Amid a fast-growing GP-led secondaries market, the Securities and Exchange Commission case that came out in September 2018 only confirmed that information asymmetry and potential conflicts of interest in GP-led deals need to be addressed promptly.
The sanction related to stakes in the New York firm’s Fund III, which was raised in 1999 and VSS was looking to dissolve in late 2014. The fund had two remaining portfolio companies at the time VSS offered a deal to LPs: a cash distribution-in-kind payout at a price based on 100 percent of the fund’s December 2014 net asset value. The SEC says the NAV of the fund at the time was $33.9 million, and VSS used this as the basis for the offer to LPs.
However, at the beginning of May 2015, before the deal went through, VSS failed to inform limited partners that it had received information indicating the NAV of the fund had “increased significantly” on the amount previously stated, to the tune of approximately $1.74 million, the SEC said.
The regulator said the “omission of this information regarding the potential increase in the value of Fund III’s portfolio companies resulted in certain statements in VSS’s May letter being misleading. In addition, after the offer was made, VSS did not provide the remaining Fund III limited partners with the first quarter 2015 financial information, which, according to VSS’s calculations, still showed an increase in Fund III’s NAV.”
The SEC said that the offer letter made it appear the limited partners would receive the full value for their interests.
VSS and one of its managing partners, Jeffrey Stevenson, settled for $200,000 with the SEC.
The essence of the case wasn’t a complete surprise. The SEC has focused on potential conflicts of interest in the private fund management world for years and had already expressed concerns – coincidentally starting back in May 2015 – about those arising in fund restructurings.
Add to that the growth of the secondaries market and of GP-led secondaries in recent years, it didn’t come as a surprise that the SEC started paying closer attention.
“In certain of these transactions, the net benefit may be geared towards the GP rather than the LPs,” says Brian Mooney, a managing director at secondaries advisor Greenhill. “What the SEC is saying is that GPs need to be very clear and specific about how they are managing the inherent conflicts.”
In many GP-led secondaries transactions, the GP, which has a fiduciary duty to its funds’ LPs, finds itself on both sides of the table. It is representing the existing LPs, but also designing the transaction, running the process, picking the advisor and the buyer, negotiating the terms, and as in cases like VSS’s, it is also a buyer of the assets.
That position, combined with the fact it is the party that knows the most about the assets, puts it in a highly conflicted position.
Call in the advisors
In other corners of the financial world, all parties typically have advisors. But in GP-led secondaries there’s information asymmetry, often between the parties to the detriment of existing LPs.
“There is a large disparity today between resources, expertise, information and available advice,” says Mooney. “In most investment banking transactions, such as M&A and bankruptcy/restructuring, both sides of the deal have engaged their own expert financial and legal advisors. We believe this market will move that way fairly quickly as LPs seek to level the playing field and achieve better outcomes in these types of transactions.”