Buzz

Dodd-Frank Act Rulemaking: Form PF Inaugurates Era Of Detailed Reporting By Managers Of Private Fund

Jesse P. Kanach, Nathan J. Greene, and Christine Ballantyne of Shearman & Sterling LLP


Shearman

Newly adopted Form PF caps a banner year for investment adviser rulemaking and, at least for larger hedge fund managers, promises a burdensome quarterly filing exercise in which extensive enterprise-wide and fund-by-fund reporting will be disclosed to the Securities and Exchange Commission. The form responds to a Dodd-Frank Act information collection mandate and underpins an SEC effort to aid the Financial Stability Oversight Council in assessing systemic risk. Unlike information requested of those advisers on the SEC's amended Form ADV, the Form PF information will be non-public. But both forms, and especially the two together, represent meaningful new administrative burdens for investment advisers that manage private funds. At present Form PF will apply to many SEC-registered investment advisers but will not apply to unregistered firms. [1]

By mid-2012 for the earliest filers and early 2013 for most others (see "Deadlines for Reporting" below), a registered adviser must determine whether it must file Form PF, and if so under what level of reporting, interpret the various questions posed by the form, [2] compile the necessary information (including from affiliates, as discussed below), and file the completed form with the SEC. Despite changes (some additions, some subtractions) made to Form PF since it was proposed at the beginning of the year, [3] the information required to be reported remains extensive. However, it is worth noting that while these changes do not significantly reduce the burden of reporting for any particular filer, the addition of a minimum reporting threshold has reduced the aggregate burden that Form PF imposes because fewer advisers will be required to report. Under the final rules, the SEC now estimates that a total of approximately 3,570 advisers will be required to file all or part of Form PF, as compared to earlier estimates that 4,450 advisers who would have been required to file under the original rule proposal.

Reporting Thresholds

Under the new reporting requirements, which can vary quite substantially depending on which reporting thresholds and category of adviser is at issue, some advisers are free of the obligation to file altogether, some must file annually, and others must file quarterly.

An adviser that is neither registered nor required to register (including an exempt reporting adviser [4]) is not required to file Form PF. Nor is an SEC-registered adviser that fits under a $150 million assets under management ("AUM") [5] threshold required to file the new form.

Private fund advisers that exceed this $150 million minimum threshold are divided by size into two broad groups-what the SEC calls Smaller Private Fund Advisers and Large Private Fund Advisers. Smaller Private Fund Advisers only need to complete section 1 of Form PF. This section requires advisers to provide certain basic information regarding any "private funds" they advise and the private funds' AUM, performance and use of leverage. [6]

Large Private Fund Advisers on the other hand must complete additional sections of Form PF, which require more detailed information. These Large Private Fund Advisers are divided into the following three categories:

  • any adviser having at least $1.5 billion in AUM attributable to "hedge funds" (as defined below) as of the end of any month in the prior fiscal quarter ("large hedge fund advisers");
  • any adviser managing a "liquidity fund" (as defined below) and having at least $1 billion in combined AUM attributable to liquidity funds and registered money market funds as of the end of any month in the prior fiscal quarter ("large liquidity fund advisers"); and
  • any adviser having at least $2 billion in AUM attributable to "private equity funds" (as defined below) as of the last day of the adviser's most recently completed fiscal year ("large private equity fund advisers").

The distinction between fund types can create some counterintuitive outcomes. For example, an adviser in respect of multiple funds that has, for example, $1.25 billion in AUM attributable to hedge funds and $1.75 billion in AUM attributable to private equity funds would be neither a large hedge fund adviser nor a large private equity fund adviser and so would not be caught by the heightened reporting requirements. On the other hand, an adviser of over $1 billion of registered money market funds generally would have to file on Form PF if it also advises any private fund (regardless of size) that meets the definition of a liquidity fund.

These thresholds have been increased from those proposed in January, which will come as a relief to some. Private equity fund advisers especially benefit from the higher thresholds, with the SEC estimating that the number of US-based advisers who would be categorized as large private equity advisers will fall from approximately 270 firms to approximately 155.

