What the NYPPEX case could mean for private funds

Insights survey: Our 2020 Insights survey revealed an unexpected pattern. Even though demands on the back office are increasing rapidly, the rate of back office hiring appears to be slowing. Check out “The rise of outsourcing” here.

Waterfalls: Face your fears, say EWM Global’s Riyaz Gadiwalla, Rebecca Symonds and Scott Pearson in this sponsored article. They say automation of waterfalls can minimize mistakes, optimize carry and still leave GPs in control of the calculation itself.

Greenmailing: Why this is so interesting, I’ll recount below, but ‘greenmailing’ is not something you would associate with private funds. Yet, Laurence Allen – the head of NYPPEX who is accused of fraud by the New York attorney general – said in an email exchange with me that that is what has happened to him. Greenmailing is a corporate raider tactic, much-used in the 1980s, in which an investor forces a company to buy back shares at a premium or face the threat of a hostile takeover. The IRS penalizes profits made from, and some states bar companies from paying, such premiums. But it doesn’t really apply to private funds, for obvious reasons. Nonetheless, Allen says that’s what an LP in his ACP X fund essentially tried to do – force a buyback or make a complaint of mismanagement. That was in 2014.

But here’s the thing: the AG knows all of this. In fact, the threat made by the LP in 2014 is referenced in its lawsuit, and Allen says he did eventually buy that LP out (see my story).

There’s kind of a legal Rashomon effect going on here: It is part of the AG’s case that the LP successfully…er… greenmailed?…Allen and NYPPEX. Why it matters to them is that Allen had at least two other LPs seek to be redeemed in 2017, and he didn’t comply. The AG claims Allen would have had to in order to treat all LPs in the fund fairly. And, it appears, he also may have agreed with that at the time. In an email the AG says is from Allen, he wrote: “We cannot redeem your investment as per the terms of the operating agreement of ACP X. ACP X is a private equity partnership (and not a hedge fund some of which redeem investments). Otherwise, we would have to provide the same opportunity to all LPs.”

And Allen says even now that the AG seems to be confusing his fund with a hedge fund. From our email exchange: “Possibly, the NYAG is confusing ACP X, LP with a hedge fund, which does generally redeem interests because they hold public securities.”

On the other hand, Allen says, the decision to buy out an LP of their interests rests solely with the GP. And, yeah, that seems correct. From ACP X’s PPM:

“A Limited Partner may not solicit prospective buyers, including other Limited Partners; offer for sale, sell, assign or transfer all or any part of any interest in the Partnership except with the prior written consent of the General Partner, which consent may be granted or withheld by the General Partner in its sole discretion. A Limited Partner may not withdraw from the Partnership.”

Allen says he might have bought out the LPs in 2017, but that decision involves taking into consideration 1) the best interests of all LPs, 2) the best interests of the fund and 3) a consultation with the LP advisory committee and outside legal counsel, among others.

There is more to the AG’s claims against Allen of course, but this should prove to be an interesting part of the discovery process.

There is an irony to all of this: the focus is the right of an LP to transfer a stake in a private fund, which is a fundamental element of the secondaries market. NYPPEX is in the business of matching secondaries buyers with sellers and ACP X is … a secondaries fund. That said, Allen stated he generally allows secondary transfers of interests in his funds. It was requests to be bought out by NYPPEX that he refused in 2017.