[PPT] - Private Equity Fund Formation in 2013 Navigating JOBS Act, State PowerPoint Presentation

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Private Equity Fund Formation in 2013

Navigating JOBS Act, State Adviser Registration, SEC "Bad Actor" and "Red Flag" Rules, and the EU's AIFM Directive

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TUESDAY, NOVEMBER 5, 2013

Presenting a live 90-minute webinar with interactive Q&A

Scott W. Naidech, Partner, Chadbourne & Parke, New York Adam D. Gale, Partner, Mintz Levin Cohn Ferris Glovsky and Popeo, New York Jonathan R. Talansky, Partner, Mintz Levin Cohn Ferris Glovsky and Popeo, New York Edouard S. Markson, Partner, Chadbourne & Parke, New York

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MINTZ LEVIN

Mintz Levin Cohn Ferris Glovsky and Popeo PC

Strafford Webinar: Private Equity Fund Formation in 2013

Presentation (November 5, 2013) by Scott Naidech, Chadbourne & Parke LLP Adam Gale, Mintz Levin Jonathan Talansky, Mintz Levin Edouard Markson, Chadbourne & Parke LLP

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MINTZ LEVIN

Mintz Levin Cohn Ferris Glovsky and Popeo PC

Goals of Presentation

Describe significant changes impacting private equity fundraising in 2013
Describe recent market trends, including structural changes taking place in

the market

Highlight changes in “market” terms, including ILPA changes and other

market impacts

Summarize certain new regulations impacting PE funds (including Dodd-

Frank, state adviser registration, broker-dealer issues, JOBS Act, Bad Actor Rules, AIFMD, Red Flags, Volcker Rule)

Sun Capital decision – Ramifications for PE Funds
FATCA update

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1. What do we mean by “Private Funds”?
Any (i) “blind pool” vehicle (ii) invested by a sponsor (iii) who
ften receives a management fee and profit participation (known

as a carried interest or performance fee) (iv) offered to qualified high net worth investors only

For purposes of this presentation, “Private Funds” means

“Private Equity Funds”. For example, Venture Capital Funds, Growth Equity Funds, Buyout Funds, Real Estate Funds, Distressed Debt Funds, Mezzanine Funds, etc., investing in illiquid securities

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2. Key incentives for raising a Private Fund?
Key Economic Incentives for Sponsor Raising a Fund: Access to

private capital from alternative sources; Carried Interest and Management Fee

Key Economic Incentives for a Limited Partner Investing in a

Fund: Access to a diversified pool of investments in a targeted geographic region and/or industry being managed by a specified team of experts

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3. Recent changes in key incentives…
Ten years ago, most fund negotiations focused on economics;

five years ago…governance; in 2013…back to economics

Impacts on incentives altering the standard “2 and 20” model –

economy and fund size.

Volume: currently over 1,900 Private Equity and Real Estate

Funds looking to raise capital, seeking almost $800 billion

Total amount of probable commitments from this pool: only $250

to $300 billion/year.

Conclusion: less than one-half of fundraises will successfully

raise their target amounts.

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173 79 78 78 79 82 212 94 66 94 92 137 128 59 80 61 84 50 171 86 67 92 110 $105 $219 $361 $547 $665 $684 $318 $290 $325 $364 $269

100 200 300 400 500 600 700 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Q1 Q2 Q3 Q4 Full year

Following unprecedented highs, fundraising fell materially through the global economic downturn

($ in billions)

Capital committed to private investment funds by year of final close

Gradual stabilization since 2010 … the “new normal”

54%

Data and graphics compiled by Credit Suisse Private Fund Group. Source: Preqin, as of Jul-2013. Includes all Buyout, Distressed, Fund of Funds, Infrastructure, Mezzanine, Real Estate, Secondaries, Venture and Other (excludes Hedge Funds). Total fund size is accounted for in the year of a fund’s final

closing. Interim closings for funds that have not held their final closing are accounted for in the year of each closing, and amounts are rolled forward to the

quarter in which the final closing occurs. Capital committed in 2003-2007 is provided annually in the year of final closing. Data are continuously updated and therefore subject to change.

