Friday, September 25, 2015
Given that the Rural Metro appeal will be heard by the Delaware Supreme Court next week, it's probably appropriate for me to post the abstract to Andrew Tuch's new paper on Banker Loyalty in Mergers & Acquisitions.
Abstract: Investment banks often face conflicts of interest in their role as advisors on merger and acquisition (“M&A”) transactions. In performing their advisory role, are banks fiduciaries of their clients, and thus obliged to act loyally; gatekeepers, and thus required to perform a guardian-like function for investors; or simply arm’s length counterparties with no other-regarding duties? The prevailing scholarly view resists characterizing M&A advisors as fiduciaries, putting faith in the power of contract law and market constraints to discipline errant bank behavior. This Article develops a theoretical account of investment banks as fiduciaries of their M&A clients, showing why they should act loyally toward their clients unless they obtain informed client consent.
Second, the Article develops an analytical framework for assessing what liability rules will best deter disloyalty by investment banks toward their M&A clients. The framework applies optimal deterrence theory, drawing an analogy between bank disloyalty and tortious conduct. It shows why holding only banks liable for disloyalty is unlikely to adequately deter such disloyalty. It suggests the need for fault-based liability rules on corporate directors (of M&A clients) for their oversight of banks and for public enforcement to supplement private enforcement of liability rules.
Applying this framework, the Article assesses recent Delaware decisions, including Del Monte, El Paso, and Rural Metro, generally supporting them but suggesting that private enforcement alone under-deters bank disloyalty and includes certain gaps in liability. It proposes modest but potentially significant doctrinal shifts, including subjecting directors’ decisions to “contract out” of fiduciary protections in engagement letters to heightened judicial scrutiny, and argues for increased regulatory oversight of banks in M&A deals. The Article nevertheless argues against imposing aiding and abetting liability on banks, regarding that doctrine as ill-suited to deterring bank disloyalty and, to the extent it hinges on treating banks as gatekeepers, as lacking theoretical justification.
Tuesday, November 4, 2014
In the context of a merger and in the making of other decisions, boards are entitled to rely on advice from experts and advisors. When they do so in good faith, board members are "fully protected" to use the words of 141(e). In the wake of Rural Metro, bankers now seem to feel that the target is on them and that they will forever be liable for bad choices of boards. Not so. Chief Justice Leo Strine has posted a paper that lays out some straightforward advice for legal and financial advisors in the wake of Rural Metro. In short, if you do the right thing by your clients, you won't have anything to fear:
This article addresses what legal and financial advisors can do to conduct an M&A process in a manner that: i) promotes making better decisions; ii) reduces conflicts of interests and addresses those that exist more effectively; iii) accurately records what happened so that advisors and their clients will be able to recount events in approximately the same way; and iv) as a result, reduces the target zone for plaintiffs’ lawyers
Chief Justice Strine sums up the problem facing independent directors in going private transactions in the following way:
The worst of all worlds is for independent directors to wake up one day, and find that they not only cannot rely upon the impartiality of management, but that management has also co-opted the company’s long-standing financial and legal advisors, so all of the
most knowledgeable sources of advice are suspect.
When that happens the independent directors must get the strongest possible outside advisors. But often, this does not happen. Instead of getting the best advisors, they often get second- or third-rate financial and legal advisors, while management (advantaged already by its deep knowledge of the company) arms itself with the best.
This is a DANGER SIGNAL, akin to the one at Niagara about the approaching falls. You don’t guard Dwight Howard with Nate Robinson — however much you enjoyed their teamwork in the NBA slam dunk contest a few years ago. If independent directors get weak advisors, they will screw up. They will not do right by the stockholders, they will get sued, and they may lose or at the very least, get publicly embarrassed.
This paper is well worth reading for a number of reasons, including its forthright advice to directors and their advisors. For example, independent directors are well served by examining red-lined versions of the merger agreement. They are also well served by red-lined versions of the financial advisor's power point presentations where changes can happen, but are often overlooked because they are not highlighted or brought to the attention of independent directors:
I am told that the United States of America’s technology capacity is not sufficient to allow for the production of a legible PowerPoint redline or compare rite version. Count me as patriotic. My law clerks over the years have demonstrated an ability to do a compare rite version of most anything. If this is the only hurdle, I believe our nation is capable of vaulting it. Only someone who does not like hot dogs, hamburgers, cheesesteaks, lobster rolls, clam chowder, shrimp and grits, jambalaya, pit beef sandwiches, brisket, barbecue ribs, Good Humor ice cream bars, spaghetti and meatballs, fish tacos, Kentucky Fried Chicken, or things fried at state fairs could question our nation’s ability to do this; in other words, only someone who despises America itself.
