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We are very pleased to announce that Henry Liu is joining our New York office today as a Finance Partner and as leader of the Financial Institutions & Infrastructure Teams for Greater China and Asia.

Henry has enormous reach within business, banking and government in China and is the former general counsel and director general at the China Securities Regulatory Commission.  Henry will provide valuable assistance to the Pillsbury Investment Funds group on the structuring of investment funds in China as well as the movement of capital from China into investment funds outside of China.

“Henry brings a unique combination of experience as a former high-level Chinese government official and as an extremely successful and well-connected attorney for our China practice,” said Pillsbury partner Jim Rishwain. “Henry is an incredibly rare find, as he can navigate the United States and Chinese business and legal landscapes with ease. Likewise, he has enormous reach within business, banking and government circles in Greater China and has earned the very highest reputation among his colleagues and peers. As a result, he will greatly enhance Pillsbury’s stature and presence in Asia – long a key market for our firm and our clients.”

Henry has also served international, Chinese and Asia Pacific clients ranging from Fortune 500 global firms to emerging companies and has been involved in most major types of cross-border corporate and financing transactions and regulatory matters involving Asia and China, across most major industry sectors, in mergers and acquisitions, capital markets, banking and financing, corporate, private equity and investment funds, foreign direct investments, real estate, technology transfers and international trade. He has over his career been exposed to most industries and sectors, including financial services, manufacturing, real estate, transportation, energy, telecom and media, and sports and entertainment.  Henry was previously managing director of investment banking with Donaldson, Lufkin & Jenrette/Credit Suisse First Boston in Hong Kong as well as the chair of a large international law firm’s China practice.

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Written by: Jay Gould and Peter Chess

1.  What is the Form PF?

The Form PF (PF is short for “private funds”) is a new form that focuses mainly on private fund reporting with regard to information such as counterparty dealings, leverage, and investment exposure.  A “private fund” under the Form PF refers to any issuer that would be an investment company under the Investment Company Act of 1940, as amended, if not for the exemptions provided by Sections 3(c)1 or 3(c)7 of that Act.  Under some circumstances, non-“private funds” such as money market funds registered with the SEC may be required to report on the Form, in addition to “private funds.”

2.  Do investment advisers need to file the Form PF?

Yes, in certain circumstances.  Only investment advisers registered with the SEC that meet a $150 million threshold must report on the Form PF.  The $150 million threshold refers to a specific and somewhat complicated calculation with regard to regulatory assets under management. 

3.  What are the categories of filers? 

Advisers required to file the Form PF need to determine which category of filer corresponds to them.  Large private fund advisers are categorized as either large hedge fund advisers, large liquidity fund advisers, or large private equity fund advisers.  Large hedge fund advisers are those having at least $1.5 billion in regulatory assets under management attributable to hedge funds, subject to other conditions.  Large liquidity fund advisers are those having at least $1 billion in regulatory assets under management attributable to “liquidity funds” and money market funds registered with the SEC, subject to other conditions.  Large private equity fund advisers are those having at least $2 billion in regulatory assets under management attributable to private equity funds, subject to other conditions.  All other filers are categorized as smaller private fund advisers.

4. What are the reporting deadlines?

Initial compliance under the Form PF will be in phases.  The first required filers will be large private fund advisers with at least $5 billion attributable to hedge funds, to liquidity funds, or to private equity funds.  These large hedge fund advisers will have 60 days, and large liquidity fund advisers will have 15 days, after the end of the first fiscal quarter ending on or after June 15, 2012, to file their first Form PF.

Other filers will have to make their first filing by the deadline following the end of the first fiscal quarter for each adviser, as applicable, on or after December 15, 2012.  Under the initial compliance, many advisers will not need to file their first Form PF until 2013.

Going forward, the Form PF must be filed:

  • For large hedge fund advisers, within 60 days of its fiscal quarter end;
  • For large liquidity fund advisers, within 15 days of each fiscal quarter end; and
  • For other filers, within 120 days of each fiscal year end.

5.  What constitutes the Form PF? 

The Form PF, in its entirety, contains sixty pages, and is divided into four sections with corresponding subsections.  Most advisers will not have to complete all four sections.  The four sections feature reporting on, among other things: identifying information about the adviser; fund-by-fund reporting by all advisers about items such as fund identification, performance and valuation; fund-by-fund reporting by hedge fund advisers about items such as strategies, counterparties, and trading practices; aggregated private fund reporting for large hedge fund advisers; fund-by-fund reporting by large hedge fund advisers about items such as asset classes, portfolio liquidity, and risk metrics; fund-by-fund reporting for large liquidity fund advisers; and, fund-by-fund reporting for large private equity fund advisers. 

