SEC Significantly Expands Reporting Requirements for Private Fund Advisors.

The Securities and Exchange Commission (SEC or Commission) has adopted significant new reporting requirements applicable to investment advisors to all Private Equity Fund Advisors, Large Private Equity Fund Advisors, and Large Private Hedge Fund Advisors.[1] Form PF, the confidential reporting form for certain advisors to private funds, has been amended. The enhanced reporting requirements are designed to improve the ability of the Financial Stability Oversight Council (FSOC) to monitor systemic risk and to bolster the Commission’s regulatory oversight and investor protection responsibilities.

Which Investment Advisors are Affected?

1. All Private Equity Fund Advisors–

A Private Equity Fund Advisor is any private fund that is not a hedge fund, liquidity fund, real estate fund, securitized asset fund, or venture capital fund[2] and does not provide investors with redemption rights in the ordinary course.[3] All Private Equity Fund Advisors are now subject to quarterly reports under Section 6 of Form PF, as discussed below.

2. Large Private Fund Advisors–

A private equity fund advisor is a Large Private Equity Fund Advisor if the advisor and its related persons,[4] collectively, had at least $2 billion in private fund equity fund assets under management as of the last day of its most recently completed fiscal year:

• Unless the assets managed by the related person are separately operated.[5]
• Note that if the advisor reports answers on an aggregated basis for any master-feeder arrangement or parallel fund structure, and is reporting with respect to the reporting fund for such arrangement or structure, it is included within this definition.

Large Private Equity Fund Advisors are now required to complete Section 4 of Form PF.

3. Large Hedge Fund Advisors–

An advisor to a hedge fund is a Large Hedge Fund Advisor if the advisor and its related persons, collectively, had at least $1.5 billion in hedge fund assets under management as of the last day of any month in the fiscal quarter immediately preceding its most recently completed fiscal quarter, unless the related person is separately operated. Large Hedge Fund Advisors must complete Section 5 of Form PF.

What Information Now Must be Reported for Each Type of Advisor?

• All Private Equity Fund Advisors are now subject to Quarterly Event Reporting. Advisors must report if any of the triggering events occurred during the applicable quarter for each private equity fund they advise, but only must report each event once. Private Equity Reporting Events include: (a) closing of an advisor-led secondary transaction,[6] or (2) an investor election to remove a fund’s advisor or its affiliate as the general partner (or similar control person) or to terminate a fund’s investment period or to terminate a fund.

The advisor must report a description of the transaction.

• Large Private Equity Fund Advisors must complete a separate Section 4 of Form PF with respect to each private equity fund it advises, including the following new information:
  • Implementation of any General Partner or Limited Partner Clawback[7] exceeding an aggregate of 10% of the fund’s aggregate capital commitments.
  • Information about private equity fund investment strategies,[8] generally including:
  • Private credit and associated sub-strategies, such as distressed debt, senior debt, special situations, etc.
  • Private equity and associated sub-strategies such as early stage, buyout, growth, etc.
  • Real estate
  • Annuity and life insurance policies
  • Litigation finance
  • Digital assets
  • General Partner Stakes Investing[9]
  • And other information
  • If a reporting fund engages in multiple strategies, the advisor will have to provide a good faith estimate of the percentage of the reporting fund’s deployed capital represented by each strategy. Advisors must choose from a list of strategies and assign a percentage of deployed capital even if the categories do not precisely match the characterization of the reporting fund’s strategies. To facilitate completion, filers will be able to choose from a drop-down menu that includes all investment strategy categories for Form PF, including hedge fund strategies. If the reporting fund’s strategy is not listed, the advisor may choose “other” but must explain the strategy.
• Large Hedge Fund Advisors must file current reports of events occurring with respect to a qualifying hedge fund[10] they advise. The information must be reported on an aggregate basis for all hedge funds advised. Form PF Section 5 lists the triggering events.

