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Could This Be the Year to Start

Expensing Stock Options? page 3

Guest Column: Due Diligence –

A Duffer’s Delight page 4

Do Big-Boy Letters Really Work?

page 5

Making Sense of the New Tax

Rules Applicable to Confidential

Transactions page 6

China’s Revised Venture Capital

Rules: The Rule-Making Process

in China page 8

Indemnification by Stockholders

of Public Targets page 10

Going, Going, Gone? page 11

Convertible Preferred Shares

à la Française page 12

Alert:

German Funds Made Easier

page 28

What’s Inside

Securitization of Private Equity Fund Interests:What Every Fund Sponsor Should Know

The possibility of securitizing private equityfund interests has been under discussionfor several years now, in both the privateequity and asset-backed securities busi-nesses. To date, the institutions that havecreated securitized pools of interests inprivate equity funds have done so in orderto move these assets off their balancesheets, often to obtain regulatory capitalrelief. These pools are sometimes referredto as CFOs, which is shorthand for “collat-eralized fund obligations” and a take off onthe abbreviations for “collateralized debtobligation” funds (CDOs) and “collater-alized loan obligation” funds (CLOs). In a CFO, as in any securitization, assets – in this case interests in private equity funds– are transferred to a special purposevehicle (SPV). That vehicle, or anothervehicle that owns all or substantially all of the equity in the SPV, issues one or, typically, several series of notes and equityinterests to institutional investors. Themore senior of these notes often are rated.In a CFO, even more so than in mostsecuritizations, however, the assets beingtransferred into the SPV are highly illiquidand cash flows are unpredictable – distri-butions out of private equity funds are“lumpy.” These limitations and other busi-ness and regulatory concerns, discussedbelow, raise serious concerns aboutwhether private equity funds are an appro-priate asset class to be securitized, andmake these transactions difficult tocomplete. Thus, despite all of the talk aboutthe securitization of private equity fundportfolios, the number of such transac-tions that has been completed to date can

be counted on the fingers of one hand.Nevertheless, interest in CFOs remainsstrong. Now that more of these transac-tions are on the drawing board, sponsorsof private equity funds ought to be aware of the issues raised by CFOs.

During the past four months, threemajor financial institutional investors withsignificant private equity portfolios havenotified a number of our private equitysponsor clients that the financial institu-tions intend to securitize their portfolios ofinterests in private equity funds, includingfunds sponsored by our clients. Amongother things, these financial institutionshave asked our clients to consent to trans-fers of limited partnership interests in ourclients’ funds to SPVs formed in connec-tion with the securitizations. While a transferby a limited partner in a fund to an unaffil-iated third party raises certain business andlegal issues, generally these issues areeasily handled. A transfer in connectionwith a securitization, however, raisessignificant additional legal and businessissues, including (1) disclosure of con-fidential fund information,including potentially sensitiveportfolio company informa-tion, to unrelated third parties,(2) creditworthiness of thenew limited partner (the SPV),(3) increased risk of litigation,(4) tax and regulatory con-siderations, (5) anti-moneylaundering compliance issuesand (6) legal fees and expensesincurred by the fund sponsorin its review of the securitizationcontinued on page 14

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Volume 3 Number 3 Spr ing 2003

P r i v a t e E q u i t y Re p o r t

letter from the editor

Private Equity Partner/ Counsel Practice Group Members

The Debevoise & Plimpton Private Equity Report l Spring 2003 l page 2

Franci J. Blassberg Editor-in-Chief

Ann Heilman Murphy Managing Editor

William D. Regner Cartoon Editor

Please address inquiries regardingtopics covered in this publication to the authors or the members of the Practice Group.

All other inquiries may bedirected to Deborah BrightmanFarone at (212) 909-6859.

All contents © 2003 Debevoise & Plimpton. All rights reserved.

The articles appearing in thispublication provide summaryinformation only and are notintended as legal advice.Readers should seek specificlegal advice before taking anyaction with respect to thematters discussed herein.

The Private Equity Practice GroupAll lawyers based in New York, except where noted.

Private Equity FundsMarwan Al-Turki – LondonAnn G. Baker – Paris

Kenneth J. Berman–Washington, D.C.Jennifer J. BurleighWoodrow W. Campbell, Jr.Sherri G. CaplanMichael P. HarrellGeoffrey Kittredge – LondonMarcia L. MacHarg – FrankfurtAndrew M. Ostrognai – Hong KongDavid J. SchwartzRebecca F. Silberstein

Mergers and Acquisitions/ Venture CapitalAndrew L. BabHans Bertram-Nothnagel – FrankfurtE. Raman Bet MansourPaul S. Bird

Franci J. BlassbergColin Bogie – LondonRichard D. BohmGeoffrey P. Burgess – LondonMargaret A. DavenportMichael J. GillespieGregory V. GoodingStephen R. HertzDavid F. Hickok – FrankfurtJames A. Kiernan, III – LondonAntoine Kirry – ParisMarc A. KushnerRobert F. QuaintanceKevin M. SchmidtThomas Schürrle – FrankfurtAndrew L. Sommer – LondonJames C. Swank – Paris

The Debevoise & Plimpton Private Equity Report is a publication ofDebevoise & Plimpton919 Third AvenueNew York, New York 10022(212) 909-6000

www.debevoise.com

Washington, D.C.LondonParisFrankfurtMoscowHong KongShanghai

As we put this issue of The Debevoise & Plimpton

Private Equity Report to bed, it appears that Spring

has finally, at long last, arrived. In celebration of its

return, and, undoubtedly, of many of you to the fair-

ways, our Guest Columnist, Joseph F. Coughlin, a

Managing Partner at Corporate Risk Solutions LLC,

aptly uses a golf analogy to explain how the incred-

ible tightening of the insurance market over the last

year-and-a-half necessitates that private equity firms

carefully diligence the insurance marketplace as part

of their pre-bid processes.

In our cover article, Michael Harrell and Mia

Warren discuss the much-touted, but rarely completed,

transaction of securitizing private equity fund inter-

ests and outline the legal and regulatory constraints

that should make fund sponsors think carefully

before consenting to a securitization of its funds’

interests by institutional investors.

Elsewhere in this issue, David Mason reports that

FASB is once again considering making the fair value

method of valuing stock options mandatory in the

wake of recent corporate accounting scandals and

discusses the pros and cons of voluntarily adopting

the fair value method early.

From an overseas perspective, Jeffrey Wood, a

partner in our Hong Kong office, reports that while

the recently adopted 2003 Chinese foreign invest-

ment rules do not fundamentally change the overall

attractiveness of investing in China-based venture

capital funds, the rulemaking process illustrates

the surprising willingness of Chinese rulemaking

authorities to work constructively with industry pro-

fessionals. From Europe, we also describe structuring

techniques that can mimic some of the benefits of

convertible redeemable preferred shares notwith-

standing the absence of a class of preferred stock

under French company law.

Steve Hertz provides an interesting analysis of

the enforceability of “Big-Boy” letters given spare case

law and legal prohibitions against waivers of securi-

ties law protections. His article suggests key provisions

for private equity investors to include in such letters

to maximize the prospect of their being enforced.

Finally, in the context of a chilled deal environment

and with recent corporate scandals making all buyers

of businesses, both public and private, skittish,

Andrew Bab suggests that seeking a limited indem-

nity from stockholders of a public target may be just

the way to move a stalled deal forward.

These are just some of the topics we present in

this issue for your interest and consideration. As

always, if there is a issue of concern or a region of

interest to your business that you would like to see

addressed in these pages, we welcome your

comments and suggestions.

Franci J. Blassberg

Editor-in-Chief


Could This Be the Year to Start Expensing Stock Options?

It is usually taken as an article of faiththat a portfolio company should usethe “intrinsic value” method of APBOpinion No. 25 (Accounting for StockIssued to Employees) to account foroption grants to employees, becauseunder this method a fixed stock optiongranted with a fair market value exer-cise price will have no intrinsic value –no difference between the share valueand the exercise price – and thereforethe portfolio company would not recognize any compensation cost. Thealternative “fair value” method of FAS123 would require the company torecognize the value of an option calcu-lated under a Black-Scholes or othersimilar option-pricing model (usuallyrecognized over the vesting period).Because fair value is measured on thegrant date, all option grants have somevalue (even those that later wind upout of the money). When given thechoice between using a method thatrequires a compensation cost to berecognized or one that does not, thedecision to use the no-cost approachwould seem to be an easy one.

But all that may be changing.

The intrinsic value method has becomemuch maligned in these post-Enrontimes, and its days may be numbered.

More than 200 public companies,including Coca-Cola and AmericanExpress, have switched to the fair valuemethod. FASB has announced that it isreexamining the issue, which is usuallyviewed as an opening for FASB againto try to make the fair value methodmandatory, as it tried in the mid-1990s(when it was forced to back downunder overwhelming pressure fromCongress and the corporate community).Finally, the International AccountingStandards Board’s Proposed Interna-tional Financial Reporting Standard,Share-Based Payment, uses a fair valuemethod, so the fair value methodmight become the rule as a result of the international convergence ofaccounting standards. It is, of course,impossible to predict with certaintywhen or if the fair value method mightbe made a requirement. But the oddswould seem to suggest 2004 or 2005.

Why would a company voluntarilyadopt the fair value method before itbecomes mandatory? Under limitedcircumstances, a company may want to switch now in order to qualify forfavorable transition rules set to expirenear the end of 2003.

When a company switches to the fairvalue method, the question of how totreat previously outstanding awardsraises some knotty questions. Originally,the transition rules in FAS 123 requiredcompanies switching to the fair valuemethod to apply the fair value methodprospectively. All awards granted afterthe beginning of the year in which acompany elects to switch to the fairvalue method must be reported usingthe fair value method, and companiesare generally not permitted (much lessrequired) to apply the fair value methodto awards granted in prior years. This led

to criticism. Some of it from “purists”who argued that companies were onlytelling half the story, in that only futuregrants would be expensed. In addition,and perhaps more importantly, manycompanies criticized the rule becausecompensation expenses would seem to artificially ramp up year-to-year. For example, let’s take a company thateach year grants options with a fair valueof 100 vesting over four years. If thecompany first adopted the fair valuemethod for 2003, it would show 25 ofexpense in 2003 – nothing for the priorawards, and 25 for the portion of thegrants made in 2003 that vest in thatperiod. In 2004, it would show 50 ofexpense, 25 from the vesting of the 2003grants and 25 for the 2004 grant. Anincrease in expense, even though thecompany had been doing the samething year after year. The “ramp up”problem is likely less of a concern forprivate equity portfolio companies,which typically do not make annualoption awards (instead favoring one-time awards).

The difficulties raised by the trans-ition rules originally found in FAS 123led FASB to issue FAS 148, which gen-erally supercedes FAS 123’s transitionrules. FAS 148 no longer permits thefair value method to be applied purelyprospectively, unless the company switchesto the fair value method before December15, 2003. Companies switching to thefair value method in fiscal years begin-ning after December 15, 2003 (i.e., the2004 fiscal year) are required to recog-nize expense as if the fair value methodhad been applied to all awards grantedafter December 15, 1994. Thus, compa-nies switching methods after December15, 2003 would be required to recognize

continued on page 18

John M. Vasily Philipp von Holst

– Frankfurt

Acquisition/High Yield FinancingWilliam B. BeekmanCraig A. Bowman

–LondonDavid A. BrittenhamPaul D. Brusiloff A. David Reynolds

TaxAndrew N. BergRobert J. CubittoGary M. FriedmanFriedrich Hey – Frankfurt

Adele M. KarigDavid H. SchnabelPeter F. G. Schuur

–London

Employee Compensation & BenefitsLawrence K. CagneyDavid P. MasonElizabeth Pagel

Serebransky

Estate & Trust PlanningJonathan J. Rikoon


Due Diligence – A Duffer’s Delightguest column

The role that insurance plays in privateequity investing has never been morerelevant. Since the late ’70s, there havebeen two fundamental approaches toprivate equity investing – that of thefinancial buyer and the hybrid opera-tional/financial buyer. While each stylehas its own pros and cons, historicallythe latter has had a more thoroughapproach to due diligence, in part be-cause the operating partner has morefirst-hand knowledge of the impact ofinsurance costs and their effect onprofit margin. For many years, however,this focus was not necessarily recog-nized. From 1985 through mid-2000the insurance industry went through a downward-spiraling soft market,making insurance more of a commodity.It was plentiful, it was flexible and itwas cheap. Insurance could easily andeconomically be used to fill inadver-tent cracks that may have appeared inthe walls or foundation of an acquiredcompany even after closing. In short,making informed insurance decisionswas less critical.

