After the 2008 financial crisis, the U.S. Securities and Exchange Commission (the “SEC” or “Commission”) introduced the Form PF (Private Fund), which the SEC intended to serve as a tool for monitoring and assessing systemic market risks posed by private funds. Since 2011, following the Dodd-Frank Act (“Dodd-Frank”), the SEC has required certain investment advisers to file a Form PF with the agency to report information about the private funds they manage. As mandated by Dodd-Frank, Form PF provides the SEC and the Financial Stability Oversight Council (“FSOC”) with information about the basic operations and strategies of private funds, which the SEC uses in its efforts to assess systemic risk in U.S. financial markets.

Earlier this year, the SEC made several amendments to Form PF to address certain purported information gaps and a potential lack of responsiveness to identifying potential systemic risk in the private funds market. Such amendments primarily affect three categories of advisers: large hedge fund advisers to qualifying hedge funds (with at least $1.5 billion in assets under management), private equity fund advisers (with at least $150 million in assets under management), and so-called “large” private equity fund advisers (with at least $2 billion in assets under management). Much of the industry’s commentary on the Form PF amendments to date has summarized the changes to the form that ultimately will be put in place. The SEC’s adopting release and fact sheet provide similar overviews. By contrast, the following analysis considers how the SEC arrived at the final amendment language after initial comment from the industry and examines some areas of the amendments that may pose challenges for private fund advisers as they update compliance procedures to adhere to new reporting obligations under the amended Form PF.

72-Hour Reporting Window for Large Hedge Fund Advisers

For advisers to qualifying hedge funds (i.e., those with at least $1.5 billion in AUM), a new Section 5 on Form PF will require the advisers to file a current report “as soon as practicable, but no later than 72 hours” after certain reporting events occur that may indicate significant stress at a fund which could harm investors or signal risk in the broader financial system. According to the SEC’s adopting release, the 72-hour window was chosen over an initially proposed one-business-day window to allow for timely reporting even on weekends and holidays, and the SEC asserts that large hedge fund advisers already have the resources and operations to timely provide such reports. The Commission expressed concern that the one-business-day approach would not provide enough time for hedge funds to identify each reportable event and collect information that may not be readily ascertainable immediately upon such event. The SEC stated that the 72-hour window will not impose a burden as “in [their] experience, advisers to qualifying hedge funds generally already maintain the sophisticated operations and resources necessary to provide these reports.” The accuracy of the foregoing, however, is likely hedge fund adviser-dependent, because even “large” advisers have varying degrees of back office and other compliance operations in place.

The 72-hour reporting window will begin upon the occurrence of a reportable event, or otherwise when the adviser “reasonably believes” that a reportable event occurred. Although the SEC clarified that an adviser will have to respond “to the best of its knowledge” on the date of the report, these changes will require hedge fund advisers to make subjective determinations (as discussed below) within those 72 hours. This could stress compliance resources. In some cases the 72-hour window may actually require reporting on a shorter timeline than would be required under the one-business-day window, since reporting deadlines may fall on weekends or holidays. Impacted advisers would be prudent to assess their compliance protocols to adjust to the 72-hour reporting window under new Section 5 of Form PF.

Subjectivity

The inherent subjectivity of some of the new reporting requirements in the amended Form PF is another potential concern for some large hedge fund advisers. For example, Item E of new Section 5 requires advisers to file a report within 72 hours of the termination or “material restriction” of a prime broker relationship, but little guidance is provided as to what constitutes a “material restriction.” Some instances of “material restriction” are clear, such as if the prime broker decides to no longer execute certain trades on behalf of a reporting fund in a given market. In other situations, however, it may be unclear whether certain occurrences rise to the level of a “material restriction,” such as the following:

• introduction by a prime broker of substantial changes to credit limits or significant price increases;
• cessation by a prime broker in supporting a particular fund in a crucial market or asset type; and
• impairment by a prime broker of a fund’s trading capabilities.

Advisers should develop protocols for making these and other similar judgment calls and implement a reporting mechanism that can respond within 72 hours. Further, the market for prime brokerage may experience complications if large hedge fund advisers create different reporting procedures and/or reach disparate determinations on generating Forms PF for “material restrictions” in response to the same prime brokerage occurrences.

Item G of new Section 5, which requires reporting within 72 hours any “significant disruption or degradation” of the reporting fund’s “critical operations,” also introduces potential subjectivity concerns. The Commission’s adopting release identified investment, trading, valuation, reporting, compliance and risk management functions as “critical operations”, but did not further elaborate. Given the varying operations of large hedge fund advisers in the market, there is likely to be a time lag before a consensus is reached in the industry as to what constitutes “critical operations” worthy of a Form PF report in the event of a “significant disruption or degradation” (a term which the Commission left undefined, contrary to its initial proposal) of such operations.

Calculation of Margin Increases

Section 5 of the new Form PF also tasks large hedge fund advisers with filing within 72 hours reports of any increase in the total dollar value of a reporting fund’s requirements for margin, collateral or an equivalent of 20% or more within a rolling 10-business-day period.¹ The Commission explained in the adopting release that this portion of the amendment is intended to refer to assets and cash that can be claimed by a fund counterparty, lender or clearinghouse if needed to satisfy an obligation, regardless of whether they have been physically segregated or marked and identified as collateral. However, as some in the industry have noted, this reporting requirement does not delineate increases in a fund’s assets and cash marked as collateral (which effectively captures an entire prime brokerage account for most hedge funds) due strictly to performance, rather than other factors that may signify systemic risk.

Quarterly Reporting for Private Equity Advisers

Private equity fund advisers with at least $150 million in AUM are required under new Section 6 of Form PF to report on a quarterly basis in the event of adviser-led secondary transactions, general partner removals, or investor decisions to terminate the fund or investment period. Interestingly, the final amendments relating to private equity adviser reporting were far less onerous than the Commission’s original proposal. For example, the requirement for quarterly reporting replaced the SEC’s original proposal for such events to be reported within one business day, which would have been a logistical and compliance challenge for most private equity advisers. Additionally, the Commission raised the threshold on requiring reporting on general partner or limited partner clawbacks such that only “large” private equity advisers (i.e., those with at least $2 billion in AUM) must provide them, and the final amendment additionally makes clawback reporting an annual function under Section 4 of Form PF rather than an event-based report under Section 6, as had been provided in the Commission’s initial proposal. While the new amendments result in a material increase in compliance obligations for large hedge fund advisers, this round of changes to Form PF did not create as stringent a compliance regime for private equity sponsors as industry stakeholders had initially anticipated.

Conclusion

While the SEC views the recent Form PF amendments as an important step in enhancing the FSOC’s ability to monitor systemic risk posed by the private funds market, the amendments raise potential concerns for many in the industry. These concerns include increased compliance costs for advisers and funds (which are ultimately borne by investors) and uncertainty and subjectivity regarding reporting standards.

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¹ The 20% reporting threshold is calculated based on “average daily reporting fund aggregate calculated value,” a new defined term in the Form PF glossary, which represents the average of the fund’s daily “reporting fund aggregate calculated value” (“RFACV”) as of the end of each business day in the 10-business-day reporting period.

Sofia Cuadra, a rising third-year law student at the University of North Carolina and summer associate at Robinson Bradshaw, contributed to this post.