POLSINELLI FUNDS AND PRIVATE EQUITY DIGEST | 1 Polsinelli Funds and Private Equity Digest The Polsinelli Funds and Private Equity Digest highlights certain recent significant developments affecting advisers, broker-dealers, fund sponsors, mergers and acquisitions and a diverse range of investment funds and fund transactions including private equity, mezzanine and credit funds, real estate and infrastructure funds, fund-of-funds, venture capital investments, secondaries, co-investments, distressed investments and more. John T. Woodruff Shareholder Houston Edward J. Hannon Shareholder Chicago Frank Koranda Shareholder Kansas City “The Future Ain’t What It Used to Be” Impact of the New NOL Carryback Rules on M&A Transactions Introduction In March 2020, the CARES Act was signed into law, in part, to create fiscal stimulus programs intended to address the economic fallout from the global COVID-19 pandemic. While the Payroll Protection Loan Program has received much of the attention, there are many changes to the Internal Revenue Code (the “Code”) contained in the CARES Act. Among these changes is a provision that “undoes” some of the restrictive net operating loss carryback rules that were created in the Tax Cuts and Jobs Act in December 2017 (“TCJA”). Now that the use of NOLs has been expanded by the CARES Act, M&A advisors should revisit whether an NOL carryback is available when evaluating JULY 2020 | VOL. 3 CONTINUED ON PAGE 2 Table of Contents “The Future Ain’t What it Used to Be” Impact of the New NOL Carryback Rules on M&A Transactions 1 Simply Not Exceptional: Potential Changes Omitted from Volcker Rule Amendments 5 Advantages of Private Equity Minority Investments for Companies 7 DOL Reapplies Previous Definition of Investment Advice, Proposes New Fiduciary Exemption 9 OCIE Issues Risk Alert on Compliance Issues Involving Private Fund Advisers 10 Proposed Form 13F Amendment: Bringing Reporting Threshold into this Century 12 A Quick Look at Venture Debt 13 Other Recent Polsinelli Alerts 14
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POLSINELLI FUNDS AND PRIVATE EQUITY DIGEST | 1
Polsinelli Funds and Private Equity Digest
The Polsinelli Funds and Private Equity Digest highlights certain recent significant developments affecting advisers, broker-dealers, fund sponsors, mergers and acquisitions and a diverse range of investment funds and fund transactions including private equity, mezzanine and credit funds,
real estate and infrastructure funds, fund-of-funds, venture capital investments, secondaries, co-investments, distressed investments and more.
John T. WoodruffShareholder Houston
Edward J. HannonShareholder Chicago
Frank KorandaShareholder Kansas City
“The Future Ain’t What It Used to Be”Impact of the New NOL Carryback Rules on M&A Transactions
Introduction
In March 2020, the CARES Act was signed into law, in part, to create fiscal stimulus programs intended to address the economic fallout from the global COVID-19 pandemic. While the Payroll Protection Loan Program has received much of the attention, there are many changes to the Internal Revenue Code (the “Code”) contained in the CARES Act. Among these changes is a provision that “undoes” some of the restrictive net operating loss carryback rules that were created in the Tax Cuts and Jobs Act in December 2017 (“TCJA”).
Now that the use of NOLs has been expanded by the CARES Act, M&A advisors should revisit whether an NOL carryback is available when evaluating
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Table of Contents� “The Future Ain’t What it Used to Be”
Impact of the New NOL Carryback Rules on M&A Transactions 1
� Simply Not Exceptional: Potential Changes Omitted from Volcker Rule Amendments 5
� Advantages of Private Equity Minority Investments for Companies 7
� DOL Reapplies Previous Definition of Investment Advice, Proposes New Fiduciary Exemption 9
� OCIE Issues Risk Alert on Compliance Issues Involving Private Fund Advisers 10
� Proposed Form 13F Amendment: Bringing Reporting Threshold into this Century 12
a potential transaction. Further, for closed transactions, the new law may provide opportunities to unlock newly created economic benefits. This article is intended to provide a general overview of various considerations when evaluating and negotiating the carryback of NOL’s. This article is not a thorough or complete discussion of the technical tax rules that apply.
The Tax Cuts and Jobs Act Included a General Prohibition of NOL Carrybacks.
The NOL provisions of the Code have undergone significant changes over the past several years. Prior to the effective date of the TCJA in December 2017, NOL’s were allowed to be carried back two years and carried forward twenty. However, corporations were also subject to an alternative minimum tax, which generally limited utilization of NOL’s to 90% of alternative minimum taxable income. Thus, full utilization of an NOL often resulted in an AMT credit carryforward.
With the passage of the TCJA, significant changes were made to the NOL rules. For example, the TCJA limited the utilization of NOLs to 80% of taxable income. In addition, the TCJA eliminated NOL carrybacks altogether and allowed indefinite carryforwards. The TCJA also eliminated the alternative minimum tax for corporations and allowed existing AMT credit carryforwards to be refunded over a four-year period ending in 2021. Thus, prior to the passage of the CARES Act, the topic of NOL carrybacks and the potential value of NOLs was not typically a focus in M&A transactions.
Changes to the NOL Rules in the CARES Act.
As a result of the CARES Act, the TCJA’s 80% taxable income limitation on a corporation’s use of NOLs was eliminated
for tax years beginning before January 1, 2021. The CARES Act also accelerated the refund of AMT credits to tax years 2018-2019. Accordingly, because of the elimination of the 80% and the modification of the AMT refund rules for the 2018, 2019 and 2020 taxable years, the potential tax benefit created by an NOL has increased.
Perhaps more significantly, the CARES Act provides that an NOL arising in a tax year beginning in 2018, 2019 or 2020 can be carried back up to five years. These changes are intended to allow corporations to amend prior year returns and utilize losses, providing cash flow and liquidity during the pandemic-induced recession. Accordingly, the new NOL carryback rules create negotiation opportunities for parties to M&A transactions closing in 2020 and should be added back to the list of deal issues to be evaluated. In addition, the new NOL carryback rules create an opportunity to evaluate transactions completed in 2018, 2019 and 2020 to determine if historic tax returns can and should be amended to realize potential NOL benefits.
NOL Eligible Transaction Structure.
As a threshold issue, not all transaction structures allow for the carryback of a target corporation’s NOLs. Accordingly, among the first set of issues to consider is whether the proposed deal structure will allow for the carryback of losses. There are, of course, a host of other considerations that will drive deal structure. However, identifying the types of deal structures that will allow for the carryback of NOLs should become part of the deal structure analysis for 2020 M&A transactions.
Generally speaking, the acquisition of the stock of a target corporation will preserve the target corporation’s tax attributes.
