Alert January 28, 2022

How the Proposed Amendments to Form PF Would Affect Private Fund Sponsors

On January 27th, the U.S. Securities and Exchange Commission (the “SEC”) proposed amendments to the Form PF that would (i) introduce new “current reports” for (a) “large hedge fund advisers” with respect to “qualifying hedge funds” and (b) all advisers to private equity funds (without a size requirement), (ii) lower the threshold required to be a “large private equity fund adviser” and expand the annual reporting required by “large private equity fund advisers,” and (iii) make the reporting by “large liquidity fund advisers” consistent with the proposed reporting requirements for registered money market funds. For purposes of this alert, we focus on the changes applicable to “large hedge fund advisers” and “private equity fund” advisers.

The new “current reports” represent a potentially significant new burden that would trigger a need to review an adviser’s compliance and reporting systems to ensure that it is able to identify the reporting events and report them within one business day. 

In addition, these proposed amendments would reflect an expanded use of Form PF for purposes other than the analysis of systemic risk (e.g., in the SEC examination program). In particular, the amendments applicable to private equity fund advisers are generally justified by concerns relating to conflicts of interest, and not systemic risk. The increased reporting requirements for private equity fund advisers (along with the expanded universe to whom they would be applicable) could lead to additional examination (and enforcement) activity in the future.

Finally, “hedge funds” and “private equity funds” are technical terms defined under Form PF that do not line up in all cases with how those terms are used in the market. For example, some private equity, private credit and real estate funds are classified as “hedge funds” for Form PF purposes. In addition, some newer strategies (such as funds investing in digital assets or litigation finance) may be classified as “hedge funds” or “private equity funds.” Firms should review the classifications of their private funds as the reporting requirements for “hedge funds” and “private equity funds” continue to diverge.

Comments will be due 30 days after the proposed rule is published in the Federal Register. 

Overview

For “large hedge fund advisers” (generally advisers with greater than $1.5 billion in hedge fund assets under management), the amendments would require “large hedge fund advisers” to make “current reports” within one business day when certain reporting events occur with respect to a “qualifying hedge fund” (generally net asset value of at least $500 million), including (1) extraordinary investment losses, (2) significant increases in the margin or collateral requirements, (3) margin defaults or the inability to meet a margin call (by the fund or a counterparty), (4) material changes in a prime brokerage relationship, (5) significant declines in unencumbered cash holdings, (6) significant disruptions or degradation of the fund’s key operations, (7) significant amounts of redemption requests or (8) the inability to satisfy redemption requests or the suspension of redemptions. 

For private equity fund advisers, the amendments would: 

  • Require the filing of “current reports” for all private equity fund advisers within one business day of the occurrence of a “reporting events” with respect to a “private equity fund” (with no size requirement), including the execution of an adviser-led secondary transaction, a general partner or limited partner clawback, the removal of a fund’s general partner, an election to terminate a fund’s investment period, and an election to terminate the fund; and

  • Lower the threshold to be a “large private equity adviser” from $2 billion to $1.5 billion in “private equity fund assets under management and expand the annual reporting requirements applicable to “large private equity advisers” to include additional information on (1) private equity investment strategies, (2) restructurings and recapitalizations of a portfolio company, (3) investments in different levels of the capital structure by related funds, (4) fund-level borrowings, (5) financing of portfolio companies by the reporting fund, (6) floating rate borrowing of controlled portfolio companies, (7) count of controlled portfolio companies, (8) events of default, (9) bridge financings, and (10) the geographical breakdown of investments.

Additional information on the requirements applicable to “large hedge fund advisers” and private equity fund advisers is below. 

Requirements for Large Hedge Fund Advisers. 

Under the proposal, “large hedge fund advisers” will be required to file “current reports” on a new section 5 within one business day of the occurrence of “reporting events” at a “qualifying hedge fund” that they advise. A “large hedge fund adviser” is an investment adviser who had at least $1.5 billion in “hedge fund assets under management” (as defined in Form PF) and “qualifying hedge fund” is generally a fund with a net asset value of at least $500 million. Note that a reportable event at a fund that is not a “qualifying hedge fund” would not trigger a reporting requirement for a “large hedge fund adviser.”

