Unions Grasp for Influence Over Private Equity

Mention the names of certain large corporations, and many people think bad things—from ExxonMobil gouging drivers with high gas prices to Wal-Mart destroying city downtowns by undercutting mom-and-pop shops. Sound familiar? That’s because these companies have been targets of "corporate campaigns"—public relations onslaughts designed to damage a company’s reputation.

When planning corporate campaigns, unions and activist groups research their target and identify its weaknesses. One key pressure point is a company’s need for capital. Because they often have great influence over pension funds, many unions are able to pressure companies by having the funds offer shareholder resolutions at corporate annual meetings.

However, the enactment of the 2002 Sarbanes-Oxley Act, in the wake of the Enron and WorldCom scandals, has had an unintended consequence. To avoid burdensome government regulation, some companies are deciding not to list their shares on American stock exchanges—a trend that is leading to more stock listings in overseas financial centers like London and Hong Kong. In some cases, companies have even de-listed their stock shares in the U.S.

This has created great asset shopping opportunities for private equity firms, which are buying up publicly owned companies. Because they do not trade publicly, private equity firms are not directly exposed to the kinds of shareholder pressure that publicly traded companies face. However, organized labor isn’t about to sit idly by and let this development go on unchecked.

Leveraging Pension Funds

The ideological roots of union corporate campaigns can be found in the 1960s left-wing group Students for a Democratic Society (SDS). According to George Washington University political scientist Jarol Manheim, who has studied the history and tactics of corporate campaigns, it was SDS that adopted as a central philosophical principle "a view of the corporation, per se, as the critical actor in contemporary American society and as a target of opportunity to force social change."

To influence corporation to achieve the social change they wanted, SDS student activists began to forge alliances with other groups such as labor unions and religious organizations that had the capacity to pressure corporations. SDS and its allies developed a methodology for conducting research on corporations. Their aim was to identify the weaknesses of a targeted company by identifying key "stakeholders" who could bring pressure to bear on the company—customers, suppliers, financial lending institutions, the media, government regulators and the general public. For publicly traded companies, another key constituency was the firm’s shareholders.

Manheim has noted that "on the one hand, while [union membership] has been declining, another base of power has been increasing" through the leveraging of $3 trillion in assets in public employee and multi-employer pension funds run by boards that include union representatives. It is now a standard practice for unions to advance their goals by introducing resolutions at public company shareholder meetings. Typically, the resolutions call on the company to change its corporate governance practices or adopt specific public policy positions.

A key to helping unions leverage these assets was the establishment in 1995 of the AFL-CIO Center for Working Capital. This was the year John Sweeney became president of the federation. Even before heading the AFL-CIO, he led the stridently activist Service Employees International Union (SEIU), which perfected the strategy of the corporate campaign. In his 1995 AFL-CIO inaugural address, Sweeney proclaimed, "We will use old-fashioned mass demonstrations, as well as sophisticated corporate campaigns, to make worker rights the civil rights issue of the 1990s."

Sweeney’s strategy got a boost in 1998, when the Securities and Exchange Commission revised its Rule 14a-8 to allow shareholders who meet certain floor criteria to submit resolutions and have them included in the company’s proxy materials. Before 1998, companies could exclude proposals that dealt with social issues such as the environment and human rights. But the new SEC rule allowed some social policy resolutions to go before shareholders over management objections. A driving force behind this change was the more than 2,000 letters that shareholder activists sent the SEC.

In 2005, SEIU, the Teamsters, United Food and Commercial Workers, and UNITE-HERE disaffiliated from the AFL-CIO and formed a new federation called Change to Win. Earlier that year, SEIU established SEIU Capital Strategies, an organization with parallel functions to the AFL-CIO Center for Working Capital. Some observers correctly recognized this as a sign that the SEIU would leave the AFL-CIO.

Labor Meets Private Equity

Fittingly, SEIU President Andrew Stern has moved quickly to respond to the rise of private equity. He has met with the heads of some of the largest buyout firms, including David Rubenstein of the Carlyle Group, Stephen Schwarzman of Blackstone and David Bonderman of TPG (formerly Texas Pacific Group). "I’ve been incredibly impressed," Stern told Wall Street Journal columnist Alan Murray. "Compared to most of my meetings with company CEOs, these men are much more business-like, and have much more understanding of what we are trying to accomplish."

Stern’s complimentary tone may indicate that private equity CEOs are more willing to play ball with his union than the CEOs of publicly traded companies. But the private equity CEOs may feel they have no choice. Murray notes that Stern operates like Jesse Jackson: "Attack first, then engage—with a hand out for the ultimate payoff."

Stern’s union is likely to keep up the pressure on prospective private equity buyers of unionized companies. SEIU maintains a website called BehindtheBuyouts.org, which promises to reveal embarrassing information about private equity executives whom union officials believe might be unsympathetic to union interests.

Stern hopes this pressure will get unions favorable contracts from companies that go private. His interest in private equity intensified during the summer of 2006, when HCA, a hospital corporation that is one of the largest employers of SEIU members, agreed to go private. Stern also was jolted early in 2007, when Blackstone bought out Equity Office Properties, a large employer of janitorial services that employ SEIU members.

Stern realizes that he still has leverage over these companies because they have been bought out by private equity firms that rely on capital from union-dominated pension funds. (Of course, union influence will be reduced to the extent that private equity buyout deals rely on other sources of capital.)

Even when they are not its investors, labor unions have other forms of pressure that they can exert on a private equity firm. One is the tax treatment of private equity buyouts. Currently, top executives at private equity buyout firms can earn hefty payouts of 20 percent of the profits from their funds and their payments are considered "carried interest." They are taxed at the capital-gains tax rate of 15 percent rather than the top personal income rate of 35 percent.

