Recent enforcement actions highlight the increased regulatory scrutiny that private funds may face with respect to internal cybersecurity protocols and responses to cyber-crimes and cyber incidents under new and updated cybersecurity laws.
Regulators’ Increased Focus on GP-Led Secondaries and Continuation Funds
As IPOs and other traditional paths to liquidity for private assets have become more challenging, GP-led secondary transactions have emerged as a powerful and popular tool across closed-end private funds, leading to explosive growth over the last five years. And while macro factors influence their prevalence year over year, these transactions remain broadly popular across the various stakeholders in these transactions, facilitating different goals for different parties:
- Existing Investors (LPs): Near-term liquidity in a liquidity-constrained market, typically with an option to continue participation if desired
- New Investors (Buyers): Access to a mature portfolio with unrealized upside
- Fund Adviser (GP): Extended duration to capture future upside of well-performing assets, additional capital to support existing portfolio, and reset economics aligning with longer-term outlook
Energy Transition: A New Risk Climate for Investors
Go to any private equity event in the last 12 months, and “energy transition” will have been discussed, meaning the shift in energy production away from fossil‑based systems to low or zero carbon ones. As fund managers continue to raise funds focused on investments in this sector, we see no reason for this trend to change in 2023.
The ever-increasing web of ESG regulation is of course highly relevant for such funds and their investments, but the sector-relevant risks are much wider. There are four risks of which fund managers need to be aware.
Ripples Following the SPAC Wave: Litigation and Regulatory Risks
It’s a pattern we often see in boom-and-bust cycles—disputes rising in the period after a wave crests. SPAC deal volume hit an unprecedented high in 2021, but then slowed down in 2022 alongside IPOs. However, the fallout from the SPAC wave will continue to unfold this year, generating increased regulatory attention and a growing number of disputes.
Messaging Missteps: SEC’s Increasing Focus on Off-Channel Communications
The SEC’s Enforcement Division is conducting a sweep investigation of large investment advisers regarding their employees’ use of “off-channel” communications. The sweep, which has been widely reported in the press, focuses on text messages from personal phones, personal email, WhatsApp and other platforms not typically captured or monitored by advisers. The sweep is causing considerable industry concern, following the SEC’s announcement of settlements against a number of large broker-dealers for use of off-channel communications, that resulted in $1.235 billion of cumulative penalties.
SEC Overreach: Insurers Underwrite?
Implications of SEC attempt to curb indemnification for private fund managers
The SEC spent 2022 making multiple and sweeping proposals to amend rules under the Advisers Act, many of which have the ability to significantly re-shape market standards for private funds. Here, we focus on the SEC’s proposal to undo a common protection for private fund advisers – the ability to rely, as against the private fund or its investors, on exculpatory and indemnification provisions for a breach of fiduciary duty, willful misfeasance, recklessness, or simple negligence in providing services to the private fund. This prohibition would relate not just to liability under the Advisers Act, but to all causes of action.
The New Reality: Valuation in a Volatile Market
Amid rising interest rates, tightening credit markets, geopolitical concerns in Europe and Asia, stubborn inflation and continuing supply chain issues, there is a growing sense of economic uncertainty. This uncertainty will no doubt increase the frequency of valuation disputes in the year ahead. We generally see valuation disputes spring from four primary sources:
- breach of representations and warranties in purchase agreements, which raise questions as to company value absent the breach;
- unfair prejudice to minority investors or limited partners;
- disagreements about price paid at exit, including earn out disputes; and
- increased regulatory focus on exams, which may assess valuation policies and require recurring asset valuations.
Valuation disputes tend to be centered on disagreements about accounting practices, dates of assessed value, and valuation methodology.
The SBF Superseder: A Second Bite at the Scienter Apple
Following the collapse of FTX and the civil and criminal enforcement actions arising from FTX’s and its founder’s alleged misconduct, partners Bill Komaroff and Seetha Ramachandran offer their reactions to the superseding indictment of Sam Bankman-Fried (SBF) obtained on March 27, 2023 by the U.S. Attorney’s Office for the Southern District of New York (SDNY).
Read the full article on NYU’s Compliance and Enforcement blog.
In Continuation of Longstanding Focus on Cybersecurity, SEC Proposes Significant Amendments to Regulation S-P
On March 15, 2023 the U.S. Securities and Exchange Commission (“SEC”) released its proposal to amend Regulation S-P: Privacy of Consumer Financial Information and Safeguarding Customer Information, while simultaneously issuing two additional cybersecurity-related rule proposals and re-opening the comment period for its previously-proposed cybersecurity risk management rule released in February 2022. This set of sweeping reforms makes it clear, if not already, that the SEC is serious about implementing comprehensive cybersecurity and privacy standards across its regulated entity population—including investment advisers.
Crypto Contagion – Managing Risk on Multiple Fronts
Crypto firm bankruptcies and resulting disruption in the crypto ecosystem will continue to exacerbate liquidity and regulatory concerns in this space. Signs of contagion are evident as prices of almost every cryptocurrency type have halved in recent months. Since all participants supporting the crypto ecosystem are at risk, managing that risk is critical.