Hedge Funds “Secret Sauce” (ISS) Going Public via Risk Metrics IPO

Institutional Shareholder Services (ISS) was purchased by Risk Metrics in the last year and will now be part of Risk Metrics upcoming IPO, see SEC S1 filing. ISS is the leading proxy firm and its opinions on merger and acquisition activity often determine a merger votes outcome. Sadly, many great companies with solid long term prospects, including Willamette Industries in Portland Oregon, have been eliminated by ISS actions.

It is simply astonishing that both shareholder rights advocates focused on maintaining shareholder value and union leaders focused upon jobs don’t pay more attention to Risk Metrics/ISS. It is my opinion that the IPO itself should be rejected by the SEC because it does not fully disclose the ownership structure of ISS, which is essential given SEC proxy rules. This is somewhat like allowing a political action committee (PAC), or in this case ISS, to cast a US Senator’s vote and not knowing who that Senator really is. ISS is owned by what many call “private equity” firms that do not disclose anything to the SEC.

Given that such firms do not disclose their holdings, accounting policies, etc. my sense is that they actually nothing but speculative hedge funds whose primary business is leveraged buyouts. What ISS has effectively become is hedge funds secret sauce used to grease the wheels for mergers that make no long term economic sense, robbing shareholders of future gains and eliminating good jobs.

MIT’s Technogy Review has a nice article about the “quant” related activities including a the following quote regarding RiskMetrics from its article titled “Blow-Up.”

The MIT article noted  “Running such computationally intensive simulations has become a lot easier in the last decade. Gregg Berman, a former experimental astrophysicist who left the academy for the world of finance in 1993, is one of what he calls “a ¬≠plethora of PhDs” at RiskMetrics, a firm that provides models, tools, and data to the majority of important banks, brokerages, and hedge funds. (Among other things, the company tries to predict how a derivative will behave in a variety of market conditions–how it might respond, for instance, to weakening exchange rates or increased interest rates.) When Berman started in the business, he says, “full-blown simulations [of the Monte Carlo type] were rare.” Now that computers can be so easily linked, however, ¬≠Berman might put as many as 1,000 processors to work at once to run “simulations within simulations,” which might measure risk on a product like a mortgage-backed security.”Like many of the deals ISS has annointed for hedge and private equity firms doing hostile takeovers of public companies, this proposed IPO is itself a leveraged buyout in which debt is being used to finance the IPO. In addition, almost two thirds of the stock options listed are currently exerciseable.

Two firms, ISS and Glass Lewis, are effectively the nation’s corporate Congress.  In the accounting industry it was once the Big 8 and now the final four after mergers and the dissolution of Arthur Andersen.  In the proxy world it is simply the dynamic duo and while Glass Lewis is now owned by a Canadian Pension plan with much greater disclosure than its previous owner, a Chinese Bank, ISS ownership is now cascading into the world of derivatives and hedge funds.

Perhaps most remarkable about ISS is that it is in clear violation of SEC proxy rules by not adequately identifying its ownership structure, both before its purchase by RiskMetrics in addition to its planned disclosure post RiskMetrics IPO.

If someone were looking for a theoretical peak in merger activity, perhaps the SEC sleeping while ISS goes public and its owners cash out by loading it up with debt is a signal the cycle is over. In the end the remaining public shareholders of Risk Metrics/ISS will end up competing with shareholders of the companies they issue opinions on. Perhaps this would make sense if ISS were selling tires yet they are selling proxy services, i.e. votes, on key corporate resolutions.

Perhaps an additional irony is the debate over campaign finance reform and concern over candidates buying elections. Just another day at the office for ISS? With no disclosure, who knows?

I suppose the good news is that former SEC Chair Arthur Levitt is on the board of Risk Metrics/ISS and he clearly will be able to explain how this IPO violates SEC proxy rules if given an opportunity. Levitt has a history of integrity and competence.