Take-Two Proxy Fight

Business Law Prof Blog, March 30, 2007:

The success of the dissident shareholders in the annual meeting of Take-Two Interactive Software, Inc., is stunning (five new directors and the firing of the CEO) and may be a harbinger of a new day for corporate governance. Institutional investors held large stakes in the company, got together when problems surfaced, and in a no-nonsense show of steady strength, put a turnaround artist in control of the company. The ousted CEO tried to sell the company and delay the annual meeting but in the end, he lost. The meeting will have long run effects -- it will encourage institutional investors to be active and, most important perhaps, it will encourage outside directors (two of whom survived by aligning themselves with the dissidents) to switch sides when it is obvious that there are internal problems.

Deal Makers Are Setting a Torrid Pace for 2007

After breaking the record for mergers and acquisitions last year, deal makers have started 2007 at an even faster pace.

With the first quarter drawing to a close, the value of corporate deals announced through Wednesday reached $1.08 trillion, according to Thomson Financial. That is 24 percent more than the value of deals in the first quarter of 2006.

The tempo has slowed from last year’s fourth quarter, when $1.2 trillion in transactions were announced. But the deal cycle is seasonal, and fourth quarters have been the busiest ones for announcements in recent years — a trend that could partly reflect a desire by investment bankers to plump up their year-end bonuses.

Many of the conditions favorable to deals remain in place, including an accommodating credit market and an abundance of well-financed private equity firms.

Securities Class Action Settlements Reach Record Level

The dollar amounts of federal securities class action settlements reached record highs in 2006, two industry surveys have reported.

Securities Class Action Services (SCAS) estimates that the total was $18 billion, about $1 billion higher than a finding by Cornerstone, whose count topped its 2005 figure by $3.5 billion -- an increase of more than 300 percent.

However, observers who track case filings and potential legal and economic developments say those dizzying totals may drop.

SCAS attributed last year's numbers to the settlements of mega-cases involving Enron, AOL-Time Warner, Nortel Networks, European supermarket chain Royal Ahold and McKesson Corporation.

Meanwhile, there are indications that settlement totals may slow in the next few years.

In a statement accompanying the latest report, Stanford Law School professor Joseph Grundfest said the 2006 record is a peak and predicted that 2007 is virtually certain to generate a far smaller aggregate settlement amount.

U.S. Enters Non-Prosecution Pact With Jenkens & Gilchrist

Jenkens & Gilchrist is shutting down and will pay the IRS a $76 million fine. That’s part of the firm’s non-prosecution agreeement with the feds for criminal violations related to the firm’s tax-shelter activities. As part of the non-prosecution pact, J&G admitted to developing and marketing fraudulent tax shelters, as well as to issuing fraudulent opinion letters.

Says the DOJ press release:

J&G has recognized . . . that its tax shelter practice has caused serious damage to its reputation, revenues and stability, and that as a result it
ultimately cannot continue in business. It was once a thriving firm with over
600 attorneys and offices across the nation. Approximately two-thirds of those
attorneys left, and its revenues declined sharply, as Government scrutiny of the
firm’s tax shelter practices intensified, as civil suits were filed, and as the
firm’s reputation was accordingly tarnished. The firm has advised the Office
that it has recently closed several of its offices, that it will be closing the
last of its offices — its flagship office in Dallas — at the end of the month,
and that J&G will no longer engage in the practice of law.

Here’s part of J&G’s statement made to the Justice Department as part of the non-pros:

We believe certain J&G attorneys developed and marketed fraudulent tax shelters, with fraudulent tax opinions, that wrongly deprived the U.S. Treasury
of significant tax revenues. The firm’s tax shelter practice was spearheaded by
tax practitioners in J&G’s Chicago office who are no longer with the firm.
Those responsible for overseeing the Chicago tax practice placed unwarranted
trust in the judgment and integrity of the attorneys principally responsible for
that practice, and failed to exercise effective oversight and control over the
firm’s tax shelter practice. . . . We deeply regret our involvement in this tax
practice, and the serious harm it caused to the United States Treasury.

Justices Challenge Arguments in Favor of Shareholders Suing Companies

Several Supreme Court justices challenged shareholder groups who were arguing Wednesday against standards that could make it tougher for investors' cases to go forward when they sue companies for fraud.
Appeals courts have been split on whether a stricter standard should be applied for initially making a case in such lawsuits. The Bush administration favors the tougher standard, but the investor groups say it would go too far in choking off suits.
Several justices suggested not only going along with the stricter standard for starting cases but raising the bar for proving cases later on to the same higher level.

IPO case could split top court

An engaged and likely divided Supreme Court heard arguments Tuesday, March 27, in a case that asks whether the securities industry can be sued for allegations of antitrust violations in creating syndicates for initial public offerings.
If the justices decide SEC oversight is not sufficient, the banks may become vulnerable to private antitrust challenges for many common practices in taking companies public.
In addition to exposing the industry syndication practices to a flood of lawsuits, applying antitrust law would increase the financial stakes for perceived wrongs as well. In antitrust cases, unlike violations of securities law, damages are tripled for plaintiffs who can prove they were illegally harmed.

