# Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF

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URL: https://www.frixlaw.com/law-library/documents/fr%3A2011-2175

## Record

- **Collection:** Federal Register
- **Document type:** Proposed Rule
- **Published:** February 11, 2011
- **Citation:** 76 FR 8068

## Text

COMMODITY FUTURES TRADING COMMISSION
17 CFR Part 4
RIN 3038-AD03
SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 275 and 279
[Release No. IA-3145; File No. S7-05-11]
RIN 3235-AK92
Reporting by Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors on Form PF

AGENCIES:

Commodity Futures Trading Commission and Securities and Exchange Commission.

ACTION:

Joint proposed rule.

SUMMARY:

The Commodity Futures Trading Commission (“CFTC”) and the Securities and Exchange Commission (“SEC”) (collectively, “we” or the “Commissions”) are proposing new rules under the Commodity Exchange Act and the Investment Advisers Act of 1940 to implement provisions of Title IV of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The proposed SEC rule would require investment advisers registered with the SEC that advise one or more private funds to file Form PF with the SEC. The proposed CFTC rule would require commodity pool operators (“CPOs”) and commodity trading advisors (“CTAs”) registered with the CFTC to satisfy certain proposed CFTC filing requirements by filing Form PF with the SEC, but only if those CPOs and CTAs are also registered with the SEC as investment advisers and advise one or more private funds. The information contained in Form PF is designed, among other things, to assist the Financial Stability Oversight Council in its assessment of systemic risk in the U.S. financial system. These advisers would file these reports electronically, on a confidential basis.

DATES:

Comments should be received on or before April 12, 2011.

ADDRESSES:

Comments may be submitted by any of the following methods:

CFTC

•
Agency Web site, via its Comments Online process: http://comments.cftc.gov.
Follow the instructions for submitting comments through the Web site.

•
Mail:
David A. Stawick, Secretary, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581.

•
Hand Delivery/Courier:
Same as mail above.

•
Federal eRulemaking Portal: http://www.regulations.gov.
Follow the instructions for submitting comments.

“Form PF” must be in the subject field of comments submitted via e-mail, and clearly indicated on written submissions. All comments must be submitted in English, or if not, accompanied by an English translation. Comments will be posted as received to
http://www.cftc.gov.
You should submit only information that you wish to make available publicly. If you wish the CFTC to consider information that may be exempt from disclosure under the Freedom of Information Act, a petition for confidential treatment of the exempt information may be submitted according to the established procedures in 17 CFR 145.9.

The CFTC reserves the right, but shall have no obligation, to review, prescreen, filter, redact, refuse, or remove any or all of your submission from
http://www.cftc.gov
that it may deem to be inappropriate for publication, including, but not limited to, obscene language. All submissions that have been redacted or removed that contain comments on the merits of the rulemaking will be retained in the public comment file and will be considered as required under the Administrative Procedure Act and other applicable laws, and may be accessible under the Freedom of Information Act, 5 U.S.C. 552,
et seq.
(“FOIA”).

SEC

Electronic Comments

• Use the SEC's Internet comment form (
http://www.sec.gov/rules/proposed.shtml
); or

• Send an e-mail to
rule-comments@sec.gov.
Please include File Number S7-05-11 on the subject line; or

• Use the Federal eRulemaking Portal (
http://www.regulations.gov
). Follow the instructions for submitting comments.

Paper Comments

• Send paper comments in triplicate to Elizabeth M. Murphy, Secretary, Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File Number S7-05-11. This file number should be included on the subject line if e-mail is used. To help us process and review your comments more efficiently, please use only one method. The SEC will post all comments on the SEC's Web site (
http://www.sec.gov/rules/proposed.shtml
). Comments are also available for Web site viewing and printing in the SEC's Public Reference Room, 100 F Street, NE., Washington, DC 20549 on official business days between the hours of 10 a.m. and 3 p.m. All comments received will be posted without change; we do not edit personal identifying information from submissions. You should submit only information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT:

CFTC:
Daniel S. Konar II, Attorney-Advisor, Telephone: (202) 418-5405, E-mail:
dkonar@cftc.gov,
Amanda L. Olear, Special Counsel, Telephone: (202) 418-5283, E-mail:
aolear@cftc.gov,
or Kevin P. Walek, Assistant Director, Telephone: (202) 418-5405, E-mail:
kwalek@cftc.gov,
Division of Clearing and Intermediary Oversight, Commodity Futures Trading Commission, Three Lafayette Centre, 1155 21st Street, NW., Washington, DC 20581;
SEC:
David P. Bartels, Attorney-Adviser, Sarah G. ten Siethoff, Senior Special Counsel, or David A. Vaughan, Attorney Fellow, at (202) 551-6787 or
IArules@sec.gov,
Office of Investment Adviser Regulation, Division of Investment Management, U.S. Securities and Exchange Commission, 100 F Street, NE., Washington, DC 20549-8549.

SUPPLEMENTARY INFORMATION:

The CFTC is requesting public comment on proposed rule 4.27(d) [17 CFR 4.27(d)] under the Commodity Exchange Act (“CEA”)
1

and proposed Form PF. The SEC is requesting public comment on proposed rule 204(b)-1 [17 CFR 275.204(b)-1] and proposed Form PF [17 CFR 279.9] under the Investment Advisers Act of 1940 [15 U.S.C. 80b] (“Advisers Act”).
2

1
7 U.S.C. 1a.

2
15 U.S.C. 80b. Unless otherwise noted, when we refer to the Advisers Act, or any paragraph of the Advisers Act, we are referring to 15 U.S.C. 80b of the United States Code, at which the Advisers Act is codified, and when we refer to Advisers Act rule 204(b)-1, or any paragraph of this rule, we are referring to 17 CFR 275.204(b)-1 of the Code of Federal Regulations in which this rule would be published. In addition, in this Release, when we refer to the “Advisers Act,” we refer to the Advisers Act as in effect on July 21, 2011.

I. Background

A. The Dodd-Frank Act

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”).
3

While the Dodd-Frank Act provides for wide-ranging reform of financial regulation, one stated focus of this legislation is to

“promote the financial stability of the United States” by, among other measures, establishing better monitoring of emerging risks using a system-wide perspective.
4

To further this goal, Title I of the Dodd-Frank Act establishes the Financial Stability Oversight Council (“FSOC”), which is comprised of the leaders of various financial regulators (including the Commissions' Chairmen) and other participants.
5

The Dodd-Frank Act directs FSOC to monitor emerging risks to U.S. financial stability and to require that the Board of Governors of the Federal Reserve System (“FRB”) supervise designated nonbank financial companies that may pose risks to U.S. financial stability in the event of their material financial distress or failure or because of their activities.
6

In addition, the Dodd-Frank Act directs FSOC to recommend to the FRB heightened prudential standards for designated nonbank financial companies.
7

3
Public Law 111-203, 124 Stat. 1376 (2010).

4

See
S. Conf. Rep. No. 111-176, at 2-3 (2010) (“Senate Committee Report”).

5
Section 111 of the Dodd-Frank Act provides that the voting members of FSOC will be the Secretary of the Treasury, the Chairman of the FRB, the Comptroller of the Currency, the Director of the Bureau of Consumer Financial Protection, the Chairman of the SEC, the Chairperson of the Federal Deposit Insurance Corporation, the Chairperson of the CFTC, the Director of the Federal Housing Finance Agency, the Chairman of the National Credit Union Administration Board and an independent member appointed by the President having insurance expertise. FSOC will also have five nonvoting members, which are the Director of the Office of Financial Research, the Director of the Federal Insurance Office, a state insurance commissioner, a state banking supervisor and a state securities commissioner.

6
Section 112 of the Dodd-Frank Act.

7

Id.

The Dodd-Frank Act anticipates that FSOC will be supported in these responsibilities by various regulatory agencies, including the Commissions. To that end, the Dodd-Frank Act amends certain statutes, including the Advisers Act, to authorize or direct certain Federal agencies to support FSOC. Title IV of the Dodd-Frank Act amends the Advisers Act to generally require that advisers to hedge funds and other private funds
8

register with the SEC.
9

Congress required this registration in part because it believed that “information regarding [the] size, strategies and positions [of large private funds] could be crucial to regulatory attempts to deal with a future crisis.”
10

To that end, Section 404 of the Dodd-Frank Act, which amends section 204(b) of the Advisers Act, directs the SEC to require private fund advisers
11

to maintain records and file reports containing such information as the SEC deems necessary and appropriate in the public interest and for investor protection or for the assessment of systemic risk by FSOC.
12

The records and reports must include a description of certain information about private funds, such as the amount of assets under management, use of leverage, counterparty credit risk exposure, and trading and investment positions for each private fund advised by the adviser.
13

The SEC must issue jointly with the CFTC, after consultation with FSOC, rules establishing the form and content of any such reports required to be filed with respect to private fund advisers also registered with the CFTC.
14

8
Section 202(a)(29) of the Advisers Act 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 (15 U.S.C. 80a-3) (“Investment Company Act”), but for section 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 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.

9
The Dodd-Frank Act requires such private fund adviser registration by amending section 203(b)(3) of the Advisers Act to repeal the exemption from registration for any adviser that during the course of the preceding 12 months had fewer than 15 clients and neither held itself out to the public as an investment adviser nor advised any registered investment company or business development company.
See
section 403 of the Dodd-Frank Act.
See also infra
note 11 for the definition of “private fund adviser.” There are exemptions from the registration requirement, including exemptions for advisers to venture capital funds and advisers to private funds with less than $150 million in assets under management in the United States. There also is an exemption for “foreign private advisers,” which are investment advisers with no place of business in the United States, fewer than 15 clients in the United States and investors in the United States in private funds advised by the adviser, and less than $25 million in assets under management from such clients and investors.
See
sections 402, 407 and 408 of the Dodd-Frank Act.
See also Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers,
Investment Advisers Act Release No. IA-3111 (Nov. 19, 2010), 75 FR 77,190 (Dec. 10, 2010) (“Private Fund Exemption Release”);
Rules Implementing Amendments to the Investment Advisers Act of 1940,
Investment Advisers Act Release No. IA-3110 (Nov. 19, 2010), 75 FR 77,052 (Dec. 10, 2010) (“Implementing Release”). References in this Release to Form ADV or terms defined in Form ADV or its glossary are to the form and glossary as they are proposed to be amended in the Implementing Release.

10

See
Senate Committee Report,
supra
note 4, at 38.

11
Throughout this Release, we use the term “private fund adviser” to mean any investment adviser that (i) is registered or required to register with the SEC (including any investment adviser that is also registered or required to register with the CFTC as a CPO or CTA) and (ii) advises one or more private funds. We are not proposing that advisers solely to venture capital funds or advisers to private funds that in the aggregate have less than $150 million in assets under management in the United States (“exempt reporting advisers”) be required to file Form PF.

12
While Advisers Act section 204(b)(1) could be read in isolation to imply that the SEC requiring private fund systemic risk reporting is discretionary, other amendments to the Advisers Act made by the Dodd-Frank Act (such as Advisers Act section 204(b)(5) and 211(e) suggest that Congress intended such rulemaking to be mandatory.
See also
Senate Committee Report,
supra
note 4, at 39 (“this title requires private fund advisers * * * to disclose information regarding their investment positions and strategies.”).

13

See
section 404 of the Dodd-Frank Act.

14

See
section 406 of the Dodd-Frank Act.

This joint proposal is designed to fulfill this statutory mandate. Under proposed Advisers Act rule 204(b)-1, private fund advisers would be required to file Form PF with the SEC. Private fund advisers that also are registered as CPOs or CTAs with the CFTC would file Form PF to satisfy certain CFTC systemic risk reporting requirements.
15

Information collected about private funds on Form PF, together with information the SEC collects on Form ADV and the information the CFTC separately has proposed CPOs file on Form CPO-PQR and CTAs file on Form CTA-PR, will provide FSOC and the Commissions with important information about the basic operations and strategies of private funds and will be important in FSOC obtaining a baseline picture of potential systemic risk across both the entire private fund industry and in particular kinds of private funds, such as hedge funds.
16

15
For these private fund advisers, filing Form PF through the Form PF filing system would be a filing with both the SEC and CFTC. Irrespective of their filing a Form PF with the SEC, all private fund advisers that are also registered as CPOs and CTAs with the CFTC would be required to file Schedule A of proposed Form CPO-PQR (for CPOs) or Schedule A of proposed Form CTA-PR (for CTAs). Additionally, to the extent that they operate or advise commodity pools that do not satisfy the definition of “private fund” under the Dodd-Frank Act, private fund advisers that are also registered as CPOs or CTAs would still be required to file proposed Form CPO-PQR (for CPOs) and proposed Form CTA-PR (for CTAs), as applicable.

16
The information reported through the various reporting forms is designed to be complementary, and not duplicative. Information reported on Form ADV would be publicly available, while information reported on Form PF and proposed Forms CPO-PQR and CTA-PR would be confidential to the extent permitted under applicable law. Form ADV and Form PF also have different principal purposes. Form ADV primarily aims at providing the SEC and investors with basic information about advisers (including private fund advisers) and the funds they manage for investor protection purposes, although Form ADV information also will be available to FSOC.

Information on Form ADV is designed to provide the SEC with information necessary to its administration of the Advisers Act and to efficiently allocate its examination resources based on the risks the SEC discerns or the identification of common business activities from information provided by advisers.
See
Implementing Release,
supra
note 9. In contrast, the Commissions intend to use Form PF primarily as a confidential systemic risk disclosure tool to assist FSOC in monitoring and assessing systemic risk, although it also would be available to assist the Commissions in their regulatory programs, including examinations and investigations and investor protection efforts relating to private fund advisers.

Information the SEC obtains through reporting under section 404 of the Dodd-Frank Act is to be shared with FSOC as FSOC considers necessary for purposes of assessing the systemic risk posed by private funds and generally is to remain confidential.
17

Our staffs have consulted with staff representing FSOC's members in developing this proposal. We note that simultaneous with our staffs' FSOC consultations relating to this rulemaking, FSOC has been building out its standards for assessing systemic risk across different kinds of financial firms and has recently proposed standards for determining which nonbank financial companies should be designated as subject to FRB supervision.
18

17

See
section 404 of the Dodd-Frank Act;
infra
note 39 and accompanying text.

18

See, e.g., Authority to Require Supervision and Regulation of Certain Nonbank Financial Companies,
Financial Stability Oversight Council Release (Jan. 18, 2011);
Advance Notice of Proposed Rulemaking Regarding Authority to Require Supervision and Regulation of Certain Nonbank Financial Companies,
Financial Stability Oversight Council Release (Oct. 1, 2010), 75 FR 61653 (Oct. 6, 2010) (“FSOC Designation ANPR”).

B. International Coordination

In assessing systemic risk, the Dodd-Frank Act requires that FSOC coordinate with foreign financial regulators.
19

This coordination may be particularly important in assessing systemic risk associated with hedge funds and other private funds because they often operate globally and make significant investments in firms and markets around the world.
20

As others have recognized, “[g]iven the global nature of the markets in which [private fund] managers and funds operate, it is imperative that a regulatory framework be applied on an internationally consistent basis.”
21

International regulatory coordination also has been cited as a critical element in facilitating financial regulators' formulation of a comprehensive and effective response to future financial crises.
22

Collecting consistent and comparable information is of added value in private fund systemic risk reporting because it would aid in the assessment of systemic risk on a global basis and thus enhance the utility of information sharing among U.S. and foreign financial regulators.
23

19

See
section 175 of the Dodd-Frank Act.

20

See
Damian Alexander,
Global Hedge Fund Assets Rebound to Just Over $1.8 Trillion,
Hedge Fund Intelligence (Apr. 7, 2010) (“HFI”).

21
Group of Thirty, Financial Reform: A Framework for Financial Stability (Jan. 15, 2009).

22

See
U.S. Department of the Treasury,
Financial Regulatory Reform: A New Foundation
(2009), at 8; and
Equipping Financial Regulators with the Tools Necessary to Monitor Systemic Risk,
Senate Banking Subcommittee on Security and International Trade and Finance, Feb. 12, 2010 (testimony of Daniel K. Tarullo, member of the FRB).
See also
Group of 20 and the International Monetary Fund, The Global P Crisis for Fure Regulation of Financial Institutions and M arkets and for Liquidity Management (Feb. 4, 2009).

23
The Commissions expect that they may share information reported on Form PF with various foreign financial regulators under information sharing agreements in which the foreign regulator agrees to keep the information confidential.

Recognizing this benefit, our staffs participated in the International Organization of Securities Commissions' (“IOSCO”) preparation of a report regarding hedge fund oversight.
24

Among other matters, this report recommended that hedge fund advisers provide to their national regulators information for the identification, analysis, and mitigation of systemic risk. It also recommended that regulators cooperate and share information where appropriate in order to facilitate efficient and effective oversight of globally active hedge funds and to help identify systemic risks, risks to market integrity, and other risks arising from the activities or exposures of hedge funds.
25

The types of information that IOSCO recommended regulators gather from hedge fund advisers is consistent with and comparable to the types of information we propose to collect from hedge funds through Form PF, as described in further detail below.
26

24
Technical Committee of the International Organization of Securities Commissions, Hedge Funds O (June 2009),
available at https://www.iosco.org/library/pubdocs/pdf/IOSCOPD293.pdf
(“IOSCO Report”).

25

Id.
at 3.

26

See
IOSCO Report,
supra
note 24, at 14; Press Release, International Regulators Publish Systemic Risk Data Requirements for Hedge Funds (Feb. 25, 2010),
available at https://www.iosco.org/news/pdf/IOSCONEWS179.pdf.
The IOSCO Report states that systemic risk information that hedge fund advisers should provide to regulators should include, for example: (1) Information on their prime brokers, custodian, and background information on the persons managing the assets; (2) information on the manager's larger funds including the net asset value, predominant strategy/regional focus and performance; (3) leverage and risk information, including concentration risk of the hedge fund adviser's larger funds; (4) asset and liability information for the manager's larger funds; (5) counterparty risk, including the biggest sources of credit; (6) product exposure for all of the manager's assets; and (7) investment activity known to represent a significant proportion of such activity in important markets or products. Some of this information would be collected through the revised Form ADV, as proposed by the SEC in the Implementing Release, rather than Form PF.

In addition, our staffs have consulted with the United Kingdom's Financial Services Authority (the “FSA”), which has conducted a voluntary semi-annual survey since October 2009 by sampling the largest hedge fund groups based in the United Kingdom.
27

Because many hedge fund advisers are located in the United Kingdom and subject to the jurisdiction of the FSA, this coordination has been particularly important.
28

UK hedge fund advisers complete this survey on a voluntary basis, and the survey collects information regarding all funds managed by the particular hedge fund adviser as well as for individual funds with at least $500 million in assets. The information the survey collects is designed to help the FSA better understand hedge funds' use of leverage, “footprints” in various asset classes (including concentration and liquidity issues), the scale of asset/liability mismatches, and counterparty credit risks.
29

In addition, for more than five years the FSA has been conducting a semi-annual survey of hedge fund counterparties to assist it in assessing trends in counterparty credit risk, margin requirements, and other matters.
30

Our staffs' consultation with the FSA as they designed and conducted their hedge fund surveys has been very informative, and we have incorporated into proposed Form PF many of the types of information collected through the FSA surveys.

27
The survey canvasses approximately 50 FSA-authorized investment managers.
See, e.g.,

Financial Services Authority,
Assessing Possible Sources of Systemic Risk from Hedge Funds: A Report on the Findings of the Hedge Fund as Counterparty Survey and the Hedge Fund Survey
(Jul. 2010),
available at http://www.fsa.gov.uk/pubs/other/hf_report.pdf
(“FSA Survey”).

28
According to Hedge Fund Intelligence, U.K.-based advisers manage approximately 16% of global hedge fund assets. This concentration of hedge fund advisers is second only to the United States (managing approximately 76% of global hedge fund assets).
See
HFI,
supra
note 20.

29
FSA Survey,
supra
note 27.

30

Id.

SEC staff also has consulted with Hong Kong's Securities and Futures Commission regarding hedge fund oversight and data collection because Hong Kong is an important jurisdiction for hedge funds in Asia.
31

This consultation also has proven helpful in designing proposed Form PF.

Collectively, hedge fund advisers based in the United States, the United Kingdom, and Hong Kong represent over 92 percent of global hedge fund assets, and thus a broad consistency among these jurisdictions' hedge fund information collections, including our own, will facilitate the sharing of consistent and comparable information for systemic risk assessment purposes for most global hedge fund assets under management.
32

Finally, in connection with the IOSCO report, IOSCO members (including the SEC and CFTC) agreed, on a “best efforts” basis, to conduct a survey of hedge fund reporting data as of the end of September 2010 based on the guidelines established in the IOSCO report and the FSA survey. This internationally coordinated survey effort has also informed our proposed reporting.

31
According to Hedge Fund Intelligence, Hong Kong-based advisers manage approximately 0.54% of global hedge fund assets, which is the largest concentration of hedge fund advisers in Asia.
See
HFI,
supra
note 20.

32

See
HFI,
supra
note 20.

International efforts also have focused on potential systemic considerations arising out of other types of private funds, such as private equity funds. For example, an International Monetary Fund (“IMF”) staff paper has focused on “extending the perimeter” of effective regulatory oversight to capture all financial activities that may pose systemic risks, regardless of the type of institution in which they occur.
33

The IMF paper proposed that these financial activities be subject to reporting obligations so that regulators may assess potential systemic risk and emphasized the need to capture all financial activities conducted on a leveraged basis, including activities of leveraged private equity vehicles.
34

Others also have recognized a need for monitoring the private equity sector because having information on its potentially systemically important interactions with the financial system are an important part of regulators' obtaining the complete picture of the broader financial system that is so vital to effective systemic risk monitoring.
35

We have taken these international efforts relating to systemic risk monitoring in private equity funds into account in the proposed reporting discussed below.

33

See
Ana Carvajal
et al., The Perimeter of Financial Regulation,
IMF Staff Position Note SPN/09/07 (Mar. 26, 2009),
available at http://www.imf.org/external/pubs/ft/spn/2009/spn0907.pdf.

34

Id.,
at 8.

35

See, e.g.,
Lorenzo Bini Smaghi, Member of the Executive Board of the European Central Bank, Going Forward—Regulation and Supervision after the Financial Turmoil, Speech by at the 4th International Conference of Financial Regulation and Supervision (Jun. 19, 2009),
available at http://www.bis.org/review/r090623e.pdf
(stating “macro-prudential analysis needs to capture all components of financial systems and how they interact. This includes all intermediaries, markets and infrastructures underpinning them. In this respect, it is important to consider that at present some of these components, such as hedge funds, private equity firms or over-the-counter (OTC) financial markets, are not subject to micro-prudential supervision. But they need to be part of macro-prudential analysis and risk assessments, as they influence the overall behaviour of the financial system. To gain a truly “systemic” perspective on the financial system, no material element should be left out.”);
Private Equity and Leveraged Finance Markets,
Bank for International Settlements Committee on the Global Financial System Working Paper No. 30 (Jul. 2008),
available at http://www.bis.org/publ/cgfs30.pdf
(“BIS Private Equity Paper”) (“Going forward, the Working Group believes that enhancing transparency and strengthening risk management practices [relating to private equity and leveraged finance markets] require special attention. * * * The recent market turmoil has demonstrated that a number of the risks in the leveraged finance market are likely to materialise in combination with other financial market risks in stressed market conditions. * * * In the public sector, there is a stronger case for developing early warning indicators and devoting more research efforts to modelling the dynamic relationships between risk factors with a view to understanding the interrelationships across markets and their impact on the financial sector.”).
See also
Macroeconomic Assessment Group established by the Financial Stability Board and the Basel Committee on Banking Supervision, Interim Report: Assessing the Macroeconomic Impact of the Transition to Stronger Capital and Liquidity Requirements (Aug. 2010), at section 5.2,
available at http://www.financialstabilityboard.org/publications/r_100818b.pdf.