In contrast, while the threshold for large hedge fund advisers has also been increased from the $1 billion threshold that was proposed to $1.5 billion, this is not expected to substantially change the number of advisers estimated in the proposal to be classified as large hedge fund advisers, due to the difference between the way in which AUM will be measured by Form PF as compared to how AUM would have been measured in reaching the proposed $1 billion threshold amount. [7]

The thresholds described above count as AUM in "private funds" that the adviser advises even certain AUM managed outside of a fund. Notably, a firm has to count AUM in separate accounts that the firm advises parallel to the private funds (unless the separate accounts' aggregate AUM is larger than that of the parallel funds). "Parallel managed accounts" are those that pursue substantially the same investment objective and strategy and invest in substantially the same positions as private funds advised by the firm. Parallel managed accounts also will include non-private funds (including US registered mutual funds and non-US retail funds such as UCITS and SICAVs) if they pursue substantially the same investment objective and strategy and invest in substantially the same positions to that of a private fund advised by the firm.

A firm also has to count the AUM of private funds advised by the firm's affiliates who are required to be listed on Item 7.A. of Part 1 of the firm's Form ADV. Thus, even an adviser that does not file Form PF may have its AUM counted toward an affiliated registered adviser's AUM for purposes of determining whether that affiliate must submit filings on Form PF. An adviser may, but is not required to, report the private fund assets that it manages and the private fund assets that its affiliates manage on a single Form PF.

Under the new Form PF instructions, an adviser may chose to provide information regarding master-feeder arrangements and parallel fund structures in the aggregate or separately, provided that it does so consistently throughout the form.

Reduced Reporting Requirements for Non-US Advisers

An adviser with its principal place of business outside the United States (a "Non-US Adviser") does not have to provide information on Form PF for any private fund if, during the adviser's last fiscal year, (i) the fund was not a "US person" [8], (ii) interests in the fund were not offered "in the United States" (with that phrase apparently interpreted in accordance with Regulation S rules) and (iii) the fund was not beneficially owned by a US person. Moreover, a non-US fund that has never used US jurisdictional means in the offering of the securities it issues would not be a private fund, presumably even if the fund happens to have some small group of investors as US persons.

Fund Types

As discussed above, Form PF requires more detailed information from Large Private Fund Advisers. Large Private Fund Advisers are in turn divided into large hedge fund advisers, which must complete section 2 of the form, large liquidity fund advisers, which must complete section 3 of the form, and large private equity fund advisers, which must complete section 4 of the form. Each section of the form is covered in some detail below.

Form PF generally requires more information regarding hedge funds than private equity funds, as the SEC and CFTC consider the latter to pose less risk to US financial stability. Accordingly, the proposed definition of a hedge fund was a focus point for many advisers reviewing the original rule proposal. The final Form PF instructions define a "hedge fund" generally to include any private fund having any of the following common characteristics of a hedge fund: (a) a performance fee the payment of which takes into account market value (instead of only realized gains); (b) high leverage [9]; or (c) short selling (other than hedging of currency exposure or managing duration). The definition of hedge funds expressly excludes securitization vehicles such as CDOs or CLOs, which the release refers to as "securitized asset funds." These vehicles may nonetheless meet the "private fund" definition and be part of the aggregate (but not fund-by- fund) Form PF reporting by a collateral manager. Solely for purposes of Form PF, a commodity pool that is reported or required to be reported on Form PF is treated as a hedge fund. In respect of leverage and short selling as definitional characteristics, Form PF focuses on a fund's ability to engage in these practices-that it may not actually do so is irrelevant.

The definitions of "liquidity fund" and "private equity fund" were adopted as proposed, with a liquidity fund being defined as "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" and a private equity fund being "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."

Content of Form PF

Form PF is divided into four sections. The following briefly describes the items covered in each section, but an adviser should review the form itself (see footnote 1 above) for a deeper sense of the level of detail required.

