SEC Adopts Enhanced Reporting Requirements For Private Funds - Securities

On May 3, 2023, the U.S. Securities and Exchange Commission (SEC) approved amendments to Form PF (the Form PF Reporting Amendments), the confidential reporting form required to be filed by certain investment advisers to private funds that are registered or are required to be registered with the SEC. The amendments dramatically modify and expand the reporting requirements for private equity fund advisers and large hedge fund advisers. The stated goals of these amendments are to enhance the ability of the Financial Stability Oversight Council to assess systemic risk and to bolster the SEC's oversight of private fund advisers and its investor protection efforts, which concerns are only heightened after the recent unforeseen failures of certain banks and a series of large fund failures in recent years.

Akin to the requirements that public issuers file current reports on Form 8-K upon the occurrence of certain material events, the amendments will require large hedge fund advisers (i.e., advisers with at least US$1.5 billion of regulatory assets under management (RAUM) attributable to hedge funds) to file reports within 72 hours of the occurrence of certain reportable events that the SEC has determined could indicate significant stress at a fund, the potential for investor harm, or increased systemic risk. All private equity fund advisers will be required to file quarterly reports upon the occurrence of other events that could be indicative of the same types of issues. The amendments will also require large private equity fund advisers (i.e., advisers with at least US$2 billion of RAUM attributable to private equity funds) to modify and expand the information included in their annual filings.¹ The effective date of these requirements vary as discussed below.

These enhanced reporting requirements will require advisers to report competitively sensitive and proprietary information. The U.S. Investment Advisers Act of 1940 precludes the SEC from being compelled to reveal Form PF information except in certain limited circumstances. In its adopting release, the SEC reiterated its intention to maintain the confidentiality of Form PF information, including by aggregating and masking any information reported to the public. The SEC may, however, use Form PF information in enforcement actions against advisers and to assess potential systemic risk, likely resulting in increased investigative and enforcement activity in this already active arena.

Current Reporting Requirements for Large Hedge Fund Advisers

Under the existing rules, large hedge fund advisers are required to file quarterly updates to their Form PF. The Form PF Reporting Amendments will expand upon these reporting requirements by requiring large hedge fund advisers to file a "current report" on Section 5 of Form PF as quickly as possible (and in any event within 72 hours) following the occurrence of certain "current reporting events" (as defined in the amended Form PF). These new reporting requirements for large hedge fund advisers will go into effect six months after the SEC's adopting release is published in the Federal Register, which, as of the date of this Alert, has not yet occurred. These current reporting events include:

Extraordinary Investment Losses. This current reporting event will be triggered by losses at any "qualifying hedge fund" (i.e., any hedge fund with a net asset value of at least US$500 million as of the last day of any month in the fiscal quarter immediately preceding the adviser's most recently completed fiscal quarter) equal to or greater than 20% of its "reporting fund aggregate calculated value" (RFACV) over a rolling 10-business-day period.

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." Advisers are permitted to use their own internal methodologies or those of their service providers when calculating RFACV, provided that they are consistent with information reported internally.
Significant Increase in Margin Requirements. This current reporting event will be triggered if the total dollar value of the margin, collateral, or an equivalent posted by any qualifying hedge fund at the end of any rolling 10-business-day period is greater than or equal to 20% of the average of the daily RFACV for the end of each business day during the applicable 10-business-day period.

Margin Defaults. This current reporting event will be triggered by the default of a qualifying hedge fund on a call for margin, collateral, or an equivalent of any size, resulting in a deficit that the fund will not be able to cover or address by adding additional funds. If there is a contractually agreed upon cure period, then this reporting requirement will not be triggered until the expiration of the cure period, unless the fund does not expect to be able to meet the margin call during the cure period. Advisers are not required to report a margin default if there is a dispute regarding the size and appropriateness of a margin call and the reporting fund has sufficient assets to meet the greatest of the disputed amounts.

Inability to Meet a Margin Call. This current reporting event will be triggered by a determination by the adviser that one of its qualifying hedge funds is unable to meet a call for increased margin, collateral, or equivalent, regardless of size, even if the fund has not yet defaulted on its margin requirements. The current report requirement relating to this event applies even in situations where there is a dispute regarding the size and appropriateness of the margin call.

Counterparty Defaults. This current reporting event will be triggered by the failure of a counterparty to a qualifying hedge fund to meet a margin call or to make any other payment of an amount exceeding 5% of RFACV in the time and form contractually required (taking into account any contractually agreed upon cure period).

