ABC Capital wants to set up a fund that will invest in a new asset class, and anticipates that the investors will be drawn from inside and outside the United States. It has been working with U.S. counsel and wants to optimize utilization of its securities and tax lawyers. What are some strategies to accomplish this?
This is a common dilemma faced by fund impresarios. The easiest answer is to identify a law firm that has both capabilities and negotiate an alternative fee arrangement for all services needed to bring the fund to market. Finding the correct partner inside that firm is often a challenge, though.
Here are a few strategies that we have found effective.
If the matter is originated on the securities side of the house, the securities partner should associate with the tax partner sooner rather than later. It is important to understand the strategy, and early on to identify those tax issues that can be resolved decisively, and those that are merely a matter for disclosure because there is no definitive answer.
In the challenge above, we identified the underlying issuers of the portfolio investments to be acquired, how the fund as investor would acquire the investments, and the structure that the fund promoters thought they wanted. The securities partner then contacted the tax partner and worked through the various tax issues.
It helped in this instance that the securities partner was an erstwhile tax lawyer and was familiar with the tax issues presented by both the investment strategy and the holding of the investment instruments. That enabled us to identify the stumbling blocks – and develop resolution strategies – sooner.
A key “gating” question is whether the tax issues are “show stoppers,” or if a sufficient basis exists for the investment program to proceed, if it is coupled with robust risk disclosure. A fair degree of analysis is usually needed at this stage, and often it is necessary to engage the fund sponsor to see if the issues can be overcome or sidestepped, or if the client is comfortable with the likely disclosure and risk fact listing. The securities partner would then prepare a rudimentary disclosure document and share it with the tax partner. Once the disclosure framework is agreed, the securities team drafts a more complete document for dissemination to the formation team.
If the matter is originated on the tax side, the exercise is similar, though not quite the same. The tax professionals use their understanding of the basic economics (it is always necessary to understand the economics to figure out how to tax it!) and likely will have identified an ideal tax structure. They will then engage securities counsel to identify any domestic or cross-border issues. The next step is to merge the tax and securities analysis and for the securities lawyers to prepare the disclosure document. From this point the process is the same. Issues that can be resolved are resolved; those that can’t are addressed through disclosure.
If different firms are used for these functions, it is essential for the “lead firm” to drive the process for the benefit of the promoter and issuer. Having sufficient lead time is essential so that all of the participants can perform the necessary reviews.
The most important strategy is to ensure communication among the lawyers and between the lawyers and the promoters.
The challenge described above is one of the factors that led to the creation of Pepper’s Investment Funds Industry Group. This is an interdisciplinary group that includes more than 60 lawyers nationwide, who focus their practices in areas vital to the success of all types of investment funds throughout their entire life cycle, including with respect to formation, transactional and investment, operational, and regulatory and compliance matters. Pepper has a long history of inter-departmental collaboration on investment fund matters, and the formalization of training, marketing and recruiting within the Investment Funds Industry Group should only further enhance the working relationship among attorneys who represent investment funds, and make Pepper more “user friendly” for our clients.
Gregory J. Nowak and Steven Bortnick