Foreign Corrupt Practices Act (FCPA) enforcement is becoming stricter and is rapidly expanding into a number of areas; banking and finance being highlighted as particular regions of focus for potential investigations. There are steps that can be taken to avoid monetary penalties and a damaged reputation. Learn about the pitfalls that hedge fund and private equity managers can encounter and how to effectively prevent the risks of a potential violation.

The advisory is provided in PDF on the Alston & Bird website: www.alston.com/advisories/hedge-fund-FCPA

Written by Edward Kang, Partner, and Brian Frey, Senior Associate, Litigation & Trial Practice | Alston & Bird LLP  

The Delaware Court of Chancery recently issued a preliminary injunction in In re Del Monte Foods Company Shareholders Litigation (i) blocking the shareholder vote to approve the sale of Del Monte to a group of private equity firms led by KKR for a period of 20 days and (ii) precluding the enforcement of the deal protection measures, including the no-shop, matching-right and break-up fee provisions during that period, pending the shareholder vote to approve the transaction.

The court applied the traditional tests for determining whether an injunction was warranted: whether the plaintiffs have demonstrated (1) a reasonable likelihood of success on the merits; (2) an imminent threat of irreparable injury; and (3) that an injunction would not threaten more harm than good. Based on the preliminary record and not findings of fact after a full trial, the Court found that plaintiffs had satisfied those requirements with respect to their claims that the Del Monte Board had breached its fiduciary duty by failing to provide adequate oversight over its financial advisor, Barclays who, as a result of conflicts of interest arising from contemporaneously providing sell-side advice to the Del Monte Board and seeking to provide financing to the potential acquirors of Del Monte, “secretly and selfishly manipulated the sale process to engineer a transaction that would permit Barclays to obtain lucrative buyside financing fees” and taking actions that “materially reduced the prospect of price competition for Del Monte.” According to the Court, the Board did not act reasonably in consenting to Barclays participating in the buy-side financing because the board did not inquire as to whether KKR could finance the transaction without Barclays and granted its consent “without some justification reasonably related to advancing shareholder interests.” In addition, the Court was highly critical of KKR and Vestar, two members of the private equity group that agreed to acquire Del Monte, for allegedly making a joint bid in violation of anti-clubbing restrictions in the confidentiality agreements they signed with Del Monte and of Barclays for allegedly facilitating and hiding Vestar’s participation in KKR’s bid from Del Monte.

The Del Monte case highlights the need for a Board of Directors to carefully monitor and supervise the process pursuant to which a company is sold, particularly where its financial or other advisors may be alleged to have a conflict of interest. More active oversight by the Board and the earlier and more substantial involvement of unconflicted advisors can substantially reduce the risk that the adequacy of the Board’s oversight will be brought into question.

The Securities and Exchange Commission has proposed a rule to require registered advisers to hedge funds, private equity funds and other private funds to report information for use by the Financial Stability Oversight Council in monitoring risk to the U.S. financial system. The information reported and the frequency of reporting would depend on the adviser's assets under management, with larger fund advisers being subject to heightened requirements. The proposed rule will be published for comment for a period of 60 days.

The SEC has published its proposed preliminary rules to implement provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act that, among other things, (i) impose certain reporting requirements on hedge fund and private equity fund advisers, (ii) require limited reporting by advisers that are exempt from SEC registration and (iii) clarify the exemptions to investment adviser registration for venture capital funds, foreign private advisers and private fund advisers with less than $150 million in assets under management in the U.S.

The proposed rules will be subject to public comment before they are finally adopted. Comments on the proposals should be received by the SEC within 45 days after publication in the Federal Register.

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According to Standard & Poor’s, 2010 is on pace to match the annual total dividend-related financings during the 2005-2007 “Golden Age” of private equity.  A recent Wall Street Journal article, citing S&P, reports that companies have already sold $40.3 billion in dividend-related financing loans and bonds this year as compared to $56.2 billion and $55 billion in 2006 and 2007, respectively.

The latest in this wave of new dividend-related financings was announced by Hospital Corporation of America ("HCA"), the Tennessee-based hospital operator that was acquired for approximately $33 billion in 2006 by a leveraged buyout consortium led by KKR, Bain Capital and Merrill Lynch & Co.  HCA plans to pay a $2 billion dividend to its equity investors, which will be financed, in large part, through the sale of high yield bonds maturing in 2021 and yielding to bondholders a dividend rate of 7.75%.

The deal is structured as a “holding company dividend recapitalization,” a structure made popular during the pre-credit-crunch LBO boom, but disappearing after the crisis.  HCA plans to create a newly formed Delaware company, HCA Holdings Inc., to issue the bonds.  The new unsecured bonds will be funded by HCA’s operations and structurally subordinated to existing HCA debt.

Dunkin’ Brands, Burlington Coat Factory and Petco are among other companies that are raising new debt to return capital to their private equity sponsors.

As the number of M&A deals has increased over the last several months, so it seems has the amount buyers are agreeing to pay for the right to walk away from those deals. Before the recent economic downturn, reverse termination fees were generally around three percent of the purchase price. Now, the trend is for buyers and sellers to agree to reverse termination fees of five to twelve percent of the deal’s value. For example, in May, Silver Lake Technology Management, L.L.C. and Warburg Pincus LLC agreed to a reverse termination fee of 6.7% of the purchase price in their acquisition of Interactive Data Corporation, and Thomas H. Lee Partners, L.P. has agreed recently to reverse termination fees of 5.0% and 6.0%, respectively, of target’s equity value in its deals to acquire CKE Restaurants, Inc. and inVentiv Health, Inc. Last month, Irving Place Capital agreed to a reverse termination fee of 12.5% of the purchase price in its acquisition agreement for Thermadyne Holdings Corporation.