High Court to Consider Liability of 'Secondary Actors' in Securities Fraud

The Supreme Court said Monday it will consider whether shareholders of companies that commit securities fraud should be able to sue investment banks, lawyers and others that allegedly participated in the fraud.
The case, which won't be argued until the Court's next term beginning in October, will be closely watched on Wall Street and in law firms around the country as federal appeals courts have split on whether such "secondary actors" can be held liable.
Last week, the 5th U.S. Circuit Court of Appeals ruled against a class action lawsuit brought by former Enron shareholders against several investment banks, including Merrill Lynch & Co. Inc. and Credit Suisse Group, over their alleged role in Enron's collapse.
The 5th Circuit found that the banks only "aided and abetted" Enron's fraud. Under a 1994 Supreme Court ruling, companies are generally protected from shareholder lawsuits if they aid and abet fraud, though the Securities and Exchange Commission can pursue civil actions against them.

Collins & Aikman Settlements Reached, Former Executives Charged

Collins & Aikman confirmed that it had reached a non-prosecution agreement with the United States Attorney in connection with that office's investigation into matters investigated by the Company's audit committee and certain other conduct undertaken by executives and employees who were in place at the Company on or before May 1, 2005. The non-prosecution agreement removes the threat of an indictment of Collins & Aikman by the United States government for any such conduct. The Company also confirmed it had reached a settlement with the S.E.C., under which the Company agreed--without admitting or denying any wrongdoing--to be enjoined from future violations of the securities laws. The S.E.C. did not impose civil monetary penalties against Collins & Aikman, noting the significant remedial steps and extensive cooperation provided by the Company. The S.E.C. settlement was effectuated by the S.E.C. commencing and simultaneously settling a lawsuit alleging violations of federal securities laws. The lawsuit and settlement relate to matters that were the subject of an audit committee investigation of, among other things, the Company's accounting for certain supplier rebates and the Company's forecasts for the first quarter 2005 as well as the Company's accounts receivable securitization facility. In a related matter, the United States Attorney also unsealed one indictment and four criminal informations charging eight individuals, including former executives and employees of Collins & Aikman with securities fraud and other related charges stemming from their investigation into accounts receivable, customer and/or supplier rebates and other matters for the fiscal years 2000-2005. The indictment charged Collins & Aikman's former chairman and chief executive officer, David Stockman and three others with conspiracy to commit securities fraud, making false statements in annual and quarterly reports, making false entries in books and records and lying to auditors as well as committing bank fraud, wire fraud and obstruction of an agency proceeding. The others charged in the indictment were J. Michael Stepp, David R. Cosgrove and Paul C. Barnaba. All three pleaded not guilty and were released on $500,000 bail.
www.bankruptcydata.com/BDR.asp?ID=2395

Feds Indict David Stockman in Securities-Fraud Case

David Stockman, former White House budget director under President Ronald Reagan, was chargedcriminally today, along with seven other individuals, in a securities-fraud case involving improper accounting of rebate transactions at auto supplier Collins & Aikman, according to court documents. Here’s theindictment.
Stockman, who controlled Collins & Aikman along with his private-equity fund, Heartland Industrial Partners, ran C&A from August 2003 to May 2005, when the board removed him a few days before the company filed for Chapter 11. He told the WSJ last week that he collected no salary as the company’s top executive and personally lost $13 million when Collins & Aikman filed for bankruptcy and millions more covering company expenses.
Click here and here for two fascinating statements — one from Stockman, the other from his lawyer, Elkan Abramowitz.
Said Stockman: “The massive loss of jobs and money which occurred at C&A was not due to fraud or deception, but was the consequence of an industry melt-down that generated $50 billion in supplier bankruptcies.” Says Abramowitz: “Today’s announcement . . . reflects a disappointing attempt by federal prosecutors to criminalize the good-faith efforts of a dedicated CEO to save his company . . . This is a misguided prosecution that threatens todestroy an innocent man.”

Carlyle to Acquire Goodyear’s Engineered Products Unit

Goodyear Tire & Rubber has agreed to sell almost all of its Engineered Products business, which makes hoses and conveyor belts, to a unit of the Carlyle Group for $1.475 billion, the tire maker said. Carlyle will make the acquisition through a portfolio company, EPD.
As part of the deal, Goodyear has agreed to let EPD use the Goodyear brand in connection with the Engineered Products business.
The deal “reinforces our focus on our core consumer and commercial tire businesses,” Robert J. Keegan, Goodyear chairman and chief executive officer, said Friday.
Engineered Products has 32 facilities in 12 countries and about 6,500 employees. Its products include hoses, conveyor belts, rubber track and molded products. Last year the unit had sales of about $1.5 billion.
Goodyear shares fell 3 cents to $30.29 in trading Friday on the New York Stock Exchange, close to the upper end of its 52-week trading range of $9.75 to $30.61.
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A Look Inside Blackstone’s Money Machine

