The Apollo "IPO": another challenge to the corporate model

Steve Davidoff has some unfavorable comments on the recently filed IPO-that-is-not-really-an-IPO for Apollo Global Management LLC. As he points out:

This offering is not by Apollo, and it is not by the employees of Apollo. In fact, it may not even be an offering. Apollo is simply complying with its obligations to its new equity holders. This filing may be a prelude to an offering by these equity holders of the Apollo stock they own, but it may simply be a means for them to sell these interests on the open market.

That background aside, what particularly interested me is Davidoff’s comment on the firm’s governance structure:

I will repeat the now trite point about the limited governance public holders of the equity in this vehicle will have. Once again, shareholders who purchase into this will have limited voting rights, fiduciary duties are contractually eliminated in some circumstances and Apollo is applying to the NYSE for an exemption from the independence requirements for directors on the board and nominating and audit committees. If people want to buy into this, that is their business, but the rules requiring equity holder enfranchisement and independent directors are there for a reason — perhaps it is time to examine whether that reason is still justified. If it is, the rules should be applied to these private equity and hedge fund adviser public entities. Sermon over.

Indeed, the S-1 does spell out a structure that’s clearly not your typical publicly held corporation. Here’s some highlights:

We intend to continue to employ our current management structure with strong central control by our managing partners and to maintain our focus on achieving successful growth over the long term. . . . . [W]e have decided to avail ourselves of the “controlled company” exception from certain of the NYSE governance rules, which eliminates the requirements that we have a majority of independent directors on our board of directors and that we have a compensation committee and a nominating and corporate governance committee composed entirely of independent directors. It is also the reason that the managing partners chose to have a manager that manages all our operations and activities, with only limited powers retained by the board of directors, so long as the Apollo control condition is satisfied. * * *

We do not have a compensation committee. Our managing partners have historically made all final determinations regarding executive officer compensation. * * *

Whenever a potential conflict arises between our manager or its affiliates, on the one hand, and us or any Class A shareholders, on the other hand, our manager will resolve that conflict. Our operating agreement contains provisions that reduce and eliminate our manager’s duties (including fiduciary duties) to the Class A shareholders. Our operating agreement also restricts the remedies available to Class A shareholders for actions taken that without those limitations might constitute breaches of duty (including fiduciary duties).

[The S-1 states that the agreement provides that the manager may but is not required to set up an independent board with a conflicts committee, and may but is not required to get that committee’s approval to conflicts transactions. It also may, but is not required, to get approval from Class A shareholders.]

If our manager does not seek approval from a conflicts committee of our board of directors or our Class A shareholders and it determines that the resolution or course of action taken with respect to the conflict of interest satisfies . . . the standards set forth . . . above, then it will be presumed that in making its decision our manager acted in good faith, and in any proceeding brought by or on behalf of any shareholder or us or any other person bound by our operating agreement, the person bringing or prosecuting such proceeding will have the burden of overcoming such presumption. Unless the resolution of a conflict is specifically provided for in our operating agreement, our manager . . . may consider any factors it determines in good faith to consider when resolving a conflict. Our operating agreement provides that our manager will be conclusively presumed to be acting in good faith if our manager subjectively believes that the decision made or not made is in the best interests of the company. * * *

In addition to the provisions relating to conflicts of interest, our operating agreement contains provisions that waive or consent to conduct by our manager and its affiliates that might otherwise raise issues about compliance with fiduciary duties or otherwise applicable law.

For example, our operating agreement provides that when our manager, in its capacity as our manager, is permitted to or required to make a decision in its “sole discretion” or “discretion” or that it deems “necessary or appropriate” or “necessary or advisable,” then our manager will be entitled to consider only such interests and factors as it desires, including its own interests, and will have no duty or obligation (fiduciary or otherwise) to give any consideration to any interest of or factors affecting us or any Class A shareholders and will not be subject to any different standards imposed by the operating agreement, the Delaware Limited Liability Company Act or under any other law, rule or regulation or in equity. These modifications of fiduciary duties are expressly permitted by Delaware law.

* * * [E]ven if there has been a breach of the obligations set forth in our operating agreement, our operating agreement provides that our manager and its officers and directors will not be liable to us or our Class A shareholders for errors of judgment or for any acts or omissions unless there has been a final and non-appealable judgment by a court of competent jurisdiction determining that our manager or its officers and directors acted in bad faith or engaged in fraud or willful misconduct. These modifications are detrimental to the Class A shareholders because they restrict the remedies available to Class A shareholders for actions that without those limitations might constitute breaches of duty (including fiduciary duty).

The agreement details some of the conflicts the managers can decide in their own capacious discretion, including contracts between the manager and its affiliates, conflicts between investors in the subsidiary funds and the interests of the LLC members, and federal tax considerations.

The S-1 notes that the Delaware LLC Act permits elimination of fiduciary duties that might otherwise be owed, and details differences between standard form fiduciary duties and the operating agreement.

As for whether the Delaware courts actually would enforce the agreement as written, I have some thoughts based on a survey of recent Delaware LLC and partnership law in The Uncorporation and Corporate Indeterminacy.

Why would somebody invest in such a company?  In my Rise of the Uncorporation I detail what makes this sort of structure work, specifically including the tradeoff of high-powered incentives for costly corporate-style monitoring such as an independent board, shareholder voting and fiduciary duties.  The Apollo S-1 notes this tradeoff:

[W]e seek to retain the culture we have developed as a privately owned firm by having primarily performance-based compensation for our managing partners, contributing partners, and other professionals. Our managing partners and contributing partners retain personal investments in our funds * * * directly or indirectly, and we continue to encourage our managing partners, contributing partners and other professionals to invest their own capital in and alongside our funds. Our partners (other than our managing partners) retain a portion of their “points” in our funds and, in regard to future funds, will generally continue to receive allocations of points. * * *

It may be too early to see all the pitfalls in this structure, and whether it really will hold up in court.  But there is no doubt that large publicly held businesses are starting to look very different from the corporations of old, and it's a development that "corporate" scholars ought to be paying attention to.  The standard publicly held corporation is not the only governance game in town.

Comments

[M. Hodak]

This is basically a management team telling its shareholders: "We're a money machine. We're letting you in on it, but we'll decide how much you get from this machine. If you don't feel it's enough, you can sell out."

It's like contemplating hooking up with a drop-dead blonde who tells you up front, "I might be faithful or I might not. Any problem with that?" Some guys might not have any problem with that.