United States: Podcast - Credit Funds: How Managers Can Avoid And Mitigate ERISA Conflicts

Credit fund managers face unique conflicts issues under ERISA that require specific policies and procedures designed to identify, avoid and mitigate the risks these conflicts pose. This podcast serves as an introduction to how credit fund managers should approach some of the common and emerging scenarios and misconceptions surrounding ERISA, including season and sell, loan participations, venture capital operating company designations and transacting in secondary markets.

This is the first in a series of podcasts featuring discussions of market trends and common issues related to credit funds.

For key takeaways from this discussion click here.


Transcript:

Jessica O'Mary: Hello, and welcome to the first podcast in a series of podcasts focused on issues related to credit funds. My name is Jessica O'Mary, and I am a partner at Ropes & Gray in our investment funds practice, with a particular focus in the credit funds industry. Joining me today is Josh Lichtenstein a partner in our tax and benefits group who focuses on ERISA and employee benefit matters. Today we'll be discussing with Josh the features of ERISA that impact credit fund managers and how to navigate a few issues that are relevant for those managers.

Jessica O'Mary: Josh, what do you see as the most important thing for credit fund managers to know about ERISA? 

Josh Lichtenstein: ERISA is fundamentally about identifying and avoiding or mitigating conflicts of interest between ERISA fiduciaries and the plans they work with. The primary way that these conflicts can be mitigated is through having policies and procedures to identify and resolve these conflicts, and making sure that they are followed. For credit funds, the most common conflicts that we see are those where our credit manager is on multiple sides of the same transaction. ERISA prohibits cross trades, but cross trades are conceived of under ERISA much more broadly than they are other purposes, and so any transaction where the same manager is managing multiple mandates on the buy and sell side, or otherwise on opposite sides of the transaction it is potentially going to be cross trade under ERISA that would be prohibited. So season and sell, or other types of syndication transactions, are a common example of a transaction that a credit fund may engage in, that may create an issue under ERISA.

Jessica O'Mary: So, Josh, it sounds like other similar situations that might raise issues that are common with credit fund managers may be loan participations, or shared S.P.V.s below the fund. Is that correct?

Josh Lichtenstein: That's correct. Anytime that you have a transaction where the manager is representing an ERISA mandate, and another mandate, whether or not that second mandate is an ERISA mandate, and their transacting with each other, that is where these issues are raised, and where these concerns may be present. The other common conflict that we see is when a manager that has multiples mandates that are both invested in the same capital structure has to make a decision about whether or not to exercise rights on behalf of the ERISA mandate. This can happen if you have an ERISA mandate that holds senior debt securities, and another mandate ERISA or not that holds junior debt securities, or where you have one mandate holding debt securities, and one mandate holding equity securities at the same company. In these situations, the concern that would be raised is where you have to determine whether to exercise rights that the ERISA mandate has with respect to its securities. And those rights may have a different impact on the ERISA mandate versus the other mandates that also hold in the capital structure. And the conflict that would be of concern, and must be mitigated, is any situation where the manager could be viewed as having taken into accountant the impact of those decisions on the mandates as a whole, not just making a decision to act in a matter that's in the best interest of the ERISA mandate.

Jessica O'Mary: Are there any common misconceptions in the marketplace about ERISA issues for credit funds?

Josh Lichtenstein: There are a few. The first one is that you'll often hear people say that credit funds can't be exempt from ERISA as venture capital operating companies, or V.C.O.C.s. Generally in order to be a V.C.O.C. and so be exempt from ERISA, you need to have a fund that is investing primarily into operating companies, and which possesses certain management rights with respect to those operating companies. While it can be more difficult to manage to negotiate these management rights as a credit fund, particularly when investing outside of the U.S. where people may be less familiar with the requirements of ERISA, and so may be less familiar with seeing these management rights requests. But credit funds are not precluded from being V.C.O.C.s, and it's actually quite common for mezzanine debt funds to qualify as V.C.O.C.s, particularly where they're also taking some small equity position in a company along with the debt, and are able to negotiate management rights with respect to both investments. Another common misconception is that credit funds cannot make use of realization-based waterfalls in determining how they're incentive allocation will work. In general under ERISA, an ERISA fiduciary is prohibited from having control over the timing or the amount of their fee. And so realization-based waterfalls can create a conflict, because the manager has the ability to determine when to sell an investment, and at what price. And so there are concerns that if they were to use that discretion in order to generate a fee for themselves at a time that is advantageous to them, but may not be in the best interest of the ERISA mandate, than that would be a prohibited transaction under ERISA. But this does not necessarily apply to a credit fund, because a credit fund could have a realization-based waterfall, where the realization events are just the collecting of interest payments it's entitled to with respect to its debt holdings. If you have a strategy where the majority of the income being received is just from holding these securities, as opposed to buying and selling the securities before maturity, then it may not be a problem under ERISA to use a realization-based waterfall. 

Jessica O'Mary: Are there any recent developments that credit funds should be aware of?

Josh Lichtenstein: ERISA is always evolving, and there are a couple of relatively recent developments that are of particular interest to credit funds. First is the issues of ERISA restricted securities. There are certain securities that are generally traded, not on public markets, but traded through fairly robust secondary markets where the offering documents may have originally stated that ERISA investors are not permitted to participate in certain of the securities that are offered. When an asset manager is given the opportunity to buy these securities on the secondary market, you know, through Bloomberg or some other secondary market maker, they may not necessarily have access to the original offering documents, and they may also not have good visibility into whether those documents contained any sort of ERISA related restriction. And the parties facilitating these transfers generally will not tell you whether a security is a ERISA restricted or not. And so if you're buying a debt security, that's being traded on a secondary market, it's important to obtain the original offering documents and review them, to make sure that the specific security you're buying does not contain a restriction from being held by ERISA investors. If you were to hold such a security in an ERISA account, then you could be subject to fines from the department of labor, and you could also have to make the plan whole for any losses that it incurs, even if absent the explicit language saying that it's not a security that's eligible for ERISA investors, you would have viewed as otherwise being an appropriate investment for the ERISA investor. The other major recent development is the department of labor's fiduciary role. This is a complicated topic, and without going into a lot of detail, the department of labor fiduciary role has broadened the range of activity that will cause a manager to be considered a fiduciary to an ERISA plan. This means that a lot of activity that would traditionally be thought of as marketing or sales activity, can actually be viewed as fiduciary investment advice, that a plan should invest into the asset manager's fund. This can be the case even if the fund that they invest in does not ultimately itself hold plan assets. To protect against this risk, it's important to review marketing materials, including pitch books, and to talk with your sales force to make sure that they're aware of the changes under the rule, and understand what they can and cannot say if they do not want to become fiduciaries under ERISA.

Jessica O'Mary: Thank you, Josh. That is all the time we have today. Thank you for listening, and for more information, please refer to the handout attached to this podcast, and visit our website at www.ropesgray.com. Stay tuned throughout the coming months for more news and analysis concerning credit funds issues.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions