Updates from US regulatory intelligence

Form PF

SEC Expands Scope of Reporting on Private Funds

On 23 May 2023, the SEC adopted final amendments to Form PF, the confidential reporting form for certain investment advisers to private funds.

The final amendments are meant to enhance the ability of the Financial Stability Oversight Council (FSOC) to assess systemic risk in light of the growing private fund industry by (i) adding new reporting requirements, (ii) reducing the assets under management threshold for reporting by private equity advisers and (iii) requiring more detailed information from large private equity advisers. The SEC adopted the final amendments largely as proposed, with modifications to the reporting requirements for:

• large hedge fund advisers by (i) eliminating the proposed report for changes regarding unencumbered cash and (ii) adjusting the reporting period from one business day to "as soon as practicable upon, but no later than 72 hours after" the occurrence of events that "indicate significant stress" or pose potential systemic risk implications;
• all private equity fund advisers by requiring event reporting on (i) adviser-led secondary transactions, and (ii) partner removals and investor elections regarding the termination of a fund or its investment period; and
• large private equity fund advisers by (i) retaining the current $2 billion reporting threshold, (ii) requiring more detailed information on activities of private equity funds that are "important to the assessment of system risk" as well as investor protection and (iii) implementing "tailored amendments" on fund strategies and the use of leverage.

In addition, the SEC decided not to adopt certain amendments to Form PF which would have required large liquidity fund advisers to "report substantially the same information" that money market funds are required to report on Form N-MFP. Instead, the SEC decided to continue to evaluate comments on the proposed large liquidity fund adviser amendments.

The amendments become effective six months after publication in the Federal Register for current and quarterly reporting and one year after publication in the Federal Register for the remainder of the amendments.

SEC Chair Gary Gensler said that the final amendments would provide regulators "greater visibility" into private funds which have "nearly tripled in size in the last decade."

SEC Commissioner Caroline A. Crenshaw emphasized that the final amendments would provide regulators with the right information prior to periods of stress and help to prevent investor harm.

SEC Commissioner Jaime Lizárraga said that the final amendments update the reporting framework to "meet the needs of current market realities" by helping regulators to (i) detect potential systemic risks to U.S. capital markets and (ii) take appropriate action if necessary to ensure investor protection regarding market exposure.

SEC Commissioner Mark T. Uyeda called the final amendments "arbitrary and capricious" with "no discernable practical purpose." Mr. Uyeda said that the SEC failed to identify a need for the additional information. Instead of addressing systemic risk and investor protection concerns, Mr. Uyeda argued that the final amendments will create additional costs ultimately borne by investors. Further, he asserted that because the information reported on Form PF is confidential, the increase in information has no useful purpose to investors in assessing a private fund's risk-return profile.

SEC Commissioner Hester M. Peirce characterized the expansion of Form PF as the latest in the SEC's "unquestioning faith in the Benevolent Power of More." She said that the additional information provided under the final amendments "may tempt regulators to intervene in markets in ways that would undermine long-term market resilience and exceed jurisdictional bounds." Ms. Peirce criticized the final amendments for being part of an "SEC compliance exercise" to "recast private fund regulation in the mold of retail fund regulation." She warned that the final amendments "ironically could be harmful from a systemic risk perspective" by sending the message to markets that the SEC is a "back-up risk manager for funds" through its demand for real- time data.

Commentary: The questions posed in Form PF are so badly structured that the information collected is almost entirely useless. This has been a central complaint since the adoption of the Form more than a decade ago. (See, e.g., SEC Director Champ Remarks on Investment Adviser Regulation). Rather than admitting that the Form and its questions are fundamentally flawed, which would require that Form PF either be abandoned or redone from scratch, the SEC chose, instead, to collect even more information that will be of little use to anyone. Garbage in, garbage out; now more garbage in, more garbage out.

CFTC and SEC adopt amendments to expand private fund reporting

In the final rule, the agencies described Form PF as the form that certain SEC-registered investment advisers to private funds, including those that also are registered with the CFTC as a commodity pool operator (CPO) or commodity trading adviser (CTA) "use to report confidential information ... about the basic operations and strategies of private funds ... for use in assessing systemic risk."

