Articles Tagged with Private Equity

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On September 22, 2014, the Securities and Exchange Commission (the “SEC”) charged private equity fund adviser, Lincolnshire Management, Inc. (“Lincolnshire”), with misallocating expenses shared between two portfolio companies. Lincolnshire integrated two portfolio companies that were each owned by a different Lincolnshire private equity fund. Lincolnshire owed a fiduciary duty to each fund and such fiduciary duty was breached when Lincolnshire would charge one portfolio company more than its fair share for expenses benefiting both portfolio companies.

Lincolnshire was aware of the complexity involved in sharing expenses and did have an expense allocation policy in place, though it was not in writing. The instances that resulted in a breach of Lincolnshire’s fiduciary duty were those in which the verbal expense allocation policy was not followed. The SEC also found, with respect to the integration of the portfolio companies, that Lincolnshire did not have sufficient written policies and procedures in place to prevent violations of the Investment Advisers Act of 1940 (“Adviser’s Act”). Lincolnshire agreed to a settlement with the SEC in excess of $2.3 million.

It is interesting to note that, while the SEC announced several months ago it had conducted presence exams and found many issues in private equity managers, Lincolnshire was not one of the companies subject to a presence exam. Private equity managers who have not had a presence exam should not assume they are unlikely to be examined outside of the presence exam protocol. This enforcement action reinforces the requirement that private equity fund advisers are required to have policies and procedures in place that are designed to prevent violations of the Adviser’s Act and other securities laws. More importantly, once in place, such policies and procedures must be monitored by the chief compliance officer and observed by all “covered persons.”

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On September 16, 2014, the Securities and Exchange Commission (“SEC”) announced the latest sanctions in a continuing enforcement initiative against certain hedge fund advisers and private equity firms that have participated in an offering of a stock after short selling it during a restricted period in contravention of SEC rules.

The SEC last year announced the initiative to enhance enforcement of Rule 105 of Regulation M, which is designed to preserve the independent pricing mechanisms of the securities markets and prevent stock price manipulation.  Rule 105 typically prohibits firms or individuals from short selling a stock within five business days of participating in an offering for that same stock.  Such dual activity typically results in illicit profits for the firms or individuals while reducing the offering proceeds for a company by artificially depressing the market price shortly before the company prices the stock.

The SEC’s investigations targeted 19 firms and one individual trader in the latest cases engaged in short selling of particular stocks shortly before they bought shares from an underwriter, broker, or dealer participating in a follow-on public offering.  Each firm and the individual trader have agreed to settle the SEC’s charges and pay a combined total of more than $9 million in disgorgement, interest, and penalties.

Pursuant to this enforcement initiative, the SEC’s Enforcement Division works closely with FINRA and the SEC’s National Exam Program to identify potential violations of Rule 105.  Enforcement staff seeks trading data and certain other relevant information from traders and expedites these cases by using uniform methodologies for determining trading profits and deciding appropriate penalties.

This latest round of administrative proceedings for Rule 105 violations included the following organizations with the monetary sanctions as indicated below:

  • Advent Capital Management – The New York-based firm agreed to pay disgorgement of $75,292, prejudgment interest of $3,836.36, and a penalty of $65,000.
  • Antipodean Advisors – The New York-based firm agreed to pay disgorgement of $27,970, prejudgment interest of $702.83, and a penalty of $65,000.
  • BlackRock Institutional Trust Company – The California-based firm agreed to pay disgorgement of $1,122,400, prejudgment interest of $22,471.13, and a penalty of $530,479.
  • East Side Holdings II – The New Jersey-based firm agreed to pay disgorgement of $26,613, prejudgment interest of $397.38, and a penalty of $130,000.
  • Explorador Capital Management – The Brazil-based firm agreed to pay disgorgement of $83,722, prejudgment interest of $6,936.65, and a penalty of $65,000.
  • Formula Growth – The Canada-based firm agreed to pay disgorgement of $42,488, prejudgment interest of $4,255.15, and a penalty of $65,000.
  • Great Point Partners – The Connecticut-based firm agreed to pay disgorgement of $43,068, prejudgment interest of $1,529.13, and a penalty of $65,000.
  • Indaba Capital Management – The California-based firm agreed to pay disgorgement of $194,797, prejudgment interest of $11,990.79, and a penalty of $97,398.59.
  • Ironman Capital Management – The Texas-based firm agreed to pay disgorgement of $21,844, prejudgment interest of $382.66, and a penalty of $65,000.
  • James C. Parsons – An individual trader who lives in New York City agreed to pay disgorgement of $135,531, prejudgment interest of $3,063.90, and a penalty of $67,765.72.
  • Midwood Capital Management – The Massachusetts-based firm agreed to pay disgorgement of $72,699, prejudgment interest of $5,248.19, and a penalty of $65,000.
  • Nob Hill Capital Management – The California-based firm made sworn statements to the Commission attesting to a financial condition that makes it unable to pay any penalty.
  • RA Capital Management – The Massachusetts-based firm agreed to pay disgorgement of $2,646,395.21, prejudgment interest of $73,394.16, and a penalty of $904,570.84.
  • Rockwood Investment Management (also known as Rockwood Partners LP) – The Connecticut-based firm agreed to pay disgorgement of $156,631, prejudgment interest of $9,222.16, and a penalty of $72,135.23.
  • Seawolf Capital – The New York-based firm agreed to pay disgorgement of $192,730, prejudgment interest of $7,842.28, and a penalty of $96,365.
  • Solus Alternative Asset Management – The New York-based firm agreed to pay disgorgement of $39,600, prejudgment interest of $895.22, and a penalty of $65,000.
  • SuttonBrook Capital Management – The New York-based firm agreed to pay disgorgement of $70,000.
  • Troubh Partners – The New York-based firm agreed to pay disgorgement of $262,744, prejudgment interest of $39,315.13, and a penalty of $106,651.15.
  • Vinci Partners Investimentos – The Brazil-based firm agreed to pay disgorgement of $283,480, prejudgment interest of $23,487.08, and a penalty of $141,740.
  • Whitebox Advisors – The Minnesota-based firm agreed to pay disgorgement of $788,779, prejudgment interest of $48,553.49, and a penalty of $365,592.83

Pillsbury’s Investment Funds Team regularly advises clients on how not to show up on lists such as these.

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The relentless attention being paid to cyber-attacks is driving companies to increase cyber security budgets and purchases. In turn, this has led institutional investors and asset managers to see potentially massive returns associated with companies in the cyber security market. Indeed a number of companies that have gone public have had phenomenal success, and the constantly morphing nature of cyber-attacks means that purchasing trends are not likely to slow down any time soon.

However, it is critical to keep in mind that just as cyber security capabilities can be a very attractive component in evaluating a potential investment; it also could lead to potentially negative consequences. Ignorance of some key legal and policy considerations could lead to an improper assessment of the value/future earnings potential of technology investments. These considerations are true regardless of whether or not the technology or service has a core “security” component.

Below are some key issues to consider when making cyber security investment decisions:

