Tag Archives: Private Equity

Some Questions and Concerns for Hedge Fund Managers

Questions and Concerns

My last post was an open letter to hedge fund managers and private equity investors, and I’d like to share a few follow up concerns and questions.

Fund marketing must be more transparent. Firms must provide historical documents showing how they calculate internal rates of return.

What if some numbers in a firm’s marketing materials contradict numbers in its SEC filings for non fraudulent reasons? Will the firm be liable and subject to sanctions?

The SEC is permitted to share information with certain agencies. Will this lead to congressional access resulting in investment strategies becoming a matter of public record?

What is Next?

After the Advisors Act deadline passes, buyout shops will have a new Form PF which private equity firms will be required to file once a year within 120 days of the end of the fiscal year.

Firms with at least $2 billion in assets under management will be required to answer questions at the portfolio-company level about leverage, bridge financing and financial-industry investment. Firms with over $5 billion in assets must file Form PF following the first fiscal year after June 15, 2012. Firms with under $5 billion must begin filing the first year after December 15th of this year.

The Volker Rule

The Volcker Rule, which is to be finalized in the next few months, will prohibit banks from engaging in proprietary trading and from owning proprietary or sponsoring private equity funds.

One question: Will break-ups be truly “arms length” or will banks have merely created third party entities to do proprietary trading? What do you think?

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Private Equity Portfolio Funds and Indemnification Arrangements

A private equity fund investing in a portfolio company, customarily requires at least one of its related parties to be elected to the board of the portfolio company.  The private equity fund will require the portfolio company to provide the board member with an indemnification for his actions in addition to any indemnity available to the same person through the private equity fund.

In these types of arrangements, there may be overlapping indemnity obligations between the fund and the portfolio company. Indemnification provisions are typically found in the organizational documents of the fund and the portfolio company or in stand-alone indemnification agreements. While separate fund and portfolio company indemnification obligations protect the board member against personal liability, it often creates confusion regarding the relative priority of the indemnification obligations.

If the agreements do not specify whether the fund or the portfolio company will be the indemnitor of first resort, how will courts interpret such arrangements?

In the case of Levy v. HLI Operating Company Co., Inc.,* the Delaware Chancery Court allowed a board member to seek indemnification from the private equity fund without first seeking it from the portfolio company. The court suggested that the private equity fund should pursue a contribution action against the portfolio company and made it clear that, absent a contractual arrangement to the contrary, the fund and the portfolio company would be expected to share in liability for any indemnity claims.

Though the Levy case was decided by the Delaware state courts and involved a Delaware corporation, it is likely that other state courts would apply the underlying legal concepts with equal force to contracts and cases under the laws of those states.

This decision is one that underscores the need for private equity funds to clarify indemnification obligations relative to those of its portfolio companies.

*Levy v. HLI Operating Company Co., Inc., 924 A.2d 210 (Del. Ch. 2007).

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