SEC Charges Middle Market Private Equity Firm with Violation of MNPI

Summary:

• On December 26, 2023, the Securities and Exchange Commission (“SEC”) settled an administrative proceeding with a middle market private equity investment manager¹ for violating Section 204A of the Advisers Act and Rule 206(4)-7.
• The adviser manages approximately $10 billion and executes a traditional middle market private equity strategy.
• The investment manager paid a $4,000,000 penalty, which is high for the conduct described in the SEC Order.
• This may be the first MNPI enforcement case brought against a middle market private equity firm, and one of the few enforcement cases focused on marketing statements made by a private equity adviser. No violations of the marketing rule were charged.

Allegations and Conduct:

1. MNPI related conduct –
   • The investment manager disclosed confidential and non-public concerning unconsummated mergers, strategy for auction bids, information about meetings with acquisition target management.
   • Many recipients of this information were investors, potential investors, and others who themselves had executed NDAs. However, the manager’s own policies and procedures defined MNPI broadly and required a “legitimate business purpose” and no such “legitimate business purpose” had been documented for the conduct in question.
   • The SEC appeared to rely heavily on policies outlined in the manager’s compliance manual as the basis of the 204A and 204(6)-7 violation.
     • Analysis:
       • Many smaller managers rely on their size being a structural protection from MNPI or insider trading claims, and this may be the first case to challenge that notion even though, given the size of the typical deal for a manager of this size, some might argue that that “materiality” prong of MNPI was not met.
       • Lack of documentation appeared to be key to the SEC’s MNPI legal theory. Specifically, there was no documentation supporting the “legitimate business purpose” required for MNPI sharing even though there is no evidence that such documentation was required by the manager’s compliance manual. The SEC did not make the argument that no “legitimate business purpose” determination was made. Rather no supporting documentation existed.
       • Many, if not most, middle market managers share this type of information with existing and potential investors during fund raising and should take note of this case.
2. Marketing related conduct –
   • The manager distributed materials claiming “embedded” or “built-in” gains in portfolio companies to entice investors to commit capital to the subsequent closes of an active fund.
   • The investment manager distributed claims such as: “We generally make 2-2.5x [return on investment] and 25-35 pc irr depending on the time it takes- [Fund] will be high because it happened fast, but still in the 2-2.2x range…. If we assume we can complete all the combinations in process [for the Fund], realize our usual synergies, and value the cos at a reasonable 8.25x [projected earnings], … an investor in [Fund] could be looking at a [dollar amount] plus imbedded gain in the context of a [dollar amount] [F]und that is 40 pc plus invested.”
   • The manager’s policies and procedures stated that all written communication distributed to more than one person required compliance review and approval and that valuations required Valuation Committee approval before distribution. The manager did not review every communication as required by their policy and the Valuation Committee did not approve every discussion about company or portfolio value.
     • Analysis:
       • While these statements appear aggressive, they are not uncommon during fund raising, especially in the current capital raising environment.

¹ OEP Capital Advisors; File Number le No. 3-21819