Accordingly, if the transaction is structured as a taxable stock purchase, a “B” reorganization or a reverse triangular merger, the ability to carryback NOLs of the target corporation will generally be preserved. On the other hand, stock transactions and mergers that are treated as asset acquisitions for U.S. federal income tax purposes, will generally not preserve the target’s ability to carryback an NOL. Accordingly, asset sales, asset reorganizations, forward cash mergers and transactions in which an election is made under Code Section 338 or 336 to treat the stock purchase as an asset sale will not create a NOL carryback-friendly structure.
NOL Carryback Treatment Will Depend Upon Whether the Target Company Was Part of a Consolidated Group at the time of the Acquisition.
If the transaction structure preserves the target corporation’s tax attributes, additional analysis is required to determine the desirability of an NOL carryback. For example, the NOL carryback analysis is different depending on whether the target corporation was a member of a consolidated return group at the time of the transaction.
A. Target Is Not a Member of a Consolidated Group
If the target corporation is not a member of a consolidated return group and has a net operating loss in the year of sale or in a post-acquisition period beginning after December 31, 2017, and before January 1, 2021, the NOL may carried back to each of the target corporation’s five taxable years preceding the taxable year of the loss. In fact, unless the target corporation makes an affirmative election to relinquish the entire carryback period, the NOLs generated during the period beginning after December 31, 2017, and
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before January 1, 2021, must be carried back to the earliest taxable year to which they may be applied.
If the transaction structure preserves the tax attributes of the target corporation (e.g., a stock purchase) and the target corporation was not a member of a consolidated group prior to its acquisition, amending prior returns to claim NOL carrybacks should be within the control of the acquiring company (as the sole owner of the target corporation), provided that the carryback is not prohibited by the purchase agreement. For transactions that closed prior to the passage of the CARES Act, the purchaser should evaluate whether there is an opportunity to amend prior target returns to take advantage of the new NOL carryback provisions.
For transactions closing in 2020, if the transaction structure preserves the tax attributes of the non-consolidated target corporation, the new NOL carryback rules provide an opportunity for negotiations between the seller and the purchaser on amending prior returns to claim the benefit of an NOL carryback and the allocation of the economic benefits and timing of any NOL carrybacks between the purchaser and the seller. Practitioners should evaluate the risks and collateral concerns in respect of amending prior-year tax returns (e.g., amending an earlier return could subject such returns to additional IRS scrutiny). Additional considerations regarding these negotiations are provided later in this article.
B. Target Is a Member of a Consolidated Group
A different and more complex set of tax rules will apply where the target corporation was a member of a consolidated group prior to its acquisition. In general, when a member
1 For May 2020, the rate was 1.15%.
of a consolidated return group leaves the consolidated group, it becomes or ceases to be a member at the end of the day of the acquisition and its tax year ends for all Federal income tax purposes. In these circumstances, the net operating loss carryovers attributable to the leaving member are first carried to the consolidated return year, then are reduced for certain cancellation of indebtedness events and may be reduced under the unified loss rules. Absent the making of an affirmative election, if the target corporation is leaving a consolidated return group, its apportioned NOL remaining after running this gauntlet is carried back to prior periods, and then any remaining NOL is carried forward to its post-acquisition separate return year.
Where the target corporation was a member of a consolidated return group at the time of its acquisition, if the target corporation recognizes a post-acquisition NOL in 2018-2020, absent the making of an election to waive the carryback, the target’s NOL must first be carried back to the earliest return year available, which may be a consolidated return year of its former parent. In such a case, the refund would apparently inure to the former consolidated group parent (as agent for the group) rather than to the target. However, the target corporation can waive the carryback. Accordingly, there may be room to negotiate an allocation of the benefits of the NOL carryback between the parties notwithstanding the complexities associated with the effect of the carryback on the selling consolidated group’s broader tax return.
Additional NOL Rules to Consider
Ownership Change Limitation
Section 382 of the Code provides for an ownership change limitation on the
use of NOL carryforwards of the target company. Under Code Section 382, when a loss corporation undergoes an ownership change, the amount of its taxable income for any post-change year which may be offset by pre-change losses may not exceed the Code Section 382 limitation for such year plus an amount equal to any unused limitation from previous years. The Code Section 382 limitation is the value of the old loss corporation, multiplied by the long-term tax-exempt rate which is published monthly.1
Given the historically low interest rates over the last several years, an ownership change can have a very detrimental effect on the time value of a target corporation’s pre-acquisition NOL carryforwards. However, the limitation only affects the use of pre-change NOL’s to offset post-change income. Accordingly, losses attributable to the portion of the tax year preceding the change date can be carried back to pre-change years without being subject to an ownership change limitation. Post-acquisition date losses, of course, should not be subject to ownership change limitations upon carryback.
Collateral Effects of the NOL Carryback
A carryback of an NOL can have a number of collateral consequences in the carryback years. For example, the carryback of an NOL can affect the calculation of available foreign tax credits. Specifically, if an NOL carryback offsets foreign source income or creates a domestic loss, the amount of the foreign tax credit that could be utilized in the carryback year may be reduced or eliminated. Accordingly, prior to pricing NOL carrybacks into a transaction, the potential collateral costs in respect of foreign tax credits should be considered.
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The carryback of an NOL can also affect the application of the GILTI tax and the application of the BEAT rules. These considerations are complicated and outside the scope of this article.
Considerations for Valuing NOL Carrybacks in Purchase Agreement Negotiations
As noted above, taking advantage of the new NOL carryback rules and the elimination of the 80% limitation on NOLs requires up front analysis. Once the potential purchaser has examined whether the proposed structure chosen for the transaction is NOL carryback-friendly and whether, under the consolidated return rules, an NOL carryback would benefit the purchaser, the next step is to identify the value that these new NOLs rules create for the parties.
The relative desirability of a carryback depends in part on the tax rate applicable to the NOL carryback year. Because of the tax rate changes in the TCJA, post-acquisition date NOL’s are potentially worth more if carried back into pre-2018 returns provided that there is sufficient income in the pre-change years since the prevailing corporate tax rate for most corporations in those years was 34-35%. However, other valuation factors include the potential collateral effects of the election, the significance of ownership change limitations, if any, the collateral consequences of the carryback and the tax refund provisions of the purchase agreement.
