5 Risks Every Private Equity Firm Needs to Manage

“[R]egulators and prosecutors are increasingly focusing on private equity firms.” (Jeffrey Legault, Mark Pedretti, and Pablo Quiñones at Reed Smith)

Managing risk is nothing new in the private equity world. But federal and state regulators – and unhappy stakeholders in acquired companies – are upping the ante.

From lawyers writing on JD Supra, here’s a look at five areas of risk that should be top of mind for every PE firm:

1.       Anti-corruption and FCPA compliance:

“A failure by PE funds to identify and properly manage anti-corruption and trade sanctions compliance risks brings real risk of investigation and prosecution of the target asset, the fund and individual managers and directors. This can result in imprisonment, director disqualifications, debarment from government contracts and fines and confiscation of assets for directors and individuals.” (Dechert)

2.       Accounting and valuation problems:

“[T]he SEC filed an order instituting settled administrative proceedings against Oppenheimer Asset Management Inc. and Oppenheimer Alternative Investment Management, LLC for allegedly misleading investors about the valuation policies and performance of its Oppenheimer Global Resource Private Equity Fund I LP (OGR). OGR was a fund-of-funds, with an investment strategy that involved investment in other private equity funds. OGR’s marketing materials and quarterly reports stated that the Fund’s asset values were ‘based on the underlying managers’ estimated values.’ According to the SEC, however, Oppenheimer shifted its valuation methodology with respect to one of the private equity funds in OGR’s portfolio, causing it to be valued at a significant markup to the underlying manager’s estimated value.” (Ropes & Gray)

3.       Questionable tax strategies:

“The New York Attorney General’s Office is investigating numerous private equity firms for converting the fees charged for managing investors’ assets into fund investments. The practice, known as a ‘management fee waiver’ or ‘fee-waiver conversion,’ occurs when private equity firms grant investors a waiver of their management fee—typically charged at 1 percent to 2 percent of investments—in exchange for being able to use that capital as their own investment income in the fund.” (Jeffrey Legault, Mark Pedretti, and Pablo Quiñones at Reed Smith)

4.       Unpaid liabilities of acquired companies:

“A federal district court in Indiana recently ruled that a plaintiff’s class action lawsuit could proceed against both a New York private equity firm and one of its portfolio companies for an alleged violation of the Worker Adjustment and Retraining (WARN) Act when the plastic components manufacturing facility where the plaintiff worked closed. The decision is significant to private equity because it delineates the factors under which a court may determine that a private equity firm itself may be liable for the employment decisions of its portfolio companies.” (David Posner at BakerHostetler)

5.       Antitrust problems:

“The Antitrust Division of DOJ has been investigating whether certain private equity firms colluded through so-called ‘buying clubs’ or ‘club deals’ to lower the purchase price of leveraged buyout targets. The investigations have spurred private suits against the private equity firms, in some cases costing the firms in excess of $100 million in legal fees.” (Legault, Pedretti, and Quiñones at Reed Smith)

The updates:

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