II. Discussion

The SEC is proposing a new rule 204(b)-1 under the Advisers Act to require that SEC-registered investment advisers report systemic risk information to the SEC on Form PF if they advise one or more private funds.
36

For registered CPOs and CTAs that are also registered as investment advisers with the SEC and advise a private fund, this report also would serve as substitute compliance for a portion of the CFTC's proposed systemic risk reporting requirements under proposed Commodity Exchange Act rule 4.27(d).
37

Because commodity pools that meet the definition of a private fund are categorized as hedge funds for purposes of Form PF as discussed below, CPOs and CTAs filing Form PF would need to complete only the sections applicable to hedge fund advisers, and the form would be a joint form only with respect to those sections.
38

36

See
proposed Advisers Act rule 204(b)-1.

37

See
proposed Commodity Exchange Act rule 4.27(d), which provides that these CPOs and CTAs would need to file other reports as required under rule 4.27 with respect to pools that are not private funds. For purposes of this proposed rule, it is the CFTC's position that any false or misleading statement of a material fact or material omission in the jointly proposed sections (sections 1 and 2) of proposed Form PF that is filed by these CPOs and CTAs shall constitute a violation of section 6(c)(2) of the Commodity Exchange Act. Proposed Form PF contains an oath consistent with this position.

38
Thus, private fund advisers that also are CPOs or CTAs would be obligated to complete only section 1 and, if they met the applicable threshold, section 2 of Form PF. Accordingly, Form PF is a joint form between the SEC and the CFTC only with respect to sections 1 and 2 of the form.

Form PF would elicit non-public information about private funds and their trading strategies the public disclosure of which, in many cases, could adversely affect the funds and their investors. The SEC does not intend to make public Form PF information identifiable to any particular adviser or private fund, although the SEC may use Form PF information in an enforcement action. Amendments to the Advisers Act added by the Dodd-Frank Act preclude the SEC from being compelled to reveal the information except in very limited circumstances.
39

Similarly, the Dodd-Frank Act exempts the CFTC from being compelled under FOIA to disclose to the public any information collected through Form PF and requires that the CFTC maintain the confidentiality of that information consistent with the level of confidentiality established for the SEC in section 404 of the Dodd-Frank Act. The Commissions would make information collected through Form PF available to FSOC, as is required by the Dodd-Frank Act, subject to the confidentiality provisions of the Dodd-Frank Act.
40

39

See
section 404 of the Dodd-Frank Act stating that “[n]otwithstanding any other provision of law, the Commission [SEC] may not be compelled to disclose any report or information contained therein required to be filed with the Commission [SEC] under this subsection” except to Congress upon agreement of confidentiality. Section 404 also provides that nothing prevents the SEC from complying with a request for information from any other federal department or agency or any self-regulatory organization requesting the report or information for purposes within the scope of its jurisdiction or an order of a court of the U.S. in an action brought by the U.S. or the SEC. Section 404 of the Dodd-Frank Act also states that the SEC shall make available to FSOC copies of all reports, documents, records, and information filed with or provided to the SEC by an investment adviser under section 404 of the Dodd-Frank Act as FSOC may consider necessary for the purpose of assessing the systemic risk posed by a private fund and that FSOC shall maintain the confidentiality of that information consistent with the level of confidentiality established for the SEC in section 404 of the Dodd-Frank Act.

40

See
section 404 of the Dodd-Frank Act.

We propose that each private fund adviser report basic information about the operations of its private funds on Form PF once each year. We propose that a relatively small number of Large Private Fund Advisers (described in section II.B below) instead be required to submit this basic information each quarter along with additional systemic risk related information required by Form PF concerning certain of their

private funds.
41

In the sections below, we describe the principal reasons we believe that FSOC needs this information in order to monitor the systemic risk that may be associated with the operation of private funds.

41

See
proposed Instructions to Form PF. Our proposed reporting thus complies with the Dodd-Frank Act directive that, in formulating systemic risk reporting and recordkeeping for investment advisers to mid-sized private funds, the Commission take into account the size, governance, and investment strategy of such funds to determine whether they pose systemic risk.
See
section 408 of the Dodd-Frank Act. The Dodd-Frank Act also states that the SEC may establish different reporting requirements for different classes of fund advisers, based on the type or size of private fund being advised.
See
section 404 of the Dodd-Frank Act.

A. Purposes of Form PF

The Dodd-Frank Act tasks FSOC with monitoring the financial services marketplace in order to identify potential threats to the financial stability of the United States.
42

It also requires FSOC to collect information from member agencies to support its functions.
43

Section 404 of the Dodd-Frank Act directs the SEC to support this effort by collecting from investment advisers to private funds such information as the SEC deems necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk.
44

FSOC may, if it deems necessary, direct the Office of Financial Research (“OFR”) to collect additional information from nonbank financial companies.
45

42

See
section 112(a)(2)(C) of the Dodd-Frank Act.

43

See
section 112(d)(1) of the Dodd-Frank Act.

44
Section 404 of the Dodd-Frank Act requires that reports and records that the SEC mandates be maintained for these purposes include a description of certain categories of information, such as assets under management, use of leverage, counterparty credit risk exposure, and trading and investment positions for each private fund advised by the adviser.

45

See
sections 153 and 154 of the Dodd-Frank Act.

The Commissions are jointly proposing sections 1 and 2 of Form PF, and the SEC is proposing sections 3 and 4 of Form PF, to collect information necessary to permit FSOC to monitor private funds in order to identify any potential systemic threats arising from their activities. The information we currently collect about private funds and their activities is very limited and is not designed for the purpose of monitoring systemic risk.
46

We do not currently collect information, for example, about hedge funds' primary trading counterparties or significant market positions. The SEC also does not currently collect data to assess the risk of a run on a private liquidity fund, a risk that could transfer into registered money market funds and into the broader short term funding markets and those that rely on those markets.
47

While we are proposing to collect information on Form PF to assist FSOC in its monitoring obligations under the Dodd-Frank Act, the information collected on Form PF would be available to assist the Commissions in their regulatory programs, including examinations and investigations and investor protection efforts relating to private fund advisers.
48

46
We note that the SEC has proposed amendments to Form ADV that also would require private funds to report certain basic information, such as the fund's prime broker and its gross and net asset values.
See
Implementing Release,
supra
note 9.

47

See
section II.A.3 of this Release for a discussion of liquidity funds and their potential risks.

48

See
SEC section VI.A of this Release for a discussion of how the SEC could use proposed Form PF data for its regulatory activities and investor protection efforts.

We have designed Form PF, in consultation with staff representing FSOC's members, to provide FSOC with such information so that it may carry out its monitoring obligations.
49

Based upon the information we propose to obtain from advisers about the private funds they advise, together with market data it collects from other sources, FSOC should be able to identify whether any private funds merit further analysis or whether OFR should collect additional information. We have not sought to design a form that would provide FSOC in all cases with all the information it may need to make a determination that a particular entity should be designated for supervision by the FRB.
50

Such a form, if feasible, likely would require substantial additional and more detailed data addressing a wider range of possible fund profiles, since it could not be tailored to a particular adviser, and would impose correspondingly greater burdens on private fund advisers. This type of information gathering may be better accomplished by OFR through targeted information requests to specific private fund advisers identified through Form PF, rather than through a general reporting form.
51

49
Industry participants (in response to FSOC Designation ANPR,
supra
note 18) acknowledged the potentially important function that such reporting may play in allowing FSOC to monitor the private fund industry more generally and to assess the extent to which any private funds may pose systemic risk more specifically.
See, e.g.,
Comment Letter of the Managed Funds Association (Nov. 5, 2010) (“the enhanced regulation of hedge fund managers and the markets in which they participate following the passage of the Dodd-Frank Act ensures that regulators will have a timely and complete picture of hedge funds and their activities”), Comment Letter of the Coalition of Private Investment Companies (Nov. 5, 2010) (“the registration and reporting structure for private funds subject to SEC oversight will result in an unprecedented range and depth of data to the Council, its constituent members and the newly created Office of Financial Research. From this information, in addition to the information gathered by the Council, the Council should be able to assemble a clear picture of the overall U.S. financial network and how private investment funds fit into it, both on an individual and overall basis”), Comment Letter of the Private Equity Growth Council (Nov. 5, 2010) (“regulators also now have the authority to require all private equity firms and private equity funds to provide any additional data needed to assess systemic risk”) (“PE Council Letter”). Comment letters in response to the FSOC Designation ANPR are available at
http://www.regulations.gov.

50

See
section 113 of the Dodd-Frank Act for a discussion of the matters that FSOC must consider when determining whether a U.S. nonbank financial company shall be supervised by the FRB and subject to prudential standards.

51
Recordkeeping requirements specific to private fund advisers for systemic risk assessment purposes will be addressed in a future release pursuant to our authority under section 404 of the Dodd-Frank Act.

The amount of information a private fund adviser would be required to report on the proposed form would vary based on both the size of the adviser and the type of funds it advises. This approach reflects our initial view after consulting with staff representing FSOC's members that a smaller private fund adviser may present less risk to the stability of the U.S. financial system and thus merit reporting of less information.
52

It also reflects our understanding that different types of private funds could present different implications for systemic risk and that reporting requirements should be appropriately calibrated.
53

As discussed in more detail below, Form PF would require more detailed information from advisers managing a large amount of hedge fund or liquidity fund assets. Less information would be required regarding advisers managing a large amount of private equity fund assets because, after a review of available literature and consultation with staff representing FSOC's members, it appears that private equity funds may present less potential risk to U.S. financial stability. The principal reasons for Form PF's proposed reporting specific to hedge funds, liquidity funds, and private equity funds are discussed below.

52
We discuss the information we propose requiring smaller private fund advisers report in section II.D.1 of this Release.