  • Cyber security matters in every investment
    • It is a simple fact that every company faces cyber threats. Multiple studies have  demonstrated that essentially every company has been or is currently subject to cyber-attack and that most if not all have already been successfully penetrated at least once. This leads to a key consideration: every company’s cyber security posture should be considered when making investment decisions. For example, a company selling information technology that is less prone to cyber-attacks should be viewed as a better investment than competitors who pay little to no attention to how their products can be breached.
  • Cybercrime is cheap
    • The cost of conducting cyber-attacks is depressingly cheap: $2/hour to overload and shutdown websites, $30 to test whether malware will penetrate standard anti-virus systems, and $5,000 for an attack using newly designed methods to exploit previously undiscovered flaws. Indeed it is now so cheap to create malware that the majority of malicious programs are only used once – thereby defeating many existing cyber security systems which are designed to recognize existing threats. This all adds up to a cost/benefit analysis that is irresistible for cyber-attackers, and essentially guarantees that the pace and sophistication of attacks will not let up any time soon.
  • Cyber security should be in the company’s DNA
    • Whether a company is offering a service or a technology, a critical factor to consider is its approach to security. Companies that consider security a key functionality that needs to be integrated from the start of the design process are far more likely to go to market with an offering that has higher degree of security. Security as an afterthought is just that – an afterthought. Weaving security into the DNA of a service or technology will be extremely helpful in decreasing security risks. Just remember though that no security program or process is flawless, and no one should expect perfection.
  • Is there a nation-state problem?
    • An R&D or manufacturing connection to countries known for conducting large-scale cyber espionage causes heartburn for companies and governments alike. Too many instances have occurred where buying items from companies owned by or operated in problem nation states have resulted in cyber-attacks. In some cases, Federal agencies are prohibited from buying IT systems from companies with connections to specific governments. Investors and managers need to stay abreast of problem countries, and also examine whether the product or service has a connection to such countries. Failure to do so can lead to investments in companies that have limited market potential.
  • Do your homework and forensic analyses
    • There’s nothing like buying a trade secret only to find out it really isn’t a secret. Before investing in any company, conduct due diligence to determine how good the security of the company is and whether IP or trade secret information has been compromised.
  • If the government cares, so should you
    • The Federal government is stepping up its requirements regarding cyber security in procurements. That means that all federal contractors (not just defense contractors) are going to have to increase their internal cyber security programs if they want to win government contracts. Failure to have a good cyber security program could lead to lost contracts, and thus decreased growth. 
  • Words matter
    • Companies have been too lax in negotiating terms that explicitly set forth security expectations for IT products as well as who will be liable should there be a breach/attack. Judicious reviews of terms and conditions can help avoid liability following a cyber-attack. For example, companies should not accept boilerplate language regarding the following of “industry standards” or “best practices” with respect to cyber security. Instead, specific obligations and benchmarks need to be agreed upon before signing any agreement. Further agreements should be drafted to that make clear that security measures are the obligation of the other party. That way the investor has set up a stronger argument for recovering losses as well as shifting liability away from itself.
  • Insurance isn’t everything
    • Companies may be tempted to think that if a company has a cyber-insurance policy, they are protected in the event of a cyber-attack. The reality is that there is an enormous chasm between buying coverage and having claims paid. Cyber policies are increasingly being written and interpreted to cover fewer types of attacks, and so do not be tempted to think that cyber insurance can fully protect an investment.
  • SAFETY Act
    • Under the Support Anti-Terrorism by Fostering Effective Technologies Act (SAFETY Act), cyber security services, policies, and technology providers are all eligible to receive either a damages cap or immunity from liability claims. The SAFETY Act also protects cyber security buyers, as they cannot be sued for using SAFETY Act approved items. Possessing SAFETY Act protections should be considered a positive sign and indicative of potential earnings growth.

There is no doubt about it; cyber risks are here to stay. Addressing those risks should be a core component of any business or investment strategy, because even if “today’s problem” is solved the introduction of new technologies will just mean a new threat vector for adversaries to exploit.

It is not all doom and gloom, however. Paying attention to cyber security trends and doing some simple due diligence will go far in minimizing digital risks. Make no mistake: defenses will always be incomplete and successful attacks will happen. However, with the right processes and approach, the bad outcomes can be minimized and investments will be protected.

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Last month, the Securities and Exchange Commission (the “SEC”), published its examination priorities for 2013.  As we suggested in our Blog posting at that time, the SEC is fixated on examining and bringing enforcement against its newest class of investment adviser – managers of private equity funds.  Fast forward four weeks, and we should not be surprised to see that the SEC is doing what they said they would do.  Today, the SEC charged two investment advisers at Oppenheimer & Co. with misleading investors about the valuation policies and performance of a private equity fund of funds they manage.

The SEC investigation alleged that Oppenheimer Asset Management and Oppenheimer Alternative Investment Management disseminated misleading quarterly reports and marketing materials, which stated that the Oppenheimer Global Resource Private Equity Fund I L.P.’s holdings of other private equity funds were valued “based on the underlying managers’ estimated values.”  The SEC, however, claimed that the portfolio manager of the Oppenheimer fund actually valued the Oppenheimer fund’s largest investment at a significant markup to the underlying fund manager’s estimated value, a change that made the performance of the Oppenheimer fund appear significantly better as measured by its internal rate of return.  As part of the Order entered by the SEC, and without admitting or denying the regulator’s allegations, Oppenheimer agreed to pay more than $2.8 million to settle the SEC’s charges and an additional $132,421 to the Massachusetts Attorney General’s office.

In its press release, the SEC reiterated its focus on the valuation process, the use of valuations to calculate fees and communicating such valuations to investors and to potential investors for purposes of raising capital.  The SEC’s order also claimed that Oppenheimer Asset Management’s written policies and procedures were not reasonably designed to ensure that valuations provided to prospective and existing investors were presented in a manner consistent with written representations to investors and prospective investors. This claim gave rise to an alleged violation of Rule 206(4)-8 (among other rules and statutes) under the Investment Advisers Act of 1940, as amended (the “Advisers Act”), the rule that the SEC passed after the Goldstein case permitted many funds to de-register as investment advisers from the SEC.

