Private Equity Newsletter

July 01, 2015

This edition of Dechert’s Private Equity Newsletter reviews recent developments in private equity worldwide, including:

  • Recent Developments in Acquisition Finance
  • Indian Private Equity: Taxation and Trends
  • Where’s the Exit? New Opportunities in China for Private Equity Firms
  • SEC Charges Corporate Insiders for Failing to Update Beneficial Ownership Disclosure in Going Private Transactions


Recent Developments in Acquisition Finance

By Jeffrey Katz and Scott Zimmerman

As we discussed in a prior newsletter, the evolving landscape for regulated financiers under the Leveraged Lending Guidance1 promulgated by the Federal Reserve Board, FDIC and OCC has increased uncertainty for regulated institutions in certain lending markets. Arranging the financing for private equity sponsors for their LBOs of middle market companies is one area where unregulated arrangers have increasingly stepped in, as regulated entities continue to work their way through the evolving regulatory environment. As the activity of alternative financiers increases in this space, issues arising under the types of financings they commonly provide become more prominent and of increasing concern to the overall market. One such financing structure, the unitranche facility, has become more common with the increased role of alternative financiers, with whom the structure originated. This structure presents certain unique issues of which private equity sponsors should be aware.

Agreements Among Lenders –  Should Borrowers Mind Their Own Business?

Unitranche facilities combine a first-lien loan and second-lien loan into a single facility, enabling the arranger to offer its private equity client a simpler debt arrangement, with a single set of operating covenants for the acquired business and a single set of conditions for closing the financing. A traditional first-lien financing coupled with a second-lien financing, on the other hand, would ordinarily contain two complete sets of documentation. A classic unitranche facility features a single class of lenders and a single administrative agent for the lenders, simplifying things from the borrower’s perspective as compared with a typical first-lien and second-lien financing with two distinct classes of lenders, each with its own agent. The classic unitranche structure further distinguishes itself by replacing the first-lien/second lien intercreditor agreement, by which the borrower would be bound, with an agreement among lenders, to which the borrower is not a party and would not be privy. The agreement among lenders, as its name implies, governs how lenders divide themselves up into first-out and last-out classes, how they apportion interest and fees among themselves, and how they vote and act on numerous matters, while not presuming to affect or bind the borrower in any way.

There has been growing unease among private equity sponsors with respect to the unknown terms contained in agreements among lenders. There has also been a growing trend for private equity sponsors to request and even demand to see the agreement among lenders, both as it is finalized and as it is being negotiated, even when the borrower is not a party to the agreement and is not even requested to be bound by it. This article will explore certain issues facing private equity sponsors in this regard.2

What might interest a borrower in connection with an agreement among its unitranche lenders? After all, if the borrower is not being asked to become a party to the agreement, or even to acknowledge it, then why should it care about its terms?

Consider a situation in which a borrower may, down the road, wish to ask its lender group for some waiver or amendment in respect of an operating covenant under its credit agreement. Typically the credit agreement itself will specify the level of lender approval required. From the borrower’s vantage point, that will govern the voting issue. But not so fast. Under the agreement among lenders, the lenders, as among themselves, will be bound by additional requirements regarding such voting. For example, they may have agreed that certain matters require a majority of each of the first-out and last-out groups into which the lenders have divided themselves under the agreement among lenders, unbeknownst to the borrower. Borrowers and private equity sponsors, who are often proactive in reaching out to lenders to test the waters and assess the likelihood of lender approval for particular amendments they are considering seeking, are obviously interested in knowing precisely whose consent would in fact be needed in such a situation.

Now consider a situation perhaps a bit further down the road, involving a possible future deterioration in the performance of the portfolio company and a looming workout scenario for the secured debt under the unitranche facility. The private equity sponsor, the borrower and their counsel in such a scenario will need to carefully consider a range of options that can satisfy the lenders and their concerns, while preserving for themselves as much value as is feasible under the circumstances. In order to do this effectively, the interests and perspectives of the debt stakeholders need to be well understood. That the lenders have divergent interests because they are split into separate groups, as they typically would be under the agreement among lenders, and the details of their arrangements, would be highly relevant to the sponsor and borrower in formulating their strategy and achieving an optimal outcome.

