On August 10, 2022, the U.S. Securities and Exchange Commission (“SEC”) and Commodity Futures Trading Commission (“CFTC”) jointly adopted proposed amendments to Form PF that would significantly expand reporting by private equity advisers and hedge fund advisers of both their investments and structures (the “Proposal,” available here). The Proposal is part of an ongoing effort to bolster the SEC’s regulatory oversight of private fund advisers and investor protection efforts, while also purportedly enhancing the Financial Stability Oversight Counsel’s (“FSOC”) ability to monitor systematic risk.
Described by Commissioner Peirce as a “blossoming … tool to scrape detailed information about private funds,” the Proposal is the second proposed amendment to Form PF this year, and follows hot on the heels of two proposals to expand reporting by all advisers on publicly available Form ADV for cybersecurity incidents and ESG investments. Lest anyone think the reporting blitz is over, the Proposal asks commentators to weigh in on adding certain proposed new reporting categories to Form ADV. If adopted, such mass data collection, accompanied by the broad and proscriptive quarterly reporting requirements under February’s private equity rule proposal (the “PE Proposal”), portend a busy future for private fund compliance teams, most of whom are already hard at work overhauling their policies and procedures to implement 2021’s revamped Marketing Rule.
Proposed Requirements for all Form PF Filers
The Proposal, if enacted, would make both major and minor changes to the reporting obligations for all registered investment advisers who file Form PF, including:
- Disaggregating complex fund structures. The Proposal would amend how advisers report complex structures, such as master-feeder arrangements and parallel fund structures (which are distinguished from parallel managed accounts, discussed below). Form PF currently allows an adviser to choose whether it wants to report master-feeder arrangements and parallel fund structures in the aggregate or separately so long as it does so consistently throughout Form PF. The current approach allows advisers to make Form PF disclosures consistent with their internal recordkeeping and reporting. The Proposal would remove that flexibility and require advisers to report each component fund of a master-feeder arrangement and parallel fund structure.
There would be an exception for any feeder fund that invests all its assets in a single master fund and/or cash and cash equivalents (i.e., a disregarded feeder fund). In the case of a disregarded feeder fund, advisers instead would identify the disregarded feeder fund and look through to any disregarded feeder fund’s investors in responding to certain questions regarding fund investors on behalf of the applicable master fund.
Disaggregation does not apply in all circumstances – an adviser would continue to aggregate these structures for purposes of determining whether the adviser meets reporting thresholds (e.g., whether it is a large hedge fund adviser). In defending the new approach, which will result in advisers who aggregate vehicles in the ordinary course having to generate two sets of books, the SEC states that mandating disaggregation will allow easier comparison across filers and complex fund structures, increasing the usefulness of data collected on Form PF.
- Parallel managed accounts. The Proposal would prohibit reporting of parallel managed accounts, defined as any managed account or other pool of assets managed by the adviser that pursues substantially the same investment objective and strategy and invests side by side in substantially the same positions as the identified private fund. Currently advisers may choose to report such accounts. Advisers would continue to report the total value of all parallel managed accounts related to each reporting fund, in order to give the SEC an accurate picture of the amount of assets being advised under a particular strategy.
In justifying the change, the SEC quoted from the 2011 adopting release for Form PF, stating that aggregating parallel managed accounts for reporting purposes is difficult and results in inconsistent and misleading data because the characteristics of parallel managed accounts are often somewhat different from the funds with which they are managed. This may be music to the ears of those concerned about parallel managed accounts being picked up by the PE Proposal’s quarterly reporting requirement, which require inclusion of “substantially similar” pools of assets to the extent doing so would provide more meaningful information to the private fund’s investors and would not be misleading. We would expect comments on the Proposal to address this issue.
- Investments in other funds. Form PF currently permits an adviser to disregard the value of a private fund’s equity investments in other private funds (i.e. a fund of funds) for purposes of both the form’s reporting thresholds (e.g., whether the adviser qualifies as a large hedge fund adviser) and responding to questions on Form PF, as long as it does so consistently (subject to certain exceptions). The Proposal would continue to permit an adviser to include or exclude the value of investments in other private funds (including internal and external private funds) when determining whether the adviser meets the reporting thresholds. However, the Proposal would remove the flexibility with respect to inclusion of fund of fund investments, and proscribe in each question whether such assets must be included. For example, an adviser would report the value of the reporting fund’s investments in other private funds when reporting its gross asset value and net asset value but would exclude the value of the reporting fund’s investment in other internal private funds when providing a breakdown of their regulatory assets under management and net assets under management. If adopted, this change will have a knock-on effect on Form ADV reporting, as advisers have generally endeavored to adopt a consistent calculation methodology for regulatory assets under management. The Proposal would also require advisers to separately report the value of the reporting fund’s equity investments in external private funds and internal private funds (including the master fund and each internal private fund), which would comprise the total investments in other private funds.