53
Congress recognized this need as well.
See supra
note 41.

1. Hedge Funds

We believe that Congress expected hedge fund advisers would be required to report information to the Commissions under Title IV of the Dodd-Frank Act.
54

After consulting with

staff representing FSOC's members, our initial view is that the investment activities of hedge funds
55

may have the potential to pose systemic risk for several reasons and, accordingly, that advisers to these hedge funds should provide targeted information on Form PF to allow FSOC to gain a better picture of the potential systemic risks posed by the hedge fund industry. Hedge funds may be important sources, and users, of liquidity in certain markets. Hedge funds often use financial institutions that may have systemic importance to obtain leverage and enter into other types of transactions. Hedge funds employ investment strategies that may use leverage, derivatives, complex structured products, and short selling in an effort to generate returns. Hedge funds also may employ strategies involving high volumes of trading and concentrated investments. These strategies, and in particular high levels of leverage, can increase the likelihood that the fund will experience stress or fail, and amplify the effects on financial markets.
56

While many hedge funds are not highly leveraged, certain hedge fund strategies employ substantial amounts of leverage.
57

Significant hedge fund failures (whether caused by their investment positions or use of leverage or both) could result in material losses at the financial institutions that lend to them if collateral securing this lending is inadequate.
58

These losses could have systemic implications if they require these financial institutions to scale back their lending efforts or other financing activities generally.
59

The simultaneous failure of several similarly positioned hedge funds could create contagion through the financial markets if the failing funds liquidate their investment positions in parallel at firesale prices, thereby depressing the mark-to-market valuations of securities that may be widely held by other financial institutions and investors.
60

Many of these concerns were raised in September 1998 by the near collapse of Long Term Capital Management, a highly leveraged hedge fund that experienced significant losses stemming from the 1997 Russian financial crisis.
61

54

See
Senate Committee Report,
supra
note 4, at 38 (“While hedge funds are generally not thought

to have caused the current financial crisis, information regarding their size, strategies, and positions could be crucial to regulatory attempts to deal with a future crisis. The case of Long-Term Capital Management, a hedge fund that was rescued through Federal Reserve intervention in 1998 because of concerns that it was “too-interconnected-to-fail,” shows that the activities of even a single hedge fund may have systemic consequences.”).

55

See
section II.B of this Release for a discussion of the definition of “hedge fund” in proposed Form PF. To prevent duplicative reporting, commodity pools that meet the definition of a private fund would be treated as hedge funds for purposes of Form PF. CPOs and CTAs that are not also registered as an investment adviser with the SEC would be required to file proposed Form CPO-PQR (for CPOs) and proposed Form CTA-PR (for CTAs) reporting similar information as Form PF requires for private fund advisers that advise one or more hedge funds.
See
Commodity Pool Operators and Commodity Trading Advisors: Amendments to Compliance Obligations, CFTC Release (Jan. _, 2011). Deeming commodity pools that meet the definition of a private fund to be hedge funds for purposes of Form PF, therefore, is designed to ensure that the CFTC obtains similar reporting regarding commodity pools that satisfy CFTC reporting obligations by the CPO or CTA filing proposed Form PF.

56

See
President's Working Group on Financial Markets, Hedge Funds, Leverage, and the Lessons of Long Term Capital Management (Apr. 1999), at 23,
available at http://www.ustreas.gov/press/releases/reports/hedgfund.pdf
(“PWG LTCM Report”).

57

See
FSA Survey,
supra
note 27, at 5 (showing borrowings as a multiple of net equity ranging from 100% in strategies such as managed futures to 1400% in the fixed income arbitrage hedge fund strategy).

58

See, e.g., Id.;
Ben S. Bernanke, Hedge Funds and Systemic Risk, Speech at the Federal Reserve Bank of Atlanta's 2006 Financial Market's Conference (May 16, 2006),
available at http://www.federalreserve.gov/newsevents/speech/bernanke20060516a.htm
(“Bernanke”); Nicholas Chan
et al., Systemic Risk and Hedge Funds,
National Bureau of Economic Research Working Paper 11200 (Mar. 2005),
available at http://www.nber.org/papers/w11200.pdf;
Andrew Lo,
Regulatory Reform in the Wake of the Financial Crisis of 2007-2008,
1 J. Fin. Econ. P. 4 (2009); and John Kambhu
et al., Hedge Funds, Financial Intermediation, and Systemic Risk,
FRBNY Econ. P. Rev. (Dec. 2007) (“Kambhu”).

59
Kambhu,
supra
note 58; Financial Stability Forum, Update of the FSF Report on Highly Leveraged Institutions (May 19, 2007).

60

See
Bernanke,
supra
note 58; David Stowell, An Introduction to Investment Banks, Hedge Funds & Private Equity: The New Paradigm 259-261 (2010).

61

See
PWG LTCM Report,
supra
note 56.

Accordingly, proposed Form PF would include questions about large hedge funds' investments, use of leverage and collateral practices, counterparty exposures, and market positions that are designed to assist FSOC in monitoring and assessing the extent to which stresses at those hedge funds could have systemic implications by spreading to prime brokers, credit or trading counterparties, or financial markets.
62

This information also is designed to help FSOC observe how hedge funds behave in response to certain stresses in the markets or economy. We request comment on this analysis of the potential systemic risk posed by hedge funds. Does it adequately identify the ways in which hedge funds might generate systemic risk? Are there other ways that hedge funds could create systemic risk? Are hedge funds not a potential source of systemic risk? Please explain your views and discuss their implications for the reporting we propose on Form PF.

62

See
section II.D.2 of this Release.

2. Liquidity Funds

“Liquidity funds” also may be important to FSOC's monitoring and assessment of potential systemic risks, and the SEC believes information concerning them, therefore, should be included on Form PF.
63

The proposed Form PF would define a liquidity fund as a private fund that seeks to generate income by investing in a portfolio of short-term obligations in order to maintain a stable net asset value per unit or minimize principal volatility for investors.
64

Liquidity funds thus can resemble money market funds, which are registered under the Investment Company Act of 1940 and seek to maintain a “stable” net asset value per share, typically $1, through the use of the “amortized cost” method of valuation.
65

63
Form PF is a joint form between the SEC and the CFTC only with respect to sections 1 and 2 of the form. Section 3 of the form, which would require more specific reporting regarding liquidity funds, would only be required by the SEC.

64

See
section II.B of this Release for a discussion of the definition of “liquidity fund” in proposed Form PF.

65
Under the amortized cost method, securities are valued at acquisition cost, with adjustments for amortization of premium or accretion of discount, instead of at fair market value. To prevent substantial deviations between the amortized cost share price and the mark-to-market per-share value of the fund's assets (its “shadow NAV”), a money market fund must periodically compare the two. If there is a difference of more than one-half of 1 percent (typically, $0.005 per share), the fund must re-price its shares, an event colloquially known as “breaking the buck.”
See Money Market Fund Reform,
Investment Company Act Release No. 28807 (June 30, 2009), 74 FR 32688 (July 8, 2009), at section III (“MMF Reform Proposing Release”).

A report recently released by the President's Working Group on Financial Markets (the “PWG MMF Report”) discussed in detail how certain features of registered money market funds, many of which are shared by liquidity funds, may make them susceptible to runs and thus create the potential for systemic risk.
66

The PWG MMF Report describes how some investors may consider liquidity funds to function as substitutes for registered money market funds and the potential for systemic risk that

results.
67

During the financial crisis, several sponsors of “enhanced cash funds,” a type of liquidity fund, committed capital to those funds to prevent investors from realizing losses in the funds.
68

The fact that sponsors of certain liquidity funds felt the need to support the stable value of those funds suggests that they may be susceptible to runs like registered money market funds.

66
Report of the President's Working Group on Financial Markets: Money Market Fund Reform Options (Oct. 2010),
available at http://treas.gov/press/releases/docs/10.21%20PWG%20Report%20Final.pdf.
The PWG MMF Report states that the work of the President's Working Group on Financial Reform relating to money market funds is now being taken over by FSOC. The SEC has discussed previously registered money market funds' susceptibility to runs.
See
MMF Reform Proposing Release,
supra
note 65, at section III.

67
PWG MMF Report,
supra
note 66, at section 3.h (“These vehicles typically invest in the same types of short-term instruments that MMFs hold and share many of the features that make MMFs vulnerable to runs, so growth of unregulated MMF substitutes would likely increase systemic risks. However, such funds need not comply with rule 2a-7 or other [Investment Company Act] protections and in general are subject to little or no regulatory oversight. In addition, the risks posed by MMF substitutes are difficult to monitor, since they provide far less market transparency than MMFs.”).

68

See, e.g.,
Sree Vidya Bhaktavatsalam,
BlackRock Earnings Beat Estimates on Hedge-Fund Fees,
Bloomberg (Jan. 17, 2008) (“During the fourth quarter, BlackRock spent $18 million to support the net asset value of two enhanced cash funds whose values fell as the credit markets got squeezed”); Sree Vidya Bhaktavatsalam & Christopher Condon,
Federated Investors Bails Out Cash Fund After Losses,
Bloomberg (Nov. 20, 2007).

Registered money market funds are subject to extensive regulation under Investment Company Act rule 2a-7, which imposes credit-quality, maturity, and diversification requirements on money market fund portfolios designed to ensure that the funds' investing remains consistent with the objective of maintaining a stable net asset value.
69

While liquidity funds are not required to comply with rule 2a-7, we understand that many liquidity funds can suspend redemptions or impose gates on shareholder redemptions upon indications of stress at the fund. As a result, the risk of runs at liquidity funds may be mitigated. The information that the SEC is proposing to require advisers to liquidity funds report is designed to allow FSOC to assess liquidity funds' susceptibility to runs and ability to otherwise pose systemic risk.

69

See
17 CFR 270.2a-7.

The SEC requests comment on this analysis of the potential systemic risk posed by liquidity funds. Does it adequately identify the ways in which liquidity funds might generate systemic risk? Are there other ways that liquidity funds could create systemic risk? Do liquidity funds lack any potential to create systemic risk? Please explain your views and discuss their implications for the reporting proposed on Form PF.

3. Private Equity Funds

It is the SEC's initial view, after consultation with staff representing FSOC's members, that the activities of private equity funds, certain of their portfolio companies, or creditors involved in financing private equity transactions also may be important to the assessment of systemic risk and, therefore, that large advisers to these funds should provide targeted information on Form PF to allow FSOC to conduct basic systemic risk monitoring.
70

70

See
section II.B of this Release for a discussion of the definition of “private equity fund” in Form PF. Form PF is a joint form between the SEC and the CFTC only with respect to sections 1 and 2 of the form. Section 4 of the form, which would require more specific reporting regarding private equity funds, would only be required by the SEC.

One aspect of the private equity business model that some have identified as potentially having systemic implications is its method of financing buyouts of companies. Leveraged private equity transactions often rely on banks to provide bridge financing until the permanent debt financing for the transaction is completed, whether through a syndicated bank loan or issuance of high yield bonds by the portfolio company or both.
71

When market conditions suddenly turn, these institutions can be left holding this potentially risky bridge financing (or committed to provide the final bank financing, but no longer able to syndicate or securitize it and thus forced to hold it) at precisely the time when credit market conditions, and therefore the institutions' own general exposure to private equity transactions and other committed financings, have worsened.
72

For example, prior to the recent financial crisis, a trend in private equity transactions was for private equity firms to enter into buyout transactions with seller-favorable financing conditions and terms that placed much of the risk of market deterioration after the transaction agreement was signed on the financing institutions and the private equity adviser.
73

71

See
Steven M. Davidoff,
The Failure of Private Equity,
82 S. Cal. L. Rev. 481, 494 (2009) (“Davidoff”).

72

See
Senior Supervisors Group,
Observations on Risk Management Practices during the Recent Market Turbulence,
at 2 (Mar. 6, 2008),
available at http://www.occ.gov/publications/publications-by-type/other-publications/pub-other-risk-mgt-practices-2008.pdf
(“Firms likewise found that they could neither syndicate to external investors their leveraged loan commitments to corporate borrowers nor cancel their commitments to fund those loans despite material and adverse changes in the availability of funding from other investors in the market”); BIS Private Equity Paper,
supra
note 35, at 1-2 (“Conditions in the leveraged loan market deteriorated in the second half of 2007, and demand for leveraged finance declined sharply. An initial temporary adverse investor reaction to loose lending terms and low credit spreads prevailing in early 2007 became more protracted over the course of the second half of the year as the turbulence in financial markets deepened and contraction in demand for leveraged loans became more severe. Global primary market leveraged loan volumes shrank by more than 50% in the second half of 2007. The contraction in demand for leveraged loans revealed substantial exposure of arranger banks to warehouse risk. Undistributed loans will contribute to increased funding costs and capital requirements for banks in 2008, on top of other offbalance sheet products that they have been forced to bring on-balance sheet. Moreover, with leveraged loan indices trading close to 90 cents on a dollar in March 2008, realisation of warehouse risks has resulted in significant mark to market losses to banks”); Bank of England,
Financial Stability Report,
at 19 (Oct. 2007),
available at http://www.bankofengland.co.uk/publications/fsr/2007/fsrfull0710.pdf
(“Bank of England”) (“The near closure of primary issuance markets for collateralised loan obligations, and an increase in risk aversion among investors, left banks unable to distribute leveraged loans that they had originated earlier in the year. This exacerbated a problem banks already faced, as debt used to finance a number of high-profile private-equity sponsored leveraged buyouts (LBOs) had remained on their balance sheets.”).

