Prospective investors are clamping down on who bears heightened Dodd-Frank related regulatory costs in fund prospectuses. The statutes new filing requirements are also causing private equity (PE) managers to scrutinise the activities permitted within fund formation documents.
June 15 was the initial compliance date for the first wave of funds needing to report to the Securities & Exchange Commission (SEC) under the new Form PF. In combination with earlier amendments to Form ADV, the changes represent the most significant and comprehensive reporting expansion for investment advisors in decades.
As fund advisors become accustomed to this new level of transparency, investors want to know whether the associated compliance and regulatory expenses will be borne by management or the fund.
Weve heard that for new fundraisings, investors today are focused on that issue, and its being discussed and negotiated, said Robin Bergen, partner at Cleary Gottlieb Steen & Hamilton in Washington DC.
The preparation by large hedge and liquidity fund advisors for their first Form PF filing in mid-August has brought the expense allocation issue into sharp focus.
The upcoming deadline has also spurred PE managers to reassess the description of funds activities in formation documents.
Form PF imposes less stringent and less frequent reporting requirements on PE funds compared to hedge funds. However the rule and accompanying FAQS (that the SEC issued on June 8) cast a wide net for hedge funds.
Of particular concern is that the definition catches funds that borrow amounts in excess of half their net asset value, or engage in shorting
There is a concern that if a funds formation documents permit shorting activity or leveraged borrowing at the fund level, even if the fund doesnt engage or intend to engage in these activities, this could force funds to register as hedge funds for the purposes of Form PF, said Jason Mulvihill, general counsel of the Private Equity Growth Capital Council.
And the fact this was put out by the SEC in the FAQS raised further reference to this, he added.
It has caused many firms to look through their PPM (private placement memorandum) and LPA (limited partnership agreements) documents to figure out if the fund allows these activities
This should be a concern for regulators as the way they have drafted this portion of the rule and tried to clarify it could set up a situation where many PE firms are forced to register as hedge funds for the purposes of the rule even though they are not hedge funds, Mulvihill said.
The expense and hassle of this for funds is clear, but Mulvihill believes this should also have the SEC worried. To the extent regulators want accurate information regarding hedge funds, and not have that information polluted with private equity data, this should be a concern for them, he said.
This definitional question is just one of many interpretation issues arising as funds are collating data to present in Form PF. It [the form] is not all that user friendly, and I expect that most funds will spend their time on the interpretive questions trying to get it right, Bergen said.
The market is also looking beyond the reporting stage and querying how the data will be used. Form PFs stated purpose is to assist the Financial Stability Oversight Councils assessment of systemic risk, and the SECs enforcement mandate.
But reported data will not be used simply to commence new investigations.
Ive heard that the exam staff is focused not only on risk assessment, but also trying to use the information for examinations they had already planned, to help focus their questions and areas of enquiry, Bergen said.
Its also thought that the Commissions enforcement staff will collate the data to identify and follow up on unusual activity.
My expectation is that, at least in the short term, they would be doing a comparative analysis to find outliers, Bergen added.