Danger up ahead

With heavy rulemaking and implementation of the Alternative Investment Fund Managers Directive (AIFMD) now completed, regulators finally have the capacity to begin reviewing non-EU managers’ ability to reach EU investors under a hazy concept known as “reverse solicitation.”

Or at least that’s what private equity lawyers are beginning to warn their clients about, pfm has learned.

The Financial Conduct Authority (FCA) is declining comment, but a source close to the UK regulator told pfm that reverse solicitation is on the agency’s radar. However, the source stressed that the FCA hasn’t discovered anything that would give them “cause for concern” – the subtext being that reverse solicitation is not a new priority for the agency.

He added: “Third-country [managers] are entitled to structure themselves in a way that takes advantage of that. That is not necessarily a nefarious thing to do.”

To date, there has been no enforcement action on reverse solicitation. Observers peg this to regulators wanting market participants to develop their own best practices before cracking down on abuse. Others cite time constraints.

“It’s a resourcing problem for regulators. Leaving aside the whole LIBOR scandal taking up their time last year, they suddenly had this brand new population of EU managers seeking AIFMD licenses,” says one UK-based private equity lawyer.

But with licenses now issued, the FCA and other regulators have more time to focus on marketing, multiple industry lawyers speaking on the condition of anonymity (citing the sensitivity of the issue) told pfm. One London-based lawyer in particular supported his comments by noting that some of his LP clients have been contacted by unnamed EU regulators curious to know about how his clients demonstrated that a reverse solicitation took place.

The probing of regulators “raises the temperature for managers around how comfortable they can be in certain scenarios, which historically they would have treated as reverse enquiry,” the lawyer said.

Guidance, please

Industry lawyers also point to a few emerging trends they fear will force regulators’ hands. First and foremost is the range of interpretations being provided to managers about what constitutes an acceptable reverse solicitation – which, put simply, is the idea that a proactive European LP can invest in a non-authorized manager provided they reach out about a fund opportunity first.

Nearly all EU member states have neglected to produce any clear guidance on what constitutes reverse solicitation, and just as importantly, what does not. Most sovereigns allow some level of premarketing; for instance, a flipbook or a few one-on-one meetings with investors, but not much beyond that.

For example, the FCA says it will acknowledge reverse solicitation when there is written confirmation from an investor that it approached the GP in a document separate from the subscription agreement. But lawyers have their reservations.

“When trying to document reverse solicitation, nothing is going to be less credible in the eyes of a regulator, or heaven forbid a court, than the same template email or same template note on every file, that just looks like a marketing campaign,” a second London-based industry lawyer recently told pfm.

Safety in numbers

A related risk is EU regulators clamping down on GPs who reach too far as an indirect way of issuing guidance. Fund managers approved under the new AIFMD regime will be put on a list showing who has an EU-wide marketing passport, which some speculate will be used by EU regulators as a way of targeting non-AIFMD authorized managers for further scrutiny.

Amid the uncertainty, fund managers, placement agents and investors have been arranging conference calls and meetings with concerns about what a true reverse enquiry is.

Prompting the meetups is a drop in the number of funds pitched to EU investors. A significant 86 percent of LPs polled by the Institutional Limited Partners Association this year said they’re receiving fewer marketing pitches from non-EU managers because of the directive.

Consequently, European LPs wanting access to non-EU funds, especially in the US, are “getting more proactive” about reaching out, a third London lawyer said, adding there’s been “some pressure on LPs to justify why they would invest in a non-compliant fund.”

In Denmark, some LPs have banded together to create a website that managers can subscribe to as a way of receiving reverse enquiries. “There’s a question if this will ultimately be allowed, but some major EU pension plans have been writing to US managers or using other means to say ‘AIFMD is not as bad as you think, come talk to us,’” the third lawyer said. 

Playing it safe

Conscious of the risks involved, private equity managers are not sitting idly by as they wait for regulators to potentially act. Many GPs relying on reverse solicitation are writing new representations into their fund documents, according to legal sources.

“A typical sentence may say something along the lines of ‘This fund has not been marketed to me [the investor],’” according to the second UK lawyer. Another representation pursued says something to the effect of: “By signing up to Fund X we automatically solicit you to tell us about every single future fund you might ever raise,” the lawyer said.

Particularly bold GPs are also considering inserting clauses that say LPs cannot claim against a GP for incorrect marketing practices, note legal sources. These types of provisions are being used to eliminate the risk of an investor bringing a claim against a GP for not performing reverse solicitation correctly, though advisors stress that a GP would still be at risk from regulators for breach of securities laws.

Lawyers warn that GPs often make reps and warranties to LPs that they will be in compliance with securities regulations, and so, given the uncertainty surrounding what constitutes reverse solicitation, they could potentially breach these reps and warranties

The question now is: Will regulators make it a priority? If lawyer intuition is anything to go by, GPs should assume yes.

 

Mixed opinion 

Not all industry lawyers speaking to pfm agree that reverse solicitation will be a priority area for EU regulators in the time ahead.

Some question the FCA providing much attention to an area of the market strictly limited to sophisticated, institutional investors.

“The FCA’s number one priority has always been retail investors, which private equity is restricted from reaching,” says one London-based financial services lawyer.

That may change in the near-term. European policymakers have approved a new fund vehicle that provides AIFMD-authorized fund managers access to both professional and retail investors so long as a few additional safeguards and transparency measures are followed. The so-called “European Long-Term Investment Fund,” which will be made available later this year, may heighten regulators’ interest in reverse solicitations, considering they could now be made by retail investors.