As another example, suppose the combined unitranche debt principal amount is US$100 million and the assumed valuation range of the blanket lien covering the borrower’s assets is US$80-90 million. The types of proposals the sponsor and borrower would make could be quite different if the first-out and last-out lender groups were each US$50 million, as opposed to, say, if the first-out group were US$75 million and the last-out group were US$25 million. In the first case, the first-out group is well oversecured, while the last-out group is partially undersecured. In the second case, the first-out group is still oversecured (even if not by much), but the last-out group is grossly undersecured, and may well require a different approach in light of the different facts. The sponsor and borrower are of course aware at the outset that these future scenarios are possible, and should do what they can to ensure that they will have the information in hand, in order to facilitate their handling of such situations should they arise. This can be achieved by a private equity sponsor’s continuing the current trend and insisting that it be kept apprised of the terms of the agreement among lenders as it is being prepared and finalized by the lenders. Similar considerations apply to subsequent amendments by the lenders of the agreement among lenders, although amendments to such agreements will be far less common.

Leveraged Lending Guidance  –  Complicating Clarifications?

The Federal Reserve Board, FDIC and OCC jointly hosted a conference call for regulated institutions under the Leveraged Lending Guidance in late February, in order to clarify certain interpretive issues under the Guidance, which frowns on debt arrangements featuring senior or overall leverage levels above certain limits. But some of the information given seems to have raised as many questions as were answered.

For example, as has been reported,3 regulators affirmed that debt baskets in credit agreements, as well as accordion and sidecar facilities provided for under such agreements, must be included when figuring leverage levels for purposes of the Guidance. But what does it really mean to include debt baskets for this purpose? Suppose the debt basket contains incurrence tests that are as yet not satisfied. Such debt shouldn’t be includable, one would suppose, so long as the conditions to its utilization are not met. One would imagine that the debt baskets regulators had in mind were more of the unconditional, fixed-amount variety. Presumably the regulatory intent was to charge the borrower with the full fixed basket amount, whether or not it has been utilized, since the borrower has the unfettered right under the credit agreement to utilize it. There is certainly a logic to that, despite the fact that it puts the leverage calculation for such regulatory purposes at odds with the calculation under most credit agreements themselves and traditional methodology, which typically limit leverage calculations to actual leverage employed (except when calculating leverage on a pro forma basis for a particular purpose).

But what would one then say about common debt baskets for items such as capital lease obligations or for net amounts owing under permitted hedging arrangements? Would the maximum allowed capital lease obligation amount be includable within the borrower’s “leverage” even if the borrower had no capital leases and no such obligations? And how about if it had chosen not to hedge certain exposures that it had the right to hedge? Would it somehow be charged with debt in some amount if prices were moving the wrong way on the type of hedging contracts it had the right to employ? And if so, what would the amount be?

The above examples illustrate some of the difficulties facing regulated arrangers of leveraged loans in attempting to fix leverage levels tied not to actual leverage (or to pro forma leverage based on a concrete proposal) but, instead, tied to hypothetical leverage that assumes full utilization of unutilized debt baskets in loan agreements. Similar issues would arise in the context of accordion and other incremental facilities.

If unutilized debt baskets raise the above concerns, then it would seem that affirmative consents sought from a regulated entity, such as an administrative agent that is an affiliate of a regulated arranger of a credit facility, would present an easier case. An administrative agent may commonly be asked by a borrower to coordinate approval and execution by lenders of a particular amendment or waiver of a term in an existing loan agreement. And yes, in fact the Guidance will indeed be applied, according to the regulators, to any modification of an existing credit facility4 (and not only to changes that would increase debt levels or allow the borrower to dispose of cash-producing assets or collateral generally).

The reach of the Leveraged Lending Guidance is thus potentially quite long, and can affect even unregulated arrangers contemplating involvement with a borrower that already has a credit facility in place arranged by a regulated institution. Even where a new facility would fit within existing debt baskets and would require no changes to the existing credit facility, even the need to just put in place intercreditor arrangements with existing creditors could potentially raise issues for certain existing regulated entities under the Guidance, as they consider proposals relating to the disposition of shared collateral or of other cash-producing assets of the borrower.

Also of note was the regulators’ clarification on the conference call that adjustments to EBITDA, which effectively reduce leverage ratios under credit documentation, will be scrutinized and not automatically accepted by regulators in determining compliance with leverage tests under the Guidance. The regulators said they would expect such adjustments to be supported by third party diligence as to appropriateness, and would in any event deem adjustments that are “too large” in total as red flags for criticism.

