Market Overhaul Proposal Draws Criticism

From NYT's Deal Book:


Depending on whom you ask, a panel’s sweeping proposal to revamp securities rules goes too far, or not far enough. The panel, formed with the endorsement of Treasury Secretary Henry Paulson, issued a report Thursday that recommended making it harder for companies to be indicted or sued and seeking to limit rules that impose high costs on business, among other changes. The Council of Institutional Investors, a corporate governance group, responded Thursday by saying that the recommendations “would undermine the effectiveness of market watchdogs and weaken critical investor protections.” The National Venture Capital Association had a very different take.
The venture association, which represents firms that invest in start-up companies, suggested the committee’s proposal did not give enough relief to small businesses. It called the report a “step backwards based on work and recommendations that have already been put forth.”
The opposing views reflect the growing debate over whether the Sarbanes-Oxley Act of 2002, passed after the collapses of Enron and WorldCom, has made the U.S. a less-hospitable place for business, a safer place for investors, or some combination of the two.
The panel, called the called the Committee on Capital Markets Regulation, is co-chaired by R. Glenn Hubbard, the dean of the Columbia University Graduate School of Business, and John L. Thornton, the chairman of the Brookings Institution. It has no official standing, but its recommendations are likely to help set the agenda at the Bush administration.
The report spends a lot of time describing what it considers to be the flight of initial public offerings to markets outside the U.S., a trend it suggests is driven by the additional red tape and costs of a U.S. listing. The Council of Institutional Investors, a nonprofit group of pension funds, called this analysis “off-base.” In a statement released Thursday, the council argued that the nation’s declining I.P.O. share reflects increased globalization, higher investment banking fees in the U.S. and the privatizations of many state-owned companies overseas.
The National Venture Capital Association issued its own statement, in which it criticized the report for failing to recommend more measures to shield small businesses from Sarbanes-Oxley. It argued that the scope of small businesses that would be granted relief is “much narrower” than a proposal recently put forth by a committee of the Securities and Exchange Commission.
Go to Press Release from the Council of Institutional Investors »
Go to Press Release from the National Venture Capital Association »

Are Securities Rules Hurting U.S. Markets?

An independent committee formed with the endorsement of Treasury Secretary Henry M. Paulson Jr. called for a sweeping overhaul of securities regulations, citing concerns that American markets are losing their competitiveness. In a report released Thursday, the committee recommends making it harder for companies to be indicted by the government or sued by private lawyers, and urges policies to keep the Securities and Exchange Commission from adopting rules that impose high costs on business. The committee has no official standing, but it includes many influential members. Harvey J. Goldschmid, a professor at Columbia Law School who had served as general counsel and as a member of the S.E.C., said the report "raised legitimate questions but over all their recommendations are unbalanced and unwise." A briefing on the report was scheduled for 10:30 a.m. Thursday in New York.
• Go to Article from The New York Times
• Go to Article from Bloomberg News
• Go to Report from the Committee on Capital Markets Regulation
• Go to Webcast of Committee Briefing

PE Week Wire - Monday, November 27

From Monday's "Random Ramblings":

