M&A Guru Rodgin Cohen on Sovereign Wealth Funds

Robert Teitelman, Yvette Kantrow and Matt Miller

In M&A circles, Sullivan & Cromwell's Rodgin Cohen is hardly a new name. For nearly four decades Cohen, 63, has been a pre-eminent banking lawyer, offering advice on scores of M&A deals and providing counsel on an array of bank regulatory matters. In October 2000, he became S&C's chairman, juggling firm business with a still-robust banking practice. More recently, Cohen has found himself negotiating a new stream of banking transactions particularly appropriate to an age of capital impairment and global capital flows: sovereign wealth funds. In fact, Cohen has shown up on nearly every SWF investment into a bank that has surfaced since the Abu Dhabi Investment Authority pumped $7.5 billion into Citigroup Inc. on Nov. 26. Cohen represented UBS (in the United States) in early December when Singapore's Government Investment Corp. invested $11.5 billion; China Investment Corp. in its late December $5 billion stake in Morgan Stanley; Merrill Lynch & Co. in mid-January when it received a $6.6 billion infusion from Singapore's Temasek Holdings Pte. Ltd. and three other funds; then Citigroup again in its blockbuster $18.4 billion recapitalization by six different investors on Jan. 18.

Cohen is characteristically low-keyed and precise about his role in this stream of deals. He shuns any prescience about the trend -- he says he wasn't involved until Citi approached him and that the banks' own investment bankers made the contacts. But he does argue that the assignments sprang from work S&C has long done on bank regulation and restructurings. Indeed, the SWF deals, he says, require a dialogue with U.S. regulators -- from traditional bank regulators like the Federal Reserve to newly engaged parties like the Committee on Foreign Investment in the United States -- eager to privately recapitalize U.S. banks but sensitive to political fears of foreign encroachment. The result: a narrow path that would allow SWFs to take stakes in U.S. banks without any degree of control.

Cohen spoke to The Deal's editor-in-chief, Robert Teitelman, executive editor Yvette Kantrow and senior writer Matt Miller.

The Deal: For most of us, sovereign wealth funds seemed to show up yesterday. Did you anticipate them?

Rodgin Cohen: The apocryphal story is, of course, that I envisioned it. The real story is that as we began to talk with various financial institutions and understand what their needs were, which were large amounts of capital, quick, and an investor prepared to do this and not want to exercise any control. That triangulation almost symbiotically led to the sovereign wealth funds, because those were the only investors who could meet all three objectives. Obviously, everybody knew they had a lot of money. They had not been investors previously in U.S. financial institutions.

In fairness, I think it was more the investment bankers who dealt with them who understood that they might be interested. It was pretty easy to figure out, for those three reasons I mentioned, that they were the most logical candidates. Our role was recognizing and helping clients recognize that [SWFs] could fulfill these three requirements. It was really the Merrill Lynches and the Morgan Stanleys and the Citigroups that had the contacts and could make the calls.

The first of these deals you were involved with was Abu Dhabi's investment in Citi. What did you take from that experience?

What we learned was that the various regulators were going to be fine with the transaction, if structured properly. These governments are not stupid. They have really smart people running these SWFs, some of their best and brightest, and they have the ability to do the assessments. [We learned] that, very critically, these were people who were prepared to make these investments without any indicia of control, which is very important from a regulatory perspective and from a corporate governance perspective.

How broad were the regulatory interests that had to be dealt with?

Because of the range of companies in which investments were made, there had to be discussions to make sure we were OK with the Federal Reserve, the Federal Deposit Insurance Corp., the Office of Thrift Supervision and CFIUS.

Clearly, if U.S. financial institutions are going to be controlled, they're going to be subject to the entire gamut of U.S. regulations. That's very difficult for an SWF, as it is for private equity, as it is for any investor.

Was it a different exercise with a foreign bank such as UBS?

We obviously handled just the U.S. side on UBS. They were very well represented in Switzerland. Actually, from the U.S. regulatory perspective, CFIUS didn't really apply, but the U.S. banking regulatory scheme did.

Did the Chinese investment in Morgan Stanley raise special difficulties?

No. There may have been one or two politicians [that were sensitive], but I found no, that was no more difficult than with the Middle East or Singapore.

I met less than a handful of their people at CIC [China Investment Corp.]. They were extremely knowledgeable. Temasek has been in this longer than anyone; maybe they and GIC may be a bit on top. But it wasn't a steep learning curve for CIC.

Did the atmosphere change at all from the first deal?

Not really. Each deal was somewhat different, but atmospherically, only modestly. This wasn't so much a change, [but an understanding] that if you wanted to go outside the path that had already been beaten, you were urged by the regulators not to do so, because that would complicate their lives.

Would you expect anyone to wander off the path?

Not if they know what's good for them.

Was the fact that the SWFs didn't demand board seats related to the percentage stakes they took?

It was a combination of both. A number of times I've seen written that there's a safe harbor with CFIUS if you're under 10 percent -- well, that's just dead wrong. The way CFIUS regs work, you have an exception for noncontrol, and a predicate of noncontrol is under 10 percent. But it's not the reverse. Just because you're under 10 percent doesn't mean noncontrol. [In these investments] it was important that none of these other controlling features be there.

So CFIUS' requirements are somewhat more loosely defined?

That's not always a bad situation. As a lawyer, you love precision so you can advise clients and be comfortable. But there's something to be said in an area that doesn't lend itself so readily to precision, to a constructive ambiguity.

Would you expect that kind of ambiguity to change?

That's a very good question. As a policy matter, I probably would prefer to keep it that way rather than have concrete lines. Concrete lines provide precision, but they also really road-map how you can evade.

You have the European Union and the U.S. calling for more SWF transparency. What effect will that have?