It is important that private equity sponsors be aware of the evolving market environment so that they are not handicapped as they try to make the most of market opportunities.

We look forward to updating you on additional developments in the next issue. 


1) Interagency Guidance on Leveraged Lending, effective March 22, 2013, Docket ID OCC-2011-0028, Federal Reserve System OP-1438.
2) Other issues involving various features of unitranche facilities, as well as other differences between unitranche facilities and first-lien/second lien structures, are beyond the scope of this article.
3) See The Wall Street Journal, MoneyBeat (February 26, 2015).
4) See Frequently Asked Questions for Implementing March 2013 Interagency Guidance on Leveraged Lending, Board of Governors of the Federal Reserve System, FDIC, Office of the Comptroller of the Currency (Nov. 7, 2014), Question no. 6.


Indian Private Equity: Taxation and Trends

By Asma Chandani

With a new government at India’s center and positive macroeconomic fundamentals working in its favor, the private equity industry is expected to invest more actively into India over the short to medium term. In the past year, inflation has steadily tapered, the fiscal deficit has been reduced, domestic demand has seen an uptick and the external value of the Indian rupee has stabilized. The first quarter of 2015 started on a steady note, attracting US$2.8 billion across 130 deals, representing the best performing quarter since 2011.1

Key issues and challenges affecting Indian private equity stem from tax and regulatory bottlenecks, a mismatch in valuation expectations and a tough, competitive environment for good-quality deals. India is also experiencing a significant exit overhang, and the pressure to exit is expected to rise. As compared to the same period last year, exit activity for Q1 2015 was three times higher, with almost 50% of total exits effected through strategic deals. Macroeconomic conditions, exit environment and investor sentiment remain the top three growth influencers affecting Indian private equity in 2015.

The Indian Finance Act, 20152 (the “Act”) became law on May 14, 2015 after receiving the President’s assent. While this first, complete fiscal bill of the Narendra Modi government evidences the pro-investment proclivity of the administration, it falls short of removing tax uncertainties that continue to temper foreign investor appetite and affect private equity fund structures and deal terms. Below is an overview of some of the key reforms introduced by the Act, as pertinent to GPs and LPs in Indian private equity funds.

Clarity on Application of the Minimum Alternate Tax (“MAT”)

Fund sponsors have been concerned with the recent assertion by the Indian revenue authorities that a Minimum Alternate Tax (“MAT”) should be levied on their activities. The concept of MAT in Indian tax law has historically been used to tax profitable Indian companies that avoided tax by using exclusions, deductions and incentives. MAT is levied on the book profits of a company, when the overall tax paid is less than 18.5% of the book profits. An overwhelming consensus of Indian tax advisors suggests that MAT should not apply to foreign companies that do not prepare their accounts in accordance with Indian corporate law (i.e., foreign companies not having a place of business in India).

Reassuringly, the Act grants a prospective exemption from MAT to all foreign companies, including Foreign Portfolio Investors (“FPIs”), for the following streams of income: (i) all capital gains from transfer of marketable securities and (ii) interest, royalty and fees for technical services accruing to a foreign company. The government has also clarified that private equity funds in treaty jurisdictions such as Mauritius and Singapore fall outside the ambit of MAT.

Indirect Transfer Provisions and Retroactive Tax Threat Linger

By virtue of Section 9 of the Indian Income-tax Act, 1961 (“ITA”), capital gains are taxed based on the source of the gains. The indirect transfer tax provisions, which were introduced in the Finance Act, 2012 by way of Explanation 5 to Section 9(1)(i) of the ITA, expand the existing source rules for capital gains by “clarifying” that an offshore capital asset would be considered to have a situs in India if it substantially derived its value (directly or indirectly) from assets situated in India.

The Act limits the indirect transfer tax provisions to transactions where the underlying assets in India constitute at least 50% of the global enterprise value. Further, sellers that do not control the overseas target and hold less than 5% in the company will not be subject to the tax. However, these indirect transfer provisions remain on the books. Thus, despite rhetoric from the administration that notices assessing taxes based upon these provisions should be avoided, their codification in the ITA spells continuing uncertainty for foreign investors.

