Last week, a private fund manager and its principal settled with the U.S. Securities and Exchange Commission (“SEC”) in connection with the principal’s purchase of limited partner interests from investors in the manager’s fund based on stale year-end pricing, when the manager and its principal had received financial information indicating a materially higher valuation since year-end.
The consent order1 alleged that:
- The manager advised a 17-year-old private equity fund with two remaining portfolio companies;
- Given the age of the fund and small value of remaining investments (approximately 4% of called capital), certain limited partners requested that the manager offer liquidity;
- The manager determined to make an in-kind distribution of the remaining portfolio companies to the partners and, in connection with such distribution, the manager’s principal determined also to make a cash offer to limited partners to purchase their interests in the portfolio companies at the year-end value determined by the manager; this offer was communicated to investors in April, together with a description of the recent down performance of one of the portfolio companies;
- Shortly after the April communication to investors, the manager received financial information from the two portfolio companies showing improved results and resulting in the manager’s finance department increasing the valuation by a material amount from the year-end valuation that had been previously shared with the fund’s investors; and
- In May, 80% of investors had accepted the principal’s cash offer; the manager thereafter determined to terminate the distribution in kind and proceed with the principal’s cash offer for interests based on the year-end valuation; the communication did not discuss the potential increase in valuation from year-end and the manager did not make a timely delivery of financial statements for the quarter to the limited partners reflecting improved results.
In the consent order, the SEC found that the manager and its principal violated the antifraud provisions of the Investment Advisers Act of 1940 (“Advisers Act”) by failing to disclose the increased valuation of the portfolio companies. The manager and its principal agreed to a cease and desist from further violations and to pay a civil money penalty of $200,000.
This consent order emphasizes the Advisers Act fiduciary duty to disclose material facts to investors, including in end-of-fund life situations seeking investor liquidity. Managers should be particularly attentive to such obligations when purchasing investor interests in their funds given the potential for information disparity between the manager and fund investors.
1. See Consent Order.↩
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