Top 5 Regulatory and Litigation Risks for Private Funds in 2018
It might appear unnecessary to forecast litigation and regulatory risks due to the ever-increasing public equity markets and private equity fundraising, which is in a record-setting all-time high. However, business litigation follows capital and the risk of regulatory investigation and litigation increases with the gradient of the growth curve. Based on this background, Proskauer postulated 5 main regulatory and litigation risk for private funds in 2018 which include:
1. Regulation of both Cryptocurrencies and ICOs:
Fintech has witnessed the emergence of Cryptocurrencies and other related financial instruments that are supported by blockchain technology. There are now numerous Initial Coin Offerings (ICO) that the SEC have had to exercise control over this product, the SEO has now gone ahead to pursue a structure that will identify violators of the anti-fraud provisions and registration violations involving cryptocurrencies and ICOs. There are already ongoing cases currently being handled by a number of enforcement attorneys in the SEC’s newly established Cyber Unit, which focuses primarily on investigating cryptocurrencies and ICO. In addition, under the Commodity Exchange Act, virtual currencies like Bitcoin are commodities can now be investigated by CFTC. In fact, the CFTC has already commenced some slammed some industry participants by acting on the anti-fraud provisions of the Commodity Exchange Act. The rippling effect has swept throughout the financial sector with fund managers susceptible to increasing investigation and regulatory scrutiny on ICOs related investments.
2. Potential Disputes against failed Unicorns:
The IPO market is gaining ground, company valuations now limit opportunities for liquidity and future funding rounds, thus positioning unicorns as a high-risk investment for private investors. The impending situation means that future funding rounds that are lower than recent company valuations could result in disputes among investors or also in the circumstances when investors are exiting a company, thus, requiring investigations by SEC. This situation played out in recently when a tech company in the healthcare sector, Theranos failed, the failure of more unicorns will, therefore, increase the regulatory investigations and private litigations given the huge amount of investment lost when a unicorn fails.
3. Increasing privacy and data security risks:
The importance of cybersecurity cannot be overemphasized, there have been increasing numbers of sophisticated cyber-attacks targeting more private fund advisers and even data protection specialist, with the targets falling prey every time. The SEC had issued an earlier warning, alerting fund advisers of the impending risk and how there are no existing barriers to thwart these threats, especially as there is no proactive cybersecurity policies and outlined procedures to reduce the damaging effect of these cyber-attacks.
4. Focus on Fund Performance Marketing:
Recent amendments to the Investment Advisers Act of 1940, the establishment of risk alert by the National Examination Program and its recent enforcement points to the obvious problems surrounding fund performance marketing. The focus on performance marketing becomes important as private investment funds sponsors have to maintain high-performance presentations so as to be able to retain existing investors and attract potential investors.
5. Regulatory Focus on the Use of Subscription Credit Facilities:
In a bid to increase returns on investments for investors, sponsors of various investment funds have continually optimized their fund’s structures, putting into place systems like subscription credit lines that enable them to expedite swift portfolio investment opportunities whenever they need to.
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