Rule2023-09775
Form PF; Event Reporting for Large Hedge Fund Advisers and Private Equity Fund Advisers; Requirements for Large Private Equity Fund Adviser Reporting
Primary source
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Published
June 12, 2023
Effective
June 11, 2024
Issuing agencies
Securities and Exchange Commission
Abstract
The Securities and Exchange Commission ("SEC" or "Commission") is adopting amendments to Form PF, the confidential reporting form for certain SEC-registered investment advisers to private funds to require event reporting upon the occurrence of key events. The amendments also require large private equity fund advisers to provide additional information to the SEC about the private equity funds they advise. The reporting requirements are designed to enhance the Financial Stability Oversight Council's ("FSOC") ability to monitor systemic risk as well as bolster the SEC's regulatory oversight of private fund advisers and investor protection efforts.
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<title>Federal Register, Volume 88 Issue 112 (Monday, June 12, 2023)</title>
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[Federal Register Volume 88, Number 112 (Monday, June 12, 2023)]
[Rules and Regulations]
[Pages 38146-38278]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2023-09775]
[[Page 38145]]
Vol. 88
Monday,
No. 112
June 12, 2023
Part II
Securities and Exchange Commission
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17 CFR Parts 275 and 279
Form PF; Event Reporting for Large Hedge Fund Advisers and Private
Equity Fund Advisers; Requirements for Large Private Equity Fund
Adviser Reporting; Final Rule
Federal Register / Vol. 88, No. 112 / Monday, June 12, 2023 / Rules
and Regulations
[[Page 38146]]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 275 and 279
[Release No. IA-6297; File No. S7-01-22]
RIN 3235-AM75
Form PF; Event Reporting for Large Hedge Fund Advisers and
Private Equity Fund Advisers; Requirements for Large Private Equity
Fund Adviser Reporting
AGENCY: Securities and Exchange Commission.
ACTION: Final rule.
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SUMMARY: The Securities and Exchange Commission (``SEC'' or
``Commission'') is adopting amendments to Form PF, the confidential
reporting form for certain SEC-registered investment advisers to
private funds to require event reporting upon the occurrence of key
events. The amendments also require large private equity fund advisers
to provide additional information to the SEC about the private equity
funds they advise. The reporting requirements are designed to enhance
the Financial Stability Oversight Council's (``FSOC'') ability to
monitor systemic risk as well as bolster the SEC's regulatory oversight
of private fund advisers and investor protection efforts.
DATES:
Effective dates: This rule is effective June 11, 2024, except for
the amendments to Form PF sections 5 and 6 (referenced in 17 CFR 279.9)
which are effective December 11, 2023.
Compliance dates: For the amended, existing Form PF sections and
amendments to 17 CFR 275.204(b)-1, June 11, 2024. For new Form PF
sections 5 and 6, December 11, 2023.
FOR FURTHER INFORMATION CONTACT: Robert Holowka, Jill Pritzker, and
Samuel Thomas, Senior Counsels; Sirimal R. Mukerjee, Senior Special
Counsel; or Melissa Roverts Harke, Assistant Director, at (202) 551-
6787 or <a href="/cdn-cgi/l/email-protection#93dad2e1e6fff6e0d3e0f6f0bdf4fce5"><span class="__cf_email__" data-cfemail="9ed7dfecebf2fbeddeedfbfdb0f9f1e8">[email protected]</span></a>, Investment Adviser Regulation Office, Division
of Investment Management, Securities and Exchange Commission, 100 F
Street NE, Washington, DC 20549-8549.
SUPPLEMENTARY INFORMATION: The Commission is adopting amendments to
Form PF [17 CFR 279.9] and Rule 204(b)-1 under the Investment Advisers
Act of 1940 [15 U.S.C. 80b] (``Advisers Act'').\1\
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\1\ 15 U.S.C. 80b. Unless otherwise noted, when we refer to the
Advisers Act, or any section of the Advisers Act, we are referring
to 15 U.S.C. 80b, at which the Advisers Act is codified, and when we
refer to rules under the Advisers Act, or any section of these
rules, we are referring to title 17, part 275 of the Code of Federal
Regulations [17 CFR 275], in which these rules are published.
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Commission reference CFR citation
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Form PF............................. 17 CFR 279.9.
Rule 204(b)-1....................... 17 CFR 275.204(b)-1.
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Table of Contents
I. Introduction
II. Discussion
A. Current Reporting for Large Hedge Fund Advisers to Qualifying
Hedge Funds
1. Timing of Hedge Fund Current Reports
2. Extraordinary Investment Losses
3. Significant Margin and Default Events
4. Prime Broker Relationship Terminated or Materially Restricted
5. Changes in Unencumbered Cash
6. Operations Events
7. Large Withdrawal and Redemption Requests, Inability To
Satisfy Redemptions, or Suspensions of Redemptions
8. Explanatory Notes
B. Quarterly Private Equity Event Reports for All Private Equity
Fund Advisers
1. Adviser-Led Secondary Transactions
2. Removal of General Partner or Election To Terminate the
Investment Period or Fund
C. Filing Fees and Format for Reporting
D. Large Private Equity Fund Adviser Reporting
1. New Question on General Partner or Limited Partner Clawbacks
2. Other Amendments to Large Private Equity Fund Adviser
Reporting
E. Effective and Compliance Dates
III. Other Matters
IV. Economic Analysis
A. Introduction
B. Economic Baseline and Affected Parties
1. Economic Baseline
2. Affected Parties
C. Benefits and Costs
1. Benefits
2. Costs
D. Effects on Efficiency, Competition, and Capital Formation
E. Reasonable Alternatives
1. Changing the Frequency of Current Reporting, Quarterly
Reporting Events, and Annual Reporting Events
2. Changing Current Reporting Filing Time
3. Alternative Reporting Thresholds for Current Reporting by
Hedge Fund Advisers (Versus Just Large Hedge Fund Advisers to
Qualifying Hedge Funds)
4. Different Size Thresholds for Private Equity Fund Advisers
Who Must File Quarterly and Annual Reports on the Occurrence of
Reporting Events
5. Changing the Reporting Events for Current Reporting by Hedge
Fund Advisers
6. Alternative Size Threshold for Section 4 Reporting by Large
Private Equity Fund Advisers
7. Alternatives to the New Section 4 Reporting Requirements for
Large Private Equity
V. Paperwork Reduction Act
A. Purpose and Use of the Information Collection
B. Confidentiality
C. Burden Estimates
1. Proposed Form PF Requirements by Respondent
2. Final Form PF Requirements by Respondent
3. Annual Hour Burden Proposed and Final Estimates
4. Annual Monetized Time Burden Proposed and Final Estimates
5. Annual External Cost Burden Proposed and Final Estimates
6. Summary of Proposed and Final Estimates and Change in Burden
VI. Regulatory Flexibility Act Certification
Statutory Authority
I. Introduction
The Commission is adopting amendments to Form PF, the form that
certain investment advisers registered with the Commission use to
report confidential information about the private funds that they
advise. Form PF provides the Commission and FSOC with important
information about the basic operations and strategies of private funds
and has helped establish a baseline picture of the private fund
industry for use in assessing systemic risk.\2\ We now have almost a
decade of experience analyzing the information
[[Page 38147]]
collected on Form PF.\3\ In that time, the private fund industry has
grown in size and evolved in terms of business practices, complexity of
fund structures, and investment strategies and exposures.\4\ Based on
this experience and in light of these changes, the Commission and FSOC
identified significant information gaps and situations where more
granular and timely information would improve our understanding of the
private fund industry and the potential systemic risk within it, and
improve our ability to protect investors.\5\ Accordingly, to enhance
the FSOC's monitoring and assessment of systemic risk and to collect
additional data for the Commission's use in its regulatory programs, in
January 2022 the Commission proposed amendments to enhance the
information advisers file on Form PF.\6\
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\2\ Advisers Act section 202(a)(29) defines the term ``private
fund'' as an issuer that would be an investment company, as defined
in section 3 of the Investment Company Act of 1940 (``Investment
Company Act''), but for sections 3(c)(1) or 3(c)(7) of that Act.
Section 3(c)(1) of the Investment Company Act provides an exclusion
from the definition of ``investment company'' for any issuer whose
outstanding securities (other than short-term paper) are
beneficially owned by not more than one hundred persons (or, in the
case of a qualifying venture capital fund, 250 persons) and which is
not making and does not presently propose to make a public offering
of its securities. Section 3(c)(7) of the Investment Company Act
provides an exclusion from the definition of ``investment company''
for any issuer, the outstanding securities of which are owned
exclusively by persons who, at the time of acquisition of such
securities, are qualified purchasers, and which is not making and
does not at that time propose to make a public offering of such
securities. The term ``qualified purchaser'' is defined in section
2(a)(51) of the Investment Company Act. Since Form PF's adoption
Commission staff have used Form PF statistics to inform our
regulatory programs and establish census type information regarding
the private fund industry. See SEC 2022 Annual Staff Report Relating
to the Use of Form PF Data (Dec. 2022), available at <a href="https://www.sec.gov/files/2022-pf-report-congress.pdf">https://www.sec.gov/files/2022-pf-report-congress.pdf</a>. Staff reports,
statistics, and other staff documents (including those cited herein)
represent the views of Commission staff and are not a rule,
regulation, or statement of the Commission. The Commission has
neither approved nor disapproved the content of these documents and,
like all staff statements, they have no legal force or effect, do
not alter or amend applicable law, and create no new or additional
obligations for any person. The Commission has expressed no view
regarding the analysis, findings, or conclusions contained therein.
\3\ Form PF was adopted in 2011 as required by the Dodd-Frank
Wall Street Reform and Consumer Protection Act of 2010. Public Law
111-203, 124 Stat. 1376 (2010). See Reporting by Investment Advisers
to Private Funds and Certain Commodity Pool Operators and Commodity
Trading Advisors on Form PF, Advisers Act Release No. 3308 (Oct. 31,
2011) [76 FR 71128 (Nov. 16, 2011)], at section I (``2011 Form PF
Adopting Release''). In 2014, the Commission amended Form PF section
3 in connection with certain money market fund reforms. See Money
Market Fund Reform; Amendments to Form PF, Advisers Act Release No.
3879 (July 23, 2014) [79 FR 47736 (Aug. 14, 2014)] (``2014 Form PF
Amending Release''). Form PF is a joint form between the Commission
and the Commodity Futures Trading Commission (``CFTC'') only with
respect to sections 1 and 2 of the Form; sections 3 and 4, were
adopted only by the Commission. Current Form PF section 5, request
for temporary hardship exemption, which will become new section 7,
is adopted only by the Commission. We are adopting new sections 5
and section 6 and amending section 4, all of which are adopted only
by the Commission.
\4\ The value of private fund net assets reported on Form PF has
almost tripled, growing from $5 trillion in 2013 to nearly $14
trillion through the second quarter of 2022, while the number of
private funds reported on the form has increased by 110% in that
time period. Unless otherwise noted, the private funds statistics
used in this Release are from the Private Funds Statistics second
quarter of 2022. Any comparisons to earlier periods are from the
private funds statistics from that period, all of which are
available at <a href="https://www.sec.gov/divisions/investment/private-funds-statistics.shtml">https://www.sec.gov/divisions/investment/private-funds-statistics.shtml</a>. SEC staff began publishing the private fund
statistics in 2015, including data from 2013. Therefore, many
comparisons in this Release discuss the nine year span from the
beginning of 2013 through the second quarter of 2022. Some
discussion in this Release compares data from a seven year span,
from the beginning of 2015 through the second quarter of 2022,
because the SEC staff began publishing that particular data in 2016.
\5\ We are adopting these amendments, in part, pursuant to our
authority under section 204(b) of the Advisers Act, which gives the
Commission the authority to establish certain reporting and
recordkeeping requirements for advisers to private funds and
provides that the records and reports of any private fund to which
an investment adviser registered with the Commission provides
investment advice are deemed to be the records and reports of the
investment adviser.
\6\ Amendments to Form PF to Require Current Reporting and Amend
Reporting Requirements for Large Private Equity Advisers and Large
Liquidity Fund Advisers, Advisers Act Release No. 5950 (Jan. 26,
2022) [87 FR 9106 (Feb. 17, 2022)] (``2022 Form PF Proposing
Release''). The Commission voted to issue the 2022 Form PF Proposing
Release on Jan. 26, 2022. The release was posted on the Commission
website that day, and comment letters were received beginning that
same date. The comment period closed on Mar. 21, 2022. We have
considered all comments received since Jan. 26, 2022. In Aug. 2022,
the Commission and the CFTC proposed amendments to Form PF regarding
certain reporting requirements for all filers and large hedge fund
advisers. Form PF; Reporting Requirements for All Filers and Large
Hedge Fund Advisers, Advisers Act Release No. 6083 (Aug. 10, 2022)
[87 FR 35938 (Sept. 1, 2022)] (``2022 Form PF Joint Proposing
Release'').
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The Commission received a number of comment letters on the 2022
Form PF Proposing Release.\7\ Some commenters generally supported the
policy goals of the proposal, stating that the proposal would help the
Commission and FSOC assess and respond to systemic risk as well as
consider appropriate policy responses.\8\ Other commenters generally
asserted that the proposal was not the appropriate way of achieving
FSOC and the Commission's policy goals of assessing systemic risk and
investor protection, respectively, due to the reporting and monitoring
burdens they would impose.\9\ Certain commenters stated that the
reporting requirements are not indicative of systemic risk.\10\ Some
commenters argued that, instead, the proposed reporting requirements
were more focused on supporting the Commission's regulatory examination
and enforcement functions, and that these requirements would overburden
advisers (especially smaller advisers) with compliance costs that
investors would likely bear and obscure data that is related to
systemic risk.\11\ Lastly, other commenters stated that the SEC should
consider the proposed amendments in tandem with the 2022 Form PF Joint
Proposing Release as the amendments to both may impact each other and
create a collective compliance burden that potentially should be
implemented at one time if adopted.\12\
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\7\ The comment letters on the 2022 Form PF Proposing Release
(File No. S7-01-22) are available at <a href="https://www.sec.gov/comments/s7-01-22/s70122.htm">https://www.sec.gov/comments/s7-01-22/s70122.htm</a>.
\8\ See, e.g., Comment Letter of The Predistribution Initiative
(Mar. 21, 2022) (``PDI Comment Letter''); Comment Letter of Mark C.
(Feb. 21, 2022) (``Mark C. Comment Letter''); Comment Letter of
Public Citizen (Mar. 21, 2022) (``Public Citizen Comment Letter'');
Comment Letter of Anonymous Retail Investor (Mar. 24, 2022)
(``Anonymous Retail Investor Comment Letter''); Comment Letter of
Better Markets (Mar. 21, 2022) (``Better Markets Comment Letter'');
Comment Letter of Americans for Financial Reform Education Fund
(Mar. 21, 2022) (``AFREF Comment Letter'').
\9\ See, e.g., Comment Letter of Alternative Investment
Management Association Limited and the Alternative Credit Council
(Mar. 21, 2022) (``AIMA/ACC Comment Letter''); Comment Letter of
Real Estate Roundtable (Mar. 21, 2022) (``RER Comment Letter'');
Comment Letter of Managed Funds Association (Mar. 21, 2022) (``MFA
Comment Letter''); Comment Letter of Center for Capital Markets
Competitiveness, U.S. Chamber of Commerce (Mar. 21, 2022) (``USCC
Comment Letter'').
\10\ See, e.g., AIMA/ACC Comment Letter; RER Comment Letter;
Comment Letter of the American Investment Council (Mar. 21, 2022)
(``AIC Comment Letter''); Comment Letter of the Real Estate Board of
New York (Mar. 21, 2022) (``REBNY Comment Letter'').
\11\ See, e.g., AIMA/ACC Comment Letter; AIC Comment Letter.
\12\ See, e.g., AIC Comment Letter (Oct. 11, 2022); MFA Comment
Letter (Mar. 16, 2023). See discussion infra at section II.E.
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We are adopting the amendments largely as proposed, but with
certain modifications in response to comments received:
<bullet> First, we are adopting new current reporting requirements
for large hedge fund advisers regarding their qualifying hedge
funds.\13\ We are modifying the proposal and eliminating the proposed
current report for changes in unencumbered cash. Also, instead of
reporting in one business day, as proposed, the amendments will require
large hedge fund advisers to qualifying hedge funds to report as soon
as practicable upon, but no later than 72 hours after, the occurrence
of certain events that we believe may indicate significant stress or
otherwise serve as signals of potential systemic risk implications or
as potential areas for inquiry so as to mitigate investor harm.
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\13\ Currently, most private fund advisers report general
information on Form PF, such as the types of private funds advised
(e.g., hedge funds, private equity funds, or liquidity funds), fund
size, use of borrowings and derivatives, strategy, and types of
investors. Depending on their size, certain larger private fund
advisers report more detailed information on the qualifying hedge
funds, the liquidity funds and the private equity funds that they
advise on a quarterly or annual basis. In particular, three types of
``Large Private Fund Advisers'' must complete certain additional
sections of the current Form PF: (1) any adviser having at least
$1.5 billion in regulatory assets under management attributable to
hedge funds as of the end of any month in the prior fiscal quarter
(``large hedge fund advisers''); (2) any adviser managing a
liquidity fund and having at least $1 billion in combined regulatory
assets under management attributable to liquidity funds and money
market funds as of the end of any month in the prior fiscal quarter
(``large liquidity fund advisers''); and (3) any adviser having at
least $2 billion in regulatory assets under management attributable
to private equity funds as of the last day of the adviser's most
recently completed fiscal year (``large private equity fund
adviser''). A qualifying hedge fund is defined in Form PF as ``any
hedge fund 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 your
most recently completed fiscal quarter.''