73

See
Davidoff,
supra
note 71, at 495-496 (noting the trend in private equity transaction agreements signed prior to the financial crisis to have no financing condition and to have limited “market outs” and “lender outs” in the debt commitment letters and further noting that “by agreeing to a more certain debt commitment letter and providing bridge financing, the banks now took on the risk of market deterioration between the time of signing and closing.”). Bank regulators and industry observers also noted the trend in private equity financing prior to the financial crisis for banks to enter into “covenant lite” loans, which did not require borrowers to meet certain performance metrics for cash flow or profits.
See The Economics of Private Equity Investments: Symposium Summary,
FRBSF Economic Letter (Feb. 29, 2008),
available at http://www.frbsf.org/publications/economics/letter/2008/el2008-08.html
(noting growth in the first half of 2007 in such “covenant lite” loans); Financial Stability Forum, Report of the Financial Stability Forum on Enhancing Market and Institutional Resilience, at 7 (Apr. 7, 2008),
available at http://www.financialstabilityboard.org/publications/r_0804.pdf
(“Another segment that saw rapid growth in volume accompanied by a decline in standards was the corporate leveraged loan market, where lenders agreed to weakened loan covenants to obtain the business of private equity funds.”); Bank of England,
supra
note 73, at 27 (“Market intelligence suggested that private equity sponsors had considerable market power to impose aggressive capital structures, tight spreads and weak covenants because investor demand was so strong. But in August, the flow of new LBOs came to a virtual standstill and the debt of a sequence of high-profile companies could not be sold [by banks].”).

In addition, some industry observers have noted that the leveraged buyout investment model of imposing significant amounts of leverage on their portfolio companies in an effort to meet investment return objectives subjects those portfolio companies to greater risk in the event of economic stress.
74

If private equity funds conduct a

leveraged buyout of an entity that could be systemically important, information about that investment could be important in FSOC monitoring and assessing potential systemic risk.
75

74

See, e.g., Paying the Price,
The Economist (Jul. 31, 2010) (“Pension funds could decide to make a geared bet on equities by borrowing money and investing in the S&P 500 index. But they would understandably regard such a strategy as highly risky. Giving money to private-equity managers, who then use debt to acquire quoted companies, is viewed in an entirely different light but amounts to the same gamble”).
See also
BIS Private Equity Paper,
supra
note 35, at 24-25.

75
For example, some noted the role of private equity investments in companies that the government ultimately bailed out during the financial crisis.
See, e.g.,
Casey Ross,
Cerberus' Success Hurt by a Pair of Gambles,
The Boston Globe (Mar. 25, 2010) (discussing private equity investments in GMAC and Chrysler Corp., both of which received government bailouts); and Louise Story,
For Private Equity, A Very Public Disaster,
N.Y. Times (Aug. 8, 2009) (same).

For these reasons, the SEC believes certain information on the activities of private equity funds and their portfolio companies is relevant for purposes of monitoring potential systemic risk.
76

In addition, based on the SEC's consultations with staff representing FSOC's members, private equity transaction financings, and their interconnected impact on the lending institutions, could be a useful area for FSOC to monitor in fulfilling its duty to gain a comprehensive picture of the financial services marketplace in order to identify potential threats to the stability of the U.S. financial system.

76

See
section II.D.4 of this Release for a discussion of the information we propose requiring certain private equity fund advisers report on Form PF.

The SEC requests comment on this analysis of the potential systemic risk posed by the activities of private equity funds. Does it identify the ways in which private equity fund activities might generate systemic risk? Are there other ways that private equity funds or their activities could create systemic risk? Is the preliminary view that private equity fund activities may have less potential to create systemic risk than hedge funds and liquidity funds correct? Many advisers to private equity funds have noted that certain features of the private equity business model, such as its reliance on long-term capital commitments from investors, lack of substantial debt at the private equity fund level, and investment primarily in the equity of a diverse range of private companies, mitigate its potential to pose systemic risk.
77

Do private equity funds not have any potential to create systemic risk? Is the monitoring of private equity fund activities unnecessary to assess systemic risk generally? Please explain your views and discuss their implications for the reporting proposed on Form PF.

77

See, e.g.,
PE Council Letter,
supra
note 49; Testimony of Mark Tresnowksi, General Counsel, Madison Dearborn Partners, before the Senate Banking Subcommittee on Securities, Insurance and Investment, July 15, 2009.

B. Who Must File Form PF

We propose that any investment adviser registered or required to register with the SEC that advises one or more private funds must file a Form PF with the SEC.
78

A CPO or CTA that also is a registered investment adviser that advises one or more private funds would be required to file Form PF with respect to any advised commodity pool that is a “private fund.” By filing Form PF with respect to these private funds, a CPO will be deemed to have satisfied certain of its filing requirements for these funds.
79

Under these rules, most private fund advisers would be required to complete only section 1 of Form PF, providing certain basic information regarding any hedge funds they advise in addition to information about their private fund assets under management and more generally about their funds' performance and use of leverage. The information collected under section 1 of Form PF is described in further detail in section II.D.1 of this Release. Certain larger private fund advisers would be required to complete additional sections of Form PF, which require more detailed information.

78
Proposed Advisers Act rule 204(b)-1.

79
Proposed CEA rule 4.27(d). A CPO registered with the CFTC that is also registered as a private fund adviser with the SEC will be deemed to have satisfied its filing requirements for Schedules B and C of proposed Form CPO-PQR by completing and filing the applicable portions of Form PF for each of its commodity pools that satisfy the definition of “private fund” in the Dodd-Frank Act.

Three types of “Large Private Fund Advisers” would be required to complete certain additional sections of Form PF:
80

80

See
proposed Instruction 3 to Form PF.

• Advisers managing hedge funds that collectively have at least $1 billion in assets as of the close of business on any day during the reporting period for the required report;

• Advisers managing a liquidity fund and having combined liquidity fund and registered money market fund assets of at least $1 billion as of the close of business on any day during the reporting period for the required report; and

• Advisers managing private equity funds that collectively have at least $1 billion in assets as of the close of business on the last day of the quarterly reporting period for the required report.

1. Types of Funds

Proposed Form PF would define “hedge fund” as any private fund that (1) has a performance fee or allocation calculated by taking into account unrealized gains; (2) may borrow an amount in excess of one-half of its net asset value (including any committed capital) or may have gross notional exposure in excess of twice its net asset value (including any committed capital); or (3) may sell securities or other assets short.
81

As noted above, “liquidity fund” would be defined as any private fund that seeks to generate income by investing in a portfolio of short term obligations in order to maintain a stable net asset value per unit or minimize principal volatility for investors.
82

“Private equity fund” would be defined as any private fund that is not a hedge fund, liquidity fund, real estate fund, securitized asset fund or venture capital fund and does not provide investors with redemption rights in the ordinary course.
83

81

See
proposed Glossary of Terms to Form PF. This definition also is the same as the SEC has proposed in amendments to Form ADV.
See
Implementing Release,
supra
note 9. For purposes of the definition, the fund should not net long and short positions in calculating its borrowings but should include any borrowings or notional exposure of another person that are guaranteed by the fund or that the fund may otherwise be obligated to satisfy. In addition, a commodity pool that meets the definition of a private fund is treated as a hedge fund for purposes of Form PF.

82

See
proposed Glossary of Terms to Form PF.

83

See
proposed Glossary of Terms to Form PF. Proposed Form PF would define “real estate fund” as any private fund that is not a hedge fund, that does not provide investors with redemption rights in the ordinary course and that invests primarily in real estate and real estate-related assets. Proposed Form PF would define “securitized asset fund” as any private fund that is not a hedge fund and that issues asset backed securities and whose investors are primarily debt-holders. These definitions are designed to encompass entities that we believe are typically considered real estate or securitized asset funds, respectively, and are primarily intended to exclude these types of funds from our definition of private equity fund to improve the quality of data reported on Form PF relating to private equity funds. Proposed Form PF would define “venture capital fund” as any private fund meeting the definition of venture capital fund in rule 203(l)-1 of the Advisers Act for consistency.
See
proposed Glossary of Terms to Form PF.
See also
Private Fund Exemption Release,
supra
note 9, for a discussion of proposed Advisers Act rule 203(l)-1.

Our proposed definition of hedge fund would cover any private fund that has any one of three common characteristics of a hedge fund: A performance fee using market value (instead of only realized gains), high leverage or short selling. We are not aware of any standard definition of a hedge fund,
84

although we note that our proposed definition is broadly based on those used in the FSA survey and in the IOSCO report described in section I.B above and thus generally would promote international consistency in

hedge fund reporting.
85

Moreover, we believe that any fund meeting this definition is an appropriate subject for this higher level of reporting even if the fund would not otherwise be considered a hedge fund.

84

See, e.g. Goldstein
v.
SEC,
451 F.3d 873 (DC Cir. 2006) (“ `Hedge funds' are notoriously difficult to define. The term appears nowhere in the federal securities laws, and even industry participants do not agree upon a single definition.”)

85
The FSA survey is voluntary and does not proscriptively define a hedge fund, but states that if a fund generally satisfies a number of the following criteria, it should be deemed to fall within the scope of the FSA hedge fund survey: (1) Employs investment management techniques that can include the use of short selling, derivatives, and leverage; (2) takes in external investor money; (3) are not UCITS funds; (4) pursue absolute returns; (5) charge performance-based fees; (6) have broader mandates than traditional funds which give managers more flexibility to shift strategy; (7) have higher trading volumes/fund turnover; and (8) frequently set a high minimum investment limit. The IOSCO Report generally considered as a hedge fund all investment schemes displaying a combination of some of the following characteristics: (1) Borrowing and leverage restrictions are not applied; (2) significant performance fees are paid to the manager in addition to an annual management fee; (3) investors are typically permitted to redeem their interests periodically,
e.g.,
quarterly, semi-annually or annually; (4) often significant `own' funds are invested by the manager; (5) derivatives are used, often for speculative purposes, and there is an ability to short sell securities; and (6) more diverse risks or complex underlying products are involved.
See
IOSCO Report,
supra
note 24, at 4-5.

The Commissions request comment on the hedge fund definition proposed in Form PF.
86

Does this proposed definition capture the appropriate features of funds that should be subject to more detailed reporting as “hedge funds”? Many private funds sell short. Is the bright line of classifying
any
private fund that engages in short selling as a hedge fund appropriate? Is the proposed leverage threshold for hedge funds set at the appropriate level? One alternative approach we could take is to not define a hedge fund in Form PF and simply require that all advisers managing in excess of $1 billion in private fund assets (regardless of strategy) complete section 2 of Form PF. Would this be a more effective approach? For purposes of Form PF, a commodity pool satisfying the definition of a “private fund” is categorized as a hedge fund. Is this treatment appropriate?

