Lawyer liabilities

In order to thrive, the private funds industry needs strong support services – and arguably, none are as important as good legal advice. Virtually every step a private fund manager takes is swiftly followed by an attorney guiding their direction. Raising a fund? You need a fund formation lawyer. Striking a deal in a new market? Call in some M&A experts. And then of course there is guidance on compliance matters, arguably the legal sector’s growth market over the past few years. Naturally then GPs and their attorneys have formed very close bonds.

 

The issue is to what extent a lawyer becomes responsible for a firm experiencing a compliance failure. Historically GPs have taken the bulk of the liability; they’re the ones who execute (or fail to execute) a decision, after all. But the US Securities and Exchange Commission (SEC) is beginning to see things a bit differently, wondering out loud if general counsel or outside lawyers should take on more of the responsibility if their opinion was the underlying cause of a compliance breach. SEC commissioner Kara Stein even went as far as to recently say that lawyers may become targets of enforcement actions when a fund manager has been poorly advised. Stein said she was “troubled greatly” by cases where lawyers gave bad advice that was relied upon by managers yet were not held accountable. 

 

The SEC clampdown should not only serve as a warning to law firms, but also to fund managers who are digesting reams of legal advice via email news alerts, blogs and client memos. Jay Bould, partner in law firm Pillsbury’s investment funds and investment management team, warns against “forum shopping”, arguing that you can always find a lawyer somewhere that is “complacent, desperate, or unethical enough to tell a fund manager what they want to hear.”

 

Moreover fund managers need to be aware of the levels of due diligence sophisticated investors are now putting in on the matter. Bould says LPs want to understand that a fund manager has appointed good service providers and has not opted for a “low-end option that the fund manager can dominate and control”. Particularly for first time fund managers, the choice of a lawyer that is unknown or not respected can kill the offering before it ever gets started.

 

Predictably, the trend may force lawyers to be more cautious when issuing their legal opinions. For GPs this may mean more time digesting qualified answers when straightforward response are preferred; but ultimately more cautious advice can keep them safe from the growing  threat of litigation (see “Seeking protection” a more in-depth look on this very point).

 

To be sure, fund managers and industry lawyers will always have a symbiotic and close relationship. But in the time ahead, lawyers may begin thinking more about regulators becoming a third wheel.