Compliance: New SEC Rule 204(b)-1 Requires Periodic Risk Reporting

April 1, 2011

On January 25, 2011, the Securities and Exchange Commission (SEC) proposed new Rule 204(b)-1 under the Investment Advisers Act of 1940 (Advisers Act), which would require registered investment advisers to make periodic filings on new Form PF with the SEC. The new rule was proposed as part of the implementation of the Dodd-Frank Wall Street Reform and Consumer Protection Act, and is designed to assist the Financial Stability Oversight Council (FSOC) in assessing potential systemic threats. The rule will affect all managers of hedge funds, private equity funds and liquidity funds (“Private Fund Advisers”) and some commodity pool operators, and will require maintenance and disclosure of certain categories of records and reports, which will be subject to inspection by the SEC.

The content of information required to be reported by Rule 204(b)-1 and the frequency of the reporting would vary based on the assets under management (AUM) of the investment advisor and the types of private funds advised. The rule is designed to require more detailed information from larger advisers (with collective AUM of at least $1 billion) than from smaller advisers (AUM under $1 billion), and more information from hedge fund advisers than from private equity fund advisers. Form PF would require all private fund advisers to disclose certain basic information about the operations of its funds (i.e. assets under management). Larger advisers would be required to complete additional information on Form PF based on fund type.

For example, larger advisers to private equity funds would file information regarding leverage, credit providers, investor concentration, and fund performance; whereas advisers to hedge funds would report information about fund strategy, counterparty credit risk, and use of trading and clearing mechanisms. Smaller advisers would report basic information only and do so once each year, whereas larger advisers would be required to update this information along with certain systematic risk related information quarterly, and no later than 15 days after the end of each calendar quarter. Additionally, larger advisers will be required to measure the $1 billion threshold – hedge funds and liquidity funds would do so daily; and private equity funds quarterly.

With the proposed initial compliance date of December 15, 2011 (the Effective Date; see reference link below) approaching, private advisers should be planning now as to how they will address the new requirements. We discussed the issue with Judith Gross, Principal at JG Advisory Services (provider of comprehensive compliance solutions to investment management firms). “The SEC’s estimate of the work involved for the large hedge fund adviser is 75 hours for the initial quarterly filing, and 35 hours thereafter each quarter; and for smaller advisers at 10 hours initially and 3 hours thereafter. The work for private equity advisers is estimated at 25 hours initially and 12 hours thereafter. Form PF, as proposed, will certainly be an increased burden on all advisers, regardless of their fund(s) type and whether they fall into the “large” or “small” adviser category” commented Ms. Gross.

Obviously, the new requirements may be especially challenging for those Private Fund Advisers who will be reporting to a regulatory body for the first time and need to collect a significant amount of data in a short period of time – first regulatory reporting is January 15, 2012 (or 15 calendar days after the year-end). The information has to be exact and the process will need to be consistent and repeatable, which means a systematic solution. Firms will need to understand what information needs to be reported based on their fund profile, and then develop new processes to compile this information, and possibly develop new custom reports leveraging existing systems.