With respect to investments in funds that are not private funds, the Proposal would keep the requirement to include the value of these investments when determining reporting thresholds and responding to questions, unless a question specifically requires otherwise.
Additionally, as a general matter, the Proposal would require that advisers not apply a “look through” of investments in private fund vehicles or other funds to the underlying assets of such funds (such as, for example, when reporting borrowings and counterparty exposures). One notable exception is the reporting of private fund exposures to certain asset classes, including long and short positions. For this reporting, a look through to the exposures of the underlying fund would be required.
As with the disaggregation rule discussed above, these proposed changes would potentially require Form PF treatment that conflicts with an adviser’s ordinary course recordkeeping and investor reporting.
- Trading vehicles. The Proposal defines a trading vehicle as a wholly owned separate legal entity that holds assets, incurs leverage, or conducts trading or other activities as part of the private fund’s investment activities, but which the adviser does not operate as a business. Currently Form PF does not require advisers to report trading vehicles. The Proposal would require that trading vehicles either (1) be separately identified and then aggregated into the answers for the associated reporting fund, or (2) reported as a separate reporting fund. A trading vehicle that holds assets, incurs leverage, or conducts trading or other activities on behalf of more than one reporting fund must be separately reported as a reporting fund. Given the widespread use of trading vehicles, this requirement would greatly expand the universe of entities that get disclosed on Form PF, with a corresponding burden on the reporting advisers.
- Gross asset value and net asset value. Form PF currently requires advisers who file quarterly updates to report gross and net asset value as of the end of each reporting period. The Proposal would require such advisers to report these values at the end of each month of the reporting period. The Proposal would also require advisers to separately report the value of unfunded commitments that are included in the gross and net asset values. This change would make Form PF reporting more granular than asset reporting for Form ADV, where uncalled commitments are included in regulatory assets under management but are not broken out as a separate category.
- Assets under management. Form PF currently requires advisers to provide a breakdown of regulatory assets under management and net assets under management. As discussed above, the Proposal would require advisers to exclude the value of private funds’ investments in other internal private funds to avoid double counting of fund of funds assets, but would include the value of trading vehicles owned by such fund.
- Withdrawal or redemption rights. Form PF currently requires only large hedge fund advisers to report whether each qualifying hedge fund provides investors with withdrawal or redemption rights in the ordinary course. The Proposal would require all advisers who file Form PF to provide this information for each reporting fund, including how often withdrawals or redemptions are permitted.
- Inflows and outflows. The Proposal would add reporting of a fund’s activity, including contributions to the reporting fund, withdrawals, redemptions or other distributions of any kind to investors. This would include all new contributions from investors, but exclude contributions of committed capital that they have already included in gross asset value. Quarterly filers would provide this information for each month of the reporting period.
- Expanded and revised reporting. While less headline worthy, the Proposal also makes general updates and adjustments to a number of reporting categories, all of which will require significant overhauls to an adviser’s current Form PF compliance procedures. These include changes to the fair value hierarchy for assets and liabilities, beneficial ownership reporting, reporting of borrowings and types of creditors, and calculation of fund performance.
Proposed Requirements for Hedge Fund Advisers
In a rare break for private equity advisers, the Proposal limits the latest SEC push for more regulation over and visibility into crypto assets to investments by hedge funds. The Proposal would update the required reporting of hedge fund investment strategies to include more granular categories such as statistical arbitrage, emerging markets, and “digital assets.” The Proposal defines a digital asset as “an asset that is issued and/or transferred using distributed ledger or blockchain technology (‘distributed ledger technology’), including, but not limited to, so-called ‘virtual currencies,’ ‘coins,’ and ‘tokens.’” This definition is notably agnostic with respect to whether the instrument qualifies as a security or commodity. The Proposal requests comment regarding whether the definition should be broken down further, such as by distinguishing between digital assets that are exchangeable for fiat currencies or other assets or even requiring reporting of digital assets by name. If adopted, reporting of digital asset strategies will allow the SEC’s newly renamed Crypto Assets and Cyber Unit (which doubled in size this year) to quickly and efficiently identify examination targets – an ominous tool given the SEC’s focus on digital assets and the increasing number of enforcement actions in this space.
The Proposal also amends and adds other reporting obligations for hedge fund advisers, including additional information with respect to borrowing and counterparty exposure, market factor effects, risk metrics, portfolio liquidity and more.
The comment period will remain open for 30 days after the Proposal’s publication in the Federal Register.