PRINT THIS PAGE Sir David Walker Publishes Guidelines for Disclosure and Transparency in Private Equity 05/12/2007. Source: Weil, Gotshal & Manges. Alison Hampton
In February this year, the British Venture Capital Association (BVCA) and a group of major private equity firms asked Sir David Walker, the former chairman of Morgan Stanley, to conduct an independent review of the adequacy of disclosure and transparency in private equity with a view to recommending a set of guidelines for the industry in the UK. This review has been conducted during a period of unprecedented scrutiny of private equity, and was seen by many as a pre-emptive strike by the industry to ward off the spectre of regulation, writes Weil, Gotshal & Manges. Following the publication of a consultative document in July, Sir David has now published his final report together with the proposed guidelines.
The guidelines themselves are intended to be adopted by the industry on a voluntary “comply or explain” basis. They apply to private equity firms authorized by the FSA which either have one or more UK portfolio companies which meet certain criteria and to which the guidelines also apply already in their portfolio or which have the capability to do so.
A private equity firm to which the guidelines apply should publish either an annual review or regularly update its website to cover the following:
- a description of its own structure and investment approach and of the UK companies in its portfolio (including investment holding periods), an indication of the leadership of the firm in the UK and confirmation that arrangements are in place to deal with conflicts of interest (particularly where the private equity house also engages in other activities e.g. corporate finance activities);
- a commitment to conform to the guidelines on a “comply or explain” basis;
- a categorization of its limited partners by geography and by type (the categories specified are: pension funds, insurance companies, corporate investors, funds of funds, banks, government agencies, endowments of academic and other institutions, private individuals and others);
- private equity firms should follow established guidelines in their reporting to limited partners and should support the BVCA’s new data gathering role (there is a separate recommendation that the BVCA takes on the responsibility of conducting an ongoing rigorous evidence-based analysis of the impact of private equity on the economy); and
- in particular, at a time of strategic change for a portfolio company, a private equity firm should ensure timely and effective communication with its employees either directly or through that portfolio company, as soon as confidentiality constraints are no longer applicable.
It is not automatically the case that only UK firms have FSA authorization — many funds located elsewhere which do business in the UK have some form of authorization from the FSA or for a related entity which acts as an adviser to the fund in the UK. While the guidelines can be interpreted not to apply to a fund which only has a related advisory entity authorized by the FSA, it is very much within the spirit of the guidelines that such funds should consider compliance on a purely voluntary basis.
Portfolio companies to which the guidelines apply are those where:- more than 50% of their revenues are generated in the UK; and
- there are more than 1,000 full-time equivalent UK employees;
and
- either the enterprise value at the time of acquisition was over Ł500 million, or, where the acquisition was by way of a going private transaction, the market capitalization at the time was in excess of Ł300 million.
Walker estimates that this portfolio company criteria will currently apply to approximately 65 UK companies (and that there are 18 private equity firms to which the guidelines will apply).
A portfolio company to which the guidelines apply should publish its annual report and accounts on its website within 6 months of the year end (the current period for private companies to do this is within 10 months of the year end, although this is reducing to 9 months from April 2008). The annual report should include:
- the identity of the private equity fund that owns the company, the senior managers who have oversight of the fund and detail on the composition of the board;
- the same information that a quoted company is required to include in its annual business review (essentially, an indication of the main trends and factors likely to affect the future development, performance and position of the company’s business, information on the company’s employees, environmental matters, social and community issues, and information about persons with whom the company has contractual arrangements which are essential to the business); and
- a financial review to cover risk management objectives and policies in the light of the principal risks and uncertainties facing the company including those relating to leverage.
In addition, a mid-year, summary should be published no later than three months after the mid-year giving a brief account of major developments in the company (although no updated financial information is required to be produced). This requirement creates a halfway house between the disclosure requirements of listed companies and those of private ones.
No specific date has been set for companies to begin compliance with these guidelines. We expect companies with a year end of December 31 to be the first ones to commence compliance with the publication of their accounts for 2007, although it will obviously be a matter for each private equity house to determine when they decide the extent to which they are going to comply.
Walker has deliberately not set out any additional guidelines in relation to board composition and corporate governance of portfolio companies, and has also specifically determined that the compensation arrangements of executives are properly a matter for limited partners as owners but not a matter for accountability to other stakeholders or of wider public interest.
While these guidelines are voluntary, and their adoption is on a “comply or explain” basis, the BVCA has already taken the step of establishing an independent review and monitoring group. This group is charged with keeping the guidelines under review, and monitoring ongoing compliance by BVCA member firms, which will be the subject of an annual report. Peer group pressure, and the consequent publicity, is effectively the sanction of non-compliance. Walker expressly states that private equity firms should “see their own clear interests…in ensuring effective communication” and comments that “any [portfolio] company covered by these provisions that fails to conform at least to good practice will inevitably self-select for critical public scrutiny and risk of reputational damage.”
These guidelines have developed largely as a result of the need to answer widespread, often unjustified, criticism of the industry from the media and other interested stakeholders, predominantly the unions. However, there are an increasing number of companies being bought out by entities operating like private equity houses, using a business model similar to that of private equity which have gone largely unnoticed by the critics — the guidelines will not apply to sovereign wealth funds, or to the principal investment arms of financial institutions. The report recognizes that this creates an inequality of treatment between private companies based solely on their ownership structure, and recommends that the BVCA seeks to engage with such investors with a view to securing their commitment to compliance. Whether this is achievable in practice remains to be seen.
While compliance with these guidelines should go some way to appeasing media critics, they have received only a lukewarm reception from the unions, the most vociferous denouncers of private equity in the UK. Whether they achieve the aim of allowing the industry to self-regulate will depend on whether private equity houses operating in the UK embrace both the substance and the spirit of the guidelines, and move towards a more open dialogue with the media and with the wider stakeholders in the businesses they buy. Only in this way can the industry begin to reverse the misconceptions and negative publicity which has been heaped upon it this year. It is time to move the debate towards analyzing the benefits of private equity to the economy and the lessons in performance enhancement which public companies can learn from private equity.
Weil, Gotshal Manges is a leading legal specialist in private equity services, with dedicated private equity lawyers in major financial centres throughout the world. For more information please visit www.weil.com.
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