In response to rising geopolitical tensions – from the Middle East to the Taiwan Strait to the ongoing conflict in Ukraine –the Biden Administration is increasingly using economic incentives and sanctions to assist the United States’ foreign policy objectives or mitigate the risk of increased conflict.
Hope for a resurgence during 2024 in Venture Capital fundraising, investment, and returns was strong at the beginning of this year, with optimism fueled by the recovery in 2023 of U.S. stock markets (lead by the performance of large tech companies) and anticipation about how AI might transform industries. Market observers were optimistic then that U.S. venture investment activity would pick up significantly from 2023 levels, which—based on PitchBook data—had reverted to the lower average level of investment seen during the period of 2018-2020 as compared to the robust levels of activity seen in 2021 and the first half of 2022. This hope was centered in large part on expectations about how the Federal Reserve would begin lowering interest rates.
Big fund-raising rounds and high valuations have some wondering whether the AI sector is in a bubble in the nature of the dotcom boom. As of this writing, OpenAI is valued at over $80 billion; Amazon added another $2.75 billion to its investment in Anthropic; and even some very early-stage startups, like France-based Mistral AI, have racked up hundreds of millions in venture-capital funding at valuations over a billion dollars. Alphabet CEO Sundar Pichar has said AI could be more profound than the invention of electricity or the discovery of fire. Is the hype real?
Adviser-led secondary transactions have seen explosive growth over the last five years. That growth has brought increased regulatory concerns over the conflicts of interests inherent in these transactions and a perceived lack of transparency into this market. New SEC rules adopted in 2023 will arm regulators with additional tools to identify, exam and investigate market practices. It is therefore critical for managers running an adviser-led secondary transaction to not only comply with the new rules as they become effective but to structure any such transaction with the SEC’s concerns in mind.
2023’s excitement for generative artificial intelligence (AI) prompted the SEC to respond on multiple fronts – stump speeches, rulemaking, new exam priorities and sweeps and previewing potential enforcement actions. SEC Chair Gary Gensler raised concerns regarding potential conflicts and investor harm resulting from the proliferation of AI and warned that an AI-caused financial crisis is nearly unavoidable absent regulation. The SEC adopted a number of initiatives in 2023 to respond to these perceived risks.
Economic headwinds and the interest rate environment that developed over the course of 2023 increased financial stress on portfolio companies and portend heightened litigation risk in 2024 for portfolio companies and their private fund sponsors. Specifically, interest rate increases that accelerated through 2022 continued in 2023, and compounded existing economic stressors including tight liquidity and inflation coming out of 2020 and 2021, as well as increased cost and other burdens related to ESG and regulatory compliance. These pressures put portfolio companies in often unsustainable financial positions, causing them to prematurely seek liquidity events, violate debt covenants with lenders, and resort to bankruptcy, all of which has led to an increase in disputes and litigation, which we expect to continue in 2024.
In a wave of SEC rulemaking this past year, representing a “new world order” event akin to Dodd-Frank, the SEC has provided itself with a fresh set of tools to increase regulatory and enforcement scrutiny on private funds. Among other things, certain of the rules could result in fundamental changes to market practices and greater disclosure to LPs. While ongoing litigation will determine the fates of the Private Fund Adviser Rules, the Short Sale Disclosure Rule, and the Securities Lending Rule, and while other rules are awaiting final adoption, the SEC concerns underlying the rulemaking will continue regardless.
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:
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.
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.