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<bullet> Second, in a modification from the proposal, we are also
adopting event
[[Page 38148]]
reporting for all private equity fund advisers, which would include
quarterly reporting within 60 days after quarter ends for two of the
proposed current reporting items: (1) adviser-led secondary
transactions, and (2) general partner removals and investor elections
to terminate a fund or its investment period. We are requiring annual
large private equity fund adviser reporting, however, with respect to
general partner or limited partner clawbacks,\14\ which we had proposed
to be reported on a current basis by all private equity fund
advisers.\15\
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\14\ We have made a global modification in Form PF to replace
the term ``private equity adviser'' with ``private equity fund
adviser.'' We believe that ``private equity fund adviser'' is the
more precise term, but we do not view this modification as resulting
in substantive differences.
\15\ This item has also been moved from proposed section 6 to
section 4 because it is now an annual reporting item for large
private equity fund advisers.
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<bullet> Third, with modifications from the proposal, we are
adopting several additional reporting items as well as amendments to
require large private equity fund advisers to report more detailed
information regarding certain activities of private equity funds that
are important to the assessment of systemic risk and for the protection
of investors. We are also adopting tailored amendments to gather more
information from large private equity fund advisers regarding fund
strategies and use of leverage as well as other amendments. In a change
from the proposal, we are not adopting a lower $1.5 billion reporting
threshold for large private equity fund advisers for purposes of
reporting in section 4 and are instead retaining the existing $2
billion threshold.
The Commission proposed amendments that would have required large
liquidity fund advisers to report substantially the same information
that money market funds would be required to report on Form N-MFP under
the Commission's proposal to amend that form.\16\ However, we are
continuing to consider comments relating to the proposed large
liquidity fund adviser amendments--and the proposed amendments to Form
N-MFP on which they are based--and are not adopting amendments to Form
PF concerning large liquidity fund advisers at this time.
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\16\ See Money Market Fund Reforms, Investment Company Act
Release No. 34441 (Dec. 15, 2021) [87 FR 7248 (Feb. 8, 2022)]
(``Money Market Fund Proposing Release'').
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The amendments we are adopting are important enhancements to the
ability to monitor and assess systemic risk and to determine whether
and how to deploy the Commission's or FSOC's regulatory tools.\17\ The
amendments will also strengthen the effectiveness of the Commission's
regulatory programs, including examinations, investigations, and
investor protection efforts relating to private fund advisers. We
consulted with FSOC to gain input on these amendments to help ensure
that Form PF continues to provide FSOC with information it can use to
assess systemic risk.
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\17\ Accordingly, we are adopting the amendments the Commission
proposed in the 2022 Form PF Proposing Release at this time to
facilitate FSOC and the Commission's assessment of systemic events
and the Commission's investor protection efforts through current
reporting, and we are continuing to consider comments received in
connection with the 2022 Form PF Joint Proposing Release. See
discussion of compliance dates for respective sections of Form PF
infra at section II.E.
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II. Discussion
A. Current Reporting for Large Hedge Fund Advisers to Qualifying Hedge
Funds
We are adopting amendments that will require large hedge fund
advisers to file a current report with respect to one or more current
reporting events at a qualifying hedge fund that they advise.\18\ We
are modifying some of the proposed reporting events and eliminating the
proposed unencumbered cash current report while also extending the
reporting period from one business day to as soon as practicable, but
no later than 72 hours. Currently, large hedge fund advisers file Form
PF quarterly, which could cause Form PF data to be stale during fast
moving events that could have systemic risk implications or negatively
impact investors. The current reporting requirements for qualifying
hedge funds 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.\19\ 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. The
current reports will also enhance our analysis of information the
Commission 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. 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.
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\18\ As proposed and in connection with the addition of new
section 5 for current reporting, we are also making conforming
changes to rule 204(b)-1 under the Advisers Act to re-designate
current section 5, which includes instructions for requesting a
temporary hardship exemption, as section 6.
\19\ In a change from the proposal, we are replacing ``reporting
event'' with ``current reporting event'' in the Form PF Glossary to
highlight that these events are current events occurring at funds
specific to section 5 reporting. ``Current reporting events''
includes any event that triggers the requirement to complete and
file a current report pursuant to the items in section 5. We are
defining ``current report'' to include a report provided pursuant to
the items in section 5.
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Some commenters generally supported the requirement to provide
current reports for certain events that may signal systemic risk or
trigger certain investor protection concerns and some, in particular,
stated that the one business day requirement was necessary to formulate
an FSOC or Commission response to fast-moving market events.\20\ Other
commenters stated that some of the reporting items were not reflective
of systemic risk concerns and did not directly connect the proposed
reporting requirements with specific investor protection concerns.\21\
For example, two commenters stated that extraordinary investment losses
are not necessarily indicative of systemic risk and that losses are an
investment risk that should not be conflated with investor
protection.\22\
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\20\ See, e.g., PDI Comment Letter; AFREF Comment Letter; Mark
C. Comment Letter; Public Citizen Comment Letter; Anonymous Retail
Investor Comment Letter; Better Markets Comment Letter.
\21\ See, e.g., Comment Letter of SIFMA (Mar. 21, 2022) (``SIFMA
Comment Letter'') (stating that triggering events, like the
extraordinary loss current report, premised on investor protection
concerns such as ``large, sharp, and sustained losses'' should be
viewed as part of the investment risks associated with any
investing). See also IAA Comment Letter (stating that many of the
items proposed to be reported on a current basis will not assist the
Commission or FSOC in addressing systemic risk, that current
reporting is not necessary to meet the Commission's investor
protection goals, and that the Commission appears to conflate
investment protection with mitigation of investment risk and
losses).
\22\ Id.
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As discussed below, the current reporting events include
extraordinary investment losses, certain margin events, counterparty
defaults, material changes in prime broker relationships, operations
events, and certain events associated with redemptions. We
[[Page 38149]]
designed the current reporting events to indicate significant stress at
a fund that could harm investors or signal risk in the broader
financial system. For example, large investment losses or a margin
default involving one large, highly levered hedge fund may have
systemic risk implications. Counterparties to a fund in distress could
react by increasing margin requirements, limiting borrowing, or forcing
asset sales, and these responses could amplify the event and have
potential contagion effects on the broader financial system. Similarly,
reports of large investment losses at qualifying hedge funds (even if
not the largest or most levered) may signal market stress that could
have systemic effects.\23\ Current reports would be especially useful
during periods of market volatility and stress, when the Commission and
FSOC may receive a large number of current reports and ascertain the
affected funds and gather information to assess any potential contagion
or systemic impact. The Commission or FSOC may analyze the events and
organize outreach to the impacted entities, funds, counterparties, or
other market participants that the current reports and other data may
indicate could be next in a contagion circumstance. For example, if one
fund that was particularly concentrated in a deteriorating position or
strategy reported an extraordinary loss or was terminated by its prime
broker for reasons related to that position or strategy, Commission
staff could potentially conduct outreach to fund counterparties or
other similarly situated funds to assess whether any regulatory action
could mitigate the potential for contagion or harm to investors. Though
some commenters stated that the current reports were not properly
focused on systemic risk and would instead subject advisers to
regulatory examinations and enforcement actions, we continue to believe
that the potential seriousness of the events warrants the collection of
current reports that could indicate directly systemic risk and investor
protection concerns.\24\
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\23\ See, e.g., Better Markets Comment Letter (stating new
reporting requirements will allow regulators to determine whether an
issue at a private fund potentially signals deteriorating market
conditions that could cascade into a crisis, or whether an issue at
a private fund is itself indicative of a crisis already underway and
that, if the Commission or FSOC determines that a crisis is
underway, current reporting with details of fund assets, its
exposures, and its counterparties will give the Commission and FSOC
crucial information about where a crisis may spread).
\24\ See, e.g., AIMA/ACC Comment Letter (stating that the new
reporting requirements go beyond Congress' mandate and the current
Form PF Rule's stated objectives to foster the Commission's more
general objectives: data collection to support examinations, and its
regulatory and enforcement programs), and AIC Comment Letter
(additional information that is merely potentially useful to the SEC
as a compliance monitoring tool in administering its examination and
enforcement programs is not an appropriate justification for
significantly expanding reporting on Form PF and is inconsistent
with the primary purpose of Form PF and the intent of Congress).
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The current reporting events generally incorporate objective tests
to allow advisers to determine whether a report must be filed. In
response to comments, we either eliminated or further tailored the
current reporting events both to decrease the reporting burden and to
reduce the possibility of reporting ``false positives'' (i.e.,
incidents that trigger the proposed current reporting requirement but
do not actually raise significant risks) for events that may not
indicate the potential for systemic risk or investor harm.\25\ We also
addressed comments that indicated that we should limit or better
explain proposed current reporting triggers that use materiality
thresholds, like the proposed prime broker relationship termination and
operations event current reporting items, and instead simplify the
analysis required to determine if you need to report by making
reporting dependent on binary events.\26\ As a result, a number of the
items continue to include quantifiable threshold percentage tests or
have been further refined to trigger reporting for events that are
likely indicative of severe stress at a fund or may have broader
implications for systemic risk for which we seek timely information
while minimizing the potential for false positives and multiple
unnecessary current reports.
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\25\ In some instances our refinement of questions to include
more current statistics would also likely reduce the number of
``false negatives.''
\26\ See AIMA Comment Letter and SIFMA Comment Letter. Several
commenters pointed to National Futures Association (``NFA'')
Compliance Rule 2-50 as a form that provided more binary and limited
types of reporting. NFA Notice 9080--NFA Compliance Rule 2-50: CPO
Notice Filing Requirements. The Interpretive Notice is available at
<a href="https://www.nfa.futures.org/rulebooksql/rules.aspx?Section=9&RuleID=9080">https://www.nfa.futures.org/rulebooksql/rules.aspx?Section=9&RuleID=9080</a>. See also discussions infra at
sections II.A.4 and II.A.6.
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To supplement the objective triggers, several of the items include
check boxes, largely as proposed, that will provide additional context
and avoid requiring advisers to provide narrative responses during
periods of stress under time pressure. These check boxes will allow the
Commission and FSOC to review and analyze the current reports and
screen false positives during periods in which they may be actively
evaluating fast-moving market events and potentially prioritizing
responses to certain affected funds, counterparties, or other market
participants.
The adopted amendments will establish new section 5 that will
contain Items A through J. Section 5, Item A will require advisers to
identify themselves and the reporting fund, including providing the
reporting fund's name, private fund identification number, National
Futures Association identification number (if any), and Legal Entity
Identifier (if any).\27\ Section 5, Items B through I will set forth
the current reporting events and the applicable reporting requirements
for each event. Like the proposal, the amendments will have an optional
repository for explanatory notes in section 5, Item I that the adviser
may use to improve understanding of any information reported in
response to the other section 5 items. The following sections discuss
the timing for filing the current reports and each adopted current
reporting event.
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\27\ Form PF section 5, Item A would also require identifying
information on the reporting fund's adviser, including the adviser's
full legal name, SEC 801-Number, NFA ID Number (if any), large
trader ID (if any), and large trader ID suffix (if any), as well as
the name and contact information of the authorized representative of
the adviser and any related person who is signing the current
report.
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1. Timing of Hedge Fund Current Reports
In a change from the proposal, the amendments will extend the time
period for the filing of current reports. Instead of a one business day
filing requirement, large hedge fund advisers to qualifying hedge funds
are required to report as soon as practicable, but no later than 72
hours, upon the occurrence of certain events that we believe may
indicate significant stress or otherwise serve as signals of potential
systemic risk implications.
Some commenters expressed concern that the proposed requirement to
file reports within one business day to the Commission would be
burdensome and potentially lead to inaccurate or inadequate reporting
at a time when advisers and their personnel are grappling with a
potential crisis at the reporting fund.\28\ More specifically,
[[Page 38150]]
some commenters stated that advisers would need to develop complicated
internal operations capable of performing calculations on a daily basis
that may not be applicable to illiquid or hard-to-value assets and that
the resulting data may be of limited utility to regulators.\29\ One
commenter indicated that critical reporting of fast moving events could
be delayed by weekends or holidays.\30\ Some commenters suggested that
advisers could notify the Commission of the occurrence of current
reporting events using telephone or email in shorter time frames while
delaying current reporting on Form PF to a later date.\31\
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\28\ See, e.g., Comment Letter of the Institutional Limited
Partners Association (Mar. 21, 2022) (``ILPA Comment Letter'');
AIMA/ACC Comment Letter; Comment Letter of State Street Corporation
(Mar. 21, 2022) (``State Street Comment Letter''); Comment Letter of
National Venture Capital Association (Mar. 21, 2022) (``NVCA Comment
Letter''); RER Comment Letter; SIFMA Comment Letter; Comment Letter
of Schulte Roth & Zabel LLP (Mar. 21, 2022) (``Schulte Comment
Letter''); Comment Letter of the Investment Adviser Association
(Mar. 21, 2022) (``IAA Comment Letter''); NYC Bar Comment Letter;
REBNY Comment Letter.
\29\ See, e.g., SIFMA Comment Letter and USCC Comment Letter.
See also, infra discussion of daily fund value statistics in section
II.A.2.
\30\ See Comment Letter of Sarah A. (Mar. 11, 2022) (``Sarah A.
Comment Letter'') and AIMA/ACC Comment Letter.
\31\ See SIFMA Comment Letter and State Street Comment Letter.
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Receiving current reports on a timely basis will help address the
Commission's and FSOC's need, discussed above, for current information.
In order to allow advisers to qualifying hedge funds additional time to
evaluate and obtain the necessary data to confirm the existence of a
filing event, which will help improve the quality of the information
contained in the report, the amendments will require advisers to file
current reports for current reporting events as soon as practicable,
but no later than 72 hours, upon the occurrence of a reporting event
rather than one business day. We believe that shifting from a business
day approach to one measuring elapsed hours after an event will address
commenter concerns that critical reporting of fast moving events could
be delayed by weekends or holidays.\32\ We believe that this time
period properly balances commenters' concerns with the Commission's
need for timely information, while allowing advisers to collect
information within 72 hours that may not be readily ascertainable at
the event's immediate outset. The 72 hour period begins upon the
occurrence of the current reporting event, or the time when the adviser
reasonably believes that the event occurred, and, as proposed, the form
requires the adviser to respond to the best of its knowledge on the
date of the report. To illustrate, if an adviser determined that a
current reporting event occurred on Monday at noon, it would have to
file a current report, as soon as practicable, but no later than
Thursday before noon.
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\32\ See Sarah A. Comment Letter and AIMA/ACC Comment Letter. We
are amending Instructions 1, 3, 9, and 12 of the general
instructions to reflect this new obligation for large hedge fund
advisers. Specifically, we are amending Instruction 3 to identify
new section 5 and Instruction 9 to address the timing of filing the
current reports.
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By extending the time period from one business day to 72 hours, we
believe that an adviser will have sufficient time to identify events
and conduct sufficient analysis to review and file timely current
reports. Though some commenters stated that certain current reports
will be burdensome to establish systems and processes to identify
triggering events, in our experience, advisers to qualifying hedge
funds generally already maintain the sophisticated operations and
resources necessary to provide these reports. Moreover, changes we have
made to the metrics for the 20 percent extraordinary loss and margin
thresholds should alleviate concerns about the burdens and
uncertainties concerning the timely valuation of illiquid or hard-to-
value assets.\33\ Though some commenters suggested that current
reporting could include informal telephoning or emailing of the
Commission, we continue to believe that reporting through Form PF will
provide the Commission and FSOC with a systematic means through which
to assess the events underlying the reporting.\34\
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\33\ See discussion at infra sections II.A.2. and II.A.3.a.
\34\ Though we require filing reports using Form PF, we also
encourage engagement with Commission staff from registrants in
periods of stress or otherwise.
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Lastly, advisers will be able to file an amendment to a previously
filed current report to correct information that was not accurate at
the time of filing in the event that information in a current report
was inaccurate or was filed in error.\35\ In a change from the
proposal, to facilitate the filing of amendments, we are making a
change to include the time of filing to enable the identification of
previous filings.\36\
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\35\ Instruction 16 explains that an adviser is not required to
update information that it believes in good faith properly responded
to Form PF on the date of filing even if that information is
subsequently revised for purposes of the adviser's recordkeeping,
risk management or investor reporting (such as estimates that are
refined after completion of a subsequent audit).
\36\ See Form PF section 5, Item A. Item A also has an
additional change to require advisers to enter a CRD number to help
identify the adviser.
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2. Extraordinary Investment Losses
We are adopting, largely as proposed, current reporting to require
large hedge fund advisers, whose advised qualifying hedge funds
experience extraordinary losses within a short period of time, to
provide a current report describing the losses.\37\ In a change from
the proposal, 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''), which we
discuss further below, as opposed to the fund's most recent net asset
value (``MRNAV''), over a rolling 10-business-day period.\38\ This
current reporting event will capture, for example, a situation where
the fund's RFACV is $1 billion and the fund loses $20 million per
business day for a consecutive 10 business days. It will also capture a
loss of $200 million in one business day as the rolling 10-business-day
period is backward looking. We designed the threshold to capture a
significant loss at the reporting fund over a relatively short rolling
period as well as a precipitous loss without capturing immaterial
losses that may not be indicative of stress at the fund.
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\37\ See Form PF section 5, Item B.
\38\ The Commission proposed to include a definition for
``reporting fund aggregate calculated value'' in the 2022 Form PF
Joint Proposing Release. The comment letters on the 2022 Form PF
Joint Proposing Release (File No. S7-22-22) are available at <a href="https://www.sec.gov/comments/s7-22-22/s72222.htm">https://www.sec.gov/comments/s7-22-22/s72222.htm</a>. The RFACV statistic will
only apply to section 5 of Form PF.
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Some commenters supported the extraordinary loss event.\39\ One
commenter stated that a 20 percent loss over a 10-day period would be a
significant event for any hedge fund and may render some funds
insolvent.\40\ Other commenters questioned whether the 20 percent loss
threshold was truly significant or indicative of actual stress, and
stated that in volatile or broadly down markets, the Commission might
receive a large number of reports of limited value.\41\ Some commenters
questioned the Commission's use of MRNAV and stated that the Commission
base the loss threshold on a more current net asset value figure,\42\ a
net asset value figure compiled on a best efforts basis from their
evaluation of fair-valued assets and unaudited figures,\43\ or a month-
end net asset value.\44\
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\39\ See, e.g., Better Markets Comment Letter. See also ICGN
Comment Letter.