The difference in the tax rates between post-TCJA and pre-TCJA years could produce both a cash tax benefit and, possibly, a financial statement benefit given that a post-acquisition date NOL carryforward generated in 2018-2019 would presumably have been valued at a 21% rate (as a deferred tax asset on the taxpayer’s balance sheet). In addition, since NOL carrybacks were previously
unavailable to most corporate taxpayers in 2018-2019, if those NOL carryforwards would otherwise have been subject to a valuation allowance, a carryback could produce a financial statement benefit. The elimination of the TCJA’s 80% taxable income limitation on the use of NOL’s also may provide a benefit. Finally, time value of money concepts are relevant since a refund today is worth more than a tax benefit tomorrow, all other things being equal.
In our experience, tax refund clauses tend to take one of several common forms. One common approach is for the transaction documents to contain a prohibition on the purchaser amending pre-closing returns of the target corporation. Alternatively, the transaction documents may state that no pre-closing tax return of the target corporation can be amended unless the purchaser first obtains the consent of the seller. For historic transactions, the purchase agreement will likely require the parties to negotiate an amendment (or consent) and an economic sharing of the benefit of the NOL carryback. For 2020 transactions for which NOLs are available, the parties may negotiate the process and mechanics of filing amended returns to achieve the intended economic result. As the ultimate amount of 2020 NOLs will not be known until the filing of the 2020 tax return in 2021, the parties must draft the purchase agreement to contemplate a to-be-determined value and the process by which any resulting benefit is allocated.
When evaluating the benefits of a carryback, the seller (in the case of a consolidated target) and the target will need to consider the collateral effects of the carryback on its overall tax position. In this regard, the purchaser likely will not have visibility into the seller’s pre-closing consolidated returns or the concerns that the seller may have with respect to reopening the target corporation’s tax
return to carryback the NOL. This factor may create negotiating leverage for the seller. On the other hand, the target’s ability to waive carrybacks creates leverage for the purchaser.
Conclusion
As discussed, the CARES Act included several provisions that allow for the greater use of an NOL of a target corporation arising during 2018-2020. Accordingly, an NOL carryback analysis should be added to the issues list for 2020 M&A activity and parties to closed corporate acquisitions should reconsider whether an NOL carryback is available and beneficial. Although this analysis may be complicated by the collateral effects of the carryback, the purchaser’s lack of visibility into some pre-closing returns, the mechanics of amending previous returns and the provisions of the purchase agreement, there may be significant benefits available for the well-advised.
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On June 25, 2020, the U.S. Securities and Exchange Commission (SEC), the Office of the Comptroller of the Currency, Treasury (OCC), the Board of Governors of the Federal Reserve System (the Fed), the Federal Deposit Insurance Corporation (FDIC) and the Commodity Futures Trading Commission (CFTC), or the “agencies,” adopted amendments to the “Volcker Rule” set forth in section 13 of the Bank Holding Company Act (the “BHC Act”). The Volcker Rule generally prohibits banks and certain other financial institutions from engaging in proprietary trading and severely limits the ability of those institutions to acquire or retain an ownership interest in, or sponsor or have certain other relationships with, a “covered fund.” The adopting release largely adopts the January 2020 proposed rules with a few clarifying changes based on comments.
Most significantly, the amended Volcker Rule will exclude from the definition of “covered fund” (a) venture capital funds, (b) credit funds, (c) family wealth management vehicles (i.e., single-family offices), and (d) customer facilitation vehicles (i.e., special purpose vehicles or “SPVs”). In addition, the release adopts a number of technical and clarifying
amendments, many of which codify positions that the agencies already had been taking. These relate to foreign qualifying funds, foreign public funds, small business development companies, qualified opportunity zone funds, certain securitizations, covered transactions, ownership interests, restricted profit interests, and parallel funds. Our alert on these changes is here.
While these amendments represent a significant expansion to the exceptions from the Volcker Rule, there are a number of notable changes not included within the amendments. Many of these were mentioned and not outright rejected in the release, they were not acted upon as the agencies deemed them to be outside of the purview of the proposing release. One of them was outright rejected, and others were never considered. The agencies did not adopt changes with respect to:
Long-term investment funds. The proposing release specifically requested comment on whether all long-term investment funds should be excluded, and the agencies explicitly declined to do so. Certain proponents, including Commissioners Hester Peirce and Elad Roisman, argued that interests in long-term investment vehicles should not be subject to the Volcker Rule to facilitate capital growth. That said, while Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, the statutory provision that led to the Volcker Rule, did not itself define “covered fund,” it explicitly stated that the rule was intended to limit the ability for financial institutions to invest in both hedge funds and private equity funds. This was reiterated in the adopting release. Both of these could be – and the latter of which almost certainly would be – long-term investment funds. That
said, there are many categories of private equity funds that do not involve leveraged buyouts and have characteristics more akin to venture capital funds. These were not noted by the release.
Early-stage equity investors that do not meet the definition of venture capital fund. Many funds that serve the purpose of and market themselves as angel, seed, or venture capital funds do not meet the technical definition of venture capital fund due to having too many non-qualifying investments – generally a 20% threshold. A “qualifying investment” is (i) an equity security issued by a qualifying portfolio company that has been acquired directly by the fund from the qualifying portfolio company (i.e., not in a secondary sale), (ii) any equity security issued by a qualifying portfolio company in exchange for a security described in (i) above, or (iii) any equity security issued by a company of which a qualifying portfolio company is a majority-owned subsidiary, or a predecessor, and is acquired by the fund in exchange for a security described in (i) or (ii) above. This is particularly common with overseas investment funds that, without U.S. investors, would not be subject to U.S. jurisdiction and otherwise would need not be concerned with the U.S. definition of a venture capital fund. It is also unclear what would happen if a fund ceases to qualify as a venture capital fund.
Venture debt, preferred equity and growth equity funds. These relatively new strategies were rarely seen when the Volcker Rule initially was adopted. Venture debt funds focus on investments in venture-stage companies through debt, hybrid equity, and related warrants. While venture capital funds and credit
Daniel L. McAvoyShareholder New York
Caroline C. SteckAssociate St. Louis
Simply Not Exceptional – Potential Changes Omitted from Volcker Rule Amendments
Simply Not Exceptional – Potential Changes Omitted from Volcker Rule Amendments
funds both have new exemptions, funds that combine those two strategies are not exempt unless equity is tied to the loans in a way that permits reliance upon the credit fund exception. Further, preferred equity funds that provide ‘prefs,’ which in some ways look similar to credit, would not be excepted. Preferred equity purchased by these funds typically looks similar to deeply subordinated covenant-lite (or no-covenant) debt where repayment comes solely or primarily from the distribution waterfall of the private equity fund or its portfolio company. Normally it is true equity, but the repayment mechanisms can be closer to debt than typical preferred stock. Last, growth equity and late-stage venture capital funds generally invest in pre-IPO rounds of venture-backed companies, often through secondary market acquisitions from founders and employees. This can reduce the pressure on unicorn emerging companies from prematurely going public. Under these circumstances, because the shares would not be purchased directly from the portfolio company, they would not constitute qualifying investments.
