The spread of the coronavirus (COVID-19) continues to impact global financial markets and private funds. Private investment fund managers should consider—in addition to the potential economic exposure from unsteady financial markets—numerous risks to their businesses and the funds they manage from operational and other disruptions that may occur as a result of the global pandemic.
While fund managers are focusing on the impact of the COVID-19 virus on their portfolios, they should also keep in mind the range of industry-specific issues that have arisen as a result of this pandemic. In particular, managers should consider taking the following non-exclusive list of actions:
Monitor Business Continuity. Make sure that portfolio management, operations, and compliance functions can be seamlessly performed remotely
Prepare to Address Investors’ Concerns. Be ready to answer questions and have the following in place to field investor concerns:
Review Key Person Provisions: It will be important to review “key person” provisions in management agreements, partnership agreements, offering materials, and side letters to ensure that working remotely or potential illnesses to key persons do not trigger notification requirements and either suspension of the investment period or accelerated withdrawals. We recommend the following actions:
Confirm Service Provider Business Continuity. Confirm that the business continuity plans of key service providers are functioning properly in order to continue to deliver uninterrupted services and have fully shared contact data and authorization for accepting calls, emails, and other correspondence from remote locations. Key service providers include the following:
Assess Valuation and Liquidity. Consider the following issues associated with portfolio assets:
Hedge Funds
Private Equity, Venture Capital & Other Closed-End Funds
Furthermore, fund managers may be required to seek exit opportunities for illiquid investments for a variety of reasons (including, in the case of a closed-end fund, upon the expiration of such fund’s term, or, in the case of an open-end fund, to satisfy redemption requests). During a time of market disruption, sales of such investments may be unattractive, as they can yield lower prices. Managers should therefore consider whether to engage in “GP-led” secondary transactions or other bespoke transactions to provide liquidity to current investors, while allowing remaining investors and/or the managers to capitalize on the future upside of an investment. These transactions can take various forms, including single- or multi-asset spinouts into new vehicles.
Assess Potential Delay of Financial Report Delivery. Review all reporting requirements set forth in fund offering and governing documents and agreements such as side letters in order to determine whether
Consider New Risk Factors for Offering Documents. New launches and updates to existing offering documents should include one or more risk factors relating to the effects of COVID-19 on private funds and their managers. Managers should also consider supplementing existing offerings with risk factors. Risks could address, among other things: (1) The impact of the virus and market volatility on fund performance; (2) the possibility of significant breakdowns, delays, and other disruptions to the economy, systems, and reporting; (3) governmental interventions implemented on an “emergency” basis, including potential limits on certain trading, including short sales; (4) liquidity constraints; (5) potential difficulties to source, conduct diligence on, monitor, or exit investments; (6) potential insolvency of counterparties; and (7) the possibility that working remotely will not be effective.
Existing risk factors in offering documents should be reviewed and updated as necessary in light of recent events. Most registered managers are in the process of filing their annual Form ADV amendments. Consideration should be given to including COVID-19-related risk factors in Part 2A, Item 8.
Review Material Agreements. Material agreements with trading counterparties, key service providers, seed and other strategic investors, and investors generally (including side letters) should be carefully reviewed. We recommend the following:
Assess Compliance Infrastructure. Review compliance policies and procedures and ensure that designated persons are able to continue to perform these important functions:
Gauge the Ability to Meet Regulatory Filing Requirements. Managers will need to consider how to comply with certain regulatory filings and related requirements in light of potential COVID-19 business disruptions.
Note that the US Securities and Exchange Commission (SEC) recently issued an order granting relief relating to the Form ADV and Form PF filing and delivery requirements.[1] In issuing this relief, the SEC stated that it recognizes the challenges registered investment advisers and exempt reporting advisers (Advisers) may face as a result of COVID-19, including disruptions to transportation and the imposition of quarantines around the world that may limit access to facilities, personnel, and third-party service providers.
The relief provided under the Advisers Act (Advisers Act Order) provides up to an additional 45 days for Advisers to satisfy the filing and delivery requirements for the items set forth below, provided that, among other conditions, reliance is necessary or appropriate due to circumstances related to the current or potential effects of COVID-19:
The Advisers Act Order also requires that an Adviser relying on the order promptly provide the SEC via email at IARDLive@sec.gov (with respect to the filing of Form ADV or delivery of its brochure, summary of material changes, or brochure supplement) or at FormPF@sec.gov (with respect to filing Form PF) the following:
In addition, an Adviser relying on the Advisers Act Order with respect to the filing of Form ADV or delivery of its brochure, summary of material changes, or brochure supplement must disclose the aforementioned information on its public website (or if it does not have a public website, promptly notify clients and/or private fund investors).
Note: This relief is limited to filing or delivery obligations for which the original due date is on or after the date of the Advisers Act Order but on or prior to April 30, 2020.
In addition, the staff of the SEC’s Division of Investment Management (SEC Staff) issued a FAQ indicating that Advisers are not required to update either Item 1.F of Part 1A of Form ADV or Section 1.F of Schedule D to include temporary teleworking addresses of its employees, so long as the employees are temporarily teleworking as part of the firm’s business continuity plan due to COVID-19.
