The Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted after a long and intensive legislative process, contains numerous provisions that will impact private equity funds and their advisers both directly and indirectly.
In particular, the Dodd-Frank Act includes new registration and reporting requirements for investment advisers of private equity funds, which will translate into increased burdens and costs for many private equity fund managers. While the regulatory implementation process for the Dodd-Frank Act has already begun and is progressing at a feverish pace, there is more regulatory work to be done throughout this year and into the next, so the full impact of the Dodd-Frank Act on private equity funds may not be known for some time.
The most notable direct change for investment advisers in the Dodd-Frank Act is the elimination of the “private investment adviser” exemption for investment advisers. Beginning on July 21, 2011, investment advisers that currently rely on the private investment adviser exemption will be required to register with the U.S. Securities and Exchange Commission unless an alternative registration exemption applies. Any investment adviser may elect to comply early, subject to the rules of the SEC.
The Dodd-Frank Act does provide a number of new exemptions from registration for investment advisers, including exemptions for foreign advisers to private funds with small U.S. client and investor bases, advisers who solely advise one or more venture capital funds and advisers who solely advise private funds with assets under management in the United States of less than $150 million. Generally speaking, however, it is unlikely that many private equity fund managers will be able to avail themselves of these new exemptions created by the Dodd-Frank Act, and will therefore be subject to certain new recordkeeping and reporting requirements regarding their private equity funds. Further, even advisers that are exempt from registration as venture capital fund advisers or small private fund advisers will still be subject to certain recordkeeping and reporting requirements as described below.
The Dodd-Frank Act imposes new recordkeeping and reporting requirements on investment advisers with respect to the private funds they manage, and subjects investment advisers to enhanced SEC scrutiny and audit requirements, which will increase the burden and costs for private equity funds and their advisers that do not currently prepare and maintain this information. These new requirements will become effective one year after enactment, on July 21, 2011.
Under the Dodd-Frank Act, a typical adviser to private equity funds will be required to maintain records and reports for each private equity fund that it advises, including (1) the amount of assets under management, (2) the use of leverage (including off-balance-sheet leverage), (3) counterparty credit risk exposure, (4) trading and investment positions, (5) valuation policies and practices of the fund, (6) types of assets held, (7) side arrangements or side letters, (8) trading practices and (9) other information deemed by the SEC, in consultation with the Financial Stability Oversight Council, to be necessary and appropriate in the public interest and for the protection of investors or for the assessment of systemic risk.
The SEC is required under the Dodd-Frank Act to issue rules requiring each investment adviser to a private fund to file reports containing this information as the SEC deems necessary and appropriate. The SEC has already proposed rules to implement this mandate.
Form PF Reporting.
Recently, on Jan. 25, the SEC and the U.S. Commodity Futures Trading Commission jointly proposed rules that would require private equity fund advisers that are registered (or required to be registered) under the Advisers Act to file reports periodically with the SEC on new Form PF disclosing, generally on a confidential basis, various information about the private equity funds they advise for the assessment of systemic risk. The extent and frequency of the reporting generally would depend on the size of the adviser measured by assets under management. Large private equity fund advisers (i.e., those advisers managing private equity funds that collectively have at least $1 billion in assets) would be subject to greater disclosure obligations and more frequent filing requirements than those for smaller private equity fund advisers.
Smaller private equity fund advisers would need only to report limited information about each of the funds they manage, including basic information regarding the fund’s leverage, its credit providers, net assets, aggregate notional value of its derivative positions, fund performance and the concentration of the fund’s investor base. Large private equity fund advisers would be required to report all of this limited information about each of their funds and also additional information, including more extensive disclosures about the fund’s borrowings and guarantees, the leverage of its portfolio companies, the use of bridge financing (including the name of the institution providing such bridge financing to the portfolio company and the amount), any related person’s co-investment in portfolio companies, investments in financial industry portfolio companies and the breakdown of investments by geography and industry.
In addition, smaller private equity fund advisers would need only to report on Form PF annually, while large private equity fund advisers would be required to file Form PF on a quarterly basis.