The “reportable events” for a “large hedge fund adviser” that could trigger the current reporting requirement are:

  • Extraordinary Investment Losses. Extraordinary investment losses (defined as “a loss equal to or greater than 20[%] of a fund’s most recent net asset value over a rolling 10 business day period”), which will trigger a requirement to report (i) the dates of the relevant 10 business day period and (ii) the dollar amount of the loss;

  • Increases in Margin or Collateral Requirements. Significant increases in the fund’s requirements for margin, collateral, or an equivalent (defined as “a cumulative increase in margin of more than 20[%] of the reporting fund’s most recent net asset value over a rolling 10 business day period”), which will trigger a requirement to report (i) the dates of the relevant 10 business day period, (ii) the cumulative dollar amount of the increase, (iii) the identity of the relevant counterparty or counterparties and (vi) the circumstances of the margin increase (e.g., exchange requirements, regulatory actions, independent increase by the counterparty, new relationship or new business, new investment positions, investment approach or strategy, or deteriorating position or other credit trigger);

  • Margin Default by Fund. A margin default or inability to meet a call for margin, collateral or an equivalent (taking into account any contractually agreed cure prior), which will trigger a requirement to report (i) the date of relevant default, (ii) the dollar amount involved, (iii) identifying information of the counterparty, and (iv) the circumstances of the default (e.g., an increase in margin requirements, losses in the fund’s portfolio, or default or settlement failure of a counterparty);

  • Margin Default by Counterparty. A margin default by a counterparty if the amount involved is greater than 5% of the most recent net asset value of the fund, which will trigger a requirement to report (i) the date of the default, (ii) the dollar amount involved, and (iii) identifying information of the counterparty;

  • Material Change in Prime Brokerage Relationship. A material change in the relationship with a prime broker (e.g., material change to the fund’s ability to trade or a termination for default or breach of the prime brokerage agreement), which will trigger a requirement to report (i) the date of the material change, (ii) identifying information of the prime broker, and (iii) the circumstances of the material change (e.g., material trading limits or investment restrictions, requests to reduce positions or unwind positions, whether the relationship was terminated and by whom);

  • Decline in Unencumbered Cash. A significant decline in holdings of unencumbered cash (defined as a decline “by more than 20[%] of the reporting fund’s most recent net asset value over a rolling 10 business day period”), which will trigger a requirement to report (i) the last day of the relevant 10 business day period, (ii) the dollar amount of the unencumbered cash on the last day, and (iii) the circumstances of the decline (e.g., whether the change is attributable to or related to redemption activity, new investment positions, strategy and/or portfolio turnover, losses in the fund’s portfolio, or a margin call);

  • Disruption or Degradation of Key Operations. A significant disruption or degradation (generally a 20% disruption or degradation of normal volume or capacity) of the fund’s key operations (including the investment, trading, valuation, reporting, and risk management of the fund and the operation of the fund in accordance with the Federal securities laws and regulations), which will trigger a requirement to report (i) the date of the event, (ii) the date of discovery, (iii) the circumstances of the operations event (e.g., whether the event occurred at a service provider, the reporting fund, its adviser or a related person, or is related to a natural disaster or other force majeure event), (iv) whether the event is covered by a business continuity plan, and (v) the current understanding of the impact of the operations event (e.g., disruption or degradation in trading, valuation, risk management, or compliance with applicable laws); 

  • Significant Volume of Redemption Requests. A significant amount of redemption requests (defined as cumulative redemption requests, on a net basis, exceeding 50% of the most recent net asset value), which will trigger a requirement to report (i) the date the net redemption requests exceed threshold, (ii) the net value of redemptions paid between the last data reporting date and the date of the current report, (iii) the percentage of the net asset value that the redemption request represents, and (iv) whether the adviser has notified the investors that the fund will liquidate; and

  • Inability to Satisfy or Suspension of Redemptions. An inability to satisfy redemptions or a suspension of redemptions for more than five consecutive business days, which will trigger a requirement to report (i) the date the fund was unable to pay the redemption requests or suspended redemptions, (ii) the percentage of redemptions requested and not yet paid, and (iii) whether the adviser has notified the investors that the fund will liquidate.