This case illustrates the new regulatory landscape for private equity fund managers.  Many private equity fund managers have not dedicated the time and resources to bringing their organizations in line with the fiduciary driven rules under the Advisers Act.  Many of these managers have not implemented the compliance policies and procedures required by the Advisers Act, nor have their Chief Compliance Officers been empowered to enforce such compliance policies and procedures when adopted.  Much of this oversight goes to the fact that many private equity fund managers do not have a history of being a regulated entity nor have they actively sought out regulatory counsel in their typical business dealings.  Private equity fund managers generally use outside counsel to advise them on their transactional or “deal” work and they often do not receive the advice that a regulated firm needs in order to meet its regulatory obligations.  Oppenheimer serves notice that failing to meet these regulatory obligations can have dire consequences.

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Written by:  G. Derek Andreson, James L. Kelly, Christopher M. Zochowski, and Ryan R. Sparacino

This article was also published in Law360.

Until a few years ago, private equity firms enjoyed relative insulation from regulatory scrutiny of overseas acquisitions and the operations of multi-national portfolio companies. No longer is that the case. Spurred by the unfounded belief that PE firms are not invested in compliance or the conduct of their portfolio companies, the DOJ and SEC are now training their attention on how PE firms exert oversight and control over their portfolios, with a particular emphasis on FCPA issues. PE firms should prepare for this new scrutiny by taking proactive measures to demonstrate both their awareness and their commitment to earning profits on a level playing field. Most importantly, PE firms must recognize that these efforts are not about appeasing regulators, but go directly to maximizing return on investment. 

It’s About Deal Risk, Not Legal Risk 

A private equity firm’s foreign investments carry unique risks in the anti-corruption world: the firm may have exposure to substantial fines, penalties and reputational harm through the conduct of a portfolio company, even though the firm maintains only partial control.

This risk arises not only in the context of acquisitions, but also in strategic combinations such as joint ventures. And under successor liability principles, the conduct at issue may have occurred years before the firm considered taking a stake in the company or venture.

These risks permeate the deal cycle, including the exit phase. A sophisticated buyer in today’s market will take a hard look at a target’s anti-corruption compliance. If the compliance program falls short of industry standards, that fact may persuade the buyer to look for other opportunities, or it may convey additional leverage in negotiations.


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By Peter J. Hunt, Susan P. Serota, Matthew C. Ryan1

In welcome news for private equity (“PE”) funds, a recent district court opinion determined that two PE funds and their bankrupt portfolio company were not a “controlled group” and thus the PE funds were not responsible for pension liabilities at the portfolio company. The decision, Sun Capital Partners III, LP v. New England Teamsters and Trucking Industry Pension Fund, explicitly rejected a prior Pension Benefit Guaranty Corporation (“PBGC”) ruling on the same question and illuminated best practices for structuring future PE fund investments.


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We are very pleased to announce that Henry Liu is joining our New York office today as a Finance Partner and as leader of the Financial Institutions & Infrastructure Teams for Greater China and Asia.

Henry has enormous reach within business, banking and government in China and is the former general counsel and director general at the China Securities Regulatory Commission.  Henry will provide valuable assistance to the Pillsbury Investment Funds group on the structuring of investment funds in China as well as the movement of capital from China into investment funds outside of China.

“Henry brings a unique combination of experience as a former high-level Chinese government official and as an extremely successful and well-connected attorney for our China practice,” said Pillsbury partner Jim Rishwain. “Henry is an incredibly rare find, as he can navigate the United States and Chinese business and legal landscapes with ease. Likewise, he has enormous reach within business, banking and government circles in Greater China and has earned the very highest reputation among his colleagues and peers. As a result, he will greatly enhance Pillsbury’s stature and presence in Asia – long a key market for our firm and our clients.”

