All’s Fair in M&A?

Judges and regulators are taking aim at conflicted "fairness" opinions.

When TCI Corp. agreed to be acquired by AT&T in 1998, TCI’s board got a fairness opinion on the proposed transaction from the same investment bank that recommended the $54 billion deal, Donaldson, Lufkin & Jenrette Inc. Once the deal was complete, TCI paid DLJ a handsome success fee of $40 million.

Such an arrangement has been typical since 1985, when the Delaware Supreme Court prodded dealmakers to start seeking third-party opinions of a transaction’s fairness. What could be easier than getting the opinion from the investment bank that did the deal? But that could change, depending on the outcome of a shareholder lawsuit before the Delaware Chancery Court. The suit charges that because TCI’s board did not hire an independent third party to produce the fairness opinion, the board violated its fiduciary duty to holders of TCI’s tracking stock. Last December, Chancellor William B. Chandler III denied a defense motion to dismiss the suit.

Dealmakers were quick to react to the ruling. One New York law firm, Wachtell, Lipton, Rosen & Katz, reportedly sent a memo to clients warning that Chandler’s ruling jeopardized practices commonly used in merger transactions. William McGuinness, a litigator in the New York office of Fried, Frank, Harris, Shriver & Jacobson LLP, calls the decision “an important road map on how not to handle a number of issues.”

McGuinness adds that he expects the decision, along with that in another Delaware Chancery Court case last summer (see “Better a Paper Clip” at the end of this article), to prompt more directors to seek second opinions. Says Philip Wisler, a Philadelphia-based managing director in the advisory firm Duff & Phelps LLC: “Conflicts of interest are really under a spotlight.”

Fairness opinions, of course, are supposed to ensure that shareholders receive a fair price for their holdings. But such opinions can add to the cost of deals, and that cost won’t be recovered if a deal falls through, as John Malone, TCI’s chairman and CEO at the time, pointed out to the Delaware court. “The committee had an interest in not having the big expense that was being borne by the company absent a deal,” Malone testified.

Chandler, however, rejected that thinking. Getting a fairness opinion from the investment banker that recommends a deal might be cheaper and more convenient, he wrote, “but its potentially misguided recommendations could result in even higher costs” to the target company’s shareholders.

Enter the Activists

The Delaware Chancery Court isn’t the only powerful critic of fairness opinions offered by sources that have conflicts of interest. Last year, the NASD, the self-regulatory trade group that represents investment banks and other brokers and dealers in securities (and was formerly known as the National Association of Securities Dealers), proposed new rules that require members to disclose any conflicts they have when issuing such opinions. The rules await approval by the Securities and Exchange Commission.

The NASD took this action after seeking guidance from a variety of industry participants. But some, including institutional investors such as the California Public Employees’ Retirement System, sought outright bans on deal advisers offering such opinions. And others besides investors believe the NASD’s rules don’t go far enough. One such critic is Jeffrey Williams, founder of a valuation firm that bears his name. Like a growing number of such firms, New York–based Jeffrey Williams & Co. makes a point of avoiding business that would compromise the independence of its opinions. Another such firm is Duff & Phelps, which no longer issues credit ratings and merged with S&P’s Corporate Value Consulting Business last year expressly to beef up its valuation business.


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