It certainly has been a new marketover the last year-and-a-half. The once invincible soft market has beenreplaced with a new hard one that iswreaking havoc on its quest for under-writing stabilization and investmentreturns. The harshness of the currentinsurance environment has clearlymade itself known in every boardroom

of every portfolio company and atevery private equity fund. The insur-ance marketplace has turned with avengeance on unsuspecting privateequity firms which were created in thesoft cycle and which never experiencedanything but year after year of 20%decreases in insurance costs. Gone, at least for now, are the days of towerprograms with shared aggregatelimits. Gone are the unsupportedprograms that did not require letters of credit. Surety issues are virtuallyimpossible to weave around, andproduct liability and pension trustissues have everyone’s ear. Today there is a forced awakening to insur-ance due diligence, and the very critical role insurance plays in privateequity transactions.

Private equity firms contemplatingdivestitures need to pay careful atten-tion to boxing future insurance impacton Newco prior to submitting a bid.Lenders are increasingly concernedabout insurance programs and a com-fort factor must be achieved to getfunding commitments. In many cases it is not uncommon to have extremelyintrusive questioning on behalf oflenders seeking a sense of securitywith insurance risk. Today’s marketdemands accountability for the past, an understanding of the present and a business plan for the future.

In one recent example, three credibleprivate equity bidders went head-to-head in an auction for a company witha bona fide product liability exposure.Only one firm had already received afirm commitment from the most viable insurer in this particular prod-ucts arena to support a product liabilityprogram into the future. The other two firms are in for a rude awakeningshould their bids prevail. Even themost skilled investor cannot predictthe tightness in the product liabilitymarketplace without thorough due diligence of insurance options andpotential litigation exposure. Multiple100% increases tend to be hard todigest under the best of circumstances,let alone in a faltering economy.

We recommend that private equityplayers carefully diligence the insur-ance marketplace to determine thebest way to provide the appropriateamount of coverage of potential acqui-sition targets with the best carriers at the lowest cost. The stakes in theinsurance environment have gottenhigher, and it deserves the kind ofthoughtful due diligence that privateequity investors undertake in manyother aspects of their business. — Joseph F. Coughlin

Managing Partner, Corporate RiskSolutions LLC, an advisory servicesprovider to the private equity andmergers and acquisitions communities

Like many of you, two of my biggest interests are golf and the private equity business. Sometimes I think that the private equity businessand a golf game are exact opposites except, perhaps, that both skill and luck are important in both. When it comes to due diligence inthe private equity world, the “winner” of the game will not be the player with the lowest score, or the most direct approach to the hole.It will be the player who has covered the most terrain, landed in the most traps, explored neighboring fairways and roughs and ultimatelyarrives on the 18th green exhausted. Here, the miserable golfer is actually our due diligence Champion.

Do Big-Boy Letters Really Work?


In recent years, private equity playersand other M&A professionals haveincreasingly employed so called “Big-Boy” letters as a means to allocate riskin transactions involving the sale ofsecurities.

Big-Boy letters are typically utilizedin connection with private sales ofpublicly traded securities, where oneparty has non-public information thatis not available to the other party andboth parties wish to preclude anysubsequent claims by the non-insiderbased on the non-disclosure of thatinformation, including any claimsarising under Rule 10b-5. While Big-Boy letters come in different shapesand sizes, they all typically include very broad representations by the non-insider that (1) it is financiallysophisticated, (2) it has had the oppor-tunity (whether or not exercised) toconduct the due diligence it wishes toconduct in connection with the trans-action, (3) it is not relying on anyrepresentations not expressly set forthin the Big-Boy letter, and (4) it waivesall claims against the insider arisingout of the purchase or sale of the secu-rities, including all claims under Rule10b-5 with respect to the non-disclo-sure of any non-public information.

There is no question that the colorfulterm “Big-Boy” letter deserves inclusionin the Legal Buzzwords Hall of Fame,right beside “poison pill,” “cram-down”and “caveat emptor.” But in light ofSection 29(a) of the Securities ExchangeAct, which provides that waivers ofcompliance with any portion of theExchange Act are void, and the well-known common law principal that “fraudvitiates everything,” the harder ques-tion is: are these letters enforceable?

The answer is “yes, probably.” Thereason for the hedge is due to theabsence of any controlling case law inthis area and the fact that most fraudand 10b-5 claims turn uniquely on thefacts and circumstances of a particulartransaction. But an emerging body of case law in similar – although notidentical – contexts suggests that theseletters are likely to be enforced in mostcircumstances, in large measure dueto the very strong judicial bias in favorof enforcing express contractual pro-visions as written, particularly whenthey are the product of arm’s-lengthnegotiations between sophisticated,well-represented parties.

BackgroundBig-Boy letters have traditionally beenutilized by financial sellers of distresseddebt securities, where the seller hasnon-public information due to itsmembership on a creditor’s committeeof the issuer. In these situations, theseller is often barred by a confidentialityagreement from disclosing non-publicinformation or concludes that it issimply impractical to disclose all of thenon-public information in its posses-sion to the purchaser. Even if the sellercan disclose the information, thepurchaser may be unwilling to accept it because it wants to be able to resellthe securities freely, without having to worry about whether it is in posses-sion of inside information.

Big-Boy letters are now also beingemployed by private equity funds whenthey seek to purchase or sell (typicallyin private transactions) securities of a portfolio company that they havesuccessfully taken public, or in whichthey otherwise hold an investment. In this context, the fund may havenon-public information as a result

of its historical relationship with theissuer or, in some instances, as a result of its right to designate one ormore directors or its provision ofmanagement services. Here, the fund is unlikely to be restricted by a confi-dentiality agreement from disclosingnon-public information, but may not be in a position to disclose it forreasons similar to those that have his-torically applied to sellers of distresseddebt securities.

In some cases, insiders recognizethat the non-public information in their possession is material. In othercases, insiders genuinely believe thatthe non-public information in theirpossession is not material in light of the total mix of publicly availableinformation. Still, given the volume

There is no question that the

colorful term “Big-Boy” letter

deserves inclusion in the Legal

Buzzwords Hall of Fame…

but in light of Section 29(a)of

the Securities Exchange Act,

which provides that waivers of

compliance with any portion

of the Exchange Act are void,

and the well-known common

law principle that “fraud

vitiates everything,” the

harder question is: are these

letters enforceable?



Making Sense of the New Tax Rules Applicable to Confidential Transactions

BackgroundIn order to understand the new rules, it is helpful to put them in context. The last five to 10 years have witnesseda resurgence in the marketing of taxshelters. The tax shelters of today arefar more sophisticated and compli-cated than the ones marketed 20 yearsago and involve much larger dollars.An individual tax shelter often involvesclaimed tax savings in the hundreds ofmillions of dollars. Along with the levelof sophistication and dollars involved,the types of promoters have grown toinclude the big accounting firms, largeNew York law firms and investmentbanks and the types of consumers ofthe tax shelters have expanded to includelarge public corporations.

Many of the tax shelters are consid-ered proprietary by the promoter and are offered under conditions of confi-dentiality – meaning that a personoffered an interest in the tax shelter isrequired to agree up front that it willnot disclose the structure of the taxshelter to anyone, including its regulartax advisor.

Although the IRS invariably chal-lenges each new tax shelter, there is asignificant time lag between when anew shelter is first marketed and whenthe IRS learns about it. Also, less than1% of taxpayers are audited each year,and, therefore, even if the IRS knowsabout a particular tax shelter, the chanceof the IRS actually challenging thetreatment by any particular taxpayerremains relatively small. As a result,

the audit lottery has proven to be aprofitable bet for many taxpayersparticipating in tax shelters.

The new regulations are intended to change the odds by listing a variety of features that are common to tax shelters (such as confidentiality) andrequiring each taxpayer who engages in a transaction that has one of thesefeatures to file a form with the IRSOffice of Tax Shelter Analysis thatdescribes the transaction and itsintended tax treatment. This allows the IRS to learn about tax sheltersmore quickly. In addition, if an advisor(such as a law firm or placement agent) to a transaction that has one of thesefeatures makes any kind of statementabout the tax treatment of the transac-tion, the advisor is generally viewed as a promoter of the transaction and is required to keep a list of each personwho participates in the transaction.This allows the IRS to learn about eachtaxpayer who participated in a par-ticular tax shelter and challenge thetreatment claimed by all of the parti-cipating taxpayers in a systematic and coordinated manner.

ConfidentialityBecause tax shelters are often soldpursuant to confidential offerings, theregulations treat confidentiality as oneof the features common to tax shelters.Accordingly, a transaction is considereda “reportable transaction” under theregulations (meaning that taxpayers whoparticipate in the transaction are requiredto file the form with the IRS and mate-rial advisors are required to keep lists

of taxpayers who participate in the trans-action) if it is “offered under conditionsof confidentiality.” A transaction is considered offered under conditions of confidentiality if the taxpayer’s dis-closure of the “tax treatment” or the“tax structure”of the transaction islimited in any manner by an express orimplied understanding or agreementwith or for the benefit of any person whomakes or provides a statement to thetaxpayer about the potential tax conse-quences of the transaction.

The fundamental problem with thisnew regulation is that many (if not most)regular, commercial transactions (suchas M&A deals, debt and equity offer-ings, licenses, etc.) that have nothing todo with tax avoidance involve agreementsthat contain confidentiality agreements.As a result, these transactions aregenerally treated as reportable transac-tions under the regulations if any partymakes any kind of statement about the tax treatment of the transaction toanother party, unless the typical confi-dentiality provision is modified to permitdisclosure (to anyone) of the tax structureand the tax treatment of the transac-tion. However, adding this carve-out istroubling because (1) the term “taxstructure” is given an extremely broadmeaning by the regulations, (2) nobodyreally knows how to apply the definitionof “tax structure” to regular, commercialtransactions, and (3) it probably includeswaiving confidentiality as to underlyingfacts which the parties would otherwiseprefer to keep confidential.

You have probably heard about but do not really understand the new rules issued by the IRS regarding so-called “confidential trans-actions.” This article explains the thinking behind the new rules and recommends an approach for dealing with them.


Also, even if carve-outs permittingdisclosure of the tax structure and taxtreatment are added to the expressconfidentiality provision, the IRS canstill assert that there was an impliedunderstanding that the tax structurewould be kept confidential and there-fore the transaction is reportable. Inorder to reduce this possibility, theregulations allow taxpayers to add thefollowing language, in which case thetransaction will be presumed not tohave been offered under conditions ofconfidentiality: “The taxpayer (andeach employee, representative or otheragent of the taxpayer) may disclose toany and all persons, without limitationof any kind, the tax treatment and taxstructure of the transaction and allmaterials of any kind (including opin-ions or other tax analyses) that areprovided to the taxpayer related to suchtax treatment and tax structure.” Thedownside to adding this language is thatthe reference to “all materials of anykind” will in many cases allow disclosureof even more information that theparties would prefer to keep confidential.

What’s So Bad About Engaging in a Reportable Transaction?For the taxpayer who participates in areportable transaction, the most sig-nificant concern is that it will increaseaudit risk. (Of course, even taxpayerswho believe their tax return is correctin every respect do not wish to beaudited.) It is unclear whether the fearof increased audit risk will turn out tobe justified in cases where the report-able transaction is clearly not designedfor tax-avoidance purposes.

For the material advisors (e.g., invest-ment banks that serve as advisors orplacement agents), the biggest concernis their ability to comply with their obligations to keep lists of information

about each transaction that they areinvolved with and turn that informa-tion over to the IRS if the IRS asks for it. For investment banks and otheradvisors that work on thousands oftransactions each year, this is an unbe-lievably difficult task, as the regulationsgenerally require the advisor to keep a list of each participant in every trans-action that is considered reportableunder the regulations, as well as certainother information about the transac-tion. Although these obligations onlyarise in respect of a transaction if theadvisor makes a statement (oral orwritten) that relates to a tax aspect ofthe transaction, such statements in factare frequently made and it is virtuallyimpossible for a large investment bankor other similar advisor to monitorwhether any person (whether managingdirector or associate) on the teammade such a statement at any pointduring the course of the transaction.

What Are Private Equity Firms Doingin the Face of These Regulations?There has not been a universal responseby private equity firms to these regula-tions. Some firms have decided not toadd any kind of “tax structure” or “taxtreatment” carve-out to the confiden-tiality provisions contained in theiroffering documents and fund agree-ments, based on the firm’s decisionthat confidentiality is of utmost impor-tance and that being considered areportable transaction is not that bad.Other firms do not view confidentialityas important at all and have, therefore,added the presumption language totheir offering documents and fundagreements.

Most funds have tried to have itboth ways, meaning that they haveadded language that is intended toavoid treatment as a reportable trans-action, but still limits disclosure of

certain information that the fund feelsis important to keep confidential. Forexample, some funds have said thatthe “tax structure” and “tax treatment”may be disclosed, but that the name(and identifying information) of thefund is not part of the tax structure and therefore may not be disclosed.Other funds have taken a similar posi-tion with respect to the track recordand certain other information containedin the offering document. Still otherfunds are prohibiting disclosure of thename and other identifying informationof the fund just during the marketing ofthe fund.

