Aug. 4, 2020

Sponsor‑Appointed Directors on Portfolio Company Boards: Conflicted Transactions, MNPI and Other Risk Areas (Part One of Three)

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).

Practical Tips for Overcoming the Operational Challenges of Corporate Carve-Out Transactions by PE Funds

Although carve-out transactions – in which a corporation sells a subsidiary or business line – have always been challenging, new economic realities of the coronavirus pandemic are elevating execution risks of the deals and increasing sellers’ desire to complete the transactions. That may result in increased numbers of carve-out acquisitions in an environment where it is simultaneously more difficult to execute an in-person carve-out transition plan. In a guest article, ContinuServe managing director Pradeep Khurana details several steps PE sponsors can take to prepare for certain challenges introduced by carve-out transactions and to increase the likelihood that those transactions are successful. Among other things, the article recommends that PE sponsors take special care when appointing transition task forces to manage the process and that they ensure the carved-out business has adequate back-office functionality from day one. For more on transaction types and approaches gaining greater prominence during the pandemic, see “Considerations When Using Earn‑Outs to Consummate Secondary Transactions During a Downturn” (Jun. 16, 2020); and “Types of Rescue Capital PE Sponsors Can Pursue to Help Their Portfolio Companies Survive the Pandemic (Part One of Two)” (Jun. 9, 2020).

Inflection Points in Negotiating PE Fund Core Economic Terms and Structuring GP‑Entity Carry Allocations to Incentivize Employees

Fund economics are a significant part of negotiations between sponsors and prospective investors in new PE fund launches. Almost as important as the economics themselves, however, are how the provisions are drafted in the fund documents and whether certain LP protections are included (i.e., clawbacks and escrow accounts). Ambiguity or obstacles in GPs receiving carry distributions on that basis can trickle down into potential issues with subsequent payments to retain talented employees. In addition, sponsors need to be mindful of ways the GP vehicle can be structured to incentivize employees waiting for carry distributions. Strafford CLE Webinars recently hosted a program examining those and other facets of PE funds’ core economic terms, including how those issues were dealt with in the initial iteration of the model limited partnership agreement released by the Institutional Limited Partners Association. This article summarizes the key takeaways from the presentation, which featured insights from Tremont Street Partners managing partner John J. McDonald and Alston & Bird partner Michael D. Saarinen. For further commentary from Saarinen, see “SEC’s Reg Flex Agenda Promotes Transparency While Adding Potential Compliance Burdens” (Mar. 15, 2018); and “SEC Signals Aggressive Stance on Individual Responsibility, Including Potential CCO Liability, in FY 2017 Annual Report” (Dec. 14, 2017).

Insurance in the Pandemic: Protective Measures for PE Sponsors to Avoid Claims and Guard Against Cyber Risks (Part Two of Two)

Although insurance coverage provides invaluable protection against disasters or unexpected issues, those are not the only contexts in which it is merited. There are also forms of insurance coverage that can protect fund managers and their portfolio companies from claims filed against them by others, which is an important risk-mitigation angle to consider. Having coverage is only one piece of the equation, however, as fund managers need to promptly and frequently engage with their insurers to successfully file claims thereunder. To consider those issues in the context of the coronavirus pandemic, Proskauer hosted a recent program which was moderated by partner Michael R. Hackett and featured insights from partner John E. Failla and senior counsel Nathan R. Lander. This second article in a two-part series details how fund managers can use insurance to protect against third-party claims and from the rising risk of cybersecurity breaches. The first article summarized the insurance market during the coronavirus pandemic, while also providing advice on how to successfully file claims for business interruption losses caused by the virus. For more coverage of cyber insurance, see “Cyber Insurance Coverage, Pre-Breach Mitigation Efforts and Post-Breach Response Plans Can Reduce Harm to Fund Managers From Cyber Attacks” (Jan. 19, 2017); and “Essential Tools for Fund Managers to Combat Escalating Cyber Threats” (Feb. 4, 2016).

Strategies and Tactics for Developing an Effective Tabletop Exercise (Part One of Two)

An incident response plan is a critical component of a cybersecurity program. A tabletop exercise can be used to test whether a response plan functions as desired and to identify gaps and other weaknesses in a firm’s cyber preparedness. Those topics were covered in a seminar co-hosted by the Private Equity Law Report’s sister services – the Hedge Fund Law Report and the Cybersecurity Law Report – which delved into the appropriate development and conduct of tabletop exercises. The panel featured Luke Dembosky, partner at Debevoise & Plimpton and former DOJ prosecutor; John “Four” Flynn, chief information security officer of Uber; and Jill Abitbol, Senior Editor of the Cybersecurity Law Report. This first article in a two-part series addresses how fund managers can effectively develop tabletop exercises, including whether they should be conducted in-house or externally; who should participate; what role counsel should play; and how frequent and long they should be. The second article will outline ways advisers can successfully conduct tabletop exercises, including their content and scope; participant engagement; common errors; and follow-up efforts. See “How Fund Managers Can Prepare for the Latest SEC Cyber Sweeps” (Jul. 16, 2019).

WilmerHale Adds Private Funds Team to Boston Office

Private fund lawyers Steven Giordano and Omar Hemady have joined WilmerHale’s investment management practice and securities department as partners in the firm’s Boston office. Giordano and Hemady focus their practices on fund formation across the liquidity spectrum, including hedge, credit, PE, venture, hybrid, crossover and real estate funds, as well as permanent capital vehicles, bespoke vehicles, funds of funds and funds of one. They serve as counsel to fund sponsors on the full range of strategic matters, including corporate governance, compensation planning and buyout arrangements, as well as transactional matters, such as seed capital and revenue sharing arrangements; minority and majority asset acquisitions; and strategic equity investments. For additional commentary from Giordano, see “How Emerging Fund Managers Can Raise Capital in a Challenging Market Without Overstepping Legal Bounds” (Aug. 4, 2016).