In 2001, the Boston Red Sox hiked ticket prices just 24 hours after the New England Patriots had won their first Super Bowl. It was an egregious increase, but no one noticed.
People also don’t notice much on the day after Thanksgiving, because they either are suffering tryptophan hangovers or are in pre-stampede mode at the local Best Buy. Even the public markets take half the day off.
So it isn’t terribly surprising that hospital chain HCA picked Friday to disclose additional terms of its $21 billion sale to Bain Capital, KKR and Merrill Lynch. After all, $175 million in transaction fees and $15 million annual management fees aren't something to promote (or list in the small print on an ER visit bill). In addition, the management fee can increase annually beginning in 2008, while new owners will be entitled to: “a fee equal to 1% of the gross transaction value in connection with certain subsequent financing, acquisition, disposition, and change of control transactions as well as a termination fee based on the net present value of future payment obligations under the management agreement in the event of an initial public offering or under certain other circumstances.”
Once again, we are watching new private equity owners raid the corporate coffers for their own benefit (as opposed to for the company’s benefit). Let me repeat that word: “Owners.” Shouldn’t it be implicit that owners will participate in company management? Do they deserve extra financial credit for paying active attention to their own control investment? And, even worse, why do they get paid to terminate said agreement? It’s a pre-baked golden parachute that presumes KKR is just as valuable to HCA while “not managing” as it is “managing.” I wonder if Daddy Thomson would agree that I'm as valuable when "not writing" as when "writing?" Methinks not.
The counterargument here is: “Hey, the private equity firms now own HCA, so they’re the only ones who get hurt if the company’s valuation is reduced.” Yes and no. First, value also is being reduced for any HCA employee holding company options (for the inevitable flip). More importantly, not all private equity firms share either the transaction or management fees with limited partners. You remember limited partners, don’t you? They’re the ones who actually funded the buyout’s equity tranche.
Bain, for example, almost never shares any of those fees with LPs. Well, it officially does, but then takes out all of the unaccounted for consulting fees generated by affiliate Bain & Co. Even firms with more generous sharing – which usually means 50/50 or 60/40 in the LP’s favor – still apply carried interest, which means that even firms that give 100% to LPs may only end up giving 80 percent. It’s worth pointing out that buyout firms all used to take 100% of such fees for themselves, but progress in this area has still moved like stubborn molasses.
The solution: End management fee agreements, and probably transaction fees as well. Private equity is supposed to be about building portfolio company value over time – not about getting rich on Day 1.

Richard Epstein Blasts Thompson Memorandum

Today in a searing WSJ op-ed, Chicago law professor Richard Epstein takes aim at deferred prosecution agreements. He blasts the Thompson Memorandum, the 2003 Justice Department policy statement that laid out guidelines for prosecuting corporations. “The Thompson memorandum insisted that corporations receive a temporary reprieve only if they purge themselves of individual wrongdoers and agree to extensive government oversight to make them walk the straight and narrow path.”
He mocks the deferred-prosecution agreement the feds struck with Bristol-Myers Squibb, which was accused of inflating its revenues. New Jersey U.S. Attorney Chris Christie went too far, says Epstein. “The most striking evidence of the abuse of power is paragraph 20 of the agreement, which requires BMS to ‘endow a chair at Seton Hall University School of Law,’ Mr. Christie’s alma mater, for teaching business ethics, a course that he himself could stand to take.”

NASD, NYSE Agree to Merge Regulatory Arms

The NASD and the NYSE Group said Tuesday they intend on combining their regulatory operations, creating a single private overseer for all stock market activity in the United States. The new organization, which has not yet been named, is expected to begin operation next year, the NYSE Group said in a press release.
The new regulator will retain all of NASD’s 2,400-person regulatory team, as well as 470 of the NYSE Group’s operation. NYSE’s regulation chairman, Richard G. Ketchum, will serve as interim chairman of the combined operation for three years, while NASD’s chairman and chief executive, Mary L. Schapiro, will serve as C.E.O.
Earlier this year, the Securities and Industry Association, Wall Street’s trade and lobbying group, said it favored eliminating duplication by creating one regulator with one set of rules and interpretations to govern the industry. The association also sought a seat for itself on the board of whatever regulator emerged.
Go to NYSE Group Press Release »

S.E.C. Sets Date to Consider New Hedge Fund Regulations

It’s a date. After indicating that it would seek tougher regulations for hedge funds, the Securities and Exchange Commission has scheduled a public meeting for Monday, Dec. 4, to consider two measures that would tighten rules governing these lightly regulated pools of capital.
One proposal to be considered would deal with the minimum net worth that an investor must possess to be allowed to invest in hedge funds. Earlier this month, S.E.C. chairman Christopher Cox said that it was necessary to further isolate hedge funds from small investors.
Another measure to be batted about next Monday would tighten up the anti-fraud statute dealing with hedge funds.