The SEC also stated that it will continue to monitor the current situation and may be willing to extend the time period for relief or provide additional relief as circumstances warrant. To the extent you have questions or would like us to raise particular issues with the SEC Staff, please let us know.
Custody Compliance/Audits
In light of COVID-19, private fund managers must consider whether annual fund audits may be delayed, which could impact a manager’s ability to comply with Advisers Act Rule 206(4)-2 (Custody Rule). While neither the SEC nor its staff have issued relief or guidance with regard to audits to date, we are hopeful they will provide additional deference to managers (and their accounting firms) that may find it impracticable to complete audits and distribute audited financial statements in a timely manner in accordance with the Custody Rule, in light of COVID-19-related disruptions. The SEC Staff has already updated its Custody Rule FAQ to address one COVID-19-related issue. Specifically, Custody Rule FAQ II.1 was updated to state that to the extent an Adviser inadvertently receives funds or securities from clients at an office location that is temporarily closed due to the firm’s business continuity plan in response to COVID-19, the SEC Staff would not consider the Adviser to have received client assets until firm personnel are able to access the mail or deliveries at that office location.
Electronic Signatures
Each manager should consider whether the manager and any fund administrator has the technological capabilities and appropriate procedures for investors, manager personnel, and administrator personnel to complete subscriptions, process transfers and redemptions, and execute fund agreements using electronic signature capabilities, and whether existing powers of attorney may be utilized for certain purposes. In particular, managers should consider whether their procedures would comply with the Electronic Signatures in Global and National Commerce Act (E-Sign) and applicable state law. Given the potential unavailability of notaries, managers should also review whether any notary requirement can be waived.
Employment Considerations
Many managers of private funds already have robust and tested business continuity plans that permit their personnel to continue to manage assets remotely in an uninterrupted manner. Others with employees working in an office, to the extent permissible, may have implemented policies to seek to prevent the spread of COVID-19. In any event, there are business considerations and legal requirements (often at the state and local level) that managers need to be mindful of with respect to their employees, including antidiscrimination and privacy laws, safe workplace obligations, potential business travel, and potential furlough and layoff issues. Visit our Coronavirus COVID-19 resource page for information about employee-related issues to consider.
Credit Facilities
As credit facilities are typically a key source of liquidity for funds, fund managers should be fully aware of any limits, covenants, and other obligations with respect to the fund's credit facilities. Even for funds that do not regularly use their credit facilities, but simply have them in place for unforeseen situations, the COVID-19 global pandemic may be such a situation, and fund managers should understand any limitations that may be in place for accessing such facilities.
In considering a fund's short-term and long-term liquidity needs (including situations where a fund may want additional liquidity to take advantage of opportunities in the market), fund managers should review the fund's credit facilities to determine what, if any, action needs to be taken or considered in light of anticipated liquidity needs. Managers may want to pay particular attention to whether
Derivatives and Counterparty Arrangements
Managers should consider the repercussions of COVID-19 on both cleared and uncleared derivatives transactions. For both cleared and uncleared derivatives transactions, managers should be in frequent contact with their counterparties and futures commission merchants to understand how the impact of the virus may affect a party’s ability to perform under the relevant contract or even its ability to communicate. In order to appropriately address events related to the virus as they unfold, managers will need to avoid unintentional events of default and other termination events. Conversely, managers may need to be able to declare events of default and termination events with respect to the counterparty if necessary. Below are some recommendations for managers:
For our clients, we have formed a multidisciplinary Coronavirus COVID-19 Task Force to help guide you through the broad scope of legal issues brought on by this public health challenge. We also have launched a resource page to help keep you on top of developments as they unfold. If you would like to receive a daily digest of all new updates to the page, please subscribe now to receive our COVID-19 alerts.
If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following members of Morgan Lewis’s investment management practice:
New York
Thomas V. D’Ambrosio
Christopher J. Dlutowski
Jedd H. Wider
Joseph D. Zargari
Washington, DC
Gregg S. Buksbaum
Courtney C. Nowell
Boston
Marion Giliberti Barish
Katherine Dobson Buckley
Richard A. Goldman
Gerald J. Kehoe
Daniel A. Losk
Stephen C. Tirrell
Philadelphia
Sean Graber
Timothy W. Levin
Christine M. Lombardo
John J. O’Brien
London
Simon Currie
William Yonge
Miami
Ethan W. Johnson
San Francisco
Peter M. Phleger
Orange County
Jarrod A. Huffman
Dallas
Carrie J. Rief
Tokyo
Tomoko Fuminaga
Tadao Horibe
Carol Tsuchida
Christopher P. Wells
Abu Dhabi
William L. Nash III
Alishia K. Sullivan
Dubai
Ayman A. Khaleq
Hong Kong
Alice Huang
[1] Order Under Section 206A of the Investment Advisers Act of 1940 Granting Exemptions from Specified Provisions of the Investment Advisers Act and Certain Rules Thereunder, Investment Advisers Act Rel. No. 5463 (Mar. 13, 2020).