Blackstone Group, confirming a firestorm of speculation, said Thursday it would seek an initial public offering that would value the firm at as much as $40 billion. The preliminary prospectus offered a first glimpse inside Blackstone’s closely guarded money machine, which churned out $2.3 billion in profit in 2006. The offering is being structured to allow Blackstone to retain many advantages of a private business — a setup that Breakingviews compares with Berkshire Hathaway under Warren Buffett.
Using data from Thursday’s prospectus, Bloomberg News calculates that Blackstone’s 770 employees generated almost nine times more earnings per person in 2006 than their counterparts at Goldman Sachs, Wall Street’s most-profitable investment bank.
Blackstone’s I.P.O. is a role reversal for an industry that has long espoused the benefits of private ownership. It also comes amid a boom in buyout activity, which has led some industry watchers to wonder if Blackstone is trying to cash out at the top.
The New York Times’s Jenny Anderson suggests that a Blackstone I.P.O. will solve one issue associated with hyperkinetic private financial-service firms: crystallizing value.
But Time magazine’s Michael Kinsley likens the offering to “selling full-price tickets to a ball game in the ninth inning, as the stock market fizzles out.”
Breakingviews sees potential problems in Blackstone’s proposed ownership structure, writing that it will only “worsen the ‘agency problem’ — the separation of ownership from management –that [Blackstone chairman Stephen] Schwarzman has so loudly complained about in the past.”
Mr. Schwarzman will trade all of his current shares in the company for new shares that vest over a four-year period, The Times writes. He will receive a $350,000 salary and performance fees from the firm’s investments.
His partners, however, have cut a different deal: they will own shares in the public company, but they will also continue to receive income directly from the firm’s investments, aligning their interests more closely with the firm’s limited partners like pension funds.
Ms. Anderson notes that Blackstone principals will do very, very well if the offering comes off. Public market investors, she says, will have to determine if they can imitate any fraction of that success with the very little information and very limited voting rights Blackstone seems to be providing them.
Underwriters on the Blackstone offering include Morgan Stanley and Citigroup, but not Goldman Sachs, UBS or J.P. Morgan Chase.
The New York Post speculates that the banks left out of the Blackstone deal may be busy preparing an offering from another big buyout firm — possibly Kohlberg Kravis Roberts.
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Exec pay measure near House nod

The legislation, expected to pass out of the House Financial Services Committee, would require all public companies to submit their executives' salaries, bonuses and pensions to a nonbinding vote of their shareholders. Companies would also be required to allow nonbinding votes when golden-parachute packages for executives are negotiated as part of a merger or sale of the business.
The bill, introduced by House Financial Services Committee chairman Barney Frank, D-Mass., would result in more behind-the-scenes discussions between executives and shareholders over CEO pay packages.

Court Wary of Executive Compensation's Influence on Governance

by: David Marcus, The Deal, March 19, 2007

The Delaware Court of Chancery has seen enough. In five cases issued since November, Chancellor William B. Chandler III and Vice Chancellor Stephen Lamb have censured corporate defendants for issues related to executive compensation. The decisions involve a range of fact patterns, from options backdating and spring-loading to the spinoff of a subsidiary, a management-led buyout and a large stock-for-stock merger.

Taken as a body of work, the decisions reflect the belief that executive compensation has become a pervasive -- and pernicious -- influence on corporate governance, profoundly affecting even such fundamental decisions as when and to whom to sell a company.

Judges can hear only the cases that come before them, of course, and the recent spate of opinions ultimately stems from the displeasure with CEO pay that has motivated investors to bring the suits in the first place. But in the most closely watched ruling of the quintet, Chandler went out of his way to savage Edwin "Mac" Crawford, the CEO of Caremark Inc., for the pay he will receive if Caremark completes its merger with CVS Corp. rather than succumb to a hostile bid from Express Scripts Inc. Chandler usually employs a restrained if sometimes pointed style, and his chiding tone in Caremark suggests a personal distaste not just for Crawford's compensation but for the standard practice it exemplifies.

The cases are perhaps most significant in their implications for Delaware takeover law, which is premised on the belief that directors and managers can generally be trusted to act in good faith -- and thus that courts should generally defer to their decisions even when the company's fate hangs in the balance. Read broadly, Chandler's comments in Caremark and, to a lesser extent, Lamb's in SS&C, cast doubt on that assumption and the conclusion that flows from it.

The five recent Chancery cases present situations where an executive profits from his position at a company at the expense of shareholders and with inadequate -- even nonexistent -- board oversight. In the three cases involving a major transaction, the court depicted a CEO at least as concerned with what he stood to receive in the deal as with the return to shareholders. Chandler's Caremark decision and Lamb's in SS&C suggests that image has affected Chancery's view of M&A significantly. Now the big question is, will it affect Delaware takeover law?

Take-Two shareholders in charge

Take-Two Interactive Software Inc.'s weak anti-takeover defense puts the company at the mercy of shareholders seeking control of the video game publisher.

Locked in a proxy fight with a group of investors led by asset management firm OppenheimerFunds Inc. of New York, Take-Two on Monday postponed its annual meeting, which had been scheduled for Friday, until March 29. Under the New York company's corporate governance charter, however, shareholders may act to replace Take-Two's board members so long as a majority backs such a proposal, obviating the need for a formal vote.

The shareholder-friendly provision is a 'gaping hole' in Take-Two's takeover defense, said Christopher Young, a director with proxy advisory firm Institutional Shareholder Services Inc.
'The company in its governance document allows for action in lieu of a meeting,' he said. 'Once the required percentage of shareholders sign, the action is taken immediately.'

That poses a serious danger to Take-Two CEO Paul Eibeler and other senior managers, because investors representing more than 46% of the company's shares are backing the dissident shareholders. Analysts expect other investors also to pledge their support, which would give the group the necessary shares to oust Take-Two's leadership.

Rejecting Enron class action poses stark choice: Injustice for plaintiffs or injustice for defendants?

Candidly conceding that its ruling "may not coincide ... with notions of justice and fair play," the U.S. Court of Appeals for the Fifth Circuit yesterday decertified the shareholder class action against the banks that allegedly helped perpetrate Enron's frauds -- a case that has already produced more than $7 billion in settlements. The ruling, if it is not overturned by the full appeals court or the U.S. Supreme Court, will benefit Merrill Lynch, Credit Suisse First Boston, and Barclays, which had not settled, saving each potentially billions in liability.