Real estate funds that cannot rely on exceptions from the 1940 Act other than Section 3(c)(1) – the 100 and under beneficial owner exception – or 3(c)(7) – the all qualified purchasers exception. Section 3(c)(5) of the 1940
Act excepts from registration most funds in the business of purchasing or otherwise acquiring mortgages and other liens on or interests in real estate. Rule 3a-7 under the 1940 Act also excepts most issuers of asset-backed securities, including most CMBS and RMBS. These funds were never captured by the Volcker Rule, although the amendments do provide a technical expansion of what is permitted. Many real estate funds are unable to rely on either of these exemptions. This could be due to holding impermissible assets, creating new forms of complex structured products, or giving these vehicles greater flexibility in their investment strategies. When such a real estate fund cannot rely on Section 3(c)(5) or Rule 3a-7, then typically it would need to rely on Section 3(c)(1) or 3(c)(7), making it a covered fund for purposes of the Volcker Rule.
Digital asset funds. In 2013, when the Volcker Rule was first adopted, cryptocurrencies were uncommon and other digital assets were all but unheard of. While many digital assets clearly are commodities, equity securities, or debt securities, it remains unclear which, if any, of those categories other digital assets may fall. Further, tokens that the SEC would treat as equity securities might not be qualifying assets for purposes of the venture capital exception simply because they technically are not
‘issued’ by the company to which they relate. There may be legitimate reasons why it could be unclear whether an equity-linked digital asset was actually issued by the company to which the equity relates, including if the token is intended to have shifting characteristics or there is an intent to decentralize those equity-like characteristics in the future. These distinctions will need to be clarified before it becomes clear that banking entities can sponsor or invest in certain types of these funds, which may hinder widespread adoption.
Multi-family offices. The new family investment vehicle exception is consistent with the treatment of family offices under the Advisers Act, which only excepts single-family offices. It can be difficult to maintain the single-family office exception. For instance, certain people who might be thought of as family, such as descendants of former stepchildren, may not be family members for purposes of the rule. Further, there are many ways that outside investors might be integrated with a family office, and it may be difficult for family members to maintain control of the family office. In these instances, family offices might need to look to non-financial institutions to sponsor their wealth management vehicles.
The final rule is scheduled to become effective October 1, 2020.
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For middle market companies that are not venture-backed, but rather are family- or founder-owned, minority investments by private equity (PE) or growth capital funds may be an attractive liquidity option. Until recently, private equity firms were doing a small number of minority investment transactions. More recently, there has been a spike in minority investment activities and the establishment of minority investment and growth capital funds by PE firms. Such investments pose advantages, as well as challenges, to both investors and the business owners.
A minority investment is one where the investor purchases an equity interest that represents less than 50% of the company’s entire outstanding equity interests on a fully diluted basis. Such an investment is often described as a noncontrolling interest, although there are control compromises, some of which are discussed below. By selling a minority share of the business, the business owner can obtain capital and possibly provide some liquidity to the owner while maintaining the business’s voting control. This approach is useful for business owners seeking growth capital or a partial liquidating event, but are uncomfortable relinquishing control to a private equity firm. It also presents an opportunity for an owner to obtain outside management, financial experience, expertise and resources that would otherwise not be available (e.g., lender relationships
that will finance add-on acquisitions).
However, this approach also has its disadvantages. Selling a minority investment will generally yield a discounted valuation compared to standard PE investments that require a controlling interest. The payback period is an additional consideration that is important for evaluating a minority investment. Further, there could be economic or other downsides if the business is unable to achieve enough value growth to justify both the discount and the financial obligations to be paid to the new PE partner.
Oftentimes, the PE minority investment will be in a preferred stock that includes a preferred, cumulative annual return, a liquidation preference and a participation feature. Here is an example of possible economics. A PE fund invests $10 million for preferred stock with a 7% preferred cumulative return, a liquidation preference and a participation feature. The preferred stock represents a 40% interest in the business. In order to complete the transaction, the PE fund causes the company to borrow $6 million. Five years later, the company sells for $35 million and at the time of the sale, the company owes $1 million of borrowed funds. The sale proceeds likely would be distributed as follows: $1 million to pay off bank debt; $4,025,517 to pay the PE fund the 7% cumulative return; $10 million to pay back the PE fund’s original investment; with the balance of $19,974,483 split 40% (or $7,989,793) to the PE fund and 60% or $11,984,689 to the original business owner. The original business owner would also cash out part of his or her original ownership interest at the time of the PE investment.
Even if a business owner continues to maintain voting control, the minority investor might negotiate for a number of veto rights. These may non-exclusively include the following:
1. amend, alter or repeal any provision of the certificate of incorporation or bylaws in a manner that adversely affects the powers, preferences or rights of the preferred equity;
2. create or authorize the creation of or issue any equity security or security convertible into or exercisable for any equity security, or incur or guarantee any indebtedness in excess of a particular amount;
3. declare or pay any dividends to any holders of any class or series of capital stock of the company, or purchase or redeem any capital stock (other than stock repurchased from former employees or consultants in connection with the cessation of their employment/services, at the lower of fair market value or cost);
4. increase or decrease the size of the board of directors;
5. sell, license (other than in the ordinary course of business), assign, pledge or encumber material technology or intellectual property, or enter into any material strategic acquisition of another person or acquire all or substantially all of the assets of another person;
Paul G. KlugShareholder St. Louis
Advantages of Private Equity Minority Investments for Companies
6. make any material capital expenditures unless set forth in an annual budget previously approved by the board;
7. other than an employee option plan existing as of the closing, establish, commit or grant of any profit sharing or equity-based compensation arrangements or increase or decrease of the units authorized under the company’s current option plan;
8. hire, terminate, approve or change any compensation or benefits arrangement of any senior-level employees with a base annual salary in excess of a certain amount;
9. approve the company’s annual budget with respect to any fiscal year of the company, or any deviation by more than 10% from the parameters contained in an approved budget with respect to the applicable fiscal year; or
10. directly or indirectly enter into, amend, modify or waive any rights under any agreement between the company or any operating subsidiary and any executive, board member, shareholder or any of their respective subsidiaries, affiliates and family members, including any employment agreement.