\40\ Better Markets Comment Letter.
\41\ See, e.g., AIMA/ACC Comment Letter. AIMA/ACC also stated
that the 20% threshold may not properly account for volatile market
strategies that funds may employ.
\42\ Comment Letter of Anonymous (Feb. 25, 2022). Two commenters
also criticized basing this threshold on a dated net asset value
figure. See SIFMA Comment Letter and MFA Comment Letter.
\43\ See MFA Comment Letter.
\44\ See Schulte Comment Letter and MFA Comment Letter.
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We continue to believe that the extraordinary loss current
reporting
[[Page 38151]]
event will capture critical periods of hedge fund stress. Accordingly,
we are adopting, as proposed, current reporting based on a 20 percent
loss but, in a change from the proposal, are establishing the threshold
by reference to the RFACV fund value statistic. As discussed below,
RFACV is a more current statistic than the MRNAV filed on Form PF and
will limit the potential for over or under-reporting. We believe that a
20 percent loss of RFACV over a 10-business-day period is sufficiently
high to avoid over-reporting during periods of relative market
stability, but sufficiently low that it avoids under-reporting during
periods of market stress.\45\ It is also our understanding that prime
brokers and other fund counterparties already track certain net asset
value triggers over varying periods and routinely build them into the
risk control provisions of their agreements (e.g., prime broker
agreements, total return swap agreements, or ISDA Master
Agreements).\46\ Such net asset value decline triggers typically range
from 10 percent to 25 percent declines over a 30 day period.\47\
Accordingly, we believe a 20 percent decline is appropriate considering
that such a decline may have triggered or nearly triggered a
contractual reporting threshold with credit and trading counterparties
who view net asset value triggers as potential early warning indicators
of hedge fund stress or potential liquidation. The reporting of large
losses will provide notice to the Commission and FSOC of potential fund
or market issues in advance of the occurrence of more downstream
consequences, such as sharp margin increases, defaults, fund
liquidations, or ramifications for other types of Commission
registrants.\48\ Such losses could signal a precipitous liquidation or
broader market instability that could lead to secondary effects,
including greater margin and collateral requirements, financing costs
for the fund, and the potential for large investor redemptions.
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\45\ See discussion of thresholds at infra section IV.C.1.a.
\46\ See, e.g., Poseidon Retsinas, How Fund Managers Can
Mitigate NAV Triggers' Impact on Trading Agreements, Hedge Fund Law
Report (May 14, 2020) (``HFL Report''), available at <a href="https://www.hflawreport.com/6769831/how-fund-managers-can-mitigate-nav-triggers-impact-on-trading-agreements.thtml">https://www.hflawreport.com/6769831/how-fund-managers-can-mitigate-nav-triggers-impact-on-trading-agreements.thtml</a>. See also discussion of
the 20% threshold infra at text accompanying footnote 323.
\47\ Id.
\48\ For example, a hedge fund's registered broker-dealer
counterparties may be subject to large losses, or registered
investment companies with similar portfoloio exposures, though not
necessarily as leveraged, might be at risk for future losses.
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Though commenters asserted that sharp broad-based market downturns
may lead to a large number of reports from advisers, we believe that
such reporting still will be useful to FSOC or the Commission during
market instability. Moreover, in singular events, large, sharp, and
sustained losses suffered by one fund within this short period may
signal potential concerns for similarly situated funds, allowing FSOC
and the Commission to analyze the scale and scope of the event and
whether additional funds that may have similar investments, market
positions, or financing profiles are at risk.
The amendments use RFACV as a reference statistic in response to
commenters' concerns that MRNAV was too dated of a statistic and could
result in false positives.\49\ RFACV also is responsive to commenters'
assertions that the reference value statistic be compiled on a best
efforts basis from an evaluation of fair-valued assets and unaudited
figures. 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 adviser's own methodologies and conventions
of the adviser's service providers, provided that these are consistent
with information reported internally.\50\ The RFACV is a signed value
calculated on a net basis and not on a gross basis. While the inclusion
of income accruals is recommended, the approach to the calculation
should be consistent over time.\51\ This calculation is similar to the
typical practices for computing daily profit and loss and generally
should include all items at their most recent, reasonable estimate,
which will be marked-to-market for all holdings that can reasonably be
marked daily. These value estimates are appropriate because they are
both guided by the reporting fund's valuation policies and procedures
that are shared with fund investors and counterparties and are
increasingly performed and provided by third-party administrators who
specialize in position-level valuation and reporting.\52\
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\49\ See Comment Letter of Anonymous (Feb. 25, 2022). Other
commenters also criticized basing this threshold on a dated net
asset value figure. See SIFMA Comment Letter and MFA Comment Letter.
\50\ See section IV.C.2 infra (discussing the risks of
unintended consequences of using RFACV statistics and the factors
that mitigate those risks including the sharing of valuation
policies with investors and that fund valuation is often outsourced
to fund service providers with standardized methodologies).
\51\ See Form PF Glossary. Those funds that do compute a daily
net asset value may use it as their reporting fund aggregate
calculated value. Where one or more portfolio positions are valued
less frequently than daily, the last price used should be carried
forward, though a current FX rate may be applied if the position is
not valued in U.S. dollars. It is not necessary to adjust the RFACV
for accrued fees or expenses. Position values do not need to be
subjected to fair valuation procedures. While the RFACV definition
permits funds to compute it excluding accrued fees and expenses, and
without updating less frequently valued positions, these are
optional, and intended to reduce burden for the funds. If the funds
already calculate net asset value without these modifications on a
daily basis, they can use it wherever RFACV is used.
\52\ See infra footnote 423.
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Using this statistic will be both more timely and less burdensome
than a requirement to calculate a daily net asset value, which would
necessarily require the adviser to make daily calculations of all of
the fund's assets and liabilities, including accrued fees and expenses.
Referencing a timelier statistic based on a daily estimate of the
fund's value will provide a more current and accurate picture of large
fund losses and also acknowledges that many funds do not perform daily
net asset value calculations, because they may only strike a net asset
value weekly, at month end, or at investor request, or because certain
of their portfolio assets are only valued on a periodic basis.\53\ The
use of RFACV will be less burdensome than a daily net asset value
figure to operationalize because, in our experience, it will rely on
systems that many large hedge fund advisers already employ, while not
requiring the adviser to adjust for accrued fees or expenses, subject
position values to fair valuation procedures, or include income
accruals. At the same time, we are allowing advisers to use their own
internal methodologies or those of their service providers when
calculating RFACV, provided that these are consistent with information
reported internally.
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\53\ Advisers utilizing RFACV should rely upon the information
available to them at that current point in time when filing this
item. For example, if reporting on Friday, and the reporting fund
knows it has a position mark that will not be updated until Sunday,
the adviser should generally rely on the Friday number for purposes
of the calculation and the determination of whether to file.
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Under this current reporting event, the revised Item B requires
reporting 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.'' In a change from the proposal,
``holding period return'' and ``daily rate of return'' are new terms in
the Form PF Glossary to help advisers calculate the daily rate-of-
return and link those daily returns together to calculate a cumulative
rate of return over the 10-day holding period to promote consistent
responses to the
[[Page 38152]]
current report.\54\ When triggered, an adviser must file the following
information: (1) the dates of the 10-business-day period over which the
loss occurred, (2) the holding period return, and (3) the dollar amount
of the loss over the 10-business-day period.\55\ If the loss continues
past the initial 10-business-day period, advisers will not report a
second time until the fund has experienced a second loss of an
additional 20 percent of the fund's RFACV over a second rolling 10-
business-day period to begin on or after the end date stated in the
adviser's initial Item B current report. This information will allow
the Commission and FSOC to understand the scale of the loss and its
potential effects both to investors in the reporting fund as well as
the broader financial markets, particularly if current reports are
filed by multiple advisers.
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\54\ ``Holding period return'' is defined in the Form PF
Glossary to mean the cumulative daily rate of return over the
holding period calculated by geometrically linking the daily rates
of return. Holding period return (%) = (((1 + R<INF>1</INF>) x (1 +
R<INF>2</INF>) . . . (1 + R<INF>10</INF>))-1) x 100 where
R<INF>1</INF>, R<INF>2</INF> . . . R1<INF>0</INF> are the daily
rates of return during the holding period expressed as decimals.
``Daily rate-of-return'' is defined as the percentage change in the
reporting fund aggregate value from one day to the next and adjusted
for subscriptions and redemptions, if necessary.
\55\ ``Dollar amount of loss over the 10-business-day period''
is defined in the Form PF Glossary to facilitate reporting of the
extraordinary loss current report and is equal to the reporting fund
aggregate value at the end of the 10-business-day loss period less
the reporting fund aggregate value at the beginning of the 10-
business day loss period less the net of any subscriptions or
redemptions during the 10-business-day period.
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3. Significant Margin and Default Events
We are adopting, largely as proposed, current reporting of
significant margin and default events that occur at qualifying hedge
funds advised by large hedge fund advisers or at their
counterparties.\56\ Significant increases in margin, inability to meet
a margin call, margin default, and default of a counterparty are strong
indicators of fund and potential market stress. The triggers and
underlying thresholds are calibrated to identify stress at a fund that
may signal the potential for precipitous liquidations or broader market
instability that may affect similarly situated funds, or markets in
which the fund invests.
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\56\ See Form PF section 5, Item C.
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a. Increases in Margin
We are requiring advisers to report significant increases in the
reporting fund's requirements for margin, collateral, or an equivalent
(collectively referred to as ``margin'') based on a 20 percent
threshold.\57\ In a change from the proposal, and consistent with our
adopted amendments to the extraordinary loss current report, we are
referencing a different fund value statistic, average daily RFACV.
Average daily RFACV is a more current statistic than MRNAV and,
accordingly, will increase the report's accuracy and limit the
potential for over- or under-reporting. In particular, in response to
commenters that stated that the daily computation of net asset value
may be burdensome, we selected average daily RFACV, because it is
comparatively less burdensome and does not require all the calculations
(e.g., adjustments for accrued fees and expenses or fair valuation
procedures) necessary for striking a daily net asset value.\58\ The
margin increase current report relies on RFACV outlined above in the
extraordinary loss section, but is the average of the daily RFACV for
the end of the business day on business days one through ten of the
reporting period. As with the use of RFACV in the extraordinary loss
current report, using the average daily RFACV will provide a more
current daily number from which to calculate margin increases as
opposed to using a dated net asset value statistic reported on Form PF
that may be in excess of 60 days old.
---------------------------------------------------------------------------
\57\ An equivalent is any other type of payment or value
understood to serve the same purposes as margin or collateral.
\58\ See discussion in supra section II.A.2.
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Current reporting of margin increases will provide 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. 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.
Some commenters supported the requirement as proposed.\59\ One
commenter stated that if the fund triggered a 20 percent margin
increase it could be indicative of a risk to investors in the fund and
should be reported.\60\ Others opposed it, stating that the 20 percent
threshold was too low or arbitrarily drawn without support,\61\ would
capture routine margin activity occurring in the normal course of
business,\62\ would likely cause excess reporting that would not be
indicative of fund stress, and relied on a dated net asset value
statistic that had the potential to induce either over or
underreporting.\63\ Other commenters expressed concern that the terms
``margin,'' ``collateral,'' or ``an equivalent'' were not clearly
defined.\64\
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\59\ Comment Letter of International Corporate Governance
Network (Mar. 21, 2022) (``ICGN Comment Letter''); AFREF Comment
Letter.
\60\ ICGN Comment Letter.
\61\ AIMA/ACC Comment Letter; IAA Comment Letter.
\62\ AIMA/ACC Comment Letter.
\63\ AIMA/ACC Comment Letter; SIFMA Comment Letter.
\64\ AIMA/ACC Comment Letter; MFA Comment Letter, SIFMA Comment
Letter.
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In response to commenters that questioned the 20 percent threshold
and its reliance on a dated MRNAV statistic, the amendments will
reference a more current value statistic while retaining the 20 percent
increase. We are triggering reporting on whether the total dollar value
of margin, collateral, or an equivalent posted by the reporting fund at
the end of a rolling 10-business-day period less the total dollar value
of margin, collateral, or an equivalent posted by the reporting fund at
the beginning of the rolling 10-business-day period is greater than or
equal to 20 percent of the average daily RFACV during the period.
We are adopting ``average daily reporting fund aggregate calculated
value'' as a new defined term in the Form PF Glossary to help advisers
calculate the amount of the margin increase and promote consistent
responses to the current report.\65\ This change away from the
reference net asset value statistic (MRNAV) should lessen under- and
over-reporting by providing a more current reference statistic,
decreasing the potential for false positives. In response to comments
that specifically questioned the 20 percent threshold, we believe a 20
percent increase based on the new RFACV statistic will improve our
ability to capture truly large and sudden margin increase events.\66\
Specifically, 20 percent is an appropriate threshold for reporting
increases in margin
[[Page 38153]]
because our experience and data suggests that a margin increase of this
magnitude as a percentage of a fund's market value could represent a
significantly higher percentage increase in margin itself.\67\ Given
that margin increases can happen quickly in volatile markets, reporting
limited to large margin defaults alone would not allow the Commission
and the FSOC to identify the extent of increasing liquidity constraints
among market participants which could impair market function.\68\
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\65\ The Form PF Glossary definition of ``average daily
reporting fund aggregate calculated value'' references the
``reporting fund aggregate calculated value'' that is utilized by
the Item B extraordinary loss question.
\66\ See supra section II.A.2. discussion of RFACV.
\67\ One estimate from the academic literature indicates that an
increase in margin or collateral of 20% of the average daily RFACV
over a ten-day period represents a substantially large increase in
the actual level of margin or collateral, which would have
potentially serious consequences for a fund depending on its
circumstances. Based on a sample of large hedge fund advisers'
qualifying hedge funds from Q4 2012 to Q1 2017, the paper finds that
the hedge funds in the sample had median collateral as a percentage
of borrowings of 121%, median borrowings of $.443 billion, and a
median NAV of $.997 billion. This indicates that a typical hedge
fund in the sample has collateral as a percentage of NAV of
approximately 54.1%. For such a hedge fund, an increase in margin/
collateral of 20% of RFACV represents an almost 40% increase in the
level of margin/collateral posted. See Mathias S. Kruttli, Phillip
J. Monin & Sumudu W. Watugala, The Life of the Counterparty: Shock
Propagation in Hedge Fund-Prime Broker Credit Networks, (Dec. 2022).
See also discussion of the margin increase threshold infra section
IV.C.1.a.
\68\ See Review of Margining Practices, Bank for International
Settlement, Basel Committee on Banking Supervision, Committee on
Payments and Market Structure, Board of International Securities
Commissions (Sept. 2022), available at <a href="https://www.bis.org/bcbs/publ/d537.htm">https://www.bis.org/bcbs/publ/d537.htm</a>.
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We continue to believe that the terms ``margin'' and ``collateral''
are general terms that will allow advisers to apply the reporting
trigger to their unique collateral requirements. Commenters requested a
more detailed definition of both ``margin'' and ``collateral,'' but
these terms are common terms for margin that we believe properly scope
the margin activity for which we seek reporting without potentially
narrowing or limiting reporting to certain types of margin requirements
specific to certain funds and their counterparty agreements.\69\ In our
experience, ``margin'' and ``collateral'' generally refer to assets and
cash that can be claimed by a fund counterparty, lender, or
clearinghouse if needed to satisfy an obligation. These terms refer
both to assets that have been physically transferred to an account
outside the fund as well as those that remain in the fund's accounts,
but have been identified by custodians, prime brokers, and fund
administrators as collateral for an obligation. The inclusion of ``or
an equivalent'' is designed to provide increased flexibility to account
for funds' unique circumstances. In the event advisers have unique
circumstances related to their margining practices and reporting of
margin increases, advisers may use the explanatory notes section to
explain their margin increase current report.
---------------------------------------------------------------------------
\69\ See AIMA Comment Letter and MFA Comment Letter.
---------------------------------------------------------------------------
The adviser will be required to report (1) the dates of the 10-
business-day period over which the increase occurred; (2) the total
dollar amount of the increase; (3) the total dollar value amount of
margin, collateral or an equivalent posted by the reporting fund at
both the beginning and the end of the 10-business-day period during
which the increase was measured (an addition from the proposal); \70\
(4) the average daily RFACV of the reporting fund during the 10-
business-day period during which the increase was measured (an addition
from the proposal); and (5) the identity of the counterparty or
counterparties requiring the increase(s). In a change from the
proposal, we are requiring the 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 to
provide FSOC and the Commission with a fund value statistic that
provides additional context for the margin increase. If the increases
in margin were to continue past the initial 10-business-day period,
advisers should not file another current report until on or after the
next 10-business-day period beginning on or after the end date stated
in the adviser's initial Item C current report. In circumstances where
multiple counterparties are involved, advisers will list all
counterparties who increased margin requirements. In addition, the
adviser must use check boxes to describe the circumstances of the
margin increase. Commenters stated that the margin increase item would
capture margin activity that was within business as usual operations.
As discussed above, this reporting item is triggered on a 20 percent
increase in margin, which we believe is a significant increase that
will not capture margin activity that is within business as usual
operations. In addition, the amended form contains clearly defined
check boxes for this item that will allow the Commission and FSOC to
understand the cause of the margin increase reports that may help
distinguish the levels of risk. These items are largely unchanged from
the proposal and include: (1) exchange or central clearing counterparty
\71\ requirements or known regulatory action affecting one or more
counterparties; (2) one or more counterparties independently increasing
the reporting fund's margin requirements; (3) the reporting fund
establishing a new relationship or new business with one or more
counterparties; (4) new investment positions, investment approach or
strategy and/or portfolio turnover of the reporting fund; (5) a
deteriorating position or positions in the reporting fund's portfolio
or other credit trigger under applicable counterparty agreements; and/
or (6) a reason ``other'' than those outlined that, in a change from
the proposal, will now require advisers to provide an explanation in
the explanatory notes section.\72\ This information, along with any
information advisers include in the explanatory notes section, will
provide useful context concerning the margin increase and will better
enable the Commission and FSOC to both screen false positives for
margin increases (i.e., incidents that trigger the proposed current
reporting requirement but do not actually raise significant risks) and
assess significant margin events.
