Jun. 11, 2019

Parental Liability in the E.U.: Mitigating Liability at Various Stages of Portfolio Company Ownership (Part Three of Three)

Certain statutory concepts make it prohibitively difficult for E.U. parent entities to completely avoid liability for violations by their subsidiaries of the E.U. competition law or the General Data Protection Regulation. This liability can not only harm the value of investments, but it can also expose private equity (PE) sponsors and other parent entities to tens of millions of Euros in fines from E.U. regulators and potential civil lawsuits. The prudent move, therefore, is for PE sponsors and other parents to endeavor to mitigate this potential liability throughout the investment process. This final article in a three-part series prescribes measures PE sponsors can take to reduce potential parental liability in the E.U. from antitrust or data protection violations by their portfolio companies during and after the acquisition process. The first article described how the statutory “undertaking” concept extends liability to parent entities, as well as the potential reputational risks, fines and civil damages PE sponsors can face for violations. The second article analyzed the rebuttable presumption by the E.U. Commission and courts that a parent exercises decisive influence over its subsidiary’s actions, difficulties in refuting it and four common misconceptions about how parents can avoid that risk. For more on issues pertinent to sponsors and investors in the E.U., see “Dechert Attorneys Consider Impact of the GDPR (Part One of Two)” (Feb. 21, 2019); and “How Hard Is Brexit Expected to Impact Alternative Fund Managers?” (Dec. 13, 2018).

How Fund Managers Can Mitigate the Impact of Litigation on Their Transactions and Relationships

Litigation – which is expensive, diverts personnel resources and presents considerable reputational risk regardless of its result – can undermine an investment manager’s transactions and relationships. Even though litigation rarely adds value or advances an investment manager’s objectives, the reality is that disputes will arise in commercial transactions. Deal documents should provide for a process to resolve any disputes that do arise in a way that minimizes their impact on the economics and objectives of the transaction. Arbitration and mediation are the two best-known alternatives to litigation, although they are often conflated despite offering very different dispute resolution options, structures, processes and results. In a guest article, David C. Rose, partner at Pryor Cashman, discusses how fund managers can incorporate into their deal documents a multi-tiered dispute resolution process that requires parties to engage in mandatory mediation prior to submitting a dispute to litigation or arbitration, thereby mitigating the impact and risk of disputes among counterparties and salvaging or reviving valuable commercial transactions and relationships. See “Contractual Provisions That Matter in Litigation Between a Fund Manager and an Investor” (Oct. 2, 2014). For commentary from other Pryor Cashman attorneys, see “Ten Strategies for Preventing Disclosure of Confidential Private Fund Data Under State Sunshine Laws” (May 3, 2012).

SEC Fines PE Sponsor, CEO and CFO for Improper Principal Transactions and Expense Allocations

Limited partnership agreements (LPAs) are carefully negotiated and establish key components of the relationship between general partners (GPs) and limited partners (LPs). Because LPAs may sometimes receive minimal attention post-execution, investors are increasingly demanding that processes be in place to ensure that GPs comply with LPA provisions. Aside from appealing to LPs, this can mitigate the risk that violations by private equity (PE) sponsors will attract SEC scrutiny. In a recent example of that risk, the SEC settled enforcement proceedings against a PE sponsor, its CEO and its chief financial officer for improper affiliate transactions and expense allocations resulting from failures to properly interpret and implement the LPA. This article details the conduct giving rise to the proceedings, as well as the terms of the SEC settlement order. For coverage of other recent SEC enforcement actions, see “Neuberger Berman’s PE Adviser Faces $2.73 Million in Fines and Disgorgement for Improperly Allocating Employee Compensation to Its Funds” (Mar. 19, 2019); and “Allegations That Private Equity Manager Misallocated Expenses and Failed to Disclose Conflicts of Interest Result in Nearly $3 Million in Disgorgement and Fines” (Jan. 17, 2019).

Best Practices and Potential Benefits to Fund Managers of Speaking to the Media (Part Two of Two)

After decades of reluctance, fund managers are starting to talk to the media – a trend fueled by legal and business changes over the last several years. On the legal side, the JOBS Act repealed the ban on general solicitation and advertising for private funds that rely on Regulation D. On the business front, investors’ enhanced negotiating clout has forced managers to distinguish their product and service offerings. Although talking to the media can net distinct benefits, it can also trigger a range of regulatory, business, reputational and other risks. This two-part series is intended to help fund managers decide whether to talk to the media and, if they do, how to identify and manage the attendant risks. This second article reviews several distinct benefits of speaking with the press; best practices and compliance recommendations for interacting with the media; and certain situations in which managers should avoid media communications. The first article explored fund managers’ historical hesitation to speak to the press, as well as seven potential risks that they face when doing so. For more on interacting with the press, see our two-part series “Cyber Crisis Communication Plans: What Works and What Fund Managers Should Avoid”: Part One (May 14, 2019); and Part Two (May 28, 2019).

How Carried Interest Clawbacks Preserve Investor Returns and Affect Taxation (Part Two of Two)

Although general partners of private equity funds are often well intentioned when drafting waterfalls in fund documents, they can occasionally be overzealous about securing early cash distributions. To protect against this risk, most limited partners insist on a carried interest clawback mechanism that allows them to reshuffle cash disbursements at the end of the fund’s term to accurately reflect the fund’s economics. This feature can greatly complicate a fund’s waterfall, however, as well as the tax treatment of the fund. Strafford hosted a recent webinar presented by Kirkland & Ellis partners David H. Stults and Aalok Virmani that addressed some of these issues. This second article in a two-part series evaluates carried interest clawbacks at length, including the impact of different features and some of the tax considerations that they invoke. The first article analyzed how different styles and permutations of waterfalls can shift the balance between partners’ competing interests and objectives. For additional insights from Kirkland & Ellis, see “The Power of ‘No’: SEC Commissioner Peirce on Enforcement As Last Resort” (Jun. 21, 2019); and our two-part series: “Understanding the CFIUS Review Process and How to Structure Investments to Minimize Regulatory Risk” (Apr. 2, 2019); and “FIRRMA Expands the Scope of Transactions Subject to CFIUS and Lengthens the Target Acquisition Timeline” (Apr. 9, 2019).