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Preqin Ltd. recently reported 70 secondary transactions through June 30, 2010, valued at $18.5 billion, which is over three times the $6 billion total for 59 reported transactions in 2009.  In Q1 of 2010, 24 secondary buyouts were reported, representing $7 billion in value.  Secondary buyout activity includes both transactions involving secondary sales of private equity funds and transactions involving the change of ownership of a company among private equity groups.  A recent example of secondary buyouts includes AXA Private Equity’s recent purchase of $1.9 billion in equity funds from Bank of America in April, 2010.  Other examples include TPG’s scheduled purchase of insurance software provider Vertafore Inc. from Hellman & Friedman and JMI Equity for $1.4 billion, and Goldman Sachs Group Inc.’s acquisition of refrigerated foods company Michael Foods from Thomas H. Lee Partners for $1.7 billion.  Following suit, in an estimated $3.1 billion buyout, private equity firms BC Partners and Silver Lake Partners have recently announced plans to purchase MultiPlan Inc., a health care company that is one of the largest U.S. independent preferred provider organizations, from Carlyle Group in the year’s largest secondary buyout to date.

During the 6th annual Aspen Ideas Festival held July 5-11, 2010, David Rubenstein, Co-Founder and Managing Director of The Carlyle Group, spoke in a CNBC interview about the current global private equity investment climate. According to Mr. Rubenstein, deal opportunities are not as robust in the U.S. and Western Europe compared to “large” emerging markets such as China, India and Brazil. He expects that by 2035 China and India will have, respectively, the world’s two largest economies. Because China is shifting from an export economy to a consumer economy, The Carlyle Group has invested in several Chinese consumer companies, including a fisheries company and a milk company.

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The final legislation resulting from the separate House and Senate financial regulatory reform bills is expected to be signed into law before the end of July. The Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Bill, will require many unregistered advisers of “private funds” to register with the Securities and Exchange Commission as investment advisers by narrowing or otherwise eliminating a number of the exemptions upon which private funds have historically relied to avoid registration – most notably the de minimis (less than 15 clients) exemption.

While the Dodd-Frank Bill offers other exemptions from registration for advisers of certain kinds of private funds, it does not contain the categorical exemption from registration for advisers to “private equity funds” proposed by the Senate version of the legislation. Instead, only advisers to venture capital funds and advisers of smaller private equity funds (less than $150 million assets under management) will be exempt from SEC registration requirements, subject to record keeping and reporting requirements to be determined by the SEC. Although the Dodd-Frank Bill does not define the term “venture capital fund,” it directs the SEC to do so within one year of the law’s enactment.

The relevant provisions of the legislation may be found here.

According to a recent survey by the Emerging Markets Private Equity Association and Coller Capital (the “Survey”), private equity investors plan to increase their investments in leading emerging markets like Brazil, China and India as well as other less penetrated markets like Vietnam, Indonesia and Thailand, anticipating higher returns. Sarah Alexander, President and CEO of EMPEA, noted “Investors are clearly drawn to markets with strong underlying growth rates, which trumps leverage in driving returns. LPs now see a mature group of fund managers with the skills and experience to capture the private equity opportunities fueled by growth and to minimize investor risk.” The Survey found:

• over half of limited partners (LPs) currently invested in emerging market private equity intend to accelerate their new commitments;
• emerging markets’ share of private equity investment will continue to rise;
• over three-quarters of LPs expect annual net returns greater than 16% from their emerging market private equity portfolio;
• almost three-quarters of LPs are satisfied or very satisfied with their emerging market private equity portfolio relative to their listed equity market equities; and
• more than half of LPs see the alignment of their emerging market managers just as strongly as that of their developed market GPs.

Congress is again considering a potential change to the tax rate applied to “carried interests” – a form of profit earned by managers of private equity firms, as well as buyout firms, hedge funds and venture capital firms. Consequently, professionals in these industries are bracing for a change and examining alternatives to their current fund structure. Summarized below is an introduction to carried interests as well as a summary of the current debate regarding taxation of carried interests.

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As of April 15, 2010, over 100 institutional investors had endorsed the Private Equity Principles (the “Principles”) published by the Institutional Limited Partners Association (“ILPA”) in September 2009. ILPA is a non-profit trade association whose members include some of the world’s largest investors in private equity funds. The Principles are a set of best practices developed by ILPA with a focus on “enhancing partnership governance, strengthening alignment of interests and improving investor reporting and transparency for the private equity industry,” according to an ILPA press release. ILPA hopes to “strengthen the long-term viability of private equity as an asset class.”

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The financial services industry experienced one of its slowest M&A markets in 2009, and strategic buyers dominated what little activity there was by taking advantage of distressed deals (mainly acquisitions of assets from FDIC receiverships and distressed loan portfolios) to gain market share, expand their geographic footprint,to build their portfolios and acquire strategic assets.

As the economy improves, there are reasons to be optimistic about M&A activity in the financial services sector. A recent report issued by PricewaterhouseCoopers (“PWC”) predicts an improved M&A market in 2010 with a more balanced mix of distressed and non-distressed deals and strategic and financial buyers.

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During the robust M&A market of the mid 2000s, prearranged financing terms were commonly included in (or “stapled” to) offering memoranda by sellers seeking bids in auction sales. The investment bank advising the seller would offer to provide debt financing on preset terms to all qualified bidders, usually giving the winning bidder the option, but not the obligation, to accept such financing. Such stapled financing provided several benefits to the seller, including increasing the number of bidders, creating a more robust auction, reducing the time necessary to sign a transaction agreement and possibly providing greater certainty of closing the sale. With the onset of the credit crunch in 2008, however, the willingness of lenders to provide stapled financing greatly diminished.

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