SEC Proposes Additional Private Fund Disclosures

Ellen Kaye Fleishhacker and Robert Holton are partners and Patrick Derocher is an associate at Arnold & Porter LLP. This post is based on an Arnold & Porter memorandum by Ms. Fleishhacker, Mr. Holton, Mr. Derocher, Stephen Culhane, and Veronica Callahan.

On January 26, 2022, the US Securities and Exchange Commission (SEC or Commission) voted in favor of proposing amendments to Form PF, which is the confidential reporting form that certain SEC-registered investment advisers to private funds must file with the SEC. In the SEC’s press release regarding the proposed amendments, Chair Gary Gensler pointed to the decade of experience the SEC and Financial Stability Oversight Council (FSOC) have had analyzing the information collected on Form PF, and stated: “We have identified significant information gaps and situations where we would benefit from additional information.”

The proposed rules, which will be open for a 30-day public comment period, would (i) require large advisers to hedge funds and private equity funds to file reports within one business day of the occurrence of certain reporting events, (ii) lower the reporting threshold for large private equity advisers from $2 billion to $1.5 billion in private equity fund assets under management, and (iii) require additional information regarding large private equity funds and large liquidity funds to be reported.

This post discusses the background of Form PF, explains the amendments that have been proposed by the SEC, and identifies certain practical considerations related to the proposed amendments.

Background

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) amended Section 204(b) of the Investment Advisers Act of 1940 to require certain disclosures by private fund investment advisers. The purpose of these disclosures­, which became the basis for Form PF in 2011, is to assist FSOC in assessing systemic risk in the US financial system and protect investors. The requirements came about in response to the financial crisis of 2008 and the subsequent regulatory push to improve the ability of the SEC—and the federal government more broadly—to assess the health of the financial system and respond to developments that may threaten the stability of the markets and negatively impact individual investors.

Currently, registered investment advisers that have at least $150 million in private fund assets under management (AUM) must file Form PF. “Large” advisers must provide more detailed information on Form PF than smaller advisers, and the required filing deadlines depend on the type of adviser and AUM. Specifically:

  • Advisers with at least $1 billion in liquidity fund and money market fund AUM are large liquidity fund advisers and must file Form PF with specific information within 15 days after the end of each quarter.
  • Advisers with at least $1.5 billion in hedge fund AUM are large hedge fund advisers and must file Form PF with specific information within 60 days after the end of each quarter.
  • Advisers with at least $2 billion in private equity fund AUM are large private equity advisers and must file form PF with specific information within 120 days after the end of each quarter.

For nearly a full decade after Form PF was first adopted, the SEC did not make changes to the form, and there was no apparent appetite at the Commission for major changes to the reporting structure. Recent market events, however, appear to have prompted the proposed amendments, and the proposing release cites to “the March 2020 COVID-19 turmoil and the January 2021 market volatility in certain stocks” as a justification for the proposal.

The Proposed Amendments

The proposed amendments fall into three categories: (1) new requirements for rapid reporting by certain funds; (2) decreasing the reporting threshold for large private equity advisers; and (3) requiring additional information to be reported by advisers to certain funds.

Rapid Reporting of Certain Events. The new rapid reporting requirements would apply to large hedge fund advisers and advisers to private equity funds. The SEC has proposed that these advisers would have one business day from the occurrence of certain reporting events to file with the SEC. As a general matter, the SEC has said that these reporting events are those that “indicate significant stress at a fund that could harm investors or signal risk in the broader financial system.” In particular, for large hedge funds, the reporting events include extraordinary investment losses, significant margin and default events, material changes in relationship with a prime broker, changes in unencumbered cash, significant disruption or degradation of a fund’s operations, and large or suspended withdrawals and redemptions. As for private equity funds, reporting events include adviser-led secondary transactions, implementation of a partner clawback, removal of a fund’s general partner, termination of an investment period, or termination of the fund itself. Both hedge fund and private equity advisers would be allowed to append their disclosures with explanatory statements.

