Private Equity
Autumn 2009
d
In this issue
p1 The Obama Bill:Implications forPrivate Funds andUnregistered Advisersp3 PIPEs in Hong Kongp6 DevelopingOpportunities forPrivate Equity in theHealthcare Sectorp9 More Loans Maturing,Fewer OptionsAvailablep12 Determining the Valueof the Share Transferof a Leaving Partnerp13 How the SEC’sProposed “Pay-to-Play” Rule AffectsPrivate Equity andHedge Fundsp15 News from the Group
Editor: Roger Mulvihill
The Obama Bill: Implicationsfor Priate Funds andUnreistered Adisers
by
Kein P. Scanlan
,
Roer Mulihill
,
and
Joseph J. Muscatiello
Introduction
The Treasury Department released on July 15, 2009the Obama Administration’s proposed “PrivateFund Investment Advisers Registration Act of 2009”(the “Obama Bill”) to Congress, which removesthe 15-client private adviser exemption under theInvestment Advisers Act of 1940, as amended (the“Advisers Act”). The Obama Bill, if enacted, wouldrequire advisers to most hedge funds, private equityfunds, and venture capital funds to register with theSEC and to comply with the requirements of theAdvisers Act. As a result, all unregistered advisersmust now assess the impact that registering withthe SEC will have on their business. This assessmentshould include a complete review of the adviser’spolicies and procedures to ensure they meet bestpractice standards and, if they do not, considerwhat changes can and should be made.
Who is Subject to the Adisers ActUnder the Obama Bill?
The Obama Bill will presumably require any U.S.adviser to register with the SEC, although withoutthe repeal of Rule 203A under the Advisers Act, itis possible that the Bill’s application will be limitedto advisers who have $25 million or more in assetsunder management. A limited intrastate exemptionwill survive for advisers whose only clients reside inthe same state as the adviser, but even that exemp-tion will be unavailable for advisers to private funds.A “private fund” is defined as any fund that relies
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2 Autumn 2009on Section 3(c)(1) (sold to fewer than 100 investors) orSection 3(c)(7) (sold exclusively to “qualified purchas-ers”) for its exemption under the Investment CompanyAct of 1940, as amended (the “1940 Act”), and either (1)is organized under the laws of the United States, or (2)has 10% or more of its outstanding securities owned byU.S. persons. The Obama Bill does not require a “foreignprivate adviser” to register with the SEC.
Adisers Act Requirements
Adiser Reistration
All advisers not prohibited or exempted from registrationwith the SEC must file and update their Form ADV annu-ally and whenever certain information contained thereinbecomes inaccurate.
SEC Eaminations and Record-Keepin Requirements
Rule 204-2 under the Advisers Act contains an extensivelist of the records that registered advisers are requiredto keep. An adviser’s records are subject to discretionaryexamination by the SEC at any time.
Deelopment of Compliance Proram and Appointmentof CCO
Rule 206(4)-7 under the Advisers Act requires each reg-istered adviser to adopt and implement written policiesand procedures reasonably designed to prevent violationof the Advisers Act (a “Compliance Program”), to assessits Compliance Program at least annually for sufficiencyand successful implementation, and to designate a ChiefCompliance Officer (“CCO”) responsible for oversight andmanagement of the Compliance Program.
Personal Tradin; Codes of Ethics
When the adviser, its access persons, and/or employeestrade for their own accounts, conflicts of interest canarise, and the SEC has brought a number of enforcementactions against advisers and their employees in this areaunder the antifraud provisions of the Advisers Act. UnderRule 204A-1, registered investment advisers must adoptcodes of ethics that address these issues and adhere tothe specific content requirements of the Advisers Act.
Presentation of Past Performance
Any adviser presenting a past investment performancerecord must disclose all material facts necessary to avoidmisleading clients or creating any unwarranted inferences.In no-action letters, the SEC staff has provided clarifica-tion and detail relating to performance advertising andenforces such guidance under the anti-fraud provisionsof the Advisers Act. The Advisers Act imposes numerousadditional restrictions that are specific to the marketingactivities of registered advisers. These restrictions anddisclosure requirements could be particularly relevant tothe fund-raising documentation of private fund advisers,particularly the disclosure in private placement memo-randa and other marketing materials.
Requirements for Adisers With Custody of Clients’Funds or Securities; Surprise Audits
Registered advisers that have “custody” of client assetsmust maintain those assets (other than certain privatelyoffered securities) with a “qualified custodian” under Rule206(4)-2 of the Advisers Act (the “Custody Rule”). Underthe existing Custody Rule, an adviser must generally havereasonable belief that the qualified custodian sends aquarterly account statement to each client for whom thecustodian has custody of funds or securities, or ensurethat each private fund that it advises is audited annuallyand provide investors with audited financial statementswithin 120 days of each private fund’s fiscal year-end, inorder to avoid being subject to an annual surprise audit byan independent public accountant. On May 20, 2009, theSEC issued proposed amendments to the Custody Rulethat would significantly increase regulation of advisers’custody arrangements, particularly self-custody and cus-tody of client assets with an affiliate, by effectively subject-ing any adviser with “custody” (defined broadly under theCustody Rule to even include authority to deduct advisoryfees from client accounts) to an annual surprise audit,regardless of whether a qualified custodian sends reportsto the client or the adviser provides audited financial state-ments in respect of the private funds it advises.