6.  What about the confidentiality of information reported?

Because of the nature of governmental sharing of the data provided on the Form PF, advisers should consider the options available to them with regard to preserving confidentiality.  Consequently, advisers should consider changing their overall recordkeeping practices so that they routinely identify funds solely by numerical or alphabetical designations.  

7.  How is the Form PF filed? 

The Form PF will be filed using the same IARD system on which advisers make the Form ADV filing.

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Written by Michael Wu and Judy Deng

The Year of Rabbit continued to see the proliferation of RMB funds and portfolio investments made by RMB funds. As of Q3 of 2011, 63 RMB funds were raised in mainland China and the total capital raised for investments in mainland China was estimated to be RMB4.2 billion (Source: Zero2IPO). Perhaps no longer a new term, “RMB funds” generally refer to the investment funds organized as corporations, limited partnerships or other unincorporated forms in China that invest in non-public companies primarily located in China. Over the past five years, RMB funds have become the investment vehicle of choice for many non-Chinese fund managers, as they have certain advantages over non-Chinese funds investing into China, including: (1) access to domestic Chinese investors (i.e., limited partners), which generally are more inclined to invest through a China-registered fund, than a non-Chinese fund; and (2) the ability to permit large non-Chinese institutional investors, which only have non-Chinese currencies, to capitalize on the regulations designed to attract foreign investment into China (e.g., the “Qualified Foreign Limited Partnership” or “QFLP” regime in Shanghai, Beijing and other RMB fund hubs).

Yet, it is notable that less than half of the capital raised in RMB funds from domestic Chinese investors has come from state owned institutional investors.  To date, due to regulatory reasons, state-owned institutional investors, particularly government institutions, government-funded guidance funds and universities, have been playing a very limited role as limited partners in private equity and venture capital funds in China (Source: First Financial Daily).  Over the past couple years, China’s regulators, including the National Reform and Development Commission (NDRC), China Securities Regulatory Commission (CSRC), China Banking Regulatory Commission (CBRC), China Insurance Regulatory Commission (CIRC) and People’s Bank of China (PBOC), have implemented legislation designed to allow certain institutions greater flexibility to make equity investments in private companies.  However, much of this legislation has yet to be implemented and official guidance thus far has been limited.  Thus, we haven’t seen a significant increase in investments into RMB funds by state-owned institutional investors.

The following lists certain of the key state-owned institutional investors and the regulatory developments in 2011 that have impacted or will impact their equity investment capabilities.

  • Securities Companies.   Securities companies are now officially permitted to make direct equity investments in Chinese companies pursuant to a set of guidelines issued by the CSRC in July 2011.  The guidelines permit securities companies to directly invest in Chinese entities or form “direct investment funds” (“DIF”) to raise and manage capital for equity investment into such companies, provided that (i) a securities company must form an intermediary known as a “direct investment subsidiary”; (ii) the aggregate capital employed by a securities company in its direct investment business may not exceed 15% of its net assets; and (iii) the securities companies abide by certain restrictions regarding fund raising (e.g., they can only raise capital in a private offering from institutional investors and may not have more than 50 investors).  Prior to the issuance of the guidelines, the CSRC only approved the direct investment of securities companies on a special approval or case-by-case basis.  Reportedly, China International Capital Corporation Limited (CICC) became the first securities company to raise an equity investment fund approved pursuant to the guidelines.
  • Pension Funds.  The Administrative Measures on Enterprise Pension Funds (“Measures”) were amended early this year and went into effect on May 1, 2011. The amended Measures removed the previous investment limit regarding the capital that may be used in “stock investments” by a pension fund, which had been 20% of its net assets.  However, the Measures still require that no more than 30% of a pension fund’s net assets be invested in “rights instruments such as stock and investment-nature insurance products, and stock funds.”  Apparently, there is still some uncertainty regarding whether the terms “stock” and “rights instruments” were intended to include private equity investments. As such, many industry experts believe that it would be some time before pension funds are officially permitted to make private equity investments.
  • Commercial Banks.  Under the Commercial Banks Law (amended in 2003), commercial banks are restricted from making equity investments in “domestic” enterprises. Although this restriction is currently still in place, some commercial banks reportedly seek to make indirect investments into domestic equity investment projects, such as investing through an offshore intermediary.
  • Insurance Companies. There was no new guidance in 2011 regarding whether Chinese insurance companies may make outbound private equity investments. In addition, many industry experts have concluded that an insurance company may not act as a limited partner in an equity investment fund unless it is managed by the insurance company.  In 2011, China Life reportedly became the first insurance company to obtain a private equity investment license under the 2010 regulation.  For a discussion on the 2010 regulation, please see our blog post titled “China Permits Insurance Companies to Invest in Private Equity.”

