Institutional Investor Newsletter
Welcome to the fall 2023 issue of DLA Piper’s Institutional Investors Newsletter.
The aim of this occasional publication is to keep you informed about developments in the investment funds space, share our perspective on a hot topic or two, and stay connected through updates about our team of lawyers.
At the outset, we want to acknowledge the significant impact on the investment funds industry of the new SEC rules adopted in August. The five new rules address preferential treatment, restricted activities, quarterly statements, mandatory private fund audits, and advisor-led secondary transactions. These rules expand the regulatory requirements for private fund advisors in an effort to provide greater transparency to institutional investors, but they are already subject to a lawsuit from several trade associations challenging the authority of the SEC to regulate private funds. We will be monitoring this litigation as the compliance dates for the new rules approach and we will be sure to share our analysis of additional developments.
|David B. Parrish
DLA Piper Executive Committee Member
|Nicole J. E. Brennig
Austin Managing Partner
New Advisers Act rules – expected impact
On August 20, 2023, the SEC adopted new rules under the Investment Advisers Act of 1940 (the New Rules) which apply to advisers to certain private funds. Each of the New Rules viewed individually and in isolation has its pros and cons (which obviously depends on your particular seat). The investment world, however, is not “paint by number” and to fully appreciate the New Rules you have to step back and really look at the complete picture. It is a bit like watching an old “The Joy of Painting” episode with the late, great Bob Ross. You think he is painting one thing but the outcome is often much different than what you thought – you have to see the entire journey. What should you be thinking about?
Key takeaways for investors:
- Look for a unified approach in reporting. Expect a one size fits all model. Of course, there will be exceptions based on sponsor culture and the duration view of sponsor leaders, but that will be the exception and not the rule.
- Expect co-invest dedicated vehicles (sometimes known as “side cars”) to be harder to implement if being done for pure cost reduction purposes.
- Expect to have an increase in resources to close investments. You will likely get a pre-close data dump of side letter provisions. What will your plan be to deal with this?
- Expect investment teams to increase their time spent on due diligence. Sponsors may give you verbal information but will be reluctant to give written comfort on special information.
- Expect an increase in Fund operating expenses (generally and due to what we expect to be an exponential growth in GP-led transactions). How much is TBD but it will not be de minimis.
- GP-led transactions are here to stay and will increasingly be a part of both investor and sponsor portfolio tools. Fairness opinions (and their costs) will be provided more frequently than valuation opinions.
- Do not be shocked if you start seeing more aggressive legal terms such as requiring “syndicated” co-investments to bear broken-deal exposure and pre-clearing transactions that would equate to compliance with the New Rules.
- Expect sponsors to hold the line or reduce providing “side letter” comfort on LPA terms and conditions.
Key takeaways for sponsors:
- Why take risk on giving specialized information beyond the new “baseline” if you do not have to? If you leave yourself open to regulatory second guessing and potential fines then you are taking regulatory risk.
- Are there other financing structures that you can use to gain the benefits of a sub line but that do not create the reporting headaches required by the use of an actual sub line?
- Why create customized post-fund raise disclosure systems if you can purely avoid risk by limiting side letters to only things that are required by written policy, law or regulation for an investor?
- Given the “disclosure” framework, most of the costs of compliance with the New Rules become a fund operating expense.
The playing field is still evolving and as you may already know, litigation has been filed to derail the New Rules. Feel free to reach out to any of the members of the DLA Piper team if you wish to discuss in more detail or have any specific questions.
Legal term spotlight
Withholding obligations in secondaries
In this issue, we’ve decided to turn the spotlight on a legal term that is a topic of frequent discussion in our growing secondaries practice: withholding obligations in secondary transactions.
Over the past few years, the IRS has tightened withholding obligations in private fund secondary transactions and enforcement of such obligations. As of January 1, 2023, such obligations were explicitly revised to extend to the general partner of the private fund in which a transfer of interest takes place.
