Form PF that smaller advisers are not. Large Private Fund Advisers are:
- advisers managing one or more hedge funds that collectively have at least $1 billion in assets as of the close of business on any day during the reporting period for the required report
- advisers managing one or more liquidity funds (see definition below), and having combined liquidity fund and registered money market fund assets of at least $1 billion as of the close of business on any day during the reporting period for the required report, and
- advisers managing one or more private equity funds that collectively have at least $1 billion in assets as of the close of business on the last day of the quarterly reporting period for the required report.
Advisers would be required to monitor on a daily basis whether the above thresholds have been crossed for hedge funds and liquidity funds; for defined “private equity funds,” the monitoring is quarterly.
For purposes of determining whether an adviser is a Large Private Fund Adviser for purposes of Form PF, each adviser would have to aggregate together the assets of managed accounts advised by the adviser that pursue substantially the same investment objective and strategy and invest in substantially the same positions as the private fund (parallel managed accounts) and assets of that type of private fund advised by any of the adviser’s “related persons.”
- the term “hedge fund” is defined to mean any private fund that: (a) has a performance fee or allocation calculated by taking into account unrealized gains; or (b) may borrow an amount in excess of one-half of its net asset value (including any committed capital) or may have gross notional exposure in excess of twice its net asset value (including any committed capital); or (c) may sell securities or other assets short. With respect to any adviser, hedge fund assets under management are the portion of such adviser’s regulatory assets under management that are attributable to hedge funds that it advises.
If this definition is adopted intact, the “hedge fund” reporting requirements may apply to the advisers of many SPVs and similar entities that might not consider themselves “hedge funds.”
- the term “private equity fund” is defined to mean any private fund that is not a hedge fund, liquidity fund, real estate fund, securitized asset fund or venture capital fund and does not provide investors with redemption rights in the ordinary course. With respect to any adviser, private equity fund assets under management are the portion of such adviser’s regulatory assets under management that are attributable to private equity funds it advises. For Form PF, “regulatory assets under management” is not the same as “net assets under management” – Form PF “net assets under management” is an adviser’s “regulatory assets under management” minus any outstanding indebtedness or other accrued but unpaid liabilities. An adviser is to include in its calculation of regulatory assets under management the amount of any uncalled capital commitments.
- the term “liquidity fund” is defined to mean any private fund that seeks to generate income by investing in a portfolio of short-term obligations in order to maintain a stable net asset value per unit or minimize principal volatility for investors. With respect to any adviser, liquidity fund assets under management are the portion of such adviser’s regulatory assets under management that are attributable to liquidity funds it advises (including liquidity funds that are also hedge funds).
- the term “qualifying hedge fund” means any hedge fund that has a net asset value individually, or in combination with any parallel funds and/or parallel managed accounts, of at least $500 million as of the close of business on any day during the most recently completed calendar quarter.
Filling Out Form PF?
Form PF has five sections. For managers filing on an annual basis (i.e., smaller managers), generally only Section 1 will need to be completed.
For managers filing on a quarterly basis (Large Private Fund Advisers), Sections 2, 3 or 4 will need to be completed, depending on the nature and size of their private fund clients. The Form PF sections are:
- Section 1 (to be completed by all filers)
- Section 2 (to be completed by “large” hedge fund managers – $1 billion hedge fund AUM)12
- Section 3 (to be completed by “large” liquidity fund managers – $1 billion liquidity fund AUM)13
- Section 4 (to be completed by “large” private equity fund managers – $1 billion private equity AUM)14
- Section 5 – Managers Applying for Hardship Exemption (a very limited exemption)15
Section 1 in greater detail:
The discussion below is not intended to cover all of the questions asked or data to be provided, but does note key items.
Section 1a asks for general information about the adviser and for a breakdown, by dollar amounts, of its net assets under management attributable to each of: (a) hedge funds, (b) liquidity funds, (c) private equity funds, (d) real estate funds, (e) securitized asset funds, (f) venture capital funds, (g) other private funds, and (h) funds and accounts other than private funds.