The additional information includes data about a fund's assets, financing, investor concentration and performance. Form PF will now include questions devoted to digital assets. In addition, calculations that determined an adviser's reporting obligations based on the adviser's size were amended with the result that more advisers will be considered "large," and thus subject to additional reporting requirements.The effective/compliance date for the Form PF final rule is one year from the date of publication in the Federal Register.

Commentary: In his statement supporting the adoption of the amendments to Form PF, Chair Gensler said "the Commissions [meaning the SEC and the CFTC] and FSOC have identified some gaps in the information we receive," which thus necessitated the expansion of the information required by the Form.

This comment is, for better or worse, an understatement. Form PF was essentially useless when it was first adopted, over ten years ago, because the questions were so badly conceived and written. That is the reason one so seldom hears about the valuable information collected by the Form; there is little to talk about. Rather than re-assess whether the information collected has been of any value, rather than stopping the collection of data that is not useful, the regulator's fix is simply to collect more data.

To justify the additional collection of information, the regulators say that the information is needed by FSOC. But there is very little reason to believe that FSOC has any ability to assess the data. Evidenced by FSOC's 2022 Annual Report, the agency missed the boat on identifying the risk that inflation ultimately had on regional banks shortly before three of them collapsed primarily due to inflation effects. (Perhaps they were overly focused on climate risk, a danger highlighted 112 times in the Report.") See prior commentary, and also FSOC Says Digital Assets May Create System Risk (observing that the extent of FSOC's concerns about digital assets seemed wholly disproportionate to its interest in either inflation or energy costs.)

Ultimately, requirements to produce detailed regulatory reports are a tax on the businesses required to create them. If the report provides valuable information and if the regulatory agency demonstrates an ability to use the information, then the tax may be worthwhile. It is very hard to feel confident that this tax is justified.

On 12 March 2024, an SEC and CFTC joint final rule adopting amendments to Form PF will go into effect on March 12, 2025. The final rule was published in the Federal Register.

As previously covered, the final rule requires additional information "about the basic operations and strategies of private funds ... for use in assessing systemic risk."

13D/G requirement changes

SEC sets effective and compliance dates for beneficial ownership reporting requirements

On 7 November 2023, the SEC set an effective date of February 5, 2024 for final rules on the filing of certain beneficial ownership reports and guidance. The SEC also outlined compliance date requirements (see here). The SEC final rules and guidance were published in the Federal Register.

As previously covered, the amendments shorten the reporting periods under Exchange Act Sections 13(d) ("Reports by persons acquiring more than five per centum of certain classes of securities") and 13(g) ("Statement of equity security ownership"). The SEC final guidance addresses (i) disclosure requirements with respect to derivative securities and (ii) the legal standards applicable to certain common types of shareholder engagement activities.

Marketing Rule

SEC provides guidance on IAA Marketing Rule

February 16, 2024

On 16 February 2024, the SEC updated its FAQ guidance on investment adviser marketing since the adoption of amendments to Advisers Act Rule 206(4)-1 (the Marketing Rule).

The SEC highlighted the following:

• Compliance Date: An adviser cannot choose to comply partially with the amended marketing rule before the compliance date of November 4th, 2022. They must either adhere to the rule in its entirety from the effective date of May 4th, 2021 or continue following the previous advertising and cash solicitation rules until they can fully adhere to the rule.
• Time Period Requirement: Advisers are allowed to use interim performance information in advertisements if they cannot calculate their one-, five-, and ten-year performance data immediately following a calendar year-end, as long as this interim information is as current as possible and updated to the required calendar year-end data within a reasonable period, generally not exceeding one month. This interim information must comply with the other provisions of the marketing rule.
• Gross and Net Performance: When an adviser to a private fund displays the gross performance of a single investment or a group of investments, it is also required to also show the net performance.
• Calculating Gross and Net Performance: Gross and net performance must be calculated using the same methodology and over the same time period.

Investment advisers settle charges for marketing violations

On 12 April 2024, four investment advisers settled SEC charges for advertising hypothetical performance on their websites without adopting policies to ensure that the published information was relevant to the likely financial situation and investment objectives of the intended audience.