What Should You do in the Face of These Regulations? The lawyerly answer is that you shouldconsider the issue separately for eachtransaction, based on how importantconfidentiality is to that particulartransaction. However, if you take this continued on page 18

The new regulations are

intended to change the odds

by listing a variety of features

that are common to tax shel-

ters (such as confidentiality)

and requiring that each

taxpayer who engages in a

transaction that has one of

these features file a form with

the IRS Office of Tax Shelter

Analysis that describes the

transaction and its intended

tax treatment.


In August 2001, China released then-new foreign investment rules intendedto encourage foreign sponsors to formChina-based venture capital funds.These rules (the 2001 Rules) imposedmany non-market restrictions on fundformation and operation. There wasalso no way foreign investors coulduse them without becoming subject to on-shore rates of taxation on invest-ment gains – at a 15% rate if you werean optimist and believed that theChinese would allow foreign economiczone incentive tax rates to apply tofinancial investments as well as directinvestments in productive assets, orotherwise at a 30% rate.

In December 2001, we were invitedby Xiaoyang Yu, a principal of VictoriaCapital (a Hong Kong-based boutiquecorporate finance advisory firm), tojoin them in explaining to the draftersof the 2001 Rules why those rules weredestined to be unsuccessful. The all-day meeting with representatives ofseven ministries led to a request thatwe and Victoria Capital suggest to therelevant staff members ways in whichthe 2001 Rules might be improved,within the context of existing laws andregulations.

From January to September 2002,we exchanged five or six drafts withMOFTEC (the Ministry of ForeignTrade and Economic Cooperation, nowunder the new name of the Ministry of Commerce), the lead agency respon-sible for the 2001 Rules, and providedthem as well as the central taxationauthority with a great deal of background

information about the organizationand technical operation of internationalventure capital funds. At the sametime, our friends at Victoria Capitaltried to make sure the staff membersunderstood the economic and otherpractical motivations of fund managersand fund investors.

The most interesting thing aboutthis process to us was the willingnessof the various ministry representativesto listen to the suggestions we madeand to take them into account in thesuccessive drafts. The whole processbore little resemblance to some of the criticism one hears of Chinese rule-makers. They seemed genuinelyinterested in understanding industrypractice and in accommodating to it whenever it would not conflict withfundamental principles that, as mid-level administrators, they could noteasily change. Our lawyers and XiaoyangYu were able to talk quite openly withthe staff members to ask them whyparticular comments from us were notaccepted, or why they had implementedthem in ways we found peculiar andcounterproductive. Their answers weregenerally frank and straightforward.

The larger message we draw fromthis is twofold. first, if you have aninterest in the Chinese rulemakingprocess you are far more likely to besuccessful if you try to insert yourselfas an educator and not as a pleader for a specific interest or transaction. It was quite clear that we had no“client” whose particular views andneeds we were seeking to accom-modate. Similarly, Victoria Capital was

not in the process of trying to get aspecific fund approved. We were bothhonestly able to say that “this is busi-ness we want to do but under the rulesyou have drafted we simply can’t do it– and here are the 15 reasons why.”

Second, it was clear from the begin-ning that our goals were not at cross-purposes with the ministries’ goals.The staff was charged with trying tobring both foreign capital and foreignfund management skills into China.We were not in the position of makingzero-sum game arguments – whereany gain for the foreigners would havebeen a loss for China. Instead, we were able to take what amounted to amoral high road and say, as to most of the unsatisfactory provisions of the2001 Rules: “Look, these do nothing to protect legitimate Chinese interests,and at the same time they are totallyinconsistent with the expectations offund managers and investors as to the way in which venture capital andprivate equity funds operate.”

And even in the taxation discus-sions, we could show that we were not pleading for special treatment inChina because investing in China was,for example, more dangerous or morerisky. It is easy to show that China’s tax treatment of venture capital invest-ments by off-shore investors divergesso much from the treatment of off-shore venture capital and private equityinvestment in most of the rest of theindustrialized (and industrializing)world that a reasonable investor wouldnot want to invest significant amounts

China’s Revised Venture Capital Rules: The Rule-Making Process in China


in a China-based fund even if the risk-reward profiles were otherwise equal.

This back-and-forth drafting processcontinued until the fourth quarter of2002. Toward the end of the process,as word began to filter out that newrules were being considered, otherventure capital and private equity firmsbegin asking about them. MOFTECshowed a good deal of bureaucraticsophistication at this point byconverting the process to almost theequivalent of a public hearing on thenew rules. The new China VentureCapital Association, a group of off-shoreand domestic venture capital firms,including some of the biggest interna-tional players, was then just beingformed. MOFTEC made the draft rulesavailable to the association’s board for comment, and then met with them(and with us again) to discuss the draft– effectively deflecting any future argu-ment that the “industry hadn’t beenconsulted.”

So what did this nine- or 10-monthprocess produce for the internationalventure capital industry? The bestshort answer is “not enough” – butthis is not the fault of MOFTEC andthe other ministries involved in formu-lating the new rules. The new rules,published in February 2003 (the 2003Rules), eliminated many if not most of the structural problems associatedwith the 2001 Rules. Unfortunately, the central taxation authority did not,in spite of what appeared to be stren-uous efforts by MOFTEC and others,change the tax rules applicable to off-shore investors in on-shore funds. So, for the time being, we are left withrules that would probably work proce-durally and administratively, but in anuneconomic tax environment where

China will tax investment gains byforeigners at rates of 30% or, in thebest case, 15%. For this reason, we are of the view that the 2003 Rules “donot fundamentally change the overallattractiveness of investing in China.”

Having said this, we think it is stilluseful to understand the structure ofthe 2003 Rules, including some of theways in which they might be used, ifonly because we understand that thetax question is still under discussion in China.

• The 2003 Rules are officially targetedat “venture capital” sponsors andinvestors. However, because permittedinvestments are not limited to pureventure capital start-up situations, we believe that private equity fundsponsors could also organize a fundunder the 2003 Rules. (Some thought,however, would have to be given tothe fund’s statement of purpose. Aswith many other things in China, so long as one’s intent can be statedin language that complies with theterms of the relevant rules, and oneoperates within the letter of the rele-vant rules, the fact that the ultimateoutcome somewhat differs from official expectations at the time therules were promulgated is notnormally a problem.)

• Even in the absence of favorable taxtreatment, a fund sponsor couldorganize for a taxable manufacturingcompany (as distinct from a tax-exempt institutional investor) a veryflexible vehicle for making, holdingand disposing of industry-specificventure capital and other small stra-tegic investments. In such a structure,the sponsor would have to cede muchmore investment control to the

investor than is customary elsewhere in the world, and as a result wouldprobably not be given the sameupside as in a true managed fund.But such a vehicle would give thesponsor an opportunity, supported by a deep-pocket investor, to getinside the process and understandthe 2003 Rules in anticipation offuture tax changes that would makeinvesting under the 2003 Rules viablefor traditional private equity investors.

• The other interesting avenue forexploration is using the 2003 Rules as a basis for mobilizing primarilydomestic money. A fund formedunder the new rules need have only25% foreign investment. The balancecan be domestic. Moreover, theminimum size of a fund under the2003 Rules is only U.S.$10 million.Therefore, a fund sponsor withChinese domestic contacts couldorganize a small fund, of, say U.S.$20million, with primarily domesticinvestors, and market the remaininginterests to a few foreign investors onthe basis that, although the tax ratesare unattractive, this is an inexpensive


…[I]f you have an interest

in the Chinese rulemaking

process you are far more

likely to be successful if

you try to insert yourself as

an educator and not as a

pleader for a specific interest

or transaction.


In this brave new world marked byincreased regulatory burdens on publiccompanies and a skittishness for dealmaking, public companies maybecome more receptive to innovationsthat encourage dealmaking or helpdeals get across the finish line. Apublic indemnity is one such innova-tion. Why not ask the target’s publicstockholders to indemnify the privateequity buyer for breaches of represen-tations in the acquisition agreement?Although this technique was used fifteenyears ago when U.S. Cable TelevisionGroup bought Essex Communications,very few if any deals have used a publicindemnity since.

What would a public indemnity looklike? In a cash acquisition, the private

equity firm might place a portion of the cash consideration into a trust.Subject to a variety of negotiated limi-tations (e.g., baskets, caps, survivalperiods), the private equity firm couldrecover cash held in trust if it demon-strates that the target breached itsrepresentations in the merger agree-ment. To protect the target stockholders,the agreement should contain a disputeresolution mechanism that ensuresthat appropriate challenges to theprivate equity firm’s indemnity claimsare made and resolved fairly. After alltimely indemnity claims are resolved,each former target stockholder wouldreceive its pro rata portion of theremaining corpus of the trust. Theindemnity might be made more palat-able to the target stockholders bylimiting it to breaches of particularlyimportant representations – accuracyof financial statements and absence of undisclosed liabilities, for instance.

Would the target stockholders’contingent right to the money in trustbe considered a security requiringregistration under the federal securitieslaws? If the right is structured properly,the answer is probably no. In the 1988Essex Communications no-action letter(which involved a public indemnitysimilar to the one described above), andin the later Celina Financial no-actionletter, the SEC made clear that as longas the following conditions (amongothers) are met, contingent rightsneed not be registered:

• The rights must be granted pro ratato stockholders as an integral part of the acquisition consideration;

• The rights must be uncertificated and not transferable;

• The rights may have no voting or dividend privileges; and

• The amounts paid pursuant to therights must not depend on the oper-ating results of any relevant entity.

The proposed indemnity structureshould satisfy all of these conditions.

Of course, if the logistical issues(e.g., keeping track of the names andaddresses of potentially tens of thou-sands of former stockholders) becomeoverwhelming, or the target stock-holders desire additional liquidity,there is no reason that the interests inthe trust cannot be registered andtraded publicly, although some of thebenefits of a cash deal – speed andlimited disclosure – would be lost. Forprivate equity firms, the continuingdisclosure obligations associated with a publicly traded security may beparticularly distasteful. Fortunately, the logistics have been successfullyaddressed without registration inrelated contexts.

Whether or not the rights are traded,there is a question as to whether stock-holders would discount the overallvalue of the transaction considerationdue to the conditional nature of thecontingent rights. And what would theinvestment banker’s fairness opinioncontinued on page 24

Private equity firms considering acquisitions of public companies generally worry about all the added risks the public nature of thetarget entails – visibility, public disclosure, a hefty dispersed stockholder base (read: “potential plaintiffs”), limited due diligence.They also recognize that unlike in private deals, stockholders of public companies don’t usually indemnify the buyer for breaches ofrepresentations and warranties. Since the Enron, WorldCom and other debacles, this absence of post-closing protection has becomean even greater concern, as buyers of public companies become increasingly worried that no matter how good their due diligencemay be, they could still miss something ugly that could come back to bite them after the acquisition closes.

Indemnification by Stockholders of Public Targets

Despite… concerns, a limited

indemnity might be just the

thing to jump-start a stalled

deal in the current environ-

ment or to encourage a

private equity firm to consider

a public acquisition[;]…

given the choice betweenno

deal and a good deal with

a limited indemnity, target

stockholders may well choose

the latter.


Reminder of the FactsNear-insolvent NCS looked for anacquiror. Of two nibblers, only Genesisinitially offered a price that would repayNCS’ debt and pay something to stock-holders. Omnicare then made a higherbid, but with a due diligence condition.Genesis bumped, but only if NCSagreed to a total lock-up: NCS stock-holders holding a majority of the votingpower had to commit to vote for themerger, and NCS had to agree to put themerger to a stockholder vote, even ifNCS’ board no longer recommendedthe deal. These provisions guaranteedGenesis’ deal would be approved, evenif a better bid appeared (and one did:Omnicare offered more than doubleGenesis’ price per NCS share).

The majority in Omnicare found the NCS lock-ups invalid and unen-forceable because:

• they were “preclusive and coercive,”and therefore not a reasonableresponse to a threat, under Unocal,since stockholders couldn’t take abetter deal; and

• the board had no authority toapprove a merger agreement thatprevented it from executing itsongoing fiduciary responsibilities.

The majority said boards may agreeto merger protection devices thatincrease the cost to a competing bidderand are “economic and reasonable,”but the devices “cannot limit or circum-scribe the directors’ fiduciary duties.”

The court held that the board was“required to contract for an effectivefiduciary out clause to exercise itscontinuing fiduciary responsibilities.”