Lowered Reporting Threshold. The second category of proposed amendments would lower the threshold for reporting as a large private equity adviser from $2 billion to $1.5 billion in private equity fund AUM. According to the proposing release, the $2 billion threshold from 2011 captured some 75% of the private equity market in the US, but only two-thirds of the market today—and, by lowering the AUM level to $1.5 billion, the SEC hopes to get back to 75% of market coverage. This is in alignment with a statement from Commissioner Allison Herren Lee, who notes that the total amount under private fund management has doubled to $11.7 trillion in the past seven years.

Additional Information Reporting. Finally, the proposed amendments would require additional information to be reported by large private equity advisers and large liquidity fund advisers, as follows:

  • The proposed amendments would add a question to Form PF for large private equity advisers that is designed to elicit information about investment strategies. The new question would mirror a question on the current Form that is directed at hedge fund advisers, so that large private equity advisers would be required to estimate the percentage of their funds that are invested according to a list of mutually exclusive investing strategies. The SEC’s stated reason for proposing this new question is to allow the FSOC to monitor investment trends and analyze risk in a more targeted fashion.
  • The proposed amendments would require large liquidity fund advisers to supplement their current reporting such that it is substantially identical to the requirements placed on money market funds pursuant to Form N-MFP. Practically speaking, this means that liquidity fund advisers would be required, among other things, to report certain operational information, to state whether their funds seek to maintain stable prices per share, and to describe certain asset, portfolio, financing, and other information with more particularity. The SEC has stated that these changes are designed to “enhance the Commission and FSOC’s ability to assess short-term financing markets and facilitate our oversight of those markets and their participants.”

A Divided Commission

While the 2011 rulemaking that led to Form PF passed unanimously, the recent amendments were proposed after a 3-1 vote by the Commission, with Republican Commissioner Hester M. Peirce as the dissenter. Peirce released her own statement in response to the proposal, in which she broadly criticizes the additional reporting requirements as seeming to be “intended primarily to provide the Commission with additional information to support its regulatory and enforcement programs,” rather than to advance the stated purpose of Form PF, which is “primarily intended to assist [FSOC] in its monitoring obligations under the Dodd-Frank Act.” Many of Commissioner Peirce’s critiques are likely to be echoed by industry participants, as she takes issue with the increased burden of “almost immediate reporting of localized events,” taking her fellow Commissioners to task for seeking to “distend Form PF into a tool for government to micromanage private fund risk management.”

Practical Considerations

There are several practical considerations and open questions resulting from the proposed amendments, including the following:

  • Impact of rapid reporting requirement. Requiring current reporting with a turnaround time of one business day is likely to cause a significant increase in reporting and compliance costs. Large advisers may need to commit additional resources to help ensure compliance.
  • Impact of lowered reporting threshold and additional information reporting. The lowered reporting threshold will capture more private equity advisers and will require more advisers to be aware of and comply with the Form PF requirements. Chief Compliance Officers will need to get up to speed on the new reporting requirements and dedicate the necessary resources to completion of Form PF, both on a periodic basis and following reportable events.
  • The possibility of increased enforcement activity. The enhanced reporting requirements could spur increased enforcement activity for large advisers, as the SEC could initiate investigations in response to what is seen in the Form PF filings. This can further result in a “pile on” effect with other state and federal regulators, such that one filing can spur multiple investigations and possibly private litigation if those investigations become public. Even if this activity does not result in any meaningful findings of inappropriate conduct, the time, cost, and reputational damage associated with the investigations can be highly disruptive to the business of an adviser and can spook investors.
  • Reaction by industry participants. We expect strong opposition to certain of the proposed changes, such as the events that would require rapid reporting by private equity advisers, certain of which would result from a private equity fund’s investors banding together to exercise rights they have negotiated for their own protection and would seem to have no or little impact on the US financial system.

Conclusion

By proposing the amendments to Form PF, the SEC is signaling that it considers short-term and quickly evolving changes to the financial markets worthy of its attention. The proposed rule was expressly drafted in the wake of recent market disruption caused by COVID-19 and the “meme stock” phenomenon, and the amendments appear designed to give the Commission and FSOC insight into market changes nearly in real time. If the proposed amendments are approved in their current form, advisers should be prepared for an increase in the time, talent, and resources that will be required to help ensure compliance and to anticipate additional enforcement activity.

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