According to the separate Orders, the firms' advertisements included hypothetical performance information derived from model portfolios and the firms' marketing materials were disseminated to the general public rather than to a particular intended audience in violation of the Amended Marketing Rule.

The SEC found that the firms violated Advisers Act Section 206(4) (Prohibited transactions by investment advisers) and Rule 206(4)-1(d) (Investment Adviser Marketing).

To settle the charges, all of the firms consented to (i) the entry of orders finding that they violated the Investment Advisers Act and ordering them to be censured, (ii) cease and desist from violating the charged provisions and (iii) comply with certain undertakings.

The first firm agreed to pay a civil penalty of $20,000.

The second firm agreed to pay a civil penalty of $30,000. 

The third firm agreed to pay a civil penalty of $30,000.

The fourth firm agreed to pay a civil penalty of $20,000.

The civil money penalties reflected that the firms removed the advertisements containing hypothetical performance from their websites prior to being contacted by the SEC.

Commentary: This marks the second wave of Marketing Rule enforcement actions by the SEC following charges brought against nine registered investment advisers in September 2023. These actions should serve as a reminder that all registered investment advisers must regularly review and update all marketing materials, including websites, social media, and printed materials to ensure they are not misleading and are in compliance with the Marketing Rule. It's interesting to note that for each of the four advisory firms, the offending material was removed from the applicable public website prior to the firms being contacted by the SEC staff. Further, the SEC's acknowledgment of the firms' actions prior to contact shows how a proactive approach to managing potential risks can influence enforcement outcomes, possibly resulting in more favourable terms in the event of any settlement.

SEC Examination Staff Warn Advisers to Comply with Marketing Rule

On 18 April 2024, the SEC Examination staff issued a Risk Alert which highlighted deficiencies in compliance with the Investment Adviser Marketing Rule ("IAA Rule 206(4)-1").

SEC Examination staff made the following observations:

• Compliance Rule. The staff observed Marketing Rule policies and procedures that were (i) incomplete, (ii) not implemented, (iii) not tailored, (iv) informal rather than in writing and (v) consisted only of general descriptions and expectations related to the Marketing Rule. Even to the extent that they were written, they were sometimes not implemented.
• Books and Records Rule. The staff observed that advisers failed to maintain (i) copies of completed questionnaires or surveys used in the preparation of a third-party ratings, (ii) copies of information posted to social media and (iii) documentation to support performance claims included in advertisements.
• Form ADV. The staff observed Marketing Rule-related deficiencies on Form ADV, as to advertisements that did not include: (i) third-party ratings, when firm websites included them or social media posts that touted the firms as being ranked in certain third-party ratings; (ii) performance results, when performance results were included in firm marketing materials; and (iii) hypothetical performance, when hypothetical performance was included in advertisements. The staff also observed advisers using outdated language on their Form ADVs.

The staff observed compliance deficiencies under the Marketing Rule, including advertisements that:

• false represented that the advisers were "free of all conflicts";
• publicized the receipt of awards that were not actually received;
• touted that the adviser was "seen on" national media, when, in fact, the only adviser's only appearances were paid advertisements;
• represented performance of products that were no longer available;
• touted that clients were serviced by a team of professionals when only one person was responsible for servicing clients; and 
• included disclosures in an unreadable font.

SEC Enforcement staff encouraged advisers to reflect upon their practices, policies and procedures and to implement appropriate modifications to their training, supervisory, oversight and compliance programs.

Commentary: It's not a coincidence that this came out the week after the SEC's wave of enforcements against five advisers for violations of the Marketing Rule. (See e.g., Investment Advisers Settle Charges for Marketing Violations and Investment Adviser Settles Charges for False Advertisements.) The SEC is very focused on enforcement with regard to adviser advertising. This Alert gives some reasonably concrete examples of, and guidance about, the particular behaviours that the SEC deems enforcement worthy. Perhaps the most important is for advisers to have procedures for the review of advertising materials that are very detailed and that require demonstration that the procedures have been satisfied.

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