The Capital Commitment

Proskauer on Private Equity Litigation

Pay-to-Play – SEC Expands Scope of Rule to CABs

The SEC’s pay-to-play rule has given advisers reason to worry about potential foot faults since its adoption. As we have noted in prior posts, the rule is filled with landmines and is therefore difficult to navigate.  As was evident from the SEC’s announcement of a series of settlements of alleged pay-to-play violations in early 2017, even a small contribution without any intent to influence an election or an official can run afoul of the rule and put two years of fees and carry at risk.

Last week, the SEC issued an order that will expand the scope of the pay-to-play rule.  The SEC approved a FINRA proposal to extend the self-regulatory organization’s Rules 2030 and 4580 (its pay-to-play and associated recordkeeping rules) to a recently established category of FINRA-registered firms known as capital acquisition brokers, or CABs.

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Veil-Piercing Under California Law – Heightened Risks for Fund Managers

We recently posted about the risks associated with veil-piercing claims and the ways in which fund managers can protect themselves from exposure to these claims. Our first post on veil-piercing focused on Delaware standards, while this post discusses California law.

California law differs in several important respects from Delaware law on this topic. If a company is subject to suit in California, there are increased risks even if the company is incorporated elsewhere.  Courts may assert that California law should apply when the plaintiff is a California resident or when the company operates in California.

And where California law applies, courts may aggressively set aside corporate distinctions, leading to unanticipated results. Continue Reading

SEC Flags the Top Six Advertising Rule Deficiencies for Investment Advisers

The SEC staff recently published an alert highlighting the most common deficiencies seen in investment advisers’ marketing materials.  Based on its recent examinations and initiatives, the Office of Compliance Inspections and Examinations (OCIE) issued its risk alert to highlight compliance issues relating to Rule 206(4)-1 (the “Advertising Rule”).  Here are the top six:

  1. Misleading Performance Results.
  2. Misleading One-on-One Presentations.
  3. Misleading Claim of Compliance with Voluntary Performance Standards.
  4. Cherry-Picked Profitable Stock Selections.
  5. Misleading Selection of Investment Recommendations.
  6. Lack of Adequate Compliance Policies and Procedures.

Earlier this year, we wrote that performance marketing was one of the top 10 regulatory risks for private funds.  And after an OCIE risk alert, we often expect to see an uptick in related enforcement activity.  At minimum, OCIE is putting the industry on notice that it will scrutinize managers’ advertising and marketing materials.

For additional guidance, please read our full client alert on this topic.

Veil Piercing/Alter Ego Determinations – How Fund Managers Can Protect Themselves

A veil piercing claim can be a worst-case scenario for a private fund manager dealing with a struggling portfolio company investment – the company fails, and ensuing legal claims are brought not only against the portfolio company, but also against the fund and its GPs. How can fund managers manage that risk?

Limited liability is a hallmark of the corporate structure. Yet the legal doctrines of veil piercing and alter ego permit courts to “pierce” or bypass the corporate structure in order to hold shareholders and directors personally liable for a corporation’s actions or debts.  These doctrines have important implications in the context of a fund that owns large stakes in portfolio companies. Continue Reading

Snap Judgment: Unicorns Under Pressure and Addressing Risks of Private Lawsuits

The recent IPOs of Snap, Inc. and Blue Apron indicate that while the IPO pipeline continues to flow, there may be a cautionary tale for “unicorns” – venture-backed companies with estimated valuations in excess of $1 billion.

After Snap went public in March, it posted a $2.2 billion loss in its first quarter, yielding a 20% same-day drop in stock price that erased much of the company’s gains since its IPO. A snapshot of Snap’s stock price shows the obvious risks faced by late-stage investors in unicorns.  High valuations are not a guarantee of continued success, particularly where historical performance and profitability are lacking.  Although one commentator recently asked: “Are Blue Apron and Snap the worst IPOs ever?”, there is plenty of time for those stock prices to recover, especially in the months after their insider lockup periods expire.

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SEC Speaks on Initial Coin Offerings: Tokens May Be Securities

Initial Coin Offerings (“ICOs”) are generating attention from both investors and the SEC. Investors’ interest is indicated by the more than $1.2 billion that ICOs reportedly have raised so far this year.  Meanwhile, the SEC has recently asserted its authority in the space, releasing a report stating that digital tokens issued by ICO platformThe DAO qualify as securities under the Securities Act of 1933 and the Securities Exchange Act of 1934, as investment contracts under the Howey test.

While the SEC is not pursing an enforcement action in this instance, a private right of action under Section 12(a)(1) of the Securities Act could still arise. Going forward, organizations thinking about an ICO should consider, among other things, the following options to address this issue:

  • Craft the attributes of the ICO token so as not to implicate securities laws.
  • Conduct the offering outside of the United States (although applicable non-US securities laws would need to be considered in that case).
  • Structure the ICO as a private placement. Filecoin has raised $52 million in a pre-ICO sale aimed at accredited investors to be SEC compliant.
  • If none of the foregoing options are viable, pursue a securities offering registration with the SEC.

While this report may at first appear to create a chilling effect on ICOs, there are actually nuances which should be considered.

Read the full alert.

SEC Chairman Identifies Guiding Principles

On July 12, 2017, newly appointed SEC Chairman Jay Clayton delivered a speech at the non-partisan Economic Club of New York wherein he set forth several high-level guiding principles for the agency.  In general, these remarks focused on (i) ensuring protections for retail investors, (ii) positioning the SEC as a regulator which is able to evolve on pace with industry, and (iii) taking a more measured and effects-focused approach to rulemaking.   In addition, Chair Clayton stated that he opposed any wholesale changes to the SEC’s fundamental regulatory approach. 

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