In a vigorous dissent, the minorityjustices called the majority rule “clearlyerroneous” and noted there could becircumstances when business realitiesdemand a lock-up to permit wealth-enhancing transactions to go forward.The dissenters, concerned that themajority’s bright-line prohibition woulddeter bidders who are willing to bidonly with solid deal protection, expressedthe hope that the decision will be inter-preted narrowly.

The majority’s language, however,doesn’t leave much room for a privateequity firm holding a major stake in apublic Delaware target to grant completedeal certainty to one bidder before the stockholders have voted. That’s a bright-line test. Less clear is how far the large stockholder can still go to grant deal protection to a buyer.

Approaches to explore:

Lock Up Less Than a Majority

The NCS lock-up provided certaintythat the deal would be approved.Target’s board should be able to approvelock-up agreements with stockholdersowning less than a majority, or perhapscovering only a portion of a majoritystockholder’s shares. How much less?Presumably, enough so that a competingbid still is a realistic possibility.

Dis-Incent the Private Equity Firm

Maybe the private equity firm, oranother of Target’s large stockholders,can agree to pay over to Bidder 1 much of its upside if Target is sold to a higher bidder. That’s not a lock-up,but it lessens the big stockholder’sincentive to entertain a competing bid.A private equity firm would need toconsider carefully its fiduciary duties to its fund investors before deciding togive up possible upside.

Similarly, the large stockholder mightagree with Bidder 1 not to tender toanother bidder or to vote in favor ofanother bid even for some months afterthe deal with Bidder 1 is terminated.The legal question: for how long beforethat would be viewed as precluding acompeting bid?

Is Target Board Approval Needed?

Can the deal be locked up by havingthe private equity firm commit to tenderinto Bidder 1’s offer? That won’t work ifTarget board action is otherwise required– e.g., to amend a pill or bless a trans-action under a business combinationact. Would Bidder 1 be willing to proceedwithout the benefit of representationsand warranties in a merger agreement

Going, Going, Gone?

In our last issue, we promised to update you once the Delaware Supreme Court issued a full opinion explaining its split 3-2 decision toenjoin a fully locked-up merger in Omnicare-NCS. (See “Goodbye to Lockups?” in the Winter 2003 issue.) After a nearly four-monthwait, the opinion has been released. It’s an important decision for private equity firms because it sets a bright-line test that will limit afirm’s ability to control the sale process for a public company. At the same time, it creates new line-drawing challenges for M&A dealmakers.

One likely Omnicare result:

more private equity firms and

founding stockholders will

have companies opt out of

business combination acts,

and not adopt poison pills.



Convertible Preferred Shares à la Française

The U.S. Investor’s PerspectiveA U.S. private equity or venture investorwill generally approach a minorityinvestment in a French company withthe same expectations regarding theoverall package of rights and protectionsas those involved in an investment in preferred shares in the U.S. Theseexpectations typically include guaranteedeconomic returns via fixed dividendsand a priority return upon a change ofcontrol, protection for the initial invest-ment by way of a liquidation preferenceand mandatory redemption, the right to participate in the equity upside via a conversion feature, anti-dilution pro-tection through adjustments to theconversion ratio and preemptive rights,governance rights via board represen-tation and information rights and theadditional liquidity provided by tag-along and drag-along rights.

The French LandscapeAs a preliminary matter, this articleassumes that the French company willbe a société anonyme (SA), which is theFrench corporate form most analogousto an American corporation and one of only two allowable corporate formsfor French publicly listed companies(the other form being of little interestwhere outside investors are involved).Where, however, the French company is a société par actions simplifée (SAS),greater flexibility exists to structuremany of the U.S.-style rights and protec

tions in the articles of incorporation,alleviating many of the concernsdiscussed in this article. Nonetheless,the SAS form would present separateissues, including the need for thecompany to be converted into an SAprior to any IPO. Additional structuringat the time of the investment would be required to provide for the eventualconversion and many authors suggestthat, in some circumstances, a unani-mous vote of shareholders would berequired upon conversion.

Although French company law does allow for creation of a class ofpreferred shares (actions de priorité)that have special rights giving them a ranking superior to common shares,some of those desired rights cannot be built into the company’s articles ofincorporation as part of the preferred-share instrument. However, many of these rights can be obtained eitherthrough a shareholders’ agreement or a simultaneous issuance of speciallydesigned securities (e.g., warrants or bonds). Additionally, shareholders’agreements can reinforce certain of the rights provided for in the preferred-share instrument.

The Share Instrument

The rights and protections that can be achieved through a preferred-shareinstrument include preferential divi-dends, a priority distribution uponliquidation, rights to nominate direc-tors for election to the board and

special veto and information rights.Certain particularities of the Frenchlegal system do, however, make Frenchpreferred-share instruments less effec-tive in protecting the investors’ rightsand more difficult to implement thantheir U.S. counterparts.

Shareholder approval required for issuance

of preferred shares. One of the principalhurdles U.S. investors will encounterwhen attempting to structure a pre-ferred-share investment in a Frenchcompany is the need to obtain share-holder approval for the issuance of the preferred shares. In Delaware,“blank check” preferred provisions arefrequently contained in a company’scertificate of incorporation and allowthe board of directors acting alone to set the terms of and to issue a newseries of preferred shares so long asthe voting power of the preferredshares does not implicate the stockexchange shareholder approvalrequirements. In France, by contrast,the issuance of preferred shares willalways require shareholder approval,because under French company law, allshareholders have statutory preemp-tive rights that would normally apply tothe issuance of the preferred shares. Asupermajority vote of the shareholdersis required to waive these preemptiverights and allow the issuance of thepreferred shares to the investors.Additionally, because the preferredshares can be viewed as creating special

U.S. private equity and venture capital funds are sometimes reluctant to make minority investments in or participate in LBOs ofFrench companies or use a holding company outside of France once they learn that the equivalent of convertible, redeemablepreferred shares does not exist under French company law. This initial reaction stems from a perception that the economic rightsand legal protections offered by a U.S. preferred-share instrument cannot be obtained under French law. While it is unfortunatelytrue that the U.S. investor may have to forego certain of the rights and protections a U.S.-style instrument would provide, there are structuring approaches that, although adding a layer of complexity, can provide a private equity or venture investor with rights and protections similar to those obtained in a U.S.-style preferred instrument.



rights for a particular group of share-holders (i.e., the preferred investors), a report of a special auditor may berequired to be presented at the share-holders’ meeting approving theissuance of the preferred shares. Thepreparation of such a report can raise timing concerns, and the need for shareholder approval prior to theissuance of the preferred shares can present an execution risk, in partbecause the shareholder approvalcannot be put in place in advance of the specific proposed issuance. Anundertaking to vote in favor of theissuance of preferred shares could beprovided for in a shareholders’ agree-ment (but is not specifically enforceable).

Avoiding “clauses léonines.” An impedi-ment to crafting the financial preferencesfor the preferred shares, such as prefer-ential dividends or a priority distributionupon liquidation, stems from theprohibition in French company law onprovisions deemed “unconscionable”(clauses léonines), which includes provi-sions that completely deprive thecommon shareholders of interests inthe profits of the company or thatprotect certain shareholders from partici-pating in losses suffered by the company.

Liquidation preferences. In practice, thismeans that the liquidation preferenceof the preferred shares, i.e., the amountof the priority distribution to preferredshareholders upon liquidation, shouldbe structured as a percentage of theassets available for distribution toshareholders rather than the typicalU.S.-style fixed dollar amount. (Notethat the inclusion of a liquidation pref-erence in the preferred applies only tothe actual liquidation of the companyand not to other events such as amerger, consolidation, asset sale, etc.that are sometimes characterized as“liquidation events” in U.S. preferred

share instruments.) A consequence of structuring the liquidation prefer-ence as a percentage of distributableassets is that in the event of thecompany’s liquidation the preferredshareholders are not guaranteed areturn of their initial investment inpriority to distributions to commonshareholders. Super-multiple andparticipating preferences would mostlikely be viewed as unconscionableand, therefore, prohibited.

Preferential dividends. The prohibition onclauses léonines seems to have less ofan effect when structuring preferentialdividends than liquidation preferences.Specifically, French company law permitsthe dividend to be set at a percentageof the subscription price for thepreferred shares. The major difficultyunder French law would be to structurethe preferred shares as a pay-in-kind(PIK) instrument, which frequentlyoccurs in the U.S. when the companyis not expected to generate significantdistributable cash. A PIK instrument inFrance is impractical because it wouldrequire initial shareholder approval of the PIK feature as well as reautho-rization for the issuance each year ofadditional shares in the amount of thedividend payment. In addition, if thecompany has already issued convert-ible bonds, the unanimous approval of the bondholders would be requiredbefore any preferred stock with prefer-ential dividends could be issued.

Board representation. While Frenchcompany law does allow assignment of rights to board representation tospecific classes of shares, certain provisions make enforcing those rightsdifficult. As a general matter of Frenchlaw, directors are elected by shareholdersrepresenting a majority of shares of allclasses voting together without anyclass distinction. Several mechanisms

exist to achieve the goal of electingdirectors designated by the investors.These mechanisms cannot, however,completely eliminate the freedom of shareholders to vote for the candi-dates of their choice. Accordingly, while French company law permitsprovisions requiring that a certainnumber of directors must fulfill speci-fied criteria and/or be chosen from a list established, for instance, by thepreferred shareholders, the company’sshareholders must be able to decidebetween several candidates. Addi-tionally, any director can be removedwith or without cause by a majority ofthe shareholders. Consequently, eventhough the terms of the preferredshares may provide that the preferredshareholders are entitled to boardrepresentation, investors cannot becertain of having permanent boardrepresentation unless the company’s

While it is unfortunately

true that the U.S. investor

may have to forgo certain of

the rights and protections a

U.S.-style instrument would

provide, there are struc-

turing approaches that,

although adding a layer of

complexity, can provide

a private equity or venture

investor with rights and

protections similar to those

obtained in a U.S.-style

preferred instrument.


transaction. The following is notintended to be a detailed examinationof a securitization transaction, butrather a thumbnail sketch of the majorissues of interest to a fund sponsor.

StructureA securitization of interests in privateequity funds generally involves thefollowing basic (and for purposes of thisarticle, simplified) steps: The limitedpartner (the Transferor) will transfer allor a portion of its portfolio of interestsin private equity funds (the Funds) to anSPV. The SPV will be admitted to theFunds as a substitute limited partner inrespect of the transferred interests. TheSPV will assume all of the rights andobligations of the Transferor under theFunds’ limited partnership agreements,including the obligation to make ongoingcapital contributions for investments,expenses and management fees, as wellas any “LP clawback” obligations,pursuant to an assignment agreement.

The SPV will grant a 100% (or nearly100%) participation interest in the distri-butions and rights to distributions inrespect of the SPV’s interest in the Fundsto a bankruptcy-remote entity that willserve as the securitization vehicle (the

Issuer). Typically the SPV will also granta security interest in the limited part-nership interests held by it to theIssuer to secure payments due underthe participation. As consideration forthe participation, the Issuer will paycash and other securities to the SPV.

The Issuer will be capitalizedthrough the issuance of one or moretranches of rated and (for the morejunior notes, unrated) notes (theNotes) to institutional investors thatqualify as “qualified institutionalbuyers” within the meaning of Rule144A promulgated under the SecuritiesAct of 1933 (the Securities Act). TheNotes will be secured by, among otherthings, a pledge by the Issuer of theparticipation interest in the limited part-nership interests held by the SPV. Theproceeds from the sale of the Notes willbe used to capitalize the SPV and payfor the limited partnership intereststransferred to it by the Transferor.

The SPV will be a limited partner inthe Funds in which it acquires interestsand, as such, will be entitled to exerciseall of the rights, and will retain all of the obligations, of a limited partner ofsuch Funds. The Issuer generally willbe a passive entity (at least in theabsence of a default) with no rights to cause the SPV to take any action as a limited partner of any of the Funds.

The Issuer will use distributions fromthe SPV (assuming that the SPV hasreceived sufficient distributions fromthe Funds in which it holds interests) to service the Notes, generally back-stopped bya liquidity facility and reserves.The SPV will honor its obligations tothe Funds,such as the obligation to makecapital contributions to fund invest-ments and management fees, out ofreserves, a liquidity facility and/or distri-butions from the underlying Funds.

Disclosure IssuesFund sponsors generally wish to keepinformation about the Fund, its per-formance and its portfolio companiesconfidential. Sensitivity to confidentialityissues has been increased by the recentflurry of state Freedom of InformationAct (FOIA) requests made by newspa-pers and other organizations of publicplan limited partners. Fund sponsorsshould carefully consider what informa-tion can and should be released to thevarious third parties involved in a securi-tization transaction.