The Indian tax authorities can bring tax claims for a period of seven years, well after the harvesting cycle of a fund concludes and gains are returned to investors. In the face of a continued threat of retroactive taxation stemming from the indirect transfer provisions, private equity buyers seeking to acquire strategic or majority stakes are increasingly insisting on deal terms that require the seller to be liable for any retrospective tax demands. Sell-side fund managers claim that such tax indemnities would prevent them from returning capital to their LPs. The use of standard LP clawback provisions for future tax liabilities could be a way to accommodate these competing interests.

Safe Harbor Norms for Indian Fund Managers

The Act seeks to mitigate the risk of a permanent establishment to fund managers or investment advisors in India, thereby exposing the fund to additional tax liability, by promulgating certain safe harbor norms. The proposed regime provides that the eligible offshore funds will not become taxable in India merely because a fund manager undertaking fund management activities on their behalf is located in India.

Qualifying criteria for a fund are as follows:

  • that the fund is a tax resident of a treaty country;
  • the fund must be subject to investor protection regulations in such country;
  • Indian residents do not contribute more than 5% of the fund’s corpus;the fund must have at least 25 investors;
  • no individual investor can hold more than 10% in the fund;aggregate participation interest of 10 or less members and their connected persons must be less than 50% of the fund;
  • the fund cannot invest more than 20% of its corpus in any entity;
  • the fund cannot invest in an associate entity;
  • the monthly average corpus of the fund cannot be lower than INR 1 billion;
  • the fund cannot carry on or control and manage any business in or from India;
  • the fund does not undertake any other activity in India that can result in a business connection; and
  • the fund must remunerate the fund manager on an arm’s length basis.

Further, qualifying criteria for the fund manager requires that:

  • the manager is not an employee or connected person of the fund;
  • the manager is acting in the ordinary course of his business; and
  • the manager is not entitled to more than 20% of profits earned by the fund from transactions carried out by the fund through the manager.

In light of the aforesaid conditions, particularly the condition that the fund cannot carry on and manage any business in or from India, the practical ability of India-focused funds, and in particular, India-focused private equity buyout/growth funds, to rely upon the safe harbor is doubtful. Funds with less than 25 investors, with anchor investors holding more than a 10% interest in the fund, and funds that hire their fund managers as employees (instead of independent contractors) will not be able to benefit from the safe harbor exemption.

Corporate Residence Test Widens Tax Net

Prior to the Act, offshore companies were treated as “non-resident” in India unless wholly controlled and managed from India. Accordingly, the income of such offshore companies was not taxable in India, unless distributed to an Indian resident shareholder. The Act codifies certain changes to the corporate residence test that could potentially bring several offshore entities within the Indian tax net. The higher threshold for qualifying as a non-resident could be a cause of concern for private equity investors.

The Act introduces the subjective test of place of effective management (“POEM”), taking the relevant financial year as a whole into consideration. POEM has been defined to mean “a place where key management and commercial decisions that are necessary for the conduct of the business of an entity as a whole are, in substance made.”

This new subjective framework introduces the possibility that a company could be construed to be an Indian company by virtue of the fact that majority control is exercised by Indian resident persons, or where some portion of shareholding of the offshore company is held by non-Indian investors and Indian promoters exercise significant ownership and control. Once deemed a resident of India, a foreign company could be subject to taxation in India on the company’s worldwide income.

The new POEM standard for tax residency is likely to proliferate tax litigation in India for fund managers utilizing offshore carry structures, as well as for Indian companies with subsidiaries abroad.

Further Deferral of General Anti Avoidance Rules (“GAAR”)

Shying away from giving foreign investors the certainty that India’s threatened General Anti Avoidance Rules (“GAAR”) will be shelved for good, the Act defers GAAR by another two years. Once implemented, GAAR will apply only prospectively to investments made on or after April 1, 2017. Investments made prior to April 1, 2017 will be grandfathered, providing relief to managers already invested in India.

GAAR represents a major area of concern and uncertainty for India-focused fund GPs and LPs. GAAR provisions would give Indian tax authorities greater powers to examine cross-border transactions for signs of tax evasion. Such powers would include the power to override all tax treaties and to disregard, look through, or re-characterize business arrangements that are deemed to be impermissible avoidance arrangements. The Indian government has not yet issued promised guidelines to explain the implementation of GAAR.

Tax Pass Through For Certain Alternative Investment Funds

The Act provides a special tax regime for taxation of Category-I and Category-II Alternative Investment Funds (“AIFs”) registered with the Securities and Exchange Board of India (“SEBI”) and provides that foreign investment will be allowed into AIFs. The special tax regime provides for a tax pass through to the specified AIFs in respect of all income other than business income. Business income of the AIFs is taxable at the level of the AIFs at the applicable rates and is exempt in the hands of the unit holders.

