Do The Right Thing

Dow Chemical publicly announced today that it had terminated two high-ranking executives, one a member of its board of directors and former chief financial officer, for unauthorized discussions with third parties (read private equity firms) concerning a leveraged buy-out of the company.   Dow, a company with a $45 billion market capitalization, has recently been rumored as one of the next "mega" private equity LBOs.

As the private equity craze continues to froth, it is becoming increasingly hard for boards to control insiders who otherwise wish to participate.  Officers, and even independent directors, are initiating sales processes themselves or otherwise requesting to join in the bidding with or against other potential acquirers.  These insiders usually stand hand-in-hand with private equity shops who provide necessary LBO financing.  Hint of this problem recently surfaced when it was reported by the Wall Street Journal back in September, 2006 that the top management at Kinder Morgan waited more than two months to inform their board of directors that they were contemplating an ultimately agreed to LBO.  The risk here for all companies is that these executives or directors will have an undue head start or inside track on bidding, and this is a risk largely regulated today through traditional duty of loyalty analysis.  The Delaware Chancery Court has previously criticized such conduct, but it has yet to consider the parameters of the duty of loyalty in this context.  In the interim, boards would do well to be mindful of this potential and amend their codes of conduct to require insiders to report commencement of active planning for a management buy-out. 

Steven M. Davidoff