86
The SEC previously defined private fund for purposes of registration of advisers to hedge funds by focusing on the structure of the fund to differentiate it from other pooled investment vehicles, while the definition of hedge fund we propose today for purposes of Form PF reporting focuses on the strategy of the fund in order to monitor trading strategies and behaviors which could contribute to systemic risk.
See Registration under the Advisers Act of Certain Hedge Fund Advisers,
Investment Advisers Act Release No. 2333 (Dec. 2, 2004), 69 FR 72054 (Dec. 10, 2004) (rulemaking vacated,
Goldstein,
451 F.3d at 884).

The proposed definition of liquidity fund is designed to capture all potential substitutes for money market funds because we believe these funds may be susceptible to runs and otherwise pose systemic risk that FSOC will want to monitor. The SEC recognizes that its proposed definition of liquidity fund potentially could capture some short-term bond funds. Are there ways that the SEC could define a liquidity fund to capture all potential substitutes for money market funds, but not short-term bond funds? The SEC requests comment on the liquidity fund definition proposed in Form PF.

Our proposed definition of a private equity fund is intended to distinguish private equity funds from other private funds based upon the lack of redemption rights and their not being engaged in certain investment strategies (such as securitization, real estate or venture capital), while these funds would typically have performance fees based on realized gains. Has the SEC appropriately distinguished private equity funds from other types of private funds in its proposed definition? Should others be excluded? The SEC requests comment on the private equity fund definition proposed in Form PF.

2. Large Private Fund Adviser Thresholds

As noted above, we are proposing $1 billion in hedge fund assets under management as the threshold for large hedge fund adviser reporting, $1 billion in combined liquidity fund and registered money market fund assets under management as the threshold for large liquidity fund adviser reporting, and $1 billion in private equity fund assets under management as the threshold for large private equity fund adviser reporting. Advisers would be required to measure whether these thresholds have been crossed daily for hedge funds and liquidity funds and quarterly for private equity funds based on our belief that, as a matter of ordinary business practice, advisers are aware of hedge fund and liquidity fund assets under management on a daily basis, but are likely to be aware of private equity fund assets under management only on a quarterly basis. We designed these thresholds so that the group of Large Private Fund Advisers that would be included based on the proposed thresholds is relatively small in number but represents the large majority of their respective industries based on assets under management. For example, we understand that the approximately 200 U.S.-based advisers managing at least $1 billion in hedge fund assets represent over 80 percent of the U.S. hedge fund industry based on assets under management.
87

Similarly, SEC staff estimates that the approximately 250 U.S.-based advisers managing over $1 billion in private equity fund assets represent approximately 85 percent of the U.S. private equity fund industry based on committed capital.
88

87

See
HFI,
supra
note 20.

88
Preqin. The Preqin data relating to private equity fund committed capital is available in File No. S7-05-11.

The SEC is proposing that private fund advisers combine liquidity fund and registered money market fund assets for purposes of determining whether the adviser meets the threshold for more extensive reporting regarding its liquidity funds because it understands that an adviser's liquidity funds and registered money market funds often pursue similar strategies and invest in the same securities and thus are subject to many of the same risks. Historically, most advisers of enhanced cash funds or other unregistered money market funds also advised a substantial amount of registered money market fund assets, and so the SEC's criteria for liquidity fund reporting is expected to encompass most significant managers of liquidity funds, which it estimates number around 80 advisers.
89

89

See, e.g.,
iMoneyNet, Enhanced Cash Report (3rd quarter 2009). The estimate of the number of large liquidity fund advisers is based on the number of advisers with at least $1 billion in registered money market fund assets under management.

We believe that requiring basic information from all advisers about all private funds but more extensive and detailed information only from advisers with these amounts of assets under management in hedge funds, private equity funds, and liquidity funds would allow FSOC to effectively conduct basic monitoring for potential systemic risk in these private fund industries and to identify areas where OFR may want to obtain additional information. In addition, requiring that only these Large Private Fund Advisers complete additional reporting requirements under Form PF would provide systemic risk information for most private fund assets while minimizing burdens on smaller private fund advisers that are less likely to pose systemic risk concerns. The proposed approach thus incorporates Congress' directive in section 408 of the Dodd-Frank Act to take into account the size, governance, and investment strategy of advisers to mid-sized private funds in determining whether they pose systemic risk and formulating systemic risk reporting and recordkeeping requirements for private funds.
90

90
We note that the SEC has proposed to collect information regarding the governance of private fund advisers through Form ADV.
See
Implementing Release,
supra
note 9.

We request comment on the proposed thresholds. Are there more appropriate dividing lines as to when a private fund adviser should be required to report more information? Should any of the assets under management thresholds be lower or higher? Are the daily (for hedge fund and liquidity fund managers) and quarterly (for private equity fund managers) measurement periods for the assets under management thresholds set appropriately? Should we, as proposed, base the threshold on the amount of assets under management? If not, what should we base it on?

We request comment on our proposed approach of only requiring these Large Private Fund Advisers to report additional information on Form PF. Will collecting the information required by sections 2, 3, and 4 of Form PF only from advisers managing in excess of these asset thresholds provide adequate information about potential systemic risk in these industries? Should we instead require that all private fund advisers registered with the SEC complete all of the information on Form PF appropriate to the type of private funds they advise regardless of fund size or assets under management? Are there advisers to other types of private funds that should be required to report more information on Form PF? For example, should advisers to other types of private fund report more information if they manage in excess of a certain threshold of that type of private fund assets?

3. Aggregation of Assets Under Management

For purposes of determining whether an adviser is a Large Private Fund Adviser for purposes of Form PF, each adviser would have to aggregate together:

• Assets of managed accounts advised by the firm that pursue substantially the same investment objective and strategy and invest in substantially the same positions as the private fund (“parallel managed accounts”);
91

and

91

See
proposed Instructions 3, 5, and 6 to Form PF; and proposed Glossary of Terms to Form PF.
See also
definitions of “hedge fund assets under management,” “liquidity fund assets under management,” and “private equity fund assets under management” in the proposed Glossary of Terms to Form PF.

• Assets of that type of private fund advised by any of the adviser's “related persons.”
92

92

See
proposed Instructions 3 and 5 to Form PF. “Related person” is defined generally as: (1) All of the adviser's officers, partners, or directors (or any person performing similar functions); (2) all persons directly or indirectly controlling, controlled by, or under common control with the adviser; and (3) all of the adviser's employees (other than employees performing only clerical, administrative, support or similar functions).
See
proposed Glossary of Terms to Form PF and Glossary of Terms to Form ADV. The adviser would be permitted, but not required, to file one consolidated Form PF for itself and its related persons.
See
section II.B.4 of this Release below.

These proposed aggregation requirements are designed to prevent an adviser from avoiding the proposed Large Private Fund Adviser reporting requirements by re-structuring the manner of providing private fund advice internally within the private fund manager group. The adviser also would be required to exclude any assets in any account that are solely invested in other funds (
i.e.,
internal or external fund of funds) in order to avoid duplicative reporting.
93

We request comment on these proposed aggregation requirements. Would these proposed aggregation rules appropriately meet our goal of preventing improper avoidance of the reporting requirements while giving a complete picture of private fund assets managed by a particular private fund adviser group? Would aggregating in a different manner be more effective at meeting our goal? Should funds that invest most (
e.g.,
95 percent), but not all, of their assets in other funds be excluded from Form PF reporting? Would excluding such funds still provide FSOC with a complete enough picture of private fund activities to have an adequate baseline for systemic risk monitoring purposes?

93

See
proposed Instruction 7 to Form PF.

If the adviser's principal office and place of business is outside the United States, the adviser could exclude any private fund that during the last fiscal year was neither a United States person nor offered to, or beneficially owned by, any United States person.
94

This aspect of the proposed form is designed to allow an adviser to report with respect to only those private funds that are more likely to implicate U.S. regulatory interests. We request comment on this aspect of the proposed form. Should we require different reporting relating to foreign advisers or foreign private funds?

94

See
proposed Instruction 1 to Form PF. “United States person” would have the meaning provided in proposed rule 203(m)-1 of the Advisers Act, and “principal office and place of business” would have the same meaning as in Form ADV.
See
Private Fund Exemption Release,
supra
note 9.

4. Reporting for Affiliated and Subadvised Funds

To provide private fund advisers with reporting flexibility and convenience, the adviser could, but is not required to, report the private fund assets that it manages and the private fund assets that its related persons manage on a single Form PF.
95

This would allow affiliated entities that share reporting and risk management systems to report jointly while also permitting affiliated entities that operate separately to report separately. With respect to sub-advised funds, to prevent duplicative reporting, only one adviser would report information on Form PF with respect to that fund. For reporting efficiency and to prevent duplicative reporting, we are proposing that if an adviser completes information on Schedule D of Form ADV with respect to any private fund, the same adviser would be responsible for reporting on Form PF with respect to that fund.
96

We request comment on this approach. Should we not allow advisers to file a consolidated form with its related persons? Are there other persons related to a private fund adviser that should also be able to report on Form PF on a consolidated basis? For example, should we adjust Form PF to permit consolidated reporting with related persons that are exempt reporting advisers in the event an adviser chooses to voluntarily report exempt reporting adviser information? Should we allow a different arrangement on reporting of sub-advised funds? If so, what would those arrangements be?

95

See
proposed Instruction 2 to Form PF.
See supra
note 92 for the definition of “related person.”

96

See
proposed Instruction 4 to Form PF.

5. Exempt Reporting Advisers and Other Advisers Not Registered With the SEC

We are proposing that only private fund advisers registered with the SEC (including those that are also registered with the CFTC as CPOs or CTAs) file Form PF.
97

The Dodd-Frank Act created exemptions from SEC registration under the Advisers Act for advisers solely to venture capital funds or for advisers to private funds that in the aggregate have less than $150 million in assets under management in the United States (“exempt reporting advisers”).
98

We are not proposing that exempt reporting advisers be required to file Form PF.
99

We believe that Congress' determination to exempt these advisers from SEC registration indicates Congress' belief that they are sufficiently unlikely to pose systemic risk that regular reporting of detailed information may not be necessary.
100

Based on consultation

with staff representing FSOC's members and on the basic information that the SEC has proposed requiring exempt reporting advisers report to the SEC on Form ADV, the SEC is not proposing to extend Form PF reporting to these advisers.

97

See
proposed Advisers Act rule 204(b)-1.

98

See
Private Fund Exemption Release,
supra
note 9; Implementing Release,
supra
note 9.

99
To the extent an exempt reporting adviser is registered with the CFTC as a CPO or CTA, that adviser would be obligated to file either proposed Form CPO-PQR or CTA-PR, respectively.

100

See
Senate Committee Report,
supra
note 4, at 74 (“The Committee believes that venture capital

funds * * * do not present the same risks as the large private funds whose advisers are required to register with the SEC under this title. Their activities are not interconnected with the global financial system, and they generally rely on equity funding, so that losses that may occur do not ripple throughout world markets but are borne by fund investors alone.”).
See also
Private Fund Exemption Release,
supra
note 9.

Our proposed rules, however, would require some advisers managing less than $150 million in private fund assets to report limited information on Form PF. While Congress exempted from registration with the SEC advisers
solely
to private funds that in the aggregate have less than $150 million in assets under management, it provided no such exemption for advisers with less than $150 million in private fund assets under management that also, for example, advise individual clients with over $100 million in assets under management. Because this latter group of advisers is registered with the SEC and thus is subject to the full range of investor protection efforts that accompany registration, and because of the limited burden of the basic reporting, we believe it is appropriate to require these advisers to complete and file section 1 of Form PF. We request comment on this approach. Should we require that exempt reporting advisers file Form PF?
101

Why or why not? If so, which portions of Form PF should we require that exempt reporting advisers complete?