In connection with such revised regulations, a buyer in a secondary transaction will now have to withhold 10% of the gross proceeds (plus share of liabilities) paid to a non-US seller if the seller cannot qualify for an exemption (i.e. obtain a certificate allowed under the US Treasury regulations that withholding is not required). If the underlying fund has any liabilities (essentially, fund level indebtedness), the seller will also need to certify to buyer the seller’s share of the fund’s liabilities, which can either be based on the seller’s Schedule K-1 (that is not more than 22 months old) or based on certification from the general partner. If the buyer cannot obtain either of these certificates, the buyer will be required to withhold 100% of the purchase price.
Another notable change is that if a buyer is able to obtain a certificate that excuses or reduces withholding, it is required to provide a copy of that certificate to the general partner/fund within 10 days of the transfer. Technically the delivery of this certificate must be on a separate certificate from the buyer to the general partner/fund. The certification must either (1) include a copy of Form 8288–A that the transferee files with respect to the transfer (which is filed when there is tax withheld), or (2) state the amount realized and the amount withheld on the transfer (including none if withholding is zero). The certification must also include any certifications that the buyer relied on to apply an exception to withholding or to determine the amount to withhold (e.g. the certificate showing the seller’s share of liabilities). A buyer that relied on a certification to apply an exception or adjustment to withholding remains liable when the general partner knows, or has reason to know, that the certification is incorrect or unreliable.
As a result of these enhanced requirements, as a threshold matter, it is very important to understand the potential withholding obligations and possible certifications that can be obtained as early as possible in the process of reviewing a secondary transfer involving a non-US seller. We have seen secondary PSA negotiations fall apart and deals not proceed to PSA execution and closing as a result of these requirements, which can lead to unnecessary expense and effort if the issue is not analyzed early in the process.
For more information about these withholding requirements please contact any member of our institutional investors team. For more information about the secondaries practice we are building, please visit our DLA Piper secondaries page.
As you know, we and our DLA Piper colleagues in other practice areas publish alerts and news updates from time to time. In case you missed these headlines in recent months, here are a few items of interest to many institutional investors:
The SEC adopted a series of new rules and rule amendments in August that will impact some of the rights and requirements for private fund advisers and institutional investors. The final rules were softened in certain respects relative to the SEC’s initial proposal.
We’ve developed an online resource to help you navigate the complexities of carried interest across the globe.
President Joe Biden signed an Executive Order (EO) in August that bars investments in sensitive technology in China, with the goal of preventing American capital from contributing to advanced industries and applications that could support China’s military modernization and threaten US national security.
US Senate Finance Chairman Ron Wyden introduced a legislative bill in July that would, if enacted, effect a landmark change in available tax strategies for many of the world’s largest sovereign wealth funds. It could encourage these sovereign wealth funds to make debt investments instead of equity investments in the United States.
Investment fiduciaries should pay close attention to this case and how it develops. Furthermore, the implications of this matter may extend to regulatory concerns.
Our Institutional Investors team
Our team of lawyers dedicated to working with institutional investors has continued to grow in recent months. We announced some exciting news in September, welcoming several new colleagues to our Washington, DC and San Diego offices: partners Mara Topping, Kate McCullough, and Evan Zhao in DC, and tax partner Andrew Kreisberg in San Diego. As David Parrish noted, “The addition of Andrew, Mara, Kate and Evan reflects the strength of DLA Piper in private markets, and their presence and combined experience will be a significant asset to our clients. We are all very excited and enthusiastic about their arrival.”
These additions further expand our representation of the world’s largest and most active investors in private markets, both domestically and internationally. Our team is now 37 lawyers strong: 12 partners, 4 counsel, 18 associates and 3 attorneys. Most of us are based in Austin, but we also have a presence in Dallas, Atlanta, and Boston, alongside our growing numbers in Washington, DC. Last year we assisted clients in over 2,000 transactions in jurisdictions and sectors spanning the investment funds space, and we are on track to once again exceed that number in 2023.
Please check out this snapshot of each of our US lawyers and their educational backgrounds.
Please note that our team is not limited to our US offices: we also work closely with our DLA Piper investment funds colleagues based in London, led by James O’Donnell, and our colleagues in Hong Kong, led by Luke Gannon.