557 846 1,071 1,297 1,466 1,412 930 918 989 945 461

Number of final closings

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1,624 1,561 1,619 1,845 1,958 $888 $699 $607 $758 $770 200 400 600 800 1,000 1,200 1,400 1,600 1,800 2,000 Q4 2009 Q4 2010 Q4 2011 Q4 2012 YTD 2013

Number of funds raising Aggregate capital sought

Congested fundraising market has caused fundraising duration to increase significantly

Number of funds on the road and aggregate target(1) Time spent on the road for funds closed in Q2 2013(2)

Data and graphics compiled by Credit Suisse Private Fund Group. (1) Preqin, The Private Equity Fundraising, Q2 2013. (2) Preqin, The Preqin Private Equity Quarterly, Q2 2013. Represents months from fundraising launch to final close. (3) Preqin, average of Q1 – Q2 2013. (4) Preqin, Jul-2013. 16% 18% 19% 22% 16% 9% 5 10 15 20 25 1-6 Months 7-12 Months 13-18 Months 19-24 Months 25-30 Months 31-36 Months % of Funds Closed

Average time taken to close: approximately 19 months(3)

($ in billions)

Status of funds on the road(4)

56% of the over 1,900 funds on the road have yet to hold a closing, and the average fundraise is taking 19 months to complete

No close 56% 1st close 31% 2nd close + 13%

Funds yet to hold a first close seeking more than $380 bn 11

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Liquidity challenges for LPs are ever-present, but improving

Unfunded commitments remain high(1)

($ in billions) ($ in billions)

Duration of buyout dry powder(2)

$406 $559 $799 $1,002 $1,068 $1,062 $988 $1,007 $944 $1,025

200 400 600 800 1,000 1,200 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Buyout Venture Mezzanine Distressed Real Estate Growth Other

Drawdowns from and distributions to LPs (U.S.)(3) Net cash flow to LPs (U.S.)(3)

Data and graphics compiled by Credit Suisse Private Fund Group. (1) Preqin, Jul-2013. 2013 numbers are as of Jul-2013. (2) Preqin, Jul-2013. S&P Leveraged Buyout Review, Q1 2013. Bain, 2013. CS PFG Analysis. (3) VentureXpert, Jul-2013. Cash flow to LPs defined as cash distributions less drawdowns. Quarterly totals may not sum to annual totals due to rounding.

$49 $59 $78 $131 $113 $54 $85 $83 $64 $66 $66 $67 $79 $35 $23 $73 $89 $101 20 40 60 80 100 120 140 2004 2005 2006 2007 2008 2009 2010 2011 2012

Drawdowns Distributions ($ in billions) ($ in billions)

$86 $95 $230 $220 $80 $37 $83 $76 $73 $177 $258 $380 $442 $485 $484 $426 $391 $355 2.1 years 2.7 years 1.7 years 2.0 years 6.1 years 13.0 years 5.1 years 5.1 years 4.9 years 10 0 20 0 30 0 40 0 50 0 60 0 20 04 20 05 20 06 20 07 20 08 20 09 20 10 20 11 20 12

E quity value of buyout inves tm ents D ry p ow der for buyouts /years of sup ply at c urrent deal p ac e

$10 $8

$5
$7

$4 $9 $8 $17 $12

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10
5

5 10 15 20 Q 1 ' 11 Q 2 ' 11 Q 3 ' 11 Q 4 ' 11 Q 1 ' 12 Q 2 ' 12 Q 3 ' 12 Q 4 ' 12 Q 1 ' 13 12

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Changes of key incentives…

Larger managers compete for the same capital (from government

plan, pension plans, foreign institutions, sovereign wealth funds)

Face same pressures, which increases LP leverage in

negotiations

Pace of investment slowed creating “dry powder”
Management fees have provided greatest share of GP economics
Fund sizes are being capped at lower amounts
Greater competition for capital = lower fees and carry, greater LP

controls, increased fundraising periods, higher customization

Still, sponsors increase their negotiating leverage through certain

key differentiators, including higher performance, strategy diversification, oversubscription, better terms

