Side Letter: SVB’s APAC custody quandary; PE’s wire transfer cyber-threat

Asia-Pacific GPs had to consider PE's custody rule when acting to protect LP capital following Silicon Valley Bank's collapse. Plus: why the SVB issue could leave firms more susceptible to cyberattacks. Here’s today's brief, for our valued subscribers only.

Just happened

SVB’s PE custody quandary
Silicon Valley Bank’s collapse this month presented Asia-Pacific GPs with a dilemma. When it looked unclear whether customers would be able to access their deposits over the weekend following the incident, managers had to decide whether to transfer funds’ capital into other bank accounts. This decision had to be weighed against private equity’s custody rule, which prevents the mingling of GP and LP funds in the same account lest there be any confusion or dispute over ownership.

The custody rule is an SEC requirement for registered investment advisers. Though a majority of APAC managers are not registered with the SEC, they tend to follow the guidance as best practice as far as possible. Moving LP funds to another account doesn’t necessarily guarantee mingling of capital, but it is a possibility if the GP does not have an empty account going spare.

Ultimately, it seems, most APAC GPs believed their fiduciary duty to protect LP capital outweighed custody concerns. “Sponsors often have a number of bank accounts with different banks,” Liyong Xing, a Hong Kong-based partner at Clifford Chance, tells Side Letter. “On the Thursday when the stock price fell 60 percent, people started transferring money out of SVB accounts; lots of our clients managed to do so. Even if there is a mingling of funds, it would only be temporary. It’s not ideal, but there’s an emphasis on making the best immediate decision to safeguard LP capital. Transparency is really important, and we’ve been working with GPs to keep LPs informed and updated.”

Of course, the FDIC’s speedy intervention over that weekend ultimately prevented deposits from being tied up. Still, these events represent an interesting case study in establishing and testing the boundaries of fiduciary duty in the asset class.

PE’s wire warning
The banking crisis has also rendered the PE industry more susceptible to cyberattacks, our colleagues at Private Funds CFO report (registration required). While GPs, investors and portfolio companies are on the hunt for new banks, changing wire instructions has become something of an Achilles’ heel for potential victims.

Wire transfers are one of the most popular attack vectors, with scammers able to pose as LPs’ managers or con management companies’ employees into sending wires to fake accounts. Mid-market firms are said to be especially appealing to bad actors, as they seem to have more liquid cash and weaker cybersecurity compared with large firms.

To avoid falling victim to scams, everyone should employ extra caution. Jeremy Bergsman, a managing director at risk management specialist ACA Group, says PE clients are reinforcing the importance of security controls to their portfolio companies and staff, on top of guarding their own. GPs and portfolio companies should only follow instruction changes with known contacts, and only after verification, he adds. Cybersecurity firm BW Cyber, meanwhile, suggests PE houses require trading partners and investors to verify change requests over the phone.


In case you missed it
The UK’s latest Spring Budget introduced an elective accruals basis of taxation for carried interest. This will allow UK resident investment managers who receive carried interest to pay their tax liabilities earlier to align with the timing of their tax position in other jurisdictions. The proposed change was introduced with UK resident US taxpayers in mind, and is intended to assist those with claims for double tax relief in the US and other jurisdictions. For context, UK carried interest is usually taxed when it is paid, while carry is taxed in the US as it accrues in the fund.

“We are still awaiting further detail of how this is intended to operate in practice, Akin Gump partner Serena Lee tells Side Letter. “Whether the new election will actually permit claiming an improved foreign tax credit position in the US remains to be seen, as the new rules will need to be scrutinised from a US tax perspective: it is possible that the voluntary nature of the UK tax accrual may call such a claim into question in the US.” The measure will apply from the 2022-23 tax year onwards.

Healthy competition
The US Federal Trade Commission has proposed a rule that would ban employers from imposing non-compete agreements on their workers. If passed, the rule is likely to impact the way M&A deals are negotiated for PE and VC-backed tech companies, according to our colleagues at Venture Capital Journal (registration required). “Investment firms are going to have to figure out whether there are alternative types of restrictions that provide them the comfort that they need to get a return on their investment or to make the investment in the first place, in the absence of a non-compete,” says Kevin Passerini, a partner in Blank Rome’s trade secrets and competitive hiring practice.

The FTC argues that the freedom to change jobs is “core to economic liberty”, and that putting an end to non-compete agreements would “promote greater dynamism, innovation and healthy competition”. It also estimates that the rule could increase wages by nearly $300 billion per year and expand career opportunities for roughly 30 million workers. If the rule is passed, companies exploring M&A will have to find new ways of reassuring buyers that employees won’t share confidential information with competitors.

Dig deeper

LP meetings. It’s Monday, so here are some LP meetings to watch out for this week.

20 March

21 March

22 March

23 March

24 March

Today’s letter was prepared by Alex Lynn with Carmela Mendoza, Helen de Beer and Katrina Lau.