Our strength in numbers underscores our depth and breadth of experience in every type of transaction and in every sector of the investment funds space, including strong secondary market capabilities on both the buy and the sell side of deals. Our secondaries practice has grown significantly in recent years, with colleagues like Mike Nissim joining Sara Stinnett and other experienced secondaries lawyers on our team. In this issue we highlight Mike’s background, below, and we also focus on a legal term that has come up often in our secondaries work this year.
As many of you know, we are closely integrated with colleagues who focus on tax and ERISA law. We also frequently collaborate with lawyers across a variety of legal practices such as private equity, structured finance, real estate, even sports team acquisitions. Please see our go-to list of cross-practice advisors, linked here, for key DLA Piper partners who are always available to assist with any needs in areas that are related to your fund investments.
As always, please visit our DLA Piper home page for more information about the scope and scale of our practice.
Meet the team: Mike Nissim
Mike Nissim, of counsel in the DLA Piper office in Washington, DC, is among our experienced Institutional Investor lawyers. Many of you have had the opportunity to work closely with him over the last two years. We thought we would give him the chance to share a little about himself through a Q&A:
Mike, describe your practice and how you got connected with the DLA Piper team.
I joined the team in early 2022 after spending over sixteen years at another large international law firm. I worked on M&A and public securities transactions for the first six years of my career, and in the fund transactional space for the next ten years, including leading a large number of different types of secondary transactions for a variety of institutional buyers and sellers. I came to a point in my career where I became interested in exploring new opportunities and after canvassing the legal private funds industry, I was drawn to the DLA Piper team in part due to its strength and position in the market and DLA Piper’s impressive global platform, but also to the cohesiveness of the group and its commitment to fostering a strong team-oriented culture and atmosphere. From speaking with various members in the group it became clear to me that it would be a great fit for me, and now that I have been here for a year and a half I couldn’t be more excited about the opportunity to work with my colleagues to continue to develop my practice and provide significant value to our clients.
How have you seen the private funds secondary market evolve, and where do you see it going?
I have been fortunate to be involved in the secondaries market for more than a decade, and in such time I have seen it grow from a small part of the private funds industry to a major avenue of liquidity for limited partners. My secondaries practice has grown in size and complexity as the market has evolved, with what used to be a handful of single interest or small portfolio trades between LPs turning into a thriving market involving multi-billion dollar LP portfolio sales, large tenders offers, GP led-continuation fund transactions and everything in between.
While the current market is much larger than it was when I first began leading these transactions, I think there continues to be significant room for growth in secondaries as more participants enter the market both from the buy and sell side and parties explore further innovative solutions to facilitating liquidity (for example, collateralized fund obligations). It’s an exciting market to be a part of and I look forward to continuing to help our clients execute transactions successfully and achieve their goals.
How do you approach a new client, investment or transaction? What is your philosophy and how does that translate to your practice?
I view my role as steering a transaction from beginning to end, including advising on structuring, negotiation and execution. While these three stages are all different in terms of the work and knowledge required, I think that each is equally important, and deal execution in particular can sometimes be overlooked. Secondaries transactions in particular require a sound and consistent process given their complexity and the number of parties involved. I have focused a lot in my career on making sure my colleagues and I stay organized and have processes in place to ensure that each transaction, large or small, is efficiently and successfully executed. Part of my attraction to the DLA team was that they share this philosophy, resulting in a real focus on process, efficiency and quality control that flows through the entire team, from partners to the legal practice assistants.
Where are you originally from?
I was born and mostly raised in Forest Hills, Queens, New York, about a mile from Shea Stadium (now CitiField) and the US Open tennis stadiums. My wife is from DC and we moved down here after our first son was born in 2011. I’ll always be a New Yorker and sometimes I miss the energy of New York City. However, I went to school in Manhattan from grades 7-12 and had to take a public bus and two subways to and from school for an hour and fifteen minute commute each way – so one thing I don’t miss are the NYC subways!
Our Chambers recognitions
This year, for the fifth consecutive year, Chambers USA ranked DLA Piper as Band 1 for its Investor Investment Funds: Investor Representation practice in the US and singled out seven of our lawyers for individual rankings. See the listings here.
We invite you to share an issue or term you would like us to cover in a future edition of this newsletter. Please contact us via DLA-InvestmentFunds@us.dlapiper.com.
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