The US Securities and Exchange Commission (SEC) warned the industry it was closely watching end-of-life funds and studying how general partners were dealing with so-called zombie situations.
A number of funds raised in 2002 and 2003 are now past their extension periods and GPs may be tempted to turn to secondaries markets for GP-led restructurings or stapled secondary transactions, to return cash to their limited partners and to raise fresh capital. While there’s nothing inherently wrong with those transactions, they are rife with conflicts of interest which need to be effectively managed.
“We are coming out of a strong fundraising market and those that have not been able to raise capital in the current market might be tempted to resort to creative approaches in markets that are less favorable,” said Igor Rozenblit, co-head of the SEC’s private funds unit. “We are watching to make sure that those creative approaches don’t cross the line and violate federal securities laws.”
Conflicts of interest and feemismanagement can arise from certain transactions such as GPled fund restructurings and stapled secondaries. Zombie funds, which are past-term vehicles which are unlikely to raise additional capital and keep collecting fees are also on the SEC’s radar.
Fenway Partners, which settled with the SEC November for failing to disclose conflicts of interest like rerouting portfolio company fees to an affiliate, is a good illustration of how such conflicts of interest can arise. “I think the general takeaway from that case is that these kinds of things are actually not that uncommon when funds enter zombie mode, and this is what makes zombies particularly of interest to us,” said Rozenblit.
He added that in many cases, it will be up to investors to navigate some of these stressful end-of-life situations. “Investors shouldn’t be afraid to band together and fire their manager if their assets aren’t being managed appropriately and they shouldn’t be afraid to report fraud to the SEC if it occurs,” Rozenblit said.
The SEC also reassured the audience its mission was not to go after CCOs. It had charged CCOs in a couple of cases last year, prompting a heated debate regarding CCO liability, but according to Jennifer Duggins, new co-head of the private funds, the SEC doesn’t typically like charging CCOs as a rule, but there are some specific situations that can require it due to blatant negligence or fraud. She added that as a former CCO herself, she understands the pressures they face.
“We are going to assess quickly whether a CCO is not doing his or her job and we have the ability to determine whether that may be because the CCO has too many responsibilities or whether he or she is not getting the resources they need,” she said.