Private Equity

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The Second Circuit yesterday affirmed the insider trading conviction of the principal of a potential acquiror who, in breach of a nondisclosure agreement with a potential target company, had provided a tippee with nonpublic information about an impending acquisition of the target. The decision in United States v. Chow held that:

  • The nondisclosure agreement (“NDA”) between the transaction parties created a duty to keep information about the potential transaction confidential and not to use it for any purpose other than the transaction;
  • The defendant tipper violated that agreement by providing information to the tippee, who purchased significant amounts of the target’s shares before the transaction was announced;
  • The evidence supported the jury’s finding that the tipper had intentionally provided material, nonpublic information (“MNPI”) to the tippee; and
  • The tipper had received a sufficient personal benefit in exchange for providing MNPI.

Yesterday, SEC Director of Enforcement Andrew Ceresney gave a keynote address on Private Equity Enforcement.  In his remarks, Ceresney reiterated the SEC’s view that private equity is and will be a key enforcement area, and detailed recent actions showing the Commission’s particular focus on undisclosed fees and expenses and on increasing transparency in the industry.  Ceresney also provided guidance on arguments that the SEC staff has typically found unavailing.

Ceresney noted that the unique nature of private equity investments were a concern, asserting that the “investment structure of private equity and the nature of private equity investments can lend themselves to some of the misconduct that we’ve observed.” However, recent enforcement actions show that problems typically arise when fee and expense allocations are not appropriately managed, giving rise to undisclosed conflicts of interest.  Ceresney further stated that as fiduciaries, private equity advisers are expected to eliminate or disclose such conflicts.

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.

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. 

On November 3, 2015, the Securities and Exchange Commission (SEC) announced that it had reached a settlement with Fenway Partners, LLC, a New York-based private equity firm, and several of the firm’s executives (the Respondents) in connection with a failure to disclose conflicts of interests to investors with respect to payments made by portfolio companies of a private equity fund to certain affiliates and former employees of the firm. In settlement of the matter, the Respondents agreed to collectively disgorge approximately $8.7 million, and pay an approximately $1.5 million civil monetary fine.

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:

  1. 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.

At the recent Columbia Law School Conference, “Hot Topics: Leading Current Issues in Securities Regulation and Enforcement,” SEC Commissioner Kara M. Stein’s keynote address focused on a number of transparency and disclosure issues regarding municipal securities, private equity and exchange traded funds.

Municipal Securities

Commissioner Stein highlighted the importance of municipal finance to the growth of the nation and noted that ordinary investors now own over 70 percent of the municipal securities market, either directly or through investment companies.

In light of this data, Commissioner Stein addressed two areas where, in her view, regulators could act to improve transparency in the municipal securities market.  The first is to require post-trade pricing disclosure showing transaction costs on customer confirmations.  Second, Commissioner Stein urged that market information, such as who in the market is interested in trading a municipal security and at what price, be made available to ordinary investors in advance of trading.

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.