Termination or Material Restriction of a Prime Broker Relationship. This current reporting event will be triggered if a prime broker terminates or materially restricts its relationship with a qualifying hedge fund, in whole or in part, in markets where the prime broker continues to be active. A prime broker will be considered to have "materially restricted" its relationship with a fund if the prime broker changes the terms of its relationship with the fund in a way that significantly limits the fund's ability to operate under the terms of the original agreement or significantly impairs the fund's ability to trade (for example, it will no longer conduct certain trades in a particular market). A current report is only required for fund-specific terminations, not for terminations relating to a decision by a prime broker to cease activities in a market for all of its customers.²

Large hedge fund advisers will also be required to report on the occurrence of fund-specific termination events under a prime brokerage or related agreement that lead to a termination of a relationship between a prime broker and a qualifying hedge fund within 12 months, regardless of whether the relationship is terminated by the prime broker or the fund. Advisers are not required to report termination events that are isolated to the financial status, activities, or other characteristics solely of the prime broker.

Operations Events. This current reporting event will be triggered if the adviser or one of its qualifying hedge funds experiences a significant disruption or degradation of the fund's critical operations, whether as a result of an event at a service provider, the fund, or the adviser.

Critical Operations are those operations necessary for (1) the investment, trading, valuation, reporting, and risk management of the reporting fund or (2) the operation of the reporting fund in accordance with federal securities laws and regulations. For example, operational issues at a service provider that significantly disrupt or degrade an adviser's ability to value a reporting fund's assets and severe weather events causing wide-spread power outages would likely be reportable events for purposes of this requirement.

The SEC originally proposed that this current reporting event would be triggered by a 20% disruption or degradation of normal volume or capacity, but ultimately did not adopt the 20% threshold because there may be circumstances where it would be difficult to quantitatively measure disruptions in critical operations. Nevertheless, the SEC has indicated that, in circumstances where operations are reasonably measurable, it would generally consider a 20% disruption or degradation of normal capacity to be a triggering event. For example, a software malfunction that disrupts trading volume of a qualifying hedge fund by 20% would likely be a reportable event.

Large Withdrawal and Redemption Requests; Suspensions of Redemptions. This current reporting event will be triggered if a qualifying hedge fund receives cumulative requests for withdrawals or redemptions exceeding 50% of the most recent net asset value of the fund (after netting against subscriptions or other contributions from investors), regardless of any pre-existing gates or liquidity limitations.

Large hedge fund advisers will also be required to file a current report if a qualifying hedge fund is either unable to satisfy redemptions or suspends redemptions for more than five consecutive business days.

Quarterly Reporting by Private Equity Fund Advisers

Under the existing rules, investment advisers to private equity funds are required to file an annual update to their Form PF. The Form PF Reporting Amendments will expand upon these reporting requirements by requiring all private equity fund advisers (regardless of size) to file a "private equity event report" on Section 6 of Form PF within 60 days after the end of any fiscal quarter in which certain "private equity reporting events" (as defined in the amended Form PF) occur. Like the hedge fund reporting requirements discussed above, these new reporting requirements will go into effect six months after the SEC's adopting release is published in the Federal Register. These private equity reporting events include:

Adviser-Led Secondary Transactions. This private equity reporting event will be triggered by the completion of any transaction initiated by an adviser or any of its related persons that offers private fund investors the choice to (1) sell all or a portion of their interests in a private equity fund advised by it or (2) convert or exchange all or a portion of their interests in the private equity fund for interests in another vehicle advised by the adviser or any of its related persons.

Whether a transaction will be considered "initiated" by an adviser will depend on the facts and circumstances of the specific transaction. The SEC will not generally view a transaction to be initiated by an adviser or one of its related persons to the extent the adviser or its related person, at the unsolicited request of an investor, participates in the secondary sale of the investor's fund interest.³

Removal of the General Partner; Termination of the Fund; or Termination of the Investment Period. This private equity reporting event will be triggered if the investors in a private equity fund (1) remove the adviser or its affiliate as the general partner or similar control person of the fund, (2) terminate the fund's investment period, or (3) terminate the fund, in each case, for any reason contemplated by the fund documents.⁴

Enhanced Annual Reporting for Large Private Equity Fund Advisers

Large private equity fund advisers (i.e., those with over US$2 billion in RAUM attributable to private equity funds) will be required to provide the enhanced reporting described below in Section 4 of their annual Form PF filings. These enhanced annual reporting requirements for large private equity fund advisers will go into effect one year after the SEC's adopting release is published in the Federal Register.

General Partner and Limited Partner Clawbacks. Large private equity fund advisers will be required to report whether a general partner clawback of any size or a limited partner clawback in excess of 10% of the reporting fund's aggregate capital commitments was effectuated during the applicable reporting period.

For purposes of these enhanced reporting requirements, 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 a fund pursuant to that fund's governing agreements. A "limited partner clawback" is any obligation of a fund's investors to return all or any portion of a distribution made by the fund to such investor to satisfy a liability, obligation, or expense of the fund pursuant to the fund's governing documents. Once the fund has exceeded the 10% threshold for limited partner clawback reporting, a new reporting event is triggered upon each additional limited partner clawback, regardless of size, over the course of the fund's remaining life.