Over the past several years, non-Chinese fund managers have shown great interest in raising capital from Chinese limited partners.  However, for regulatory and practical reasons, the fund raising efforts of non-Chinese fund managers have not been as successful as hoped.  In addition to the regulatory restrictions specifically affecting state-owned institutional investors, as discussed above, there are a number of other hurdles that must be overcome before a limited partner may or will invest in a RMB fund.  The following are two examples of the hurdles non-Chinese fund managers currently face when attempting to fund raise from domestic Chinese investors.

  • NDRC Recordation.  In early 2011, the NDRC issued a Notice to reinforce the “recordation” requirement applicable to equity investment enterprises (“EIEs”) primarily in six provinces/municipalities. Institutional EIEs with investment capital of more than RMB500 million are required to obtain a recordation with the national office of NDRC, while other EIEs need to be recorded with the regional offices of NDRC.  Currently, there is no explicit requirement or process for recording a foreign-invested EIE with NDRC, which would pose a hurdle on such EIEs’ efforts  to raise capital from the National Social Security Foundation. However, some of the larger, foreign-invested RMB funds have been successful in obtaining recordation with NDRC on a case-by-case basis.
  • Structuring.  How a fund is structured is critical to fund raising.  A fund with any foreign equity investment will be considered as a foreign-invested enterprise (with limited exceptions, such as certain funds blessed by the QFLP regime), and thus restricted from investing in various industrial sectors, such as internet, automobile, certain energy industries and certain real estate developments.  Domestic Chinese investors often prefer to invest in a purely domestic fund, which does not have the same restrictions as foreign-invested funds.  To address this issue, some fund managers have structured their funds as “parallel funds,” which is accomplished through a contractual arrangement between two separate funds to share management, deal sourcing and exit opportunities. 

The industry is hoping that the regulators will enact an Amended Securities Investment Fund Law (SIFL), which many believe will include guidance on private equity investment. However, even if private equity investment is thoroughly covered in the SIFL, we speculate that the provisions will be focused on investor protections, rather than on clarifying the investment capabilities of various investor groups. 

As always, we will continue to provide timely updates on new developments affecting private equity and venture capital investment in China, as they occur, in 2012.

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Written by Jay Gould

On October 26, 2011, the SEC adopted a new rule requiring SEC-registered advisers to hedge funds and other private funds with at least $150 million in private fund assets under management to report information to the Financial Stability Oversight Council (“FSOC”) to enable it to monitor risk to the U.S. financial system.  The information which must be reported to the FSOC on Form PF will remain confidential, and not accessible to the general public.

These private fund advisers are divided into (1) large private fund advisers and (2) smaller private fund advisers.  Large private fund advisers are advisers with at least $1.5 billion in hedge fund, $1 billion in liquidity fund, and $2 billion in private equity fund assets under management.  All other advisers are regarded as smaller private fund advisers.  The SEC anticipates that most advisers will be smaller private fund advisers, but that the large private fund advisers represent a significant portion of private fund assets. 

Smaller private fund advisers must file Form PF once a year within 120 days of the end of the fiscal year, and report only basic information about their hedge funds, private equity funds and/or other private funds, such as information regarding size, leverage, investor types and concentration, liquidity, fund performance, fund strategy, counterparty credit risk and the use of trading and clearing mechanisms.

Large private fund advisers must provide more detailed information than smaller advisers.  The focus and frequency of the reporting depends on the type of private fund the adviser manages.

  • Large advisers to hedge funds must report on Form PF within 60 days of the end of each fiscal quarter, on an aggregated basis, information regarding exposures by asset class, geographical concentration and turnover.  If a hedge fund has a net asset value of at least $500 million, the adviser must report information regarding the fund’s exposures, leverage, risk profile, and liquidity.
  • Large advisers to liquidity funds must report on Form PF within 15 days of the end of each fiscal quarter, the types of assets in their liquidity funds, information relevant to the risks of the funds, and the extent to which the liquidity funds comply with Rule 2a-7 of the Investment Company Act of 1940, as amended.
  • Large advisers to private equity funds must file Form PF annually within 120 days of the end of the fiscal year and respond to questions regarding the extent of leverage incurred by their funds’ portfolio companies, the use of bridge financing and their funds’ investments in financial institutions.

