Fight over Sculptor hedge fund sale entwined in Daniel Och’s tax affairs
The value of the former Och-Ziff Capital Management has plunged 96% since its 2007 IPO
Sculptor Capital Management explicitly warned investors ahead of its 2007 initial public offering that “conflicts of interest” stemming from a complicated ownership structure could one day pit the hedge fund’s billionaire founder Daniel Och against public shareholders.
That theoretical tension has turned very real in recent weeks as Sculptor — worth $12bn when it listed — aims to sell itself to real estate specialist Rithm Capital for a fraction of the sum.
Och this month attacked the $639mn transaction as bad for shareholders, accusing the board of breaching its fiduciary duty by selling Sculptor on the cheap.
The board has fired back, insisting it struck the best deal possible and alleging that Och has undermined the company out of his own self interest.
The ugly dispute underscores how Wall Street firms dominated by big personalities can have an awkward existence as public companies. It involves complex partnership units and tax agreements that are common among the private asset managers that have listed over the past 25 years.
The latest twist in the saga came late on Wednesday, when Sculptor said it rejected a rival bid to Rithm led by billionaire hedge fund managers including Boaz Weinstein of Saba Capital and Pershing Square’s Bill Ackman. The group had boosted its offer to $12.76 a share, compared with the $11.15 a share agreed with Rithm.
Och, a former star trader at Goldman Sachs, co-founded what was then known as Och-Ziff Capital Management in 1994 as a hedge fund investing across debt, equity and global macro. Its assets eventually peaked at $50bn.
But disappointing results followed the global financial crisis and investor enthusiasm for hedge funds waned. In 2016 the firm paid $412mn to settle charges of bribery in several African countries, which it now says led to Och’s removal as chief executive and Och-Ziff’s rebranding as Sculptor.
In a scorching letter released this week, Sculptor accused Och of orchestrating a campaign of “retribution” and a “well-publicised, years-long smear campaign against the company’s management” since his exit. The firm said Och had taken home $3.3bn in profits and dividends even as Sculptor’s share price collapsed by 96 per cent.
In an earlier securities filing, Sculptor detailed a year-long process to find a buyer for the hedge fund amid what its board said was Och’s distracting meddling.
Sculptor said Och has demanded outsized personal payouts and that his and other founders’ “economic interests diverge in certain respects from those of a public company shareholder”.
The alleged divergence largely stems from layers of partnership units held by Och and other founders that remained in place after the Och-Ziff IPO. Och and other founders owe tax liabilities on their units, costs not borne by public holders of Sculptor’s common stock.
The IPO structure used at Och-Ziff was replicated by several private capital managers and boutique investment banks, crystallising wealth for their founders but also complicating a potential sale down the road.
Several bidders initially made offers for the firm as a whole, but they could not provide a per-share bid because they were unable to count the number of Sculptor’s underlying shares, according to the securities filing.
“The alphabet soup of units was a real issue,” said one deal adviser to Sculptor. “Bidders all had the wrong share counts and no understanding of how those things work. When they saw how the payout waterfall works, they’d be like, ‘I have a ton of different units I didn’t know about and that I have to pay up for.’”
Victor Fleischer, a tax law professor at the University of California at Irvine, told the Financial Times that US investors were more accustomed to traditional corporations which offer more recourse for minority shareholders.
“Publicly traded partnerships have much more complicated structures and may not provide the same level of protection that corporate shareholders receive”, he said.
The board launched its auction at a time when Och was also criticising the company over Sculptor chief executive Jimmy Levin’s pay, which totalled $146mn in 2021. The securities filing described “alternative transaction approaches” and “inducements” aimed at winning Och’s support for a deal.
In one concession, Rithm offered Och and the other founders the chance to keep or “roll over” their stakes in Sculptor’s “class A” partnership units, which would spare Och from a large tax on capital gains. However, Rithm says it is no longer contractually bound to the rollover now that the Och group has publicly criticised its deal.
Rithm will also separately assume $173mn that Sculptor will be obliged to pay Och and other fund founders over several years under what is known as a tax receivable agreement.
Under the terms of the transaction, Sculptor realises corporate tax deductions when Och swaps his partnership units into common stock. Under the TRA, Sculptor pays Och as compensation for the tax benefits from the exchange of units into shares.
Sculptor’s proxy filing said that Och had considered supporting a Rithm buyout, but demanded that it “pre-pay a significant portion” of the $173mn and “reimburse the [Och] group for historical legal fees”. This week Sculptor disclosed that the Och group had already reaped $150mn in TRA payments since the firm’s IPO.
Rithm has assumed the obligation to pay the $173mn even if it does not ultimately generate enough income to need the tax deductions. Still, Och would prefer to have at least a portion of the sum made immediately upon the deal closing, according to securities filings and people familiar with the matter.
“He’s got a $170mn reason to ensure he blocks the deal [and] for Rithm to pay him to go away,” said an adviser to Sculptor. “If you’re sitting there and Rithm is saying ‘I’d like you to support the deal’, these are all parts of the play,” the adviser added.
A representative for Och denied that his personal financial priorities were influencing his public campaign against the Rithm deal, which he has described as the product of a “breach of fiduciary duty” by the Sculptor independent directors.
“It is outrageous that the special committee continues to restrict the [Och group] and other parties from engaging in discussions that could surface a higher offer that would benefit all shareholders,” the representative said.
This week Och demanded that Sculptor release previous bidders from confidentiality agreements in order to spark rival offers and pushed for detailed records on how Sculptor conducted the sale process.
Both Sculptor and Och each say they have made big concessions in order to ease a sale for common stockholders.
Sculptor’s current management said in the securities filing that it had given up $112mn of special class of partnership units they had previously been granted, while Levin had reduced his upcoming pay as well.
A representative for Och said that the founders, including Och himself, gave up $600mn of equity in a 2019 restructuring intended to put the fund on a firm footing following the Africa bribery scandal and allow it to add and retain new talent.