All’s Fair in M&A?

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

Even some investment banks are trying to distinguish their valuation opinions from those of larger banks, which have a broader array of services and thus more potential conflicts. Increasingly, for instance, multiline banks such as Citigroup and JPMorgan Chase & Co. promise financing to buyers on deals they have recommended to sellers. While such arrangements, called “stapled financing,” can smooth the way for a deal’s completion, the technique was singled out for criticism last summer in a Delaware Chancery Court decision involving the leveraged buyout of Toys “R” Us, which was arranged and financed by Credit Suisse First Boston.

Conflicts Remain

Following the decision in that case, Goldman Sachs announced it would avoid financing any deals on which it offers a fairness opinion. But that’s not much of a sacrifice for Goldman, since it does relatively little underwriting to begin with. And it isn’t passing up advisory fees on the same deals. That was amply evident when it offered a fairness opinion on the New York Stock Exchange’s acquisition later in the year of the Archipelago electronic trading system. (The investment bank, of course, also has a seat on the exchange. “Goldman was all over that deal,” says Williams.)

Even more-narrowly focused M&A advisory firms, investment boutiques such as Greenhill & Co. and Evercore Partners, can still have conflicts when supplying fairness opinions, even when they are not advisers to the deal in question. That’s because they may seek other, more-profitable types of business, including future M&A advisory work, from the parties to the deal, Williams points out.

But can valuation-only firms make enough profit on fairness opinions for the service to be a viable business in its own right? Williams expects the demand for such opinions will grow both in the wake of Chancellor Chandler’s ruling (even if the lawsuit is ultimately lost) and if the SEC approves the NASD’s rules.

Granted, some academics question the need for such opinions in the first place, arguing that investors should be able to judge for themselves whether a price is fair. Rather than focus on such opinions, these academics contend that courts and regulators should ensure that shareholders’ ability to vote on deals isn’t inhibited by antitakeover mechanisms such as staggered board terms and poison pills. “The answer is to make sure there’s an active market for corporate control,” Larry Ribstein, a law professor at the University of Illinois, recently wrote on his Weblog, Ideoblog. “If companies are auctioned freely, we don’t have to worry as much about getting someone’s opinion as to what the price should be.”

But corporate lobbyists have successfully beaten back SEC proposals to discourage antitakeover devices. Given that, and a legal climate dominated by Sarbanes-Oxley and related efforts to eliminate or at least manage conflicts of interest more effectively, fairness opinions from advisers playing multiple roles are likely to continue to draw criticism. “The independence bubble has expanded,” says Duff & Phelps’s Wisler.

Ronald Fink is a deputy editor of CFO.

Better a Paper Clip

The board of Toys “R” Us fared better than TCI Corp.’s did in Delaware Chancery Court last year. But the Toys board still came in for some sharp criticism by the judge in its case, because it agreed to accept “stapled” financing for its leveraged buyout from Credit Suisse First Boston (CSFB). In such deals, banks representing sellers offer to provide financing to buyers.

Stapled financing, in fact, has become commonplace in M&A transactions during the past 18 months or so, notes Jeffrey Williams, who left Morgan Stanley in 1996 to found Jeffrey Williams & Co., a valuation advisory firm. But that didn’t win Toys or its bank any respect from the chancery court.

“That decision [to provide such financing] was unfortunate,” wrote Vice Chancellor Leo Strine, because it served to create “the appearance of impropriety, playing into already heightened suspicions about the ethics of investment banking firms.” Instead, Strine wrote, CSFB should have “taken the position that its credibility as a sell-side adviser was too important in this case, and in general, for it to simultaneously play on the buy-side in a deal when it was the seller’s financial adviser.” Given CSFB’s refusal to refrain, the judge said “it might have been better” if the board of Toys had declined the bank’s offer. — R.F.


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