August 21, 2014
SEC Report on Form PF to Congress
As part of its obligations under Dodd Frank, the U.S. Securities and Exchange Commission
(SEC) issued its second annual report on Form PF to Congress just last week, on August 15,
2014.
The report indicates that, while the primary aim is create source data that can be used by the
Financial Stability Oversight Council (FSOC) in assessing systemic risk, the Commission (SEC)
has started using the information in Form PF to “support its own regulatory programs, including
examinations, investigations and investor protection efforts relating to private fund advisers.”
The SEC is now also using Form PF data for their “risk monitoring activities [and in] issuing
additional guidance to filers and working with other federal regulators and international
organizations regarding issues relating to private fund advisers.”
Key Takeaways from the SEC’s Report
• Examination and Investigations: the SEC’s Office of Compliance and Examinations (OCIE) is using Form PF data in the examination process. OCIE staff use the PF data pre-exam to understand the “nature of an adviser’s business and investment strategy” and during the examination process, for checking and evaluating “inconsistencies with other information obtained from the adviser during an examination, such as due diligence reports, pitch books, offering documents, operating agreements and books and records.” In addition, the OCIE staff have been checking that the “investment strategies disclosed to investors match the information contained in the adviser’s Form PF filing, particularly with respect to holdings, leverage, liquidity, derivatives and counterparties.” The OCIE staff has already begun to ask private fund managers “to substantiate or to explain any inconsistency or red flag.” In fact, the SEC has indicated that they will send out an examination “deficiency letter” based upon such use of Form PF data in an examination.
• Enforcement Action: the SEC’s enforcement staff obtains and review Form PF filings of certain advisers in connection with “investigations of private fund advisers.”
• Risk Monitoring: the SEC continues to develop analytical tools and reports based on Form PF data as part of its risk monitoring activities. In addition, various groups within the SEC such as the Division of Economic and Risk Analysis (DERA) and the Office of Compliance Inspections and Examinations (OCIE) are using Form PF data for their respective needs including to:
o Identify possible “red flags at firms that may trigger examinations”;
o “Identify trends and possible emerging risks in the private fund industry”; and
o Support their screening process for improper conduct or fraud as part of an “aberrational performance inquiry (API)”.
[Click Here to access full SEC report]
GRMA Recommendations
• Importance of Periodic Independent Review: given the emphasis the SEC is placing on
looking for inconsistencies between Form PF information and a fund manager’s internal
and external documents and reporting, we believe it is critical for a fund to have an
independent and periodic review and check of the interpretation and assumptions used to
respond to Form PF. Also, we recommend that all of the calculations — risk calculations
such as durations, delta-adjusted exposures, VaR, and stress tests, as well as calculations
of leverage, re-hypothecation, liquidity, and counter-party exposures — be independently
evaluated to ensure that they accurately reflect the risk profile of the fund.
• Form PF “Bible”: as Form PF data is now being used by the SEC in the examination
process, we believe that it is essential for private fund managers to have a good Form PF
“Bible” in place. This document should include policies and procedures for Form PF,
interpretation/assumptions used for each filing, and supporting regulatory audit trail data.
• Must Report All Key Information: many funds are, we believe, at risk of being deemed
materially non-compliant with Form PF because they have elected not to provide some
key requested risk information — especially VaR and some stress tests (where funds may
have indicated a risk factor is “relevant but not tested”). We believe the SEC wants and
needs funds to answer all of these risk questions so the agency can fulfill its
Congressional mandate to measure systemic risks related to the private funds. Also, it
does not portray your fund favorably to the SEC or investors if you are unable or
unwilling to produce basic and generally accepted risk statistics for your fund for the
purposes of Form PF.
• “Handwriting is on the Wall”: the new SEC report further confirms that regulators (as
well as investors) continue to expect private fund managers to enhance their formal risk
management and risk transparency. It seems likely that global regulatory convergence
will lead US regulators to require that private funds – as AIFMD now requires in Europe
– have “independent” risk management and risk governance and have remuneration
policies that properly align risk/reward incentives as key aspect of fulfilling their
fiduciary responsibilities to their investors.
The GRMA team is happy to assist funds to ensure that their processes, controls and governance
for Form PF and other risk-related reporting such as Annex IV and Open Protocol are sound and
will stand up to regulatory and investor scrutiny.
To view the full PDF of the report, please click here.