For M&A, a Much-Deserved Holiday

Investment bankers and corporate lawyers seemed to take a break on Wednesday — and they certainly earned it. About $3.1 trillion worth of transactions have been announced this year, including about $50 billion on Monday alone. That was when Blackstone offered $20 billion (excluding debt) for Equity Office Properties and Freeport-McMoRan agreed to pay $25 billion for Phelps-Dodge.
On Wednesday, both BusinessWeek and Fortune magazine took a look at why there is such a deal-making frenzy.
They covered some familiar territory (bulging private equity funds in search of takeover targets, easy access to the debt markets), but BusinessWeek hinted at a tantalizing, if a bit far-fetched, political angle. It cited the incoming Democratic congress as one big reason for the year-end spate of deals. In the new year, “deals may see a greater degree of scrutiny in Washington,” it concludes.
Meanwhile, the tone of the media’s merger-related coverage seems to grow more portentous every day. “If the good times keep rolling,” Fortune writes, the buyers will “do fine.” But “if the normal cycle reasserts itself, if the world hasn’t really changed, the buyers will end up with a wicked hangover.”
Because private equity buyers tend to offer cash, as opposed to the stock that strategic buyers tend to offer, sellers are more willing to deal. But that shows that the sellers “apparently would rather cash out than bank their future on the success of an expensive merger,” the article continued.
On Tuesday, The New York Times noted how the deal-financing scene has gone topsy-turvy, thanks to free and easy debt markets. It is so cheap to borrow that buyers essentially cannot help themselves, and debt financing is often seen as safer than using stock. While “normally cautious bond investors are living like Las Vegas high rollers,” the article noted, “stock speculators are behaving like worry-warts.”
Go to Article from BusinessWeek »
Go to Article from Fortune »
Go to Earlier Article from The New York Times »

The Importance of Being Private

Leveraged buyouts are not the get-rich-quick schemes they are often made out to be. Or at least, not always. That is the assessment of Geoffrey Colvin and Ram Charan, whose article in Fortune offers a different view of the private-equity phenomenon than many recent articles in the business media.
Rather than focus on buyout funds’ record-setting size or quick exits, Fortune looks at how private equity investment changes business.
Go to Article from Fortune »

The Sorkin RoadMap for Fairness

From today's PE Week Wire:

Andrew Ross Sorkin of NY Times Dealbook has developed some middle ground between Ben Stein’s call for banning management buyouts and the private equity market’s calls for continued regulatory indifference. Specifically, he has a four-part plan for fixing certain problems inherent in management buyouts. It goes something like this:
Require that a majority of minority shareholders approve the transaction. If senior management holds a control position, don’t let its vote be the only one that matters.
Use independent advisors. Real ones without either existing company relationships or a financial stake in the deal (i.e., stapled financing agreements).
Set aside up to 10% of the newly-private company for public shareholders. In other words, pre-empt the whining.
Provide some detail of the business plan for the company, once it becomes private. Let shareholders decide if management can best add value as a public or private entity.
Points one and two seem like no-brainers. Both help prevent self-dealing without much downside. If it’s really a good deal, then the minority shareholders will vote for it. Sure certain Wall Street firms will lose some fees, but not in the aggregate. It might even promote the creation of new boutique I-banks.
Points three and four are a bit trickier (as Sorkin admits).
My concern on point three isn’t so much the mechanics of it, difficult though they may be to design. Instead, it’s an issue of consistency. Assuming the point one becomes a generally-accepted principle, would a majority of this new 10% class have the right to veto a subsequent sale? If not, why not? Maybe the answer is that public and private shareholders are granted different levels of privilege, but then the same could be argued of controlling and non-controlling shareholders. It seems that you must either accept point one and deny three, or accept them both with a giant addendum to number three.
I have been arguing for a while that there is an inherent unfairness that public shareholders vote on acquisitions without knowing what the future possibilities are. I also think that the only viable solution is to demand more of the banks charged with writing fairness opinions (I’d also ask more of corporate boards, but it’s futile to request objectivity of cronies). If a company gives away its future gameplan – particularly when adoption of said plan is not yet approved – it almost certainly puts the company at a competitive disadvantage. Again, put some bite in the currently-toothless fairness opinions.
Finally, let’s add a fifth point (as first suggested by DealBook reader Andy Johnston): Make public all auctions of public companies. Once a corporate board is actively willing to consider buyout bids, retain a banker and issue what would amount to a buyout RFP (request for proposal). Give everyone one month to submit bids – which is a tight enough timeframe to still reward those private equity firms that helped initiate the deal.To be clear, I mean something even more transparent than afterthought “go shop” provisions.
Some M&A bankers may object to this proposal, saying that their selective bluebook mailing lists are designed to discourage frivolous bids. I say that I’d rather suffer through a handful of frivolous bids, rather than arbitrarily restrict the process in a may that may depress/prevent legitimate bids.
It also is worth noting, of course, that all of the above likely would require federal regulatory action. So be it. Even free markets require some ground rules.