In these transactions, disclosure ofotherwise confidential information cantake a variety of forms. For example, inorder to value the Transferor’s privateequity portfolio, investment banks andappraisal firms (including their counsel)will ask to receive copies of all infor-mation distributed by a Fund’s generalpartner to the limited partners, includingfinancial statements, quarterly andannual reports and portfolio companyinformation (basically, all the informa-tion relating to the Funds that is in the Transferor’s files). In order for theNotes to be rated, rating agencies suchas Moody’s Investors Service, Inc. and Standard & Poor’s Rating Serviceswill need to receive the same infor-mation. Also, prospective purchasersof the Notes will receive an offeringmemorandum that is likely to discloseat least the following types of informa-tion: name of Fund, vintage year andjurisdiction, expected termination date,name of general partner, net assetvalue and amount of unfunded com-mitment. After the Notes are rated, the rating agencies will need further,ongoing access to information aboutthe underlying Funds, including eachFund’s net asset value, total contribu-tions, total distributions and list ofportfolio companies.

Securitization of Private Equity Fund Interests (continued)

Fund sponsors generally wish

to keep information about the

Fund, its performance and

its portfolio companies confi-

dential…. Fund sponsors

should carefully consider what

information can and should

be released to the various

third parties involved in a

securitization transaction.


If a Fund’s general partner is willingto consent to the disclosure describedabove, there are certain safeguards thatcan be put in place to limit the disclosureas much as possible. First, the generalpartner could require that the Transferorprovide it with a list of recipients of theFund information, preferably beforesuch information is disclosed to suchrecipients. Alternatively, the Transferorcould provide the general partner withperiodic updates of the parties to whominformation is sent. In addition, thegeneral partner should seek to ensurethat such parties receiving any Fundinformation agree to keep such infor-mation confidential pursuant to aconfidentiality agreement. The generalpartner and the Fund ideally should beeither parties to or third-party benefici-aries of the confidentiality agreement sothat they may enforce their rights underthe agreement. The agreement shouldprovide that the general partner’sconsent would be required for anyamendment or waiver of any provisionof the confidentiality agreement in amanner that would adversely affect thegeneral partner’s or the Fund’s rightsthereunder. In the three securitizationtransactions mentioned at the beginningof this article, none of the confidentialityagreements initially provided to uscontained these protections. And, whileone of the rating agencies involved toldus orally that it keeps all informationprovided to it confidential, it refuses “asa matter of policy” to sign a confiden-tiality agreement.

Even with confidentiality agreementsin place, Fund sponsors should beaware that, obviously, the more partiesthat possess the Fund’s information,the greater the likelihood that suchinformation will find its way into thepublic domain. In order to adequatelyprotect itself, the Fund’s general partnershould request an indemnity from theTransferor and the SPV against any

claims, damages or losses suffered inconnection with the disclosure of Fundinformation and, as further discussedbelow, the securitization transaction asa whole.

Even with the benefit of a confiden-tiality agreement, to the extent that aFund discloses, or consents to thedisclosure of, information to a broadcircle of people and institutions (theSPV, the Issuer, evaluators and ratingagencies, holders of the Notes, andtheir counsel and advisors), the Fund(1) subjects itself to an increasedadministrative burden, (2) may decreaseits ability to argue, in connection withFOIA requests made of its public planlimited partners and other matters,that the information disclosed consti-tutes “trade secrets” that have beenkept confidential and thus ought to beexempt from public disclosure, and (3)increases the likelihood that sensitiveinformation, such as portfolio companyinformation, will be disclosed, possiblyto the detriment of the Fund or its port-folio companies.

Credit RisksAny time that a limited partner requestsa transfer to an SPV, the general partnershould take steps to ensure that thenew limited partner will be adequatelyfunded so that it can fulfill its obligationsunder the Fund’s limited partnershipagreement with respect to (1) makingcapital contributions for future invest-ments and expenses, includingmanagement fees, and (2) returningdistributions if so required under an“LP clawback” provision.

The limited partners that are in theprocess of structuring a securitizationhave to varying degrees, and with varyingdegrees of specificity, anticipated thisconcern and have proposed differentmethods of giving a Fund’s generalpartner comfort that the SPV will beable to satisfy its obligations under thepartnership agreement. In each of the

three proposed securitizations men-tioned at the beginning of this article,the Transferor pointed out that it wastransferring interests in dozens ofFunds, of different types and differentvintage years, into the SPV. Thus, eachTransferor argued, this diversified portfolio of interests should generatesufficient cash flow to service all obli-gations. This might prove to be correct,of course, but many private equity fundsonly make distributions very infrequentlyin the best of times. It is possible thatmost if not all of the Funds in a portfoliomight cease making distributions alto-gether at the same time if they are allunable to exit portfolio investmentsbecause the IPO window is closed, or ifstrategic buyers generally aren’t buyingduring an economic downturn.

The Transferors acknowledged thispossibility, and thus sought to provideadditional comfort in the form of creditsupport. In one of the proposed trans-actions, the SPV will maintain a cashreserve account or liquid investmentsin an amount that the Transferor believesis sufficient for the SPV to meet its anti-cipated ongoing obligations. In another,a liquidity facility will be provided; thefacility is intended to assure paymentof the SPV’s remaining capital commit-ments and clawback obligations. In athird case, the SPV will have the rightto borrow funds as necessary from theTransferor (or an entity with equal orbetter credit standing). In certain ofthese cases, we were required to asknumerous questions before being givenany detail about these arrangements.In one case it seems that the liquidityfacility described as a potential sourceof comfort for our clients in fact was at the Issuer level, which protects theholders of the Notes but not the Funds;this was revised after we pressed. Theseproblems did not necessarily arisebecause the Transferor was being continued on page 16


unhelpful, but, instead, because (1)certain of the transactions were stillbeing structured at the same time asconsents were being obtained and (2)in other cases the lawyers structuringthe transactions were familiar withsecuritizations but had little familiaritywith private equity funds or the concernsof private equity fund sponsors. (Thisis a theme that became evident not justin the credit area, but also when weraised disclosure and regulatory concernson behalf of our clients.) In all cases, it is a business call whether the creditbackstops provide adequate creditprotection, since the credit backstopsare structured to cover anticipatedneeds, which can not be currently quanti-fied with precision and may or may notprove to have been correctly estimated.

A Fund’s general partner should nothesitate to ask questions of the Transferorand SPV, and should consider requiringas a condition to granting its consentthat certain representations and cove-nants be included in the assignmentagreement, in order to satisfy itself thatthe proposed manner of funding theSPV is indeed sufficient to meet itsongoing obligations under the Fund’slimited partnership agreement.

Increased Risk of LitigationA securitization transaction may havethe effect of increasing somewhat thepotential risk of litigation to the generalpartner and the Fund, simply becausemore players are involved. For example,a purchaser of the Notes could attemptto make a securities law claim againstthe Fund or the general partner withrespect to the information (includingvaluations) provided by the Fund. Inorder to protect itself from any suchpotential litigation, a general partnershould consider requiring that theTransferor and SPV indemnify it, the

Fund and the Fund’s manager againstany claims, damages or losses thatmight arise from any aspect of thesecuritization transaction, includingthe disclosure of Fund information and the offering and sale of the Notes.

Publicly Traded PartnershipThe transfer of a limited partnershipinterest in connection with a securiti-zation transaction raises the concernthat a Fund may become a “publiclytraded partnership” (a PTP). This wouldbe a disastrous result for most privateequity funds, which are structured asflow through vehicles for tax purposes,because PTPs are taxable as corporationsfor U.S. federal income tax purposes.

A partnership becomes a PTP if director indirect interests in the partnershipare traded on an established securitiesmarket or readily tradable on a secon-dary market or the substantial equivalentthereof. (In the transactions in questionthe Notes are expected to trade in the144A market.) This is because the U.S.tax rules provide in this context thatinterests in a partnership include anyderivative instrument, other than a non-convertible debt interest, the value ofwhich is determined in whole or in partby reference to the partnership. Derivativeinstruments do not ordinarily present a PTP issue because a partnership gen-erally cannot become a PTP unless itparticipates in the establishment of amarket or recognizes any transfersmade on any such market. Because theTransferor will ordinarily be required toobtain the general partner’s consent tothe securitization (which involves thecreation of what are arguably derivativeinstruments), the latter exception willnot be available to the Fund. We recom-mend that the Fund seek to obtain anopinion of counsel to the Transferor thatthe transactions contemplated by the

securitization will not jeopardize theFund’s partnership status either becausethe Notes to be sold by the Issuer willconstitute non-convertible debt forfederal income tax purposes or becausesome other safe harbor applies.

Investment Company Act ConcernsA Fund that relies on the exception fromregistration provided by Section 3(c)(1)or Section 3(c)(7) of the InvestmentCompany Act of 1940 (the InvestmentCompany Act) should carefully considerthe following issues:

100-beneficial owner limit of Section

3(c)(1). If the Fund in question relies on the Section 3(c)(1) exception, theSPV in the securitization should beasked to represent that it will be treatedas one beneficial owner of the Fund’soutstanding securities for the purposes of Section 3(c)(1) of the InvestmentCompany Act. It should be able to makethis representation, if it owns less than10% of each class of the Fund’s securi-ties. However, this should be confirmedwith counsel for the SPV in light of the particular structure of the securiti-zation. Also, general partners shouldremember that the Transferor willcount as an additional beneficial ownerif the Transferor retains some portionof its interest in the Fund.

Qualified purchaser requirement of

Section 3(c)(7). If the Fund in questionrelies on the Section 3(c)(7) exception,the SPV in the securitization shouldrepresent that it is a “qualified purchaser”as defined in Section 2(a)(51) of theInvestment Company Act. The SPVshould be able to make this representa-tion if at the time of the transfer it willhold more than $25 million of interestsin Funds, which will almost certainly be the case. Again, however, this shouldbe confirmed with counsel to the SPV.

Securitization of Private Equity Fund Interests (continued)


Legal opinions. Virtually all partnershipagreements of private equity fundsprovide that the general partner of theFund may require, as a condition togranting its consent to a transfer by alimited partner, that the transferringlimited partner or the transferee providean opinion of outside counsel as toInvestment Company Act compliance.(The opinion typically covers othermatters as well, including that the offerand sale of the partnership interestbeing transferred did not require regis-tration under the Securities Act.) Ourclients occasionally waive this require-ment, especially where they know thetransferee, or where the transferee is anaffiliate of the transferor. General part-ners should consider not waiving thisrequirement in connection with a transferin a securitization transaction, however,because the structure may be morecomplex or novel than is typical, andthe general partner and its counsel maynot know all the facts they need to getcomfortable with the Investment Com-pany Act analysis.

Anti-Money Laundering ComplianceWhen a limited partner intends totransfer its interest, the general partnershould consider whether the transfer willhave implications for the Fund’s compli-ance with anti-money laundering (AML)regulations. We note that at this timemost buyout funds and venture fundsare not required by U.S. law to instituteAML compliance programs, althoughhedge funds generally are covered byU.S. AML regulations, and Funds organ-ized in the Cayman Islands or in England,for example, will be subject to the AMLregulations in those jurisdictions.

Whether or not a Fund is requiredto implement an AML complianceprogram under U.S. laws and regula-tions, we recommend that the generalpartner and the Fund obtain from theSPV representations on anti-moneylaundering procedures similar to those

that would be obtained from any initialinvestor in the Fund who is serving asan intermediary (as in the fund of fundscontext). At a minimum, the generalpartner and the Fund should obtainassurances that the SPV has AML poli-cies and procedures in place.

ExpensesAny transfer by a limited partner of itsinterest in a Fund will cause the Fundand the general partner to incur certainexpenses, albeit generally of only anominal amount. Given the complexityof securitizations and the fact that secu-ritizations of interests in private equityfunds in particular are relatively novel atthis point in time, a transfer in connec-tion with a securitization may cause theFund and the general partner to incursubstantial legal expenses. While mostpartnership agreements provide thatexpenses incurred by the Fund in connec-tion with a transfer by a limited partnerwill be reimbursed by the transferringlimited partner, the general partner maywant to consider including an expensereimbursement provision in any writtenconsent (as well as in the assignmentagreement), so that if the transfer doesnot actually take place, the Fund may stillseek reimbursement for its legal andother out of pocket expenses. In fact, ageneral partner may want to seek reim-bursement of expenses incurred whiledetermining whether to consent to thetransfer, because it may ultimately decidethat the credit support for future capitalcalls is inadequate and opt not to consent.

Most Favored Nations ProvisionWe have found that, as the structure fora particular CFO evolves, and as variousFund general partners negotiate withthe Transferor to provide them withcomfort on the issues discussed aboveand on other issues of concern, therights granted to general partners maychange. Accordingly, a general partner(particularly a general partner that

grants its consent to the transactionrelatively early in the process) shouldconsider negotiating a “most-favorednations” provision in the originalconsent so that it may benefit from anyside letters or other agreements enteredinto by the Transferor and the SPV withother general partners in connectionwith the securitization transaction.

