When you are a syndicator or a fund manager, you have certain duties to your investors. It’s not only good business sense, it’s a matter of law that you treat your investors right, and you have certain fiduciary duties to them. In this video, we’re going to describe what those duties are and the best practices to comply with them to keep you out of trouble, keep your investors happy, and help you be more successful. My name is Tilden Moschetti. I’m a syndication attorney with the Moschetti Syndication Law Group.
There are three main duties that are owed to all of your investors. They’re all members of the LLC that you’re using for your private equity fund or syndication, whatever. These three duties are always present; you can’t get rid of them entirely. But you may be able to establish a way to work with them, and we’ll discuss how that happens in a minute.
It’s important to note that we put an asterisk on this and say, yes, we know that you have an operating agreement that probably says something like the manager, meaning you, doesn’t owe a duty to all members, meaning your investors. Now that is true in some respect, but it’s not true in all respects. It’s not true as it relates to these three duties, which are sacrosanct.
The first duty is the duty of care. You, as a manager, have a duty to safeguard your investors’ money in order to make reasonable decisions. You cannot just throw their money away, you cannot be negligent in the care of their money. You can’t do things that a normal, reasonable person wouldn’t do. You must be diligent and do your due diligence. That’s one of the most important duties; if somebody is trusting you with that amount of money, they are expecting that you’re at least going to make reasonable decisions and not screw up and just totally be negligent. I mean, that kind of goes without saying. So that duty is always there.
Number two is the duty of disclosure. That means that you should be an open book to your investors. I’ve had syndicators ask for the work to create a world that’s a closed book, and I don’t recommend that. It certainly is possible that you could narrowly tailor these rules, but it’s going to start to look very fishy. I’ve had people ask me before, “Can we make it so that they can’t ever see the books or the accounting?” Well, we can put that into an operating agreement, but I don’t think you’d actually be able to win a court battle if an investor was to say, “I just want to see how my money’s being used and to make sure that it’s following a good duty of care, or that it’s not being stolen from under me.”
So I don’t think it’s a good policy, not only for PR reasons on being transparent, but it’s just also the right thing to do, to let investors know exactly how their money is working for them. And if you’re doing a good job, this is a great thing to be telling them. Because here are the books, here are the great things we’re doing for you to make you more money. So the duty of transparency is something I don’t think you can just get rid of, and I don’t think that you should narrowly tailor it. And at the end of the day, it’s just bad policy to try and do it.
The third duty is the duty of loyalty. These are investors who have trusted money with you; you owe them loyalty and cannot engage in self-dealing. Self-dealing is where you’re putting your interests ahead of your investors’ interests. Now, it’s important to note that there are many inherent conflicts of interest in this very duty. If you’re making a large management fee, and it’s time to sell the property and you don’t want to sell the property, or whatever the assets or the fund is, and your own self-interest says, “Hey, keep this thing going for another 10 or 20 years,” I’ve seen this happen. I’ve seen people syndicating try and do this and it’s wrong. You owe a duty to your investor to put their interests first.
Now, like I said before, there is a conflict of interest inherent here. For example, you may be trying to sell a property or sell an asset because it’s time to exit and you’ll cash out, right? Anytime you’re making money at the expense of whatever the asset is, there’s this question about whether or not there is self-dealing going on, because you’re about to make some additional money based on whatever happens with their asset.
Now, why that’s okay is because at the very beginning of the investment, you gave them a private placement memorandum. Let’s put it in a real estate context, because that’s the easiest given example. In the real estate context, let’s say you bought a building and you say, “Okay, in five years, we’re gonna sell this building at a high price. I’m gonna get not only a disposition fee of 1%, but I’m also going to be the selling broker that’s going to be taking a commission on it.”
Some time goes by, two and a half years, three years go by. You told them five years, but three years have gone by and an offer comes in. You didn’t solicit it, it just comes in, hits your table. You obviously, because of the duty of transparency, have a duty to report that to your investors. But you also want that transaction to occur because now you’re going to get cash pretty quick. So you actually want that transaction to occur early. That automatically is self-dealing.
But in your private placement memorandum, you said, “Hey, look, I am a licensed real estate broker, I am going to be making this disposition fee here.” And then when it comes time for that transaction to occur, you say, “Hey, I want some input on this to decide whether or not this is a good idea and whether or not we should go forward with it.” You’ve let the investors know that you’re going to let the market dictate when you actually sell the property.
So you’ve given them all this information that says, “Hey, there’s also this possibility that I’m going to be self-dealing here. I am going to look after your interest and I’m not going to make unreasonable decisions. And I’m not going to be non-transparent, to use a double negative. And I’m going to let you know what things are going on.” So you’ve complied there. But you’ve also acted in a way that’s been loyal, because you’ve told them what those conflicts are. And you should continue to tell them what those conflicts are so that people can make reasonable decisions.
And I’ll tell you what, if you’ve been straightforward with your investors up until this point, they’re gonna go along with you anyway, because they already trust you. They already see what you’re trying to do. So you have nothing to lose by being more transparent, more caring for their money, and just being loyal to them. They will do what you want them to do anyway, almost always, unless it’s a bad decision. Unless there’s a very good reason that you’re not making a good decision, they’re gonna go along with you anyway.
So those are the three main duties that are owed to your investors as a syndicator or fund manager. Now, the key takeaways here are this: The fiduciary duties including the duty of care, duty of disclosure, and duty of loyalty are the foundation of the financial relationship between you and your investors. Breaching these fiduciary duties can result in severe consequences, such as legal implications, reputational damages, and possible criminal misconduct. Engaging in separate deals that do not conflict with the company’s or investors’ interests are always going to be permissible. Understanding and upholding your fiduciary duties are crucial to maintaining that trust, and ethical conduct in financial relationships is only going to make your job as a syndicator or fund manager even easier.
My name is Tilden Moschetti. I am a syndication attorney with the Moschetti Syndication Law Group. We help syndicators and fund managers organize and set up their syndications or investment funds and give them the support that they need in order to be successful. If we can help you, don’t hesitate to give us a call.