It was only a matter of time before the corporate reform wave rolled into the buyouts market, and that time would appear to be September.
Within a few weeks, the Securities and Exchange Commission (SEC) is expected to approve amended rules governing the composition of public company boards and other various committees where buyout investors have often played major roles. The only question now is whether the new regulations will prompt a sea change in the way buyout business is done, or if this is all just much ado about nothing.
“The extent of the impact will all depend on what type of buyout person you’re talking about,” says George Davitt, an attorney with Testa, Hurwitz & Thibeault LLP. “The typical buyout doesn’t involve a public company, but those that do will almost certainly be affected.”
The SEC is considering two sets of regulations-one filed by the New York Stock Exchange (NYSE) on Aug. 16 and one submitted by Nasdaq at the end of July. The NYSE proposal is the more stringent of the two, but both reflect a newfound skepticism over the alignment of ownership interests between large institutional shareholders and blue-collar traders.
The NYSE proposal requires that independent directors must comprise a majority of a public company board, unless a single individual or group owns more than 50% of the company’s voting stock. Moreover, only independent directors are now allowed to sit on a company’s auditing, nominating and compensation committees. The definition of “independent” has remained relatively intact, with the only difference being that the cooling-off period for former employees and their family members has been extended from three years to five. The Nasdaq proposal has a much lower ownership exemption, but its committee restrictions are essentially the same.
Because the buyouts market is now dominated by middle-market players looking for 20% stakes in private companies, the primary impact of these new rules will be felt by larger, control-oriented investors like Texas Pacific Group or TH Lee Partners. While the former might need to alter a few pre-existing IPO agreements, the latter will be required to thoroughly reevaluate how they do deals in terms of both size and structure. This is especially true for buyout investors specializing in public carve-outs or spinouts.
“This is going to make it much harder for us to execute on a plan,” says a source from a multi-billion dollar buyout shop. “We want board control so that management is receptive to our guidance. If that means we have to put a little more in to get over that 50% [ownership] mark, maybe that’s what we’ll have to do.”
If other control-oriented firms were to follow suit, it would mean an overall decrease in big deal volume, but a simultaneous increase in the price tags of the transactions that do get closed. There are, however, two potential stumbling blocks on the way to widening the gap between large-market and middle-market buyouts.
Deborah Quinn, an attorney with Nixon Peabody LLP, finds the 50% number in the NYSE proposal high and wouldn’t be surprised if it were lowered after some additional lobbying by the financial industry. But regardless of how many board seats they possess, Quinn says buyout shops will simply voice their opinions through an intermediary. “If buyout guys have selected management in the course of putting the deal together, they’ll still have management’s ear whether or not they are actually sitting on the board,” she explains.
“The new regulations haven’t sought to eliminate prior business relationships, although that doesn’t mean that independent directors are hesitant to ask the hard questions,” adds John LeClaire, co-chair of the private equity group at Goodwin Procter LLP.
It also is important to note that neither the NYSE nor Nasdaq proposal requires current buyout-based directors to give up existing seats. Instead, many boards may simply choose to expand so that non-independent directors are no longer in the majority. Some boards may also become grayer, with retirees inhabiting director positions viewed as too time-consuming by younger individuals still in the prime of their careers.
No matter what, companies and their investors have still have a significant grace period before they have to decide how to reconfigure their boards. Once approved by the SEC, the NYSE reforms would go into effect after a 24-month transition. The Nasdaq changes would occur a bit sooner, as they would hit exactly one year after a company’s next annual meeting.
“All in all, I’d put this in the category of the state authorities saying they’re going to lower the speed limit from 60 to 55 because of safety statistics,” says the buyout firm source. “Even though I’m a good driver and would love to go 60, I think it makes sense to set a rule that’s best for the whole society.”