This article has attempted to highlightand address the key legal and businessconsiderations for a general partnerraised by a securitization of private equityfund interests. Because of the very smallnumber of completed CFOs to date,only time will tell whether general part-ners will obtain the comfort that theyrequire on these issues and whetherthese kinds of securitization transactionswill become commonplace in the privateequity world. — Michael P. [email protected]

— Mia B. [email protected]

In a [securitized pool of

interests in private equity

funds], even more so than in

most securitizations, however,

the assets being transferred…

are highly illiquid and cash

flows are unpredictable….

These limitations and other

business and regulatory

concerns… raise serious

concerns about whether

private equity funds are

an appropriate asset

class to be securitized….


approach, you will likely be driven madsince the issue is going to arise in virtually every transaction you do.Accordingly, we recommend that youtalk through the issue once with yourtax advisor and make a decision thatwill apply to each type of deal you do(e.g., M&A deals, offering a new fund,etc.), unless the circumstances of a

particular transaction are materiallydifferent from what you typicallyencounter in that type of transaction.

For most taxpayers, this will meaneither adding to every confidentialityprovision in every transaction they enterinto either (1) the presumption languagequoted above or (2) a modified form ofthe presumption language tailored tothe taxpayer’s particular confidentialityconcerns for that type of transaction. In addition, many taxpayers will stateexplicitly that the name and identifyinginformation may not be disclosedduring the marketing period or is notpart of the tax structure or tax treat-ment (meaning it cannot be disclosedeven after the marketing period).

Two Other PointsBesides confidentiality, a transactionmay be considered reportable if (amongother things) (1) it generates a signifi-cant loss for tax purposes or (2) thereis a significant difference between how

it is treated for GAAP purposes andhow it is treated for tax purposes. Also,there are a variety of special rules, suchas (1) an exception that generally allowstaxpayers to maintain confidentialityduring the due diligence and negotiationof certain M&A transactions, includingmost acquisitions of at least 50% of thestock of a business and (2) an exceptionthat allows limitations on disclosurethat are reasonably necessary to complywith securities laws.

What’s Next? We expect that the IRS will significantlymodify the regulations applicable toconfidential transaction in the not-too-distant future. In the meantime, whenyou are faced with the issue, we recom-mend that you talk to your tax advisor,make a decision and stick to it. — David H. [email protected]

— Adele M. [email protected]

Making Sense of the New Tax Rules (continued)

Could This Be the Year to Start Expensing Stock Options? (continued)

expense amounts related to the unvestedportion of previously issued awards.(Again, because this expense is notionallymeasured on the grant date, a companymight find itself recognizing expense for options that are out of the money.)

So, to ask the question again, Whywould a portfolio company switch to thefair value method now? To take advantageof the transition rule that lets the companyavoid having to recognize compensationexpense for prior option grants.

Is the decision to switch this year ano brainer? Clearly not. It is possiblethat the intrinsic value method may beallowed to live on, in which case makinga preemptive switch now would be likesecuring a favorable berth on a shipthat never sails. In addition, althoughadopting the fair value method onlyprospectively has the possible advan-tage of not having to recognize any of the expenses for pre-existing optiongrants, for companies that typicallygrant options on a regular basis it does

raise the “ramp up” problem ofincreasing compensation expense asfuture awards are made. Nevertheless,and especially for private equity firmsthat are unlikely to experience a “ramp-up” problem, there is an opportunity tomove now and avoid having to recog-nize the expenses of prior options, andit should be discussed with accountingadvisors before slipping by. — David P. [email protected]

Besides confidentiality, a

transaction may be consid-

ered reportable if (among

other things) (1) it generates

a significant loss for tax

purposes or (2) there is a

significant difference between

how it is treated for GAAP

purposes and how it is

treated for tax purposes.

of information which may be in itspossession and, in some cases, itsunique access to the board or manage-ment of the issuer, a genuine riskexists that non-public informationwhich is not viewed by the insider asmaterial at the time of a securitiestransaction may later emerge as sig-nificant. This could occur with respectto information actually known to theinsider but not then viewed as material(e.g., a health problem for the com-pany’s CEO that initially appears to bebenign but later proves problematic).It could also occur with respect toinformation not actually known by it but that perhaps could have beenknown through closer examination of the information then available to it or greater exercise of its access rights(e.g., accounting irregularities).

In order to protect an insider againstsubsequent claims by a non-insiderbased on the insider’s failure to disclosenon-public information in connectionwith a securities transaction (whetheror not such information is material),Big-Boy letters include very broadwaivers by the non-insider of all suchclaims, including all claims under Rule10b-5. In essence a non-insider tellsthe insider in a Big-Boy letter: “I am asophisticated investor (i.e., a Big-Boy); I understand the rules of engagementon this transaction; and I am notgoing to complain about any aspect of it later under any circumstances.”

These letters make a whole lot ofcommercial sense. But do they workas a legal matter?

Section 29(a)Section 29(a) provides that: “Anycondition, stipulation or provisionbinding any person to waive compliancewith any provision of [the ExchangeAct] or of any rule or regulation there-

under… shall be void.” Rule 10b-5prohibits the owner of a security inpossession of material non-publicinformation from purchasing or sellingthe security without disclosing thatinformation. Thus, on its face, Section29(a) would appear to invalidate thecentral feature of any Big-Boy letter: thewaiver of all claims against the insiderin connection with the purchase or saleof securities, including claims arisingunder Rule 10b-5.

CasesNotwithstanding Section 29(a), manycourts have enforced broad waiversand releases of federal securities lawclaims under a variety of circumstances.

For example, in Korn v. Franchard,388 F. Supp 1326 (S.D.N.Y. 1975), theU.S. District Court for the SouthernDistrict of New York upheld a broadrelease of an existing, matured claimof which the releasing party had actualknowledge. The Korn court cited Wilkov. Swan, 346 U.S. 427 (1953), for theproposition that Section 29(a) barsanticipatory waivers of compliance withthe provisions of the securities laws, notwaivers or releases of known, ripenedclaims. Numerous cases in other juris-dictions have upheld similar waivers.

In Goodman v. Epstein, 582 F. 2d 388(7th Cir. 1978), the Seventh Circuitwent further, holding that waivers arevalid under Section 29(a) with respectto claims which were known or shouldhave been known by the waiving party.In Goodman, a group of LPs in a realestate venture released all securitieslaw claims against the venture’s GP.The LPs later discovered that the GPhad called capital prior to the releasewithout disclosing the existence of avariety of adverse developments whichultimately contributed to the demise of the project. The LPs sued, arguing

that their release was void underSection 29(a) since they did not haveactual knowledge of these adversedevelopments when they signed therelease. But the Court enforced therelease, holding that the GP’s requestfor a release put the LPs on notice that further inquiry with respect to theactions of the GP should be under-taken, and that the LPs, therefore, had“constructive knowledge” of the under-lying claims, which could have beendiscovered had due inquiry been taken.

In Petro-Ventures, Inc. v. Takessian,967 F. 2d 1337 (9th Cir. 1992), theNinth Circuit enforced a release ofsecurities law claims on a basis thataugers particularly well for the enforce-ability of Big-Boy letters.

In Petro, the parties had a disputeabout the value of certain propertiesthat the plaintiff had contributed to the defendant in exchange for partner-ship interests. The parties subsequentlysettled their dispute and released allclaims against each other “regardlessof whether or not such claims hadbeen [raised in the dispute] to whichthe settlement agreement relates.”Shortly thereafter, the plaintiff broughtfraud and 10b-5 claims against thedefendant after discovering that itspartnership interests had not beenproperly registered with the SEC,thereby reducing their value. The plain-tiff contended that its suit was notprecluded by its release because“unknown claims pursuant to the fed-eral securities laws cannot be released…even by the execution of a settlementagreement that purports to release allknown and unknown claims.”

The Ninth Circuit rejected the plain-tiff’s argument and upheld the validityof the release. Although the court

Do Big-Boy Letters Really Work? (continued)




Do Big-Boy Letters Really Work? (continued)

could have applied the logic underlyingGoodman to reach its conclusion, itinstead focused principally on theexpress terms of the parties’ contrac-tual arrangement: “There is no doubtthat the language of the release isunambiguous in conveying the intentof the parties to release all unknownclaims… [W]hen, as here, a release issigned in a commercial context byparties in a roughly equal bargainingposition and with ready access tocounsel, the general rule is that, if thelanguage of the release is clear,… theintent of the parties [is] indicated bythe language employed.”

A 1996 Second Circuit case, Harsco v. Segui, 91 F.3d 337, further illustratesthe willingness of courts to enforceexplicit Big-Boy-like waivers that are the result of arm’s-length negotiationsbetween sophisticated, well representedparties. In Harsco, the plaintiff/purchaseracquired all of the stock of an operatingcompany following an extended periodof due diligence. The definitive purchaseagreement contained an extensive setof representations and related indem-nities for the benefit of the plaintiff. Italso contained an express disclaimerof any representations not contained inthe definitive agreement. Following theclosing, the purchaser sued the defen-dant/seller alleging various 10b-5 andfraud claims based on representationsallegedly made by the defendant out-side of the agreement. It argued thatany provisions of the agreement whichpurported to bar such claims were void under Section 29(a).

The Second Circuit framed the centralissue in the case as “whether parties whonegotiate at arm’s length for the saleand purchase of a business can definethe transaction in a writing so as topreclude a claim of fraud based onrepresentations not made, and explicitly

disclaimed, in that writing.” The courtconcluded that the answer to that ques-tion was yes, holding that enforcingthe limitations in the contract did notrun afoul of Section 29(a) in light of allthe other substantive rights the plain-tiff had bargained for under the contract.It noted:

“Harsco bought… 14 pages of repre-sentations. Unlike a contractualprovision which prohibits a party fromsuing at all, the contract here reflectsin detail the reasons why Harsco bought[the business] – in essence, Harscobought the representations and…nothing else…. Thus it is not fair tocharacterize the [purchase agreement]as having prevented Harsco fromprotecting its substantive rights. Harscorigorously defined those rights in [thebalance of the purchase agreement.]”

So, What’s the Answer?Notwithstanding the outcome and the helpful language, Korn, Goodman,Petro-Ventures and Harsco do not allowone to conclude with certainty that the waiver provisions in a Big-Boy letterwould be enforced. None of thesecases is a U.S. Supreme Court caseand some courts in other jurisdictionshave been less willing to enforce similarwaivers or releases of securities claims.Unlike a Big-Boy letter, most of thesecases involved releases in connectionwith litigation settlements and thus maybe driven more by an effort to furtherjudicial economy than by a willingnessto disregard Section 29(a) in othercircumstances. The plaintiff in each ofthese cases was put on notice, withgreater specificity than would be presentin a typical Big-Boy letter, of the nature

The following are the key provisions to include in any Big-Boy letter to maximize its prospects for enforceability:

• The non-insider is a sophisticated investor, and has the appropriate knowledge

and experience to evaluate and negotiate the transaction;

• The non-insider has had the opportunity to consult with such advisers as it

deems appropriate;

• The non-insider has adequate information to evaluate the transaction and has

had the opportunity to discuss such information with its advisers;

• Neither the insider nor any person affiliated with the insider has made any repre-

sentation or warranty, express or implied, regarding any aspect of the transaction

except as set forth in the Big-Boy letter, and the non-insider is not relying on any

such representation or warranty not contained in such letter (the more particular-

ized the disclaimer, the better);

• The non-insider acknowledges that the insider may possess or have access to

material non-public information which has not been communicated to the

non-insider;

• The non-insider waives any and all claims it may have or may hereafter acquire

against the insider, relating to any failure to disclose non-public information in

connection with the transaction; and

• The non-insider is aware that the insider is relying upon the truth of the foregoing

representations in connection with the transaction.


of the claims it was waiving and was alsoin a better position than most non-insiders in a typical Big-Boy context todiscover the underlying factors whichgave rise to its later claim. And, in thecase of Harsco, the plaintiff enjoyed thebenefit of a number of other remedies,something that would not be true inthe case of a Big-Boy letter.

Still, taken together, Korn, Goodman,Petro-Ventures and Harsco, along with a number of other cases decided underSection 29(a), make it more likely thannot that the waiver provisions of atypical Big-Boy letter would be enforcedin most cases. Like the releases inthese cases, Big-Boy letters are theproduct of bilateral negotiations ratherthan unilateral relinquishments orwaivers of rights. They do not waivefuture violations of the securities lawsbut only violations that might occur in connection with the closing of thetransaction. The insider’s request for a Big-Boy letter puts the non-insider on notice that further inquiry withrespect to information known to theinsider may be appropriate; to theextent the non-insider proceeds with-out such information, it reflects aknowing assumption of risk and mayalso directly benefit it by positioning it to resell the securities freely. In addi-tion, in many situations, the insidergenuinely believes that the non-publicinformation in its possession is notmaterial, unlike the defendants inGoodman and Petro-Ventures, whopresumably were well aware of themateriality of the facts underlying theclaims that were later brought againstthem. And most importantly, Big-Boyletters, by definition, reflect an expresscontractual allocation of risk betweensophisticated, well represented partiesunder no compulsion to act, andcourts consistently have been loathe to undue these type of arrangements.