Section 1: All Advisers

Section 1 applies to all advisers who must file Form PF. Section 1a requires advisers to provide certain basic identifying information regarding any private funds they advise. Section 1b requires fund-by-fund information about their private funds' AUM, performance and use of leverage. This section also includes a breakdown of the fund's investors by category and a summary of fund assets and liabilities using the "Level 1", "Level 2", "Level 3" hierarchy of fair valuation, which are items not originally proposed for Form PF. These two items had been proposed and then excluded from the SEC's recent Form ADV amendments due, respectively, to their proprietary nature and administrative burdens-they nonetheless find new life here. Section 1c requires additional fund-by-fund information relating to each hedge fund, such as to identify its top trading counterparties.

Section 2: Large Hedge Fund Advisers

Large hedge fund advisers must complete section 2 of Form PF. Section 2a requires certain aggregate information about the hedge funds the adviser manages, such as the value of assets invested (on a short and long basis) in different types of securities and commodities. The form asks, for example, about long and short positions in several dozen different types of equities, fixed income securities, derivatives, commodities and structured products. To be clear, this disclosure is given by security type and not at a CUSIP level. Section 2b of Form PF requires a large hedge fund adviser to report certain additional fund-by-fund information about any hedge fund it advises that has a net asset value of at least $500 million as of the end of any month in the prior fiscal quarter, including on portfolio liquidity, large individual positions, posting of collateral by counterparties, borrowings, and results of internal formal risk assessments.

Section 3: Large Liquidity Fund Advisers

Large liquidity fund advisers are required to complete section 3 of Form PF and must provide information regarding the fund's valuation methodology, portfolio liquidity, maturity (of several dozen categories of asset), large positions, number of large holders of the fund, and borrowings, among other things.

Section 4: Large Private Equity Fund Advisers

Large private equity fund advisers must complete section 4 of Form PF and report certain information for each private equity fund they manage. The reporting includes, among other items, certain information about guarantees of portfolio company obligations, the size and leverage of the portfolio companies that the fund controls, the identities of all persons who have provided any part of a bridge loan to any controlled portfolio company, and the amounts financed with each person.

Deadlines for Reporting

There will be a two-stage phase-in period for compliance with Form PF filing requirements. Most private fund advisers will be required to begin filing Form PF following the end of their first fiscal year or fiscal quarter, as applicable, to end on or after 15 December 2012. Large Private Fund Advisers with at least $5 billion in AUM attributable to either hedge funds, liquidity funds or private equity funds will have until the end of their first fiscal year or fiscal quarter, as applicable, to end on or after 15 June 2012. The earliest filers will be large liquidity fund advisers with at least $5 billion of AUM in liquidity funds and a fiscal quarter ending on 30 June 2012; their first filing is due within 15 days after that fiscal quarter. [10]

Smaller Private Fund Advisers, as well as large private equity fund advisers, must make filings only annually and have until 120 days after the end of their first fiscal year occurring on or after the compliance date (an extension from the 60 day lag-time put forward in the rule proposal). This means that private equity fund advisers and Smaller Private Fund Advisers having 31 December fiscal year-ends would file their first Form PF by 30 April 2013 (120 days after their fiscal year-ends) and annually thereafter. This is very good news for large private equity fund advisers who, under the rule proposal, would have been required to make quarterly filings.

For large hedge fund advisers and large liquidity fund advisers, filings still will need to be made quarterly. The lag-time for large hedge fund advisers has, however, been extended and the first filing is due 60 days (instead of 15 days in the rule proposal) after the first quarter-end after that compliance date. This means that large hedge fund advisers having 31 December fiscal year-ends would file their first Form PF by 1 March 2013, and quarterly thereafter. The lag-time for large liquidity fund advisers remains 15 days.

An adviser who must file on a quarterly basis will only be required to do so in respect of the type of fund that caused them to exceed the threshold. Advisers of multiple kinds of funds may find themselves making initial filings and amendments on different timetables, e.g., on 15, 60 and 120 day lags, according to different business types.

