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    Jul. 25, 2024

With PE Secondary Sales, Tax Is a Primary Concern

Although a traditionally illiquid asset, investors in PE and other closed-end funds sometimes need to cash out prior to the end of a PE fund’s term. Secondary sales of PE fund interests offer a straightforward pathway for an investor to achieve liquidity. Several key U.S. federal income tax considerations must be weighed, however, by PE sponsors and investors planning to engage in secondary sales of PE fund interests. In addition, there are non-tax issues that should be considered when structuring a secondary sale of a PE fund interest. This guest article by Seward & Kissel partners Sonita M. Bennitt, James C. Cofer and Brett R. Cotler discusses common tax-driven transfer restrictions contained in PE fund operating documents; U.S. federal withholding taxes and related withholding certificates; optional and mandatory tax basis adjustments; and allocation methodology and indemnification considerations when drafting purchase and sale agreements of PE fund interests. See “Asset Managers’ Perspectives on Secondary Market Challenges and Product Expansion” (Jan. 11, 2024); and “Prevailing Trends in Transactions, Terms and Considerations in the Secondary Market (Part One of Two)” (Dec. 29, 2022).

Communication Tactics, LPA Provisions and Fund Structures to Allay LPs’ Anxiety About “Synthetic” Distributions (Part Two of Two)

As a way to generate liquidity while the exit environment remains unfavorable, some PE sponsors have begun issuing LPs “synthetic” distributions generated from proceeds from preferred equity issuances, net asset value (NAV) facilities and other debt-backed capital returns. LPs have expressed concerns about synthetic distributions, however, including their costs, a lack of GP transparency and their impact on a fund’s risk profile. The strong reactions of some LPs to so-called “leverage on leverage” risks threaten to inhibit the potential value to sponsors of NAV facilities and synthetic distributions as liquidity tools. Sponsors can adopt a two-prong approach to abating those concerns, however, by both building safeguards into their fund documents and dispelling LPs’ misunderstandings through increased and improved communications. This second article in a two-part series details specific ways GPs can address investors’ concerns about synthetic distributions, both in terms of how they communicate about and structure synthetic distributions and the NAV facilities that facilitate them. The first article provided an overview of synthetic redemptions, detailing LP concerns and common misconceptions about their use. See “Trends in Private Fund Terms and GP‑LP Fundraising Perspectives in the Current Market Environment” (Jul. 27, 2023).

Update on Rapidly Evolving Market Trends and Regulations in Europe, Asia and the Middle East

A panel at a recent Morgan Lewis conference discussed relevant regulatory updates and key trends in Europe; the Middle East and North Africa; Japan; and the rest of Asia (excluding China). The program highlighted the ways in which different regulators are focused on their own jurisdictions or looking to harmonize with other regions and support incomers, and also discussed recent trends such as sovereign wealth funds keeping capital within their nations and the rise of tokenization. The panel featured Morgan Lewis partners Ayman A. Khaleq, Steven Lightstone, Divya Thakur and Carol Tsuchida. This article summarizes the key takeaways for private fund managers. For additional insights from Morgan Lewis, see our two-part series: “LP Perspective on Negotiating PE Terms and Structuring Bespoke Vehicles” (Feb. 1, 2022); and “Tax Issues, China, Trade and Sanctions” (Feb. 8, 2022).

Seven Tax Issues Addressed in YA Global That Could Impact Non‑U.S. Investors (Part Two of Two)

For sponsors of private funds with non‑U.S. investors, considerable time and expense is committed to structuring those funds in a manner to mitigate, as much as possible, any adverse tax consequences that could flow through to those investors. One of the biggest risks faced by non‑U.S. investors is for them to be subject to U.S. tax on income that is treated as being effectively connected with the conduct of a U.S. trade or business. A recent ruling by the U.S. Tax Court (Court) in YA Global Investments, LP v. Commissioner addressed that topic in the private funds context, raising concerns about tax structuring practices that need to be modified going forward. That topic was addressed in a recent program hosted by Strafford CLE Webinars in a panel that featured Mayer Brown partner Mark H. Leeds, KPMG partner Jay Freedman, and BlackRock’s global co‑head of alternatives tax, Sarah Ryan. This second article in a two-part series analyzes the seven primary issues raised in YA Global, how the Court ruled on each item and potential alternative considerations that private fund managers should weigh as to each topic. The first article summarized the tax rules implicated by YA Global, along with pertinent facts from the case that contributed to the Court’s ruling. See our two-part series: “Notable Tax Provisions and Circumstances to Weigh to Optimize Treatment of Non‑U.S. and Tax Sensitive Investors” (Jun. 28, 2022); and “Ways That Tax Concerns Drive Structuring Strategies for PE, Real Estate and Private Credit Funds” (Jul. 12, 2022).

Testing Is an Integral Component of Compliance Programs

Rule 206(4)‑7 under the Investment Advisers Act of 1940, commonly known as the “Compliance Rule,” requires advisers to review the adequacy and effectiveness of their compliance policies and procedures. An essential tool advisers use to fulfill their obligations under the Compliance Rule is testing. An ACA Group presentation, part of its “Building a Gold Standard Compliance Program” series, examined the role of testing in a compliance program; hallmarks of effective testing; and testing design and implementation. The program featured L. Allison Charley, director, and Jaqueline Hummel, director of thought leadership, at ACA Group. This article synthesizes their insights. For coverage of prior installments in that series, see “Improving Compliance Programs With Gap Analysis and Risk Assessments” (Dec. 14, 2023); and “Managing Conflicts and Developing Effective Compliance Policies and Procedures” (Oct. 19, 2023).

Fund Formation Partner Joins Dechert in New York

Dechert has announced the addition of Gerald H. Brown, Jr., as a partner in its New York office. His practice focuses on a broad range of asset management matters, including, more specifically, the formation of closed-end funds. See our two-part series “Dechert and Mergermarket 2024 PE Outlook”: Navigating Fundraising and Regulatory Headwinds (Jan. 25, 2024); and Parsing the Ongoing Growth of GP‑Led Transactions and Other Sectors (Feb. 8, 2024).

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