Though the issues are complicated, and have lots of twists and turns, the heart of the problem has actually been apparent to most lawyers watching this case from the moment it was filed in 2002. Back in 1995, in a 5-4 ruling of the U.S. Supreme Court that shocked lawyers at the time -- it ran counter to what every appeals court that had faced the question had previously assumed -- the Court found that the securities laws did not create liability for those who "aid and abet" fraud (i.e., knowingly help others to commit fraud), as opposed to those who act as "principals" in such schemes. Even as they rendered that ruling, several of the justices in the majority acknowledged that the outcome of the ruling was unjust, and they urged Congress to fix the problem by amending the law to include aiding and abetting liability. In almost every other legal arena -- including the criminal arena -- aiders and abettors are treated as every bit as responsible as principals. (Indeed, the distinction between the two is often hard to draw.)

Congress never fully fixed the problem, however. It did allow the Securities and Exchange Commission to go after aiders and abettors, but not private plaintiffs attorneys. The reason is simple: it did not trust the latter to use good judgment in doing so; rather, it anticipated -- no doubt correctly -- that allowing aiding and abetting liability would result in banks, accountants, and law firms being routinely named in nearly every shareholder class action suit filed, no matter how frivolous. (Fittingly, the Enron case is brought by Bill "Partner B" Lerach, who is king of both the wheat and the chaff when it comes to class actions. He is lead counsel in the Enron case, and yet earlier in his career, for example, his firm also brought a series of civil RICO class actions against baseball trading card manufacturers for allegedly promoting gambling among children by giving away bonus trading cards in some, but not all, packs.)

Investors Call On Congress to Go Green

Joining a growing chorus from American businesses, more than 50 major U.S. investors are asking Congress Monday to enact tough federal legislation to curb carbon emissions and to overhaul energy policies nationwide.
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Are First-Year Lawyers Overpaid?

These days, a first-year lawyer at a top firm can earn more than an associate justice of the Supreme Court. This is just one of the points made by Susan Hackett, general counsel of the Association of Corporate Counsel, as she argues that there is no good reason for the recent rise in legal associates’ pay. Her organization represents the in-house legal departments that pay for outside lawyers.
After Simpson Thacher & Bartlett announced in January that it was raising its first-year associate pay to $160,000, many other firms soon followed suit. Writing in Corporate Counsel magazine, Ms. Hackett said she has heard “disgusted buzzing” from some corporate lawyers, but “no hint of the revolution that I was sure would erupt.”
“In-house counsel of the world: What are you waiting for?” she entreats. “Who’s managing your company’s legal spending: you, or the firms?”
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Under Pressure, Take-Two Says It Will Consider a Sale

Already taking heat from a group of high-powered activist shareholders, Take-Two Interactive Software said Monday that it will postpone its annual investors meeting by nearly a week and will review a possible sale of the company. In a statement, the embattled maker of the “Grand Theft Auto” videogame series said that it was moving the meeting to March 29 from this Friday to better study the proposals of the dissident shareholders and assess strategic alternatives.
In its statement, Take-Two asked shareholders to wait until it had presented any of its own proposals before making up their minds about the activists’ proposed slate of directors. That group of shareholders, which includes OppenheimerFunds and the hedge funds SAC Capital, Tudor Capital and the D.E. Shaw Group, recently said in a regulatory filing that they want to take control of the company. Among the candidates they have nominated is Strauss Zelnick, a former BMG executive.
The embattled maker of the “Grand Theft Auto” franchise said that the record date of Feb. 26 remains the same.
Take Two has been beset by a passel of troubles lately. Ryan A. Brant, Take Two’s former chief executive, pleaded guilty this year to criminal charges related to backdating of stock options. Take Two also said it found that five independent directors had received improperly dated stock options. They have agreed to repay the company hundreds of thousands of dollars.
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Delaware Court Faults Sale to Buyout Firms

In a ruling that could have broader effects on the booming buyout business, a Delaware judge faulted Netsmart Technologies for excluding strategic buyers from its sale process and ordered the company to delay a vote on its proposal to be acquired by two private equity firms. In a memo to clients, law firm Wachtell, Lipton, Rosen & Katz called the decision, issued late Wednesday by Vice Chancellor Leo E. Strine Jr. of Chancery Court, a “major opinion” on a deal that, although small, had many of the same elements as large private-equity transaction.
The ruling comes as some shareholders are growing concerned that their companies are not being adequately shopped around before agreeing to a buyout. For example, shareholders of Adesa are suing that company in Delaware Chancery Court over its agreement to sell itself to a group of private equity firms for $2.5 billion. Among other things, the lawsuit alleges that Adesa’s investment bankers urged Adesa’s board only to consider transactions with private equity firms, which the plaintiffs say depressed the price that Adesa was able to fetch at auction.
Some deal-makers have also been suggesting that courts in Delaware, where many companies are incorporated, has been issuing decisions that are less friendly toward corporations.
In this week’s opinion, Chancellor Strine was critical of what he termed Netsmart’s “sporadic” efforts to find a strategic buyer that might offer more for the company than private equity investors. He has barred Netsmart from polling shareholders on a $115 million offer to sell out to Insight Venture Partners and Bessemer Venture Partners until it tells investors more about how the software company was shopped. The vote had been scheduled for April 5.
By looking only at private equity buyers, Netsmart’s board may have failed to find a better deal among strategic buyers, companies that might be interested in adding Netsmart’s software for the mental health industry to their own portfolio of offerings, the judge suggested.
In his opinion, Chanceller Strine found that “the [Netsmart] board’s failure to engage in any logical efforts to examine the universe of possible strategic buyers and to identify a select group for targeted sales overtures was unreasonable and a breach of their Revlon duties.”
Netsmart’s sale process had many features common to much larger buyout deals: It was an auction involving private equity firms, and the deal was approved by a special committee of Netsmart’s independent directors. There was also a so-called “go shop” provision, allowing the company to seek out better offers after the deal was signed.
Despite these elements, which are ostensibly intended to insure that shareholders get the best deal, the Delaware court found the Netsmart auction was flawed.
Wachtell Lipton, a firm that is involved in many large takeover deals, said in a memo that the decision is a reminder that Delaware courts “will be skeptical of arguments that deal-structuring and deal-protection decisions are proper because they are common or have been approved in other contexts.”
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CVS Shareholders (But Not Calpers) Approve CareMark Deal