The temptations of private equity

With financing free and easy, many companies are coming out of leveraged buyouts with just enough cash flow to cover their interest expense and capital spending, according to an analysis by The Deal. But some buyouts have more liquidity and flexibility than might appear on the surface, The Deal writes. Breakingviews suggests that easy access to funds has driven many private equity firms to chase "larger, more expensive and overly indebted companies," which it calls a "classic sign of a bubble."
• Go to Article from The Deal
• Go to Article from Breakingviews

Treasury Chief Urges ‘Balance’ in Regulation of U.S. Companies

Amid growing fears that London may replace New York as king of the I.P.O. castle, Treasury Secretary Henry M. Paulson Jr. said yesterday that excessive regulation and burdensome litigation were prompting companies to choose to list their stock on foreign exchanges over American ones.
• Go to Article from The New York Times

Merger Monday

Merger and acquisition activity worldwide surged on Monday with a focus on real estate, mining, media and exchanges sectors as demand by private equity funds and the push for industry consolidation gathered pace.
• Go to Article from Reuters
• Go to Item on DealBook

Rewriting the Rules for Buyouts

How can shareholders trust management to represent their interests when it is trying to make off with the company? DealBook's Sunday column in The New York Times offers a four-step cure for the conflicts of interest that are inherent in management-led buyouts.

$70 Billion Merger Monday

Investment bankers have plenty to be thankful for in this holiday-shortened week, which began with several megadeal announcements with a combined value of more than $70 billion. There was the Blackstone Group’s record-breaking agreement to buy Equity Office Properties Trust, the nation’s largest office-building owner and manager, for about $36 billion in cash and debt. That deal, announced Sunday night, ranks as the largest leveraged buyout in history, surpassing the $33 billion buyout earlier this year of hospital chain H.C.A.
In a research note published Monday, Sri Nagarajan of RBC Capital Markets called Blackstone’s offer “attractive” for Equity Office’s shareholders and said he thought competing bids were unlikely. By targeting Equity Office, Blackstone is probably betting that it can further reduce corporate overhead at the company and profit from a rise in office rents in late 2007 or early 2008, Mr. Nagarajan wrote.
Also on Sunday, mining giant Phelps Dodgesaid it would be acquired by smaller competitor Freeport-McMoRan Copper and Gold in a cash and stock deal worth $25.9 billion. Earlier this year, Phelps Dodge unsuccessfully tried to arrange a three-way transaction with two Canadian miners.
John Tumazos of Prudential Equity Group suggested Monday that Freeport-McMoRan is getting a bargain in the proposed transaction, which calls for each Phelps Dodge’s share to be swapped for $88 in cash plus 0.67 of a Freeport-McMoRan share. Mr. Tumazos wrote in a research note Monday that the offer is “not the full or maximum value that [Phelps Dodge] could obtain,” even though it represents a 33 premium over Phelps Dodge’s closing price on Friday.
Early Monday, Nasdaq unveiled a $5.1 billion offer for the London Stock Exchange, marking its second attempt to buy Europe’s largest stock market. And Charles Schwab said Monday morning it would sell its U.S. Trust wealth-management unit to Bank of America for $3.3 billion in cash.

M&A party is rocking, for now

On today's Business Week Online "Deal Flow" blog:

Researcher Dealogic reported today--and I know, this is a shock--that global M&A volume has hit an all time record....

Before too long, we're likely to see another record broken, as investment bankers share the largest bonus pool in history.

I know, everyone hates a buzz kill. But I won't be surprised a few years from now if the M&A party is followed by a huge hangover, as more and more of the principal on the junk bonds used to finance these deals has to be paid back. It's a borrowers market. Lenders are competing to win deals. I hear a number of them have been offering easy terms, in which a few years of interest-only payments are allowed. But if financial sponsors can't make an exit, they will be stuck with huge bills when the payments on principal kick in three, four, five or more years down the road. Weaker acquisitions are going to be under extreme pressure at that point, as limited cash flow is stretched to pay back expensive junk debt. It's like the corporate version of an exotic mortgage.

Hedge funds face a shortage of talent

Of all the problems hedge funds face today — increased government scrutiny, declining returns for some — this is perhaps the strangest problem to have: running short of talent.
Chalk it up to their success. According to Financial News Online, so much capital has flown in that managers cannot find enough savvy employees to maintain that momentum. Hedge funds collected $111 billion in the first nine months of 2006, swelling hedge fund assets under management to $1.3 trillion and helping pump up salaries and bonuses more than 20 percent to an average of $1.5 million before profit sharing. While one would think that enviable, that rise in investors’ money has created a “structural problem” for the industry.
Individual managers, attracted to the billions being poured into hedge funds, are striking out on their own, leaving the established firms that are favored by most institutional investors without enough help.

Civil Suit Accuses 13 Buyout Firms of Antitrust Violations

Three investors filed a class-action lawsuit Wednesday against some of the biggest buyout funds in the United States, accusing the firms of colluding to take companies private at below-value prices. The suit, which was filed in federal court in Manhattan, follows a similar Justice Department investigation into the practice in question, known as the club deal.
The suit is the first civil action taken against the buyout funds, several of which already have received letters from the Justice Department regarding potentially anticompetitive behavior. At the heart of both suits seem to be club deals, when private-equity firms form consortiums to collectively bid on a target.

The Ben Stein Interview

PE Week Wire interviewed Ben Stein on his controversial NYT OpEd piece of last month:

Last month, Ben Stein wrote in The New York Times that management buyouts of public companies should be outlawed. Pretty surprising for a free-market Republican who made his bones in the Nixon White House, before becoming an economic pundit, actor, gameshow host and economic pundit (again). So surprising, in fact, that some financial bloggers wondered if it was a fit of pique that has since abated.
It hasn’t. I spoke with Stein yesterday about the article, and have posted the entire audio interview at peHUB.com. My goal was to let Stein expound on the points he made in print, but also to play a bit of Devil’s Advocate. For example, if management buyouts are such good deals for company management, how come they don’t get outbid? Aren’t there certain operational efficiencies a company can recognize as a private entity that it can’t as a public entity? Isn’t there a possibility that company management will overvalue its corporate assets (the “falling in love with your own players” problem)? Don’t shareholders have the ultimate responsibility here, since they have the final vote?

Hedge Funds and Wall St. Are Warned to Be Vigilant on Misdeeds

The Securities and Exchange Commission expects to file more lawsuits aimed at hedge funds accused of illegal trading and violating their clients’ trust, the agency’s chief enforcer said yesterday.
At the same time, a senior official at the New York Stock Exchange said that Wall Street’s prime brokerages, which lend to hedge funds and process their trades, might be held accountable if they failed to catch illegal conduct.
The S.E.C.’s enforcement director, Linda C. Thomsen, said that federal regulators were concerned about illegal trading and the potential for harm to hedge fund investors.
“I expect to see activity in connection with both,” she said yesterday at a securities conference in Manhattan.

Venture firms bank on Pelosi to relax Sarbanes-Oxley rules

SAN FRANCISCO: For Silicon Valley venture capitalists eager to weaken the corporate governance law known as Sarbanes-Oxley, Representative Nancy Pelosi may prove to be a useful ally.
Pelosi, a Democrat, already has identified revising the law as a priority when she becomes the speaker of the U.S. House of Representatives in January.
Venture capital firms have been lobbying the White House, legislators and regulators for months to water down the law, arguing that higher auditing and legal fees were driving companies to take initial public offerings overseas. This year, Pelosi has received more campaign money from partners at Kleiner Perkins Caulfield & Byers, which helped get Google and Amazon.com started, than she got from the labor federation AFL-CIO.