Transparency Run Amok

Form PF herds private funds into data hell

If the private fund industry hadn’t gotten the message before, the new SEC reporting requirement – Form PF – should do the trick. For hedge funds and private equity funds, the days of hiding the ball are over. The federal government wants to know everything you’re doing.

Form PF is the brainchild of Dodd-Frank. Its purpose is to collect the information about private investment funds operating in the U.S. that will enable the Financial Stability Oversight Council (FSOC) to monitor the risks large private funds present to our financial markets. The enormous amount of information requested (from 450 to 1600 data points) from managers covers their types of investors, investment strategies, portfolio holdings, derivatives exposures, position liquidity (including side pockets), asset valuations, leverage ratios, gross and net monthly returns, counterparty credit exposures, posted collateral, high-frequency trading, clearing operations and risk metrics. Everyone agrees that Form PF will provide the federal government with unprecedented insight into the investments and operations of private investment funds managed or marketed in the U.S.
The survey is 42 pages long. There is also a 10-page glossary of terms. Hedge fund operators estimate Form PF will require as many as 3,000 to 5,000 man-hours to complete. It must be filed by any hedge fund or private equity fund manager with more than $150 million in fund assets, and the filing deadline for managers with more than $5 billion of fund assets is August 29th of this year. Smaller managers have until April of next year to submit their initial reports.

Apart from the sheer volume of data required by Form PF, what is giving private fund managers added indigestion is the conundrum they face in answering questions that don’t precisely fit their business practices. The one that seems to have attracted the most attention is Question 42, in which the fund manager is asked to stress test its portfolios against various up-and-down changes in general equity prices, risk-free interest rates, credit spreads, currency rates, commodity prices, option-implied volatilities and credit default rates.

Managers who view one or more of these market factors as irrelevant to their portfolios can so indicate and then set forth their actual risk measurement procedures in a separate section of the questionnaire. Their concern, however, is that negating any market factor will invite special scrutiny from the SEC or FSOC. Alternatively, if managers were to provide results for every stress test (even when not used in practice) to avoid such scrutiny, their Form PF disclosures would not match the risk profiles described in their other government and investor reports. The same problem crops up in Form PF’s calculation of assets under management, which can produce different results from the net asset values fund managers normally report to their investors.

Lastly, there is the privacy issue. The SEC recognized that much of the information furnished in Form PFs will be of a sensitive nature (such as individual securities positions, monthly fund performances and proprietary investment strategies), and so the contents of each filing will be given confidential treatment (i.e., not subject to FOIA requests). Nevertheless, because the data contained in Form PF are so much more extensive and detailed than the fund descriptions contained in pitchbooks, private placement memoranda and Form ADVs, managers should not be surprised if their institutional investors demand to see their PF filings for purposes of both due diligence and cross-fund comparisons.

If and when that confrontation occurs, fund managers will be faced with the awkward question of whether to withhold trade secrets from their investors which they have already revealed to the government. The answer will pit their deep-seated fears of reverse engineering against the escalating calls of their clients for complete transparency.