Investor's Business Daily, May 21st, 2007
In case you missed it, private equity is having a gonzo year. Just last week, three major firms agreed to private-equity buyouts, including American auto icon Chrysler. On Monday Blackstone Group set its IPO price range at $21 to $31 a share, signaling that the $4 billion offering could occur within weeks.
Now, say hello to the backlash.
Last week, the AFL-CIO laid a tripwire across Blackstone's path to the NYSE. In a letter to the Securities and Exchange Commission, the country's largest labor union implied there are dirty dealings in Blackstone's March 22 prospectus.
"We believe, based on the limited information provided in the Blackstone LP preliminary prospectus, that it is an investment company and should be subject to the Investment Company Act of 1940," the union wrote.
In case you're not up on Depression-era securities laws, an investment company under the 1940 Act means any firm with more than 40% of its assets in securities.
Once that threshold is crossed, a whole slew of rules kick in. The company must be governed by a semi-independent board, gain shareholder approval for changes in investment policy and accept limits on the concentration of assets, the amount of debt it can build up, and many other items. In other words, it has to operate like a mutual fund company.
But What Is It Really?
On one level, it might seem like a no-brainer that Blackstone is an investment company. After all, its Web site's slogan reads, "A leading investment and advisory firm." But Blackstone got around the law by creating an incredibly convoluted limited partnership. The entity that would sell shares is several steps removed from the actual investments.
The structure is so complex, in fact, that even experts have had trouble figuring it out.
"We were racking our brains and tearing out our hair for weeks," said Heather Slavkin, an attorney with the AFL-CIO's Office of Investment. "But we realized that there's basically nothing to this structure. Of the 12 new corporate entities created for the IPO, not one has any real practical purpose."
Slavkin also charges Blackstone with duplicity on the tax front. In order to keep taxes at their current level, the firm has to draw 90% of its income from passive investments.
"You can't have it both ways," she said.
Blackstone is keeping mum due to pre-IPO press limits. But Steven Howard, an attorney with corporate law firm Thacher Proffitt & Wood, calls the union's case "interesting but not compelling."
In his view, the legal details are beside the point. Business has changed in the last 67 years.
"A public private equity group just did not exist in 1940," he said. "The SEC needs to provide an exemption for publicly traded private equity firms in the same way that banks and insurance companies are exempt."
The debate raises a larger question: How can a private-equity firm go public while keeping its edge? One boon to the field is the fact that its buyout targets like escaping the scrutiny of shareholders and governments.
Many Paths To Market
Tom Taulli, author of "Investing in IPOs" and "The Complete M&A Handbook," says these players have been trying out different ways of walking the tightrope.
"Apollo may do a private offering, and then eventually become a public company as shares get registered," he said. "And there's the newfangled approach that Goldman Sachs GS is coming up with: creating a private marketplace for buying and selling limited partner interests in private equity funds."
Fortress Investment Group FIG took yet another approach. It went public in February as a limited liability company. Slavkin says there may be similar 1940 Act issues with Fortress, but at least it doesn't duck fiduciary duty.
"Investors can sue Fortress if they take the money and run," she said. "I'm not saying Blackstone will take the money and run, but there's nothing stopping them."
Howard and Slavkin disagree about whether it's even possible for Blackstone to operate under 1940 Act rules. Howard says flatly that it wouldn't work since it would stymie its ability to borrow money and work with affiliates. Slavkin points out that American Capital Strategies ACAS has been trading on the Nasdaq for 10 years and drawing 22% annualized returns without running afoul of the law.
American Capital Chief Executive Malon Wilkus explained that his firm's structure is a bit different from Blackstone's.
"We're both a fund and a management company all in one -- we're a hybrid," he said. "Blackstone is trying to be a public alternative asset manager and is not taking any of the funds public."
Wilkus welcomes the current interest by private equity in going public, saying it will "rationalize the industry." Taulli also welcomes the trend, but says it's time people started thinking about these issues.
"There's just been this sudden increase in the sector, and we haven't really stopped to think, 'What does it mean for the next five years?'" Taulli said.
The challenge to Blackstone is only one part of the debate. Also last week, Congress launched hearings on charges that private-equity buyouts shaft the workers. Taulli suspects this is why the AFL-CIO got involved in the Blackstone deal to begin with.
"What does a private equity group do when it buys a company?" he asked. "Lay people off."
Slavkin, however, says that they were actually more worried about benefits and pension plans.
"We have 10 million members with over $400 billion invested in the public market," she said. "A lot of money was imperiled after Enron. That gave a large impetus for us to step up our interest in these concerns."
