A major issue that has emerged in private equity is how to deal with funds that are approaching the end of their lives. Especially those where the GP continues to collect fees and expenses.
The U.S. Securities and Exchange Commission has over the past year increased its scrutiny around this issue. Timothy Mungovan, co-head of the private equity and hedge fund litigation practice at law firm Proskauer, said GPs with these types of funds should prepare for SEC scrutiny.
“The SEC will evaluate GP incentives for not liquidating funds at the end of their life, particularly where the manager has been unable to raise a new fund,” Mungovan said. “Is the manager continuing to collect fees? Or maybe the GP is facing a clawback, and the sale of a portfolio company will crystalize that clawback.”
Mungovan has specialized in disputes involving private investment funds for nearly two decades. Four years ago, he joined Proskauer, one of the largest global law practices in private equity, where he counsels limited partners and sponsors of all types.
He said the SEC spent the last several years sharpening its understanding of private equity. Now, the regulator is focused on creating accepted standards of conduct within the industry.
Most areas of regulatory scrutiny fall under the umbrella of a single, important issue: conflicts of interest between limited partners and general partners, Mungovan said.
“The SEC will examine any area where the manager has discretion and is retaining an economic benefit that could arguably be shared with or transferred to the fund,” he said.
Looking forward, Mungovan expects the SEC to step up scrutiny of valuation practices, paying particular attention to hard-to-value assets like private technology companies, debt instruments and derivatives.
“The SEC will look at whether GPs follow their stated valuation policies to the letter,” Mungovan said. “If valuation practices are inconsistent with a firm’s policies and procedures, the SEC may then focus on the performance presentation of those sponsors when they’re raising new funds.”
The SEC has come a long way in understanding private equity since the Dodd-Frank financial reform brought nearly all firms under its purview. “If the SEC is conducting an exam of a sponsor, you can bet they will be acting in a very sophisticated and intelligent fashion,” Mungovan said.
Phone: 212-969-3201
Email: tmungovan@proskauer.com
Website: www.proskauer.com
Photo of Timothy Mungovan courtesy of Proskauer
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