Managers must provide the following information (on a fund-by-fund, individual basis)16 for the “private funds” that they manage:
- gross and net asset value
- borrowing/creditor information (breakdowns, dollar amount and types of creditors, not names)
- the identity of each creditor (by name), if any, to which the reporting fund owed an amount in respect of borrowings equal to or greater than 5 percent of the reporting fund’s net asset value as of the data reporting date. For each such creditor, provide the amount owed to that creditor
- derivative positions (values, not counterparty names)
- investor concentration (total number of beneficial equity owners, percentage beneficially owned by the top five – no names required)
- monthly performance data, both before and after deduction of performance fees/charges.
Managers must provide the following information on the “hedge funds” they manage:
- strategies (by percentage of NAV – 17 choices provided, in addition to an “other” box)
- percent of assets traded using computer-driven trading algorithms to select investments
- counterparties/exposure data (names and percent of exposure re: the five trading counterparties to which the reporting fund has the greatest net counterparty credit exposure, names and dollar amounts of the five trading counterparties that have the greatest net counterparty credit exposure to the reporting fund, measured in U.S. dollars)
- trading and clearing data, including the percent of equity, debt, ABS cleared by a central clearing counterparty (CCP) and not cleared by a CCP
- percent of repos and repo clearing information.
Section 2 in greater detail:
- for the adviser as a whole, the form requires a dollar value for long and short positions as of the last day in each month of the reporting period, by sub-asset class, including all exposures whether held physically, synthetically or through derivative, with the breakdown being by asset class and sub-class, including equity (four classes and eight sub-classes), bonds (two classes, four sub-classes and duration information), convertible bonds (two classes, four sub-classes and duration information, sovereign/municipal bonds (six classes and duration information), loans (three classes and duration information), repos, ABS structured products (11 classes and duration information), credit derivatives (three classes), foreign exchange derivatives, interest rate derivatives, commodities (with various breakdowns), and cash.
- for each month of the reporting period, a manager must provide the turnover rate for the aggregate portfolio of the hedge funds that it advises.
- a geographical breakdown of the investments made by the hedge funds that the manager advises (by percentage of the hedge funds’ aggregate gross asset value geographic breakdown of instruments) is also required. There are 17 choices, including Brazil, Canada, Mexico, United States, Other Americas, etc.
Section 2b only must be completed if an adviser manages one or more “qualifying hedge funds” (i.e., $500 million class). An adviser must complete a separate Section 2b for each qualifying hedge fund that it advises (or, in the case of parallel fund structures that collectively comprise a qualifying hedge fund, each parallel fund that is part of that parallel fund structure). An adviser must report aggregate information for parallel managed accounts and master-feeder funds, but not parallel funds.
For each fund, the following information is required:
- investment breakdown data (detailed)
- liquidity related data (including the percentage of the reporting fund’s positions that may be liquidated in various specified time periods)
- positions representing 5 percent or more of fund’s NAV
- counterparty information
- CCP information
- reporting fund risk metrics information, including (if calculated) VaR information
- information related to market factors and the results on the fund’s portfolio (two pages of instructions and fields to fill out)
- two pages devoted to secured/unsecured borrowing data
- derivative and liquidity breakdowns
- pages of investor related information – side pockets, whether manager has right to suspend withdrawals, whether gating exists, whether a suspension of withdrawals or gating is actively taking place.
Section 3 in greater detail:
Section 3 is applicable to advisers that manage $1 billion or more in “liquidity funds”17 and is less extensive than Section 2 (six pages of questions).
Section 4 in greater detail:
Section 4 is applicable to advisers that manage $1 billion or more in private equity assets, and contains three pages of questions. A separate Section 4 is required for each private equity fund that is advised. Information required includes:
- the name/identifying information for the fund
- basic data about loan or other borrowing facilities (dollar amount and by percentage of unfunded commitments)
- an answer to a question concerning whether the fund guarantees the obligations of any portfolio company in which the reporting fund invests
- an answer to a question about the weighted average debt-to-equity ratio of the controlled portfolio companies in which the reporting fund invests
- answers to general debt-to-equity ratio questions concerning controlled portfolio companies
- a breakdown of the indebtedness of the reporting fund’s controlled portfolio companies by maturity data
- an answer to a question concerning the percentage of the aggregate indebtedness of the reporting fund’s controlled portfolio companies, which may be payment-in-kind (PIK) or zero-coupon debt
- an answer to a question asking whether any controlled portfolio company of the reporting fund have in place one or more bridge loans or commitments (subject to customary conditions) for a bridge loan; if the answer is yes, the form requires names and details
- an answer to a question asking whether the reporting fund invests in any financial industry portfolio companies; if the answer is yes, the form requires names and details
- a breakdown of the reporting fund’s investments by industry, based on the NAICS codes of its portfolio companies, and
- if the adviser or any of its related persons invest in any companies that are portfolio companies of the reporting fund, the aggregate dollar amount of such investments.