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4. Who are the Sponsors of Private Funds?
Sponsors range in size from the largest asset managers in the

world to smaller first-time funds

Private Equity International released the “PEI 300” in May 2012:
1. TPG (Fort Worth, TX): raised $35.7 billion in capital for their Private Funds over

the last five years

2. The Carlyle Group (Wash DC): $32.8 billion
3. The Blackstone Group (New York): $29.6 billion
4. Kohlberg Kravis Roberts (New York): $28.4 billion
5. Warburg Pincus (New York): $26.0 billion
6. Goldman Sachs Principal Investment Area (New York): $24.6 billion
7. Advent International (Boston): $23.1 billion
8. Apollo Global Management (New York): $22.1 billion
9. Bain Capital (Boston): $19.4 billion

10.CVC Capital Partners (London): $18.0 billion

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Fee envy…

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US Buyout Fund I US Buyout Fund II Asia Fund US Mezz Fund US Real Estate Fund GP GP GP GP GP Investment Adviser

Sponsor

Each Fund pays a Management Fee to the Investment Adviser…can result in large aggregate fees that alter incentives (from carried interest based to fee based); thus downward fee pressure Each Fund pays a Carried Interest to the GP (or an affiliated entity) Carry Management Fees

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Zombies!

Pressure on smaller and mid-sized managers to reduce fees and

fundraise

Given the reduction in commitments and increased pressure, it is

possible that a significant portion of existing fund managers will cease to continue meaningful operations, becoming so-called “zombie funds”

Governance provisions in some fund agreements may be

inadequate to handle orderly liquidations/terminations/Key Person events/removal events (fund agreements often infer that the team will remain in place to raise a subsequent fund)

While the process may be clear, the cost of implementing may

discourage a single LP from pursuing.

There may be little or no economic incentive for the GP to initiate the

process.

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Fee anxiety…

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Fund I ? ? ? ? GP ? ? ? ? Investment Adviser

Sponsor

For advisers with fewer funds under management, downward pressure on fees by the “market” means smaller budget, leaner staff, harder to pay consultants and advisors…less overall fees to manage the team. Carry Management Fees

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Results…

Overall result:
increased LP leverage and lower capital commitments alter dynamics
f negotiation
longer fundraising periods
greater investment strategy definition
lower fees and carry
greater LP participation in investment process
co-investment rights
deal-by-deal opt-outs and investment vetoes
(some of these are covered later in presentation from a legal perspective)
“Classes of LPs”: concern that larger LPs have leverage and can

therefore negotiate better terms in side letters, or in separate parallel or co-investment funds

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LP portfolio managers (like sponsors) face pressures too…

Because of the economic turmoil of the past four years, investors

are unable to achieve adequate returns from more traditional portfolio allocations, e.g., publicly-traded strategies

Lack of new contributions to trusts
Uncertain performance of North American and European stocks
Levels of distrust in Asian and Indian issuers and political

environments

Challenge: where to find new markets/or strategies for investment

that can provide one or more:

Current cash flow
Stability in interim valuations
Shorter investment horizons

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5. Recent Structures and Changes in Legal Terms
Institutional Limited Partners Association (ILPA)
Download ILPA Principals from www.ilpa.org
Private Equity Principles 1.0 published in Sept 09
Private Equity Principles 2.0 published in Jan 2011
Goals: to establish “best practices” regarding fund partnerships

between GPs and LPs

Three guiding principles:
Alignment of Interests
Governance
Transparency

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ILPA: a pretty good outline of issues and considerations…

ILPA: Outlines Key Principles and Concepts, along with reporting

templates

Economics:
carried interest calculation and waterfall structures (deal-by-deal vs.

aggregate-return waterfall structures and considerations)

Management fee considerations, along with GP Expenses and Fee

Income offsets

Clawbacks: Principles 2.0 contains detailed Appendix on Carry Clawback

Best Practices (e.g., considerations such as a guarantee or escrow; clarification that the GP clawback is net of taxes paid; other considerations based on the waterfall structure)

Governance:
Key Man events considerations
Investment Strategy considerations
Conflicts of interest, fiduciary duties and LP Advisory Committee

(Appendix A)

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…but not a checklist!

