TESTIMONY OF JAMES R. DOTY, GENERAL COUNSEL CONCERNING BANKATLANTIC FINANCIAL CORPORATION BEFORE THE SUBCOMMITTEE ON OVERSIGHT AND INVESTIGATIONS July 10, 1991 Chairman Dingell and Members of the Subcommittee: I am pleased to testify at this hearing concerning your inquiry into certain "roll-up" transactions sponsored by BankAtlantic Financial Corporation ("BankAtlantic"). This statement will provide a brief background on the relationship of federal securities regulation and state fiduciary law as regards limited partnerships and roll-ups. It will also discuss (i) the types of concerns that such roll-ups have raised, including a summary of the terms of the BankAtlantic transactions, based upon the information contained in public filings, (ii) the Commission staff's processes for review of disclosure made in connection with roll-ups, and (iii) certain Commission initiatives for improving that disclosure. While, as General Counsel, I have general familiarity with these matters, I have of course relied on information supplied by other members of the Commission's staff in preparing my testimony today. As the Subcommittee is aware, the staff of the Commission's Division of Enforcement is currently reviewing the BankAtlantic 2 transactions. Therefore, as the Subcommittee has been advised, the Commission respectfully requests that the Subcommittee respect the confidential nature of this inquiry, and the Commission's reluctance to address in this forum specific issues related to BankAtlantic's compliance with the federal securities laws. I. The Legal Framework and Interests in limited partnerships have given many individual investors a means to participate in real estate, oil and gas, other industries, with substantially the same favorable tax treatment as direct investment. With the significant reductions in tax benefits effected by tax reform legislation in 1986 and 1987, and with the difficulties in the real estate and oil and gas industries, the value of many of these limited partnership investments diminished significantly. In most cases, investors had no means of selling their investment in the partnerships to cut such losses, since in most cases no trading market for the partnership interest existed. A "roll-up" generally refers to a transaction or series of transactions involving the combination under state law of several limited partnerships or other investment vehicles into a single new entity, often involving the offer and sale of securities of a new or acquiring entity to the limited partners of the combined entities. 1/ Often the new investment vehicle is a publiclytraded corporation, designed to eliminate the illiquidity of the predecessor limited partnership interests. However, upon completion of a roll-up the equity interests in the successor entity have frequently declined in value following the transaction. Thus, the new equity holdings proved salable only at substantial discounts from the initial "exchange value" of the partnership. The perceived unfairness of roll-up transactions has, we all recognize, created considerable controversy. Critics have charged that, in structuring and selling roll-ups, general partners put their interests ahead of the interests of limited partners. Complaints of this nature have been raised in connection with the BankAtlantic roll-ups that are the subject of this hearing. The Commission is, of course, greatly concerned about any allegations of violations of the federal securities laws in any securities transactions, including partnership roll-up transactions. We are fully committed to seeking appropriate remedies against those who violate the law. The Commission is currently investigating certain roll-ups, as well as certain initial offerings of limited partnership interests, to determine 1/ The Commission's recently proposed rules would define a roll-up also to include a single partnership reorganization. See note 28, infra. whether there have been violations of the federal securities laws. The protection of investors in a corporation or partnership generally includes at least four elements: 1. Adequate Information. To enable investors to understand the consequences of an investment decision or proposed transaction, investors need to receive full disclosure of all material information regarding the security or the transaction in the documents required to be delivered, such as proxy statements and prospectuses. This, of course, is the province of the federal securities laws and the Commission's rules thereunder. The Commission vigorously enforces these laws and rules. 2. Fiduciary Duties. State law imposes strict fiduciary duties on officers and directors, general partners and other insiders towards investors. These duties impose on general partners the duty of observing the utmost candor and fair dealing in transactions with their limited partners. 3. Effective Voting Rights. State law generally provides a fundamental protection for all investors in establishing the right to vote to replace directors or general partners and to approve extraordinary transactions. Most roll-ups cannot proceed without an affirmative vote of a majority of the limited partner interests in each limited partnership involved. One very troubling aspect of some roll-ups, however, is that they restrict significantly the ability of investors in the rolled-up entity to vote out the general partner. 4. Recourse to the Courts. Investors need to be able to enforce their other rights in the courts. Limited partners have, in some cases, sued general partners to challenge the fairness and other aspects of proposed roll-ups. 2/ of these four protections, the Commission is responsible under current federal law for administering the rules requiring 2/ Although we are aware of only one reported decision 5 full disclosure of all material information in proxy statements, prospectuses and other regulated disclosure documents. It is important to recognize that the basic standards governing the fairness of transactions are found in state partnership and corporate laws, and the decisions of the courts applying those laws. A few states also regulate the compensation of, and transactions with, affiliates in connection with their review of proposed securities offerings. By contrast, the federal securities laws focus on full disclosure of the information necessary to provide investors the ability to assess the merits of the transaction and the performance of the fiduciary. Thus, it is the investor, or the state courts applying state law, not the Commission, who must decide whether a proposed transaction is fundamentally fair or unfair. The Commission's mandate under the federal securities laws, although generally limited to disclosure, is nonetheless extremely important. While the Commission cannot require fairness in business combination transactions, it can and does provide investors with the factual basis on which to make investment decisions about fairness, to evaluate the implications of the exercise of the franchise, and to bring suit when fiduciaries have misrepresented their reasons or the fairness of proposed business combination transactions. For almost sixty years the Commission has, through its enforcement of the disclosure statutes, made possible the effective enforcement by |