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\70\ In a change from the proposal, we are requiring the total
dollar value amount of margin, collateral or an equivalent posted by
the reporting fund at the end of the 10-business-day period during
which the increase was measured rather than a cumulative figure. We
believe having the dollar value figure measured both at the
beginning and at the end of the 10-business day period will provide
more detailed and useful information to the Commission and FSOC.
\71\ In a change from the proposal, we are including ``central
clearing counterparty'' or ``CCP'' requirements in this check box to
reflect better the types requirements that can be imposed by central
counterparties or clearing houses and impact margin.
\72\ In a change from the proposal we are requiring advisers
that check ``other'' to provide an explanation of their use of other
in the explanatory notes section to provide additional context to
their current report.
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b. Fund Margin Default or Inability To Meet Margin Call
We are also requiring, as proposed, advisers to report a fund's
margin default or inability to meet a call for margin, collateral, or
an equivalent (taking into account any contractually agreed cure
period).\73\ Quickly identifying such events is important because funds
that are in margin default or that are unable to meet a call for margin
are at risk of triggering the liquidation of their positions at their
counterparties, and this presents serious risks to the fund's
investors, its
[[Page 38154]]
counterparties, and potentially the broader financial system.
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\73\ See Form PF section 5, Item D. In situations where there is
a contractually agreed upon cure period, an adviser will not be
required to file an Item D current report until the expiration of
the cure period, unless the fund does not expect to be able to meet
the margin call during such cure period.
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A commenter supported reporting related to margin defaults or
inability to meet a call for margin if it was limited to circumstances
where there was a written notice of default because counterparty
agreements typically require written notice of default, and written
notice provides a bright line test for determining whether a default
occurred.\74\ The same commenter also stated that only large defaults
in excess of 5 percent of a fund's last reported net asset value
adjusted for subscriptions and redemptions should be reported to avoid
the possibility of immaterial defaults.\75\ Other commenters asserted
that if the Commission did adopt any of the current reporting items, it
should focus on margin defaults and the inability to satisfy
redemptions, as both were events that signaled potential stress to the
financial sector by contributing to fire sales and counterparty
exposure risk.\76\ Another commenter stated that other market
participants like major broker-dealers, banks, or other counterparties
could more readily provide this information to the Commission.\77\
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\74\ See MFA Comment Letter.
\75\ Id.
\76\ See, e.g., AIMA Comment Letter.
\77\ NYC Bar Comment Letter.
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We are largely adopting this item, as proposed, because margin
defaults or a determination of an inability to meet margin calls are
risk events that may portend liquidation events that could trigger
systemic risk or harm investors. While commenters indicated that we
should limit this reporting to large margin defaults or collect this
information from other market participants or registrants, we do not
believe doing so would capture key indicators of fund risk. Default
events in certain trades, strategies, or positions will provide insight
into whether funds or counterparties facing similar positions may be at
risk. Reporting limited to large margin defaults, conversely, may not
provide the FSOC with sufficiently early or fulsome information to
identify and help prevent potential contagion. Furthermore, we believe
it is important to receive this confidential reporting directly from
the advisers to these large qualifying hedge funds on Form PF, because
a fund's broker-dealer or bank counterparties may only have limited
visibility into a fund's stress rather than a comprehensive picture of
a fund's overall counterparty risks. In addition, we believe that
limiting reporting to only written notifications of a default may
incentivize funds or their counterparties to avoid written notice of
default, particularly when it may be less clear a party is in default.
The amendments, like the proposal, will continue to require advisers to
file a current report in situations where there is a dispute with
regard to the margin call to avoid delays in reporting. Advisers will
not be required to file a current report in situations where there is a
dispute in the amount and appropriateness of a margin call, provided
the reporting fund has sufficient assets to meet the greatest of the
disputed amount. According this flexibility allows funds and advisers
that are capable of meeting a margin call time to respond to and
resolve a margin dispute with their counterparties.
Under the amendments, an adviser will report for each separate
counterparty for which the event occurred: (1) the date the adviser
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;
(2) the dollar amount of the call for margin, collateral, or
equivalent; and (3) the legal name and LEI (if any) of the
counterparty. In addition, the adviser will check any applicable check
boxes that would describe the adviser's current understanding of the
circumstances of the adviser's default or its determination that the
fund will be unable to meet a call for increased margin.\78\ These
include: (1) an increase in margin requirements by the counterparty;
(2) losses in the value of the reporting fund's portfolio or other
credit trigger under the applicable counterparty agreement; (3) a
default or settlement failure of a counterparty; or (4) a reason
``other'' than those outlined for which the adviser will be required to
provide further information in the explanatory notes item.\79\ These
check boxes will enable the Commission and FSOC to identify and
evaluate the circumstances underlying the inability to meet a call for
margin. If the fund is unable to meet margin or defaulted with multiple
counterparties on the same day, the adviser will file one current
report broken out with details for each counterparty.
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\78\ Form PF section 5, Item D, Question 15.
\79\ In a change from the proposal we are requiring advisers
that check ``other'' to provide an explanation of their use of
``other'' in the explanatory notes section to provide additional
context to their current report.
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c. Counterparty Default
The amendments, like the proposal, will require advisers to report
a margin, collateral or equivalent default or failure to make any other
payment in the time and form contractually required by a
counterparty.\80\ Counterparty defaults can have serious implications
for transacting funds, the funds' investors, and the broader market. A
current report of a counterparty default will help the Commission and
FSOC identify funds or market participants that may be affected by a
counterparty's default and analyze whether there are broader
implications for systemic risk or investor protection.
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\80\ See Form PF section 5, Item E.
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One commenter supported the reporting of counterparty defaults,\81\
while others believed this item should only capture larger counterparty
defaults that accounted for a greater portion of the fund's net asset
value than the proposed 5 percent threshold.\82\ Some commenters stated
that there should not be a percentage threshold associated with the
counterparty defaults and that, if a percentage was relied upon, the
Commission's five percent threshold was too low.\83\ Another commenter
argued that counterparty default reporting should not be required for
all types of market participants, but should be limited to regulated
broker-dealers and banks, while noting that the net asset value
calculation for counterparty defaults should be amended to a timelier
figure that accounts for interim subscriptions and redemptions.\84\
Other commenters stated that the triggers for a counterparty default
notification differ from the default provisions utilized in industry
standard documents and that the definitions and default provisions in
the standard documents be expressly incorporated into Form PF
triggers.\85\
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\81\ AFREF Comment Letter.
\82\ See, e.g., SIFMA Comment Letter; AIMA/ACC Comment Letter;
IAA Comment Letter; and NYC Bar Comment Letter.
\83\ See, e.g., AIMA/ACC Comment Letter and NYC Bar Comment
Letter.
\84\ MFA Comment Letter.
\85\ NYC Bar Comment Letter.
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We are adopting the counterparty default event with minor
amendments as counterparty defaults to hedge funds of the size of
qualifying hedge funds would be central to any analysis of systemic
risk or potential risk of investor harm. A single hedge fund
counterparty, such as a large broker dealer, may have dozens of fund
counterparties that may be subject to a pending default. Though some
commenters stated that certain definitions and default provisions in
industry standard documents should be expressly incorporated into the
counterparty default current report trigger, based on our review of
certain industry contracts we believe the
[[Page 38155]]
adopted reporting item will broadly capture default reporting triggers
in many contracts. We also believe, given the variability we observed
in industry contract default triggers, that it would be impractical to
design a default trigger in the form that matches industry documents.
A current report for this item will be triggered if a counterparty
to the reporting fund (1) does not meet a call for margin or has failed
to make any other payment, in the time and form contractually required
(taking into account any contractually agreed cure period); and (2) the
amount involved is greater than five percent of RFACV. While we are not
adopting a minimum threshold for reporting on a qualifying hedge fund's
margin default given the potential implications of such a default, we
are adopting a threshold for counterparty defaults that could affect a
sizeable percentage of the fund's value. However, in response to
comments that the MRNAV was not reflective of the current value of the
fund, we are amending this item to reference the more current RFACV
statistic that is employed in the extraordinary loss and margin event
items.
While some commenters believed the five percent default trigger to
be too low, we believe that the five percent of the timelier RFACV
statistic is an appropriate threshold to trigger reporting because
counterparty defaults of this size could have systemic waterfall
effects, triggering forced-selling by the fund and identifying
potential risks for other hedge funds that may transact with the same
counterparty.\86\ Moreover, the five percent threshold is a figure we
have used in Form PF to measure and collect information regarding
sizable exposures to creditors or counterparties.\87\ We understand it
also represents an often-used industry practice for measuring
significant exposure at both the position level and the counterparty-
exposure level. A default at this level could be a sign of issues at
both the fund and counterparty making it well suited for systemic risk
monitoring. Even if a five percent default is insignificant at a fund
level, a high number of such reports across a number of hedge funds can
be significant systemically, especially if it involves similar
counterparties. Setting the threshold for counterparty defaults at five
percent of the RFACV would limit the reports for de minimis or
superficial defaults that may be the result of a short-lived
operational error. We are not limiting reporting to defaults that occur
only at regulated broker-dealer and bank counterparties because there
are circumstances where large defaults with non-regulated market
participants, such as foreign entities or private special purpose
entities, may have direct impacts on the reporting fund and broader
implications for systemic risk.
---------------------------------------------------------------------------
\86\ See Financial Stability Oversight Council, Update on Review
of Asset Management Products and Activities (Apr. 2016), at 15-18,
available at <a href="https://www.treasury.gov/initiatives/fsoc/news/Documents/FSOC%20Update%20on%20Review%20of%20Asset%20Management%20Products%20and%20Activities.pdf">https://www.treasury.gov/initiatives/fsoc/news/Documents/FSOC%20Update%20on%20Review%20of%20Asset%20Management%20Products%20and%20Activities.pdf</a> (noting that large highly interconnected
counterparties play a role in whether hedge fund activities have
financial stability implications).
\87\ See current question 47 of Form PF: Identify each creditor,
if any, to which the reporting fund owed an amount in respect of
borrowings equal to or greater than 5% of the reporting fund's net
asset value as of the data reporting date. For each such creditor,
provide the amount owed to that creditor.
---------------------------------------------------------------------------
The amendments will require an adviser to report: (1) the date of
the default; (2) the dollar amount of the default; and (3) the legal
name and LEI (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 adviser 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 adviser would file a
separate current report for each counterparty default that occurred. We
did not provide check boxes for this item, because advisers to the
funds are unlikely to have complete information regarding their
counterparty's default and the responses would likely be speculative.
4. Prime Broker Relationship Terminated or Materially Restricted
The prime broker current report we proposed would have required an
adviser to report a material change in the relationship between the
reporting fund and a prime broker.\88\ In response to comments, we are
adopting a modified reporting item to require an adviser to report only
the termination or material restriction of the reporting fund's
relationship with a prime broker.\89\ We have narrowed the focus of
this current report trigger to exclude relationship changes that could
be initiated by the fund for business reasons that may not be
indicative of fund or market stress.
---------------------------------------------------------------------------
\88\ See 2022 Form PF Proposing Release, supra footnote 6, at
section II.A.1.c.
\89\ See Form PF section 5, Item F.
---------------------------------------------------------------------------
Some commenters supported a current report for material changes in
the prime broker relationship.\90\ Others opposed it, stating that
prime brokers and funds would have difficulty discerning what
constituted a ``material'' change in the relationship,\91\ that both
parties may terminate relationships for ordinary business reasons that
are not indicative of fund or counterparty stress,\92\ and that the
Commission only should require reporting when the prime broker or the
fund terminates the relationship for default or breach of the
agreement, which would serve as a bright line.\93\ Other commenters
argued that the prime broker current reporting event was unnecessary or
duplicative of the margin default current report \94\ and, therefore,
should be removed.\95\ Another commenter stated that starting or
terminating a relationship with a prime broker occurs on a frequent
basis and is not an indication of potential stress at the fund but, in
most instances, is based on business imperatives.\96\
---------------------------------------------------------------------------
\90\ ICGN Comment Letter; AFREF Comment Letter.
\91\ See, e.g., AIMA/ACC Comment Letter; MFA Comment Letter; NYC
Bar Comment Letter; IAA Comment Letter; and USCC Comment Letter.
\92\ See, e.g., AIMA/ACC; MFA Comment Letter; NYC Bar Comment
Letter; IAA Comment Letter; and SIFMA Comment Letter.
\93\ AIMA/ACC Comment Letter.
\94\ See supra section II.A.3.
\95\ See, e.g., AIMA/ACC Comment Letter and IAA Comment Letter.
\96\ AIMA/ACC Comment Letter.
---------------------------------------------------------------------------
After considering comments that expressed concern with the broad
scope of reporting any ``material change'' in the relationship with a
prime broker, we generally are narrowing the prime broker reporting
items from what was proposed by requiring reporting under two separate
instructions. The first instruction requires reporting when the prime
broker terminates the agreement or ``materially restricts its
relationship with the fund, in whole or in part, in markets where that
prime broker continues to be active.'' For example, if a prime broker
will no longer conduct certain trades on behalf of a U.S. fund in a
particular market, like a major foreign equities market, this, in our
view, would constitute a ``material restriction.'' On the other hand,
if the same prime broker ceases activities in a market for all
customers, this should not trigger a current report for an individual
fund affected by this action. To address commenters who expressed
concern that discerning a ``material change'' was difficult, we believe
a material restriction generally would include a prime broker imposing
substantial changes to credit limits or significant price increases, or
stating that it ceases to support the fund in an important market or
asset type, even if it does not terminate the relationship. We are not
limiting this reporting trigger to
[[Page 38156]]
terminations, because there are certain circumstances indicating
potential stress or investor protection concerns in which a prime
broker may not explicitly terminate the relationship, but rather that
significantly limits the fund's ability to operate.
The prime broker current report includes a new second instruction
that captures instances where there is a fund termination event as well
as a cessation of the relationship whether initiated by the prime
broker or the fund. The change narrows the circumstances that can give
rise to a report as the instruction states that termination events, as
specified in the prime broker agreement or related agreements that are
isolated to the financial state, activities, or other conditions solely
of the prime broker should not be considered for purposes of the
current report. Thus, a termination would need to be fund-specific and
would not be reportable if the adviser understands that the termination
was a part of a widespread change applicable to other of the prime
broker's clients and isolated to the financial state, activities, or
other characteristics solely of the prime broker. By narrowing the
prime broker reporting items from the proposal, advisers would not be
required to report when funds terminate or materially restrict prime
broker relationships for ordinary course business reasons and would
limit reporting to prime broker terminations or material restrictions
that we believe are most clearly linked to potential fund stress and
resulting systemic risk.
We also believe it is appropriate to leverage prime broker
agreements to capture termination events that indicate stress at a
fund. These agreements typically contain provisions, the violation of
which may indicate stress at a fund, but may not as a matter of
industry practice be immediately enforced resulting in the termination
of the agreement or relationship between the prime broker and the
reporting fund.\97\ In our experience we believe it is important to
capture circumstances in which a fund has, for example, repeatedly
breached margin thresholds and is technically in default, but the prime
broker has not terminated the relationship, and at a later date asks
the fund to find prime brokerage services elsewhere. Accordingly, the
item will also require an adviser to report a termination of the
relationship between the prime broker and the reporting fund if the
relationship between the prime broker and the reporting fund was
terminated in the last 72 hours or less in accordance with the section
5 current reporting period, and a ``termination event'' was activated
in the prime brokerage agreement, or related agreements, within the
last 12 months.\98\ By leveraging the prime broker agreement, or other
related agreements with termination events in the trigger for
reporting, we will capture non-routine terminations that may be
indicative of stress at a fund including, for example certain ``key
man'' provisions, like the departure of a manager. While funds and
their prime brokers might terminate their relationship over ordinary
business terms, this current report will capture terminations or
material restrictions that might indicate more serious issues for a
fund. Lastly, this current reporting event is tied to termination
events that may have been triggered in the past 12 months in
recognition that a termination may take time to become finalized after
a termination event was activated.
---------------------------------------------------------------------------
\97\ Similarly, we requested comment on prime broker agreements,
specifically whether the agreements include termination events
related to net asset value triggers. We did not receive specific
comments on whether prime broker agreements specifically include
termination events related to net asset value triggers. We do not
believe it is necessary to include specific references to
terminations related to net asset value triggers in the prime broker
current report because, in our experience, net asset value triggers
are included in some agreements already, but may not be used in many
agreements depending upon the types of fund and strategies involved.
\98\ Under this reporting item the 72-hour time period within
which an adviser must report would begin to run upon the occurrence
of the termination or a material restriction or when the
adviserreasonably believed such an event occurred.
---------------------------------------------------------------------------
This current report will allow the Commission and FSOC, for
example, to assess whether a particular termination would have a
greater or lesser impact on the broader market or on investors and
better understand what potentially caused the termination. Though some
commenters stated the prime broker current report was duplicative of
the margin default current report, we continue to believe that a prime
broker-specific question is necessary in addition to the margin default
current report because prime broker terminations may signal stress that
did not lead to a margin default or may indicate other potential
investor protection issues.
Terminations or material restriction of a reporting fund's prime
brokerage relationships of this type may signal that the fund or the
brokers with whom the fund transacts are experiencing stress and may be
subject to an increased risk of default or, in the case of the
reporting fund, potential liquidation. In addition, a prime broker that
is no longer willing to provide services to a fund client could be
apprehensive of a fund's investment positions or trading practices and
may consider the fund to be an unacceptable risk as a counterparty.
