The Securities and Exchange Commission (SEC) voted 3-1 on January 26 to issue a proposal that would increase the amount and timeliness of disclosures under form PF—a reporting form for investment advisors at private equity firms and hedge funds. This represents the first major amendment to form PF since its adoption in 2012. The proposed changes are aimed at improving the ability of the regulator to identify possible systemic risks in the financial markets and to prevent investor harm. But Commissioner Hester Pierce, the commission’s sole Republican, voted against the proposal, citing concerns about the deviation from the purpose of Form PF and the bureaucratic burden of requiring near-instant reporting from distressed firms.
The SEC adopted Form PF in 2011 to help the Financial Stability Oversight Counsel (FSOC) in its monitoring obligations as required by the Dodd-Frank Act. Now, with a decade of experience gathering and analyzing data from private firms, the proposal explains that the FSOC has identified areas where more and more timely information would enhance its capability to fulfill its mandate.
Indeed, the developments in the private financial markets since the onset of the Covid pandemic support the view that more should be done to avoid systemic risk and protect investors. The January 2021 meme-stock phenomenon was as much tied to hedge fund activity as it was to retail investors’ behavior, given these firms’ massive short positions and their position as the largest sources for payment for order flow for zero-fee trading platforms. Bill Hwang’s hedge fund Archegos Capital Management’s dramatic meltdown in March 2021 caused banks more than $10 billion in losses – with $5.5 billion suffered by Credit Suisse alone. Further underscoring the potential for systemic risk, Bloomberg recently reported that hedge funds are increasingly becoming too big to fail. Against this background, the new proposal is unsurprising and fits with SEC Chairman Gary Gensler’s tougher stance on private equity and hedge funds.
The key proposed changes to Form PF are as follows. First, the proposal will lower the reporting threshold for private equity fund advisers from $2 billion assets under management to $1.5 billion. Second, and more significantly, the proposal will require firms to file reports within one business day on the occurrence of certain major events, marking a stark departure from the current annual or quarterly reporting. For example, a firm will have to report within one business day if it suffers an extraordinary investment loss, defined as an aggregate 20% or greater loss over a 10 business day rolling period in its most recent net asset value. Similarly, major increases to the collateral posted by the firm, failing to meet margin calls, and major defaults will require near-instant reporting. The proposal also includes new, more abstract triggers that try to capture other major disruptions to firms, such as cybersecurity attacks, relationships with brokers, severe weather events, and more.
Ms. Pierce’s objection to the proposal centered on two issues: first, that the SEC has not adequately shown that newly sought data will actually help the FSOC in its task, and second, that near-instant reporting will only impose a bureaucratic burden on firms already dealing with major disruptions. Calling the proposal an attempt to turn Form PF into a “tool of the government to micromanage private fund risk investment,” Ms. Pierce raised the concern that “the fund adviser will have its hands full in such a fraught period and will have little time to spare to fill out government forms.” The Commissioner also criticized the lower threshold, arguing that to fulfill its task of monitoring systemic risk, the FSOC need only look at the largest firms, and that therefore the threshold should be increased, rather than decreased.
The proposal tries to ease the burden of filling out Form PF by allowing reporting firms to check boxes that contain pre-set context, such that advisers do not have to come up with narrative responses. Providing context through a check-the-boxes approach seems unlikely to provide the meaningful data the FSOC seeks to discover systemic risk. But that is probably not the point – rather, it is enough that a firm’s Form PF raise a red flag for the FSOC to investigate further. As we head into dangerous territory in 2022, as evidenced by recent market volatility and the upcoming interest rate increases, it then only makes sense for SEC reporting to catch up to the speed of today’s financial markets.08