In addition to these veto rights, the PE minority investor might also request a “put” right that may force a purchase of the minority interest by the company or business owner, failing which the exercise of the “put” right may cause a sale of the business before the business owner would otherwise want to sell. The time period after which the “put” right will likely be operative will be five to seven years. A “put” right might provide that the preferred equity be redeemable any time upon the request of PE investor on or after an anniversary of the closing date at a price already set in the deal documentation. The “put” exit price may include the preferred return, a return of the original investment and a premium negotiated value. The business owner may negotiate a counter provision, providing that the business owner shall upon receiving such redemption notice have the right to either cause the company to redeem such stock or cause the company to be sold (and may go on to describe who will have control of the sale process with the PE investor likely reserving rights to participate in and approve the sale process).
A PE investor will also typically require regular financial reporting by the company, access to all financial information, one or more seats on or observers to the board of directors and a voice in some of the business’s operations. While the business owners may maintain control of the
board, the control will be subject to the PE investor’s veto rights, “put” right and rights to financial information.
Under the current COVID-19 slowdown, founders or family owners of a business that is operating with good fundamentals in an industry that has not been impacted significantly by the pandemic, who want to take some (but not all) of the chips off the table, team with a strong financial and operational partner, and continue to manage the business for the next 5+ years with potential upside, should consider seeking out a PE firm that provides minority investments. However, each owner should understand fully and be willing to accept the costs, obligations and control compromises that will be made before pursuing this strategy.
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On June 29, 2020, the U.S. Department of Labor (“DOL”) proposed a new class exemption from certain of the self-dealing and prohibited transaction rules in ERISA and the Code. This exemption will be available to investment advice fiduciaries and would allow such persons to receive compensation and engage in principal transactions that would otherwise be in violation of the laws above.
The proposed exemption, however, does not expand investors’ ability to enforce their rights in court or create any new legal claims above and beyond those expressly authorized in ERISA.
Investment Advice Fiduciary
Effective immediately, the DOL is reintroducing the five-part test the DOL established in 1975 to determine whether an investment adviser is a fiduciary. In 2016, the DOL had finalized a new regulation that would have replaced the 1975 test but for a Fifth Circuit ruling in 2018. The 1975 test applies to the definition of “fiduciary” both under ERISA and the Code.1
Under the reintroduced definition, a financial institution or investment professional is an investment advice fiduciary if such a person renders “investment advice,” and receives a fee or other compensation, whether direct or indirect. For advice to constitute “investment advice,” the financial institution or investment professional must:
1. render advice as to the value of securities or other property,
or make recommendations as to the advisability of investing in, purchasing or selling securities or other property;
2. on a regular basis;
3. pursuant to a mutual agreement, arrangement or understanding with a retirement plan, a plan fiduciary or IRA owner;
a. that the advice will serve as a primary basis for investment decisions with respect to plan or IRA assets, and
b. that the advice will be individualized based on the particular needs of the plan or IRA.
Proposed Exemption
Under the exemption, financial institutions and investment professionals could receive a wide variety of payments that would otherwise violate the prohibited transaction rules, including, but not limited to, commissions, 12b-1 fees, trailing commissions, sales loads, mark-ups and mark-downs and revenue sharing payments from investment providers or third parties. The exemption’s relief would extend to prohibited transactions arising as a result of investment advice to roll over assets from a plan to an IRA. The exemption also would allow financial institutions to engage in principal transactions with plans and IRAs in which the financial institution purchases or sells certain investments from its own account.
The exemption currently applies to registered investment advisers, broker-dealers, banks, insurance companies and their employees, agents and representatives that are investment advice fiduciaries. The proposal would also allow the availability of the exemption to expand to other persons based upon subsequent grants of
individual exemptions to additional entities that are investment advice fiduciaries that meet the five-part test and seek to be treated as covered financial institutions.
To qualify for the exemption, investment financial institutions and their investment professionals must comply with the Impartial Conduct Standards. That is, these investment advice fiduciaries must provide advice that is in the investor’s best interest, charge only reasonable compensation and make no materially misleading statements about the investment transaction and other relevant matters. The Impartial Conduct Standards would further require the investment advice fiduciary to seek to obtain the best execution of the investment transaction reasonably available under the circumstances, as required by federal securities laws. The proposal sets forth a definition for the “best interest standard” noting that the standard is to be interpreted and applied consistent with the standard in the SEC’s Regulation Best Interest and the SEC’s interpretation regarding the conduct standard for registered investment advisers.
Prior to engaging in a transaction pursuant to the exemption, an investment advice fiduciary must provide a written disclosure to the client acknowledging that the investment advice fiduciary and its agents are fiduciaries under ERISA and the Code, as applicable. The disclosure also would be required to provide an accurate written description regarding the services to be provided and any material conflicts of interest.
The proposal also includes some recordkeeping requirements. Investment advice fiduciaries would be required to establish, maintain and enforce written policies and procedures prudently designed to ensure that they and
Rafael Ramos AguirreAssociate Kansas City
DOL Reapplies Previous Definition of Investment Advice, Proposes New Fiduciary Exemption
their agents comply with the Impartial Conduct Standards. Financial institutions would also be required to conduct an annual retrospective review.
Exclusions
Financial institutions and investment professionals would be ineligible to rely on the exemption if, within the previous 10 years, they were convicted of certain crimes arising out of their provision of investment advice to retirement investors. They would also be ineligible if they engaged in systematic or intentional violation of the exemption’s conditions or provided materially misleading information to the DOL in relation to their conduct under the exemption. Ineligible parties could rely on an otherwise
available statutory exemption or apply for an individual prohibited transaction exemption from the DOL.
Additionally, certain specific transactions would be excluded from the exemption. The exemption would not extend to transactions involving ERISA-covered plans if the investment advice fiduciary, or an affiliate is either (1) the employer of employees covered by the plan, or (2) is a named fiduciary or plan administrator, or an affiliate thereof, who was selected to provide advice to the plan by a fiduciary who is not independent of the investment advice fiduciaries and their affiliates. The exemption also would not extend to transactions that result from robo-advice arrangements that do not involve interaction with an investment
professional. Finally, the exemption would not extend to transactions in which the investment professional is acting in a fiduciary capacity other than as an investment advice fiduciary.
Written comments and requests for a public hearing on the proposed class exemption must be submitted to the DOL by August 6, 2020. Given the short comment period, entities interested in making a submission are urged to request any assistance they may require as soon as possible. Note, however, that certain lawmakers have urged the DOL to extend the comment period. In the event the proposed rule is finalized, the exemption will be available 60 days after the date of publication of the final exemption in the Federal Register.
