The buyout industry plays host to a variety of sticky wickets, which include public disclosure, generational planning and exorbitant deal fees being charged on top of management fees. In most cases, investors are more than willing to discuss these issues with reporters without resorting to shadowy “off-the-record” or “on background” poses. That norm, however, has not held true when it comes to The Blackstone Group’s decision to blow the whistle on financial shenanigans at Parmalat SA.
For the uninitiated, Parmalat is a large Italian food conglomerate that recently went bankrupt and subsequently was charged with fraud by the Securities and Exchange Commission. Among the company’s alleged whoppers is one about a $1 billion cash reserves account with Bank of America, which regulators say never existed (neither the cash nor the account). Parmalat also has watched many of its executives get arrested and incarcerated, another throw himself off a highway bridge and the financial press refer to the once-proud dairy as Europe’s Enron.
Not everything in the Parmalat story, however, followed the Enron script. The first significant difference is that Parmalat seemed to recognize its dire predicament one year before falling apart, and reportedly even held preliminary talks with buyout shops Kohlberg Kravis Roberts & Co. and Hicks, Muse, Tate & Furst. This is in contrast to Enron, which only entertained a merger opportunity after its ship (and stock price) had sailed.
A more relevant difference was in the way that each firm’s fraudulent balance sheet was exposed. Enron’s implosion began slowly, and picked up speed as more and more fraudulent transactions and missing assets were exposed. Parmalat, on the other hand, appeared relatively healthy until it opened up takeover talks in December 2003 with Blackstone. Rather than shielding the truth from Blackstone as it reportedly did from both KKR and Hicks Muse Parmalat decided to put its entire house of cards on the table for Blackstone to see.
New York-based Blackstone has declined to publicly comment on its meetings with Parmalat, but sources say that the firm killed the negotiations in their crib. It also informed the SEC of what had been learned during the truncated due diligence, which immediately opened up an investigation that led to formal fraud charges.
It is unclear if Blackstone had, or felt it had, a legal obligation to share its findings with the SEC. Attorneys Robert Knutts and Scott Beach of Day, Berry & Howard LLP argue in the next article (page 44) that private equity firms do not bear such responsibilities when negotiating with public companies like Parmalat. They do believe, however, that it in a private equity firm’s best legal interest to avoid any transactions with a tainted company prior to full and corrective public disclosure.
But there is a larger question surrounding Blackstone’s actions in the Parmalat case, and its answer won’t be found in any securities law textbook. It asks whether or not a private equity firm has a civic duty to report on obvious fraud at a public company. Moreover, how will peer firms and/or limited partners react to the exercise of that duty.
This question was put to the industry masses in mid-January on the PE Week Wire, a sister publication to Buyouts that is delivered daily via email. It suggested that while Blackstone’s moral imperative was clear, the firm might have harbored legitimate concerns that public companies would look elsewhere for future buyout business.
Response was swift and mostly one-sided in Blackstone’s favor. Per that publication’s rules of engagement, however, it also was anonymous. The most strident supporters were institutional investors, including the following comment: “Viewing this from the perspective of a $90 billion pension fund, of which only 7% is committed to private equity, I would view rather dimly any private equity firm that noticed such activity, failed to disclose it to the proper authorities and therefore ultimately had a hand in reducing the value of the other 93% of my portfolio. In fact, such inaction would be a very compelling reason not to invest with that general partner in the future.”
A direct buyout investor added that Blackstone should publicly acknowledge its whistle-blower status, because corrupt companies would be unlikely to waste Blackstone’s time in the future.
Buyouts decided to run a follow-up to the above discussion in this issue, but with industry pros commenting on-the-record. Not necessarily about Blackstone and Parmalat in particular, but about general issues of a firm’s obligation-or lack thereof-when it learns of fraudulent dealings at a public company. Voice mail and email messages were left with over one dozen major private equity firms, but the vast majority opted not to respond, while those that did issued a terse “no comment.” Even some of the original Wire respondents were asked to put their full names to their words, but none agreed to do so.
It is difficult and a bit arrogant to extrapolate the meaning of such official silence, but here are a few possibilities nonetheless: (1) Buyout firms agree with Blackstone, but nonetheless do not want to deny themselves a look at troubled public companies; (2) Buyout firms feel Blackstone overstepped its bounds, but there is little value in publicly chastising an industry giant; (3) Buyout firms might eventually want a piece of Parmalat, and don’t want to do anything that may scuttle those chances; or (4) This wicket is just a bit stickier than the rest.