Category-I AIFs are AIFs that invest in start-up or early stage ventures, social ventures, small and medium enterprises, infrastructure or other areas that the government considers as socially or economically desirable. Category-II AIFs are funds, including private equity and debt funds, which do not:

  • lever their investments;
  • use complex trading strategies; or
  • receive specific incentives or concessions from the government.

All non-business income payable to investors will be subject to withholding tax at the rate of 10% (plus applicable surcharge and education cess). This 10% withholding tax may deter foreign investors from investing into AIFs. In the absence of precise criteria to distinguish business income from capital gains, there is also a risk that the withholding tax will be imposed on other exempt income such as dividends and long-term listed gains, and an increased litigation risk over characterization of income.

Concessions for REITS and Infrastructure Investment Trusts

A new framework for Real Estate Investment Trusts (“REITs”) and Infrastructure Investment Trusts (“InvITs”) was introduced last year, and while investor interest in these instruments remains high, they have yet to be utilized due to absence of clarity around the tax incidence associated with these vehicles.

The Act introduces certain changes to the taxation regime for REITs and InvITs, with effect from the tax year beginning April 1, 2015. The pass through status to REIT investors in relation to interest income earned by the REIT from a special purpose vehicle (“SPV”) is now extended to rental income earned in respect of property directly held by the REIT. Further, a concessional capital gains tax regime will be available to sponsors of REITs who acquire units through a swap of SPV shares, subject to levy of a securities transaction tax.

Additional reforms to the overall tax treatment of REITs and InvITs are required before these instruments can be viable.

Extension of SARFAESI TO NBFCs

The Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (“SARFAESI Act”) provides certain measures for recovery of non-performing assets. Non-banking financial companies (“NBFCs”) that (i) are registered with the Reserve Bank of India (“RBI”) and (ii) have an asset size of INR 5 billion shall now be entitled to SARFAESI protection, enabling them to expeditiously enforce security interests without court intervention. Furthermore, assets of eligible NBFCs can now be sold to asset reconstruction or securitization companies. Additionally, eligible NBFCs are now able to acquire security receipts issued by an asset reconstruction company or a securitization company.

Additional Tax Reforms Signal Positive Changes

India’s corporate tax rate of 30% (excluding surcharge and education cess) is one of the highest in the Asia-Pacific region. The government has signaled a gradual reduction of the corporate tax rate to 25% over a period of four years from 2016.

The Act also extends, by two years, the eligibility period for a concessional rate of 5% (plus applicable surcharge and education cess) withholding tax on interest payments made to FPIs with respect to INR denominated bonds of an Indian company or government securities. The benefit will now be available on interest payable through June 30, 2017. This extension should facilitate substantial debt investment into India.

Additionally, the lower house of Parliament has passed a bill introducing a single Goods and Services Tax ("GST"), subsuming most indirect taxes. GST is expected to rationalize India’s indirect tax regime and reduce the cascading effect of multiple taxes (including, inter alia, customs duties and service taxes) and also reduce administrative costs of compliance in relation to multiple taxes. The government expects to roll out GST with effect from April 1, 2016. It is anticipated that the implementation of GST will have profound effects for inter-state commerce and development of India’s supply chain infrastructure, and will enhance cost efficiencies for business operations.

Despite continuing tax uncertainties and other legacy issues including exit overhang and currency fluctuations, the Indian private equity market has enjoyed a bull run over the past year or so, and seems poised to continue its upward trajectory in the short to medium term. Additional developments in the AIF, business trust (REIT/InvITs), and GST regimes can also be expected. 


1) See PwC MoneyTree India Report (Q1 ’15). 
2) See Indian Finance Act (2015).


Where’s the Exit? New Opportunities in China for Private Equity Firms

By Dean Collins, Karl Gao and Hailin Cui


It has long been a well established exit route in developed markets for a private equity firm to sell its interest in a portfolio company to a listed company in exchange for shares in that listed company. Until recently, this was not a route that was used by acquirers that are listed on the local Chinese stock exchanges, and with more than 2,700 companies listed on such stock exchanges (each a “Listco”) this has effectively shut out a financing route for many potential acquirers. A key reason for this relates to the weaker capital markets in China, which meant that this was not necessarily an attractive route for private equity sponsors. However, with a deepening of China’s A-Share market this has become a more attractive route, although it has been unclear how on account of regulatory constraints, this could be achieved for foreign sellers. A recent transaction has thrown interesting light on this issue.