Therefore, material restrictions upon such relationships may indicate
potential stress at the fund that may have implications for investor
harm and broader systemic risk concerns. In a modification from the
proposal, the prime broker reporting item will require an adviser to
provide the date of the termination or material restriction, the date
of the termination event(s) if different, and the legal name and LEI
(if any) of the prime broker involved. We are not adopting the check
boxes that we proposed, because they are no longer needed in light of
the narrower focus of the report on terminations or material
restrictions. However, the explanatory notes item is available if
advisers would like to provide more details. Lastly, the item will
include a new note stating that if a prime broker changes the terms of
its relationship with the reporting 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, the
adviser should consider it a ``material restriction'' that would
require filing of the prime broker current report.\99\ We believe this
note is necessary to ensure that certain circumstances that amount to
an effective ``firing'' of the fund are captured by the current report.
Moreover, in response to commenters that had generally asserted that a
``material change'' to the prime broker agreement would be difficult to
determine when considering filing this item, we are providing this note
to provide specificity as to when there is a ``material restriction.''
---------------------------------------------------------------------------
\99\ See Form PF section 5, Item F.
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5. Changes in Unencumbered Cash
In a departure from the proposal, we are not adopting a requirement
that an adviser report a significant decline in holdings of
unencumbered cash. In the proposal, a current report for changes in
unencumbered cash would have been triggered if the value of the
reporting fund's unencumbered cash declined by more than 20 percent of
the reporting fund's most recent net asset value over a rolling 10-
business-day period.
Some commenters supported the inclusion of this item, stating that
unencumbered cash was an important metric for understanding hedge fund
stability.\100\ Other commenters
[[Page 38157]]
challenged it, primarily on the grounds that it would capture new
investments or routine cash movements in certain strategies resulting
in some funds filing numerous reports over the course of a year.\101\
Another commenter also stated that the definition of ``unencumbered
cash'' in Form PF is inconsistent with how most advisers would
calculate unencumbered cash internally.\102\ Another commenter stated
that the 2022 Form PF Joint Proposing Release's change of the
definition of ``cash equivalents'' that excluded U.S. Treasury
securities would create confusion for advisers seeking to comply with
an unencumbered cash current report.\103\
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\100\ AFREF Comment Letter and ICGN Comment Letter.
\101\ See, e.g., AIMA/ACC Comment Letter; SIFMA Comment Letter;
IAA Comment Letter; Schulte Comment Letter; TIAA Comment Letter; and
MFA Comment Letter.
\102\ AIMA/ACC Comment Letter.
\103\ See MFA Comment Letter (Mar. 16, 2023) (stating that the
proposed definition of ``cash equivalents'' was inconsistent with
how financial markets generally and advisers treat short-term
Treasury securities for risk management and cash management
purposes).
---------------------------------------------------------------------------
We are not adopting this item after considering comments received,
including those commenters that stated the unencumbered cash current
report may result in a large number of false positives related to
certain transactions that occur in the normal course of some
strategies. For example, commenters stated that changes in unencumbered
cash to purchase highly liquid sovereign bonds or to transfer cash
between U.S. Treasuries and sovereign debt would result in a fund
submitting 30-70 reports a year to the Commission.\104\ Though we still
believe that unencumbered cash levels could serve as a marker for fund
health in periods of market volatility or stress, receiving such a
potentially large number of reports annually that may not be indicative
of fund stress does not align with our policy goals for current
reporting. For example, it may be difficult to distinguish quickly for
reporting purposes between increases of unencumbered cash that could be
attributable to ordinary course trading activity versus substantial
increases or decreases that are a direct result of fund losses or cash
transactions that the fund undertook in response to increased market
volatility. An additional difficulty is that different types of
strategies utilize very different unencumbered cash levels making it
difficult to find a single unencumbered cash indicator that is
meaningful, without many false positives and negatives. Lastly, other
current reporting items, especially the extraordinary loss, margin, and
prime broker questions, will provide real time insight into fund stress
and hedge fund stability, at which this proposed question was aimed.
---------------------------------------------------------------------------
\104\ MFA Comment Letter.
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6. Operations Events
The proposed operations event current report would have required an
adviser to report when the adviser or reporting fund experiences a
``significant disruption or degradation'' of the reporting fund's ``key
operations,'' whether as a result of an event at the reporting fund,
the adviser, or other service provider to the reporting fund.\105\
Under the proposal, key operations would have meant operations
necessary for (1) the investment, trading, valuation, reporting, and
risk management of the reporting fund; as well as (2) the operation of
the reporting fund in accordance with the Federal securities laws and
regulations. The proposal also would have defined ``significant
disruption or degradation'' to mean a 20 percent disruption or
degradation of normal volume or capacity. We are adopting, with certain
changes from the proposal, the requirement for an adviser to report
when the adviser or reporting fund experiences a ``significant
disruption or degradation'' of the reporting fund's ``critical
operations,'' whether as a result of an event at the reporting fund,
the adviser, or other service provider to the reporting fund.\106\ As
discussed below, in light of comments received, we are not adopting the
proposed 20 percent threshold for the ``significant disruption or
degradation'' definition.
---------------------------------------------------------------------------
\105\ See 2022 Form PF Proposing Release, supra footnote 6, at
section II.A.1.e.
\106\ See Form PF section 5, Item G. The Operations Events
report was initially proposed as Item H.
---------------------------------------------------------------------------
We continue to believe that an operations event involving a
qualifying hedge fund could have systemic risk implications if the fund
is not able to trade as a result of such an event. In addition, notice
of operations events from multiple advisers could provide an early
indicator of market-wide operations events to both the Commission and
FSOC. Such events could include a service provider outage that may
affect the ability of multiple funds to trade, leading to negative
implications for those funds' investors and broader systemic risks.
Some commenters generally supported the Commission's receiving
current reports about operations events that affected private fund
advisers, their funds, and their service providers.\107\ For example,
one commenter stated that operations events should be the subject of
reporting because they can have systemic risk implications while also
supporting the Commission's policy goal of investor protection.\108\
Others took issue with the proposal defining a ``significant disruption
or degradation'' as a ``20% disruption or degradation of normal volume
or capacity,'' generally arguing that quantifying the scale of a
disruption would be both difficult and operationally burdensome.\109\
Some commenters indicated that the operations event item would be too
difficult to respond to in one day under what may be potentially
difficult operational circumstances in which the origin of the problem
may still be undiscovered.\110\ One commenter objected to the inclusion
of service providers in the item, stating that naming a service
provider in a filing to the Commission could violate confidentiality
agreements or open the adviser or fund to legal liability from their
service providers.\111\ Other commenters stated that we should only
require reporting in the event that an adviser initiated a disaster
recovery or business continuity plan.\112\ Some commenters questioned
whether Form PF was the appropriate place for operations event
reporting, stating that the Form PF operations event item may
potentially conflict with, or be duplicative of, the Commission's
proposal relating to cybersecurity risk management.\113\ One such
commenter asserted that the operations item's timing for reporting
conflicted with the Commission's recent cybersecurity proposal and also
did not properly reflect the dichotomy between adviser and fund-level
events, stating that events involving severe weather or cybersecurity
issues appear to be adviser-level events as opposed to the other
proposed key events, which are all fund-level specific.\114\ Another
[[Page 38158]]
commenter indicated that there were broad trends from other legislative
and regulatory initiatives that the Commission should draw from in its
approach to operations event reporting to help ensure Commission
reporting works consistently with these other requirements.\115\ The
same commenter requested that, if the Commission adopted the operations
report, it provide an additional mechanism to provide updates on the
status of the significant disruption or degradation so as to provide
ongoing details and eventual notice to the Commission and FSOC of the
event's resolution.
---------------------------------------------------------------------------
\107\ AFREF Comment Letter and ICGN Comment Letter.
\108\ See CRINDATA Comment Letter.
\109\ See, e.g., AIMA/ACC Comment Letter; CRINDATA Comment
Letter; ICGN Comment Letter; MFA Comment Letter; IAA Comment Letter;
Schulte Comment Letter; and SIFMA Comment Letter.
\110\ See, e.g., AIMA/ACC Comment Letter; NYC Bar Comment
Letter; and IAA Comment Letter.
\111\ AIMA/ACC Comment Letter.
\112\ See, e.g., Schulte Comment Letter; IAA Comment Letter; and
MFA Comment Letter.
\113\ See generally AIMA/ACC Comment Letter; USCC Comment
Letter; Comment Letter of CRINDATA, LLC (Mar. 21, 2022) (``CRINDATA
Comment Letter''). See Cybersecurity Risk Management for Investment
Advisers, Registered Investment Companies, and Business Development
Companies, Advisers Act Release No. 5956 (Feb. 9, 2022) [87 FR 13524
(Mar. 9, 2022)].
\114\ AIMA/ACC Comment Letter, at 25 (stating that in another
Commission proposal, Cybersecurity Risk Management, Strategy,
Governance, and Incident Disclosure, certain advisers are required
to disclose information, on amended Form 8-K, about a cybersecurity
incident within four business days after it has determined that it
has experienced a material cybersecurity incident).
\115\ See CRINDATA Comment Letter. The letter discussed the
recent enactment of the Cyber Incident Reporting for Critical
Infrastructure Act of 2022 (``CIRCIA''). See Cyber Incident
Reporting for Critical Infrastructure Act of 2022, H.R. 2471, 116th
Cong. (2022). The letter also discussed the 2021 Department of the
Treasury and banking regulators rule. See Office of the Comptroller
of the Currency, the Board of Governors of the Federal Reserve
System, and the Federal Deposit Insurance Corp., Computer-Security
Incident Notification Requirements for Banking Organizations and
Their Bank Service Providers (Nov. 18, 2021) [86 FR 66424 (Nov. 23,
2021)].
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In response to comments, we are adopting much of the operations
event current report as proposed, but are making two modifications: (1)
re-titling ``key operations'' to be ``critical operations''; and (2)
not adopting the definition of a ``significant disruption or
degradation'' which contained the 20 percent threshold. In response to
commenter concerns that the operations item may be conflating adviser
and fund-level events, we believe that the check boxes and associated
reporting fund census data collected from Item A of the current report
will allow us to properly determine whether this is an adviser-wide
issue or fund-specific. We believe it is important to include adviser
events in the operations report, because it will allow the Commission
and FSOC to determine quickly whether all, or just some, of an
adviser's funds or other systems are significantly disrupted or
degraded. Moreover, we believe that by including the adviser and the
reporting fund in the current report, the report will be more tailored
and capture situations in which only certain of an adviser's reporting
funds will have suffered a significant disruption or degradation. For
example, this could include a situation in which only one of an
adviser's funds are impacted by an outage at a pricing provider that
values certain asset types specific to that fund's portfolio. In
addition, we acknowledge that there are other government cybersecurity
initiatives and our own proposed cybersecurity rulemaking as raised by
commenters.\116\ However, this reporting requirement relates to
operations events that go beyond cybersecurity, and receiving such
private fund specific operations event reporting with this
particularity will inform the FSOC's and Commission's assessment of
systemic risk and investor protection efforts.
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\116\ See supra footnote 113.
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In response to commenters' concerns that operations events may be
difficult both to discern and accurately report within one business
day, we are, as discussed above, extending the reporting period from
one business day to as soon as reasonably practicable, but no later
than 72 hours upon the occurrence of the event. In such circumstances,
with this additional time, an adviser likely will be able to ascertain
more information about the operations event and its impact(s) on the
reporting fund. As a result, and to alleviate commenter concerns, the
report will serve as an expedient means of notifying the Commission and
FSOC with salient information about potential stress events rather than
an alert that would need to be updated.
While some commenters stated that naming a service provider in
operations reporting could open a fund or adviser to liability, we
believe that identifying which service provider is contributing to the
impairment of a reporting fund's operations may have implications for
other advisers and funds that utilize the same service provider, the
identification of which is critical for FSOC's ability to monitor
systemic risk.\117\ Moreover, Form PF is a non-public confidential
reporting form, and any current reports identifying service providers
involved in an operations event would be reported on a confidential
basis.
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\117\ AIMA/ACC Comment Letter.
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We are not triggering an operations current report only upon the
initiation of a business continuity or disaster recovery plan as there
are certain internal operations scenarios that may be indicative of
fund stress, but may not necessarily cause an adviser to initiate firm-
wide disaster or business continuity plans.\118\ For example, there are
situations that do not involve natural disasters or force majeure
events, but involve more isolated adviser or fund specific events that
would not trigger a business continuity plan like when certain key
persons that are integral to certain of a fund's operations or certain
trading systems or software are unavailable and the adviser or fund is
unable to perform its critical operations without them. The current
report will include, as proposed, the check the box reporting to
indicate whether the adviser has initiated a disaster recovery or
business continuity plan relating to the operations event as this will
provide greater context to the nature of the operations event and its
impact on the adviser and fund.
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\118\ One commenter stated that a business continuity plan would
not appear to be a good proxy for receiving information sought by
the operations event report. See CRINDATA Comment Letter.
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Rather than ``key operations,'' in a change from the proposal, we
will use a different term, ``critical operations,'' but maintain
substantially the same underlying definition that we had proposed.
``Critical operations'' better reflects the nature and types of events
for which we seek reporting. For this purpose, critical operations are
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 the Federal
securities laws and regulations.\119\ In response to commenters'
concerns about the practicality of the 20 percent threshold, we are not
adopting the definition of a ``significant disruption or degradation''
which contained the threshold. After considering comments, we
understand there may be circumstances where it would be difficult to
quantitatively measure disruptions in critical operations. While we are
not adopting the numeric threshold, we continue to believe that, in
circumstances where operations are reasonably measurable, a 20 percent
disruption or degradation of normal volume or capacity generally might
be indicative of the types of stress for which reporting may be
necessary.
[[Page 38159]]
We understand that many large hedge fund advisers maintain
sophisticated back office operations, or already engage service
providers that reasonably would be able to measure whether an event has
impaired their critical operations beyond a 20 percent threshold. For
example, in most cases, operations event reporting would likely be
required if a software malfunction at the adviser disrupted the trading
volume of a reporting fund by 20 percent or more of its normal
capacity. This item will require reporting in cases where an adviser's
ability to value the fund's assets is significantly disrupted or
degraded, for example, in connection with operational issues at a
service provider. As another example, events such as a severe weather
event causing wide-spread power outages that significantly disrupt or
degrade critical operations also would require reporting.
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\119\ While the proposed definition of ``key operations''
included operations that are ``necessary for (1) the investment,
trading, valuation, reporting, and risk management of the reporting
fund; and (2) the operation of the reporting fund in accordance with
the Federal securities laws and regulations'' (emphasis added), the
Commission intended for each provision of the definition to be
considered a key operation. See 2022 Form PF Proposing Release,
supra footnote 6, at n.39 and accompanying text (``Key operations
means, for this purpose, operations necessary for (1) the
investment, trading, valuation, reporting, and risk management of
the reporting fund; as well as (2) the operation of the reporting
fund in accordance with the Federal securities laws and
regulations'' (emphasis added)). Accordingly, we are clarifying the
definition of ``critical operations'' by defining the term as
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 the Federal
securities laws and regulations'' (emphasis added). See Form PF
Glossary.
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As proposed, the operations event current report will require the
date of the operations event (or an estimate of when it occurred), and
the date the operations event was discovered. Also largely as proposed,
the operations event current report will require the adviser to provide
additional information concerning its current understanding of the
circumstances relating to the operations event and its impact on the
normal operations of the reporting fund using check boxes.\120\ These
include whether: (1) the event occurred at a service provider; \121\
(2) the event occurred at a reporting fund or reporting fund adviser or
a related person; (3) the event is related to a natural disaster or
other force majeure event; or (4) an unlisted ``other'' event occurred
for which the adviser will be required to provide further information
in the explanatory notes item.\122\ In addition, this current report
would require an adviser to indicate whether it has initiated a
business continuity plan relating to the operations of the adviser or
reporting fund as we believe this may provide additional appropriate
context to the operations event.
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\120\ Form PF section 5, Item H, Questions 26 through 28.
\121\ If the event occurred at a service provider, an adviser
also must report the legal name of the service provider; the service
provider's LEI, if any; and the types of services provided by the
service provider.
\122\ As noted above, in a change from the proposal we are
requiring advisers that check ``other'' to provide an explanation of
their use of other in the explanatory notes section to provide
additional context to their current report.
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As proposed, the operations event current report also will require
the adviser to check a box to describe its current understanding of the
impact of the operations event on the normal operations of the
reporting fund, including whether the event resulted in the disruption
or degradation of: (1) trading of portfolio assets; (2) the valuation
of portfolio assets; (3) the management of the reporting fund's
investment risk; (4) the ability to comply with applicable laws, rules,
and regulations; or (5) any ``other'' type of operational impact than
those outlined, which an adviser is required to explain further in the
separate explanatory notes item. We continue to believe that these
explanatory check boxes, along with the separate explanatory notes item
should advisers need to provide more detailed reporting, will provide
appropriate context to current reports filed for operations events and
allow the Commission and FSOC to evaluate quickly the potential level
of risk to funds, advisers, and their service providers.
7. Large Withdrawal and Redemption Requests, Inability To Satisfy
Redemptions, or Suspensions of Redemptions
We are adopting, largely as proposed, reporting for large
withdrawal and redemption requests, inability to satisfy redemptions or
withdrawals, and suspensions of redemptions or withdrawals.\123\ These
current reports will provide more detailed and timely information to
the Commission and FSOC indicating the potential for investor harm,
forced selling in liquidations, or broader systemic risk.
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\123\ See Form PF, section 5 Items H and I.
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a. Withdrawal and Redemption Requests
We are adopting the large withdrawals and redemptions current
report, largely as proposed. The current report will require an adviser
to report if the fund receives cumulative requests for withdrawals or
redemption exceeding 50 percent of the most recent net asset value
(after netting against subscriptions or other contributions from
investors received and contractually committed).\124\ We believe that
the obligation to redeem sizable withdrawal or redemption requests of
50 percent or more of a reporting fund's most recent net asset value,
despite pre-existing gates or limitations, may present significant
risks to the fund and increases the risk that it may be forced to
liquidate assets (potentially at lower prices), disproportionately
penalizing non-redeeming investors, and potentially impacting markets
more broadly.\125\
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\124\ As with the proposed use of ``most recent net asset
value'' in other circumstances described above, this measure could
result in over-reporting or under-reporting, but we believe that a
simple to determine measure would ease the monitoring and reporting
burden for advisers. In addition, the option for an adviser to add
explanatory notes to its current report to explain the circumstances
surrounding the redemptions mitigates these concerns.
