boutique investment banks

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

Ken Moelis

Ken Moelis

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.

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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.

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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.

Sanjay Sanghoee is a political and business commentator. He has worked at investment banks Lazard Freres and Dresdner Kleinwort Wasserstein, as well as at hedge fund Ramius. Sanghoee sits on the Board of Davidson Media Group, a mid-market radio station operator. He has an MBA from Columbia Business School and is also the author of two thriller novels. Follow him @sanghoee.

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