101
Section 404 of the Dodd-Frank Act states that the SEC “shall issue rules requiring
each investment adviser to a private fund
to file reports containing such information as the [SEC] deems necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk,” (emphasis added).

C. Frequency of Reporting

The Commissions propose to require that all private fund advisers other than the Large Private Fund Advisers discussed above complete and file a Form PF on an annual basis. A newly registering adviser's initial Form PF filing would be submitted within 15 days of the end of its next occurring calendar quarter after registering with the SEC so that FSOC can begin including this data in its analysis as soon as possible.
102

Annual updates would be due no later than the last day on which the adviser may timely file its annual updating amendment to Form ADV (currently, 90 days after the end of the adviser's fiscal year).
103

This frequency of reporting would allow the Commissions and FSOC to periodically monitor certain key information relevant to assessing systemic risk posed by these private funds on an aggregate basis. It also would allow these advisers to file amendments at the same time as they file their Form ADV annual updating amendment, which may make certain aspects of the reporting more efficient, such as reporting assets under management. Finally, this timing will facilitate FSOC's compilation and analysis of Form PF and Form ADV data for these filers since both sets of data will be reported as of the same date.

102

See
proposed rule 204(b)-1(a).

103

See
proposed Advisers Act rule 204(b)-1(e).

Large Private Fund Advisers would be required to complete and file a Form PF no later than 15 days after the end of each calendar quarter.
104

Our preliminary view is that, unlike for smaller private fund advisers, quarterly reporting for Large Private Fund Advisers is necessary in order to provide FSOC with timely data to identify emerging trends in systemic risk. We understand that hedge fund advisers already collect and calculate much of the information that would be required by Form PF relating to hedge funds on a quarterly basis.
105

As a result, quarterly reporting on Form PF would coincide with most hedge fund advisers' internal reporting cycles and leverage data collection systems and processes already existing at these advisers. In addition, we believe that most liquidity fund advisers collect on a monthly basis much of the information that we are proposing be reported in section 3 of Form PF and thus quarterly reporting should be relatively efficient for these advisers. We anticipate that Large Private Fund Advisers would be able to collect and file this information within 15 days after the end of each quarter, which is sufficiently timely for FSOC's use in conducting systemic risk monitoring.

104

See
proposed Instruction 7 to Form PF.

105

See
Report of the Asset Manager's Committee to the President's Working Group on Financial Markets, Best Practices for the Hedge Fund Industry (Jan. 15, 2009),
available at http://www.amaicmte.org/Public/AMC%20Report%20-%20Final.pdf
(discussing best practices on disclosing to investors performance data, assets under management, risk management practices (including on asset types, geography, leverage, and concentrations of positions) with which SEC staff understands many hedge funds comply).

Advisers would be required to file Form PF to report that they are transitioning to only filing Form PF annually with the Commissions or to report that they no longer meet the requirements for filing Form PF no later than the last day on which the adviser's next Form PF update would be timely.
106

This would allow us to determine promptly whether an adviser's discontinuance in reporting is due to it no longer meeting the form's reporting thresholds as opposed to a lack of attention to its filing obligations. Advisers also would be able to avail themselves of a temporary hardship exemption in a similar manner as with other Commission filings if they are unable to file Form PF electronically in a timely manner due to unanticipated technical difficulties.
107

106

See
proposed Instruction 8 to Form PF
.

107

See
proposed rule 204(b) 1(f). The adviser would check the box in Section 1a of Form PF indicating that it was requesting a temporary hardship exemption and complete Section 5 of Form PF no later than one business day after the electronic Form PF filing was due and submit the filing that is the subject of the Form PF paper filing in electronic format with the Form PF filing system no later than seven business days after the filing was due.

We request comment on our proposed filing frequency. Are the filing requirements for private fund advisers frequent enough to assess high-level systemic risk posed by private funds? Should smaller private fund advisers have to file more frequently or less frequently? Should Large Private Fund Advisers be required to file Form PF more frequently (such as monthly) or less frequently (such as annually or semiannually)? Is 90 days for an annual update or 15 days for a quarterly update too long to ensure reporting of timely information? Would more or less time be more appropriate? Specifically, would 15 days be enough time for Large Private Fund Advisers to prepare and file quarterly reports? Is there information in the form that should be amended promptly if it becomes inaccurate? Should Large Private Fund Advisers be required to file Form PF as of the end of each calendar quarter or as of the end of each fiscal quarter?

Currently, we anticipate that the proposed rules requiring filing of Form PF would have a compliance date of December 15, 2011, at which time Large Private Fund Advisers would begin filing 15 days after the end of each quarter (
i.e.,
Large Private Fund Advisers would need to make their initial Form PF filing by January 15, 2012). This timing should allow sufficient time for Large Private Fund Advisers to develop systems for collecting the information required on Form PF and prepare for filing. We currently anticipate that this timeframe also would give the SEC sufficient time to create and program a system to accept filings of Form PF.
108

We are proposing

that the rules allow smaller private fund advisers until 90 days after the end of their first fiscal year occurring on or after the compliance date of the proposed rule to file their first Form PF (with the expectation that this would result in smaller private fund advisers with a December 31 fiscal year end filing their first Form PF by March 31, 2012) because we anticipate that some of these advisers may require more time to prepare for their initial Form PF filing and so that the first group of private fund advisers filing Form PF would all be reporting based generally on information as of December 31, 2011.
109

Under this proposed compliance date and transition rule, smaller private fund advisers would have at least eight months after adoption of the proposed form, depending on their fiscal year end, to file their first Form PF. We request comment on when advisers should be required to comply with the proposed rules and file Form PF. Do the compliance dates and transition times that we have proposed provide sufficient time for smaller advisers and Large Private Fund Advisers to prepare for filing?

108
The SEC will work closely with the firm it selects to create and program a system for Form PF

filings and will monitor whether it could do so on this timeframe.

109

See
proposed Advisers Act rule 204(b)-1(g).

D. Information Required on Form PF

The questions contained in proposed Form PF reflect relevant requirements and considerations under the Dodd-Frank Act, consultations with staff representing FSOC's members, and the Commissions' experience in regulating those private fund advisers that are already registered with the Commissions. As discussed above, with respect to hedge fund advisers in particular, the information we propose requiring registered advisers to file on Form PF also is broadly based on the guidelines discussed in the IOSCO Report with many of the more detailed items generally tracking questions contained in the surveys of large hedge fund advisers conducted by the FSA and other IOSCO members.
110

We expect that the information collected on Form PF would assist FSOC in monitoring and assessing any systemic risk, as discussed in section II.A above, that may be posed by private funds. We discuss below the information that Form PF would require.

110

See supra
note 24.

1. Section 1

Section 1 would apply to all investment advisers required to file Form PF. Item A of Section 1a seeks identifying information about the adviser, such as its name and the name of any of its related persons whose information is also reported on the adviser's Form PF. Section 1a also would require reporting of basic aggregate information about the private funds managed by the adviser, such as total and net assets under management, and the amount of those assets that are attributable to certain types of private funds.
111

This identifying information would assist us and FSOC in monitoring the amount of assets managed by private fund advisers and the general distribution of those assets among various types of private funds.

111
Section 1 would require the adviser to indicate the adviser's total “regulatory assets under management,” using the same proposed definition of that term as used on proposed amendments to Part 1 of Form ADV, and its net assets under management, which subtracts out any liabilities of the private funds.
See
Implementing Release,
supra
note 9. Form PF, however, would require the adviser to aggregate parallel managed accounts with related private funds in reporting its assets under management (even if the accounts are not “securities portfolios” within the meaning of proposed Instruction 5.b, Instructions to Part 1A of Form ADV), and thus the total and net assets under management figures reported in section 1a of Form PF may differ from what the adviser reports on Form ADV. Proposed question 2 would require the adviser to report what portion of these assets under management are attributable to hedge funds, liquidity funds, private equity funds, real estate funds, securitized asset funds, venture capital funds, other private funds, and funds and accounts other than private funds.
See
section II.B.1 of this Release for a discussion of these different types of funds and their proposed definitions for purposes of Form PF.

Section 1b of Form PF would elicit certain identifying and other basic information about each private fund advised by the investment adviser. The adviser generally would need to complete a separate section 1b for each private fund it advised. However, because feeder funds typically invest substantially all their assets in a master fund, to prevent duplicative reporting the adviser must report information in section 1b on an aggregated basis for private funds that are part of a master-feeder arrangement and so would not file a separate section 1b for any feeder fund.
112

112

See
proposed Instructions 5 and 6 to Form PF. When providing responses in Form PF with respect to a private fund, the adviser also must include any parallel managed accounts related to the private fund.
Id.

Section 1b would require reporting of each private fund's gross and net assets and the aggregate notional value of its derivative positions.
113

It also would require basic information about the fund's borrowings, including a breakdown of the fund's borrowing based on whether the creditor is a U.S. financial institution, foreign financial institution or non-financial institution as well as the identity of, and amount owed to, each creditor to which the fund owed an amount equal to or greater than 5 percent of the fund's net asset value as of the reporting date. This section would require reporting of certain basic information about how concentrated the fund's investor base is, such as the number of beneficial owners of the fund's equity and the percentage of the fund's equity held by the five largest equity holders.
114

Finally, section 1b would require monthly and quarterly performance information about each fund.

113
The form would require the adviser to report the total gross notional value of its funds' derivative positions, except that options would be reported using their delta adjusted notional value. Long and short positions would not be netted.
See
proposed Form PF, instructions to question 11.

114

See
proposed question 12 on Form PF.

The information required by section 1b would allow FSOC to monitor certain systemic trends for the broader private fund industry, such as how certain kinds of private funds perform and exhibit correlated performance behavior under different economic and market conditions and whether certain funds are taking significant risks that may have systemic implications.
115

It would allow FSOC to monitor borrowing practices for the broader private fund industry, which may have interconnected impacts on banks (including specific banks) and thus the broader financial system. We believe that collecting both monthly and quarterly performance data also would allow FSOC to monitor the data at sufficient granularity to track trends.

115
This information also would be useful for advancing the Commissions' investor protection goals.

Finally, section 1c would require reporting of certain information only about hedge funds managed by the adviser, such as their investment strategies, percentage of the fund's assets managed using computer-driven trading algorithms, significant trading counterparty exposures (including identity of counterparties),
116

and trading and clearing practices.
117

This information will enable FSOC to

monitor systemic risk that could be transmitted through counterparty exposure, track how different strategies are affected by and correlated with different market stresses, and follow the extent of private fund activities conducted away from regulated exchanges and clearing systems. We have based some of this information, such as information about significant trading counterparty exposures and trading and clearing practices, on the FSA surveys, which would promote international consistency in hedge fund reporting.
118

116
Specifically, proposed questions 19 and 20 on Form PF would require the adviser to identify the five trading counterparties to which the fund has the greatest net counterparty credit exposure (measured as a percentage of the fund's net asset value) and that have the greatest net counterparty credit exposure to the fund (measured in U.S. dollars).

117
More specifically, proposed question 21 on Form PF would require estimated breakdowns of percentages of the hedge fund's securities and derivatives traded on a regulated exchange versus over the counter and percentages of the hedge fund's securities, derivatives, and repos cleared by a central clearing counterparty (“CCP”) versus bilaterally (or, in the case of repos, that constitute a tri-party repo).

118
For example, the FSA survey asks for identification of the hedge fund's top five counterparties in terms of net credit exposure. It also asks for estimates of the percentage of the fund's securities or derivatives traded on a regulated exchange versus over the counter and the percentage of the fund's derivatives and repos cleared by a CCP versus bilaterally.