It may end up being largely symbolic, but Calpers, the country’s biggest pension fund and a major force on corporate governance issues, said it voted its shares against drugstore chain CVS’s $23.5 billion acquisition of drug-benefits manager Caremark Rx. Objecting from both sides of the deal, Calpers said it opposed the transaction with its 3.1 million CVS shares and 2.1 million Caremark shares. Nevertheless, CVS shareholders approved the deal Thursday, leaving Friday’s vote by Caremark shareholders as the final hurdle.
The deal has been roiled by controversy from the beginning, especially after Express Scripts, a Caremark rival, made a competing, cash-and-stock bid. The CVS offer is in stock, with a special cash dividend to Caremark shareholders.
Express Scripts is fighting until the end. In a press release Thursday, the company said it is “absolutely committed to increasing our offer” for Caremark, if it can identify at least $500 in additional synergies from such a merger. To do that, it said it would need to conduct due diligence, which it claims Caremark has not allowed.
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Private Equity Sets Record Pace in 2007

If you thought that private equity funds would slow down after last year’s rapid-fire dealmaking, think again.
As of Tuesday, the pace of private equity-related mergers and acquisitions in 2007 is running at a record rate, according to data provided by Thomson Financial. Deals in which private equity firms were on the buyside had a total value of $104.2 billion as of March 13, which is more than 50 percent more than the total at the same time in 2006.
Just how much of a factor is private equity in M&A these days? Consider this: Year to date, private equity deals have accounted for a remarkable 30 percent of overall M&A value. During the same period of 2002, such deals were barely more than 5 percent of the total.
http://dealbook.blogs.nytimes.com/2007/03/13/private-equity-sets-record-pace-in-2007/#more-12615

Commission on the Regulation of U.S. Capital Markets in the 21st Century - Report and Recommendations

A committee of the United States Chamber of Commerce on Monday proposed a series of steps to ease the regulatory burdens for U.S. companies. The panel's report, which noted a "substantial decrease" in the number of initial public offerings in the U.S., called for the Sarbanes-Oxley Act of 2002 to be folded into the 1934 law that created the Securities and Exchange Commission and urged companies to stop giving quarterly earnings guidance. On Tuesday, Treasury Secretary Henry Paulson will hold a public discussion on how U.S. capital markets can maintain their edge.
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The incredible shrinking club deal

As the scale of buyouts continues to rise, elite players are tapping a reserve of capital so deep they can stage ever larger deals with fewer sponsors. What's changed? It's a complex question.
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Britain to Put Private Equity in the Hotseat

Even as a collection of private equity firms are circling the United Kingdom’s largest supermarket chain — and perhaps partly because they are circling it — Britain’s Parliament is preparing to conduct an inquiry into the private equity business. At issue: asset-stripping, “short-termism” and complaints that there is a general lack of accountability for private equity funds, which usually buy public companies in debt-financed deals in hopes of selling them or taking them public later at a profit.
The Parliamentary Treasury Select Committee, headed by Labour Party M.P. John McFall, will take up the issue. M.P.s will cross-examine private equity chiefs and will scrutinize the industry’s attempts at self-regulation.
Private equity chiefs are becoming increasingly concerned about how public criticism could affect their bottom lines. At a recent private equity conference in Frankfurt, Stephen Schwarzman, the chairman of buyout behemoth Blackstone Group, said his greatest worry related to the private equity business centered on the groups that are attacking private equity and what they consider to be its harmful effects.
“Those groups of people appear not to recognize any facts that are laid out for job creation, increased sales growth, the idea that pensioners are getting better benefits or, if they’re not getting better benefits, that the pension funds are more stable,” Mr. Schwarzman said.
British labor unions have been especially critical of buyout firms. The possibility of a takeover of the J. Sainsbury grocery chain, which would be Europe’s largest leveraged buyout ever, turned up the volume of complaints.
“With buyout firms embarking on ever bigger deals, critics have moved beyond simply balking at job cuts to calling for an end to the tax breaks that make their leveraged takeovers possible,” Reuters reported Wednesday.
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Are Some Stock Analysts Rewriting History?