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OCIE Issues Risk Alert on Compliance Issues Involving Private Fund Advisers
On June 23, 2020, the SEC’s Office of Compliance and Inspections (“OCIE”) issued a Risk Alert identifying a number of key compliance issues observed in examinations of registered investment advisers that manage hedge or private equity funds. Because this alert relates to the antifraud provisions of the Investment Advisers Act of 1940 (the “Advisers Act”), this might also impact on private fund managers that are registered at the state level, are exempt reporting advisers or are entirely exempt from substantive regulation. The Risk Alert focuses on three specific types of deficiencies: (i) conflicts of interest; (ii) fees and expenses; and (ii) policies related to material non-public information.
Conflicts of Interest
The Risk Alert cites several conflicts of interest that investment advisers had failed to disclose adequately. These include:
� Conflicts related to allocations of investments among private fund clients, co-investment vehicles and separately managed accounts, including circumstances under which advisers preferentially allocated investment opportunities to certain clients over others, or allocated securities at different prices or in inequitable amounts.
� Conflicts related to multiple clients investing in the same portfolio companies, including situations involving clients investing at different levels of a capital structure (e.g., debt versus equity).
� Conflicts related to financial relationships between investors
and the adviser, such as economic arrangements with seed investors and providing investors with economic interests in the adviser.
� Conflicts related to preferential liquidity rights, including those provided pursuant to side letters or in undisclosed side-by-side vehicles investing alongside the fund.
� Conflicts related to the adviser’s interests in recommended investments, such as preexisting ownership interests, referral fees or stock options.
� Conflicts related to co-investments, including failure to follow proper allocation procedures and agreements to provide co-investment opportunities to some investors and not others.
� Conflicts related to service providers, such as requiring or permitting portfolio companies to enter into
service agreements with entities controlled by the adviser or its affiliates, and failure to follow procedures designed to ensure that affiliated service providers charged fees at market rates.
� Conflicts related to fund restructurings and stapled secondary transactions, including acquisitions of fund interests from investors at discounted rates, and requirements that purchasers of fund interests agree to a secondary transaction or provide other benefits to the adviser.
� Conflicts related to cross transactions, such as purchases and sales between clients, where the adviser sets the price in a way that disadvantaged the buyer or the seller.
Fees and Expenses
The Risk Alert notes that OCIE staff observed a number of issues related to fees and expenses that appeared to be deficiencies under Section 206 of the Advisers Act, which prohibits misstatements or misleading omissions of material facts and other fraudulent acts and practices associated with an investment advisory business, and Rule 206(4)-8, which imposes the same duty on fund managers in respect of the investors in those funds. These include:
� Allocation of fees and expenses, such as broken-deal, due diligence, annual meeting, consultants, and insurance costs, among the adviser and its clients, in a manner that was not consistent with disclosed allocation policies and procedures.
� Charging private fund clients for expenses not permitted by the fund documents, such as salaries of the investment adviser’s employees, expenses associated with compliance, regulatory filings, and other office expenses.
� Failure to comply with caps on expenses charged to investors pursuant to the fund documents.
� Failure to follow policies related to travel and entertainment expenses.
� Inadequate disclosure of the role and compensation of operating partners.
� Valuation of assets in a manner inconsistent with applicable valuation policies, in some cases resulting in charging of excessive management fees and/or carried interest.
� Failure to accurately calculate management fee offsets and incorrect allocation of offsets across advisory clients.
� Inadequate policies and procedures required to track receipt of portfolio company fees that were required to offset management fees, resulting in an overpayment of management fees.
� Negotiation of long-term monitoring arrangements with portfolio companies and accelerating future payments of the monitoring fees upon sale of the companies.
Material Non-Public Information
The Risk Alert notes that OCIE staff observed a number of deficiencies under Section 204A of the Advisers Act, which requires investment advisers to establish, maintain, and enforce written policies and procedures reasonably designed to prevent the misuse of material nonpublic information (“MNPI”) by the adviser, and under Rule 204A-1 (the “Code of Ethics Rule”), which requires registered investment advisers to maintain a code of ethics which, among other things, includes provisions reasonably designed to prevent the misuse of MNPI and addressing conflicts of interest associated with personal trading by individuals associated with the adviser.
Deficiencies under Section 204A of the Advisers Act and the Code of Ethics Rule included the following:
� Failure to address risks associated with the exchange of MNPI in connection with interactions of employees of the investment adviser with public
company insiders, outside consultants or “value-added investors” (described as corporate executives or financial professional investors that have information about investments).
� Failure to address risks that the investment adviser’s employees could obtain MNPI by accessing office space or systems of the adviser or its affiliates.
� Failure to address risks posed by the investment adviser’s employees who had access to MNPI regarding issuers of publicly traded securities, including in connection with PIPE transactions.
Deficiencies under the Code of Ethics rule included the following:
� Failure to enforce restrictions on trading of securities that appeared on the adviser’s “restricted list” or lacking appropriate policies and procedures for adding and removing securities from such lists.
� Failure to enforce provisions of the Code of Ethics governing gifts and entertainment provided by third parties.
� Failure to enforce provisions of the Code of Ethics requiring advisory personnel to provide information concerning holdings and transactions or to submit personal securities transactions for preclearance.
Key Takeaways
Advisers of private funds should review their compliance policies and procedures, including their Codes of Ethics, to ensure that the conflicts of interest and deficiencies highlighted in the Risk Alert are adequately addressed. In addition, advisers to private funds should ensure that they have mechanisms in place to enforce those policies and procedures in practice. Both managers and purchasers should closely look at conflicts of interest in secondary transactions and may want to include in the fund’s offering documents advance
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disclosure of the conflicts that may be present in a restructuring. Finally, while the Risk Alert did not apply to unregistered advisers and exempt reporting advisers, such as those relying on the venture capital fund adviser and private fund adviser exemptions, this
provides a good guidepost for how those managers can avoid violating the antifraud provisions of the Advisers Act. OCIE is permitted to – and does – examine exempt reporting advisers, and is likely to look at a lot of the same things in those examinations. The deficiencies
noted in the Risk Alert largely were under Section 206 and Rule 206(4)-8 of the Advisers Act. These laws apply to all investment advisers to private funds, whether or not they are registered or required to register.
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Proposed Form 13F Amendment: Bringing Reporting Threshold into this Century
1 Once the manager owns 5% of the public company, it would need to disclose that ownership on Schedule 13D or Schedule 13G.
On July 10, 2020, the U.S. Securities and Exchange Commission (the “SEC”) released a proposal to amend Form 13F (the “Form”) by raising the reporting threshold for filing the Form from $100 million to $3.5 billion, along with additional amendments to increase the identifying information provided by institutional investment managers and modernize technical aspects of the Form. This proposal would mark the first increase to the Form’s filing threshold in the 40 years since it was adopted in 1978.
