SEC and CFTC impose controversial rule on hedge funds

Rick Steves

Some commissioners, like Hester M. Peirce, argue that the expansion of Form PF is driven more by an “unbridled curiosity” rather than a clear regulatory need.

The Securities and Exchange Commission (SEC) and the Commodity Futures Trading Commission (CFTC) have jointly finalized amendments to Form PF, enhancing the reporting requirements for investment advisers to private funds.

These amendments aim to improve the monitoring of systemic risk and bolster the oversight of private fund advisers, as part of the mandates of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

Among other things, the amendments to Form PF will enhance how large hedge fund advisers report investment exposures, borrowing and counterparty exposure, market factor effects, currency exposure, turnover, country and industry exposure, central clearing counterparty reporting, risk metrics, investment performance by strategy, portfolio liquidity, and financing and investor liquidity to provide better insight into the operations and strategies of these funds and their advisers and improve data quality and comparability.

The amendments are set to become effective one year after publication in the Federal Register.

Problems with the amendments to Form PF

The amendments to Form PF, while aimed at enhancing the monitoring of systemic risk and improving regulatory oversight, have raised concerns that they may exceed what is necessary and appropriate for the SEC and CFTC’s missions for several reasons:

Overreach and Excessive Data Collection: Some commissioners, like Hester M. Peirce, argue that the expansion of Form PF is driven more by an “unbridled curiosity” rather than a clear regulatory need. This suggests that the amendments might be collecting more information than necessary, potentially crossing into overregulation. Excessive data collection can burden private funds with compliance costs and operational challenges without proportionately contributing to the commissions’ understanding of systemic risks.

Lack of Clear Justification for Systemic Risk Monitoring: The dissenting opinions highlight a lack of specific justification for how the additional data collected will be used to effectively monitor and mitigate systemic risk. For example, Commissioner Caroline D. Pham points out that the rule could obscure hidden risks by mandating disaggregated reporting, which contradicts the goal of identifying and managing systemic risk through aggregated data analysis.

Potential Security and Confidentiality Concerns: The joint statement by Commissioners Mark T. Uyeda and Caroline D. Pham raises concerns about the memorandum of understanding related to sharing Form PF data between the SEC and CFTC. They argue that providing unrestricted access to sensitive data increases vulnerability to cybersecurity threats and may not be adequately protected, thus potentially compromising confidential business information.

Questioning the Scope of Jurisdiction: The amendments and the accompanying data-sharing arrangements have led to questions about whether they extend beyond the SEC and CFTC’s statutory mandates. The criticism suggests that the scope of data collection and sharing might not be fully justified by the agencies’ missions to protect investors and monitor for systemic risk, potentially infringing on the intended limits of their regulatory authority.

Costs to Investors and the Financial Industry: The concern is that the increased compliance costs resulting from the amendments could ultimately be passed on to investors, affecting returns and potentially limiting access to private fund investments. This could have broader economic implications, such as affecting capital formation and the ability of private funds to contribute to economic growth.

Commissioner Opinions on Form PF Amendments

SEC Chair Gary Gensler

Gary Gensler supported the amendments, stating they enhance the commissions’ and the Financial Stability Oversight Council’s (FSOC) understanding of the private fund industry and its systemic risk potential. The amendments are expected to improve reporting on investment exposures, borrowing, counterparty exposure, and other key areas to protect investors and assess systemic risk more effectively.

“These amendments to Form PF will enhance the Commissions’ and FSOC’s understanding of the private fund industry as well the potential systemic risk posed by the industry and its individual participants. In addition, the adoption also furthers investor protection efforts.”

SEC Commissioner Hester M. Peirce

Hester M. Peirce expressed dissent, arguing the amendments stem from “unbridled curiosity” rather than a legitimate regulatory objective. Peirce criticized the expansion of Form PF as an overreach that fails to demonstrate how the additional data collection will effectively monitor systemic risk.

“Form PF has not-so-subtly morphed into an all-purpose means to gather information from the private market under the seemingly limitless rubric of systemic risk.”

CFTC Commissioner Kristin N. Johnson

Kristin N. Johnson highlighted the importance of financial market transparency for systemic risk management. She supported the final rule to enhance oversight and improve visibility through well-calibrated data collection approaches, emphasizing the collaborative effort between the SEC and CFTC to fulfill their mandates under the Dodd-Frank Act.

“Transparency is an integral component of the regulatory framework that ensures the safety and soundness and enduring preeminence of our financial markets.”

SEC Commissioners Mark T. Uyeda and Caroline D. Pham

Mark T. Uyeda and Caroline D. Pham issued a joint statement dissenting from the memorandum of understanding related to the sharing of Form PF data between the SEC and CFTC. They raised concerns about the necessity and security of providing the CFTC with unrestricted access to all Form PF data, highlighting potential risks to data confidentiality and cybersecurity.

“We object to the MOU for three reasons: (1) it is not necessary for the CFTC to be provided Form PF data for non-CFTC registrants; (2) broader distribution of all Form PF data increases its vulnerability to cybersecurity threats; and (3) the MOU’s provisions for handling of confidential Form PF data are inadequate given the sensitivity of that information.”

Mark T. Uyeda criticized the amendments for expanding reporting requirements without adequate consideration of significant comments or analysis of overlapping obligations. He questioned the amendments’ alignment with statutory authority and expressed concern for the privacy of investors in private funds.

“The SEC’s interpretation of Title IV of the Dodd-Frank Act has the practical effect of ignoring the limitation imposed by the statute.”

Caroline D. Pham dissented from the joint final rule, arguing it fails to improve systemic risk monitoring and unnecessarily increases costs for American savers. She criticized the rule for obscuring hidden risks and generating excessive, less useful information, deviating from the goal of effective risk management and data aggregation established since the Dodd-Frank Act.

“I respectfully dissent from the Joint Final Rule on Form PF and Reporting Requirements for All Filers and Large Hedge Fund Advisers that is being issued together with the U.S. Securities and Exchange Commission (SEC) (SEC-CFTC Joint Final Rule on Form PF or Joint Final Rule) because, overall, the rule does not achieve its stated purpose to improve systemic risk monitoring because it will obscure hidden risks and unacceptably increase costs for American savers.”

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