Why IPOs don’t always offer more transparency or governance

Why IPOs don’t always offer more transparency or governance

March 12, 2014: 5:00 AM ET

Moelis & Co.’s IPO highlights a big loophole for public companies.

By Sanjay Sanghoee

FORTUNE — When Moelis & Co., the boutique investment bank that has advised on $1 trillion of transactions since 2007, filed for an IPO last week, it was following in the footsteps of similar advisory firms like Lazard Ltd. (LAZ), Evercore Partners (EVR), and Greenhill & Co. (GHL), all of whom have done well as public companies.

The timing is also good given that last year was exceptionally strong for U.S. IPOs, merger activity is up, and 80% of the top 10 deals last year involved boutique banks like Moelis & Co. according to Thomson Reuters. But what is even better for Ken Moelis, the former UBS rainmaker who founded the bank, is that he gets to keep majority control after the IPO (through ownership of super-voting shares which will carry 10 votes for every share) and hence will not have to conform to traditional corporate governance standards that most public investors expect. This includes not having a majority of independent directors on the board or having to indulge activist investors.

Nor is Moelis & Co. the only firm to enjoy this IPO loophole. According to a survey conducted by law firm Davis Polk, 70% of IPO companies had classified boards, 78% prohibited shareholder action by written consent, and 57% refused to divide the roles of Chairman and CEO — all widely considered to be good corporate governance practices for public companies.

For a boutique investment bank, such inside control is beneficial. In order to remain successful, Moelis & Co. needs to retain its unique culture of small deal teams, independent advice uncompromised by other interests, and considerably higher compensation for its bankers than their counterparts at bulge bracket firms (Moelis & Co. paid 64% of revenues to bankers as compensation in 2013 vs. only 37% at Goldman Sachs), which can be hard to maintain with outside interference.

From an investor’s standpoint, Moelis & Co. can continue to generate outsize profits precisely because it will be able to access the capital markets freely as a public company while essentially continuing to function as a private one. The decision-making autonomy that Ken Moelis will enjoy will ensure that he can deploy capital strategically while preserving the qualities that make his firm competitive.

But it is important to remember that the dynamic of boutique banking does not necessarily extend to other companies in other industries, and the IPO loophole that enables management to avoid real outside scrutiny by public shareholders can be dangerous for investors.

Public markets are there to provide companies with capital for growth, but they are also meant to benefit investors by requiring greater transparency and better corporate governance. That purpose is defeated when a company can attain public status without shouldering the basic responsibilities that go with the territory. It can be bad for smaller investors as well as for creating strategic discipline within companies.

Given their stellar track record, there is little doubt that Ken Moelis and his co-founder Jeffrey Raich (whom I worked with briefly in the mid-1990s at PaineWebber), will do a great job for their investors, but the Securities and Exchange Commission should at least consider reclassifying such IPOs to provide better information to the public.

 

About bambooinnovator
Kee Koon Boon (“KB”) is the co-founder and director of HERO Investment Management which provides specialized fund management and investment advisory services to the ARCHEA Asia HERO Innovators Fund (www.heroinnovator.com), the only Asian SMID-cap tech-focused fund in the industry. KB is an internationally featured investor rooted in the principles of value investing for over a decade as a fund manager and analyst in the Asian capital markets who started his career at a boutique hedge fund in Singapore where he was with the firm since 2002 and was also part of the core investment committee in significantly outperforming the index in the 10-year-plus-old flagship Asian fund. He was also the portfolio manager for Asia-Pacific equities at Korea’s largest mutual fund company. Prior to setting up the H.E.R.O. Innovators Fund, KB was the Chief Investment Officer & CEO of a Singapore Registered Fund Management Company (RFMC) where he is responsible for listed Asian equity investments. KB had taught accounting at the Singapore Management University (SMU) as a faculty member and also pioneered the 15-week course on Accounting Fraud in Asia as an official module at SMU. KB remains grateful and honored to be invited by Singapore’s financial regulator Monetary Authority of Singapore (MAS) to present to their top management team about implementing a world’s first fact-based forward-looking fraud detection framework to bring about benefits for the capital markets in Singapore and for the public and investment community. KB also served the community in sharing his insights in writing articles about value investing and corporate governance in the media that include Business Times, Straits Times, Jakarta Post, Manual of Ideas, Investopedia, TedXWallStreet. He had also presented in top investment, banking and finance conferences in America, Italy, Sydney, Cape Town, HK, China. He has trained CEOs, entrepreneurs, CFOs, management executives in business strategy & business model innovation in Singapore, HK and China.

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