VSS Fund Management had a fund that was getting old. VS&A Communication Partners III was in its seventeenth year and still had two portfolio companies. Several limited partners wanted a liquidity option that would get them out of the fund.
Providing that liquidity option got the firm in trouble.
In accordance with the LP Agreement for the fund, VSS prepared to make a distribution in kind to the LPs. Lots of LPs hate getting distributions in-kind.
One of the firm’s principals, Jeffrey Stevenson, must have liked those two portfolio companies because he offered to buy the LP interests from LPs who preferred cash over the distribution. The LPs knew it was Stevenson and that he was a principal of the fund manager.
In both instances, the value was based on the latest year-end NAV. VSS sent a letter to LPs in April with both options.
By the time the elections were coming in, VSS was getting some preliminary first quarter financial information from the portfolio companies.
In Mid-May, VSS decided to change course, it was going to keep the fund going for those investors that wanted to stay in and the rest could take the Stevenson cash offer. That offer was still based on the year-end NAV. The information to the investors did not provide any of the preliminary financial information. More than 80% of the LPS accepted the cash offer.
Anytime the fund manager is buying out a limited partner, the transaction is fraught with peril. There is an inherent information asymmetry. The fund manager knows a lot more about the current fund valuation and the likelihood of future returns.
VSS’s and Stevenson’s failure to include this [preliminary first quarter financial] information in connection with the May 2015 Offer represented a material omission that caused statements in the May 15, 2015 letter to be misleading.
Section 206(3) of the Investment Advisers Act makes it unlawful for any investment adviser, directly or indirectly “acting as principal for his own account, knowingly to sell any security to or purchase any security from a client, …without disclosing to such client in writing before the completion of such transaction the capacity in which he is acting and obtaining the consent of the client to such transaction.”
VSS didn’t violate that provision. The SEC found that VSS violated section 206(4) for failing to state a material fact, making the May letter misleading.
The problem is that VSS was the arbiter of the NAV. The ownership in the portfolio companies is illiquid and hard to value. There is always going to be a concern that the fund manager is going to lowball the price to get the better deal.
According to one story, that preliminary information was incomplete and turned out to be incorrect.
VSS should have made some disclosure about the first quarter results. A principal transaction like this is a tough transaction and almost no level of disclosure is enough.
I think the action is tough on VSS. It gave its partners the option to stay in the fund with the uncertainty of what the results may be. The rest chose the liquidity option. They preferred cash in the hand now, instead of the uncertainty of future returns.
The SEC chose to ignore this and focus on somewhat incomplete disclosure.
ILPA is taking a look at issue and is working on guidance.
Sources:
- In the Matter of VSS Fund Management LLC, Adm. Proc. File No. 3-18729 (Sept. 7, 2018)
- The SEC Continues to Focus on Retail Investors and Investment Advisers by T. Gorman in SEC Actions
- VSS Restructuring ends with $200,000 SEC Sanction
- ILPA to issue guidance on GP-led restructurings