Reasonable RelianceEven if a waiver of 10b-5 claims in aBig-Boy letter were found to be voidunder Section 29(a), a separate provi-sion of a typical Big-Boy letter – thenon-insider’s express disclaimer ofreliance on any representations not set forth in the letter – may separatelyshield the insider from a successful10b-5, fraud or negligent misrepresen-tation claim by the non-insider. This isbecause there is a substantial body ofcase law to the effect that a sophisti-cated, well represented party’s expressacknowledgment that it is not relyingon any representation not set forth in adefinitive agreement defeats its abilityto demonstrate an essential element of any 10b-5, fraud or negligent misrep-resentation claim – reasonable relianceon any fact or circumstance that is not the subject of the representationsexpressly set forth in the definitiveagreement. The more explicit thedisclaimer, the more difficult it will be to show reasonable reliance.

Some important distinctions existbetween the disclaimers in the decidedcases in this area and standard Big-Boydisclaimers. Big-Boy disclaimers arenormally much more general than thekind of particularized disclaimers thathave typically been held to bar a showingof reasonable reliance. They are typicallyfurnished by a party who has performedlittle, if any, due diligence, therebymaking it harder to conclude that theparty made a knowing assumption of risk that would defeat reasonablereliance. A claim by a non-insiderunder a Big-Boy letter is more likely to relate to an omission than a misrep-resentation, and some courts haveheld that reasonable reliance is not anessential element of a 10b-5 claimbased on non-disclosure. And, finally, a court may conclude that to hold that the disclaimer clause in a Big-Boyletter precludes a showing of reason-

able reliance is simply a back-door wayto achieve an impermissible waiver of federal securities law claims underSection 29(a).

Still, courts have consistentlyenforced disclaimer clauses agreed to by sophisticated, well representedparties in a wide variety of circum-stances, including in the face ofegregious misstatements and decep-tions by the non-disclaiming party. Sothe inclusion of a disclaimer clause in a Big-Boy letter, particularly a clausethat disclaims reliance on any areaswhere there may be an identifiable riskof material non-disclosure or misre-presentation (e.g., the future revenues,results of operations or financial con-dition of the issuer), may well give an insider a secondary line of defenseagainst 10b-5, fraud and negligent misrepresentation claims if the waiverclause of the letter is set aside underSection 29(a). — Stephen R. [email protected]

…Taken together Korn,

Goodman, Petro-Ventures

and Harsco, along with a

number of other cases decided

under Section 29(a), make

it more likely than not that

the waiver provisions of a

typical Big-Boy letter would

be enforced in most cases.


China’s Revised Venture Capital Rules (continued)

(in absolute dollar terms) and there-fore low-risk way of getting to knowthe Chinese market better, and, bybeing an early investor in an on-shorefund, earning the favor of the Chineseauthorities.

• The 2003 Rules contain a host ofrequirements relating to filing withthe State Administration for Industryand Commerce (SAIC) that did notappear in the 2001 Rules or in all butthe latest drafts of the 2003 Rules.We understand that this is largely the result of “turf” disputes betweenSAIC and MOFTEC – the last fewmonths have seen a number ofpublic references to efforts to limitthe sweeping authority of MOFTECover foreign investment in China.The outcome of this struggle will notbe surprising to students of bureau-cracies and public administration:the intrusion of a new regulatoryauthority rather than more individualinvestor freedom from regulation.SAIC’s role is supposed to be moreministerial than substantive, but it is hard to believe that local SAIC offi-cials will be able in all cases to refrainfrom second-guessing MOFTEC’sjudgment that a particular fund pro-posal complies with the 2003 Rules.

• We have no idea how willingMOFTEC or other relevant Chineseregulatory officials will be to acceptfund documents that contain exten-sive references to U.S.-related incometax and ERISA provisions. Fund spon-sors may want to consider adopting

uniform subscription agreementprovisions that contain appropriateVCOC undertakings, ERISA opt-outprovisions, UBTI provisions and U.S.-specialized tax allocation provisions,recognizing, in the latter case, that itmay not be possible to force acomplete match between U.S. andChinese PRC tax allocation provisions.

• The MOFTEC drafters of the 2003Rules have bent over backwards toaccommodate centralized generalpartner and fund manager operationof funds organized under the 2003Rules. But the underlying regulatoryframework leaves several oddities.

– In the first place, China has nogenerally applicable limited part-nership law and no laws permittingthe tax equivalent of a U.S. limitedliability company. The 2003 Rulesare at bottom based on old rulesrelating to Sino-foreign “coopera-tive joint ventures,” which assumepartnership-like structures butcontain nothing authorizing limitedliability for one or more partners.The 2003 Rules (and their 2001predecessors) contain only a singlesentence declaring that if oneinvestor has unlimited liability theothers can each have liability limitedto their capital commitments. Untilthere is clear authority for this in the law or in high-level judicial deci-sions, most investors will want toput a limited liability entity betweenthemselves and a China venturecapital fund.

– Secondly, notwithstanding a clearprovision in the 2003 Rules for thevesting of the fund managementfunction in a third party manageror in a single fund investor (the2003 Rule equivalent of a “generalpartner”), the 2003 Rules mandatethe formation of a “joint manage-ment committee” responsible forthe overall management supervi-sion of the fund. This requirementis taken directly from the old“cooperative joint venture” rules,and we understand the MOFTECdrafters felt that they could notunilaterally eliminate this require-ment. However, they carefully didnot specify the composition of thiscommittee, and until proven wrong,we are operating on the assumptionthat as long as there is somethingcalled a “joint management com-mittee” consented to by all investors,there is no requirement that the“joint management committee”has as members people who arenot affiliated with the generalpartner or the fund manager.

– Thirdly, the absence of a limitedpartnership law in China meansthat fund sponsors will have tochoose between including in theirfund documents some of the basic“rules” governing general partnerresponsibilities and liability, orincluding nothing and risking criti-cism from skeptical investors whowant their general partners to haveat least the limited standards of careand loyalty imposed by Delaware’s

Revised Uniform Limited Partner-ship Act (RULPA). Our initial draftof a fund agreement under the 2003Rules assumes that fund sponsorswill find their marketing task simpli-fied if they include in the funddocumentation some of the basicbehavioral guidelines imposed byRULPA.

– Fourth, China’s investment lawshave historically assumed thatinvested capital (as opposed toprofits) would be returned only atthe termination of the investmentvehicle. The MOFTEC drafters haverecognized that in venture capitaland private equity funds, investedcapital is generally returned uponan investment-by-investment basisrather than upon the final liquida-tion of the fund. But it is not at allclear that the regulatory authoritieswill understand the concept ofhaving the fund retaining otherwisedistributable profits and cash flowand deeming the application ofthose funds to constitute additional“investments” by fund investors, to count against their investmentcommitments. Historically,“invested capital” is capital thatflows from the hard currency worldinto the (relatively) closed world of the Chinese Renminbi. Initially,we suspect that funds will have tobypass the simplicity of recyclingfunds within a fund and creditingthat usage against investor capitalcommitments. Instead, they willfeel compelled to return excess cashand earnings to fund investors,

and then make new draws on committed capital to cover fundoperating expenses and newinvestments.

– Finally, the drafters of the 2003Rules were ideologically limited by the notion, also imbedded inChina’s foreign investment laws,that committed capital has to beinvested within a certain period of time after the formation of theinvestment vehicle. The 2003 Rulesrepresent a huge step forward from the 2001 Rules in that theycontemplate increases anddecreases in committed capitalduring the investment period sothat investors are not threatenedwith a legal investment require-ment when the fund sponsor can’tfind appropriate investments, but they unfortunately still contain a requirement that all committedcapital (as adjusted) has to beinvested by the end of a five-yearinvestment period.

This obviously makes follow-oninvestments difficult, and raises questions about the funding offund operating expenses followingthe end of the investment period. At present, we think that the agree-ment to fund post-investmentperiod operating expenses mayhave to be imbedded in the sub-scription agreement rather than inthe fund documentation, and thatfollow-on investments after theexpiration of the standard five-yearinvestment period will requirespecific approval by the relevantregulatory authority.

If you would like more informationabout the 2003 Rules, our translationcan be obtained from Dan Madden [email protected]. We willalso be happy to speak with any of ourclients and friends about how ourdraft on-shore venture capital partner-ship agreement might be adopted tomeet a specific need. — Jeffrey S. [email protected]


The new [2003] Rules…

eliminated many if not most

of the structural problems

associated with the 2001

Rules. Unfortunately, the

central taxation authority

did not… change the tax

rules applicable to off-shore

investors in on-shore funds.


Indemnification by Stockholders of Public Targets (continued)

Going, Going, Gone? (continued)

look like? Would the banker be opiningon the fairness of the total consideration,somehow attributing value to the targetstockholder’s contingent right to receiveadditional cash out of the trust? If not –if the fairness opinion covers only theconsideration paid up front – then thegreater the holdback, the more difficultit may be to obtain a fairness opinion.

Another related innovation that hascropped up in the past five years or sois representation and warranty insur-ance. Although readily available andstill evolving, this type of insurance hasrarely been used in the public context.Negotiating a tailored insurance policyfor a public transaction will of coursehave costs of its own.

Private equity firms considering theuse of indemnity structures in publicdeals will want to consider a number of other legal, tax and business issues.For instance, any trustee appointed to

defend the target stockholders’ rightsmight be expected to be overzealous intheir defense, possibly degrading thebenefit of the indemnity. (This problemmight be mitigated if instead the targetstockholders purchased for the buyerrepresentation and warranty insurance,because the defense of claims wouldgenerally pass to the insurance com-pany, which would not need to satisfyany fiduciary obligations to stock-holders.) Another concern is that afund’s limited partners may not want to incur the opportunity costs (andpossible reduction in overall IRR) of“paying” full price up-front, only tohave some portion of the purchaseprice returned years later (with noreturn) as the result of an indemnityclaim. While the same problem mayarise with an indemnity in a private deal,limited partners may be less willing toadd this risk to the other risks that arise

in the public arena. Public disclosure isanother issue – if the private equity firmneeds to raise high-yield debt, will it beproblematic to disclose that it has createda reserve (and the amount of the reserve)for potential problems with the business?

Despite these concerns, a limitedindemnity might be just the thing tojump-start a stalled deal in the currentenvironment or to encourage a privateequity firm to consider a public acquisi-tion. For reasons of custom, complexityand added uncertainty, private equityfirms will need to overcome naturalresistance in the market to the indem-nity structure. Nevertheless, at the endof the day, given the choice between no deal and a good deal with a limitedindemnity, target stockholders may well choose the latter. — Andrew L. [email protected]

with Target? If not, Target board approvalwill be needed for the merger.

One likely Omnicare result: moreprivate equity firms and founding stock-holders will have companies opt out of business combination acts, and notadopt poison pills.

Early Stockholder Approval

If Target’s stockholders can act bywritten consent, Bidder 1 could seek to have its deal approved up front by Target’s big stockholders, since stock-holder approval should extinguish the board’s fiduciary duty to be able to entertain a superior bid. Under

Exchange Act rule 14c-2(b), a privateequity firm could sign a consent infavor of the merger when the mergeragreement is signed – but the mergercan’t close for at least 20 days afterTarget stockholders have received adetailed information statement.

Termination Fees

One approach isn’t glamorous or novel,but has been blessed by courts (even,in dictum, in Omnicare): if Target direc-tors exercise their fiduciary out to takea competing bid, Target has to payBidder 1 a termination fee – equal sayto 3% or so of what the first bidder was

prepared to pay. That won’t preclude acompeting bid, but will make one morecostly, and will cover Bidder 1’s expenses.

Not Every Company is

Incorporated in Delaware

Courts of other states have been influenced by Delaware decisions oncorporate law matters, but may bemore likely to defer to the businessjudgment of an informed and disinter-ested board to approve a lock-up. — Meredith M. [email protected]

— William D. [email protected]


Convertible Preferred Shares à la Française (continued)

principal shareholders agree to vote to elect the investors’ designees in ashareholders’ agreement.