Two-stage phase-in compliance with Form PF filing requirements:

  1. Advisers with at least $5 billion in hedge fund, liquidity fund, and private equity fund assets under management must begin filing Form PF following the end of their first fiscal year or fiscal quarter, as applicable, to end on or after June 15, 2012.
  2. Other private fund advisers must begin filing Form PF following the end of their first fiscal year or fiscal quarter, as applicable, to end on or after December 15, 2012.

Form PF Filing Fees:  $150 for initial, quarter or annual filing.

A full text of the SEC release is available here. 

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Written by Jay Gould, Ildi Duckor and Michael Wu

On March 22, 2011, U.S. House Oversight Committee Chairman Darrell Issa (R., Calif.), sent a sharply worded letter to Chairman Mary Schapiro of the Securities and Exchange Commission (the “SEC”), in which he demanded that the SEC justify several of its rules regarding raising capital, including the “quiet period” that restricts a company’s communications ahead of an initial public offering (“IPO”) and the rules that limit the number of investors in private companies to 499. The immediate impetus of this letter (the “Issa Letter”) appeared to be the recent decision by Facebook to issue shares exclusively to non-U.S. investors due to the requirement for a private company to file financial statements with the SEC once it has more than 499 U.S. equity holders, as well as the general decline of the overall IPO market in the U.S.

The Issa Letter accuses the SEC of stifling capital creation and causing the decline of the IPO market in the U.S. by clinging to obsolete and inflexible laws and regulations. Chairman Issa asks whether the decline in public equity listings and issuances have been driven by the expansion and complexity of SEC regulations, the expansion of personal liability under the Sarbanes-Oxley Act of 2002, the new uncertainty surrounding regulations to be issued pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), securities class action lawsuits and the expansion of other regulatory, legal or compliance burdens. Chairman Issa railed against the prohibition on promotional statements made between the time that a registration statement has been filed and the time it becomes effective as a violation of an issuer’s rights under the First Amendment. Chairman Issa further finds fault in the inability of the SEC to fashion rules to permit effective early stage capital formation, accuses the SEC of certain conflicts of interest and ineptitude in its staff, and suggests that “sophisticated” investors, regardless of whether they satisfy the “accredited” investor standard, should be permitted to invest in private placements.

On April 6, 2011, Chairman Schapiro responded to Chairman Issa in a detailed and heavily footnoted tome (the “Shapiro Letter”) that sought to correct some of the basic misunderstandings in the Issa Letter. The Schapiro Letter provides an interesting and brief history of the development of private offerings, the development of the private markets, the IPO process, the rationale behind public reporting, and the SEC’s views towards capital raising strategies. Much of this discussion is either relevant to investment fund managers or directly on point with their businesses, and certainly worth a read.

Chairman Issa raises some interesting points and the combative tone of his letter should not be a reason to simply dismiss his concerns. There are, however, two interesting questions that Chairman Issa could have raised with the SEC, but did not, the answers to which may have been even more productive to the discussion.

First, does the SEC believe that if it was self-funded, it would be more responsive to the needs of the capital markets and be able to better balance its dual mandates of creating efficient capital markets and protecting shareholders? It should be noted that early drafts of the Dodd-Frank Act stated that the SEC was to be self-funded, but that language was later removed when our two political parties agreed on specific budget numbers for the SEC, which they believed would permit the SEC to meet its significant new and continuing obligations. Once the Dodd-Frank Act became law, a bi-partisan Congress promptly ignored these funding mandates and has continued to impede the effectiveness of the SEC through the budget process.

Second, does the SEC believe that significantly increasing the number of investors to which a private company can sell shares, without providing full and fair disclosure, would shrink the public markets, make fewer investment opportunities available to ordinary investors, and accelerate the wealth divide that is threatening to destabilize the U.S.? The securities laws were meant to level the playing field among investors, and the SEC over the years has attempted to enforce this mandate through the registration process and its enforcement actions. Larry Ribstein provides a thoughtful view of this dilemma here.

The balance between effective regulation for investor protection and efficient capital markets to encourage responsible investment is a delicate one that we can expect to be treated quite indelicately in the current political climate.

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Written by Michael Wu

Earlier this month, the Institutional Limited Partners Association (“ILPA”) published Version 2.0 of its Private Equity Principles (the “Principles”).  The Principles set forth the ILPA’s take on the best practices in establishing private equity partnerships between limited partners (“LPs”) and the general partner (“GP”).  The Principles focus on three guiding tenets for developing effective partnership agreements: Alignment of Interest Between LPs and GP, Fund Governance and Transparency to Investors.  The revised version of the Principles incorporate feedback from GPs, LPs and third parties in the industry to increase “focus, clarity and practicality.”