Henry has also served international, Chinese and Asia Pacific clients ranging from Fortune 500 global firms to emerging companies and has been involved in most major types of cross-border corporate and financing transactions and regulatory matters involving Asia and China, across most major industry sectors, in mergers and acquisitions, capital markets, banking and financing, corporate, private equity and investment funds, foreign direct investments, real estate, technology transfers and international trade. He has over his career been exposed to most industries and sectors, including financial services, manufacturing, real estate, transportation, energy, telecom and media, and sports and entertainment.  Henry was previously managing director of investment banking with Donaldson, Lufkin & Jenrette/Credit Suisse First Boston in Hong Kong as well as the chair of a large international law firm’s China practice.

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Written by: Jay Gould and Peter Chess

1.  What is the Form PF?

The Form PF (PF is short for “private funds”) is a new form that focuses mainly on private fund reporting with regard to information such as counterparty dealings, leverage, and investment exposure.  A “private fund” under the Form PF refers to any issuer that would be an investment company under the Investment Company Act of 1940, as amended, if not for the exemptions provided by Sections 3(c)1 or 3(c)7 of that Act.  Under some circumstances, non-“private funds” such as money market funds registered with the SEC may be required to report on the Form, in addition to “private funds.”

2.  Do investment advisers need to file the Form PF?

Yes, in certain circumstances.  Only investment advisers registered with the SEC that meet a $150 million threshold must report on the Form PF.  The $150 million threshold refers to a specific and somewhat complicated calculation with regard to regulatory assets under management. 

3.  What are the categories of filers? 

Advisers required to file the Form PF need to determine which category of filer corresponds to them.  Large private fund advisers are categorized as either large hedge fund advisers, large liquidity fund advisers, or large private equity fund advisers.  Large hedge fund advisers are those having at least $1.5 billion in regulatory assets under management attributable to hedge funds, subject to other conditions.  Large liquidity fund advisers are those having at least $1 billion in regulatory assets under management attributable to “liquidity funds” and money market funds registered with the SEC, subject to other conditions.  Large private equity fund advisers are those having at least $2 billion in regulatory assets under management attributable to private equity funds, subject to other conditions.  All other filers are categorized as smaller private fund advisers.

4. What are the reporting deadlines?

Initial compliance under the Form PF will be in phases.  The first required filers will be large private fund advisers with at least $5 billion attributable to hedge funds, to liquidity funds, or to private equity funds.  These large hedge fund advisers will have 60 days, and large liquidity fund advisers will have 15 days, after the end of the first fiscal quarter ending on or after June 15, 2012, to file their first Form PF.

Other filers will have to make their first filing by the deadline following the end of the first fiscal quarter for each adviser, as applicable, on or after December 15, 2012.  Under the initial compliance, many advisers will not need to file their first Form PF until 2013.

Going forward, the Form PF must be filed:

  • For large hedge fund advisers, within 60 days of its fiscal quarter end;
  • For large liquidity fund advisers, within 15 days of each fiscal quarter end; and
  • For other filers, within 120 days of each fiscal year end.

5.  What constitutes the Form PF? 

The Form PF, in its entirety, contains sixty pages, and is divided into four sections with corresponding subsections.  Most advisers will not have to complete all four sections.  The four sections feature reporting on, among other things: identifying information about the adviser; fund-by-fund reporting by all advisers about items such as fund identification, performance and valuation; fund-by-fund reporting by hedge fund advisers about items such as strategies, counterparties, and trading practices; aggregated private fund reporting for large hedge fund advisers; fund-by-fund reporting by large hedge fund advisers about items such as asset classes, portfolio liquidity, and risk metrics; fund-by-fund reporting for large liquidity fund advisers; and, fund-by-fund reporting for large private equity fund advisers. 

6.  What about the confidentiality of information reported?

Because of the nature of governmental sharing of the data provided on the Form PF, advisers should consider the options available to them with regard to preserving confidentiality.  Consequently, advisers should consider changing their overall recordkeeping practices so that they routinely identify funds solely by numerical or alphabetical designations.  

7.  How is the Form PF filed? 

The Form PF will be filed using the same IARD system on which advisers make the Form ADV filing.

