The private equity industry has been anything but private this year after its major players were hauled up in front of a Treasury select committee and the world at large tried to get its head around key executives’ remuneration packages.
Certainly reports that those working in the private equity world “pay less tax than a cleaning lady” are always going to make compelling media fodder, while the subsequent public outrage, if ill-informed, will undoubtedly get politicians more than a little hot under the collar.
The result? Former Morgan Stanley chairman Sir David Walker was charged with finding a means of making the industry more transparent. Almost concurrently, former Bank of England deputy chairman Sir Andrew Large was handed the task of doing the same for the hedge fund industry. Both are currently consulting on plans to introduce voluntary codes of conduct for the respective industries.
It should be noted that in the UK the managers of these vehicles are regulated by the Financial Services Authority (FSA); it is just the funds themselves that are not regulated. However, both the private equity and hedge fund markets are on the cusp of entering a quasi-regulated era. Arguably, these alternative investments should be better policed, given that recent activity from such hyper-secretive vehicles has encroached more and more into the public arena: take-privates such as Alliance Boots, the Automobile Association and Pizza Express are cases in point.
But given that these codes, which are due to be implemented later this year, will operate on a voluntary ‘comply or explain’ basis, how far can they actually go to achieve their goal of transparency? Are they really required in industries that are, after all, the preserve of ultra-rich, highly sophisticated investors? Or is the work of Large and Walker just a quick-fix solution to what is ultimately a political issue? And what challenges will lawyers face when trying to guide clients through a set of pseudo-rules that, if disregarded en masse, could be written into a tangible rulebook carrying wide-reaching regulatory burdens?Kaye Scholer partner Timothy Spangler believes the proposals are good news for both industries and should bring clarity for lawyers operating within them.
“Both of these consultations have been initiated out of their industries and are not driven by the FSA, the Treasury or Brussels,” he says. “This can be read as a sign of the maturity of the senior people in these industries, who have realised that with great success comes an increased amount of responsibility.
“Because these are areas that primarily focus on the wholesale rather than retail part of the market, the typical drivers that can be grouped under investment protection don’t apply here. To make this the subject of detailed rule-making is probably not in the industries’ best interests.”
Admitting that the impact of the codes will not be felt at a law-making level, meaning compliance burdens will not increase, Spangler stresses that lawyers working in the funds world should ignore the codes at their peril.
“The fact that these industries are evolving very rapidly means the codes will benefit lawyers because they will help generate an understanding of what should and shouldn’t be done,” he says. “These are not primarily legal issues, but the codes are very important because they will influence a lot of questions we might have to ask, or have to answer.
“Lawyers can’t ignore this,” he stresses.
The ultimate aim of the codes is to make alternative investment vehicles disclose information on their largest portfolio companies. Arguments can be made that, by definition, private equity vehicles and hedge funds should not be required to make such disclosures. However, SJ Berwin partner Simon Witney points out that it is precisely the coming of age of these markets that has led to demands for greater transparency and, by extension, accountability.
Certainly it is not the funds’ investors who stand to benefit from the release of information – the professional investors these products attract can request, and are granted, high-level meetings with their managers almost at will. As the alternative investment markets have grown and matured their investment targets have changed too. And this really is the crux: with every member of UK plc being a potential buyout or hedge fund target, it is the average man on the street who has the right to access information on these companies.
“Trade unions do have a legitimate interest in what a company like Alliance Boots is doing,” says Witney. “People in the street have a stake in these companies too. They have been asking why customers, suppliers, trade unions, employees and the media should have less information about a company just because it has been taken private.”
A no-brainer, surely? But the voluntary nature of the codes calls their status into question. The British Private Equity and Venture Capital Association will implement the private equity code of conduct and is currently looking at ways of monitoring how companies adhere to it. Meanwhile, a hedge fund working group, featuring representatives from the industry’s major players, has been set up to do the same.
But ultimately they will be undertaking exercises in futility if hedge funds and buyout houses decide not to opt in. It is all very well to either comply with a code or explain why you are not, but if you can ignore it altogether, the entire process is rendered pointless.
Witney disagrees. “It’s voluntary but it’s expected that most of the large buyout houses will sign up to it,” he says. “The fact it’s voluntary is a good thing because if it’s mandatory then it has to be done by legislation and that would result in a much more inflexible set of rules.”
The problem with codes, and something financial services lawyers are discovering when tackling the FSA’s move towards principles-based regulation (as detailed in this column on 18 June), is that they create a lot of grey areas. And if there are two industries that do not need any more shading, it is hedge funds and private equity.
The mooting of these codes stems from growing political unrest and is an ingenious way of staving off political intervention. Great in theory, but potentially useless in practice – ultimately they are a half measure designed to shun legislation.
The hope is that they will achieve their aim of shedding light on the respective industries, otherwise political pressure will again begin to mount. When it does, given that politicians love to legislate, rules will almost certainly follow.
And if the drafting of a hefty rulebook is required, not to mention the time-consuming implementation and monitoring that will ensue, that can only be good news for lawyers.