The following are the key changes from the prior version of the Principles under each of the three guiding tenets:

Alignment of Interest Between LPs and GP

  • GP cash contributions are preferred to fee waivers
  • European-style waterfalls (i.e., all contributions plus preferred returns are paid before the GP receives any carry) is preferred to American-style waterfalls (i.e., deal-by-deal), though with certain safeguards, such as carry escrows of 30% or more, 125% NAV tests and interim clawbacks, the American-style waterfall could be acceptable
  • GP clawbacks should be net of taxes, “fully and timely repaid” and should extend beyond the term of the fund
  • Joint and several liability of the GP’s members is preferred, but a joint and several guaranty from a substantial parent company or individual GP member may be acceptable, and LPs should be able to enforce the GP clawback guaranty
  • Lower management fees should be charged at the end of the investment period, the formation of a successor fund and if the term of the fund is extended
  • Deal sourcing fees should be a GP expense
  • LP clawbacks for indemnification should be capped at 25% of the capital commitments and should not apply after two years from the date of distribution
  • Term of the fund may only be increased in one-year increments and only with the consent of a majority of the Advisory Committee or the LPs, and if such consent is not obtained, the fund should be fully liquidated within one year of the end of the fund’s term
  • GP should not co-invest with the fund (i.e., GP’s entire interest should be through the fund)
  • Advisory Committee should review and approve any fees generated by an affiliate of the GP, whether charged to the fund or a portfolio company

Fund Governance

  • GP may be removed for “cause” and the fund terminated for “cause” upon a majority vote of the LPs
  • A 2/3 in interest of the LPs may terminate/suspend the commitment period without fault and a 3/4 in interest of the LPs may remove GP and dissolve the fund without fault
  • GP should accommodate LP investment policies and provide applicable excuse rights
  • A majority in interest of the LPs may make general amendments; a super-majority in interest of the LPs may make “certain amendments” (e.g., investor-specific provisions) and amendments affecting the fund’s investment strategy and the fund’s economics; and amendments negatively affecting any LP’s economics, require the consent of such LP
  • Where the interest of the LPs and the GP is not aligned, a reasonable minority of the members of the Advisory Committee may engage independent counsel at the expense of the fund

Transparency to Investors

  • Annual reports should be delivered within 90 days of the end of the year
  • Annual and quarterly reports should be provided to LPs regarding a portfolio company’s debt
  • Funds should use the ILPA’s standardized form of capital call and distribution notice template

Finally, the ILPA’s release also set forth best practices for Advisory Committees.  More information about the Principles can be found here.

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Written by Michael Wu

On January 26, 2011, the SEC proposed a rule that would require SEC-registered advisers to hedge funds, private equity funds and other private funds to report information to the Financial Stability Oversight Council (“FSOC”) that would enable it to monitor risk to the U.S. financial system.  The information would be reported to the FSOC on Form PF and the information reported on Form PF would be confidential.

The proposed rule would subject large advisers to hedge funds, “liquidity funds” (i.e., unregistered money market funds) and private equity funds to heightened reporting requirements.  Under the proposed rule, a large adviser is an adviser with $1 billion or more in hedge fund, liquidity fund or private equity fund assets under management.  All other advisers would be regarded as smaller advisers.  The SEC anticipates that most advisers will be smaller advisers, but that the large advisers represent a significant portion of private fund assets.

Smaller advisers would be required to file Form PF once a year and would report only basic information about their hedge funds, private equity funds and/or other private funds, such as information regarding leverage, credit providers, investor concentration, fund performance, fund strategy, counterparty credit risk and the use of trading and clearing mechanisms.

Large advisers would be required to file Form PF quarterly and would provide more detailed information than smaller advisers.  The information reported would depend on the type of private fund that the large adviser manages.

  • Large advisers to hedge funds would report, on an aggregated basis, information regarding exposures by asset class, geographical concentration and turnover.  If a hedge fund has a net asset value of at least $500 million, the adviser would report information regarding the fund’s investments, leverage, risk profile and liquidity.
  • Large advisers to liquidity funds would report the types of assets in their liquidity funds, information relevant to the risks of the funds, and the extent to which the liquidity funds comply with Rule 2a-7 of the Investment Company Act of 1940, as amended.
  • Large advisers to private equity funds would respond to questions regarding the extent of leverage incurred by their funds’ portfolio companies, the use of bridge financing and their funds’ investments in financial institutions.

The SEC’s public comment period on the proposed rule will last 60 days.