Originally, any manager having investment discretion over certain “13(f) securities” with an aggregate value of at least $100 million was required to file the Form. This represented a fairly significant amount for institutional investment managers at the time of the Form’s adoption, consistent with the Form’s purpose of capturing the largest institutional managers. However, the industry has grown significantly in the past 40 years, with the overall value of U.S. public corporate equities increasing from $1.1 trillion to $35.6 trillion. Accordingly, much smaller managers
have found themselves subject to the Form’s compliance requirements.
The SEC’s proposal would increase the filing threshold to reflect the modern-day equivalent of the market share $100 million in U.S. equities represented in 1975. According to the SEC’s proposal, over 90% of the dollar value of holdings data currently reported will still be reported with the revised threshold. However, the new threshold would also relieve over 90% of smaller managers from the filings’ annual costs. According to the proposal, smaller managers spend $15,000 to $30,000 annually on compliance with the Form. The proposal posits that the adoption of the $3.5 billion threshold could save these managers up to $136 million in annual compliance costs.
SEC Chairman Jay Clayton stated that the proposal would “further the statutory goal of enabling the SEC to monitor holdings of larger investment managers while reducing unnecessary burdens on smaller managers.”
Among other changes to the Form, the SEC’s proposal includes a readjustment mechanism under which the staff would review the Form’s reporting threshold every five years and recommend adjustments to the SEC if needed. Additionally, the proposal would eliminate the ability to omit certain minor positions in holdings. This would require larger managers to report virtually all of their holdings, increasing the amount of transparency provided by the Form.
Finally, the proposal includes certain technical amendments to the Form to better suit the current filing format. The SEC states that the technical amendments will make the Form easier to understand and increase the accuracy of the data on the Form.
If adopted, the amendment may have two side effects. First, it would allow smaller managers to more easily ‘creep up’ to owning 4.9% of a public company1 without worrying that it would still need to be reported on Form 13F. Conversely, publicly traded companies might have less insight regarding who owns their shares.
The SEC will be accepting comments on the proposal for 60 days following its publication in the Federal Register.
Venture debt, or venture lending, is a type of debt financing provided to venture-backed companies by specialized banks or non-bank lenders to fund working capital or capital expenses, such as purchasing equipment. While a decade ago this strategy was only used by certain specialty lenders, it has become a more common form of investment strategy with many funds now specializing in this type of investment. Venture debt can complement venture capital and provide value to fast growing companies and their investors. Unlike traditional bank lending, venture debt may be available to startups and growth companies that do not have positive cash flows or significant assets to use as collateral. It also may be attractive to venture-backed companies where the backer does not want significant dilution to its equity.
Venture debt or venture lending was originally used to refer to equipment financing (venture loans and venture leasing) provided to early-stage companies. These startups needed to acquire physical assets, such as equipment, but lacked the cash flow for traditional debt financing. In the early 1980’s, lenders created a new type of venture debt financing. Generally, these lenders did not require physical assets nor cash flow. However, they focused on providing loans to startups backed
by well-known venture capital firms. The loans were structured to complement the equity provided by the venture capital firms, and were essentially secured by the enterprise value of the startup and the expectation that the venture capital investors would continue to fund the startup in subsequent equity rounds.
More recently, institutional investors have been aggressively seeking out higher-yield lending opportunities given the low interest rate environment. Venture debt caught their attention, which has led to a tremendous increase in the number of lenders and types of loans in the market. “Venture debt” has become an umbrella term for a broad range of non-dilutive and minimally-dilutive funding. The many types of “venture” debt range from working capital revolvers to synthetic royalty loans, often with warrants and some equity-like characteristics. Most venture lenders provide more than one type, including lines of credit, term debt, equipment financing and royalty monetization.
Benefits of venture debt include providing growth capital while avoiding or minimizing equity dilution, extending cash runway and providing a bridge between equity financing rounds. Venture debt may also allow the borrower to prepare for a capital raise round. It may also be easier for a borrow to obtain venture debt as opposed to traditional bank debt, as often times it does not require positive cash flow or significant assets to use as collateral. Venture debt may offer an alternative to raising equity from a venture capital (VC) firm or selling to a private equity (PE) firm. As opposed to a minority investment by a VC or
PE fund, venture debt may have more flexible terms, less negotiation over a potential loss of control and a quicker process.
Burdens of venture debt may include that the debt must be repaid, and there is often times equity participation with the use of warrants.
A business looking at venture debt should consider the structure (e.g. senior or subordinated debt and a potential equity kicker in the form of warrants to purchase common stock); term; amortization (whether it is interest-only and scheduled amortization); interest rate (higher than traditional debt); equity participation (warrants or other equity participation resulting in potential ownership percentage change); collateral requirements (secured or unsecured); restrictive covenants; control and governance (whether there might be board seat or observer requirements, and whether there needs to be management rights for the investor to qualify as a venture capital operating company); personal guarantees; access and audit rights; and necessity of an inter-creditor agreement.
CCPA – Enforcement is Coming, Ready or NotThe California Consumer Privacy Act (“CCPA”) went into force on January 1, 2020, with enforcement delayed until July 1, 2020. With estimates that around 500 billion companies are impacted, and the enforcement deadline recently passed, fund managers should be taking a number of steps to minimize their risks and their portfolio companies’ risks.
A number of these steps include (a) confirming if the CCPA is applicable, (b) understanding what types of personal information are processed, (c) updating privacy notices, (d) creating a plan for recognizing and responding to consumer requests, (e) reviewing rewards and incentive programs, and (f) ensuring sufficient security protocols.
This alert by Liz Harding, a privacy and cybersecurity shareholder from Polsinelli’s Denver office, describes in greater detail a number of steps that should be taken.
To read the full article, please click here.
Court Provides Additional Guidance on When Notes Are Not SecuritiesThe ruling in the Southern District of New York case Kirschner v. JPMorgan Chase Bank, N.A. (“Kirschner” ) affirmed the prevailing market view that notes representing syndicated loans are not “securities.” The leveraged loan market
has been operating for decades under the assumption that syndicated loans are not securities even though there has been no firm judicial or regulatory certainty to that effect. While this is a ruling from a lower court that does not create precedent, this
was a victory for the loan syndication and debt trading industries.
