Jul. 11, 2024

LP Concerns and Common Misconceptions About the Rise of “Synthetic” Distributions (Part One of Two)

The PE industry is caught between a proverbial rock and a hard place as to liquidity. There have been a dearth of asset realizations lately due to soaring interest rates, decades-high inflation, pressure on valuations and major slowdowns in the M&A and IPO markets. That lack of realizations has limited fund distributions to LPs, making it difficult for them to participate in PE sponsors’ persistent fundraising efforts. To cure the problem, some PE sponsors have begun issuing “synthetic” distributions to LPs which, functionally, are distributions generated from the proceeds of net asset value (NAV) facilities that are collateralized by PE funds’ portfolios of investments. Although LPs generally favor the use of NAV facilities, they have concerns about sponsors using them to issue synthetic distributions due to a perceived lack of transparency, the relative cost of those distributions and the impact on certain fund performance metrics. This two-part article series holistically examines sponsors’ uses of synthetic distributions and LPs’ rising concerns about that tactic. This first article explains why and how synthetic distributions have become more popular, along with detailing LP concerns about them and some typical misconceptions in the industry. The second article will consider how PE sponsors can respond to and work to alleviate LPs concerns about synthetic distributions in a constructive manner. See “What Does It Take to Get Across the Finish Line in the Current Fundraising Environment?” (Mar. 7, 2024).

Trends and Key Drivers in PE and Private Credit Seeding Transactions

Historically, PE and private credit seeding has been rare compared to seed investments into hedge funds. Although hedge fund seeding continues to dominate the space, PE and private credit are building significant momentum and molding traditional seed transaction terms to suit the unique features of those asset classes. The growth of PE and private credit seeding - and other related trends - were observed and discussed in Seward & Kissel’s tenth annual study on seed transaction deal points for hedge funds, PE and private credit for the 2023 observation period (Report). This article summarizes key takeaways for PE and private credit managers from the Report, with additional analysis from Seward & Kissel partner Gerhard Anderson, one of the co‑authors of the Report. For insights from Anderson, see “The New Trend in PE Fund Seed Investments, Unique Deal Features and Several Options for Seed Sources” (Mar. 17, 2020).

Potential Implications for Non‑U.S. Investors of Recent Tax Court Decision in YA Global (Part One of Two)

In YA Global Investments, LP v. Commissioner, the U.S. Tax Court (Court) ruled that a non‑U.S. fund was engaged in a U.S. trade or business based on the activities of its investment manager and was subject to mark-to-market accounting rules, resulting in income earned by the non‑U.S. fund being deemed effectively connected income. The holding raises a number of issues and concerns for tax counsel and private fund managers about how to structure funds to avoid adverse tax consequences for non‑U.S. investors. To delve into the issue, Strafford CLE Webinars recently hosted a program examining the tax implications of private fund activities for non‑U.S. investors following the Court’s decision in YA Global. The panel featured Mayer Brown partner Mark H. Leeds, KPMG partner Jay Freedman and BlackRock’s global co‑head of alternatives tax, Sarah Ryan. This first article in a two-part series summarizes the tax rules implicated by YA Global, along with pertinent facts from the case that contributed to the Court’s ruling. The second article will analyze the seven primary issues raised in YA Global, how the Court ruled on each and potential alternative considerations that private fund managers should weigh. For more on tax withholding on foreign partners, see our two-part series: “Partnership-Level Duties and Consequences As the Requirement Has Evolved Over Time” (Mar. 2, 2021); and “Overview of Various Exemption Certifications and Tips for Reducing Withholdings” (Mar. 9, 2021).

Navigating the New FinCEN Beneficial Ownership Reporting Regime

On January 1, 2024, a new beneficial ownership reporting rule (Rule) issued by the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) took effect. The Rule affects a broad range of businesses, from startups to established entities, and creates particular challenges for investment management firms, noted Seward & Kissel partner Patricia A. Poglinco in a recent program devoted to the Rule. Poglinco, who moderated the discussion with fellow partners Sophia A. Agathis, Noelle Indelicato and Danielle Lemberg, discussed the key components of the Rule, including which entities are subject to it, who is a “beneficial owner,” what information companies are required to report and the practical implications of the Rule for fund managers. This article synthesizes the key takeaways from the program. See our two-part series on anti-money laundering rules proposed by FinCEN: “Parameters of the Rules and the Types of Managers Affected” (Apr. 18, 2024); and “Difficult Provisions, Potential SEC Examinations and Likelihood of Adoption” (May 2, 2024).

Crafting Effective Mobile Device Policies to Satisfy Regulatory Expectations

Government authorities expect companies to have appropriate controls over communications sent through text and messaging apps. In recent years, U.S. regulators – including, most notably, the SEC – have imposed billions of dollars in penalties on financial services firms for failing to maintain records of electronic communications in accordance with the federal securities laws. Even organizations that are not subject to specific record retention requirements may find themselves at a disadvantage if they cannot produce relevant employee communications in connection with a government investigation. This article synthesizes insights offered by Miller & Chevalier attorneys in a recent Practising Law Institute program about government expectations around companies’ management of mobile device communications, and how companies can craft and implement effective mobile device policies. See “SEC Brings First Enforcement Action Against a Stand‑Alone Investment Adviser for Off‑Channel Communication Violations” (May 30, 2024); and “Latest SEC Sweep of Off‑Channel Communications Both Befuddles and Turns Up the Heat on Investment Advisers” (Mar. 21, 2024).

Proskauer Adds Two Private Funds Experts in New York

Proskauer has announced the addition of two private funds lawyers – Jennifer E. Crystal and Jennifer M. Dunn – as partners in the firm’s New York office. Crystal’s practice focuses on representing private fund managers across asset classes, including private credit, venture capital and PE, while Dunn’s expertise spans open-end funds, closed-end funds, hybrid vehicles and co‑investment platforms. For commentary from Dunn, see “High‑Level Takeaways and Observations About the Potential Impact of the Final Private Fund Reforms” (Feb. 8, 2024); and “Upper-Tier Structures and Key Considerations” (Sep. 7, 2023).