We request comment on section 1 of proposed Form PF. Is there additional basic information that we should require from all advisers filing Form PF or regarding all of the hedge funds or other private funds that they manage? For example, should we require any of the more detailed information about their borrowing practices that we require regarding large hedge funds in Item B of section 2b? Is a creditor providing 5 percent of the fund's borrowings an appropriate threshold for significant creditors of whose identity FSOC may want to be aware for purposes of assessing the fund's interconnectedness in the financial system? Should the threshold be more or less? Are the top five equity holders in the fund an appropriate threshold for significant investors in the fund? Should the threshold be more or less? Should we require assets under management information for other private fund categories than those specified in question 4? Should we request that performance data be reported on a different basis than monthly and quarterly? Are there other primary investment strategies that hedge funds use that should be included in question 17? Is the information we have proposed requiring on the fund's borrowings necessary given that other questions in section 1b ask for information on the fund's gross and net assets? Will asking for the amount and identity of the five trading counterparties to which the fund has the greatest net counterparty credit exposure and that have the greatest net counterparty credit exposure to the fund appropriately track significant exposures for systemic risk assessment purposes? Have we requested appropriate information on trading and clearing practices sufficient to allow FSOC to examine systemic risks relating to trading and clearing outside of regulated exchanges and central clearing systems? Is there information in section 1 that we should not require, or that we should only require of large hedge fund advisers and why? With respect to the aggregation of master-feeder arrangements for reporting purposes, are there common situations in which an adviser will not have sufficient access to a feeder fund's information to report accurately on Form PF? If so, how should the form address those situations? We also request comment more generally on the definitions of terms we have proposed in the glossary of terms for Form PF.

2. Section 2

Form PF would require private fund advisers who had at least $1 billion in hedge fund assets under management as of the close of business on any day during the reporting period to complete section 2.
119

Section 2a would require certain aggregate information about the hedge funds advised by Large Private Fund Advisers, such as the market value of assets invested (on a short and long basis) in different types of securities and commodities (
e.g.,
different types of equities, fixed income securities, derivatives, and structured products). It also would require the adviser to report the duration of fixed income portfolio holdings (including asset backed securities), to indicate the assets' interest rate sensitivity, as well as the turnover rate of the adviser's aggregate portfolios during the reporting period to provide an indication of the adviser's frequency of trading. Finally, the adviser would be required to report a geographic breakdown of investments held by the hedge funds it advises.

119

See
section II.B of this Release.

This information would assist FSOC in monitoring asset classes in which hedge funds may be significant investors and trends in hedge funds' exposures to allow FSOC to identify concentrations in particular asset classes (or in particular geographic regions) that are building or transitioning over time. It would aid FSOC in examining large hedge fund advisers' role as a source of liquidity in different asset classes. In some cases, we are proposing that the information be broken down into categories that would facilitate FSOC's use of flow of funds information, which is an important tool for evaluating trends in and risks to the U.S. financial system.
120

This information also is designed to address requirements under section 404 of the Dodd-Frank Act specifying certain mandatory contents for records and reports that must be maintained and filed by advisers to private funds. For example, it would provide information about the types of assets held and trading and investment positions and practices.

120
For example, we are proposing that in some cases the data be broken down between issuers that are financial institutions and those that are not. The FRB publishes flow of funds data, which is available at
http://www.federalreserve.gov/releases/z1/.

Section 2b of Form PF would require large hedge fund advisers to report certain additional information about any hedge fund they advise with a net asset value of at least $500 million as of the close of business on any day during the reporting period (a “qualifying hedge fund”).
121

For purposes of determining whether a private fund is a qualifying hedge fund, the adviser would have to aggregate any parallel managed accounts, parallel funds, and funds that are part of the same master-feeder arrangement, and would have to treat any private funds managed by its related person as if they were managed by the filing adviser.
122

We are proposing this aggregation to prevent an adviser from structuring its activities to avoid the reporting requirement. We have selected $500 million as a threshold for more extensive individual hedge fund reporting because we believe that a $500 million hedge fund is a substantial fund the activities of which could have an impact on particular markets in which it invests or on its particular counterparties. We also believe that setting this threshold at this level would minimize reporting burdens on advisers to smaller or start up hedge funds that are less likely to have a systemic impact. Finally, this threshold is the same threshold used by the FSA in its hedge fund surveys and thus would create a certain level of consistency in reported data.

121

See
proposed Instruction 3 to Form PF. Advisers should not complete section 2 with respect to assets managed by a fund of hedge funds.
See
proposed Instruction 7 to Form PF.

122

See
proposed Instructions 5 and 6 to Form PF. Parallel funds are a structure in which one or more private funds pursues substantially the same investment objective and strategy and invests side by side in substantially the same positions as another private fund.
See
proposed Glossary of Terms to Form PF.

We request comment on the qualifying hedge fund threshold. Should it be lower or higher? If so, why? Should large hedge fund advisers have to report the information for all their hedge funds? Could all of such advisers' hedge funds, in the aggregate, potentially have a systemic impact that would merit such

reporting? Should Form PF have different requirements regarding aggregating parallel managed accounts, parallel funds, or feeder funds or aggregating hedge funds managed by affiliates?

Section 2b would require reporting of the same information as that requested in section 2a regarding exposure to different types of assets.
123

In this section, however, this information would be reported separately for each qualifying hedge fund the adviser manages. Section 2b also would require on a per fund basis data not requested in section 2a. The adviser would be required to report information regarding the qualifying hedge fund's portfolio liquidity, concentration of positions, collateral practices with significant counterparties, and the identity of, and clearing relationships with, the three central clearing counterparties to which the fund has the greatest net counterparty credit exposure.
124

This information is designed to assist FSOC in monitoring the composition of hedge fund exposures over time as well as the liquidity of those exposures. The information also would aid FSOC in its monitoring of credit counterparties' unsecured exposure to hedge funds as well as the hedge fund's exposure and ability to respond to market stresses and interconnectedness with central clearing counterparties. Finally, some of this information, such as information about the identity of three central clearing counterparties to which the fund has the greatest net counterparty credit exposure and fund asset liquidity information, was broadly based on information requested by the FSA survey, which would promote international consistency in hedge fund reporting.
125

123

See
proposed question 26 on Form PF.

124

See
proposed questions 27-34 on Form PF. For example, question 28 would require reporting of the percentage of the fund's portfolio capable of being liquidated within different time periods. Question 31 would require reporting, for each position that represents 5% or more of the fund's net asset value, of the position's portion of the fund's net asset value and sub-asset class. Questions 32 and 33 would require reporting of initial and variation margin for collateral securing exposure to the fund's top five counterparty groups as well as the face amount of letters of credit posted and certain information on rehypothecation of such collateral.

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For example, the FSA survey asks for the percentage of the hedge fund's portfolio that can be liquidated within different time periods and the identity of the fund's top three CCPs in terms of net credit exposure.

Section 2b also would require for each qualifying hedge fund data regarding certain hedge fund risk metrics, financing information, and investor information. If during the reporting period the adviser regularly calculated a value at risk (“VaR”) metric for the qualifying hedge fund, the adviser would have to report VaR for each month of the reporting period.
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The form also would require the adviser to report the impact on the fund's portfolio from specified changes to certain identified market factors, if regularly considered in the fund's risk management, broken down by the long and short components of the qualifying hedge fund's portfolio.
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This information is designed to allow FSOC to track basic sensitivities of the hedge fund to common market sensitivities, correlations in those factor sensitivities, and trends in those factor sensitivities among large hedge funds.

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If VaR was calculated, the adviser would have to report the confidence interval, time horizon, whether any weighting was used, and the method used to calculate VaR (historical simulation, Monte Carlo simulation, parametric, or other). If applicable, the adviser would have to report the historical lookback period used. The adviser would also have to report if it did not regularly calculate VaR.
See
proposed question 35 on Form PF.

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The market factors are changes in: equity prices, risk free interest rates, credit spreads, currency rates, commodity prices, option implied volatilities, ABS default rates, and corporate bond default rates. Advisers are permitted to omit a response with respect to any market factor that it did not regularly consider in the reporting fund's risk management. However, to be “regularly considered” in the fund's risk management does not require that the adviser have conducted stress testing on that market factor (it could simply mean, for example, that the fund's risk managers recognized that such a market factor could have an impact on the fund's portfolio).
See
proposed question 36 on Form PF and related instructions.

Item D of Section 2b would require reporting of certain financing information for each qualifying hedge fund, including a monthly breakdown of its secured and unsecured borrowing and its derivatives exposures as well as information about the value of the collateral and letters of credit supporting the secured borrowing and derivatives exposures and the types of creditors. It also would require a breakdown of the term of the fund's committed financing. This information would assist FSOC in monitoring the qualifying hedge fund's leverage, the unsecured exposure of credit counterparties to the fund, and the committed term of that leverage, which may be important to monitor if the fund comes under stress. Collecting financing data broken down on a monthly basis should provide FSOC with sufficient granularity to identify trends.

Finally, Item E of section 2b would require the private fund adviser to report information about each qualifying hedge fund's investor composition and liquidity. For example, it contains questions about the fund's side pocket and gating arrangements and provides for a breakdown of the percentage of the fund's net asset value that is locked in for different periods of time.
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We believe this information may be important in allowing FSOC to monitor the hedge fund's susceptibility to failure through investor redemptions in the event the fund experiences stress due to market or other factors.

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A side pocket is a type of account used by private funds to separate illiquid assets from other more liquid fund investments. Only investors in the hedge fund at the time the asset is put in the side pocket (and not future investors) will be entitled to a share of proceeds from that investment. A gate is a restriction imposed by the manager of a private fund on permissible redemptions from the fund during a certain period of time. The standards for imposing suspensions and gates may vary among funds, so in responding to these questions, an adviser would be expected to make a good faith determination as to which provisions of the reporting fund's governing documents would likely be triggered during conditions that it views as significant market stress.

The information in proposed section 2b also is designed to address requirements under section 404 of the Dodd-Frank Act for records and reports that the SEC requires of private fund advisers, such as monitoring the amount of assets under management and the use of leverage, counterparty credit risk exposure, trading and investment positions, and the types of assets held. We request comment on the information that we propose requiring large hedge fund advisers to report under section 2. Is there additional information with respect to the types of their investments, use of leverage, or counterparties that we should require and why? Have we asked for appropriate time period breakdowns of the fund's liquidity in terms of asset liquidity, financing liquidity, and investor liquidity? Is there other information we could ask to assess hedge funds' potential impact on liquidity in particular markets? Would the threshold in the proposed form capture significant central clearing counterparties? Does the proposed form ask sufficient questions regarding the fund's collateral practices to ensure that FSOC will be able to monitor the fund's unsecured exposure to significant counterparties? Should the form require reporting of hedge funds' investment in different types of instruments or commodities than those proposed in questions 23 and 27?

Are there risk metrics or additional market factors that we should require? Should we require the proposed market factors but with different specified changes? Stress testing is an important metric for FSOC's assessment of potential systemic risk posed by hedge funds, but we understand that the type of stress testing conducted varies

substantially depending on the strategy of the particular hedge fund and among hedge funds pursuing the same strategy. Is there a better way for the form to assess the effects of stresses on hedge funds than the stress testing questions included in the proposed form? Should we request the geographic breakdown of the hedge fund's investments for different geographic regions or countries? Are there existing collections of data broken down by geographic regions or countries with which we should be consistent? Should we require more or less detailed information regarding the types of assets in which the fund invests?

Is there information that we should not require and why? Is there information that we should require large hedge fund advisers to report regarding all of the hedge funds they manage that we only propose requiring qualifying hedge funds to report? Is there

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Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/fr%3A2011-2175. Public record. Not legal advice.