Requirements for Private Equity Fund Advisers. 

There are several amendments relevant to private equity fund advisers.

First, all investment advisers would be required to file “current reports” on a new Section 6 within one business day of the occurrence of “reporting events” with respect to any “private equity fund.” Note that, unlike with respect to the current reporting requirements for “large hedge fund advisers,” the reporting is not limited to “large private equity fund advisers” and there is no threshold related to the size of the funds, so a “reporting event” occurring at any “private equity fund” (regardless of size) would trigger the current reporting requirement. For an investment adviser to a “private equity fund,” the reporting events would include:

  • Adviser-led Secondaries. The execution of an adviser-led secondary transaction (defined to include any transaction initiated by the adviser or any of its related persons that offers the 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 adviser or any of its related persons”), which will trigger a requirement to report (i) the transaction completion date and (ii) a brief description of the transaction;

  • GP Clawback. A general partner clawback (defined to mean “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”), which will trigger a requirement to report (i) the effective date of the clawback and (ii) the reason for the clawback;

  • LP Clawback. A limited partner clawback or “giveback” (defined to mean “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”) in excess of 10% of a fund’s aggregate capital commitments, which will trigger a requirement to report (i) the effective date of the clawback and (ii) the reason for the clawback;

  • GP Removal. Removal of a fund’s general partner or similar control person, which will trigger a requirement to report (i) the effective date of the event and (ii) a description of such event;
  • Investment Period Termination. Election to terminate a fund’s investment period, which will trigger a requirement to report (i) the effective date of the event and (ii) a description of such event; and

  • Fund Termination. Election to terminate the fund, which will trigger a requirement to report (i) the effective date of the event and (ii) a description of such event.

In addition, the proposal would lower the threshold to be a “large private equity adviser” from $2 billion to $1.5 billion in “private equity fund assets under management” (as calculated in accordance with the Form PF instructions).

Finally, the proposal would add to and amend Section 4 of Form PF, which is additional annual reporting required for “large private equity fund advisers.” The changes to Section 4 for “large private equity fund advisers” would include:

  • Private equity investment strategies. A new question with a mutually exclusive list of strategies by percent of deployed capital;

  • Restructuring/recapitalization of a portfolio company. A new question regarding restructurings or recapitalizations of a portfolio company following the fund’s investment period, including the name of the portfolio company and the effective date of the restructuring;

  • Investments in different levels of the capital structure by related funds. A new question on whether the reporting fund held an investment in one class, series or type of securities of a portfolio company while another related fund concurrently held an investment in a different class, series or type of securities of the same portfolio company, including the name of the portfolio company and a description of the class, series or type of securities held;

  • Fund-level borrowings. A new question on whether a fund borrows or has the ability to borrow at the fund-level, including information on each borrowing or other cash financing, the total dollar amount available, and the average amount borrowed;

  • Financing of portfolio companies. A new question on whether an adviser or related person provides financing or otherwise extends credit to any portfolio company, including the value of such financing or extension of credit;

  • Floating rate borrowing of controlled portfolio companies. A new question to report what percentage of the aggregate borrowings of a fund’s controlled portfolio companies is at a floating rate rather than a fixed rate;

  • Count of controlled portfolio companies. A new question to require the reporting of how many controlled portfolio companies a reporting fund owns;

  • Events of default. Amends a question to provide more granular information about the nature of reported events of defaults (e.g., whether it is a payment default of the private equity fund, a payment default of a controlled portfolio company, or a default relating to a failure to uphold terms under the applicable borrowing agreement); 

  • Bridge financings. Amends a question to require reporting on the identity of the institutions providing bridge financing and the amount of such financing; and 

  • Geographical breakdown of investments. Amends a question to require reporting of all countries to which a fund has exposure of 10% or more of its net asset value.