PE sponsors often appoint their own employees to their portfolio companies’ boards of directors as a way of exercising control and keeping close tabs on those companies’ operations. Those benefits may be offset, however, by potential conflicts of interest or other risk factors introduced by the arrangement, including the misuse of material nonpublic information (MNPI) or improper approval of conflicted transactions. Those risks are exacerbated by the accompanying threat of litigation or regulatory actions for violations, with the latter evidenced by a recent settlement order issued by the SEC. In light of those issues, this three-part series evaluates all facets of the practice of appointing PE employees to portfolio company boards. This first article takes a look at the most common challenges arising from having sponsor-appointed board members, including breaches of competing fiduciary duties; misuse of MNPI; and scrutiny from LPs. The second article
will prescribe several board construction methods and policies to mitigate those risks, and the third article
will explore various scenarios in which risks arise from having sponsor-appointed members on portfolio company boards. For more on conflicts of interest, see “Avoiding Parallel Fund Conflicts: New SBAI Standards and Case Study Provide Guidance for Mitigating Conflicts (Part One of Two)
” (May 5, 2020); and “Navigating the Interpretation Regarding an Investment Adviser’s Standard of Conduct: What It Means to Be a Fiduciary (Part One of Three)
” (Dec. 3, 2019).