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
Pepper Point: We suggest that you review the proposed Form PF 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 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 and to be important in the FSOC obtaining a baseline picture of potential systemic risk across both the entire private fund industry and in particular kinds of private funds, such as hedge funds.
Key Terms/Conditions in Form PF:
Pepper Point: 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.”
Pepper Point: 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.”
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 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:
Managers must provide the following information on the “hedge funds” they manage:
Section 2 in greater detail:
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:
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:
We will report periodically on the status of this proposal. Please contact us if we can be of assistance.
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 and Matthew R. Silver
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The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.