A report is required:

• If a qualifying hedge fund experiences extraordinary investment losses within a short period of time, including a description of the losses. Reporting for extraordinary investment losses would be triggered by a loss equal to or greater than 20 percent of a fund’s “reporting fund aggregate calculated value” (“RFACV”)[11], as opposed to the fund’s most recent net asset value (“MRNAV”), over a rolling 10-business-day period.[12] Under this current reporting event, the advisor must report if “on any business day the 10-day holding period return of the reporting fund is less than or equal to -20 percent of reporting fund aggregate calculated value. When triggered, an advisor must report: (a) the dates of the business period over which the loss occurred; (b) the holding period return; and (c) the dollar amount of the loss over the period. Only if the fund experiences a second loss of an additional 20 percent over a second 10-day rolling period must another report be filed.
• If a qualifying hedge fund or its counterparty experiences significant increases in requirements for margin, collateral or an equivalent, based on a 20 percent threshold, referencing the RFACV. The advisor will be required to report: (a) the dates of the 10-business-day period over which the increase occurred; (b) the total dollar amount of the increase; (c) the total dollar amount of margin, collateral, or an equivalent posted by the reporting fund at both the beginning and end of the 10-business-day period during which the increase was measured (an addition from the proposal); (d) the average daily RFACV of the reporting fund during the 10-business-day period during which the increase was measured; and (e) the identity of the counterparty or counterparties requiring the increase(s); disclosure of the average daily reporting fund aggregate calculated value of the reporting fund during the 10-business-day period during which the increase was measured. In addition, the amended form contains check boxes for this item concerning the cause of the margin increase reports.
• If a qualifying hedge fund notifies advisor of a margin default or inability to meet a call for margin, collateral, or an equivalent, taking into account any contractually agreed cure period. The advisor will report for each separate counterparty for which the event occurred:
  • the date the advisor determines or is notified that a reporting fund is in margin default or will be unable to meet a margin call with respect to a counterparty;
  • the dollar amount of the call for margin, collateral, or equivalent; and
  • the legal name and Legal Entity Identifier (if any) of the counterparty. In addition, the advisor will check any applicable check boxes that would describe the advisor’s current understanding of the circumstances of the advisor’s default or its determination that the fund will be unable to meet a call for increased margin. These options include: (i) an increase in margin requirements by the counterparty; (ii) losses in the value of the reporting fund’s portfolio or other credit trigger under the applicable counterparty agreement; (iii) a default or settlement failure of a counterparty; or (iv) a reason “other” than those outlined for which the advisor will be required to provide further information in the explanatory notes regarding the underlying circumstances. If the fund is unable to meet margin or defaulted with multiple counterparties on the same day, the advisor will file one current report broken out with details for each counterparty.
• If a counterparty experiences a margin, collateral, or equivalent default or failure to make any other payment in the time and form contractually required by a counterparty, with a five percent default trigger. The amendments will require an advisor to report: (a) the date of the default; (b) the dollar amount of the default; and (c) the legal name and Legal Entity Identifier if any) of the counterparty. In the event that multiple counterparties to the fund default on the same day, the reporting item will allow an advisor to file a single current report broken out with details for each counterparty default. In the event that counterparties to the fund default on different days, the advisor would file a separate current report for each counterparty default that occurred.
• If the reporting fund’s prime broker terminates its agreement with the fund or “materially restricts its relationship with the fund, in whole or in part, in markets where that prime broker continues to be active.”
• If an operations event occurs, meaning the reporting fund or advisor experiences a significant disruption or degradation of the fund’s critical operations, whether as a result of an event at a service provider to the reporting fund, the fund itself, or the advisor. Critical operations means operations necessary for (1 )investment trading, valuation, reporting, and risk management of the fund; or (2) the operation of the reporting fund in accordance with the federal securities laws and regulations. The advisor must report the date when the event first occurred, the date the event was discovered, and the circumstances, along with the effect upon the fund’s portfolio assets, valuation, investment risk management, ability to comply with the federal securities laws, or some other impact (coupled with an explanation).
• If the reporting fund receives cumulative requests for withdrawals or redemptions from the reporting fund equal to or greater than 50% of the most recent NAV, net of subscriptions and other contributions from investors received and contractually committed, the advisor must provide the date of the event, the net value of amounts paid out between the last data reporting and the current report date, and the percent of NAV for which withdrawals have been requested. The advisor must report whether investors have been notified that the fund will liquidate.
• If a reporting fund is unable to pay redemption requests or has suspended redemptions and the suspension lasts for more than 5 consecutive business days, the advisor must report the relevant date, the percentage of the fund’s most recent NAV for which redemptions have been requested and not yet paid on the date of the current report, and advise whether investors have been notified that the fund will liquidate.