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Written by Michael Wu and Judy Deng

The Year of Rabbit continued to see the proliferation of RMB funds and portfolio investments made by RMB funds. As of Q3 of 2011, 63 RMB funds were raised in mainland China and the total capital raised for investments in mainland China was estimated to be RMB4.2 billion (Source: Zero2IPO). Perhaps no longer a new term, “RMB funds” generally refer to the investment funds organized as corporations, limited partnerships or other unincorporated forms in China that invest in non-public companies primarily located in China. Over the past five years, RMB funds have become the investment vehicle of choice for many non-Chinese fund managers, as they have certain advantages over non-Chinese funds investing into China, including: (1) access to domestic Chinese investors (i.e., limited partners), which generally are more inclined to invest through a China-registered fund, than a non-Chinese fund; and (2) the ability to permit large non-Chinese institutional investors, which only have non-Chinese currencies, to capitalize on the regulations designed to attract foreign investment into China (e.g., the “Qualified Foreign Limited Partnership” or “QFLP” regime in Shanghai, Beijing and other RMB fund hubs).

Yet, it is notable that less than half of the capital raised in RMB funds from domestic Chinese investors has come from state owned institutional investors.  To date, due to regulatory reasons, state-owned institutional investors, particularly government institutions, government-funded guidance funds and universities, have been playing a very limited role as limited partners in private equity and venture capital funds in China (Source: First Financial Daily).  Over the past couple years, China’s regulators, including the National Reform and Development Commission (NDRC), China Securities Regulatory Commission (CSRC), China Banking Regulatory Commission (CBRC), China Insurance Regulatory Commission (CIRC) and People’s Bank of China (PBOC), have implemented legislation designed to allow certain institutions greater flexibility to make equity investments in private companies.  However, much of this legislation has yet to be implemented and official guidance thus far has been limited.  Thus, we haven’t seen a significant increase in investments into RMB funds by state-owned institutional investors.

The following lists certain of the key state-owned institutional investors and the regulatory developments in 2011 that have impacted or will impact their equity investment capabilities.

  • Securities Companies.   Securities companies are now officially permitted to make direct equity investments in Chinese companies pursuant to a set of guidelines issued by the CSRC in July 2011.  The guidelines permit securities companies to directly invest in Chinese entities or form “direct investment funds” (“DIF”) to raise and manage capital for equity investment into such companies, provided that (i) a securities company must form an intermediary known as a “direct investment subsidiary”; (ii) the aggregate capital employed by a securities company in its direct investment business may not exceed 15% of its net assets; and (iii) the securities companies abide by certain restrictions regarding fund raising (e.g., they can only raise capital in a private offering from institutional investors and may not have more than 50 investors).  Prior to the issuance of the guidelines, the CSRC only approved the direct investment of securities companies on a special approval or case-by-case basis.  Reportedly, China International Capital Corporation Limited (CICC) became the first securities company to raise an equity investment fund approved pursuant to the guidelines.
  • Pension Funds.  The Administrative Measures on Enterprise Pension Funds (“Measures”) were amended early this year and went into effect on May 1, 2011. The amended Measures removed the previous investment limit regarding the capital that may be used in “stock investments” by a pension fund, which had been 20% of its net assets.  However, the Measures still require that no more than 30% of a pension fund’s net assets be invested in “rights instruments such as stock and investment-nature insurance products, and stock funds.”  Apparently, there is still some uncertainty regarding whether the terms “stock” and “rights instruments” were intended to include private equity investments. As such, many industry experts believe that it would be some time before pension funds are officially permitted to make private equity investments.
  • Commercial Banks.  Under the Commercial Banks Law (amended in 2003), commercial banks are restricted from making equity investments in “domestic” enterprises. Although this restriction is currently still in place, some commercial banks reportedly seek to make indirect investments into domestic equity investment projects, such as investing through an offshore intermediary.
  • Insurance Companies. There was no new guidance in 2011 regarding whether Chinese insurance companies may make outbound private equity investments. In addition, many industry experts have concluded that an insurance company may not act as a limited partner in an equity investment fund unless it is managed by the insurance company.  In 2011, China Life reportedly became the first insurance company to obtain a private equity investment license under the 2010 regulation.  For a discussion on the 2010 regulation, please see our blog post titled “China Permits Insurance Companies to Invest in Private Equity.”

Over the past several years, non-Chinese fund managers have shown great interest in raising capital from Chinese limited partners.  However, for regulatory and practical reasons, the fund raising efforts of non-Chinese fund managers have not been as successful as hoped.  In addition to the regulatory restrictions specifically affecting state-owned institutional investors, as discussed above, there are a number of other hurdles that must be overcome before a limited partner may or will invest in a RMB fund.  The following are two examples of the hurdles non-Chinese fund managers currently face when attempting to fund raise from domestic Chinese investors.