Where U.S.-style is to provide vetorights directly to preferred share-holders, French practice is generally toplace these rights at the board level byproviding that the specified board deci-sions require the vote of the director(s)nominated by the preferred holders in addition to an affirmative vote of amajority of all the directors present. For maximum effectiveness, these vetorights are expressly set forth in thecompany’s articles of incorporation.Although it is still debated amongFrench legal commentators, it seemsthat a French company could follow the U.S. style and provide in its articlesof incorporation that certain decisionsof the board or of the shareholderswould be subject to a veto right held bypreferred shareholders (rather than theboard members they have nominated).Certain complexities of French law,however, suggest that the Frenchmarket practice of keeping the rights at the board level may be the betteroption. As a general rule, veto rightsgranted directly to the preferred share-holders would need to be structured to avoid a total usurpation of the deci-sion-making powers reserved to thecompany’s management bodies (i.e.,the board of directors or managementcommittee) because the statutory allocation of powers to the managingbodies is not modifiable. Additionally,the veto rights must not cause theshareholders who enjoy them to beseen as de facto managers of the com-pany; otherwise, such shareholderswould be exposed to certain additionalliabilities in the event of insolvencyproceedings.

Information rights. French company lawdoes allow specific information rightsto be attached to a designated class of shares. As with veto rights, however,if these rights are too extensive, theshareholders benefiting from themmight be considered as de facto man-agers of the company. Consequently, it is generally preferable for investorswishing to obtain more detailed infor-mation about the company than ismade available to shareholders gener-ally to insist on special representationon the board.

Shareholders’ Agreements

In France, shareholders’ agreementsare the most common tool used toestablish contractual rights for aninvestor. These agreements are gener-ally valid under French contract law and help to avoid some of the rigiditiesencountered in French company law.(However, as noted below, in the eventof breach, specific performance is notavailable.) Common features in share-holders’ agreements provide fordrag-along and tag-along rights, rightsof first refusal, prohibitions on certaintransfers, anti-dilution protection andvoting agreements to ensure boardrepresentation.

Shareholders’ agreements can alsoinclude provisions designed to imitatethe feature of U.S.-style preferred thatprovides preferred shareholders with a priority distribution upon the occur-rence of certain transactions. In this vein,to achieve the same economic resultthat is obtained in the U.S. by treatingmergers, consolidations, assets sales,etc. as liquidation or redemptionevents, investors in France often rely on put or call options granted by otherprincipal shareholders. These optionswould be exercisable at a pre-agreed

price or a price based on a specified for-mula upon the occurrence of a triggeringevent such as a merger, consolidationor a sale of assets. The pricing of theput option may, however, be subject to the prohibition on unconscionableprovisions (clauses léonines). In thiscontext, the worry would be that a pre-specified minimum price would allowthe preferred shareholders to avoidparticipating in any losses the companysuffered. While some French courts will allow contractual puts at a specifiedprice to be enforced, others apply theunconscionability test to such provisions.Another complicating factor is the creditworthiness of the shareholderswho are required to purchase theshares pursuant to the put. Althoughthis solution does not appear widelytested in practice, put and call optionscould also be used to replicate man-datory redemption provisions, byrequiring other shareholders (but notthe company) to purchase the shares if the preferred shareholder has notbeen able to exit after a specified time.

Shareholders’ agreements in Francedo have important limitations that canmake relying on them more complexand problematic than in the U.S. Inparticular, any transfer restrictionsmust be limited in time and justified by a “serious and legitimate” interest,although in practice the restrictionperiod often extends for decades. Ofperhaps more importance to a U.S.investor is the fact that the remedy of specific performance – obtaining a court order forcing the violator tocomply with its obligations under theshareholders’ agreement – is not available in France. Under French law,shareholders agreements are enforce-able only through money damages.continued on page 26

Convertible Preferred Shares à la Française (continued)


Furthermore, there is uncertainty aboutthe amount of damages an investorwould be entitled to recover sincedamage payments are dependent onproviding evidence of the economicdamage actually suffered.

Additionally, the shareholders of a French publicly traded company must inform the Conseil des MarchésFinanciers (CMF) of the provisions ofany agreements containing preferentialterms relating to transfers of shares.Such agreements could be deemed toconstitute a “concerted action” (actionde concert) among the shareholderswho are parties to the agreement. If a concerted action is deemed to exist,such a conclusion could, in turn,trigger certain French securities lawsrequirements that can include jointand several responsibility for (1) fulfill-ment of notification requirements if the group of shareholders “acting in a concerted fashion” crosses certainaggregate percentage ownershipthresholds and, once the group holdstogether more than 33 % of the sharecapital of the company; (2) observationof restrictions on how quickly thegroup can acquire additional shares;and (3) in certain instances, perform-ance of the obligation to launch atender offer for the remaining shares of the company.

The shareholders’ agreement isnevertheless a widely practiced, andtherefore a well-tested and accepted,mechanism for providing special rights to investors.

Specially Designed Securities

Among the rights and protections that are the most difficult for investors to replicate in France are rights to a priority distribution upon certain transactions, redemption rights and

conversion rights with an adjustableconversion ratio. In practice, Frenchinvestors generally take speciallydesigned securities either in addition to or in place of preferred shares inorder to obtain certain of these rights.

Priority distribution. As mentionedabove, the priority distribution upon amerger, consolidation, asset sale, etc.could be provided for via put or calloptions in a shareholder agreement.Another solution involving a compositesecurity would be the issuance of apreferred or common share coupledwith a warrant that, upon the occur-rence of certain events, can be eitherexercisable into new common shares of the company or mandatorilyredeemable by the company at a pricebased on a pre-determined formula.These securities, referred to as actions àbon de souscription avec faculté de rachat(ABSARs), do not alone produce theresult obtained by using a liquidationpreference or redemption to providefor the priority distribution.

Specifically, ABSARs would normallypermit the investors to retain the linkedshares after exercise or repurchase ofthe warrants This continued equityownership could result in the investors’receiving more than the return to whichthey are entitled unless (1) the linkedpreferred shares automatically convertinto common shares and (2) othershareholders or the acquiror in thetransaction giving rise to the exercise/redemption right has the right topurchase these common shares at adeep discount calculated to take intoaccount that the preferred shareholdershave already received the targetedreturn. Calculating and negotiatingthese formulas and discounted pricespresents an additional complexity.

Although these securities are notcommonly used and remain somewhatuntested in French practice, they can be structured. Finally, some commen-tators suggest that, under certainconditions, the company’s obligationto repurchase the warrants could beconsidered unconscionable (a clauseléonine) and therefore unenforceable.

Conversion and anti-dilution. Frenchinvestors have embraced the protectionafforded by the anti-dilution protectionembodied in the U.S.-style conversionfeature. Various market-tested solu-tions exist.

French investors do not generallyrely simply on “convertible” sharesbecause the conversion from preferredshares to common stock would normallyhave to occur at a one-to-one ratio.French legal commentators take theposition that providing for an adjustmentof the conversion ratio upon subse-quent dilutive share issuances conflictswith the basic principle that in Franceshares may not be issued for less thantheir nominal value. The French legalcommunity does seem to be warmingto the idea that conversion could occurat less than a one-to-one ratio and so the practice in this area may grad-ually shift to a U.S.-style convertiblepreferred share with an adjustableconversion ratio.

Current practice, however, is forinvestors to purchase preferred shareswith attached warrants (bons de souscrip-tion d’actions) or bonds. The warrants or bonds are exercisable or convertibleupon the issuance of new shares andgenerally provide investors with adequateanti-dilution protection.

The warrants allow investors to obtainadditional shares at a low, fixed priceand accordingly reduce the average per


share price of their investment. Theydo not, however, confer voting rightsprior to exercise and, therefore, wouldnot allow the voting on an as-convertedbasis often provided in U.S.-styleinstruments. The exercise mechanismcan be designed to replicate either full-ratchet or weighted average anti-dilution protection. However, unlikeconversion price adjustments, the exercise of the warrants would requirean additional cash payment by theinvestor.

Two types of bonds are commonlyused to provide anti-dilution protec-tion: convertible bonds (obligationsconvertibles en actions or OCA) andbonds that are redeemed exclusively in shares (obligations remboursable enactions, or ORA). In either case, like thewarrants, the bonds can be designed toreplicate either full-ratchet or weightedaverage protection but do not allow thebondholders any voting rights relatingto the underlying shares prior to con-version or redemption. The principaldisadvantage of the bonds comparedto warrants is that the acquisition of the bonds requires the investor tomake a cash payment in the amount ofthe debt. Unlike the warrants, however,the bonds allow investors to obtain the underlying shares without an addi-tional cash payment. In practice,investments are structured so that theinvestment in the preferred sharescoupled with the cash payment for thedebt does not present an additionalinvestment cost.

Redemption. French laws relating tostock repurchases by a company make it impossible to rely on mandatoryredemption of preferred shares as ameans of protecting an investor’s orig-inal investment. Moreover, Frenchinvestors have generally foregone theeconomic protection that could be

provided by crafting instruments thatmimic redemption provisions. Conse-quently, many of the solutions, althoughtheoretically possible, remain untestedin the market.

While a procedure (an amortisse-ment prioritaire) does exist that allowsdesignated classes of shareholders torequire a company to reimburse (asdistinct from repurchase) their shareson a priority basis, this procedure hassignificant limitations. Specifically, thisprocedure allows the company to reim-burse all or a portion of only the parvalue of the preferred shares and would,therefore, not allow the preferred share-holders to receive a return on theirinvestment. Additionally, this procedurerequires approval of the shareholdersat the time of the proposed reimburse-ment, although an undertaking to votein favor of the reimbursement could be provided for in a shareholders’agreement. Finally, following the reim-bursement, the preferred shareholderswould retain their shares, with all priv-ileges still intact, although the type ofconversion and call right discussedabove in relation to ABSARs could beutilized to extinguish these equity rights.

In light of these limitations of Frenchcompany law, compound securitiespresent the best hope (aside from putor call options contained in share-holders’ agreement) for replicatingU.S.-style redemption. Again, ABSARscould be employed to achieve thedesired economic result.

Prospects for a French EvolutionThe French private equity and venturecapital investment community wants to encourage greater non-Frenchparticipation in French private equityand venture capital activity and toimprove the economic rights and legalprotections afforded their investors.Therefore, it is attempting to rationalize

the differences between the French legalsystem and market practice and thoseof markets where private equity andventure investing are more developed.The process of clarifying French rulesand encouraging adoption of new oneswhere desirable will not occur rapidly,and the French, by choice and perhapsby circumstance, may never receive theidentical package of rights and protec-tions now familiar to U.S. investors.Nevertheless, through careful struc-turing, investors willing to adapt to therisks and challenges of investing inFrench companies can achieve rightsand protections that are similar to manyof those that they generally expect inother markets. — Ann G. [email protected]

— Felicia A. [email protected]

In France, shareholders’

agreements are the most

common tool used to estab-

lish contractual rights for

an investor… Shareholders’

agreements can also

include provisions designed

to imitate the feature of

U.S.-style preferred that

provides preferredshareholders

with a priority distribution

upon the occurrence

of certain transactions.

German Funds Made Easieralert

The German legislature is currentlyworking on two new laws that willmake it easier for both German andnon-German private equity and hedgefunds to participate in the Germanmarkets. The new laws – the Invest-ment Act and the Investment TaxationAct – will have a significant impact on the regulatory framework for theGerman investment managementindustry. The changes that will be mostimportant to our private investmentclients are:

• the discriminatory tax treatment of non-German funds, in particularhedge funds, sold in Germany isproposed to be abolished;

• the asset class limitations for fundslicensed in Germany will be abolishedfor the most part, allowing for moreflexibility and new types of funds,such as derivative funds;

• for the first time, a regulatory frame-work for German hedge funds will be created; currently existing instru-ments such as hedge fund certificatesdesigned to give German investorsaccess to hedge fund products willbecome superfluous; and

• the sale of hedge funds to institu-tional investors will generally bepermitted; individuals will only haveaccess through public funds of fundsinvesting in hedge funds.

To date, drafts of the new laws have notbeen made available. We are closelymonitoring the legislative process andwould be happy to discuss any signifi-cant developments with you. — Marcia L. [email protected]

— Christian R. Dö[email protected]


Upcoming Speaking Engagements

May 22 Jonathan J. RikoonEstate Administration ConferenceFamily Limited Partnerships, Case History and Valuation IssuesNew York, NY

June 24 Michael P. HarrellPrivate Equity Analyst 2003 Limited Partners SummitNegotiating Lower Management Fees, Carries and Other More Favorable Terms for Private Equity FundsNew York, NY

June 23-24 Adele M. KarigInstitute for International ResearchPrivate Equity Tax PracticesBoston, MA

July 9-10 Marwan Al-TurkiThe 2003 Private Equity COO’s and CEO’s ForumOptimizing Operations – LP Reporting, Fund Administration, Technology and Compensation Issues ResolvedLondon, England

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