Sep. 22, 2022

Second Form PF Proposal: Rationale, Commissioner Views and Need for Comments (Part Two of Two)

In the decade since Form PF was adopted, the private funds industry has grown exponentially, and the types of investments and strategies used by hedge and private equity funds have expanded and grown more complex. Thus, Form PF was ripe for an update. As a result, the SEC’s release of proposed amendments to Form PF in January 2022 was no surprise to industry stakeholders. What was a surprise, however, was the SEC’s second set of proposed amendments (Proposal) to Form PF released several weeks ago in conjunction with the CFTC. This second article in our two-part series discusses the rationale for the Proposal; the views of Commissioners from the SEC and CFTC on the Proposal; and the reasons thoughtful comments to the Proposal are so important. The first article provided an overview of the Proposal and its five goals. For additional commentary from Lombardo, see our two-part series: “SEC’s Proposed Amendments to Form PF and Advisers Act Introduce Uncertainty, Increase Burden on Compliance Staff” (Apr. 21, 2022); and “Quarterly Reporting Requirements and Prescriptive Prohibited Activities in the SEC’s Proposed Amendments to the Advisers Act” (Apr. 28, 2022).

How the SEC’s Recent ESG Proposals May Impact Private Funds

In an effort to promote consistent, comparable and reliable environmental, social and governance (ESG) disclosures to investors and others, as well as reduce the risk of “greenwashing,” the SEC recently proposed amendments to certain rules and forms under the Investment Advisers Act of 1940 and the Investment Company Act of 1940 (Investment Company Act) to require specific disclosures with respect to various advisers’ and funds’ incorporation of ESG factors into their investment decisions and strategies (the Disclosure Proposal). Simultaneously, the SEC proposed to amend Rule 35d‑1 under the Investment Company Act applicable to registered funds to ensure that those funds’ names accurately reflect their investments and related risks (together with the Disclosure Proposal, the Proposals). Although the Proposals specifically exclude private funds and certain investment advisers, they may still impact private funds. In a guest article, Tannenbaum Helpern attorneys Wayne H. Davis and Karen Liu explain which investment funds and advisers are covered by the Proposals; discuss the impact of the Proposals on private funds – both directly and indirectly; present several issues raised by the Proposals; and spell out the next steps private fund advisers should take. For more on the Proposals, see “A Roadmap to Proposed ESG Disclosures on Form ADV” (Jul. 14, 2022).

Valuation and Sub‑Adviser Oversight Failures Result in Sanctions Against Adviser

Ensuring appropriate valuations is one of a fund adviser’s core compliance duties. The SEC expects advisers to adopt and implement appropriate valuation policies and procedures and to ensure appropriate supervision of third parties to which the adviser delegates any valuation duties. In a recently settled enforcement proceeding against an investment adviser, the SEC alleged that the adviser failed on both counts. First, the adviser allegedly failed to implement its own compliance policies, which required it to review the reasonableness of the daily pricing of a mutual fund’s portfolio. Second, it failed to adopt any policies with regard to oversight of its sub-adviser, to which the adviser had delegated valuation duties. The proceeding is a critical reminder that all advisers must actually implement the policies that they adopt and adopt appropriate policies for overseeing third parties to which they delegate their responsibilities. This article details the facts and circumstances that led to the proceeding and the terms of the settlement. See “HFLR Program Explores Valuation of Illiquid Assets and Valuation Governance” (Jan. 28, 2021); as well as our two-part valuation series: “Crises May Require Deviation From Usual Procedures” (Nov. 5, 2020); and “Five Steps to Take When Deviating From Usual Procedure” (Nov. 12, 2020).

CFTC Wins Seven‑Figure Verdict Against Introducing Broker and Associated Person Who Traded Against Customers

In 2018, the CFTC commenced a civil enforcement action against an introducing broker and its associated person, alleging that they had disclosed confidential information about customer trading activity to another customer and taken the opposite sides of multiple customer trades without first obtaining the customers’ consent. Although a civil jury found for the defendants on allegations that they had fraudulently misused customers’ material nonpublic information, it imposed a seven-figure fine on the defendants for improper disclosure of customer information and for taking the opposite sides of customer trades, along with an additional fine of nearly half a million dollars on the introducing broker for recordkeeping and supervision violations. This article analyzes the alleged misconduct; the CFTC’s claims; and the specifics of the jury verdict and final judgment against the defendants. See “SEC, CFTC and DOJ Take Action Against Alleged $1‑Billion Valuation Fraud” (Mar. 17, 2022); as well as our two-part review of CFTC activity in fiscal year 2020: “Enforcement Actions” (Apr. 15, 2021); and “Regulatory Actions” (Apr. 29, 2021).

Four Steps to Secure Open‑Source Software After CSRB’s Log4j Investigation

Open-source code appears in 92 percent of all applications. Those publicly available components comprise 70 percent of the average piece of software. While that shortcut propels rapid tech advances and the global economy, the Log4j event that rocked the cybersecurity world last winter shows the giant security risks of using free code all the time. This article presents four key steps that fund managers can take to use open-source software more securely, and it includes comments from Cyber Safety Review Board members about their new report on Log4j, which they called an endemic threat to companies for the next decade. See our three-part series on open-source software: “What Is It, and How Are Fund Managers Using It?” (Feb. 21, 2019); “Benefits and Risks” (Feb. 28, 2019); and “How Fund Managers Can Mitigate the Risks” (Mar. 7, 2019).