MNPI: Ares settled with the SEC over the regulator’s charge that the firm failed to implement and enforce P&Ps “reasonably designed” to prevent the misuse of material nonpublic information (MNPI), writes our Regulatory Compliance Watch colleague Hugh Kennedy.
“Remarkably, according to the SEC’s order, it appears Ares did a lot right,” said Philip Moustakis, counsel at Seward & Kissel, on the settlement filing. Moustakis said the case highlights “the importance of advisors documenting thoroughly their compliance processes to ensure they get credit for the good work they have done.”
Guide to GP liquidity solutions: We present the final installment of the upcoming Proskauer guide to GP-led liquidity solutions: preferred equity. Click the following links for the guides to GP-led fund restructurings, tender offers and continuation vehicles and strip sales.
Solution: Preferred equity
A fund can obtain additional capital through a direct or indirect issuance of “preferred equity.”
Fund-level preferred equity is a new security issued, directly or indirectly, by a fund to investors (“Preferred Equity Investors”) that grants Preferred Equity Investors a priority right to distributions from the fund until the Preferred Equity Investors have received a certain return (often measured as a multiple on invested capital and/or internal rate of return). Upon reaching this benchmark, the Preferred Equity Investors have little or no future equity interest in the fund.
The capital received from Preferred Equity Investors can be used for specified, agreed purposes (eg, particular portfolio investments, providing liquidity to existing LPs) or general fund purposes.
Scenarios for use:
1) Preferred Equity arrangements may also be tailored to single portfolio companies rather than an entire fund portfolio, and could also be used in combination with one of the strategies above, with preferred equity issued by an SPV rather than the existing fund and the assets of the SPV consisting of only a subset of fund investments.
2) The fact that the preferred equity will generally have limited upside means that the fund can obtain a vital cash infusion while leaving existing LPs with continued upside. Existing LPs may also be given a right to participate in the preferred equity.
3) Governance rights and other terms can be negotiated on a flexible and bespoke basis.
4) Avoids valuation exercises with respect to particular portfolio companies (although new investors will still seek a credible valuation of the fund or relevant fund assets, as applicable).
1) Amendments to fund documentation will likely be required to permit issuance of preferred equity. These types of fund amendments typically require a higher level of LP consents (perhaps unanimous consent) compared to other amendments because the effect of admitting Preferred Equity Investors dilutes existing LPs with respect to certain distributions.
2) LPs will need to weigh the benefits of additional capital for the portfolio against the distribution priority that Preferred Equity Investors receive in deciding whether this type of structure is in their interests.
3) Preferred equity investments could have adverse tax consequences to the provider of new capital.
4) Borrowing can be a simpler and quicker way to generate fund-level liquidity relative to a preferred equity arrangement, however restrictions on indebtedness in fund documents must be considered as well as certain tax disadvantages for tax-exempt investors.
Email prepared by Graham Bippart