Private investment funds are likely to face increased regulatory scrutiny and litigation risk in 2016, not only based on the Securities and Exchange Commission’s focus on the industry but also due to transparency and compliance initiatives of limited partners and other market developments. We have highlighted several areas that should be on the top of every private fund sponsor’s list – and how to assess and manage the associated risks.
As Litigation Risk Increases, Private Equity Sponsors Should Re-Evaluate Their Professional Liability Insurance Programs
Private equity fund sponsors are facing increased litigation risk from regulators and private parties, including limited partners and stakeholders in portfolio companies. As a result, private equity firms should re-examine their professional liability insurance policies to ensure that their coverage is properly aligned with this increasing risk.
Managing Litigation Risk: Critical Questions for Private Equity Professionals Serving on Portfolio Company Boards
Private equity funds, and individuals affiliated with fund sponsors, are increasingly being named as defendants in lawsuits involving their portfolio companies. This litigation risk arises most frequently where a fund controls one or more board seats on the portfolio company, or where an individual affiliated with the fund sponsor serves as a senior executive at the portfolio company.
When a fund sponsor (or an individual affiliated with a fund sponsor) is named as a defendant in a lawsuit involving a portfolio company, the initial assessment of the claims, risks, insurance coverage, and indemnification rights is critical. Some of the key questions for that early assessment are:
- What are the board designee’s indemnity rights? Typically, the board designee has indemnity rights at multiple levels, including the portfolio company level, the fund level, and potentially the management company/sponsor level. The interplay between the rights at different levels, and the priority of the indemnitors’ obligations, requires careful assessment. Also, it is important to understand that an indemnity right is subject to “credit risk,” as the indemnity is only as strong as the balance sheet of the indemnitor.
FINRA’s 2015 Examination Priorities Zero In On Abusive Trading Algorithms and Other Issues Involving Trading Technology
FINRA’s recently-released Regulatory and Examinations Priorities Letter for 2015 reflects substantial regulatory interest in high-frequency trading and other issues arising from trading technology. Regulatory concern over these issues has been previously reported on this blog here and here.
The 2015 Letter states that FINRA has adapted its surveillance program to identify potentially violative conduct such as trading by “abusive algorithms” made possible by advances in technology and changes in market structure. Abusive algorithms, according to FINRA, include trading algorithms that seek to manipulate the market through layering, spoofing, wash sales, marking the close, or other manipulative techniques.
Private Equity Endures Heightened Public Scrutiny
The public scrutiny on private equity fund sponsors has continued to intensify this month, evidenced by at least three recent events.
First, the government announced that it was probing performance figures at private equity funds: SEC Probing Private Equity Performance Figures. This focus on performance should not come as a surprise. Financial performance is what drives the industry. Moreover, the SEC has made it clear that private equity fund sponsors are a regulatory and enforcement priority. And if that weren’t enough, two separate academic white papers have raised questions about performance claims in the private equity industry. After the options backdating scandal a decade ago, the catalyst of which was an academic white paper, the SEC had no choice but to probe performance claims.
Don’t Get Burned by the “Sunshine:” Risk Factors for Venture Capital Firms in an Era of Increasing SEC Scrutiny
Originally published in the Venture Capital Review, 2014 edition.
Andrew J. Bowden, the Director of the SEC’s Office of Compliance Inspections and Examinations, gave a speech entitled “Spreading Sunshine in Private Equity” in May 2014. While sounding cheery, the “spreading sunshine” metaphor was an ironic evocation of Justice Brandeis’s