  • NDRC Recordation.  In early 2011, the NDRC issued a Notice to reinforce the “recordation” requirement applicable to equity investment enterprises (“EIEs”) primarily in six provinces/municipalities. Institutional EIEs with investment capital of more than RMB500 million are required to obtain a recordation with the national office of NDRC, while other EIEs need to be recorded with the regional offices of NDRC.  Currently, there is no explicit requirement or process for recording a foreign-invested EIE with NDRC, which would pose a hurdle on such EIEs’ efforts  to raise capital from the National Social Security Foundation. However, some of the larger, foreign-invested RMB funds have been successful in obtaining recordation with NDRC on a case-by-case basis.
  • Structuring.  How a fund is structured is critical to fund raising.  A fund with any foreign equity investment will be considered as a foreign-invested enterprise (with limited exceptions, such as certain funds blessed by the QFLP regime), and thus restricted from investing in various industrial sectors, such as internet, automobile, certain energy industries and certain real estate developments.  Domestic Chinese investors often prefer to invest in a purely domestic fund, which does not have the same restrictions as foreign-invested funds.  To address this issue, some fund managers have structured their funds as “parallel funds,” which is accomplished through a contractual arrangement between two separate funds to share management, deal sourcing and exit opportunities. 

The industry is hoping that the regulators will enact an Amended Securities Investment Fund Law (SIFL), which many believe will include guidance on private equity investment. However, even if private equity investment is thoroughly covered in the SIFL, we speculate that the provisions will be focused on investor protections, rather than on clarifying the investment capabilities of various investor groups. 

As always, we will continue to provide timely updates on new developments affecting private equity and venture capital investment in China, as they occur, in 2012.

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Written by Jay Gould

On October 26, 2011, the SEC adopted a new rule requiring SEC-registered advisers to hedge funds and other private funds with at least $150 million in private fund assets under management to report information to the Financial Stability Oversight Council (“FSOC”) to enable it to monitor risk to the U.S. financial system.  The information which must be reported to the FSOC on Form PF will remain confidential, and not accessible to the general public.

These private fund advisers are divided into (1) large private fund advisers and (2) smaller private fund advisers.  Large private fund advisers are advisers with at least $1.5 billion in hedge fund, $1 billion in liquidity fund, and $2 billion in private equity fund assets under management.  All other advisers are regarded as smaller private fund advisers.  The SEC anticipates that most advisers will be smaller private fund advisers, but that the large private fund advisers represent a significant portion of private fund assets. 

Smaller private fund advisers must file Form PF once a year within 120 days of the end of the fiscal year, and report only basic information about their hedge funds, private equity funds and/or other private funds, such as information regarding size, leverage, investor types and concentration, liquidity, fund performance, fund strategy, counterparty credit risk and the use of trading and clearing mechanisms.

Large private fund advisers must provide more detailed information than smaller advisers.  The focus and frequency of the reporting depends on the type of private fund the adviser manages.

  • Large advisers to hedge funds must report on Form PF within 60 days of the end of each fiscal quarter, on an aggregated basis, information regarding exposures by asset class, geographical concentration and turnover.  If a hedge fund has a net asset value of at least $500 million, the adviser must report information regarding the fund’s exposures, leverage, risk profile, and liquidity.
  • Large advisers to liquidity funds must report on Form PF within 15 days of the end of each fiscal quarter, the types of assets in their liquidity funds, information relevant to the risks of the funds, and the extent to which the liquidity funds comply with Rule 2a-7 of the Investment Company Act of 1940, as amended.
  • Large advisers to private equity funds must file Form PF annually within 120 days of the end of the fiscal year and respond to questions regarding the extent of leverage incurred by their funds’ portfolio companies, the use of bridge financing and their funds’ investments in financial institutions.

Two-stage phase-in compliance with Form PF filing requirements:

  1. Advisers with at least $5 billion in hedge fund, liquidity fund, and private equity fund assets under management must begin filing Form PF following the end of their first fiscal year or fiscal quarter, as applicable, to end on or after June 15, 2012.
  2. Other private fund advisers must begin filing Form PF following the end of their first fiscal year or fiscal quarter, as applicable, to end on or after December 15, 2012.

Form PF Filing Fees:  $150 for initial, quarter or annual filing.

A full text of the SEC release is available here