It's hard to argue transparency as a concept. I think the most important aspect is that it be done on a multinational basis. If we try to impose our own rules, we're just going to discourage investments. It's not good generally if we have our rules and the EU has its. I think there's a real interest with people in the U.S. government that this be a multilateral approach. Whether it winds up that way, who knows?

Someone has to provide capital. The government isn't going to. If you look at the most recent experience of a government supplying capital, Northern Rock, it's not pleasant.

In the media, there's a general distrust of SWFs. Is there something you could say that hasn't been put out there?

If you listen to them and look at what they've done, albeit over a limited time frame and a limited number of situations, they really do not want to exercise control. That's not the position they're in. I actually think the U.S. regulatory system is pretty tight. Not only would it be very difficult to exercise control within these limits but if someone tried to exercise control, I'm sure the first thing that would happen is that management would run to the U.S. government and say, 'They promised they wouldn't exercise control; now they're doing it.' So there's a real pragmatic disincentive to exercise control. As long as the investments are limited, it's hard for me to see what the concern really is. It's a mystery, I agree, because they're big, and they're foreign, but if you strip away some of those mysterious elements and look at what the investments are as opposed to who's making them, I think the concerns should be a lot less.

Why make those kinds of huge investments if there isn't an ulterior motive?

There are a couple of things: One, if you really want to make a good return, all you have to do is look at private equity; they don't parcel it out in tiny little chunks. They make a relatively small number of big investments as opposed to hundreds of smaller ones. That's why, for the most part, PE far exceeds mutual funds in terms of returns. I think that's the same approach [of the SWFs]. There's more of an opportunity to actually have an outperforming record.

Also, these funds are so huge; [the stakes] are not exactly major chunks of their investments. I don't think the size indicates anything nefarious. If I were one of them, I truly would be concerned if they tried to move beyond the investment parameters that were originally set up. You could be in a world of trouble.

Saudi Prince al-Waleed made a lot of money from his investment in Citi in 1991. Did that make a big impression on the SWFs?

I think it did. After Kissinger opened up China, some American was speaking to [Chinese Premier] Chou En-lai. He asked, 'After [almost] 30 years, what is your view of the Chinese revolution?' And Chou En-lai said, 'It's too early to tell.' His interlocutor said, 'Let's go back a little bit, what about the French Revolution?' He said, 'Well, it's still too early to tell.' These are, for the most part, very long-term investors. Maybe not hundreds of years, but they're not looking for a quick turn. I think your parallel [to al-Waleed] is right. Financials go in and out of favor. If you get them near the bottom, there's a lot of money to be made. Citi with Prince al-Waleed was the most famous example. But you could have looked at a number of institutions at that time, and if you had invested, you'd be way ahead today.

The structure of the second Citi deal was complex. Can you share some of the thinking on that?

The first one, the ADIA [Abu Dhabi Investment Authority] deal, was even more complicated. [It was] driven by a number of factors. Citi was paying a quite high dividend rate, because if anyone invests in a common equivalent, they needed a premium above that to compensate for paying the high premium. Citi wanted the interest to be tax-deductible, so that drove in large measure the original deal. By the second deal, with the dividend being cut, these pressures were less.

Was there any sense in the first deal that Citi might need more capital?

I honestly believe that at the time that [first] deal was done, it wasn't anticipated that there would be a second. The deals weren't negotiated that way. I'm not going to say it was in no one's mind, but I don't think that was the intention.

Many of these deals come together quickly. Were you surprised by that?

No, because they were investments at a relatively low percentage. There are only so many areas you can do due diligence on. It's not like going out and looking at a lot of plants someplace or checking what the reserves are in the oil fields. It's really a question of looking at the books and understanding what the potential losses are, or trying to.

Are there parallels with Japan investing in American companies in the 1980s?

In the broader context, it's the same, which is the wealth transfer of capital flows. Although Japan has perhaps a more collaborative approach among businesses than in the U.S., still, there's a difference between individual businesses and something which could be used as an arm of the government. Obviously, for the same reason, I'm not sure people would have had the same objections to a controlling interest in a big financial here from a Japanese financial than from a sovereign wealth fund. That's why I think you do draw a very clear line between control and noncontrol. One could argue, and I think legitimately, there is something of a breakdown between what is control and what is not. What you do therefore to limit that risk, move the line so it is very clear. You're in a noncontrol situation.

Does a billion-dollar investment get SWFs much more beside the return?

I don't think they were looking for more. One or two may lead to more collaborative efforts outside the U.S., but predominantly as investments. Interestingly enough, when you look at the agreements when the U.S. and U.K. banks invested in Chinese banks two to five years ago, there was a lot about the Chinese banks wanting U.S. technology, not in terms of computers but technology in terms of how you do things. There was virtually none of that here.

You and your firm have been involved in more SWF deals than anyone. How much of this is a competitive advantage?

You know how that works: You gain confidence after you do one deal and are more expert than anyone who's done none. It clearly helps when you've done one. If you do a deal and you do it successfully, sure it's a competitive advantage because for anybody else it's going to be an on-the-job learning experience. But this was also an outgrowth from other things we had been doing with clients for a long time.

I would not see SWFs themselves as a huge [business], in which we're going to devote 10 or 20 lawyers. I think for us, it's more that in times of financial need, we come up with solutions, whatever they may be. In our financial institutions group, we've done a lot of deals that range between rescues and stabilizations. That's something we focus on.

But it can't hurt.

I think that's perhaps the case, although we've had relationships with everyone involved. We have a relationship with Citi, although we are not their most prominent law firm. The same with Merrill. We had started to work with CIC before they did their Morgan Stanley investment, and UBS has been a major client for a long time. There were relationships that pre-existed.