Fund Developments: Continuation Vehicles Face New Regulatory Scrutiny

The use of continuation vehicles ("CVs") in the private equity fund sector has garnered media attention recently with reports that the Securities and Exchange Commission (the "SEC") appears to be pursuing investigations concerning the use of CVs to extend the life of private equity funds.

Typically, private equity funds have a finite life, often with a term of ten years, subject to certain customary and limited extensions. In recent years, funds have begun to experience serious headwinds implementing exit strategies. Challenges include rising interest rates, market volatility, inflation, investor cash flow demands and numerous geopolitical impacts. In response, fund managers and sponsors have sought to find ways to extend the exit off-ramp. By forming a CV, fund managers seek to transfer the existing assets and investments of the soon to be terminated fund to the CV, bring in fresh capital from new investors, and provide the investors in the existing fund the ability to either continue as an investor in the CV or cash out. According to media reports, CVs made up the majority of $106 billion in fund manager led secondary deals in the last year.

Over the years, the use of CVs has been criticized for disincentivizing fund managers from maximizing value during the traditional term of the fund. Further, having the same fund manager for both the existing fund and the CV presents an inherent conflict of interest and fuels concerns that managers may inflate the value of assets being transferred in favor of the CV versus the existing fund.

The SEC is now focused on these conflicts of interest, the valuation of assets and the adequacy of investor disclosure. As a result, the SEC could require fund managers to comply with tightened valuation methods and enhanced disclosure requirements, which in turn could pressure fund managers to shift their focus back to the traditional private equity fund model of maximizing value during the term of the original fund and utilizing traditional exit strategies. Additionally, while the SEC's investigation seems to be focused on private equity funds, any concerns and related restrictions imposed on the implementation and utilization of the CV model (and any potential future scrutiny by the SEC) would likely extend to other fund markets.

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For more information on this issue or other corporate matters, please contact:

Morris F. DeFeo, Jr. at +1 212 592 1463 or [email protected]
Tara Guarneri-Ferrara at +1 212 592 1406 or [email protected]

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