The Naked and The Dread

A deadline looms for a form that reveals detailed data | “You are going to have to open the kimono. There’s no way around it”

Nick Summers

It’s late August, and someone’s groaning about a stack of homework that is causing an early, cruel end to beach season. High schoolers? Nope — the managers of America’s largest private investment funds, who by Aug. 29 must file a new form providing the Securities and Exchange Commission and other federal regulators with detailed information on their operations. At 42 pages, with more than 1,000 data fields, Form PF is a chore to fill out and a threat to the secrecy in which hedge funds and private equity funds prefer to operate. “Every year for many years, August was the month everybody went to the beach,” says Doug Schwenk, the founder of Advise Technologies, a company that makes software to help funds complete Form PF. “There are a shocking number of people sitting in the office this month, plugging away at their homework.”

PF stands for private fund — the hedge funds, private equity funds, and their kin that have avoided oversight by taking on only a limited number of wealthy investors. The regulatory rationale: If a few millionaires want to risk their shirts, let ’em. That thinking changed with the 2008 financial crisis, and the realization that excessive risk in one corner of the financial sector can threaten the whole economy. Form PF is an outgrowth of the 2010 Dodd-Frank financial reforms, and it requires private investment funds to give the government more information than ever before.

Among the queries: What are your long and short positions on corporate bonds issued by financial institutions? How about credit default swaps, both single-name and exotic? Crude oil? Gold? What is the geographical breakdown of your investments? Whom do you trade with? If investors wanted to, how quickly could they remove their money? There is even space for firms to add detail and explanation to their answers. When regulators begin “to analyze and understand what they have, it will be one of the few times anyone has ever gotten a good look across all of private funds on a consistent basis,” says John Sampson, an executive in Ernst & Young’s financial services office. “And you can find out a lot.”

Being compelled to divulge this much to the government is reshaping hedge funds’ view of how they fit into the larger Wall Street culture, according to Mitch Ackles, president of the Hedge Fund Association. The message Form PF and Dodd-Frank have sent to hedge fund managers is “You now are more mainstream,” he says. “You want institutional money? You have to act like an institution.” Ackles views Form PF as an inevitable result of the industry’s growth — from a few dozen hedge funds in the 1960s to the thousands that operate today. “You are going to have to open the kimono,” he says. “There’s just no way around it.”

SEC Chairman Mary Schapiro announced Form PF in a speech last October. “This private fund data collection initiative follows from the lessons learned during the financial crisis — lessons about the importance of monitoring and reducing the possibility that a sudden shock or failure of a financial institution will cascade through the entire financial system,” she said.

All private investment firms with assets of more than $150 million will have to file Form PF eventually. The largest, those with more than $5 billion, must file first, by Aug. 29. The SEC estimates 200 firms are subject to next week’s deadline.

After the initial filing, hedge funds must file quarterly; private equity funds, annually. Schwenk, a former chief operating officer of Trafelet Capital Management, a hedge fund firm that managed $6 billion at its peak, says his company has signed up 122 clients so far. Schwenk recently got a call from a “very frightened compliance officer” at one of the 20 largest hedge funds who was worried about meeting the deadline. “Literally, the contract to get the sale done and the check for the full amount was in our hands within a week,” says Schwenk, adding that the tab was $150,000. Perhaps, like high school students, many firm officers spent months hoping the new requirement would simply go away.

In filling out Form PF, firms want to disclose no more than they must, but not so little that they draw the attention of SEC auditors, says Schwenk. That has firm officers sharing their answers with each other. “It’s like sixth-grade girls on the playground, gossiping about what they do,” he says.

For hedge funds, disclosing data on their investments is anathema. Being able to pursue their strategies stealthily and nimbly is their biggest advantage against slower, more tightly regulated rivals such as mutual funds. The federal bodies that have access to Form PF — the SEC, the Commodity Futures Trading Commission, the Financial Stability Oversight Council — are required by law to keep the data private. But Congress can ask for the information, and that means it can leak. Last year, Senator Bernie Sanders (I-Vt.) gave a newspaper CFTC-gathered data on oil speculation, alarming traders.

While seeing secrets made public is a scary prospect, private funds might have more to worry about from their own clients, says Jeannie Lewis, a principal with Deloitte’s governance and regulatory practice. “I think a bigger threat is when investors start asking for Form PF,” she says. Hedge funds vary in how much they disclose to investors about strategy. Some give only the broadest outlines; for example, saying they pursue a “macro strategy.” Now wealthy clients may demand to see Form PF before forking over their cash, says Lewis. “Once you give it to one, do you lose confidentiality to all?” she says. “It becomes a fairness issue.”

The bottom line An estimated 200 investment funds that manage more than $5 billion each must file extensive disclosure forms by Aug. 29.


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