Washington’s increased focus on private funds may send fund managers scurrying to their lawyers for advice on how best to adapt to new rules and regulations, but managers should remember that not all their attorney-client communications may stay secret, experts say.
“When you’ve got more disclosure, more regulation, you’re going to have more interaction between funds and their counsel,” says David Rose, a partner with Pryor Cashman. “That could open things up down the road for a disgruntled LP to say, ‘Hey, what were you talking about?’”
The notion of attorney-client privilege predates the Roman empire. American courts generally agree that lawyers’ advice should be between the lawyers and their clients. There are exceptions, though. A notorious one is the so-called “crime-fraud” exception, where a client doesn’t have a right to assert privilege if the legal advice they’re getting helps them perpetrate fraud.
Another exception is the fiduciary exception, where courts reason that because a fund manager is getting legal advice in his or her capacity as fiduciary to the funds, the advice is ultimately being provided to the fund’s investors. That’s one way that plaintiffs can get access to otherwise privileged records, Rose says.
“As a fiduciary, when I’m seeking advice of counsel regarding fund operations, I’m not doing it for my own sake. I’m doing it on behalf of those people who are investing in the fund,” he says. “Those beneficiaries have every right to know what that lawyer said and how it impacts my fiduciary duty.”
‘Treasure troves’ of information
It can become a kind of negative feedback loop, Rose and others say. Consider antitrust law. In the past few years, the Federal Trade Commission and the Department of Justice have each ratcheted up their scrutiny of mergers and acquisitions. Officials in both agencies have made clear they see private equity “roll-ups”—especially in the health care industry—as a problem to be addressed.
Suppose a fund manager is thinking about buying up some elder care clinics. The manager asks the fund’s lawyers for advice on getting the merger through Washington’s now-more-arduous review process. If regulators later block the merger, and the fund must abandon the deal, it’s at least thinkable that an LP would sue for breach of fiduciary duty and ask to see the e-mails between the fund and the fund’s counsel about the aborted healthcare deal.
“The possibility of enhanced communication among counsel and fund principals to account for compliance is going to provide fertile ground for this exemption,” Rose says. “There will be treasure troves of information, where somebody got advice from counsel to go left, and they went right. Somebody’s going to say, ‘Hey, I want to know what you did and whether you acted consistently with that advice.’ Now you’re getting sued for ignoring advice of counsel.”
Adam Diederich is a veteran litigator with ArentFox Schiff. He says the fiduciary exception is a potential risk, but it’s still difficult for investors to obtain attorney-client communications. In his experience, it’s not just litigious investors a manager needs to worry about—it’s their partners in the fund. In many states—Delaware among them—top executives are generally allowed access to their partners’ communications with company attorneys as a matter of corporate law, he says.
“If the two LLC managers are e-mailing the company’s lawyer about kicking out the third director—whether it’s right or wrong—generally speaking, the third director can probably get access to those records,” he says. “The lawyer is a lawyer for the company, and a director or LLC manager embodies that company.”
The SEC is “clearly getting annoyed” with the way some funds assert their attorney-client privilege, Diederich says.
On page 303 of the Commission’s new private funds rules, passed by a 3-2 vote on August 23, regulators say they’ve “observed improper claims of the attorney-client privilege, the work-product doctrine, or other similar protections over required records, including any records documenting the annual review under the compliance rule, based on reliance on attorneys working for the adviser in-house or the engagement of law firms and other service providers (eg, compliance consultants) through law firms.
Attempts to improperly shield from, or unnecessarily delay production of any non-privileged record is inconsistent with prompt production obligations and undermines Commission staff’s ability to conduct examinations. Prompt access to all records is critical for protecting investors and to an effective and efficient examination program.”
Whatever the legal risk involved in having your attorney-client chats made public, there are certainly reputational risks, Pryor Cashman’s Rose says.
“There are all kinds of things that could damage your reputation,” he says. “You could come off looking foolish, you could come off looking cavalier. It’s that moment where someone says to themselves, ‘I get it, I don’t have a breach-of-fiduciary duty claim, but I’m seeing a lot in these e-mails. If they’re this unprofessional with counsel, inside or outside, how professional are they when it comes to the management of my money?’”
These risks aren’t just hypothetical. In 2012, after shareholders in several portfolio companies sued 11 private equity firms, accusing them of helping each other keep deal prices low, executives at KKR and Blackstone handed over dozens of emails under confidential seal. A judge ordered them unsealed after a motion from the New York Times. The Times wrote the emails up as proof industry players were too cozy with one another. The firms settled the litigation two years later.
So how can firms get the advice they need and not risk having their own lawyers become witnesses against them? Experts offer a few tips:
- Remember who the client is. “Many company executives mistakenly act as if the company’s lawyer is their own lawyer,” ArentFox’s Diederich says. “In most situations, the company’s lawyer is not the executive’s lawyer, and this is often stated in the engagement letter between the company and the law firm. The client controls the attorney-client privilege.”
- Be “thoughtful” about what you put in writing, and when, Rose says. “Be deliberate about how you talk to counsel,” he says. “In this industry, particular, yes, there can be a sense of clubbiness. Yes, relationships matter. But this is a serious business. You’re dealing with massive sums of money, and in the case of pensions, you’re talking about people who’ve worked hard to earn that money. Your communications with your counsel, when it relates to legal advice, should be the paramount of professionalism.”
- Be clear about the “hats” you’re wearing. There can be conflicts between being a compliance officer and a fund general counsel, for instance, (so many that some experts believe the multi-hatted CCO is an endangered species). When talking with firm lawyers, consider labeling the role in which you’re acting in the subject heading and opening line, Rose says. “In my capacity as CCO/CFO…” e-mails might begin, making clear when you’re seeking advice acting as a fiduciary and when you’re seeking advice for yourself.
- “Silo” the counsel. If you’re worried about another firm partner or member, consider forming a special committee, and then hiring a separate attorney to advise that special committee, Diederich says.
- Use your own lawyers. If you’re worried about preserving your attorney-client privilege, hire one for yourself, Diederich says.