1 The Dodd-Frank Act created exemptions from SEC registration under the Advisers Act for advisers that solely advise venture capital funds and for advisers to private funds (including hedge and private equity funds) that in the aggregate have less than $150 million in assets under management in the United States. The proposed rule would require some advisers managing less than $150 million in private fund assets to report limited information on Form PF. While Congress exempted from registration with the SEC advisers solely to private funds that in the aggregate have less than $150 million in assets under management, it provided no such exemption for advisers with less than $150 million in private fund assets under management that also, for example, advise individual clients with more than $100 million in assets under management. Advisers to one or more registered investment companies or business development companies are also required to register with the SEC, regardless of the level of assets under management.
2 Only one private fund adviser is required to complete and file Form PF for each private fund. If an adviser files Form ADV Section 7.B.1 with respect to any private fund, the same adviser must also complete and file Form PF for that private fund. The Proposal is clear that if an adviser files a Form PF covering a specific private fund, then an affiliated sub-adviser would not be required to file a Form PF for the same fund. Under the Proposal, it is unclear whether if one adviser files a Form PF for a private fund, an unaffiliated sub-adviser would also be required to file a Form PF for that fund.
3 Section 202(a)(29) of the Advisers Act defines the term “private fund” as “an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940, as amended (Investment Company Act), but for section 3(c)(1) or 3(c)(7) of that Act.” Section 3(c)(1) of the Investment Company Act provides an exclusion from the definition of “investment company” for any “issuer whose outstanding securities (other than short-term paper) are beneficially owned by not more than one hundred persons and which is not making and does not presently propose to make a public offering of its securities.” Section 3(c)(7) of the Investment Company Act provides an exclusion from the definition of “investment company” for any “issuer, the outstanding securities of which are owned exclusively by persons who, at the time of acquisition of such securities, are qualified purchasers, and which is not making and does not at that time propose to make a public offering of such securities.” The term “qualified purchaser” is defined in section 2(a)(51) of the Investment Company Act.
4 Section 404 of the Dodd-Frank Act states that “[n]otwithstanding any other provision of law, the Commission [SEC] may not be compelled to disclose any report or information contained therein required to be filed with the Commission [SEC] under this subsection” except, as noted in the Proposal, “to Congress upon agreement of confidentiality. Section 404 also provides that nothing prevents the SEC from complying with a request for information from any other federal department or agency or any self-regulatory organization requesting the report or information for purposes within the scope of its jurisdiction or an order of a court of the U.S. in an action brought by the U.S. or the SEC. Section 404 of the Dodd-Frank Act also states that the SEC shall make available to FSOC copies of all reports, documents, records, and information filed with or provided to the SEC by an investment adviser under section 404 of the Dodd-Frank Act as FSOC may consider necessary for the purpose of assessing the systemic risk posed by a private fund and that FSOC shall maintain the confidentiality of that information consistent with the level of confidentiality established for the SEC in section 404 of the Dodd-Frank Act.”
5 A copy of the Proposal is available at http://www.sec.gov/rules/proposed/2011/ia-3145fr.pdf.
6 Ninety days after the end of their first fiscal year occurring on or after the proposed compliance date of December 15, 2011.
7 After making an initial filing, “large” firms would be required to file quarterly and small firms would be required to file annually. Advisers would also be required to file Form PF to report that they are transitioning to filing Form PF only annually with the SEC or to report that they no longer meet the requirements for filing Form PF no later than the last day on which the adviser’s next Form PF update would be timely.
