I had lunch today with some veteran private equity litigators, and asked them to predict what they’ll be spending lots of time on over the next few years. Their response was swift and certain: Increased SEC enforcement of insider trading-type activities at private equity firms.
Government agencies already take a hard look at announced take-private transactions. For example, they automatically request lists of all individuals who had information about the negotiations, including winning bidders, losing bidders, bankers, lawyers, company executives and major shareholders. Sometimes there is even a second round of letters sent, in which recipients are asked to disclose relationships with a given list of individuals and/or institutions.
But that isn’t what the litigators were talking about. Instead, they expect increased enforcement over deals that don’t happen (thus triggering no automatic investigation). For example, what if a company is on the block, distributes private financial data to six PE firms but doesn’t get any offers? Or if a buyout firm cold-calls a private company, enters into quiet due diligence and learns that it’s drawn down $149 million of a $150 million revolving credit facility?
Both of those scenarios – plus dozens of others – are open to abuse by private equity professionals. Moreover, the temptation is magnified at firms with hedge fund or credit affiliates.
The attorneys I lunched with say that the SEC cannot possibly uncover all such cases, so instead would choose to make examples of one or two firms. This would include subpoenas of all firm emails, deal logs and the personal financial records of firm professionals. The result for private equity would be lost man-hours, massive legal fees and perhaps a few indictments (yeah, I believe most large organizations have at least a few potential crooks). As the attorneys said, it’s something to keep an eye on…