\125\ See George O. Aragon, Tolga Ergun, Mila Getmansky & Giulio
Girardi, Hedge Funds: Portfolio, Investor, and Financing Liquidity,
DERA White Paper (May 17, 2017), available at <a href="https://www.sec.gov/files/dera_hf-liquidity.pdf">https://www.sec.gov/files/dera_hf-liquidity.pdf</a> (discussing hedge fund liquidity and the
impact of redemptions).
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Some commenters supported reporting for large withdrawal or
redemption requests of 50 percent or more,\126\ while another commenter
felt it was an arbitrary and unsupported.\127\ Others stated that
withdrawals or redemptions of this magnitude may occur in the ordinary
course, and the 50 percent threshold might therefore produce ``false
positives'' in certain cases, such as single investor funds with large
institutional investors, changes in client preference or commercial
considerations, or scheduled structured withdrawals or
redemptions.\128\ One commenter believed that the current reporting
event should have a minimum $1 billion threshold, asserting that $250
million in redemptions for a minimally sized $500 million qualifying
hedge fund is a relatively low number of systemic risk monitoring.\129\
This commenter also suggested this reporting trigger not disregard any
pre-existing gates or limitations as these often serve to prevent
sudden large redemptions and such reports will significantly distort
the risk posed by notified redemptions. The same commenter also
asserted that the redemptions current report did not address the
mismatch in timing between redemption requests, which are normally
given anywhere from 30 to 90 days before the applicable redemption
date, and subscriptions, which are usually contracted for in the two to
five day period prior to the subscription date meaning that advisers
would not be able to net subscriptions against redemption requests
before having to report.\130\
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\126\ AFREF Comment Letter (stating that by some estimates
redemption requests leading up to the financial crisis indicated
that a quarter of the hedge fund industry sold 40% or more of their
equity portfolios and the average hedge fund during that time sold
about 30% of its equity portfolio).
\127\ AIMA/ACC Comment Letter.
\128\ See, e.g., AIMA/ACC Comment Letter; SIFMA Comment Letter;
MFA Comment Letter; and NYC Bar Comment Letter.
\129\ MFA Comment Letter.
\130\ MFA Comment Letter.
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We are maintaining the 50 percent threshold, as proposed. We
continue to believe, and some commenters support, that funds receiving
such large withdrawal or redemption requests in
[[Page 38160]]
between routine quarterly reports on Form PF may be subject to
increased selling and liquidity pressures that could be particularly
harmful to investors and may contribute to the potential for broader
market implications, especially if the fund is invested in illiquid
assets and engages in a fire sale of assets.\131\ The 50 percent
threshold represents what we believe is well accepted as a substantial
withdrawal that could threaten the fund's health and potentially
markets if it requires substantial portfolio sales. Indeed, one
commenter that disagreed with the scope of the withdrawal and
redemptions event for the assessment of systemic risk acknowledged such
a withdrawal could indicate a run on a fund or stress at a particular
fund.\132\ Another commenter stated that substantial redemptions at a
fund could signal that external or internal events are causing
investors to lack confidence in the fund's adviser and that, if the
fund is not able to handle the redemptions without selling assets,
other investors that remain in the fund could be seriously harmed.\133\
Moreover, we do not believe that this item should have a $1 billion
floor as substantial withdrawals from multiple qualifying hedge funds
could indicate systemic risk that we believe warrants monitoring even
if such withdrawals are less than $1 billion at an individual
qualifying hedge fund. We designed this item to capture large dollar-
value redemption requests and avoid capturing routine redemptions in
the ordinary course.
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\131\ AFREF Comment Letter. See also MFA Comment Letter. MFA
noted that subject to certain conditions it supported the
50%withdrawal threshold, but that there should be a minimum dollar
threshold of $1 billion to trigger reporting.
\132\ NYC Bar Comment Letter.
\133\ ICGN Comment Letter.
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We considered the comment that this reporting item should not
disregard pre-existing gates or other liquidity limitations. However,
requests for redemptions of this size can have impacts despite
liquidity limitations. For example, if it is public knowledge that a
fund is facing large redemptions, other investors may submit
withdrawals, which will pressure a gated fund to liquidate or lead to a
flood of asset sales once the gate is lifted due to pent up redemption
pressures. If an adviser believes a report may be a ``false positive''
and the large withdrawals are occurring in the ordinary course of
business for the fund, advisers may indicate the circumstances behind
the large withdrawal(s) in the explanatory notes item. In addition, an
event that one fund may consider a ``false positive'' may be more
systemically significant if the conditions triggering it are amassed
across a number of qualifying hedge funds. Commenters stated that a
mismatch in timing between redemption requests and subscriptions could
distort reporting of this item, but withdrawals or redemptions in
excess of 50 percent in spite of subscriptions would still be a notable
event for which notice would provide the Commission and FSOC with
important insight.\134\ Based on the above, timely notice of such
events in this current report will allow the Commission and FSOC to
analyze the potential implications for the fund's investors and
systemic risks should such withdrawals or redemptions precipitate
large-scale liquidations.
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\134\ MFA Comment Letter.
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Under the withdrawals and redemptions current report, an adviser
will enter: (1) the date on which the net redemption requests exceeded
50 percent of the most recent net asset value; (2) the net value of
redemptions paid from the reporting fund between the last data
reporting date (the end of the most recently reported fiscal quarter on
Form PF) and the date of the current report; (3) the percentage of the
fund's net asset value the redemption requests represent; and (4)
whether the adviser has notified the investors that the reporting fund
will liquidate.
b. Inability To Satisfy Redemptions or Suspension of Redemptions
We are adopting, largely as proposed, the requirement for an
adviser to report if a qualifying hedge fund is unable to satisfy
redemptions, or suspends redemptions for more than five consecutive
business days. We have modified the form text from the proposal to
state that an adviser would report in either of two cases: if the
reporting fund (1) is unable to pay redemption requests, or (2) has
suspended redemptions and the suspension lasts for more than 5
consecutive business days. One commenter stated that the proposed item
was indicative of significant distress that could potentially lead to
counterparty losses and that the five consecutive business day
qualification period would appropriately limit reporting of temporary
redemption suspensions that would have less of an impact on investors
or the broader market.\135\ Another commenter suggested that the
trigger for reporting a failure to pay redemption requests should be
five days following the due date specified for payment of redemption
proceeds under a fund's governing documents and that hedge funds
typically have a specified timeframe for paying redemption requests,
and a filing should be triggered under this current report only after
this timeframe has passed if a redemption remains unsatisfied.\136\
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\135\ AIMA/ACC Comment Letter.
\136\ MFA Comment Letter.
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This reporting item will help the Commission and FSOC identify
stress at a reporting fund and evaluate the effects of these
circumstances on fund investors and the markets more broadly. We
recognize that redemptions are governed by preexisting terms and
conditions outlined in fund contracts and governing documents. However,
we are not modifying the item in response to commenters stating that
reporting should be triggered only after the period specified for
payment of redemption proceeds under a fund's governing documents
because reporting should be based on whether, as a factual matter, the
fund has suspended redemptions for a period of five consecutive
business days or not. The reporting of inability to satisfy redemptions
or a prolonged suspension of redemptions will provide a potential early
warning of the fund's liquidation and potentially allow the Commission
or FSOC to analyze or respond to any perceived harm to investors or
systemic risks on an expedited basis before they worsen. The five
consecutive business day period for suspensions is properly balanced so
as to limit reporting of temporary redemption suspensions that we
believe have less of an impact on investors or the broader market.
Under this current report, the adviser is required to report: (1) the
date the reporting fund was unable to pay redemption requests or
suspended redemptions; (2) the percentage of redemptions requested and
not yet paid; and (3) whether the adviser has notified the investors
that the reporting fund will liquidate.
8. Explanatory Notes
We are adopting the explanatory notes item, largely as proposed.
This item will allow an adviser to provide a narrative response if it
believes that additional information would be helpful in understanding
the information reported in the current report(s). Current reports may
benefit from additional context so that the Commission and FSOC can
effectively evaluate them. This approach is consistent with other
current reports filed with the Commission, where registrants have
requested the flexibility to provide additional narrative information
relating to the
[[Page 38161]]
circumstances surrounding the current report.\137\
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\137\ See Part H of Form N-RN.
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There were limited comments on this item. One commenter stated that
this information would be helpful in understanding the information
reported in response to any item in section 5, but that it is unlikely
to be helpful if operations events do not require additional
elaboration in the narrative response section.\138\ As discussed above,
we believe the operations event and its underlying reporting fields
will capture enough data so as to enable the Commission and FSOC to
assess the event properly in circumstances where advisers do not think
a narrative response would be helpful. However, in certain
circumstances where advisers check an ``other'' box we are now
requiring advisers to provide an additional explanation in the
explanatory notes section. We believe that requiring additional context
for the ``other'' items will allow the Commission and FSOC to assess
current reports, and especially the operations event item, more
readily. As reporting under this section is largely optional outside of
instances where they check ``other'', commenters will not need to
respond to this item if additional elaboration is not helpful. The same
commenter also stated that subsequent updates to the current report
should provide more detail, including when the event is resolved. We
are not, however, adopting a follow-up option for operations event
reports as these current reports' primary purpose is advance notice of
a potential systemic risk event or potential harm to investors.
---------------------------------------------------------------------------
\138\ CRINDATA Comment Letter.
---------------------------------------------------------------------------
B. Quarterly Private Equity Event Reports for All Private Equity Fund
Advisers
In a change from the proposal, we are modifying section 6 of the
proposed Form PF to be filed on a quarterly basis rather than on a
current basis and moving one of the proposed private equity event
reports to annual reporting in section 4.\139\ Under the proposal,
private equity adviser current reporting events included: (1) execution
of an adviser-led secondary transaction, (2) implementation of a
general partner or limited partner clawback, and (3) investor election
to remove a fund's general partner or to terminate a fund's investment
period or a fund. We will require reporting of the adviser-led
secondaries event and the investor election to remove a fund's general
partner or to terminate a fund's investment period or a fund event, but
in a change from the proposal, we are moving the general partner or
limited partner clawbacks event to section 4, where it will be reported
on an annual basis with the other large private equity fund adviser
reporting.\140\ The section 6 reports will be termed ``private equity
event reports'' and advisers will file these reports within 60 days
after the end of their fiscal quarters.\141\ If a private equity event
did not occur during a particular quarter, then an adviser would not be
required to file a section 6 report for that quarter. Receiving this
information on a quarterly basis will provide timely notice of these
private equity events and important information for the Commission's
regulatory programs, including examinations, investigations, investor
protection efforts, and policy relating to private fund advisers. It
also will improve the Commission and FSOC's ability to evaluate
material changes in market trends at the reporting funds by providing
information on certain events that could significantly affect both
investors and markets more broadly.
---------------------------------------------------------------------------
\139\ All private equity advisers will need to report if any of
these events occurred during the applicable quarter for each private
equity fund they advise. Private equity fund advisers must only
report each instance of a reporting event once on the section 6
filing that covers the quarter in which such instance occurred. It
is not necessary to report the same instance of a reporting event
again on future section 6 filings.
\140\ See discussion infra in section II.D.1.
\141\ See Form PF Glossary (definition of ``private equity event
reports'').
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Some commenters agreed that collecting this information from all
private equity fund advisers would be beneficial \142\ by, for
instance, providing meaningful information to the Commission's
oversight efforts \143\ and improving the Commission's and FSOC's
ability to react to market events.\144\ Other commenters argued that
the proposal did not sufficiently demonstrate how this information is
connected to systemic risk \145\ or how the Commission would use this
information to uphold investor protection.\146\ One commenter stated
that there was little justification for one business day reporting for
both the adviser-led secondary transactions event and the removal of a
general partner, termination of the investment period or termination of
a fund event and advocated for extending the time period.\147\
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\142\ See, e.g., ILPA Comment Letter; ICGN Comment Letter; and
Comment Letter of the Private Equity Stakeholder Project (Mar. 21,
2022) (``PESP Comment Letter'').
\143\ See ILPA Comment Letter.
\144\ See PESP Comment Letter.
\145\ See, e.g., AIMA Comment Letter and Schulte Comment Letter.
\146\ See, e.g., AIMA Comment Letter; NVCA Comment Letter; and
AIC Comment Letter.
\147\ See, e.g., AIMA Comment Letter.
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Several commenters asserted that a one-business-day reporting
requirement may be unnecessary in certain instances for these private
equity event reports. While some commenters recognized the importance
of timely reporting through a one-business-day reporting regime for the
events set forth in the proposal,\148\ a number of other commenters
criticized the proposed one-business-day reporting as being
unnecessarily onerous.\149\ Several commenters requested, as an
alternative, an annual reporting requirement for these events.\150\
Other commenters supported changing section 6 reporting from current
reporting to quarterly reporting if there was an event to report, and
that this delay would not diminish the Commission's ability to
investigate and, if appropriate, respond to protect investors.\151\
Some commenters stated that some of the reporting events can occur in
the ordinary course of business and do not require urgent action.\152\
---------------------------------------------------------------------------
\148\ See, e.g., ICGN Comment Letter and PESP Comment Letter.
One commenter requested that we consider using calendar days instead
of business days to avoid delays in reporting. See Sarah A. Comment
Letter.
\149\ See, e.g., MFA Comment Letter and AIC Comment Letter.
\150\ See, e.g., Comment Letter of Ropes and Gray LLP (Mar. 21,
2022) (``Ropes & Gray Comment Letter'') (recommending that if the
Commission wishes event reporting on adviser-led secondaries, it be
included as part of the regular annual reporting of large private
equity advisers on Form PF) and IAA Comment Letter (generally
objecting to the reporting of the current event items for private
equity fund advisers but saying any reporting of such items should
at a minimum be moved to section 4 of Form PF for annual reporting
by large private equity fund advisers).
\151\ See, e.g., NVCA Comment Letter (suggesting the Commission,
instead of requiring current reports for private equity fund
advisers, require quarterly event reports filed 60 days after the
end of each fiscal quarter if those events occur) and MFA Comment
Letter (suggesting quarterly reporting).
\152\ Id.
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After considering comments, we are requiring all private equity
fund advisers reporting on Form PF to file reports on a quarterly basis
upon (1) execution of an adviser-led secondary transaction, or (2)
investor election to remove a fund's general partner or to terminate a
fund's investment period or a fund, rather than within one business day
after a reporting event as proposed.\153\ We recognize that removal of
a general partner or the termination of a fund's investment period or a
fund may result from a stress event at a fund,
[[Page 38162]]
but this may not come into effect until after the stress event occurs.
For example, we understand that such an event could involve a
longstanding decline in performance, a disagreement concerning the
direction of the fund, or the replacement of key fund personnel, all of
which are events that may have serious implications for investors, but
would not necessarily indicate urgent harm or imminent systemic risk
that would necessitate a current report. We also acknowledge that some
adviser-led secondary transactions, may not inherently indicate that a
fund is in urgent distress, and that such transactions do not occur
rapidly, thus creating less of a need for a current report.\154\ We
remain concerned, however, that some of these events, which include a
higher potential for conflicts of interest or fund distress generally
may signal an investor protection issue at a particular fund. Moreover,
these reports will enable the Commission to assess trends in these
reporting events that may signal the exacerbation of conflicts of
interest within the private equity industry. Though we are adopting
quarterly reporting, we did consider requiring private equity fund
advisers to file current reports within 72 hours instead of one
business day as proposed. After considering comments, we view these
reporting items as likely to reveal trends that emerge more slowly as
compared to hedge funds because private equity funds typically invest
in more illiquid assets over longer time horizons with more limited
redemption rights.\155\ Thus, we believe that requiring reporting of
these events on a quarterly basis appropriately balances the effects
and burdens of imposing these reporting obligations on private equity
fund advisers \156\ while also enhancing the Commission's investor
protection efforts and FSOC's ability to monitor for systemic risk.
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\153\ As discussed below, we are requiring reporting of the
implementation of a general partner or limited partner clawback on
an annual basis from large private equity fund advisers. See infra
Section II.D.1.
\154\ See, e.g., Ropes & Gray Comment Letter and IAA Comment
Letter.
\155\ See discussion infra in section IV.B.2.
\156\ See infra section IV.C.2 for a more detailed discussion of
the changes in these anticipated costs.
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Both of these reporting triggers are important events for a fund,
and each one raises distinct conflicts of interest, which we discuss in
greater detail below. As one example, we understand an investor
election to terminate a fund's investment period is often tied to a
change in how management fees are calculated for the remainder of the
fund's life. Specifically, following the termination of an investment
period, management fees generally ``step down'' to a percentage of
invested capital, rather than a percentage of aggregate capital
commitments. An adviser that fails to effectively administer such a
change may overcharge management fees--a deficiency that the staff has
observed in numerous instances.\157\ Requiring reporting of these key
events on a quarterly basis will allow the Commission to better
identify such events and more carefully evaluate when conflicts of
interests may be harming investors. In addition, because removals of
general partners, terminations of a fund or its investment period, and
adviser-led secondaries represent a significant potential for conflicts
of interest and other sources of investor harm, we are not limiting
reporting to only large private equity advisers in the annual reporting
presented in Section 4. By requiring reporting of these events from all
private equity fund advisers the Commission will receive broader
reporting coverage of such transactions across the private equity
industry to target its examination program more efficiently and better
identify areas in need of more timely regulatory oversight and
assessment, which should increase both the efficiency and effectiveness
of its programs and, thus, increase investor protection.\158\
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\157\ Risk Alert, Observations from Examinations of Private Fund
Advisers (Jan. 27, 2022) available at <a href="https://www.sec.gov/files/private-fund-risk-alert-pt-2.pdf">https://www.sec.gov/files/private-fund-risk-alert-pt-2.pdf</a> (noting that EXAMS staff observed
private fund advisers that did not follow practices described in
fund disclosures regarding the calculation of the fund-level
management fee during a private fund's Post-Commitment Period. EXAMS
staff observed that such failures resulted in investors paying more
in management fees than they were required to pay under the terms of
the fund disclosures).