The Issue

The key issue for a foreign owner of shares which might be acquired by a Chinese listed company is that there are significant hurdles that apply to a foreigner who wishes to acquire shares in a Listco. It was not at all clear whether the same restrictions that would apply to a cash purchaser of A-Shares would apply to someone who is receiving such shares in return for equity.

Generally speaking, it is possible for foreign investors to invest into a Listco through one of two regulatory schemes. First, China has developed the Qualified Foreign Institutional Investor (“QFII”) program, which is designed for investors that wish to trade listed shares, and which, amongst other things, permits acquisitions of 10% or less of a Listco’s shares. Second, there are rules allowing a strategic investor to make investments into a Listco pursuant to the Administration of Strategic Investment in Listed Companies by Foreign Investors (“Strategic Investment Measures”) provided that it is acquiring more than 10% of the Listco’s shares. However, high qualification requirements, long lock-up periods, and a cumbersome approval process are impediments to the popularity of both of these schemes among foreign private equity funds. For example, applicants under the QFII program are subject to a minimum assets under management threshold of US$500 million of securities assets (the authorities generally require these assets to be publicly traded securities) in its most recent accounting year, and any investment under the Strategic Investment Measures are subject to approval of both the China Ministry of Commerce (“MOFCOM”) and the China Securities Regulatory Commission (“CSRC”), and require a 10% minimum shareholding threshold and, of particular concern to a private equity firm, a three year lock-up period.

However, a recent development has suggested that neither of these two routes needs to be adhered to if, following a share-for-share exchange, the foreign private equity fund holds less than 10% of the shares of the Listco.

The Blue Gold/Kaile Transaction

In April 2015, Blue Gold Limited (“Blue Gold”), a Hong Kong company and the investment arm of a private equity fund, together with various other companies, proposed to sell Shanghai Fanzhuo Limited, a privately owned company, to Hubei Kaile Technology Co. Ltd (“Kaile”), a company listed on the Shanghai Stock Exchange, in exchange for newly issued shares in Kaile. Following completion of the transaction, Blue Gold would hold 3.04% of the publicly listed shares in Kaile.

Public documents relating to the transaction revealed that Kaile twice sought clarification from MOFCOM as to whether this transaction was possible and/or required any approvals from MOFCOM. On both occasions, MOFCOM stated that no such approval was required. Treading carefully, Kaile also sought out a clarification from its “local MOFCOM”, the Hubei Provincial Department of Commerce, which declined authority over the matter on the basis that the shareholding percentage would be below 10% following the completion of the transaction, informing Kaile that it should seek approval from CSRC. CSRC approved the transaction.


The initial conclusion is that a share-for-share exchange which results in a private equity seller owning less than 10% of the Listco falls outside of the ambit of the Strategic Investment Measures, and is possible even if the seller does not have a QFII license. MOFCOM has in practice adopted a flexible approach to regulate a foreign investor’s purchase of listed shares. In addition to providing private equity firms with a new exit route, this precedent could potentially open up an additional route for private equity firms to make private equity style investments into public equity securities (i.e. “PIPEs”), a route that has been hitherto restricted to investments in 10% or more of the Listco.

However, there remain a number of unanswered questions. The target acquired by Kaile was a Chinese company and the foreign private equity firm would have needed to have obtained MOFCOM approval at the time of its initial investment into that company. Some commentators have surmised that this was the basis upon which MOFCOM felt they did not need to approve the transaction. It is not clear whether this is the case, and by extension, it opens up an interesting question as to whether the share-for-share exchange would work if the Listco was acquiring a foreign company where no such approval would have been obtained. With many Chinese companies building their operations abroad through acquisitions, this would open up very interesting possibilities for expansion.

Another question relates to whether MOFCOM would take a similar approach if a syndicate of foreign private equity investors were to individually receive less than 10% of the shares in a Listco but collectively hold more than 10%. The wording of the various approvals would suggest that this would be permissible, but each approval was provided in the context of a transaction where this scenario did not arise.

