Nov. 1, 2018
Nov. 1, 2018
Primer on Deal-by-Deal Funds: Key Fundraising and Structural Considerations When Establishing a Fund (Part Two of Three)
To properly consider whether to adopt the deal-by-deal fund model, private equity sponsors must understand the pros and cons of operating the vehicle on an ongoing basis. While certain sponsors may be attracted to the streamlined structure of a deal-by-deal fund – i.e., a limited partnership set up as a single-asset fund with simple mechanics – others may be deterred by the continuous fundraising process, its impact on the scope of available investment opportunities and the activist role of investors. See “Anatomy of a Private Equity Fund Startup” (Jun. 22, 2017). This three-part series aims to familiarize fund managers with the deal-by-deal fund model by analyzing various issues to consider when evaluating the viability of the structure. This second article describes unique characteristics of the fundraising process and the general process of establishing a deal-by-deal fund, including specific rights bestowed upon investors in the fund documents. The first article outlined the basic characteristics of deal-by-deal funds and analyzed investor perceptions of the vehicle. The third article will explore the economics of a deal-by-deal fund, including unique treatment of carried interest and broken deal fees, as well as several approaches to overcoming the issue of deal uncertainty. For more on the co-investment structure, which has similar features to deal-by-deal funds, see “Sadis & Goldberg Seminar Highlights the Ample Fundraising and Co-Investment Opportunities in the Private Equity Industry, Along With Attendant Deal Flow and Fee Structure Issues” (Dec. 8, 2016).
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New Foley Hoag Partner Discusses Trends in the Use of Capital Call Facilities Across the Private Funds Industry
Thomas Draper has joined the Boston office of Foley Hoag as co-chair of its debt finance practice. Draper has considerable experience representing companies and private equity sponsors in a range of acquisition financing transactions utilizing asset-based credit facilities, syndicated term loans and high-yield bond offerings. He has also worked on dozens of capital call facilities, as well as portfolio leverage and liquidity financings, for private and registered funds. In connection with his move to Foley Hoag, the Hedge Fund Law Report recently interviewed Draper about trends in private fund financing facilities. This article summarizes his thoughts on the development and use of capital call facilities; SEC scrutiny of these facilities; the impact of the Institutional Limited Partners Association guidance on subscription credit facilities; and overall trends in financing facilities for private funds. For additional commentary from Foley Hoag partners, see “HFA Symposium Offers Perspectives From Cybersecurity Industry Professionals on Preparedness, Vendor Management, Cyber Insurance and Cloud Services” (Jul. 7, 2016). To further explore the topic of capital call facilities, on Thursday, November 15, 2018, at 11:00 a.m. EST, the Hedge Fund Law Report will host a complimentary webinar discussing key considerations and prevailing trends in the use of subscription credit facilities by private fund managers. The webinar, entitled “Pros, Cons and Trends in the Use of Subscription Credit Facilities,” will be moderated by Rorie Norton of the Hedge Fund Law Report and will feature Draper, along with Cadwalader partner Michael Mascia. To register for the webinar, click here.
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SEC Order Reminds Advisers to Adhere to Stated Redemption Procedures
A recent SEC settlement order against a fund manager illustrates that advisers that stray from their disclosed redemption practices may be subject to regulatory scrutiny. Although the governing documents of one of the manager’s funds required 90 days’ notice for redemptions, the adviser had an unpublicized policy allowing investors to make partial redemptions on shorter notice and inadvertently permitted several full redemptions on 60 days’ notice. As a result, the SEC claimed that the manager had engaged in fraudulent conduct and lacked appropriate compliance policies and procedures. The manager also ran afoul of the custody rule and SEC filing requirements while winding down its funds. This article details the alleged violations and the terms of the SEC’s order. See “Can a Hedge Fund Retroactively Amend Its Partnership Agreement to ‘Rescind’ an Investor’s Redemption Request?” (May 8, 2014).
