Fiduciary duty is not new, but alts vehicles complicate oversight
The U.S Department of Justice’s recently announced investigation of Allianz for the sale of its structured alpha products is a case many are watching closely.
Several pension funds and other investors have argued that the funds did not perform as advertised in the pandemic. It’s one of many lawsuits that allege that someone did not honor a promise or fiduciary obligation.
Samuel Braver and Deborah Little are partners at Dentons who specialize in such fiduciary matters and are the first to say that wherever there are conflicts of interest between beneficiaries and trustees, and between funds and managers, there are opportunities for lawyers to file suit.
Fiduciaries have a legal obligation to work in the best interest of their beneficiaries, but gray areas abound. Some recent disputes that Little and Braver have run into involve co-investing, complicated corporate structures, and failing to document investment decisions.
“Fiduciary duties are nothing new, and fiduciaries have always had a duty to avoid conflicts of interest. But we have seen those come up with alternative investments, particularly in the context of alleged self-dealing with the fiduciary is also co-investing,” said Little.
Co-investing is especially an issue when additional rounds of financing occur. If the fiduciary and the trust invested together in an earlier round but not in a later one, then is the fiduciary putting trust money where it is no longer willing to put its own? There are all sorts of reasons that an organization might not make a follow-on investment, but Little said that this creates an opportunity for future conflict or a lawsuit.
Private investments are often channeled through separate corporations, and that causes other issues, Braver said. Any cross-corporate issues or conflicts must be documented and disclosed up front.
In fact, the key to avoiding fiduciary conflicts is as simple as documenting and disclosing. With private companies, “It might not be all the information that they like to have in an ideal world, but the goal is to assess the company’s probability of achieving its sales and revenue projections,” Braver added. “Evaluate how much capital is going to be needed before all the investors can get to a successful exit.” Doing this upfront prevents hindsight bias.
Little said that sometimes, fiduciaries feel awkward about memorializing conversations with people they consider to be friends, whether they be beneficiaries, venture capitalists or company executives. Their efforts to communicate are undone if a situation results in litigation without proof. It doesn’t have to be complicated.
“You know, I talked to so and so on such and such a date and here’s what I was told,” she says.
In family offices or family businesses, the fiduciary may not have a relationship with all generations. Discussions that meet the needs of the patriarch may not satisfy children or grandchildren, and Little added that too often leads to conflicts.
Communication includes both good and bad news. “People don’t like to be surprised,” Braver said. “If an investment is starting to smell sour, start to make your clients, investors, and beneficiaries aware of that, so that they’re not surprised when the company fails.” Also, he notes that sometimes the fiduciary has an opportunity to make changes at the company if they have a board or committee seat, but that doesn’t mitigate the shock of a nasty surprise.
The surprise, really, is that enough fiduciaries document or communicate, creating work for the Dentons fiduciary team.
There’s not much new about preparing due diligence memos and disclosing potential concerns and conflicts, and yet, it too often gets overlooked. Taking reasonable care with the paperwork, whether physical or electronic, makes a big difference. Of course, fiduciaries must be ethical. “If you’re self-dealing, reasonableness won’t be a defense,” Little said.