Among the Court’s considerations in the case was whether a syndicated term
Opportunity Zone Deadlines Extended by Coronavirus Disaster DeclarationsOn June 4, 2020, the IRS published guidance in Notice 2020-39 extending critical deadlines and rules relating to investments in qualified opportunity zones. First, any investors facing a deadline between April 1, 2020 and December 31, 2020 to invest their qualified capital gains in a qualified opportunity fund (“QOF”) now have until December 31, 2020 to invest those gains. Second, QOFs having a testing date between April 1, 2020 through December 31, 2020 for the requirement that 90% of its assets be invested in qualified opportunity zone property, and
fail the test, will automatically be granted relief from any penalty. The failure to meet the 90% test in 2020 will also be disregarded for purposes of determining whether the QOF meets the opportunity zone requirements for any tax year. The relief provided by these new rules is automatic, and no request or filings have to be made, though investors and QOFs must still file all required opportunity zone forms. The upshot is that essentially all QOFs are exempt from meeting the 90% test in 2020. Third, with respect to the requirement that existing property must be “substantially improved” within
30 months of its acquisition to be treated as qualified opportunity zone business property, the 9 months starting on April 1, 2020 and ending on December 31, 2020 is ignored in calculating the 30 month period.
This alert, by tax shareholders Jeff Goldman and Pat O’Bryan and real estate shareholder Korb Maxwell, contains additional detail as well as practice tips for those participating in the opportunity zone program.
loan was subject to state securities laws. The Court’s opinion rested on the “family resemblance test” from Reves v. Ernst & Young (“Reves” ) and further applied in Banco Espanol de Credito v. Security Pacific National Bank (“Banco Espanol” ). The four factors of the Reves Test are the: (1) motivations of the buyer and seller; (2) plan of distribution of the instrument; (3) reasonable expectations of the investing public; and (4) existence of another regulatory scheme. The court did not apply the so-called “Howey test” where an investment contract may be deemed a security if it involves an investment of money in a common enterprise with an expectation of profits from the efforts of others.
The Court found that the motivations of buyer and seller did not weigh in either
direction. However, the Court ruled that the second, third and fourth factors of the Reves Test weighed heavily in favor of finding that the notes were not securities. With respect to the second factor, the Court held that the plan of distribution was relatively narrow because the solicitation and purchasers of the Millennium notes were limited to small group of sophisticated investors, rather than to the general public. For the third factor, the Court concluded that the language of the transactions documents weighed in favor of finding that the Millennium notes were not securities because consistent reference to “loan” and “lender” throughout the credit agreement and confidential informational memorandum made clear that the parties had participated in a lending transaction, and not an investment in securities. Lastly,
the Court found that the fourth Reves factor, these being bank loans subject to regulation by other federal authorities, weighed heavily in favor of finding that the notes were not securities.
While Kirschner is important in upholding the market view that syndicated loans are not securities, the Reves Test, which is highly fact-specific. This alert by debt and claims trading shareholder Stephen Rutenberg, real estate finance attorney Naomi Burris and investment funds and securities shareholder Dan McAvoy highlights many implications of the case, discusses factors for lenders to consider to ensure their syndicated notes are not securities and outlines the case in greater detail.
To read the full article, please click here.
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SEC Announces Examination Priorities for Regulation Best Interest and Form CRSIn 2019, the SEC adopted Regulation Best Interest, colloquially known as Reg BI, which establishes a new standard of conduct for broker-dealers and persons who are associated persons of a broker-dealer when making a recommendation of any securities transaction or investment strategy involving securities (including account recommendations) to a retail customer. In addition, the SEC also adopted Form CRS which requires SEC-registered investment advisers and broker-dealers, including dual-registrants, to provide a brief relationship summary to retail investors.
The definition of “retail investor” for purposes of these rules is broader than under current FINRA and similar rules, including most individuals even if they
are sophisticated or high net worth. Accordingly, these rules may capture a much wider swath of broker-dealers and investment advisers than are subject to current rules pertaining to retail investors. In May 2020, OCIE released an extensive list of items that it would be focusing on in examinations pertaining to Reg BI and Form CRS. Since these are new rules, registered investment advisers and broker-dealers can expect that OCIE will focus on these items even in routine examinations.
This alert by investment funds shareholder Dan McAvoy, Band 1 Chambers-rated FinTech shareholder Rick Levin and corporate finance shareholder Peter Waltz details OCIE’s
focus on Reg BI and Form CRS in examinations. Furthermore, these three Polsinelli shareholders hosted a webinar on the topic How to Apply to Register with the SEC and FINRA as a Broker, Dealer or ATS
ContactFor more information about any of the articles in this volume of the Polsinelli Funds and Private Equity Digest, please contact any of the following members of the team. Special thanks to Dan McAvoy and Pete Vincent for editing contributions.
Polsinelli provides this material for informational purposes only. The material provided herein is general and is not intended to be legal advice. Nothing herein should be relied upon or used without consulting a lawyer to consider your specific circumstances, possible changes to applicable laws, rules and regulations and other legal issues. Receipt of this material does not establish an attorney-client relationship.
OCIE Releases Alert on RansomwareWhile cybersecurity has been a focus of fund managers and other financial market participants for quite a while, in mid-July OCIE released a further warning focusing specifically on ransomware. Per the alert, sophistication of these attacks recently have increased. Unlike most OCIE Risk Alerts, this does not identify specific areas that will be looked at more closely in examinations. Rather, it discusses the steps that it has seen registrants take to avoid ransomware attacks. These include:
� Assessing, testing, and periodically updating incident response and resiliency policies and procedures, such as contingency and disaster recovery plans;
� Determining which systems and processes are capable of being restored during a disruption so that business services can continue to be delivered;
� Providing specific cybersecurity training to help employees identify phishing e-mails;
� Implementing proactive vulnerability scanning and patch management, including setting anti-virus and anti-malware solutions to update automatically;
� Managing user access; and
� Implementing perimeter security to monitor unauthorized traffic.
To read the full risk alert, please click here.
Proposed California Legislation May Have Sweeping Effects on Health Care M&AThe California state legislature currently is considering a new bill that, if passed, would require California Attorney General consent and approval for a broad range of mergers, acquisitions, and affiliations in the health care sector. If passed, the legislation would apply to health care systems, private equity groups and hedge funds seeking to acquire or affiliate with a health care facility or provider and would impose additional
criteria for approval on transactions over $500,000. In addition to the consent and approval requirements, the bill would establish new substantive antitrust laws prohibiting health care systems from engaging in unilateral conduct that is not prohibited by current antitrust laws, including using market power to raise prices, reduce quality, reduce choice, increase cost or reduce access to hospital or health care services.
This alert, from Paul Gomez, Jonathan Buck, Mitchell Raup, Matthew Hans and Shuchi Parikh of Polsinelli’s Healthcare Department, Behavioral Health Law Group and Antitrust Group, describes in greater detail the scope of the proposal, the substantive provisions of the bill, items left unaddressed by the bill and its likelihood of passage.