Transparency
Fee disclosures
ILPA standardized templates
Capital call and distribution notices
Annual and quarterly reports
Appendix C covers additional considerations on reporting
Not a laundry list of must-haves
ILPA: our terms are not to be applied as a “checklist”; each partnership

should be considered separately and holistically

Goal is to provide terms and principles to be considered and that will result in

better investment returns and a more sustainable private equity industry

Generally, considered more “pro-LP” and not the “market standard”; the ILPA

terms continue to be discussed, debated and augmented

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6. Hot areas for investments…
Hot Sectors
Healthcare
Technology
B-to-B
Software
Energy & infrastructure and other Real Assets
Global demand for energy especially in emerging markets
Renewables (driven by environmental regulations and macro events, e.g.,

Fukushima, reduction in coal capacity)

Hot Geographies
BRICs less “hot”, but…
Peru; Chile; Colombia
Turkey and MENA
Africa

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Other key terms being negotiated…

Key Man
New funds
Established funds
Removal Events
For Cause/other than for Cause
Mechanics and Voting
Clawbacks
Reporting
ILPA forcing standardization
Co-Investments
Pipeline
Disclosure
Securities concerns

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7. Public investments in alternative asset managers
Larger asset managers have over the last few years gone public
The Blackstone Group (NYSE: BX)
Kohlberg Kravis Roberts & Co. (NYSE: KKR)
Apollo Global Management (NYSE: APO)
Oaktree Capital Group (NYSE: OAK)
The Carlyle Group (NASDAQ: CG)
An investment in these shares may (or may not) relate to an

investment in their managed funds, carried interest, management fees, portfolio fee income, or other revenue streams

Public filings provide a wealth of information on the detail and

scope of their operations and aspirations

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1. Dodd-Frank – Investment Adviser Registration 2. State Investment Adviser Exemptions 3. Broker-Dealer Registration Issues for PE Funds 4. JOBS Act 5. Bad Actor Rules 6. AIFMD 7. Red Flags Rule 8. Volcker Rule

Regulatory Issues

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Exemption for advisers who solely advise private funds with assets

under management in the US of less than $150mm

In calculating assets under management, include both uncalled capital

commitments and outstanding investments; must calculate on a gross basis (i.e., amounts borrowed are included)

Venture capital exemption: Exemption for advisers who solely advise

“venture capital” funds

For exemptions, still need to file Part 1 of Form ADV
Real Estate Funds: No specific exemption for real estate ("RE") fund

managers, but depending on what the RE fund invests in, and how the investments are structured, the rules may not apply

1. Dodd-Frank: Investment Adviser Registration

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Non-US Fund Managers:

–

Foreign private advisers: Exemption for non-US advisers to private funds with small US client and investor bases (less than $25mm under management and less than 15 clients and investors in the US), and no place of business in the US

–

No filing at all required if meet that exemption.

–

Otherwise, should fit within the $150mm exemption, as long as not managing $150mm from an office in the US. Fund GPs:

Can rely on the Investment Manager’s filing, if certain requirements

are met Dodd-Frank: Investment Adviser Registration (Con't)

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Fund managers who are exempt from SEC registration still need to

check the investment adviser registration requirements of the state of their principal office and place of business

For most states (but not NY), solely under state rules if AUM under

$100 million

Some states have recently added additional requirements to meet the

state exemption

For example, California and Massachusetts:
For 3(c)(1) funds, can only charge carried interest to investors that are

Qualified Clients under Adviser Act definition

Must file Form ADV as Exempt Reporting Adviser
2. State Investment Adviser Registration Exemptions

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April 2013 – SEC Div. of Trading & Markets speech – new approach
Investment Banking/Acquisition/Disposition Fees
Fund manager (or affiliate) charges success fee to portfolio co. or to fund

for identifying sellers or purchasers , or structuring transactions

Unless 100% of that success fee is offset against fund management fees,

then SEC suggesting that fund manager must register as a B-D

Personnel in Marketing Department
Dedicated sales force, regardless of how compensated, "may strongly

indicate" B-D registration required

Paying Commissions to "Finders"
Beware of potential consequences – Ranieri matter; rescission
3. Broker-Dealer ("B-D") Registration

