The Rules of Private Equity
by Lynne Levin Kaufman
Columns
The Rules of Private Equity
Regulatory governance of private equity has been well-examined in the gaming industry
Lynne Levin Kaufman is a partner with the Casino Law Department of Cooper Levenson. www.cooperlevenson.com The firm has offices in Atlantic City, Las Vegas and Harrisburg. Among Kaufman’s specialties are the financing of casinos and manufacturers. She can be reached at lkaufman@cooperlevenson.com.
Last month, we began a discussion on one of the hot topics in the gaming world—private equity. This month, we will detail some of the salient characteristics of the private equity regulatory model and explain how the model can be implemented within the requirements of the gaming laws of certain jurisdictions.
General structure
Although many private equity funds are controlled by a large group of managing directors, the actual management of a particular sector is limited to a small number of individuals. These individuals have complete discretion and control over the investment. Furthermore, the investors in the fund are passive and have no right or authority to act on behalf of the fund.
The gaming private equity regulatory model merely formalizes this existing structure. That is, a private equity fund wishing to purchase or invest in a gaming company creates a special purpose subsidiary (Gaming SPV) with two classes of securities—voting (Voteco) and non-voting (Investco).
Voteco makes all decisions with respect to the investment and is owned and operated by the same individuals who would have controlled the investment without the creation of a Gaming SPV. Voteco and such individuals will file for licensure and/or be qualified.
Investco contains the economics of the transaction and is often a limited partnership. The limited partners are passive investors, and the general partner or investment advisor of Investco is either an investment bank or a large private equity fund. Licensure and qualification issues arise with respect to Investco and its related entities and individuals.
Nevada
In Nevada, holders of under 10 percent of the voting stock of a publicly traded entity are not subject to mandatory licensure. Furthermore, licensure is only required of beneficial owners of voting stock of a publicly traded licensee. Therefore, Nevada regulators require licensure of the individuals who control Voteco but will still review, but not license the individual entities who invest in Investco. As a threshold matter, Nevada requires assurance that the individuals controlling the investment in the gaming entity, and the individuals controlling the investment in the private equity fund, are subject to the regulatory process.
Nevada has approved several private equity transactions where the acquiring entity has divided its holdings into Voteco and Investco, with licensing of individuals at the Voteco level only. However, these approvals were granted within a framework which: required evidence of a true division between Voteco and Investco; necessitated licensure of entities and individuals in control; mandated certain safeguards on the gaming investment; and the individuals who control Voteco are the same that actually control the private equity fund.
An actual split between voting and non-voting interests can be demonstrated in several ways. Regulators examine the pre-existing operations of the private equity fund, the number of individuals undergoing licensure, the qualifications of such individuals and the written documentation. The licensure requirement has been satisfied by requiring licensure of Voteco, its owners and decision-makers, but not of Investco, its limited partners and the general partner or investment advisor to the fund.
Nevertheless, in each approved transaction, the senior executives of the Investco private equity fund have also been holders of Voteco, and licensed in connection with Voteco. Therefore, individuals involved in the economics of a gaming entity are also subject to licensure. Finally, additional safeguards in connection with the gaming investment have been mandated. These safeguards include: prior approval to transfer both voting and non-voting interests; a compliance committee; restrictions on actions of both Voteco and Investco; and ongoing reporting requirements.
The proposed purchase of Harrah’s Entertainment by entities affiliated with Texas Pacific Group and Apollo Management, L.P. (the “Harrah’s acquisition”) is currently being examined by the Nevada regulators. The structure is based on the Voteco and Investco regulatory model, and will require the licensure and the waiver of myriads of individuals and entities.
New Jersey
Private equity has quietly entered New Jersey with decisions that limited partners in certain private equity funds were not required to be licensed. However, the Harrah’s acquisition will be the first major decision regarding the Voteco/Investco structure.
In New Jersey, holders of less than 5 percent of the equity of a gaming company are presumed not to have the ability to control an investment and therefore are not required to be licensed or qualified. Additionally, the New Jersey gaming statute provides for only discretionary qualification of certain entities in the ownership chain and of the officers, directors and managers of such entities. Therefore, as in Nevada, there is a certain flexibility built into the gaming laws that could accommodate a Voteco and Investco structure.
However, both voting and non-voting interests in New Jersey are subject to licensure or qualification, and there is an additional requirement for qualification of lenders to, and financial sources of, gaming companies.
As such, the regulatory model in New Jersey recognizes that both the Voteco and Investco entities and individuals will be required to qualify as holding companies and complete disclosure forms, although certain individuals may be waived from qualification. Furthermore, while the limited partner investors and the general partner or investment advisor to Investco can be waived, they will still be subject to financial source qualification.