Requirements for Adisers’ Contracts With Clients
Contracts with a registered investment adviser’s clientsmust contain some specific terms that are set forth inSection 205 of the Advisers Act. The contract languagemust convey that advisory services provided to clientsmay not be assigned to any other person without obtain-ing prior client consent. Advisory contracts generallycannot include provisions that permit compensation tobe based on the performance of a limited partner’s ac-count, unless the performance fee is structured in a waythat exposes the adviser to some downside risk, such asa performance fee imposed as a percentage of assetsunder management, or a “fulcrum fee” that is averagedand fluctuates over a specified period of time. Addition-ally, the performance fee prohibition generally does notapply to an advisory contract with a private fund relying onthe Section 3(c)(7) exemption of the 1940 Act by permit-ting only beneficial owners who are “qualified purchasers”(for non-U.S. funds, this requirement only applies to U.S.
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Autumn 2009 3investors); a private fund relying on the 3(c)(1) exemptionunder the 1940 Act, but only for those limited partnersthat are “qualified clients” as defined under the AdvisersAct; or advisory contracts with non-U.S. residents. TheObama Bill does not specifically address the applicabil-ity of the Bill to various categories of compensated anduncompensated advisers, such as consultants or specialadvisory boards or panels, who assist in deal flow and/orhelp to analyze prospective investments.
Requirements for Adisers That Pay Others to SolicitNew Clients
Rule 206(4)-3 under the Advisers Act provides that noadviser required to register under the Act may pay a feeto a solicitor who has obtained clients for the adviserunless certain conditions are met. In general, a solicitormust provide any potential client with copies of both:(1) the adviser’s current brochure; and (2) a disclosurestatement describing the terms of the solicitation agree-ment between the adviser and the solicitor (includinginformation as to fees paid and compensation received bythe solicitor or the adviser). Recently, the SEC staff hasprovided no-action guidance that Rule 206(4)-3, by itself,generally does not apply where a solicitor is being paid“solely” to compensate such person for bringing investorsinto a private fund managed by the adviser. Under suchcircumstances, a private fund’s adviser is not requiredto obtain the written acknowledgement as Rule 206(4)-3prescribes. Nonetheless, advisers should, in those circum-stances, consider their general anti-fraud obligations andprovide appropriate disclosure to investors regarding thesolicitor arrangement.
Kein P. Scanlan
+1 212 649 8716kevin.scanlan@dechert.com
Roer Mulihill
+1 212 698 3508roger.mulvihill@dechert.com
Joseph J. Muscatiello
+1 212 698 3868joseph.muscatiello@dechert.com
PIPEs in Hon Kon
by
Basil H. Hwan
and
Candy Tsui
The Hong Kong stockmarket, represented bythe Hang Seng Index,has risen nearly 40%since the start of 2009. By comparison, the DJIA has inthe same period risen by approximately 8%. Amidst arecovering but still uncertain economic environment inEurope and the United States, coupled with a gradualreturn of available liquidity, private equity funds havebecome increasingly interested in China.Private investments in public equity, or PIPEs, areinvestments into publicly traded equity securities(including ordinary shares, preferred shares, orconvertible securities) by private equity investors. thisarticle explains how PIPEs work in Hong Kong, and theHong Kong laws and regulations that govern them.
PIPEs Reulation in Hon Kon
In Hong Kong, PIPE transactions must comply with theregulations in Hong Kong relating to the public markets.The relevant Hong Kong laws and regulations governingPIPEs are largely contained in the Securities and FuturesOrdinance and its subsidiary legislation (the “SFO”), theRules Governing the Listing of Securities on the HongKong Stock Exchange (the “Listing Rules”), and theHong Kong Code on Takeovers and Mergers and ShareRepurchases (the “Takeovers Code”).
Types of PIPEs
The table on page 4 (
Types of PIPEs
) provides a usefulsummary of the main characteristics of different types ofPIPE transactions that are common in Hong Kong. Theseinclude investments in a company before (but close to) itsIPO, and during its IPO as a private placement.
Disclosure Obliations and ConnectedParty Thresholds
An investor in a Hong Kong PIPE transaction is requiredto disclose its interest in the issuer if its equity holdingis 5% or more after the investment. Holdings of shares,or other instruments convertible or exchangeable intoshares, are counted for purposes of determining if the5% threshold has been crossed.
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