Effective Dates and Compliance Dates

Advisors must build and implement internal reporting and tracking systems. We recommend fund advisors begin this project immediately, if it has not already done so. The compliance dates are as follows:

Private Equity Fund Advisors Quarterly Event Reporting-

• Effective six months after publication of the Amendments in the Federal Register.
• Advisors must file event reports within 60 days of the end of the fiscal quarter in which the trigger events occurred.

Large Private Equity Fund Advisers Expanded Reporting-

• Effective one year after publication of the Amendments in the Federal Register.
• This means that for advisors with a December 31 fiscal year-end, the new Form PF would be filed in April of 2025.

Current Reporting for Large Hedge Fund Advisors–

• Effective six months after publication of the Amendments in the Federal Register.
• Advisors must file event reports as soon as is practicable, but within no later than 72 hours from the occurrence of the event. (Advisors also have quarterly update requirements relating to large liquidity funds they advise.)

SEC Explanation and Justification

While acknowledging that the quarterly report requirements and the amendments to Form PF place reporting and monitoring burdens on fund advisors, the Commission argues in the Amending Release that the new reporting requirements will enhance the FSOC’s ability to monitor systemic risk as well as bolster the Commission’s regulatory oversight of private fund advisors and investor protection efforts.

To support its reporting requirement regarding investment strategies, the Amending Release states that different investment strategies carry different types and levels of risk for the markets and financial stability asserting that reporting on investment strategies will allow the Commission and FSOC to understand and better assess the potential market and systemic risks presented by the different strategies to both markets and investors. A shift in the reporting of private equity assets towards riskier strategies, for instance, could provide valuable information about emerging systemic risks. Similarly, this information would allow the Commission and FSOC to better assess private equity funds’ increasing role in providing credit to companies.

The Amending Release notes that, until now, Large Hedge Fund Advisors would file a Form PF only quarterly, which could render the Form PF data stale during fast moving events that could have systemic risk implications or negatively impact investors. The requirement that events be reported promptly for qualifying hedge funds, the SEC claims, will provide important, current information to the Commission and FSOC to facilitate timely assessment of the causes of the current reporting event, the potential impact on investors and the financial system, and any potential regulatory responses. More specifically, the release says:

1. The reports will enhance the Commission’s analysis of information it already collects across funds and other market participants, allowing FSOC and the Commission to identify patterns that may present systemic risk or that could result in investor harm, respectively.
2. The Commission and its staff will be able to use the information contained in the current reports to assess the nature and extent of the risks presented, as well as the potential effect on any impacted fund and the potential contagion risks across funds and counterparties more broadly.
3. More specifically, a timely notice could allow the Commission and FSOC to assess the need for potential regulatory action, and could allow the Commission to pursue potential outreach, examinations, or investigations in response to any harm to investors or potential risks to financial stability on an expedited basis before they worsen.

With regard to the requirement to report partner clawbacks and to file current reports of stress events, the Amending Release argues that such information will provide the FSOC and the Commission with valuable information that may provide early indications of stress at a fund before a potential default occurs, triggering more widespread systemic impacts or harm to investors. For example, with regard to the requirement regarding margin increases, the Release says:

Sudden and significant margin increases can have critical effects on funds that may be operating with large amounts of leverage and could serve as precursors to defaults at fund counterparties and eventual liquidation. Large, sustained margin increases also may effectively signal that counterparties are concerned about a fund’s portfolio positions as well as the potential for future margin increases from the fund’s other counterparties. Moreover, a number of margin increase reports from multiple funds that invest in certain securities or sectors through different counterparties will provide FSOC and the Commission with a broader picture of industry-wide risks and potential investor harms, respectively.

Conclusion

Systemic risk is a topic being addressed now across federal regulatory agencies. Recent bank failures coupled with post-traumatic stress disorder resulting from the events of the financial crisis in 2007-2010 is driving a strong push for increased regulation and heightened monitoring of all financial industry participants.

