Venture Capital and Private Equity Firms Face Increased Liability

Amid increased scrutiny from the Securities and Exchange Commission (SEC) and heightened market turbulence, many private equity (PE) firms are worried about their potential liabilities. These include the risk of legal actions for breaching fiduciary duties, claims for errors or omissions, and regulatory investigations. PE firms are also concerned about the potential liabilities linked to their portfolio company transactions.

Having a robust general partnership liability (GPL) insurance program is essential for protection. However, it’s crucial to create this program thoughtfully to cover the expanding risk landscape.

Shifting Regulatory Environment: In March 2022, the SEC’s Division of Examinations unveiled its 2022 examination priorities, which focus on private funds, ESG investing, cybersecurity, and crypto-assets. Proposed rules demand more extensive disclosures from private fund advisers, including improved prospectuses, reports, and audits. Advisers must steer clear of certain practices considered detrimental to the public interest. PE firms need to enhance their compliance programs to account for ESG, cybersecurity, and emerging technologies.

Adapting to Market Realities: Market volatility, the possibility of an economic downturn, and rising federal interest rates are unsettling various industries. The success of PE strategies can be influenced by economic trends. However, distressed lending often thrives in a weak economy. GP-led secondary transactions offer liquidity but bring with them regulatory obligations and conflicts of interest.

Considerations for GPL Insurance:

Coverage for Errors and Omissions: Customize this insurance to address negligent acts related to investment management.
Tailored Coverage for Individuals: Regulators hold C-suite personnel accountable, so the coverage should reflect this reality.
Coverage Against Crypto Asset Theft: Protect against theft by employees or third parties for assets in different storage types.
Cybersecurity Coverage: Cover losses related to network security, data privacy, and system failures.
Coverage for Representations and Warranties: Reimburse for financial loss due to misrepresentations in purchase and sale agreements.

Re-evaluate Policy Limits: Examine whether your policies provide sufficient coverage limits. Given the proposed SEC rules, ensure you have ample coverage to handle defense expenses. Consider the following factors:

Assets Under Management: Your current levels and future growth.
Trends Among Peer Firms: Recent purchasing trends.
Potential Impact of Proposed Regulations: Anticipated implications.
Lawsuit Frequency and Severity: Litigation involving your funds.
Directorship Liability Exposure: Consider roles as outside directors.
Costs for Defense: Expenses related to securities litigation and regulatory actions.

To safeguard against evolving risks, collaborate with risk professionals to devise an effective general partnership liability program tailored to your practice.