Fine Line of Selling, Selling Out, the Firm
Bold Steps by CEOs Get Boards Firing Back

January 30, 2007; Page C1

Where are those Hewlett-Packard private eyes when they are really needed?

Corporate boards are in desperate need of some help snooping on the executives they are supposed to oversee. Chief executives have been carousing behind their backs, canoodling with private-equity firms over steak frites and spreadsheets about buyout deals.

These transactions stand to be lucrative for top managers, who typically keep their jobs and are awarded new equity along the way. Behind the scenes, the romancing has put a flock of boards into turmoil, say some of the Street's leading deal makers. That is because the chiefs are in a position to exploit their own office and ownership positions to pursue deals that serve them best.

A few executives are pursuing deals for weeks or months without alerting their boards. Others are subtly threatening to quit if a company isn't sold and delivered back to their buyout buddies. The effects can be paralyzing. "You won't find it in the background of the merger documents, but it does happen," says one banker. "They really try to squeeze the board."

Now, after years of rubber-stamping buyout recommendations, both boards and shareholders are beginning to challenge the terms they're receiving in these deals. The end game for shareholders is simple -- getting the best price possible. They would do well to start at the very beginning, where the real business of private equity gets done.

Some of these players will eventually have to answer to the courts. Delaware judges appear eager to get their hands on a case involving what Wall Street calls a "P2P" -- public to private. Leading Delaware judge Leo E. Strine Jr., for instance, expressed some skepticism in a recent class at Harvard Law School: "The old worry would be that [CEOs] would receive offers and not tell the board," he said on a panel. "Now they go and solicit them and not tell the board."

Companies are free to go private, of course. And managements are free to make proposals or be part of someone else's buyout plan. It's how the plans come together that can mean the difference between a fair deal and a crummy one for shareholders.

Process matters because top executives carry enormous clout in buyout situations. Their knowledge and influence can subtly, or not so subtly, push a deal and its terms to a personally beneficial outcome. And they can advance a favored deal so far along that competing bidders won't come near it.

Boards are supposed to neutralize those advantages by controlling the flow of information to their CEOs, while keeping them on a short leash.

"In the life cycle of a company, this is one of the most important decisions ever taken," says the head of mergers and acquisitions at one Wall Street firm. "It shouldn't be taken unilaterally. And certainly not by the person who is in the most conflicted position at the end of the day."

Kinder Morgan Inc. founder Rich Kinder pursued a buyout for months before telling his board.

Meantime, some board members of Harrah's Entertainment Inc. were upset by a $15.1 billion buyout proposal made by two private-equity firms last fall. The company's forthcoming proxy, due in February, could explain why. The document is expected to show Harrah's chief executive, Gary Loveman, had some discussions and signed a confidentiality agreement with a buyer before the full board knew of their interest, according to people familiar with the document. In effect, Harrah's board didn't even know it was for sale. Mr. Loveman declined to comment.

Or consider a 2005 transaction that caught the eye of the Delaware courts -- a nearly $1 billion buyout of technology firm SS&C Technologies Inc. by the Carlyle Group and the Windsor, Conn., tech company's largest shareholder and CEO, William Stone. As described in company filings, Mr. Stone began soliciting offers for the company, and even hired a set of advisers to set up meetings with six potential buyers. The company went on to sign nondisclosure agreements with the private-equity groups. It took more than a month before the company's board knew any of this, according to filings. By that time, the transaction had developed a momentum of its own, notes Delaware Vice Chancellor Stephen P. Lamb.

Mr. Lamb could be writing about any number of recent management buyouts when he delivers a flurry of skeptical questions about SS&C in a ruling on a shareholder lawsuit. "Did Stone misuse the information resources of his help him identify a private-equity partner to suit his needs?" he asks. "Given Stone's precommitment to a deal," he wonders, "was the board ever in a position to consider whether or not a sale should take place?"

In an interview, Mr. Stone said, "Our process was transparent. We're not hiding anything from our board members. SS&C got the highest price in its history."

Boards are slowly changing their ways, notes James Woolery, a partner at Cravath Swaine & Moore in New York. They're demanding that chief executives seek permission -- not forgiveness -- when even exploring the possibility of a private-equity hook up. "Boards shouldn't have to deal with grenades that come from inside their own tent," he says.

Some inspiration might also come from the board at Harrah's. There the company took months to drum up a competing offer to the initial one proposed by Apollo Management and Texas Pacific Group, which kept management running the company. While risky, the extra time helped the rival bidders come up to speed -- which eventually pushed Apollo's price up by nearly another $2 billion.

Perhaps the best chance for reform comes from the shores of Australia. There a group of top managers was forced out of their jobs, after helping to launch a management-buyout plan for a utility called Alinta Ltd. The conflicts of interest were just too great, the company's board said.

It is difficult for a board to fire its chief executive out of the blue. The value of Harrah's, for instance, would have taken a big hit if the company unexpectedly dismissed its four-time gambling-industry CEO of the Year.

A high-profile firing might nonetheless be the only way to get through to the next crop of executive free-lancers and canoodlers. Nothing else seems to be working.

• The Game covers the world of deal making and Wall Street. Write to