We are aware that there are a number of similar transactions being pursued in the market at present, and further insights will no doubt be gained in due course. For now, private equity firms that have invested into Chinese companies can, at the very least, take comfort that an additional exit route appears to be available to them. 


SEC Charges Corporate Insiders for Failing to Update Beneficial Ownership Disclosure in Going Private Transactions

By Ian Hartman

Enforcement actions raise potential disclosure concerns for private equity sponsors exploring investments in public companies

Earlier this year, the U.S. Securities and Exchange Commission (“SEC”) announced charges against insiders in three going private transactions. In each case, the SEC focused on the failure of the insiders, including directors, officers and significant shareholders, to update disclosure in Schedule 13D beneficial ownership reports. These enforcement actions, which were settled by paying a financial penalty, sanctioned insiders for taking “steps to advance undisclosed plans to effect going private transactions.”1 Taken together, the enforcement actions may accelerate the timing and expand the level of disclosure required by corporate insiders when exploring a sponsor-led management buy-out or other deal to take a company private.

Beneficial Ownership Reporting – Schedule 13D

Section 13(d) of the Securities Exchange Act requires any person or group who has acquired beneficial ownership of more than five percent of a class of stock of a public company to file a Schedule 13D within ten days of the acquisition disclosing the identity of any group members and the purpose of the acquisition. Item 4 of Schedule 13D requires disclosure of the “the purpose or purposes of the acquisition of securities of the issuer,” including any plans to make changes on the board of directors or to cause an extraordinary corporate transaction, such as a merger or other going-private transaction.2

Insiders are required to promptly amend a Schedule 13D when there are material changes or developments in the information previously reported. The obligation to amend extends to ownership changes equal or greater than one percent and also requires updates to the narrative discussion of any plans to pursue or engage in extraordinary transactions required under Item 4 of Schedule 13D. Insiders typically seek to maintain flexibility by completing the Schedule 13D with “generic disclosure that indicates the beneficial owner is reserving the right to engage in any of the kinds of transactions” that require updates. In addition to disclosure when an insider has a plan to change the composition of the board or pursue a going private transaction, the SEC has also found that an amendment may be required before a plan is in place - the obligation to amend is triggered by a material change in the facts disclosed in the Schedule 13D.

The SEC Enforcement Actions

Berjaya Lottery Management (H.K.) Ltd.

Berjaya Lottery Management (H.K.) Ltd., a Hong Kong corporation headquartered in Kuala Lumpur, Malaysia (“Berjaya”), owned over 70% of the shares of International Lottery & Totalizator Systems, Inc., a public corporation based in California (“ILTS”). The SEC found that Berjaya determined to take ILTS private during 2013, and “engaged in serious discussions and took significant steps to further its plan.” Among other things, the SEC noted that during 2013 and early 2014 Berjaya:

Informed ILTS that Berjaya intended to engage in a going private transaction in July 2013;Submitted a concept paper to ILTS regarding a going private transaction in July 2013;Determined the transaction structure prior to January 2014; andApproved transactions by ILTS to facilitate the going private by written consent in lieu of a shareholder meeting prior to March 2014.

On January 31, 2014, ILTS filed a Schedule 13E-3 in connection with the planned going private transaction, including a reincorporation merger and reverse stock split that would eliminate all public shareholders of the company. Notwithstanding the steps described above and the active role played by Berjaya in driving the transaction, Berjaya did not amend its Schedule 13D Item 4 disclosure until March 2014. The SEC found that the eight month period between informing ILTS of its intention and amending its Schedule 13D constituted a failure to amend promptly. In settlement, Berjaya agreed, among other things, to pay a US$75,000 civil money penalty.

First Physicians Capital Group

First Physicians Capital Group, Inc., a publicly-traded Delaware corporation headquartered in California (“FPCG”), was controlled by a group including the Ciabattoni family trust and SMP Investments. FPCG, which traded on the OTC Bulletin Board, failed to file quarterly or annual reports with the SEC between 2011 and early 2014. In order to deregister and go private, FPCG and the insiders filed a Schedule 13E-3 in June of 2014 disclosing plans to conduct a reverse stock split and deregister FPCG’s securities.