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Under prior rules, PE funds could not engage in any general

solicitation or general advertising when raising a fund

JOBS Act eliminated this prohibition, provided that:
Everyone who ends up investing in the fund is an “accredited investor”

(though "reasonable belief" standard still applies)

Fund takes “reasonable steps” to verify accredited investor status
Fund relies on Rule 506 – called Rule 506(c)
Reasonable Steps:
Fund determines what steps are reasonable
But just relying on investor reps or checking boxes is insufficient
Safe harbor (non-exclusive list) included in rules
4. JOBS Act – General Advertising

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Safe Harbor – Applies Only to Natural Person Investors:
(A) Income – IRS Forms and rep as to future income
(B) Net Worth – Bank/brokerage statements; credit report; rep as to liabs.
(C) Written Confirmation from: B-D, RIA, Licensed Attorney or CPA that

they have taken reasonable steps to verify within prior 3 months

(D) Prior investors who invest in subsequent close – certification
Otherwise – Facts and Circumstances Test as to Reasonable Steps:
Type of Investor (e.g., plan, entity, natural person)
Amount of information about investor
Nature of offering – how investor solicited; terms of investment

JOBS Act – General Advertising (Con't)

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SEC's Release – Tips on Reasonable Steps
High investment amount may be sufficient, with confirmation of no loan
Can rely on publicly available info (e.g., Form 990 for a tax-exempt)
Third party verification okay – if reasonable basis to rely on it
Potential Pitfalls
CFTC Registration Exemptions unchanged (e.g. CPO) – no public offering
State exemptions – may still have a restriction on general advertising
Non-US laws – especially on website
RIAs – must keep records of advertisements
Use of track record in general advertisements

JOBS Act – General Advertising (Con't)

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What Can Funds Do Under 506(c) Offering
Freely advertise and market
No restriction of website access – for US persons
Fund manager personnel can speak more freely to press and conferences
Freely use social media (but note RIA record-keeping)
No need to number PPMs (but still good idea)
Form D Amended – must indicate if relying on 506(c)
Reg S Offering – can conduct concurrent with 506(c) offering

JOBS Act – General Advertising (Con't)

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Cannot rely on Reg D of Rule 506 if fund manager and affiliates,

solicitors, fund investors with 20% voting power, or affiliated issuers have been subject of certain criminal, regulatory or civil proceedings

Persons covered go well beyond those under fund manager's control
Bad actor events go beyond list in Form ADV Item 11
Form D amended – must certify that have no disqualifications
Exception if did not know and "exercised reasonable care" by making

"factual inquiry into whether any disqualifications exist"

Waivers: can apply to SEC for "good cause"; regulator issuing order

determines disqualification not necessary

Events Prior to Sept. 2013 – Do not disqualify, but must disclose
5. Bad Actor Rules

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What Constitutes Exercise of Reasonable Care:
Scope of inquiry depends on facts and circumstances
SEC suggested reps and covenants sufficient for third parties, if have no

information to the contrary

For fund and affiliates own officers – additional steps may be necessary
For placement agents – may need to consult FINRA BrokerCheck
Action Items
Sub Docs – Incorporate Bad Actor reps for investors with 20% ownership
Employees – Complete Bad Actor questionnaire, and background checks
Placement Agent Agreements
Offerings lasting over one year

Bad Actor Rules (Con't)

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Who Is Covered
Any managing member, GP, director, executive officer, or other officer

participating in the offering, of:

Fund's investment manager
The Fund
Anyone paid remuneration for solicitation
Any affiliated issuer and any predecessor to the issuer
20% Beneficial Owners of Total Outstanding Voting Equity Securities
If some investors are non-voting, may affect 20%
Total outstanding – not by class

Bad Actor Rules (Con't)

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Now in effect and applies if meet any of the following:
Market to European investors
Fund vehicle is organized in Europe
Fund manager based in Europe (including a branch office)
Non-EU Fund Manager Marketing to European Investors
Need to comply with National Private Placement Regimes (NPPRs) in

each country where market – unless meet exemption

Or rely on "reverse solicitation"
Marketing not at direct or indirect initiative of fund manager
In 2015 – can become AIFMD authorized and rely on passport regime
6. AIFMD (Alternative Investment Fund Managers Directive)