A firm that transitions from quarterly to annual filings as a result of changed circumstances (most likely arising from a decrease in the firm's AUM) must file Form PF to report that it no longer meets the requirements necessary for filing Form PF, no later than the last day on which the adviser's next Form PF update is due.

Confidentiality

One of the major objections to the original proposals put forward in January was the competitively sensitive and proprietary nature of the information to be provided on Form PF and concerns about the extent to which that information would be kept confidential. Among the suggestions from commentators to the original proposals were that: (1) fund and firm identifying information be stored using codes as opposed to actual names [11]; (2) the ability to transfer Form PF data by email or portable media be limited; (3) access be granted only to government personnel with a "need to know"; (4) filing deadlines be extended so the data contains less current information; and (5) data be shared with other regulators only in aggregated and anonymous form.

As discussed in more detail above, the deadlines for filing Form PF have, in many cases, been extended from the proposal, which the SEC and CFTC suggest would mitigate harm in the event information were to be released publicly. To date, however, the SEC and CFTC continue to work on their confidentiality procedures for Form PF and offer little concrete assurance that the types of suggestions just outlined are being implemented (though the SEC does emphasize that it is considering the recommendations of commentators in designing controls and systems for Form PF, such as whether multiple access levels can be established so that SEC employees are allowed only as much access as is reasonably needed in connection with their duties). The SEC is explicit that the Form PF information is intended to be shared with foreign governments, subject to confidentiality agreements.

Filing Mechanics and Costs

Form PF must be filed electronically through the Investment Adviser Registration Depository (IARD), which is the platform for submitting Form ADV filings and is administered by the Financial Industry Regulatory Authority (FINRA). Advisory firms must pay filing fees of $150 per annual filing and $150 per quarterly filing (that is, $600 per year for a quarterly filer), [12] subject to change. It remains to be seen whether a filer of amendments, including for a liquidity fund adviser that may later file with respect to its hedge funds, or for a hedge fund adviser that may later file with respect to its private equity funds, is subject to an additional filing fee for each amendment.

Although the final rulemaking no longer includes the proposed "under penalty of perjury" standard under which essentially all information was certified by the filer, the adopting release does note that certain misstatements may be unlawful under the Advisers Act. New liabilities aside, the information required by Form PF is extensive and the estimates of hour and cost burdens provided by the SEC have increased significantly since the rule proposal in January, in some cases to hundreds of hours of work. Unlike some other recent rulemaking, however, these cost estimates rather oddly do not attribute any expenses to in-house or outside legal counsel. Nevertheless, the degree of detail and extensive instructions suggest that, at least for some period of time, fund advisers will seek advice of counsel when preparing the Form PF.

Conclusion

Registered advisers to private funds will be grateful for reprieve represented by the delay in preparation of their first reports on Form PF. Yet many advisers can expect to be challenged by the degree of detail required. Ultimately, while the SEC has meaningfully improved the mechanics and process involved in the filing of Form PF, underneath this coat of paint it's still the same tank, with nearly the same staggering volume of information required of large hedge fund advisers today as was first proposed in January. As registered advisers prepare their first filing, they would be well- served to consider how to automate or otherwise facilitate the extensive data gathering that will be required for each filing. Finally, there remains a real concern among advisers about whether regulators (US and non-US) will be able to keep the information that is provided truly confidential.


[1] Form PF is available at http://sec.gov/rules/final/2011/ia-3308-formpf.pdf. See also Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, SEC Release No. IA-3308 (Oct. 31, 2011) (SEC-CFTC joint adopting release).

[2] The Form consists of about 10 pages of instructions, 40 pages of items requiring responses (though many advisers will not have to complete every item), and a 10-page glossary listing over 130 defined terms used throughout the Form. The 190-page adopting release provides further guidance.

[3] See Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF, SEC Release No. IA-3145 (Jan. 26, 2011) (SEC-CFTC joint proposing release).