8 An adviser that manages multiple “qualifying hedge funds,” meaning “[a]ny hedge fund that has a net asset value individually, or in combination with any parallel funds and/or parallel managed accounts, of at least $500 million as of the close of business on any day during the most recently completed calendar quarter” will require more time than estimated because managing such funds imposes significant additional Form PF requirements.
9 The voting members of FSOC are the Secretary of the Treasury; the Chairman of the Federal Reserve Board; the Comptroller of the Currency; the Director of the Bureau of Consumer Financial Protection; the Chairman of the SEC; the Chairperson of the Federal Deposit Insurance Corporation; the Chairperson of the CFTC; the Director of the Federal Housing Finance Agency; the Chairman of the National Credit Union Administration Board; and an independent member having insurance expertise, appointed by the President. The FSOC is also required to have five nonvoting members, which are the Director of the Office of Financial Research, the Director of the Federal Insurance Office, a state insurance commissioner, a state banking supervisor, and a state securities commissioner.
10 Regulatory assets under management for purposes of Form PF may differ from the amount an adviser reported on Form ADV if the adviser is filing Form PF on a quarterly basis (versus Form ADV, which is only required to be filed annually if there are no material changes) or if the adviser advises any parallel managed accounts that are not “securities portfolios” within the meaning of Instruction 5.b to Form ADV. An adviser’s AUM as calculated under Form ADV is based on the value of advised “securities portfolios,” with Instruction 5(b) noting that an account is a “securities portfolio” if at least 50 percent of the total value of the account consists of securities and that for purposes of this 50 percent test, an adviser may (but not must) treat cash and cash equivalents (i.e., bank deposits, certificates of deposit, bankers acceptances, and similar bank instruments) as securities.
11 “Related person” has the same meaning as in Form ADV. It means any advisory affiliate and any person [entity] that is under common control with your firm. Your firm’s advisory affiliates are (1) all of its officers, partners, or directors (or any party performing similar functions); (2) all persons [entities] directly or indirectly controlling or controlled by your firm; and (3) all of your firm’s current employees (other than employees performing only clerical, administrative, support or similar functions).
12 Required to be completed if an adviser and its related persons, collectively, had at least $1 billion in hedge fund assets under management as of the close of business on any day during the most recently completed calendar quarter.
13 Required to be completed if an adviser (i) advises one or more liquidity funds and (ii) as of the close of business on any day during the most recently completed calendar quarter, the adviser and its related persons, collectively, had at least $1 billion in combined money market and liquidity fund assets under management.
14 Required to be completed if an adviser and its related persons, collectively, had at least $1 billion in private equity fund assets under management as of the close of business on the last day of the most recently completed calendar quarter.
15 That is, if the adviser encountered unanticipated technical difficulties that prevented it from making a timely filing of the form online – a computer malfunction or electrical outage are specifically named as possible hardships.
16 However, an adviser must report aggregate information for parallel managed accounts and master-feeder funds, but not parallel funds.
17 Required to be completed if an adviser (i) advises one or more liquidity funds and (ii) as of the close of business on any day during the most recently completed calendar quarter, the adviser and its related persons, collectively, had at least $1 billion in combined money market and liquidity fund assets under management.
Gregory J. Nowak is a partner and resident of the Philadelphia and New York offices of Pepper Hamilton LLP, where he concentrates his practice in securities law, particularly in representing investment management companies and other clients on matters arising under the Investment Company Act of 1940 and the related Investment Advisers Act of 1940. He also represents broker-dealers and CTAs and CPOs with respect to matters under the Securities Exchange Act of 1934 and the Commodity Exchange Act.
Matthew R. Silver is an associate in the Financial Services Practice Group of Pepper Hamilton LLP, resident in the Philadelphia office. Mr. Silver concentrates his practice on the representation of investment management clients, particularly investment advisers, broker-dealers, hedge funds and other alternative investment funds, in all aspects of their business cycles.
Pepper Hamilton LLP is a multi-practice law firm with more than 500 lawyers nationally. The firm provides corporate, litigation and regulatory legal services to leading businesses, governmental entities, nonprofit organizations and individuals throughout the nation and the world.