We thought it was dead, but the controversy over a widely used database of Wall Street research has popped up again. The debate began last fall when a group of researchers questioned the integrity of Thomson Financial’s I/B/E/S service, a clearinghouse of analysts’ stock picks. The researchers appeared to backtrack after Thomson disputed their methodology, but last month they published the paper and are standing by its conclusions.
“Is it sleazy fraud or inadvertent error?” a headline on Slate asks. “You be the judge.”
In their paper titled “Rewriting History,” professors Alexander Ljungqvist of New York University, Christopher J. Malloy of the London Business School and Felicia C. Marston of the University of Virginia say they found 55,000 changes to the database from 1993 to 2002 that tend to make certain stock analysts look good.
The database is widely used by fund managers, academic researchers, by regulators to track questionable activity on Wall Street — and by The Wall Street Journal to assemble its annual list of the best analysts.
Specifically, the professors say, the analysts’ recommendations were altered to make them appear more conservative toward the end of boom cycles, causing returns on theoretical portfolios based on those picks to be 15 percent to 42 percent better. The alterations, according to the professors, strongly correlate to the best performers on the Wall Street Journal’s “Best on the Street” ranking.
The professors are careful to say they aren’t alleging malfeasance, only that the alterations are not random. It’s hard to see, though, why else the data would be changed this way.
Thomson disputes the findings. Mike Thompson, the head of research for Thomson Financial, told Barron’s that the professors “really did a hatchet job,” adding, “We’re a little stunned.”
Some outside observers, though, think the paper strongly suggests that there is something funny going on. The professors “make a good case in their paper that these are changes that do not seem to be random,” Brad Barber, a finance professor at the University of California, Davis, told Barron’s.
The Wall Street Journal ranking is meant to be an objective, data-driven ranking, unlike other rankings, like the one produced by Institutional Investor magazine, that are essentially popularity contests. But how and why could the I/B/E/S data be compromised?
According to the Wall Street Journal and Thomson, analysts are allowed to view the data through a special Thomson Web site and request changes to correct inaccuracies.
Thomson said that all requested changes are carefully reviewed by in-house analysts. Nevertheless, Mr. Barber said, allowing stock analysts to have any say in how the data are presented can’t help but skew results. It “can only lead to bias,” he told Barron’s. And a former Thomson executive challenged the company’s characterization of how carefully the analysts’ requests are screened.
Last fall, in an earlier version of the paper, the professors asserted that some analysts’ names had been stripped from the database, often in cases where their stock picks proved to be way off. At the time, Thomson attributed the deletions to database maintenance. But the professors now say that about a quarter of those deletions still are not accounted for.
Thomson insists that the correct data are all there, but are contained in different data sets, which would have to be reconciled for the results to be fully understood. A spokesperson told Slate’s Daniel Gross that Thomson has offered to walk the professors through the complex process.
“It’s hard to know what to conclude,” Mr. Gross writes. But “Wall Street executives—stock analysts among them — have shown that there’s virtually nothing they won’t do, and nobody they won’t corrupt, to advance their own careers and portfolios.”
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Clear Channel Feud May Signal Buyout Boom’s Future

The $18.7 billion buyout of Clear Channel Communications, the nation’s largest radio broadcaster, has become a test of wills between some of the nation’s largest investors, like the mutual fund giant Fidelity Investments, which plans to vote against the deal, contending it severely undervalues its shares, and the two private equity bidders, Thomas H. Lee Partners and Bain Capital, The New York Times writes.
At issue is the price. The investors want more money; the bidders refuse to raise their price and have threatened to walk away from the deal if it is voted down.
The deal, which would be the largest media and entertainment buyout in history, will be voted on in less than three weeks. The sale requires approval from two-thirds of the shares outstanding. If current shareholder sentiment holds and a higher offer does not emerge, the deal will almost certainly be dead.
The fight over the Clear Channel sale is being closely watched by investors as a proxy for the future of the buyout boom. Many investors have watched with growing unease as private equity firms have walked off with companies, at what appeared to be a reasonable premium, only to turn them around a year or two later and seemingly double their money.
In the case of Clear Channel, which also owns billboards and other outdoor advertising, the private equity firms agreed to pay $37.60 a share, representing a premium of about 25 percent over its 30-day trading average before it went up for sale. Since the deal was struck, however, shares of radio and outdoor advertising companies have surged, making the price seem cheap to some.
What lies in the balance is the future of Clear Channel, which was founded by the Mays family in 1972 and has more than 600 stations nationwide and more than $6 billion in revenue.
Some shareholders are not only willing to take the risk of continuing to hold Clear Channel if the deal collapses; they are rooting for it. Yet it is a bet that may come with some substantial risk.
Shares of Clear Channel, which closed yesterday at $35.62 in regular trading, could take a tumble, according to some analysts.
“In the absence of a buyout bid, we believe CCU shares could trade in the $32-$33 range, as we have become incrementally cautious on the radio,” Anthony J. DiClemente, an analyst with Lehman Brothers, wrote in a note to investors. Similarly, Jonathan A. Jacoby at Bank of America said, “We believe that there is downside risk if the deal falls apart.”
A decline may be fine for long-term shareholders like Fidelity and T. Rowe Price, which has also came out against the deal, but it may be harder to stomach for arbitragers and hedge funds like Highfields Capital Management, which is said to be planning to vote against it. (Fidelity, for its part, has quietly sold about 20 percent of its position already.)
Still, other analysts contend Clear Channel’s shares could rise. Laraine Mancini, an analyst with Merrill Lynch, believes Clear Channel’s shares are worth $40 a share and argues that the private equity partners could afford to pay $41 a share and still reap a 20 percent annual return.
Proxy Governance, which gave the deal a “reluctant” thumbs up, said: “Given the opposition to the merger, we would hope that management work with the investor group to raise the offer closer to what the market had anticipated — approximately $40 per share.”
But it may be wishful thinking.
“We wish we could raise our bid, but it doesn’t make sense,” a person involved with the bidding group who was not authorized to comment, told The Times. “We can’t make the numbers work. The reality is we’re getting very nervous about the radio market.”
Go to Article from The New York Times »

Hedge Funds and The Middle Market

From Merger Mogul of March 5, 2007:

The booming market for private capital has led to the breakdown of many traditional walls as investment managers seek new outlets to deploy the huge sums coursing through the public and private markets.

