Operating Partners

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On June 23rd, the staff of the U.S. Securities and Exchange Commission’s Office of Compliance Inspections and Examinations issued a new risk alert entitled “Observations from Examinations of Investment Advisers Managing Private Funds.” As discussed in the client alert below, the report highlights many practices which have been the subject…

The SEC has been active in the private equity space recently after being relatively quiet for some time. A recent enforcement action serves as a reminder for fund sponsors that regulators are continuing to look at fund sponsors’ practices relating to “operating partners,” particularly in the context of disclosures to limited partners.

A recent case in a North Dakota district court is a reminder to private equity funds and managers that, under certain conditions, they may be held responsible for actions of a fund’s portfolio companies.  Courts allow plaintiffs to pierce the corporate veil as a check against improper abuse of the corporate form.  When one corporate entity is under such extensive control by another that the first is merely an alter ego of the second, a court may permit a plaintiff to reach through the corporate structure to gain recovery.  This is particularly true if the first entity is undercapitalized.  Through this mechanism, limited liability does not mean immunity from liability, and under certain circumstances a plaintiff can hold the ultimate shareholders or owners liable for company obligations.

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.

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.

Partners Timothy W. Mungovan (co-head of Private Equity & Hedge Fund Litigation Group) and Christopher M. Wells (head of Hedge Funds Group)  have been invited to join a large collection of senior regulators at the Regulatory Compliance Association’s Enforcement, Compliance & Operations (ECO) 2016 Symposium.  The conference will take place on Tuesday May 17 at the Mandarin Oriental Hotel in New York City.

Tim will be chairing the session entitled: “Enforcement 2016 – New Priorities, Initiatives and Latest Developments.”

Chris will be chairing the panel entitled: “SEC Exam and NFA Audit Practice: 2016 Areas of Focus with Case Studies.”

SECAndrew J. Bowden, the Director of the SEC’s Office of Compliance Inspections and Examinations, gave a speech entitled “Spreading Sunshine in Private Equity” in May 2014. While sounding cheery, the “spreading sunshine” metaphor was an ironic evocation of Justice Brandeis’s famous statement that “sunlight is said to be the best of disinfectants” in response to social and industrial diseases.