The Latest on “Going Private” Deals and D & O Risk

The D & O Diary has previously commented (most recently here) on the increasing risk of D & O claims arising from “going private” transactions in which incumbent management teams up with outside investors to buy out the interests of public shareholders. The most recent high-profile “going private” transaction to be announced – the Dolan family’s $7.9 billion proposal to take Cablevision private – has already resulted in a claim against the company’s board, according to this October 10, 2006 press release, here. Shareholders’ objection to the proposed transaction is that it allegedly puts the Dolan family in an advantaged position, to the detriment of public shareholders. A colorful expression of this concern is reflected in the remarks of a T. Rowe Price portfolio manager, who was quoted in an October 10, 2006 Wall Street Journal article about the Cablevision transaction (here, subscription required), as saying that “I’m tired of management and private-equity firms trying to steal companies from underneath our noses, and I think this is another example of that.”

An interesting commentary about the Cablevision transaction and the shareholder lawsuit appears on the Lies, Damn Lies blog, here.

Shareholders concerns about “going private” transactions also extend to the ability of management to pursue potential buy-out opportunities in which management might participate, without even the board of directors' knowledge, in a way that potentially discourages or disadvantages potential competing bidders. A recent SEC filing of Kinder Morgan, whose shareholders are now considering a $14.8 billion buyout deal, provides an interesting perspective into this process. (The filing may be found here.) Kinder Morgan’s President entered discussions with investment banks in February 2006 about the possibility of pursuing alternative strategies. The discussion changed direction when the investment bank requested the opportunity to act as principal investor in a leveraged buyout. These discussions continued for months, yet the company’s board was not made aware of the potential transaction until May 13, 2006.

According to the Wall Street Journal article (here, subscription required) describing the Kinder Morgan transaction,

The timing of events is notable because boards of directors often prefer to control the process of a management buyout as much as possible. The earlier they are aware of a potential buyout, the more they can shape the terms in ways that are favorable to the overall company….The tensions between management and board can become acute because the board is often interested in maximizing the number of bidders while management is eager for its own bid to succeed. For example, Mr. Kinder [Kinder Morgan’s founder], at the request of Goldman’s private-equity team, committed to not engage in talks with any third party in connection with any bid for 90 days. In an effort to keep the playing field more level, the board’s special committee…requested that Mr. Kinder terminate that agreement.

The Kinder Morgan board' special committee later obtained more advantageous terms from the prospective acquirors and now the board supports the takeover proposal.

The Kinder Morgan transaction has also resulted in a claim against the company’s management and its board of directors. (A copy of the complaint may be found here.)

The attributes of a management-led buyout are fraught with potential conflicts of interest. Management is highly motivated to ensure that their proposed transaction will succeed, which may cause them to agree to structures (such as not to talk to potential competing bidders) that may favor their proposal, but to which shareholders might otherwise object.

Nor are the potential conflicts of interest limited to management. The Kinder Morgan transaction reflects the unusual circumstance where the investment bank to who the company’s management turned for strategic advice emerged as the principal investor, putting the investment bank in the unusual position of advising the company' management in connection with the bank’s own proposal (in which management was participating) to buy the company.

In circumstances packed with so many potential conflicts of interest, it is all too easy for allegations of wrongdoing to arise. The high stakes involved exacerbate this risk. For that reason, these transactions almost inevitably generate shareholder claims alleging that management breached their duty of loyalty and that the board breached their duty of care. A cynical view is that these lawsuits are nothing more than plaintiffs’ lawyers’ attempts to extract a toll from the transaction participants. But where management’s interests in a transaction potentially diverge from those of shareholders, the claims may present a more serious exposure.

As the Journal article (linked above) discussing the Kinder Morgan transaction put it, "As private-equity transactions continue to sweep through the financial markets, investors will begin putting extra scrutiny on how these transactions come together, and how fair they are to all shareholders."

Private Equity Conflicts: A different kind of conflict of interest may exist among the potential buyers in these “going private” transactions. According to an October 10, 2006 Wall Street Journal article entitled “Private-Equity Firms Face Anticompetitive Probe” (here, subscription required), the U.S. Department of Justice is looking into whether some of the top tier private equity firms have developed a tacit understanding that they would not undercut each other’s takeover attempts with competing bids. Among other approaches under investigation is whether these firms form “clubs” drawing in potential competing bidders, which potentially could have the effect of depressing acquisition prices. The investigation apparently is in its early stages. A second article about the investigation appeared in the October 11, 2006 Journal (here, registration required)

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