Hidden conflicts in portfolio company cap structures, control and independence in minority investments, and more in the May 2016 edition of Fund Forum

5 min

This issue of Venable's Fund Forum provides guidance to funds on protecting against hidden conflicts in portfolio company cap structures. We discuss a recent court ruling and its potential impact on private funds holding minority positions in portfolio companies. We also share two important comments: Chair White's remarks on the critical role of compliance in protecting investors and Commissioner Stein's remarks on disclosure in the digital age. Finally, we discuss CCO liability and FinTech and marketplace lenders under scrutiny.

Funds Investing in Portfolio Companies Need to Protect Themselves from Hidden Conflicts Lurking in Later-Round Cap Charts

Consider the following: Your fund is offered the opportunity to co-invest at a level of five percent (5%) in a new C round. The good news is that (i) the portfolio company has real potential, (ii) other funds (including the fund calling you with the opportunity) invested in both the A round and B round, (iii) the company's valuation has increased for each round (and those increases are supportable), and (iv) more than half of the existing A and B investors (including the lead investor in the B round) have exercised their rights to co-invest in the new C round. It all "sounds good." But hold on.

In this article, we discuss hidden conflicts in portfolio company cap structures. Click here to continue reading.

"Control" and "Independence" in Minority Investments

A recent case involved a challenge to a proposed issuance of equity by a portfolio company (the Company) initiated by its largest stockholder, a private equity firm (the Firm). The plaintiffs in this case, a group of minority stockholders in the Company (the Plaintiffs), alleged that the transaction essentially amounted to a "squeeze-out merger" diluting their interests in the Company (the Transaction). Among other things, Plaintiffs alleged that the Firm breached its fiduciary duty, as a controlling stockholder, to minority investors (Count I). Defendants filed a motion to dismiss the complaint. The Court's ruling on the motion with respect to Count I underscores the nuances in the definition of "control" in a minority stockholder context and highlights the importance of electing truly independent directors.

Click here to learn more about the court's ruling and its potential impact on private funds holding minority positions in portfolio companies.

Chair White Comments on the Critical Role of Compliance in Protecting Investors

On April 19, 2016, Mary Jo White, Chair of the U.S. Securities and Exchange Commission, delivered opening remarks at the SEC's 2016 Compliance Outreach Program for Investment Advisers and Investment Company Senior Officers. Chair White re-emphasized the critical importance of protecting investors and the integrity of markets. She pointed out that both investors and the SEC rely on firms to establish "strong, comprehensive and effective compliance programs and cultures."

Click here for Venable's summary of the remarks.

Who is the New Twenty-First Century CCO?

CCO liability was a topic of feverish discussion at the recent 2016 SIFMA Compliance & Legal conference in Orlando. Representatives from the DOJ, SEC, FINRA, CFTC and OCC spoke out on this issue during panels throughout the three-day conference, and said all the right things, among others, CCOs are not "targets of investigations," although they may be relied upon to "provide factual evidence during an investigation."

Continue reading the article that reviews and analyzes recent discussions on CCO liability and the often impossible position in which CCOs may find themselves.

Commissioner Stein Comments on Disclosure in the Digital Age

On May 6, SEC Commissioner Kara Stein delivered remarks at the 48th Annual Rocky Mountain Securities Conference. Commissioner Stein's remarks focused on two initiatives: (1) a redesign of the EDGAR electronic filing system; and (2) the Disclosure Effectiveness project, which is designed to improve communications between companies and investors. Commissioner Stein asks us to "re-imagine disclosure and how information can be exchanged . . ." and argues that the SEC should conduct investor testing to better understand what is important to today's investors.

For Venable's summary of Commissioner Stein's remarks, click here.

FinTech and Marketplace Lenders Under Scrutiny

FinTech and marketplace lenders are fast realizing that the Consumer Financial Protection Bureau (CFPB), Federal Trade Commission (FTC), and even state regulators are focused on their activities. Recent announcements that the CFPB is taking consumer complaints on marketplace lenders and has established an office of small business lending means that lenders and service providers should prepare for the possibility of investigations and examinations in the not too distant future.

All of these developments point to the potential for increased federal and state regulatory scrutiny of marketplace lending and their service providers. In this article, we provide five tips for managing enforcement and compliance risk, along with several hyperlinks to relevant articles and presentations.

Upcoming Event:

Managing Risk in 2016: Prioritizing the Issues for Investment Advisers

Please Join Venable and NSCP for our inaugural Risk and Compliance (RCOM) Program, Wednesday, June 15 at 8:30 a.m. in Venable's New York City office.

Hear from Jane Jarcho, Deputy Director of SEC's Office of Compliance Inspections and Examinations.


Don Andrews, Partner, Venable LLP (Moderator)

Michael Manley, Partner, Venable LLP

Jane Jarcho, Deputy Director of SEC's Office of Compliance Inspections and Examinations (OCIE)

Robert S. Tull, Chief Compliance Officer and Operational Risk Manager, CBRE Clarion Securities LLC

Joseph D. McDermott, FRM, CSCP, Chief Compliance Officer, Aviva Investors Americas

Click here to register.

Click here to read past issues of Venable's Fund Forum.