To understand the litigation and regulatory risks that are coming in 2024 for private capital, it is helpful to look back briefly on recent events. Arguably, the single most important event over the last 18 months was the rapid increase in interest rates by the central banks in the United States, England, and Europe. From March 2022 to August 2023, the Federal Reserve increased interest rates at the fastest clip in more than 40 years, to break inflation that had reached the highest levels since the 1970s.
William Komaroff
Bill Komaroff is a partner in the Litigation Department and White Collar Practice Group. He has a nationwide federal practice focused on corporate defense and investigations, counseling and defending institutional and individual clients in connection with a broad array of complex government investigations, prosecutions and civil disputes.
Bill also has served as a member of the Criminal Justice Act Panel for the District Court for the Southern District of New York.
From 2003 to 2007, Bill served as an Assistant U.S. Attorney for the Southern District of New York and prosecuted tax fraud, money laundering, bank fraud, mail fraud and wire fraud cases, among others. He tried numerous cases to successful jury verdicts and argued cases before the Second Circuit Court of Appeals.
Complying with the New SEC Marketing Rule: Seven Months in and Still Adapting
On November 4, 2022, compliance with amended Rule 206(4)-1 (the “Marketing Rule”) became mandatory for all investment advisers registered with the Securities and Exchange Commission (the “SEC”).[1] Seven months since the compliance date, SEC-registered investment advisers continue to discover and adapt to challenges in applying the Marketing Rule. Newly formed advisers also face significant obstacles to marketing with a predecessor-firm track record. It has also impacted advisers’ interaction with placement agents and solicitors. And finally, the SEC has begun assessing advisers’ adherence to the rule through routine compliance examinations. All parties involved continue to adapt to the new environment.
The Trend Continues: Increased Regulatory Focus on Privacy & Cybersecurity for Private Funds
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…