[4] As part of its Dodd-Frank rulemaking, the SEC recently adopted several new exemptions from registration, including two categories of exempt reporting adviser-advisers solely of private funds and certain venture capital advisers. See our related publication, available at: http://www.shearman.com/dodd-frank-act-rulemaking-sec-finalizes-exemptions-and- disclosure-requirements-for-investment-advisers-and-sets-compliance-for-early-2012-07-12-2011. Exempt reporting advisers make fund-by-fund reporting on Form ADV but not on Form PF.

[5] For the most part, AUM is to be determined in accordance with Form ADV's "regulatory assets under management" methodology.

[6] A "private fund" is defined by the form as "any issuer that would be an investment company as defined in section 3 of the Investment Company Act of 1940 but for section 3(c)(1) or 3(c)(7) of that Act". Note that a non-US fund that has never offered the securities it issues in the US generally would not be a private fund for purposes of Form PF.

[7] The SEC had consulted a commercial database that measured AUM on a net basis when proposing the $1 billion threshold. But as AUM are measured for purposes of Form PF on a gross basis, the SEC had to increase the threshold to $1.5 billion so that only hedge fund adviser of at least $1 billion in net assets are classified as large hedge fund advisers.

[8] "US person" is defined to include natural persons that are US residents or legal entities organized under any of the laws of the United States. Like new Rule 203(m)-1 under the Advisers Act, a US Person is also defined for this purpose to exclude a discretionary account managed in the United States for the benefit of a non-US person.

[9] High leverage" being the ability of the fund to borrow an amount in excess of one-half of its net asset value (including any committed capital) or have gross notional exposure in excess of twice its net asset value (including any committed capital).

[10] Registered advisers of liquidity funds should take note that the first 15 days of the first, third and fourth calendar quarters include one US federal holiday (and, every few Januaries, two holidays), effectively compressing an already tight filing timetable.

[11] A limited amount of information actually is permitted to be provided with some anonymity. For example, an adviser may, in its Form PF, replace fund names with the same numerical or alphabetical code or designation that the adviser uses when keeping its records under the Advisers Act.

[12] See Order Approving Filing Fees for Exempt Reporting Advisers and Private Fund Advisers, SEC Release No. IA-3305 (Oct. 24, 2011), available at http://www.sec.gov/rules/other/2011/ia-3305.pdf.

Jesse P. Kanach, Counsel, jesse.kanach@shearman.com

Jesse Kanach is a counsel in the firm's Asset Management Group. He regularly represents a wide range of financial institutions, including registered and private funds and investment advisers, on a variety of regulatory, corporate and transactional matters. His practice ranges from the formation and offering of hedge funds and registered open- and closed-end investment companies, to the representation of independent directors and trustees, to acquisitions of investment advisory firms.

Full Bio

Nathan J. Greene, Partner, ngreene@shearman.com

Nathan Greene is a partner in the Asset Management Group (where he is also Deputy Practice Group Leader) advising on all regulatory aspects of fund and investment advisory operations. His practice includes the formation and representation of U.S. and foreign investment companies, their sponsors, advisers, directors and marketers.

 Full Bio

Christine Ballantyne, Associate, christine.ballantyne@shearman.com

Christine Ballantyne is an associate in the firm's UK investment funds practice, specialising in advising clients in relation to the formation, promotion and operation of all types of private investment funds (in particular private equity and hedge funds), and the drafting and negotiation of associated documentation.

Full Bio

Shearman & Sterling LLP

Shearman & Sterling has been advising many of the world's leading corporations and financial institutions, governments and governmental organizations for more than 135 years. We are committed to providing legal advice that is insightful and valuable to our clients. This has resulted in groundbreaking transactions in all major regions of the world.

Material in this work is for general educational purposes only, and should not be construed as legal advice or legal opinion on any specific facts or circumstances, and reflects personal views of the authors and not necessarily those of their firm or any of its clients. For legal advice, please consult your personal lawyer or other appropriate professional. Reproduced with permission from Shearman & Sterling LLP. This work reflects the law at the time of writing November 2011.