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Exemption for Smaller Fund Managers
AIFMD not apply if manager has AUM below €100 million (~US$135M)
If fund not employ leverage, then AUM below €500 million (~US$690M)
NPPR Requirements
Must register with relevant country's regulator
Comply with rules on reporting to regulators and disclosure to investors
If began marketing prior to July 2013, have until July 2014 to comply, but

need to check each country's rules

AIFMD Authorized – may not be practical, as includes restrictions on

remuneration to fund managers AIFMD (Con't)

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Not apply to fund managers at all if not an RIA
Not apply to fund manager if no authority to redirect investor's

proceeds to third parties or others upon instructions from the investor

Need to check power of attorney if narrowly drafted
Not apply to fund manager if no investors are individuals
Does apply to fund manager if regularly lend money to permit investors

to make an investment in the fund, pending receipt or clearance of investor's capital

Not apply solely because fund itself borrows money pending receipt of

investor contributions

7. Red Flags Rule

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If Rule applies:

Must develop a written program designed to detect, prevent and

mitigate identity theft in connection with the opening of "covered accounts" (accounts for individuals)

Need policies and procedures to:
Identify relevant Red Flags indicating possible identity theft
Detect Red Flags that the program incorporates
Respond appropriately to any Red Flags detected
Ensure program is updated periodically
Continued administration, including obtaining approval from

CCO, training, oversight of service provider arrangements

Red Flags Rule (Con't)

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Volcker Rule generally prohibits banking entities, including affiliates of

banks, from engaging in, sponsoring or investing in private equity funds (and hedge funds), but the Rule is subject to a number of exceptions.

Volcker Rule also prohibits a bank from engaging in "proprietary

trading," but those are less relevant to funds.

Rule does not go into effect until July 21, 2014, and we are still waiting

for final rules to be promulgated.

Grandfather Provision: Regulators may, upon application by any

banking entity, extend the period

(i) for up to 5 years (until 2019)
(ii) to the "extent necessary to fulfill a contractual obligation that was in

effect on May 1, 2010” if fund is an “illiquid fund”

8. Volcker Rule

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The 3% Exception to the General Prohibition:

A banking entity may acquire or retain an ownership interest in a

covered fund if, among other things, it:

(i) owns not more than 3% of the total ownership interests in any single fund; and (ii) invests an aggregate amount not exceeding 3% of the banking entity's Tier 1 capital (i.e., the bank's regulatory capital) in covered funds as a whole.

Seed Investment Exception: There is an exception to the 3% rule to

allow the banking entity to make a seed investment in a fund (in which case it can own 100% of the fund) - provided that within one year of the covered fund's establishment, the banking entity must reduce its ownership to no more than 3% of the total ownership interests in the covered fund. Volcker Rule (Con't)

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Sun Capital & Private Equity Funds

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45

A PE Fund's portfolio company (SBI) was in

bankruptcy and stopped its contributions to a multiemployer pension plan (TPF)

TPF demanded payment of SBI's withdrawal liability

under ERISA

TPF also asserted that the PE Fund was jointly and

severally liable for the withdrawal liability under ERISA, on the basis that it was a "trade or business" that is "under common control" with the primary ERISA obligor (29 U.S.C. § 1301)

Sun Capital – Basic Facts

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46

No offices or employees
Report only investment income
Make investments with the aim of turning them around and selling them

at a profit

The Fund agreements vest the General Partner with authority to manage

the Fund, which includes managing and supervising investments.

GP receives a 2% management fee from the Fund, plus a share of profits
Subsidiary management companies provide management services to the

Fund's portfolio companies for a fee.

This fee results in an offset to the management fee owed by the Fund
The employees of the management companies are actively involved in the
perations and management of the portfolio companies' businesses.

Key Features of Sun Funds

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The Funds were in a "trade or business" under ERISA (and remanded for other

issues) – but the business of SBI itself.