"Therein may lie the makings of a deal," notes the Journal’s Alan Murray. "Mr. Stern has suggested the buyout firms could help his cause by, for instance, adopting standards that would encourage the use of unionized janitorial services in buildings. He hasn’t said what he wants in return. But one possibility: He eases up on his criticism of their favorable tax treatment." In August, Stern called on Congress to look at what he called "tax dodges" used by private equity firms.

Rearguard Action

In some troubled industries such as steel, airlines and autos—which are hobbled by huge health care and pension legacy costs and ever-increasing foreign competition—unions are struggling to salvage whatever jobs they can.

Last May, DaimlerChrysler announced the sale of its Chrysler division to Cerberus Capital Management, a private equity firm. United Auto Workers president Ronald Gettelfinger, who barely a month earlier had denounced private equity bidders as "strip and flip artists" and vultures "hovering overhead," said that the Cerberus deal was "in the best interest of our membership." He conceded that the union was powerless to stop the deal, so he was determined to make the best of it.

Even under pressure, however, unions can gain significant concessions when negotiating with private equity firms that buy out their employers. For instance, the United Food and Commercial Workers now routinely negotiates language in contracts requiring new supermarket owners to restore wage concessions over the life of the contract.

"If you’re a business agent for the textile workers in North Carolina, and your mill is about to move to Mexico, and [private equity mogul] Wilbur Ross shows up, you’re going to try to cut a deal with him," Santa Clara University law professor Stephen Diamond told The Washington Post. "You’re not going to like it, but you’re going to do it."

Indeed, the 850,000-member Steelworkers union has dealt with Wilbur Ross, beginning in 2001 when he started buying bankrupt steel mills. In his bid for LTV Steel, the union agreed to job cuts and reductions in job rules in exchange for the promise of profitability. Ross agreed to give buyouts to departing workers, share profits with workers who stayed and direct some of his gains to a health fund for retirees if LTV became profitable as part of Ross’s International Steel Group. Similar deals followed, with Ross acquiring Bethlehem Steel and other steel companies.

On the Bethlehem deal, Steelworkers investment banker Ron Bloom told The Wall Street Journal: "So now we say to Wilbur [Ross] ‘OK, we’ll support you. We’ll shield you from all other bidders… so you can get it real cheap,’" in exchange for Ross putting "real money" into the retiree benefit trust. "You get to put LTV and Bethlehem together—you’ve now just created by the stroke of a pen the largest steel company in America."

The union also forged an agreement that if Ross cashed out, any new owner would first have to agree to a new labor contract, essentially giving the union veto power over potential bidders. That deal paid off. In 2005 Ross sold his stake in his steel empire for $4.5 billion and a $300 million personal profit, after the new owner, Mittal Steel, met the union’s terms.

Despite their ability to negotiate such deals, the Steelworkers see these moves as playing defense in a difficult environment. For private equity investors, such deals are part of the cost of doing business. "Labor has found that these investors operate in a brutally, economically rational fashion," AFL-CIO Associate General Counsel Damon Silvers told the Post. "They have financial targets and they have to hit them. If they have to deal with a union to get there, they’ll deal with the union."

Steeling for Obstruction

In addition to threatening to push for higher taxes on public equity or block takeovers, unions can get in on the game by inserting themselves into negotiations as "creditors," with workers’ lost wages and benefits as their claims.

That strategy worked well when Toronto-based Onex Corp. bought out three failing Boeing factories in 2005. The new owners wanted to cut 1,700 jobs (out of 10,300), eliminate certain work rules, and cut pay by 10 percent. The unions agreed, but in exchange they wanted the employees to get a share of the profits when the spin-off company went public.

The new company, Spirit AeroSystems, rebounded more quickly than expected, winning contracts for the new Boeing 787 as well as from Sikorsky and Airbus. When it went public in November 2006, Spirit employees who had taken the pay cuts each got checks averaging $30,000, plus 1,000 shares of stock worth around $34,000 as of June 2007. Spirit continues to prosper.

The United Steelworkers of America (USWA), hit hard by foreign competition, has sought to strike agreements like the one in the Onex deal, called successorship clauses.

A successorship clause enabled the USWA to block the Brazilian steel giant CSN from acquiring publicly-held steelmaker Wheeling-Pittsburgh. The Steelworkers managed to steer Wheeling-Pittsburgh Corp. away from a bid by CSN and it persuaded Chicago-based upstart Esmark, Inc. to make a bid for the company. Privately-held Esmark promised that there would be no union layoffs. In return, the union agreed not to oppose Esmark efforts to import steel slabs to Wheeling-Pitt mills.

In July 2006, the union and Esmark mounted a proxy fight to oust the entire Wheeling-Pitt board. They succeeded after vigorously lobbying shareholders and adding two union representatives to the board. The Esmark-Wheeling-Pitt deal should be finalized this fall, and is expected to bring $50 million to $200 million in equity into the company. CSN executive Luiz Ernesto Migliora said that while his company remains interested in buying American steel assets, next time, "I would never try anything without going to the union first."

A New Chapter

A new chapter in American economic and labor history is now being written. Unions thought they had found in corporate campaigns a promising new organizing strategy to fix their problem of declining membership. But now they must re-orient that strategy to deal with the rise of private equity firms. Burdened by government regulations, publicly traded companies have strong incentives to accept buyout offers from private equity firms that have demonstrated that they can make companies more profitable.

Labor unions have room to maneuver in this new environment, thanks to their influence over pension funds that provide lots of private equity capital. But private equity firms have other sources of capital, and unions have no access to shareholders in dealing with a privately-held company. But don’t count the unions out yet.