Conflicted Transaction in Support of a de-SPAC by a Private Equity Firm

On July 20, 2023, the Securities and Exchange Commission (“SEC” or “Commission”) brought a settled administrative proceeding against a private equity manager who caused its funds to invest in a de-SPAC transaction that was sponsored by entities owned by the firm’s principals¹.
The Commission also accused the manager of having insufficient policies and procedures and incorrectly filing 13D and 13G reports.
The manager paid a penalty of $1 million.

de-SPAC Conflicts – Between June 2018 and June 2021, personnel working for this manager formed entities that sponsored three SPACs. The principals owned between 25% and 60% of the sponsoring entities. Ultimately, the private equity funds advised by this manager invested $25 million, $7.5 million, and $5 million into a series of PIPE transactions supporting de-SPAC transactions which benefited the sponsor and the principals of the investment manager. One fund also purchased $15 million worth of SPAC shares on the open market. The manager did not properly disclose these transactions to investors and never sought approval from investors or fund advisory committees despite the fact that fund documents explicitly gave conflict resolution power to the advisory committees of the funds.
- Analysis:
  - While this case never addresses the quality and appropriateness of the conflicted fund investments, our experience is that sometimes managers overlook conflicts of interest for investments that they think would be accretive to their fund. This case is a reminder that the SEC focuses more on potential conflicts of interest than the quality of any individual investment and that conflict protocols need to be designed and followed even for the highest quality investment opportunities.
  - There is sometimes a reticence to engage LPACs in the private equity industry which could create regulatory risk similar to the one described here.

Lack of Policies and Procedures – The SEC order acknowledges that while the manager took “certain steps” to address the conflicts of interest associated with these transactions but did not implement written policies and procedures reasonably designed to address SPAC conflicts.
- Analysis – Conflicts with outside business activities are common and our experience is that most similarly situated managers would have sufficient policies in place to address these conflicts. In cases such as these, where fund formation documents provide for a defined process, internal policies and procedures should match the limited partnership agreements.

Recognizing Conflicted Transactions – Some transactions, while conflicted, could appear to be good investment opportunities. This case is a reminder that transaction quality does not remove regulatory risks and that private equity firms should involve compliance programs in the transaction process to the extent practical.
Market Pressure and Capital Stack Investing – The SPAC market cycle was quickly receding towards the end of 2021 and pressure to complete a de-SPAC transaction could have been one factor in this case. There are different pressures in today’s market including a tighter credit environment making some LBO transactions more difficult to close. This could give rise to more transactions where funds invest in different parts of a company’s capital stack, creating a capital stack conflict.
Policies Should Match LPAs – As in this situation, some limited partnership agreements have pre-designed conflict resolution procedures. Any internal policies should match anything already memorialized in the fund formation documents.

¹ Monroe Capital Management Advisors, LLC ADMINISTRATIVE PROCEEDING File No. 3-21533 https://www.sec.gov/litigation/admin/2023/34-97957.pdf (opens in a new tab)