 

If we can help you with your advisory firm’s compliance burdens, please feel free to reach out to us at the address below:

Natalie Roberts

[email protected]

612-810-0339

Michael Macaluso

[email protected]

612-718-4200

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[1] Amendments to Form PF to Require Evet Reporting for Large Hedge Fund Advisers and Private Equity Fund Advisers and to Amend Reporting Requirements for Large Private Equity Fund Advisers, SEC Release No. IA-6297 (May 3, 2023) (the “Amending Release.”)

[2] The instructions to Form PF define all of these types of funds in the Glossary of Terms.

[3] Private Fund Advisors are those that are registered or required to register with the SEC, including any investment advisor that is also registered or required to register with the CFTC as a Commodity Pool Operator or Commodity Trading Advisor and advises one or more private funds. Note that this definition includes investment advisors that are found to be unregistered but requiring registration because a claimed exemption is deemed to be unavailable.

[4] “Related Person” means an “advisory affiliate” and any person (entity or individual) that is under common control with the advisor. An “Advisory Affiliate” is all the advisor’s officers, partners, directors, or persons performing similar functions; all persons directly or indirectly controlling or controlled by the advisor; and all the advisor’s current employees other than those performing only clerical, administrative, support, or similar functions. See Instructions to Form ADV.

[5] A “related person” is “separately operated” if the advisor is not required to complete Section 7.A. of Schedule D to Form ADV with respect to the “related person.” A “related person” consists of all the advisor’s related affiliates and any person (individual or entity) under common control with the advisor, but the advisor need not complete Section 7.A. of Schedule D to Form ADV with regard to a related person if the advisor:

1. has no business dealings with the related person in connection with advisory services the advisor provides to its clients;
2. the advisor does not conduct shared operations with the related person;
3. the advisor and related person do not refer clients or business to one another;
4. the advisor does not share supervised persons or premises with the related person; and
5. the advisor has no reason to believe that its relationship with the related person otherwise creates a conflict of interest with the advisor’s clients.

unless the related person acts as a qualified custodian in connection with the advisory services the advisor provides to is clients.

[6] An advisor-led secondary transaction is any transaction initiated by the advisor or any of its related persons that offers private fund investors the choice to: 1) sell all or a portion of their interests in the private fund; or 2) convert or exchange all or a portion of their interests in the private fund for interests in another vehicle advised by the advisor or any of its related persons.

[7] A General Partner Clawback is any obligation of the general partner, its related persons, or their respective owners or interest holders to restore, or otherwise return, performance-based compensation to the fund pursuant to the fund’s governing agreements. A Limited Partner Clawback is an obligation of a fund’s investors to return all or any portion of a distribution made by the fund to satisfy a liability, obligation, or expense of the fund pursuant to the fund’s governing agreements.

[8] A drop-down menu will offer a list of categories of mutually-exclusive strategies. The Commission will be looking for challenges to valuation arising out of conflicts of interest between the hedge fund manager and the investors. For example, hedge funds may use significant leverage in their investment strategies, the impact of which increases the importance of establishing appropriate valuations of the fund’s financial instruments. See FN 426 of IA-6297, supra FN 1.

[9] General Partner Stakes Investing is an investment strategy that acquires non-controlling interests in alternative investment managers and other entities that provide advisory services to, or receive compensation from, private funds.

[10] A qualifying hedge fund is one that has a net asset value (individually or in combination with any feeder funds, parallel funds, and/or dependent parallel managed accounts) of at least $500 million as of the last day of any month in the fiscal quarter immediately preceding its most recently completed fiscal quarter. (See Form PF Definitions)

[11] RFACV is defined as “every position in the reporting fund’s portfolio, including cash and cash equivalents, short positions, and any fund-level borrowing, with the most recent price or value applied to the position for purposes of managing the investment portfolio” and may be calculated using the advisor’s own methodologies and conventions of the advisor’s service providers, provided that these are consistent with information reported internally. The RFACV is a signed value calculated on a net basis, rather than gross. The calculation is similar to the typical practices for computing daily profit and loss. The value estimates should be guided by the reporting fund’s valuation policies and procedures shared with investors and counterparties.