Holding was based on the fact that the Funds were not merely passive investors

(as mere investment is not a "trade or business"), but were, through agents, "actively," "extensively" and "intimately" involved in the management, operation and supervision of SBI.

The court focused heavily on the management fee offset, characterizing it as the

"economic benefit" that most clearly distinguished the Fund from an ordinary, passive investor. – "It is one thing to manage one's investments in businesses. It is another to manage the businesses in which one invests" – "Under Delaware law, it is clear that the GP of [the Fund], in providing management services to SBI, was acting as an agent of the Fund."

The standard used by the court was not taken from tax precedent, but was held to

be not inconsistent with such precedent, including the Supreme Court's decisions in Groetzinger (1987), Higgins (1941) and Whipple (1963).

The Sun Capital Holding

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48

The Sun Capital decision emphasized the fee offset

arrangement as a key factor in its holding

Practitioners have historically expressed concern that

the offset arrangement gives rise to the characterization of the offending fees as having been received by the fund itself in respect of services performed "on behalf of" the fund

For this reason, management fee offsets are

commonly carved out of many LP covenants.

But isn't this just an economic arrangement? How

does it change the nature of the Fund's activities?

Management Fee Offset

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49

A Private Equity Fund that invests in securities of

portfolio companies treated as corporations for U.S. tax purposes is not engaged in a trade or business, notwithstanding the substantial managerial activities that the GP/Manager may conduct.

This is based on the fact that a PE Fund acquires

portfolio companies as investments with a view to long-term appreciation, doesn’t execute enough trades to be a "trader," and doesn’t have the customers that are necessary for "dealer" status.

Traditional View

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Sponsor – Ordinary income on gains?

– §1221(a)(1) – Investor vs. Trader vs. Dealer. "Promoter"?

Tax-Exempt Investors – UBTI

– Statutory exemption (§512(b)(5))

Significance of "customers" in both of these categories.

Further guidance would likely be necessary

Non-U.S. Investors – ECI

– Eligibility for trading safe harbor of §864?

Management fee deductions?

– Possible pro-taxpayer overall result What are the potential ramifications if a PE Fund is treated as engaged in a business for tax purposes?

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51

ECI/UBTI covenants and "opt-outs,"

availability of blocker/AIV structures

– Typically, the covenants and the definition of "ECI" carve out the activities of the Fund itself, as well as the management fee offset, which is typically contained in the Investment Advisory Agreement

LP waiver of unapplied balance of fee offset

– Usually elected upfront – Does it really help?

Common "Trade or Business" Provisions in Fund Documents

SLIDE 52

52

Case decided under ERISA, not IRC
Fund Sponsors should focus on covenants that go to

this issue

Courts can read PPMs and other marketing materials
The court did not really address the

"promoter"/"corporate developer" argument – "Promoter" characterization would have a more significant impact on PE funds – Possible change to taxation of carry without legislative action?

Key Takeaways

SLIDE 53

FOREIGN ACCOUNT TAX COMPLIANCE ACT (FATCA) Update

53

SLIDE 54

All Together Now: FATCA

Who Are You? (Townsend)
U.S. person
FFI
NFFE
I Don’t Know if I’m Coming or Going (Wainer/Fien)
U.S. person making payments
FFI making payments
FFI or NFFE receiving payments

54

SLIDE 55

Y’all Ready For This?

June 30, 2014
Last day of grandfather period
Accounts already open are “preexisting accounts”
July 1, 2014
Withholding begins on withholdable payments
New account opening procedures required
March 31, 2015
Reports due with respect to calendar year 2014

55

SLIDE 56

Sponsored Investment Entities

In general – Treas. Reg. 1.1471-5(f)(1)(i)(F)
“Registered deemed-compliant FFI”
Sponsoring entity must:
Register with IRS
Register sponsored entity with IRS (GIIN)
Be authorized to manage the FFI and enter into contracts on behalf of the

FFI (such as a fund manager, trustee, corporate director, or managing partner)

Agree to perform all participating-FFI requirements on behalf of the

MINTZ LEVIN

Mintz Levin Cohn Ferris Glovsky and Popeo PC

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN TO BE USED, AND CANNOT BE USED, BY ANY PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.