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Private Equity and SOX: The Critics Get It Wrong (Again)

By J. Robert Brown

When SOX was adopted, it engendered a fusillade criticism, with opponents focusing on everything from the need for independent audit committees to the separation of accounting and consulting functions.  Or, as Roberto Romano so colorfully labeled, SOX was "quack corporate governance."  Much of the criticism was poorly reasoned, based upon incomplete or faulty data, and shrill.  My paper, Criticizing the Critics: Sarbanes Oxley and Quack Corporate Governance, chronicled much of this phenomena.

One of the early claims was that SOX would damage public equity markets.  Companies were fleeing SOX and taking their IPOs overseas.  Companies would rather sell out to private equity or "go dark" rather than confront the costs and risks of SOX.  These claims have, in general, been shown to be inaccurate or overstated, sometimes after an examination of the empirical evidence and sometimes after watching the market.  The anecdotal evidence likewise suggests a contrary interpretation. 

Purveyors of private equity were among the loudest to decry the impact of SOX.  The Blackstone Group did this.  Henry Kravis at KKR was more balanced, viewing SOX as a benefit for shareholders, but still finding reason for concern:  

• "One consequence, however, is that they are also being more conservative and risk averse. An enormous time is spent on legal process by the board, rather than pushing innovative ideas. Sometimes this is to the long-term detriment of the business. It is easier to say ?no? to risk and play it safe than it is to examine the risk closely to determine if it is the right decision for the business. To the extent that Sarbanes Oxley causes public companies to be less competitive, there is an opportunity for the private equity industry in taking these businesses private and putting some energy back into growing them."

The attention has shifted lately to "excessive litigation," with the Chamber putting out a report that continues to make these claims (but at least doesn't blame SOX).  We will discuss the report later. 

At this point, what we note is that the criticism is belied by the private equity funds themselves.  Published reports have indicated that KKR, like Blackstone, will go public, something that will subject KKR to the full rigors of SOX and other regulatory requirements for public companies.   According to the article, KKR has, in fact, been publicizing the corporate governance changes that will come with public ownership.

• The coming IPO is in some ways designed as an antidote to its secretive and hardball-playing image by highlighting the firm's "best practices" of corporate governance and employee compensation. On the coming "road show" to present the transaction to potential investors, KKR is expected to emphasize how the new KKR will push the company's management into deeper alignment with shareholders. By buying back the KPE stake (which is itself just a vehicle for existing KKR investments) the executives will only be adding their exposure to KKR deals.

Whatever the costs of SOX, they were not great enough to discourage these scions of capitalism from going public.  Moreover, with cheap borrowing in decline, public capital will look a lot more reasonable.  Look for a return of the equity markets.  And, remember, it was SOX that at least in part gave investors the confidence to remain active in the markets, contributing to the success of public offerings like those by Blackstone and KKR. 

Full post as published by The Race to the Bottom on August 20, 2008 (boomark / email).