\158\ See discussion infra at section IV.C.1.b.
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A few commenters requested additional private equity current
reporting events, including where the adviser has indemnified itself
from covering any penalties and/or legal costs and other ``for-cause''
key events.\159\ While these events can be significant for a fund, we
do not believe they are as critical for the FSOC to monitor systemic
risk or for the Commission's investor protection efforts and may be
difficult to tailor for reporting purposes. Indemnification for
penalties and/or legal costs can cover a litany of scenarios. It would
likely be difficult to compare a specific indemnification event against
another and, as a result, may be hard to determine greater trends in
the financial condition of the private equity industry. Similarly, a
``for-cause'' key event can include a broad range of events that are
difficult to compare. Trends in some of these events across large
private equity fund advisers may be related to systemic risk and some
of these events may relate to investor protection, but some--adviser-
specific poor performance, for example--may be idiosyncratic. The
reporting triggers we are adopting, on the other hand, are better
tailored to our overall policy goals.
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\159\ See, e.g., ILPA Comment Letter and PESP Comment Letter.
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Some commenters requested an exception for reporting events that
occur in the ordinary course of a private equity fund adviser's
business that are not suggestive of or do not give rise to concerns
related to market stress or risks to investors.\160\ While we
acknowledge that some of these reporting events may not indicate a
stress event for an individual fund, monitoring these events will
support the Commission's investor protection efforts by better
informing the Commission's regulatory programs while assessing trends
in the aggregate frequencies of these reporting events across the
private equity industry will enhance FSOC's monitoring of systemic
risk. While a single adviser-led secondary transaction may not be
significant on its own, an increase in the number of these transactions
across the private equity industry could be significant.
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\160\ See, e.g., Ropes & Gray Comment Letter and IAA Comment
Letter.
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1. Adviser-Led Secondary Transactions
We are adopting proposed section 6 Item B, requiring private equity
fund advisers to report any adviser-led secondary transactions, but
with reporting on a quarterly basis within 60 days of the end of each
fiscal quarter.\161\ This item requires reporting upon the completion
of an adviser-led secondary transaction, including the transaction
closing date and a brief description of the transaction. As proposed,
we are defining ``adviser-led secondary transaction'' as any
transaction initiated by the adviser or any of its related persons
\162\ 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 adviser or any of its
related persons.\163\ Transactions are only subject to reporting if
they are initiated by a private equity fund's
[[Page 38163]]
adviser or a related person of the adviser.\164\
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\161\ See Form PF Section 6, Item B.
\162\ See Form PF Glossary (definition of ``related person'').
\163\ See Form PF Glossary (definition of ``adviser-led
secondary transaction'').
\164\ Whether a transaction is initiated by the adviser or its
related persons requires a facts and circumstances analysis.
However, we generally do not view a transaction to be initiated by
the adviser or one of its related persons to the extent the adviser
or one of its related persons, at the unsolicited request of an
investor, participates in the secondary sale of such investor's fund
interest.
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Some commenters supported the requirement to report adviser-led
secondary transactions, including some that agreed that this reporting
requirement will help the Commission fulfill its investor protection
role.\165\ Other commenters argued that adviser-led secondary
transactions are not historically connected to systemic risk, and that
they can represent a strengthening market in certain cases.\166\
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\165\ See, e.g., Better Markets Comment Letter and PDI Comment
Letter.
\166\ See, e.g., AIMA Comment Letter; AIC Comment Letter; and
USCC Comment Letter.
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We acknowledge that an adviser-led secondary transaction can
indicate strength in a particular investment in certain cases. For
instance, we understand an adviser-led secondary transaction can be
used to extend or add on to a successful investment.\167\ Nonetheless,
adviser-led secondary transactions typically reflect a deviation from
the traditional life cycle of a private equity investment. In some
instances, an adviser may use an adviser-led secondary transaction to
attempt to restructure an investment portfolio that is struggling.\168\
In other instances, an adviser may use an adviser-led secondary
transaction to extend an investment beyond the contractually agreed
upon term of the fund that holds it.\169\ In either case, an adviser-
led secondary transaction can have a meaningful impact on the liquidity
profile of a private equity investment and/or the private equity fund
that held it originally. Additionally, we understand that these
transactions may present conflicts of interest that merit timely
reporting, particularly those conflicts that arise because the adviser
(or its related person) is on both sides of the transaction with
potentially different economic incentives.\170\ As an example, in the
continuation fund context, an investor may be forced to liquidate a
position it would otherwise wish to retain if it is unable to
adequately conduct diligence or negotiate the terms of the continuation
fund before its election is due. Requiring quarterly reporting of these
complex transactions will allow the Commission to identify when such
events have occurred and more carefully evaluate whether conflicts of
interests have harmed investors.
---------------------------------------------------------------------------
\167\ See, e.g., Ropes & Gray Comment Letter. See also, GP-led
Secondary Fund Restructurings, Considerations for Limited and
General Partners, Institutional Limited Partners Association (Apr.
2019), available at <a href="https://ilpa.org/wp-content/uploads/2019/04/ILPA-Guidance-on-GP-Led-Secondary-Fund-Restructurings-Apr-2019-FINAL.pdf">https://ilpa.org/wp-content/uploads/2019/04/ILPA-Guidance-on-GP-Led-Secondary-Fund-Restructurings-Apr-2019-FINAL.pdf</a>.
\168\ See, e.g., Rae Wee, Turnover surges as funds rush to exit
private equity stakes, Reuters (Dec. 18, 2022) available at <a href="https://www.reuters.com/business/finance/global-markets-privateequity-pix-2022-12-19/">https://www.reuters.com/business/finance/global-markets-privateequity-pix-2022-12-19/</a>.
\169\ See, e.g., Madeline Shi, Investors up allocation to
secondaries as GPs seek alternative liquidity sources, PitchBook
(Sep. 15, 2022) available at <a href="https://pitchbook.com/news/articles/investor-secondaries-growth-alternative-liquidity">https://pitchbook.com/news/articles/investor-secondaries-growth-alternative-liquidity</a>.
\170\ We recognize that other types of conflicted transactions,
such as investment-level cross transactions, often raise important
conflicts of interest. However, we view adviser-led secondaries as
presenting significant, intrinsic conflicts of interest due to their
nature as fund-level conflicted transactions that often affect all
investor capital in a fund.
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Additionally, adviser-led secondary transactions can have
implications for systemic risk assessment as they have become
increasingly common in the private equity industry in recent years, and
therefore could represent changes in the liquidity of the private
equity market. For example, to the extent that an upward trend in
adviser-led secondary transactions reflects a reduction in the
liquidity of the private equity market stemming from private equity
fund advisers' inability to sell portfolio companies to third-party
buyers (or to sell those companies at existing valuations),
transactions of this nature could be an indicator of a deflating
investment bubble that may be important in informing systemic risk
assessment. This quarterly event reporting will provide the Commission
and FSOC with timely data regarding the frequency and circumstances
surrounding these transactions and allow the Commission and FSOC to
better assess market trends and potential market impacts.
One commenter stated that adviser-led secondary transactions can
raise conflicts of interest, but that such conflicts of interest can be
mitigated through thoughtful processes, disclosure and investor or
advisory board consent where necessary.\171\ While thoughtful
processes, disclosure and investor or advisory board consent can be
helpful, in the Commission's experience, they are not always utilized
and, even when used, do not always ameliorate investor protection
concerns. For example, it is the Commission's observation that
investors are often given very short timeframes in which to choose
whether to cash out of their investment or participate in an adviser-
led secondary transaction. Investors are not always able to
sufficiently diligence the adviser-led secondary transaction before
they must decide to whether to commit to it. As another example, some
advisers seek advisory board consent for adviser-led secondary
transactions, but such advisory boards are comprised of only the
largest investors in the fund, and the adviser does not seek consent
from the remaining investors. As a result, we believe it is appropriate
and necessary to require reporting of adviser-led secondary
transactions.
---------------------------------------------------------------------------
\171\ See AIMA Comment Letter.
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Another commenter suggested an ordinary course exception.\172\
Ordinary course adviser-led secondary transactions are just as integral
to the Commission's investor protection concerns as they still involve
conflicts of interest. They also will be informative to FSOC's and
Commission's assessment of systemic risk in monitoring broader
liquidity trends in the private equity market.
---------------------------------------------------------------------------
\172\ See IAA Comment Letter.
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2. Removal of General Partner or Election To Terminate the Investment
Period or Fund
We are adopting the requirement for all private equity fund
advisers to report the removal of a general partner or election to
terminate the investment period or fund item as an event reporting
item, but, in a change from the proposal, advisers will report these
events within 60 days after a fiscal quarter-end rather than within one
business day. As proposed, this item will require all private equity
fund advisers to report when a fund's investors have: (1) removed the
adviser or an affiliate as the general partner or similar control
person of a fund; (2) elected to terminate the fund's investment
period; or (3) elected to terminate the fund, in each case as
contemplated by the fund documents. This item requires reporting of the
effective date of the applicable removal or termination event and a
description of such removal or termination event. This required
reporting is triggered upon an adviser receiving notification of the
investors' election in each case.
Some commenters supported the proposed requirement to report when
investors remove a general partner, or elect to terminate an investment
period or a fund.\173\ Others criticized this reporting requirement as
being unrelated to market conditions and/or
[[Page 38164]]
likely to cause a disproportionate number of false positives.\174\
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\173\ See, e.g., AFREF Comment Letter and Public Citizen Comment
Letter.
\174\ See, e.g., AIC Comment Letter; AIMA Comment Letter; and
MFA Comment Letter.
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Investor removal of a general partner or election to terminate a
fund's investment period or a fund itself are uncommon events. We
understand that, generally, investors would prefer to avoid these
actions unless unavoidable because the consequence of each could be
damaging to a fund.\175\ If a general partner is removed, there will
likely be a gap in management of a fund as well as the risk that a new
general partner may not be able to manage the fund as effectively. If
investors elect to terminate the investment period of a fund or the
fund itself, the entire investment strategy and planning of the fund
can be disrupted and could indicate the occurrence of investor harm at
the fund or other ongoing risks to investors. A collective increase in
the number of any or all of these events occurring also could indicate
a risk of market deterioration, particularly given the broader market
impact of individual private equity funds due to the increase in the
median fund size for the private equity asset class and rise in larger
private equity funds.\176\ If the general partner of a large buy-out
fund is removed, it could also increase risk for its portfolio
companies if the adviser is no longer as willing to insert equity
capital when needed. Requiring reporting of these events will provide
the Commission and FSOC with notification of this event (of which we
might otherwise be unaware at the time it is initiated), and allow for
better evaluation and monitoring.
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\175\ See, e.g., LPs Vote to Boot GP from Debut Fund, but the
Real Challenge Lies Ahead, Buyout Insider (July 27, 2021) available
at <a href="https://www.buyoutsinsider.com/lps-vote-to-boot-gp-from-debut-fund-but-the-real-challenge-lies-ahead/">https://www.buyoutsinsider.com/lps-vote-to-boot-gp-from-debut-fund-but-the-real-challenge-lies-ahead/</a>.
\176\ See Private Market Mega-Funds Raise More than $329B in
2021, PitchBook (Dec. 14, 2021) (``Pitchbook Article''), available
at <a href="https://pitchbook.com/news/articles/2021-largest-mega-funds-private-equity">https://pitchbook.com/news/articles/2021-largest-mega-funds-private-equity</a>.
---------------------------------------------------------------------------
Furthermore, these trigger events are all indicative of critical
circumstances for conflicts of interest that present increased risks to
investors. Removal of a general partner presents an inherent conflict
for private equity fund advisers. An election to terminate an
investment period of a fund or a fund itself has numerous consequences
for investors, such as changes to management fees and liquidation
requirements, and the staff has often had insufficient visibility into
these activities by private equity fund advisers, which may pose risks
to fund investors.\177\ Requiring reporting of these events will allow
the Commission to identify such events and any associated investor
protection concerns better, including by more carefully evaluating the
inherent conflicts of interests that these events represent.
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\177\ For example, we are aware that there have been instances
where management fees were overcharged after certain triggering
events like the write-off of specific portfolio investments. See,
e.g., In the Matter of ECP Manager LP, Investment Advisers Act
Release No. 5373 (Sep. 27, 2019) (settled action) (alleging that
private equity fund adviser failed to apply the management fee
calculation method specified in the limited partnership agreement by
failing to account for write downs of portfolio securities causing
the fund and investors to overpay management fees).
---------------------------------------------------------------------------
We recognize, however, that these events likely do not create the
type of urgent distress that would necessitate current reporting, as we
had proposed. We understand that these decisions are not arrived at
suddenly and that the assets of the fund will still be held for a
significant period of time if the fund is wound down. Thus, we believe
that requiring reporting of these events on a quarterly basis
appropriately balances the effects and burdens of imposing these
reporting obligations on private equity fund advisers \178\ while also
enhancing the Commission's investor protection efforts and FSOC's
ability to monitor for systemic risk.
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\178\ See infra section IV.C.2 for a more detailed discussion of
the changes in these anticipated costs.
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Several commenters suggested limiting reporting for termination of
a fund's investment period to ``for cause'' terminations only.\179\ We
understand that general partner removals and investor elections to
terminate a fund's investment period or a fund are typically associated
with a serious conflict between investors and the adviser or between
different members of the adviser.\180\ While not all instances of these
events may be strictly ``for cause,'' they all represent serious
departures from ordinary course operations. Additionally, we are not
requiring reporting for all terminations of a fund's investment period
or of a fund. Rather, we are only requiring reporting when investors
elect to terminate a fund's investment period or a fund. We believe
that events of this nature are rare, and accordingly, reporting will
also be rare.
---------------------------------------------------------------------------
\179\ See, e.g., MFA Comment Letter and NVCA Comment Letter.
\180\ In our experience, advisers sometimes pursue these actions
when there is disagreement between different investment
professionals at an adviser that wish to separate their businesses.
For example, one of these individuals may remain associated with the
fund through a new general partner entity while the other individual
leaves the adviser entirely.
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Similar to the explanatory notes item that we are adopting in
section 5 for current reporting by large hedge fund advisers to
qualifying hedge funds, section 6, Item D, will allow an adviser to
provide an optional narrative response if it believes that additional
information is helpful in explaining the circumstances of events
reported in section 6. We proposed including an optional explanatory
note question in the proposed Section 6, Item E as part of the current
reports for private equity fund advisers. Since this explanatory note
question is optional, we think it is appropriate to give private equity
fund advisers the opportunity to provide any explanatory notes for
section 6 quarterly reporting that they deem helpful. We did not
receive specific comments on whether to include this section to allow
an adviser to provide an optional narrative response. We continue to
believe this will allow an adviser the ability to provide additional,
helpful information where necessary.
C. Filing Fees and Format for Reporting
Consistent with the proposal, we are requiring large hedge fund
advisers to file current reports and private equity advisers to file
quarterly private equity event reports through the same non-public
filing system they use to file the rest of Form PF, the Private Fund
Reporting Depository (``PFRD'').\181\ Large hedge fund advisers will
file current reports on section 5, and all private equity advisers will
file event reports on section 6 of Form PF. Filers will not submit any
other sections of Form PF at the time a either of these reports is
filed. This requirement is designed to facilitate reporting of clear
information in an efficient manner. Under the rule, advisers filing
reports on section 5 and 6 are required to pay to the operator of PFRD
fees that have been approved by the SEC. The SEC in a separate action
will approve filing fees that reflect the reasonable costs associated
with the filings and the establishment and maintenance of the filing
system.\182\ Advisers also will be able to amend their section 5 and 6
reports if they discover that information they filed was not accurate
at the time of filing.\183\
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\181\ See Instruction 12. See also rule 17 CFR 275.204(b)-1.
\182\ See section 204(c) of the Advisers Act.
\183\ Consistent with the current instructions for other types
of Form PF filings, large hedge fund advisers are not required to
update information that they believe in good faith properly
responded to Form PF on the date of filing even if that information
is subsequently revised for purposes of recordkeeping, risk
management or investor reporting (such as estimates that are refined
after completion of a subsequent audit). This requirement is
designed to provide advisers with a way to correct current reports,
just as all advisers can correct other types of Form PF filings. See
Instruction 16.
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One commenter stated that it could be counterproductive to require
an adviser
[[Page 38165]]
to pay a fee to report a potential operations event.\184\ However, this
approach is consistent with established Form PF requirements, and we
have not observed a correlation between filing fees and lower levels of
filing Form PF in the past. Filing fees also support the system for
Form PF filing, including cybersecurity and other technological
supports, which we believe benefits filers.
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\184\ See CRINDATA Comment Letter.
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D. Large Private Equity Fund Adviser Reporting
We are amending the requirements relating to reporting by large
private equity fund advisers in section 4 of Form PF to: (1) add
certain questions that are designed to improve FSOC's ability to
monitor systemic risk and FSOC's and the Commission's ability to
evaluate material changes in market trends at the reporting funds; and
(2) add new questions designed to enhance our understanding of certain
practices of private equity fund advisers and amend certain existing
questions to improve data collection.\185\
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\185\ Consistent with the proposal, Item B is being split into
three new items to be designated new Item B ``Certain information
regarding the reporting fund,'' new Item C ``Reporting fund and
controlled portfolio company financing,'' and new Item D ``Portfolio
company investment exposures.''
---------------------------------------------------------------------------
This reporting also will improve FSOC's ability to monitor systemic
risk and the Commission and FSOC's ability to evaluate material changes
in market trends at the reporting private equity funds by providing
information on certain events and developments that could significantly
affect both investors and markets more broadly. Reporting of this type
on an annual basis by the largest private equity fund advisers has
become increasingly important as private equity has continued to grow
over the last decade and become a significant part of the economy and
financial markets. Investors are increasingly exposed to the private
equity industry as many pension funds and other institutional investors
have allocated more assets to private equity investments. The number of
investors \186\ and median fund size \187\ of private equity funds has
increased. The number of larger private equity funds has risen.\188\
These developments merit greater risk-based monitoring and oversight by
the Commission and FSOC given the potential consequences for an
increasing pool of private equity investors as well as financial
markets broadly.