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How Constrained Decision Making, Along With Legal and Compliance Leadership, Can Help Reduce Fund Manager Bias (Part Four of Four)
Despite questions about the efficacy of implicit bias interventions, fund managers and individuals have autonomy to address these unconscious stereotypes. Notably, managers should create processes that constrain decision making – such as establishing staff performance criteria prior to conducting employee evaluations – thereby preventing individuals from acting on biases in the first place. Legal and compliance leaders can also play important roles in shaping the cultures of their organizations by educating employees, conducting organizational audits and promoting buy-in for practical policies. This final article in a four-part series evaluates methods for constraining decision making and reviews the role that legal and compliance leaders can take to promote diversity and reduce implicit biases. The first article discussed the lack of diversity within the financial services and alternative investment management industries and why fund managers should focus on diversity. The second article analyzed diversity training; performance ratings and hiring tests; grievance procedures; and specific actions managers can take to promote diversity and inclusion. The third article explored implicit biases, their harms and whether they can be reduced in both the short and long term. See “Four Steps NYC-Based Fund Managers Should Take in Light of Newly Enacted Law Prohibiting Compensation History Queries When Interviewing Prospective Employees” (May 11, 2017).
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Misrepresentations About Dark Pool Participants and Order Routing Cost Citi Entities Nearly $13 Million in Recent SEC Settlement
In another illustration of why fund managers must conduct careful due diligence of their counterparties, the SEC recently settled charges against two Citi-affiliated entities. The SEC alleged that one entity falsely claimed that the dark pool it marketed did not admit high-frequency traders and hid from customers that about half of all executions through the dark pool were routed to external venues. In addition, the other entity, which operated the pool, allegedly functioned as an unregistered exchange. This article details the respondents’ alleged misconduct and the terms of the SEC’s order. For another SEC action against a Citi affiliate, see “Failure by Investment Advisers to Ensure Accurate Client Billing May Lead to SEC Enforcement Action and Penalties” (Feb. 2, 2017).
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Advisers Must Ensure Auditor Independence to Satisfy Custody Rule
The SEC has again taken action against an audit firm that allegedly caused investment advisers’ violations of Rule 206(4)-2 under the Investment Advisers Act of 1940, the so-called “custody rule.” A recent settlement order with an audit firm asserts that the firm’s audits of certain private funds failed to satisfy the custody rule because the firm was not “independent” within the meaning of certain rules under Regulation S‑X. The audit firm also allegedly caused some broker-dealers that it audited to run afoul of other applicable SEC rules for the same reason. This action is an important reminder that investment advisers must ensure that their auditors confirm that they are eligible to conduct custody rule audits. This article examines the SEC’s allegations and the terms of the settlement. See “The Importance of Exercising Due Diligence When Hiring Auditors and Other Vendors” (Jun. 21, 2018); and our two-part series “Avoiding Common Pitfalls Under the Custody Rule”: Inadvertent Custody, Delivery Failures and GAAP Compliance (Mar. 23, 2017); and Custody Determination, Auditor Independence and Liquidation Audits (Apr. 6, 2017).
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Upcoming HFLR Webinar to Explore Recent Trends in SEC Examinations of Private Fund Managers
Please join the Hedge Fund Law Report on Thursday, November 8, 2018, at 11:00 a.m. EST for a complimentary webinar discussing how examiners from the SEC’s Office of Compliance Inspections and Examinations (OCIE) are currently approaching examinations of private fund managers, as well as OCIE’s key areas of focus during these exams. The webinar, entitled “Recent Trends in SEC Examinations of Private Fund Managers,” will be moderated by Kara Bingham, Senior Editor of the Hedge Fund Law Report, and will feature Andrew M. Calamari, partner at Finn Dixon & Herling and former Director of the SEC’s New York Regional Office; Patricia A. Poglinco, partner at Seward & Kissel; and Joel A. Wattenbarger, partner at Ropes & Gray. To register for the webinar, click here.
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Longtime GC/CCO Joseph H. Nesler Joins Winston & Strawn in Chicago
Winston & Strawn LLP recently expanded its Chicago office with the addition of Joseph H. Nesler as counsel in its corporate and finance group. With more than 35 years of experience as an investment management lawyer, Nesler has handled a wide range of legal and regulatory matters, including SEC, DOL, FINRA and NFA regulations and examinations. For insight from another Winston & Strawn attorney, see the first two parts of our three-part series on how fund managers can mitigate prime broker risk: “Preliminary Considerations When Selecting Firms and Brokerage Arrangements” (Dec. 1, 2016); and “Structural Considerations of Multi-Prime or Split Custodian-Broker Arrangements” (Dec. 8, 2016).
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