Private Equity Fund Strategies. Large private equity fund advisers will be required to report the investment strategy of each of the adviser's private equity funds by percentage of deployed capital. Funds that engage in multiple strategies will need to provide a good faith estimate of the percentage of the fund's capital deployed in each strategy.

Advisers will be required to choose from a dropdown list of strategies in the Form PF. Advisers should choose the strategies that best match the fund's investment strategies, even if they do not precisely match the fund's characterization of its strategies. If a fund's strategy is not listed, advisers can select the "other" category and provide an explanatory note regarding the fund's strategy.

Fund-Level Borrowings. Large private equity fund advisers will be required to report information regarding fund-level borrowing or other cash financings (with particular regard to subscription credit facilities) by each of the adviser's private equity funds. Required information will include the total dollar amount of borrowings, the average amount borrowed over the reporting period, and whether the fund's creditors are U.S.-based financial institutions.

This reporting requirement covers instances in which a fund has access to capital that would not be considered "borrowing," such as, for example, where an adviser agrees to provide a cash infusion to a fund it advises. This reporting requirement does not cover any borrowing or financing at the portfolio-company level.

Events of Default. Under the existing rules, large private equity fund advisers are required to report any events of default by any of their private equity funds or controlled portfolio companies under any indentures, loan agreements, or other instruments evidencing obligations for borrowed money during the reporting period. The Form PF Reporting Amendments will expand upon these reporting requirements by requiring large private equity fund advisers to report more granular information, including information regarding the type and nature of the reported events of default.

Bridge Financing. Under the existing rules, large private equity fund advisers are required to report annually on the amount of bridge financing provided to their controlled portfolio companies and the identity of each person providing such financing. The Form PF Reporting Amendments will expand upon these reporting requirements, by requiring large private equity fund advisers to report the legal entity identifier (LEI), if any, of each counterparty to bridge financing and whether such counterparty is affiliated with a major financial institution.

Geographic Breakdown of Investments. Under the existing rules, large private equity fund advisers are currently required to provide a geographic breakdown (by percentage of gross value) of the investments of each of their private equity funds, based on a list of pre-defined regions in Form PF. The Form PF Reporting Amendments will remove this reporting requirement and replace it with a new requirement to report each country to which a private equity fund has an exposure equal to 10% or more of the fund's net asset value.

One Last Note

Investment advisers that are required to file Form PF should also be aware that Form PF may be further amended pursuant to a joint proposal announced by the SEC and the Commodities Futures Trading Commission on August 10, 2022. We will continue to track these developments and report on them as they unfold.

Conclusion

These amendments to Form PF are significant and will require private equity fund advisers and large hedge fund advisers to adopt internal processes and procedures to track and report on a timely basis the additional information required by these enhanced reporting requirements. Consideration will also need to be given about the type and nature of the disclosures, proactively investigating and remediating disclosable events, and being prepared to interact with regulators, including enforcement staff, if inquiries are likely forthcoming based on the disclosure. These disclosures should be viewed as a tool by regulators to more proactively investigate and act on information in order to stem a cascading series of events that they believe may otherwise result in significant investor losses. Given the recent bank and fund failures that have occurred, and the negative reputational repercussions felt by the regulators in the halo of such events, fund advisers should assume the SEC will take full advantage of these enhanced disclosures to more actively patrol the private fund space.

Footnotes

1. See instruction 4 to Form PF for guidance on who is responsible for reporting information regarding a private fund for which a subadviser has been engaged. Only one adviser should complete and file Form PF for each private fund. Generally, the adviser (or subadviser) that reports the fund in Section 7.B.1 of its Form ADV should be the one that reports the fund on Form PF. Advisers to "funds of funds" are generally not required to report on events that occur at underlying funds that they do not advise.

2. At this time, it is unclear whether the SEC would view the cessation by a prime broker of activities in a market for a certain subset of its customers (e.g., U.S.-based investment funds) as a reportable event.

3. At this time, it is unclear how the SEC will view other acquisitions by an adviser or its related persons of an investor's fund interests, such as, for example, pursuant to a right of first refusal in a fund's governing documents or in a secondary transaction initiated by the investor in which the investor did not specifically ask the adviser or its related to persons to participate.

4. While the amendments focus on "elections" by investors, implying that affirmative action is required by investors in order to trigger this reporting requirement, in certain instances such events may occur as a result of inaction by the investors. For example, a fund or its investment period may be automatically terminated if investors fail to reinstate it following a key person event. It is unclear at this time whether the SEC would view events that occur because the investors did not override the adverse consequences of an identified event as a reportable event.

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