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\186\ Since 2013, the number of private equity funds has more
than doubled from under 7,000 to nearly 19,000, private equity fund
gross assets have quadrupled from $1.6 trillion to $6.4 trillion,
and private equity fund net assets have also nearly quadrupled,
increasing from $1.5 trillion to $5.7 trillion. See Private Funds
Statistics, supra footnote 4.
\187\ See Pitchbook Article, supra footnote 176.
\188\ Id.
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We proposed, but are not adopting, lowering the reporting threshold
for large private equity fund advisers for purposes of section 4 of
Form PF from $2 billion to $1.5 billion in private equity fund assets
under management. A number of commenters criticized the proposal to
lower this threshold as being arbitrary and/or not connected to
systemic risk.\189\ Some commenters stated that reducing this threshold
would result in substantial burdens for small and mid-sized private
equity fund advisers who will be newly covered.\190\ Of these, one
commenter argued that lowering this threshold could limit competition,
as the smaller private equity fund advisers find it more difficult to
compete against larger advisers, which can absorb the costs related to
the additional filing requirements more easily due to scale.\191\ Some
commenters suggested increasing the threshold rather than
reducing.\192\ On the contrary, several commenters supported the
reduction to the large private equity fund adviser reporting threshold,
stating that it is important for the Commission and FSOC to receive
reporting from the same proportion of private equity funds, based on
committed capital, as when Form PF was created.\193\
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\189\ See, e.g., IAA Comment Letter; AIC Comment Letter; and
USCC Comment Letter.
\190\ See, e.g., Schulte Comment Letter; IAA Comment Letter; and
RER Comment Letter.
\191\ See Schulte Comment Letter.
\192\ See RER Comment Letter and AIC Comment Letter.
\193\ See, e.g., ICGN Comment Letter and Better Markets Comment
Letter.
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When Form PF was originally adopted in 2011, the $2 billion
reporting threshold was intended to capture 75 percent of the U.S.
private equity industry based on committed capital.\194\ At proposal,
the existing $2 billion threshold captured about 67 percent of the U.S.
private equity industry.\195\ However, in response to commenters, we
have conducted additional analysis on the U.S. private equity industry
and have observed recent accelerated growth in the relative percentage
of large private equity fund advisers. The existing $2 billion
threshold now captures about 73 percent of the U.S. private equity
industry.\196\ If these trends continue, we expect the $2 billion
threshold to capture 75 percent or more of the U.S. private equity
industry in the near future. As a result, at this time, we no longer
believe it is appropriate to reduce this reporting threshold to $1.5
billion to achieve the original intention for Form PF to capture 75
percent of the U.S. private equity industry.
---------------------------------------------------------------------------
\194\ See 2011 Form PF Adopting Release, supra footnote 3, at
32.
\195\ Based on data reported on Form PF and Form ADV as of Dec.
2020.
\196\ Based on data reported on Form PF and Form ADV as of June
2022.
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One commenter stated that private equity fund advisers with less
than $1.5 billion in private equity fund assets under management have
the potential to either make higher risk loans or take on higher risk
borrowing.\197\ While some smaller private equity fund advisers may
sometimes engage in risky behaviors, it is less likely that such
practices by smaller advisers will lead to systemic risks based solely
on their size.
---------------------------------------------------------------------------
\197\ See PDI Comment Letter.
---------------------------------------------------------------------------
Another commenter suggested using metrics other than assets under
management to determine if a firm meets the threshold for reporting as
a large private equity fund adviser.\198\ We have considered using
metrics other than assets under management for purposes of this
threshold, but we anticipate that they would be more likely to lead to
adverse incentives.\199\ We believe that assets under management
continues to be the appropriate metric and is less likely to create
these adverse incentives. In sum, given the recent trends in the U.S.
private equity industry discussed above, we believe that the existing
threshold strikes an appropriate balance between obtaining information
on a significant portion of the private equity industry and seeking to
minimize the burdens imposed on private equity fund advisers.
---------------------------------------------------------------------------
\198\ See Comment Letter of Michelle Katauskas (Jan. 27, 2022).
\199\ For instance, if we were to define large private equity
fund advisers based on number of employees, advisers may be
incentivized to outsource operations and minimize compliance
personnel.
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1. New Question on General Partner or Limited Partner Clawbacks
We proposed to require all advisers to private equity funds to file
a current report within one business day upon the implementation of a
general partner or limited partner clawback in excess of an aggregate
amount equal to 10 percent of a fund's aggregate capital commitments.
Some commenters supported the requirement to report general and limited
partner clawbacks.\200\ Other commenters criticized this reporting
[[Page 38166]]
requirement as being unrelated to declining market environments or
systemic risk.\201\
---------------------------------------------------------------------------
\200\ See, e.g., AFREF Comment Letter; Public Citizen Comment
Letter.
\201\ See, e.g., AIC Comment Letter; AIMA Comment Letter; and
SIFMA Comment Letter.
---------------------------------------------------------------------------
Limited partner clawbacks could signal that a fund is under stress
or is anticipating being under stress. For example, a limited partner
clawback (or clawbacks) in an aggregate amount of more than 10 percent
of a private equity fund's aggregate capital commitments might suggest
that the fund is planning for a material event (e.g., substantial
litigation or legal judgment) that could negatively affect investors.
While an individual limited partner clawback of this magnitude may be
idiosyncratic, an upward trend in implementations of such limited
partner clawbacks may be a reflection of stress in the market. Such
potential impact merits regular reporting to allow for improved risked-
based monitoring.
General and limited partner clawbacks also create complex conflicts
of interests. Typically, the legal mechanics of general partner and
limited partner clawbacks are negotiated early on in a fund's life,
long before the inciting event occurs. Furthermore, fund advisers
typically have significant control over the circumstances that
eventually lead to a general partner or limited partner clawback. For
instance, if a private equity fund adviser is concerned about over
performance towards the beginning of a fund's life and under
performance later on, it can delay realizing a portfolio investment to
reduce the risk of a general partner clawback. Similarly, if a private
fund adviser anticipates needing to initiate a limited partner clawback
due to litigation, the private fund adviser is likely the one already
responding to the litigation process and informing investors about it.
Each of these circumstances raises critical conflicts of interest that
may harm investors. Requiring reporting of general and limited partner
clawbacks will allow the Commission to better identify such events and
more carefully evaluate when and whether investors may have been
harmed.
Additionally, we do not agree that general partner or limited
partner clawbacks are unrelated to systemic risk. These clawbacks often
occur when the fund has had successful investments earlier in the life
of the fund, but the fund's later investments are less successful.
Accordingly, while a single general partner clawback may not rise to a
level of systemic significance, the widespread implementation of
general partner clawbacks may be a sign of a deteriorating market,
which could have systemic risk implications. Given that the
implementation of general partner clawbacks by private equity funds is
typically rare, if there is an upward trend in funds implementing
general partner clawbacks, such trend could be indicative of a
distressed market. Reporting could help the Commission and FSOC
identify particular markets, sectors or funds on which such a declining
market environment could have an outsized impact and which may merit
additional monitoring given the potential consequence for both
investors and financial market stability.
After considering comments, as noted above,\202\ we now are
requiring information about clawbacks to be reported annually by large
private equity fund advisers.\203\ General partner clawbacks and
certain limited partner clawbacks will be reported in response to new
Question 82 in section 4.\204\ Requiring reporting of clawbacks will
enable the Commission and FSOC to monitor declining market conditions
in the markets in which private equity invests, and will improve the
Commission's visibility into circumstances involving clawbacks that may
implicate investor protection risks.
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\202\ See supra section II.B.
\203\ Large private equity fund advisers will need to report any
of these private equity reporting events that occurred during the
applicable reporting period of their filing for each private equity
fund they advise. Large private equity fund advisers must only
report each instance of a private equity reporting event once on the
Form PF filing that covers the period in which such instance
occurred. It is not necessary to report the same instance of a
private equity reporting event again on future Form PF filings.
\204\ We are also making conforming changes for its new
placement in section 4 of Form PF.
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After considering comments, we recognize that requiring reporting
of clawbacks within one business day of the event could be unnecessary,
particularly given that these events tend to build over the life of a
private equity fund with a multi-year term.\205\ As a result, we are
requiring large private equity advisers to file these reports on an
annual basis as part of their regular Form PF filing rather than one
business day as proposed. We believe this timing better balances the
Commission's need for the information to enhance its regulatory
programs and the assessment of broader private equity trends and
declining market conditions while also recognizing that general partner
or limited partner clawbacks at a particular fund may occur during
years-long investment horizons. However, we continue to believe that
clawback reporting that indicated a large spike in the number of
limited partner clawbacks across the private equity industry may raise
systemic risk or investor protection concerns that the Commission would
need to evaluate.
---------------------------------------------------------------------------
\205\ See, e.g., RER Comment Letter; SIFMA Comment Letter; AIMA
Comment Letter.
---------------------------------------------------------------------------
In another modification from the proposal, we are only requiring
large private equity fund advisers to complete this question. While
some commenters broadly supported the former current event reporting
questions as proposed,\206\ a number of other commenters criticized
them, noting that the proposal did not require current reporting for
smaller hedge fund advisers and stating that the burdens of this
reporting would fall disproportionately on smaller private equity fund
advisers.\207\ Of these commenters, several suggested adding thresholds
to these reporting questions to mitigate these burdens.\208\ Requiring
all private equity fund advisers to complete the clawbacks question
would provide additional information to FSOC and Commission that may be
helpful in the assessment of systemic risk, but after reviewing
comments, we acknowledge that the clawback question pertains more to
the monitoring of broader developing trends in private equity fund
activities relevant to the protection of investors and to the
assessment of systemic risk. As mentioned above, the widespread
implementation of general partner clawbacks at large private equity
funds may signal deteriorating market trends, which could have systemic
risk implications given the large size of the private equity funds
involved. Accordingly, we believe that by focusing clawback reporting
on large private equity fund advisers on an annual basis, we will be
able to evaluate material changes in market trends and investor
protection issues in private equity funds. This approach also preserves
FSOC's ability to monitor for systemic risk. The existing questions in
section 4 are similarly intended to serve this purpose.\209\
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\206\ See, e.g., ICGN Comment Letter; Public Citizen Comment
Letter and PESP Comment Letter.
\207\ See, e.g., IAA Comment Letter; SIFMA Comment Letter and
AIC Comment Letter.
\208\ See, e.g., SIFMA Comment Letter and TIAA Comment Letter.
\209\ See 2011 Form PF Adopting Release, supra footnote 3, at
text accompanying nn. 94-95. The relative percentage of large
private equity fund advisers in the U.S. private equity industry has
also broadly trended upwards over time. As a result, a growing
portion of private equity fund advisers are required to complete the
reporting in section 4. For example, based on staff review of Form
ADV filings and data from Private Fund Statistics reports, section 4
covered approximately 67% of private equity gross assets in 2020 and
covers 73% of private equity gross assets today. See Private Funds
Statistics, supra footnote 4.
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[[Page 38167]]
Question 82 is substantively identical to the proposed current
reporting requirement and will require reporting by large private
equity fund advisers on the implementation of: (1) any general partner
clawback or (2) a limited partner clawback (or clawbacks) in excess of
an aggregate amount equal to 10 percent of a fund's aggregate capital
commitments. This reporting includes the effective date of the clawback
and the reason for the clawback.\210\
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\210\ Question 83 pertains to both general partner clawbacks and
limited partner clawbacks. This question also requires filers to
specify the type of clawback implemented (i.e., whether it is a
general partner clawback or limited partner clawback).
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We are defining, as proposed, a ``general partner clawback'' as 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.\211\ For example, if the general partner of a
fund is entitled to performance-based compensation equaling 20 percent
of the fund's profits over the life of the fund and the fund
distributes such compensation to the general partner periodically based
on the profitability of the fund at the time of distribution, the
general partner may have received distributions of performance-based
compensation over the life of the fund in excess of 20 percent of the
fund's aggregate profits. In this situation, under the fund's governing
documents, the fund's general partner is required to return the excess
performance-based compensation it received to the fund.\212\
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\211\ See Form PF Glossary (definition of ``general partner
clawback''). We are defining ``performance-based compensation'' as
any allocations, payments, or distributions of capital based on the
reporting fund's (or its investments') capital gains, capital
appreciation and/or profit. This definition includes cash or non-
cash compensation, including in-kind allocations, payments, or
distributions of performance-based compensation. See also Form PF
Glossary (definition of ``performance-based compensation''). We have
slightly revised this definition from the proposal--and removed
``portfolio investment'' as a defined term--to more precisely
capture performance-based compensation in the private fund space. We
do not view these slight revisions as substantive changes from what
was proposed.
\212\ Specifically, this required reporting is triggered at the
time the general partner becomes obligated to return to the fund
performance-based compensation in excess of the amount it was
ultimately entitled to receive under the fund's governing documents
regardless of when such compensation is actually returned.
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We are also defining, as proposed, ``limited partner clawback''
(sometimes referred to as a limited partner ``giveback'') as 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.\213\
This required reporting is triggered when the aggregate limited partner
clawbacks over the course of a fund's life exceed 10 percent of such
fund's aggregate capital commitments at such time. Advisers generally
should file for each additional limited partner clawback, regardless of
its size, over the course of such fund's remaining life once such
fund's aggregate limited partner clawbacks have exceeded this 10
percent threshold.\214\ Requiring this minimum threshold is appropriate
because we believe a clawback of this magnitude is more likely to be
associated with an event that could have a significant negative impact
on a fund's investors.
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\213\ See Form PF Glossary (definition of ``limited partner
clawback'').
\214\ For example, if a fund has a life of 10 years and has a
limited partner clawback equal to 4% of its aggregate capital
commitments each and every year of its life, this required reporting
will be triggered in each of years 3, 4, 5, 6, 7, 8, 9, and 10.
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One commenter suggested that, like for limited partner clawbacks,
we should limit reporting on general partner clawbacks to those that
are in excess of 10 percent of the fund's aggregate capital
commitments.\215\ However, it is our understanding that private fund
advisers generally should have greater control over the circumstances
leading to a general partner clawback than a limited partner clawback.
We understand that limited partner clawbacks, on the other hand, are
often associated with lawsuits or other unforeseen events which the
adviser may be able to influence but may not be able to prevent, even
if the amount of the limited partner clawback is small. Accordingly, we
believe it is important to require reporting on all general partner
clawbacks but to limit reporting of limited partner clawbacks to those
exceeding a minimum size threshold.
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\215\ See NVCA Comment Letter.
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Similar to section 5, Item J and the proposed section 6, Item E,
Question 83 will allow an adviser to provide an optional narrative
response if it believes that additional information is helpful in
explaining the circumstances of its responses in section 4. We had
proposed including an optional explanatory note question in the
proposed section 6, Item E as part of the current reports for private
equity fund advisers. Since we are including the general partner or
limited partner clawbacks in the reporting for large private equity
fund advisers as part of section 4, we are adding an optional
explanatory note question for section 4. Since this explanatory note
question is optional, we think it is appropriate to give large private
equity fund advisers the opportunity to provide any explanatory notes
for section 4 that they deem helpful. We did not receive specific
comments on whether to include this section to allow an adviser to
provide an optional narrative response. We continue to believe this
will allow an adviser the ability to provide additional, helpful
information where necessary.
2. Other Amendments to Large Private Equity Fund Adviser Reporting
Private Equity Fund Investment Strategies. As proposed, we are
adding Question 66 to section 4 to collect information about private
equity fund investment strategies.\216\ Form PF does not currently
collect data on private equity fund strategies. Question 66 is
structured similarly to Question 20, which collects information about
hedge fund strategies and includes common strategies employed by
private equity funds. This question requires advisers to choose from a
list of strategies by percent of deployed capital even if the
categories do not precisely match the characterization of the reporting
fund's strategies. To facilitate completion of this question and
alleviate challenges filers face in choosing among a limited list of
investment strategy types, in a modification from the proposal, filers
will be able to choose from a drop-down menu that includes all
investment strategy categories for Form PF. If a reporting fund engages
in multiple strategies, the adviser will have to provide a good faith
estimate of the percentage the reporting fund's deployed capital
represented by each strategy.
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\216\ For purposes of this question, which is to be completed by
Form PF filers that fill out section 4, private equity fund
investment strategies generally include 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, and others. In connection
with this question, we are also adding one new term to the Form PF
Glossary of Terms for ``general partner stakes investing'' to
provide specificity regarding the reporting of this term and to
improve data quality. See Form PF Glossary of Terms. We proposed
adding ``digital assets'' as a new term to the Form PF Glossary of
Terms. The Commission and staff are continuing to consider this term
and are not adopting ``digital assets'' as part of this rule at this
time.
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Question 66 also includes an ``other'' category for advisers to
select in cases where a reporting fund's strategy is not listed, but an
adviser selecting ``other'' in response to this question must explain
why. This requirement is designed to improve data quality by
[[Page 38168]]
providing context to an adviser's selection of the ``other'' category.
It also should help ensure that advisers are not selecting the
``other'' category when they should be reporting information in a
different strategy category. Question 66 is designed to allow FSOC to
filter data for targeted analysis, monitor trends in the private equity
industry, analyze potential systemic risk, and to support the
Commission's oversight of advisers to the private equity industry and
investor protection efforts.
Some commenters supported adding this investment strategy reporting
requirement as being beneficial to the FSOC and Commission's oversight
of advisers to the private equity industry.\217\ Other commenters
argued that this investment strategy reporting requirement is too
burdensome relative to its nexus to systemic risk.\218\
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\217\ See, e.g., ICGN Comment Letter and PDI Comment Letter.
\218\ See, e.g., REBNY Comment Letter and RER Comment Letter.
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Due to the growth in the industry since adoption of Form PF and the
diversity of strategies currently employed by private equity funds, it
is important that we collect this investment strategy information.
Different strategies carry different types and levels of risk for the
markets and financial stability. 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
pr
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