In the United States alone, more than 1,500 private equity firms now have an estimated $811 billion in commitments, creating an active – if not overheated – market for the sale and purchase of companies. An unknown share of that money is targeted at middle-market companies.

And even those large sums are dwarfed by the $1.2 trillion being managed by the estimated 8,000 to 10,000 hedge funds in the United States. That’s led some fund managers to become active in the takeover sector, whether by financing transactions or acting as a principal and taking equity positions.

Some of the biggest names in the hedge fund world, including Eddie Lampert’s ESL Investments, Carlson Capital, Cerberus Capital Management and D.E. Shaw have made private equity-style purchases. At the same time, some of the nation’s largest private equity firms (Bain, Quadrangle, Texas Pacific, Carlyle, Blackstone) have started their own hedge funds. Talk of “convergence” is everywhere.

Over the last several years, Edgeview has expanded its deal marketing to include hedge funds. We’ve seen few true hedge fund purchases of middle market companies in an auction environment, though we expect that dynamic to change over time.

One officer who worked extensively with a large hedge fund on a public-to-private transaction in 2006 recalled that the fund operator struggled to adapt its desire for a significant equity stake to the company’s wish for a full buyout. “Playing the buyout game” was harder for fund managers accustomed to dictating the rules, the officer said.

Another officer held discussions with a hedge fund as part of a sellside assignment, but said the fund’s interest was in a pure value play. That makes a fund a very different middle market buyer than, say, a private equity firm with a history of managing for growth.

One question moving forward is whether hedge funds continue to view private equity-style deals as worthwhile. Last year, so-called Special Situations hedge funds – those known to be executing buyout-style strategies – showed a 12.3 percent return, according to the Greenwich Global Hedge Fund Index. That was barely higher than the index’s overall 12.1 percent return _ and well below the S&P 500’s 15.8 percent return.

Whether or not traditional hedge funds become a truly dominant participant in the middle market, they have become a significant source of creative capital in a short time – and an important consideration in any middle market transaction.

Private Equity I.P.O.’s: The Geography Factor

Investors and academics have long debated how private-equity-backed companies fare in their initial public offerings. One camp argues that these companies do worse then their conventional peers because they are often loaded up with debt by their financial sponsors, who are eager for a quick exit. The other camp says they perform just as well, or better, than other I.P.O.’s in the aftermarket. Data from Financial News suggest an interesting wrinkle: It may depend on which continent you are on.
Using data from Dealogic, Financial News determined that in the United States, I.P.O.’s backed by buyout firms outperformed the overall I.P.O. market from 2002 through 2005, based on share prices at the end of last year. This was especially true of 2003- and 2005-vintage I.P.O.s: In both cases, the average return for a private-equity-backed offering was at least twice the return of I.P.O.’s in general, Financial News said.
In Europe, however, the results were far less consistent. Private-equity-backed offerings trailed the others in 2002, 2003 and 2005.
DealBook ran some figures last year on a similar theme, looking at year-to-date performance of 2006 I.P.O.’s in the U.S.. The results, which covered a much shorter timeframe than Financial News’s data, showed that private-equity-backed offerings performed worse — but only slightly worse — — than their non-buyout-backed counterparts.
Go to Article from Financial News »

Mutual Fund Managers: Lost in the Hedges?

You might think that someone who decides where to invest billions of dollars could bend an equity analyst’s ear with no problem. But as Bloomberg News tells it, some mutual fund managers are getting snubbed by stock researchers at investment banks because “securities firms now order analysts to ignore everyone but the customers who pay the biggest fees.” Who are these big-spending customers? Those would be hedge funds, lightly regulated investment pools that use an array of trading strategies to earn profits for their customers.
Bloomberg describes a litany of woes: Mutual fund managers having to stay late at work because some analysts will talk to them only after hours; mutual fund managers being put on hold so an analyst can take a call from a hedgie; etc.
It needs to be this way, some Wall Streeters told Bloomberg, because research departments, since a set of new regulations were implemented following the turn-of-the century scandals, have been forced to rely more on sales and trading for their funding. There are fewer analysts, and they are writing shorter reports and have been forced to whittle their customer bases. That tends to favor the biggest clients.
James Wicklund three weeks ago left his job at Bank of America. “Half the people I talked to don’t care what companies do, they’re wondering, ‘Will I make money if I buy or sell this stock?”’ he said. “The shorter time frame of such investors and their disdain for depth caused research reports to lose most of their value.'’
Mutual fund managers are left without a crucial perspective as they try to make investments for the longer term. While bigger funds like those at Fidelity Investments still get access to analysts, many smaller ones are left out in the cold. Eventually, says one observer, those smaller firms will either get gobbled up, go out of business or become hedge funds.'’
Go to Article from Bloomberg News »

Buffett Seeks New (and Younger) Candidate for Top Investing Position

Berkshire Hathaway chairman Warren E. Buffett said in his annual letter to shareholders Thursday that he was seeking a new candidate to become chief investment officer when he steps down. Mr. Buffett also said his firm needs to pursue large acquisitions -- he called them "elephants" -- in order to put its cash to work, and was critical of hedge funds, calling their fee structures "grotesque."
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Wall Street Insiders Charged in Stock-Tipping Cases

