Carlyle’s proposed IPO disaster

February 2, 2012, 6:36 PM UTC

By Eleanor Bloxham, CEO of The Value Alliance and Corporate Governance Alliance

Carlyle Group founders (left to right) William Conway, Daniel D'Aniello, and David Rubenstein

FORTUNE — We’ve seen companies like News Corp (NWS), Blackstone (BX), and LinkedIn (LNKD) chip away at shareholder rights by limiting the voting rights of shareholders. Now Carlyle is adding insult to injury.

In its recent proposed initial public offering (IPO), Carlyle will have no requirements for an independent board, virtually no voting rights for owners, and no ability for owners to sue. As an added bonus, owners will be paying its tax liabilities without any surety that they will receive cash distributions sufficient to cover those costs.

So, what would happen if every company did a Carlyle-style IPO? The private equity firm’s IPO proposal, which is brought to you by the clever folks at J.P. Morgan (JPM), Citigroup (C), and Credit Suisse (CS), with some help from law firms Simpson Thacher and Skadden Arps begs us to ask the question.

For example, on the tax front, what if all large companies were to adopt Carlyle’s approach where the owners (called unit-holders, which is analogous to shareholders) pay the corporation’s taxes? What impact would eliminating corporate income taxes (which is required of C-corporations) have on our economy and budget deficit?

It’s not an unreasonable question, Bob Monks, founder of LENS Investment Management, told me. “Companies are already moving offshore to avoid taxes, fiduciary duties, and regulatory responsibilities. It is astounding how much business is already transacted in offshore tax-havens,” he says.

According to Carlyle documents filed with the SEC, the proposed IPO “involves complex provisions of U.S. federal income tax for which no clear precedent or authority may be available.” Owners will be subject to that risk. Congress could act to preclude the Carlyle tax structure, but it has not passed anything so far, the documents state. 

In addition to the tax risk, with no real shareholder rights in place, there is no accountability by Carlyle to those who buy their units/shares.  What if every corporation adopted such a stance?

Money managers (who are hired to invest the monies of institutions or mutual funds, pension plans, or individuals’ savings or retirement accounts) at least have fiduciary obligations to their clients and should not be able to invest in such draconian offerings as a matter of prudence.

“I’d go one step further,” Monks told me. “They are barred from investing in offerings like Carlyle’s as a matter of both law and ethics.”

Former SEC chair and current Carlyle senior advisor Arthur Levitt recently told Bloomberg that taking away investors’ right to sue “could diminish the public appetite for Carlyle stock” and “companies that consider going down this road take a perceptual risk which, in terms of an IPO, is probably not a risk worth taking.”

But will money managers follow their obligations and avoid this offering? And if they don’t, will regulators enforce the fiduciary obligations money managers owe their clients?

As the IPO is currently designed, the SEC could block the IPO outright. But Lynn Turner, former chief accountant at the SEC, told me “Given the level of regulatory capture and close ties to the securities industry at the current SEC, it is quite possible, if not likely, the SEC will allow the Carlyle IPO to move forward, to disastrous effect.”

Perhaps Carlyle, which did not respond to a request for comment, would back down if money managers refused to invest. That would be a welcome repetition of history.

Former Goldman Sachs (GS) chairman John Whitehead spoke to me several years ago about how he fought offerings that diminished shareholder rights. “When I was chairman … there began to grow up a practice of managements deciding to sell non-voting stock to the public…. And I immediately thought that that was a bad idea.  That people’s capitalism, the system that we have, depends on the age-old system of one-share-one-vote…. So Goldman Sachs decided that it would not underwrite non-voting stock, and that was a surprise because we lost some business when companies came to us and asked us.”

Once Goldman stopped underwriting non-voting stock, others began to reconsider. “And gradually, it fell out of practice,” Whitehead said. “And gradually, companies that had those kinds of shares eliminated their non-voting shares and then replaced them with full voting rights.”

Giving shareholders a say is “a self-cleansing process” and encourages companies to institute good practices, he said.

The health of capitalism itself depends on basic shareholder rights and money managers should be willing to fight for those rights. But will they? Will they remember who their customers are?

If Carlyle’s IPO moves forward with any measure of success, other companies may indeed follow suit. Corporate history is replete with examples of financial services firms creating major crises (including our most recent crisis) by acting like lemmings. Former Citi CEO Sandy Weill‘s Travelers-Citi merger pushed legislators to repeal the Glass-Steagall Act. Many large banks jumped on that bandwagon and began to sell financial instruments even they did not understand. We know the result for taxpayers and the economy.

Carlyle’s IPO raises a fundamental question about our future: we know capitalism was never perfect — but are we really ready for the end of capitalism as we once knew it, when it worked?

Eleanor Bloxham is CEO of The Value Alliance and Corporate Governance Alliance (, a board advisory firm.