NZSA Disclaimer
Opinion: Employee Ownership Pays the Price of Private Equity Playbook
Oliver Mander, CEO, NZ Shareholders Association
In the world of corporate governance, we often speak of alignment between directors, shareholders and management. The natural tensions between that trinity represent a balancing act of key financial concepts – such as risk versus reward, or striking a balance between short-term execution and long-term value. In New Zealand, we’ve seen recent examples of when that alignment becomes deliberately fractured, and the lines between the corporate trinity of governance, management and shareholders become blurred.
Recent decisions at FNZ that have resulted in increased influence of shareholder groups, seemingly at the expense of employee-shareholders, is yet another example. Governance should indeed be focused on the best interests of the company, aiming to create equal economic value for all shareholders.
At FNZ, a complex voting structure attached to different share classes has resulted in potential conflation in Board decision-making, between the role of governance and private equity shareholders, resulting in an allegation of value destruction for employee-shareholders. The upshot is that employee-shareholders now allege that now they have been systematically diluted through preference shares and warrants issued on non-commercial terms.
They have filed a claim for US$4.6 billion (NZ$7 billion) in the high court of New Zealand.
The unfolding legal battle at FNZ, one of New Zealand’s biggest yet little-known success stories, is a stark reminder that private equity’s appetite for returns can come at a devastating cost to those who helped build the business, rewarded for their efforts by share ownership schemes.
Private equity ‘squeezing’ shareholders for their own gains is not a new story. However, the scale and publicity surrounding the FNZ case raises important questions around the accountability of private equity firms and their modus operandi.
Dilution
According to the claim, preference shares and warrants were issued to institutional investors at deeply discounted terms, allegedly enabling them to acquire Class A shares at $0.25 apiece, compared to a fair market value of $145,000. The effect was to transfer wealth away from the employee shareholders, who own 23% of the economic interest of the company, to institutional investors.
The issuance of these was allegedly approved by FNZ directors, the majority of whom carried a significant conflict of interest by also working for the institutional and private equity investors who stood to benefit.
The structure reportedly ensures that if FNZ is sold, whether privately or via an IPO (initial public offering), below $8.3 billion, employee equity could be wiped out entirely. Previously, if there was a sale, employee shareholders would have made roughly a third on any sale.
Private Equity
Private equity exists to make money for the people it represents. And over decades of building a sector that is today worth US$20 trillion globally, private equity firms have perfected a set of manoeuvres, often with devastating effects for existing shareholders, founders and other stakeholders – including employees.
Private equity knows that generating an investment return doesn’t necessarily come from an alignment of business purpose and long-term goals. In fact, as we often see, and as the acclaimed US journalist Megan Greenwell writes in her new book, Bad Company, private equity firms do not necessarily need the company to succeed to make big returns for their investors.
Sovereign funds
While we might all know and accept the murky dealings of private equity, this case also involves two of the world’s biggest sovereign wealth funds managing public pension assets and employee contributions – CDPQ, the Canadian pension fund, and Temasek, Singapore’s investment fund.
While sovereign funds are entrusted with long-term stewardship, they too, can operate with limited public accountability, especially when investing through offshore structures or in ‘unlisted’ / privately held assets, as is the case with FNZ.
FNZ’s case exposes the risks of allowing sovereign wealth funds to operate unchecked in private markets, particularly when their decisions impact the retirement security of millions.
A chance to rewrite the rules?
Private equity firms operate in a zone with limited regulatory oversight. When issues arise, that leaves maligned shareholders (including employee shareholders) and/or founders with expensive, lengthy and complex litigation as the only recourse when things turn sour. More often, disagreements or disputes are settled out of court, subject to non-disclosure agreements.
FNZ now operates in more than 30 countries, but because it is still domiciled in New Zealand, the claimants have brought charges to the directors under the New Zealand Companies Act 1993, which aims to promote good business practices and protect stakeholders. Their claim alleges the FNZ directors breached fiduciary duty and governance integrity, and “that the affairs of FNZ Group have been conducted in a manner that is unfairly prejudicial to the plaintiffs in their capacity as shareholders.”
At a more ‘human’ level, it is clearly frustrating for employee-shareholders that the opportunity and deep engagement provided by employee share ownership has been regarded in such a lowly fashion by the FNZ Board.
NZSA has recently advocated for improvements in some aspects of the Companies Act, aimed at clarifying and enhancing investor protections for all companies. For example, we’re pleased to see the release of the terms of reference by the Law Commission last week, formalising a long-awaited review of the ‘director duties’ provisions within the Act.
A key NZSA focus is on reducing ‘regulatory arbitrage’ when deciding to raise capital privately or from a public listing. A focus on ‘proportionate regulation’ based on the number of shareholders, as well as existing disclosure thresholds based on assets and revenue, is surely in the public interest – regardless of listing status. This element of our advocacy is key in determining how the ‘opaque’ nature of private investment can be clarified for all.
Nonetheless, as it affects FNZ employee-shareholders, s. 174 of the Companies Act already offers seemingly strong regulation, protecting businesses and investors alike when it comes to oppressive, discriminatory or prejudicial conduct.
The FNZ case is a fascinating test, that has the potential to prompt fundamental change to investor governance and/or protection regimes; not just in New Zealand, but elsewhere.
We will be watching with interest.
Oliver Mander