An executive at UBS and a former lawyer at Morgan Stanley were charged with conspiracy and securities fraud Thursday for allegedly passing information about pending stock-rating changes and merger announcements to hedge funds and other accomplices, who then traded on the tips. In all, the insider-trading schemes involved 13 defendants who made more than $8 million in illegal profits, the U.S. Attorney for the Southern District of New York said in a news release describing the indictments.
An official from the Securities and Exchange Commission, which filed related civil charges on Thursday, called the alleged stock-tipping scheme “one of the largest S.E.C. insider trading cases against Wall Street professionals since the days of Ivan Boesky and Dennis Levine.”
“It involves fraud by employees of some of the biggest brokerage and investment banking firms in the country,” the S.E.C. official, associate director of enforcement Scott W. Friestad, said Thursday. “We will do everything possible to make sure that, in addition to any other remedies or sanctions imposed, none of these individuals ever works in the securities industry again.”
Mitchel Guttenberg, an executive director in UBS’s equity research department, was charged with two criminal counts of conspiracy to commit fraud and four criminal counts of securities fraud. Prosecutors said Mr. Guttenberg sold nonpublic information about pending upgrades and downgrades by UBS analysts for “hundreds of thousands of dollars,” allowing the recipients of the tips to make profitable trades before the changes were announced.
Randi Collotta, who was an attorney in Morgan Stanley’s global compliance division, was charged with one count of conspiracy and three counts of securities fraud, as was her husband, Christopher Collotta. Ms. Collotta allegedly leaked information about upcoming mergers and acquisitions, including the UnitedHealth Group’s $8.1 billion deal to buy PacifiCare Health Systems, announced in July 2005, allowing the tippees to trade in the company’s stocks before the transactions became public.
Go to Press Release from the Securities and Exchange Commission »

Private Equity Teams Up for Home Depot Auction, Report Says

Competition for Home Depot’s wholesale supply business is already heating up, even though the company has yet to formally announce an auction. And the roster of interested bidders reads like a private equity hall of fame. According to The Financial Times, three teams of private equity firms have formed to consider bids for the business, which could go for about $11 billion.
Bain Capital has joined forces with the Carlyle Group and Clayton Dubilier & Rice, while Thomas H. Lee Partners is teaming up with Goldman Sachs’s buy-out unit and CCMP, the former private equity arm of JPMorgan Chase, the British newspaper said. A third team of investors reportedly includes the Blackstone Group, Kohlberg Kravis Roberts, Leonard Green Partners and the Texas Pacific Group.
Earlier this month, Home Depot said that it had hired Lehman Brothers to consider a sale or spinoff of its contractor-supply business, a move that would undo an ambitious and expensive diversification strategy advocated by its recently ousted chief executive, Robert L. Nardelli.
Go to Article from The Financial Times via MSN Money »

Taking on the Myths of Private Equity

Private equity is getting plenty of attention these days. Headlines routinely mention firms such as Blackstone Group, Kohlberg Kravis Roberts, Texas Pacific Group, Carlyle Group and Providence Equity Partners as they recount the latest record-breaking buyout or takeover of a well-known company.
But Providence Equity chief executive Jonathan Nelson suggests that private equity’s new prominence has a downside: The rise of some widely accepted myths about the buyout business that could end up hurting the industry. “While many appreciate our role,” he told an audience of private equity professionals earlier this week at the Super Return conference in Frankfurt, “more still do not understand what we do and how we do it. Name recognition is not the same as real understanding.”
So Mr. Nelson ticked off what he considered to be five myths about the private equity business and tried to dispel them. Below, the myths and some excerpts from what he had to say about them:
* Private equity is private
At one time, private equity really was private, but our business has changed over the years as capital markets and our strategies have evolved. There are now many windows into our world. Consider the following realities that you all know:
First, many private equity investments soon return to the public arena in the form of an IPO — and the PE firm often continues to own a large stake in a public company. Second, in many private equity investments, public bonds are issued as part of the acquisition financing, and this debt comes with disclosure requirements. […] State pension funds and other LPs are increasingly disclosing positions and returns of the PE firms they invest with.
* Private equity firms are star-driven boutiques
The days when a star founder or group of founders did it all — raise money, find new investments, court sellers, conduct due diligence, negotiate contracts, close deals, and sit on all portfolio boards …. those days are long gone.
My point is that people outside the business, and in the media, tend to focus on the prominent personalities in PE. But with all due deference to some of my colleagues who, in fact, are stars — I think the brand names that will ultimately matter are the emerging institutional brands – such as Blackstone, KKR, TPG, Carlyle and Providence to name a few.
* Private equity firms are institutions
Whichever side you come down on in the “Star versus Institution” debate, the fact is we have not yet seen or lived through an era when the founders retire and PE firms endure.
There are still very few examples of PE firms successfully transitioning from the founder to the next generation of leadership. While we’re all getting a little older, this is largely a function of the relative youth of the private equity industry itself.
* Private equity is easy
[T]he model in our industry today is far different than the headlines would lead you to believe — and it’s far more sophisticated than it was 10 or even five years ago. In today’s environment, you have to improve businesses, not just arbitrage public and private capital structures. Or said another way, you must work on the income statement as well as the balance sheet.
* The private equity bubble is about to burst
There is an important difference between high cyclical valuations and tulip mania. We have the former and are not yet approaching the latter […]
Since 2000, the term “bubble” has been overused by pundits, and it’s easy to latch on to that word today when we know we’re approaching a high point in the cycle. What’s misapplied here is the implication that we are headed for a free fall. I don’t expect that, but I also don’t expect the laws of gravity to be repealed. We will correct, multiples will contract and credit will tighten.
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