The SEC found that the insiders had taken a series of steps to effectuate a going private transaction. Prior to amending their Schedule 13Ds, which in some cases included disclosure that the shares were held “for investment purposes” and without “any present plans or proposals that relate to or would result in” an extraordinary transaction covered by Item 4, the insiders took the following steps to pursue a going private transaction:

  • Began considering a going private transaction in early 2011 and continued to have discussions with PFCG regarding the advisability and reasons for undertaking a going private transaction through 2014
  • Requested that FPCG management engage outside counsel to consider the process and costs of going private
  • Informed FPCG management that they would support going private
  • Assisted FPCG in preparing to go private by securing waivers from certain shareholders to extinguish registration rights
  • Discussed a fractional share repurchase and reverse stock split transaction and a third party proposal for related valuation work
  • Received board information discussing valuation issues, stock split analyses, public company cost estimates and a draft preliminary proxy statement
  • Assisted FPCG with shareholder vote projections to approve the going private transaction

The SEC found that the above activities, which included actions as a member of the company board, were material changes in facts underlying the Schedule 13D disclosure and that the insiders were months late with amendments filed in June 2014. The insiders agreed to settle the matters in exchange for, among other things, civil money penalties ranging from US$15,000 to US$75,000.

Shuipan Lin

Shuipan Lin (“Lin”) served as Chairman and Chief Executive Officer and owned a significant portion of Exceed Company Ltd., a sports apparel company headquartered in China (“Exceed”). Lin received his ownership stake in connection with Exceed’s acquisition of Windrace International Company Ltd., which was majority owned by Lin, in 2009. Lin filed his initial Schedule 13D in May 2011, over 18 months after the acquisition, and disclosed that he “did not have current plans or proposals that relate or would result in any of the actions” specified in Item 4 of Schedule 13D.

In the Fall of 2012, Mr. Lin began to consider and evaluation a going private transaction involving Exceed. The SEC found that Lin “took significant steps to further the going private transaction,” including:

Studying the feasibility of a going private transactionReviewing other going private transactions by China-based issuersEngaging in discussions with other significant shareholders in ExceedEngaging in discussions with attorneys about submitting a proposal to the Exceed board of directors to take Exceed private

Lin’s efforts culminated in a written proposal to Exceed’s board to take Exceed private in August 2013 and Lin subsequently amended his Schedule 13D disclosure. The SEC brought an action against Lin in connection with his failure to amend his Schedule 13D between October 2012 and August 2013, and the matter was settled for, among other things, civil money penalties of US$30,000.

Practical Implications

  • Avoid forming a group with target management or significant shareholders
    • Formation of a group with management or significant shareholders can trigger Schedule 13D disclosure obligations
    • Rule 13d-5 provides that a group is formed when two or more persons agree to act together for the purpose of acquiring, holding, voting or disposing of equity securities of an issuer
    • Agreement can be formal or informal, avoid unwritten or tacit agreements regarding the subject company
    • The SEC’s expansive interpretation of what constitutes a “material change” for purposes of amending or updating Schedule 13D Item 4 disclosure provides another reason to avoid premature formation of a “group” with target management or other significant shareholders

  • Avoid actions that would require premature disclosure through Item 4 of Schedule 13D
    • Working with a Schedule 13D filer to plan a going private may trigger disclosure by the insider even if no group is formed
    • Premature disclosure of preliminary plans may complicate negotiations or even prevent a deal

  • Tailor board materials to avoid disclosure obligations
    • In some cases the SEC cited the receipt, review and discussion of board materials as evidence that an insider was planning a going private transaction
    • Be aware that Board materials and deliberations, which may be preliminary or exploratory in nature, can be viewed in hindsight as disclosable steps to effectuate a transaction
    • Note that parties and their counsel will need to balance disclosure considerations with need for directors to satisfy their duty of care prior to approving any going private transaction

  • Carefully consider the “Background of the Merger” section of the deal proxy statement
    • SEC proxy rules require a background section providing detailed disclosure regarding the negotiations and contacts leading up to a transaction
    • The recent enforcement actions show that the SEC is carefully scrutinizing this disclosure to identify situations where corporate officers, directors or significant shareholders took steps to advance a going private or other transactions without updating typical boilerplate Schedule 13D disclosure
    • Be aware that background disclosure will be reviewed by the SEC in hindsight after filing a deal proxy, which may create the impression that preliminary consideration of a deal was actually a “material change” in plans requiring Schedule 13D amendments


1) U.S. Securities and Exchange Commission. Corporate Insiders Charged for Failing to Update Disclosures Involving “Going Private” Transactions (March 13, 2015).
2) Exchange Act Rule 13d-101.

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