The compliance date for Form PF reporting under the SEC/CFTC joint proposal, if adopted, would be Dec. 15, 2011, at which time large private equity fund advisers would be required to file a report 15 days after the end of the next quarter (i.e., Jan. 15, 2012) and smaller private equity fund advisers would be required to file 90 days after the end of their fiscal year ending after the compliance date (i.e., March 31, 2012 for advisers with a Dec. 31 fiscal year).
Private Fund Reporting on Form ADV
Separately, on Nov. 19, 2010, the SEC, “in light of [its] increased responsibility for oversight of private funds” under the Dodd-Frank Act, proposed rules requiring advisers to provide the SEC with additional information regarding the private funds they advise and more information in general about their advisory businesses and certain non-advisory activities. These enhanced disclosures would be reported by advisers using Form ADV, the form investment advisers use to register with (and provide information to) the SEC. The SEC anticipates that the increased knowledge it will glean from the enhanced disclosures will enable it to better understand advisers’ operations, risks and conflicts and aid in the SEC’s identification of firms for examination.
The proposal would require an adviser to provide information about all of the adviser’s private funds regardless of their forms of organization. These disclosure requirements would apply to SEC-registered advisers and advisers exempt from SEC registration by virtue of the new exemptions for venture capital fund advisers and small private fund advisers. (The Form PF reporting requirements, on the other hand, would not apply to these exempt advisers.) Non-U.S. advisers would be permitted not to report on private funds they advise that are both organized outside the United States and not offered to or owned by U.S. persons.
The Nov. 19 proposal would expand the data advisers are required to disclose about their private funds. Among other items, advisers would be required to report for each of their private funds certain information about each such fund, including:
• (i) the name of the private fund; (ii) its jurisdiction of organization; (iii) its general partner, directors, trustees or persons occupying similar positions; (iv) the Investment Company Act of 1940 exclusion on which the fund relies; (v) the names and jurisdictions of each foreign financial regulatory authority with which the fund is registered; and (vi) whether the fund is in a master-feeder arrangement;
• whether the fund is a fund of funds;
• the fund’s investment strategy;
• the fund’s gross and net asset values; the value of the fund’s investments by asset and liability class and categorized in the U.S. GAAP fair value hierarchy; the fund’s minimum investment amount and the number of beneficial owners of the fund;
• whether clients of the adviser are solicited to invest in the fund, and the percentage of the adviser’s clients that has invested in the fund;
• the number and types of investors in the fund; and
• the fund’s auditors, prime brokers, custodians, administrators and marketers, their locations and whether such service providers are related persons of the adviser.
Because the reported information would be publicly available, the SEC expects that it would supplement investors’ due diligence efforts and allow service providers to identify the funds claiming to rely on their services.
Under proposed rules, advisers would also have to disclose additional information about their employees, clients and assets under management by client type.
In addition to the new reporting and recordkeeping requirements described above, the Dodd-Frank Act also provides that all records of private funds maintained by a registered investment adviser, not just those records required to be maintained by law, are subject to periodic and special examination by the SEC.
The full scope of the competitive effects of the Dodd-Frank Act on the private equity market — such as the impact of the Volcker Rule — will only become evident through the regulatory implementation stage, as regulators attempt to implement Congress’s intent while ameliorating unintended consequences and addressing shifts in market participants’ behavior. In the meantime, it is clear that the new registration requirements and reporting obligations mandated by the Dodd-Frank Act will result in increased burdens and costs for private equity fund advisers, which may be especially acute for the “large private equity fund advisers” that would be required to conduct extensive reporting to the SEC on a quarterly basis under the SEC/CFTC joint proposal.
Yukako Kawata is a partner at Davis Polk & Wardwell LLP and co-head of the firm’s Investment Management/Private Funds Group. Greg Rowland is a partner in the firm’s Corporate Department, practicing in the Investment Management Group. John O’Callaghan is an associate in Davis Polk’s Investment Management Group.