Download it and read it for your clients' sake.
Friday, June 20, 2014
Bill Bratton and Michael Wachter have a new paper, Bankers and Chancellors, on a topic that has attracted my attention over the past few weeks - liability of bankers for aiding and abetting board fiduciary duty violations in Revlon. Here's the abstract:
Abstract: The Delaware Chancery Court recently squared off against the investment banking world with a series of rulings that tie Revlon violations to banker conflicts of interest. Critics charge the Court with slamming down fiduciary principles of self-abnegation in a business context where they have no place or, contrariwise, letting culpable banks off the hook with ineffectual slaps on the wrist. This Article addresses this controversy, offering a sustained look at the banker-client advisory relationship. We pose a clear answer to the questions raised: although this is nominally fiduciary territory, both banker-client relationships and the Chancery Court’s recent interventions are contractually driven. At the same time, conflicts of interest are wrought into banker-client relationships: the structure of the advisory sector makes them hard to avoid and clients, expecting them, make allowances. Advisor banks emerge in practice as arm’s length counterparties constrained less by rules of law than by a market for reputation. Meanwhile, the boards of directors that engage bankers clearly are fiduciaries in law and fact and company sales processes implicate enhanced scrutiny of their performance under Revlon. Revlon scrutiny, however, is less about traditional fiduciary self-abnegation than about diligence in getting the best deal for the shareholders. The Chancery Court’s banker cases treat conflicts in a contractual rather than fiduciary frame, standing for the proposition that a client with a Revlon duty has no business consenting to a conflict and then passively trusting that the conflicted fiduciary will deal in the best of faith. The client should instead treat the banker like an arm’s length counterparty, assuming self-interested motivation on the banker’s part and using contract to protect itself and its shareholders. As a doctrinal and economic matter, the banker cases are about taking contract seriously and getting performance incentives properly aligned, and not about traditional fiduciary ethics. They deliver considerably more than a slap on the wrist, having already ushered in a demonstrably stricter regime of conflict management in sell-side boardrooms. They also usher in the Delaware Chancery Court itself as a focal point player in the market for banker reputation. The constraints of the reputational market emerge as more robust in consequence.
Sunday, March 10, 2013
Joe Nocera in the Times today unearths some Goldman emails about the eToys IPO from the dotcom era. eToys raised $164 million in a 1999 IPO and then subsequently failed. The story is familiar by now. The IPO was underpriced and Goldman spun shares off to preferred clients. After the company failed, creditors sued. It's emails produced in connection with that suit that Nocera uncovered. The emails and creditors raise an important question: who was Goldman working for during the IPO?
The plaintiffs charge that Goldman Sachs had a fiduciary duty to maximize eToys’ take from the I.P.O. Instead, Goldman purposely set an artificially low price, so that its real clients, the institutional investors clamoring for the stock, could pocket that first-day run-up. According to the suit, Goldman then demanded that some of those easy profits be kicked back to the firm. Part of their evidence for the calculated underpricing of eToys, according to the plaintiffs’ complaint, was that Lawton Fitt, the Goldman executive who headed the underwriting team and was thus best positioned to gauge the market demand, actually made a bet with several of her colleagues that the price would hit $80 at the opening.
If you are interested in learning more about this kind of thing, Sean Griffith has a good article on the practice of spinning in IPOs that appeared a couple of years in the Brooklyn Law Review.
Thursday, January 24, 2013
For those of you paying attention to the back and forth related to the H-P/Autonomy acquisition, the question of the potential liability of advisors has popped up more than a couple of times. How could H-P's advisors (investment bankers, lawyers, and accountants) let slip by the alleged accounting fraud that caused H-P to write down more than $5 billion? Close on the heels of that question is whether the advisors should face any liability for not picking up on the fact that Autonomy might not be a good candidate for an acquisition.
Well, for a partial answer as to the liability exposure of M&A advisors when the transaction goes wrong look no further than Baker v. Goldman Sachs, just decided by a jury in federal district court in Boston. There, the founders with Goldman's assistance sold their company, Dragon Systems to Belgium-based Lernout & Hauspie for $580 million in L&H stock. Not long after the transaction closed, fraud at the acquirer was discovered and the acquirer quickly went bankrupt leaving Dragon stockholders holding worthless stock.
Having lost everything, including their tech company, founders Janet and Jim Baker sued Goldman for allegedly failing in its duties to them, their clients, when it brokered the deal. Here's the original complaint (Baker v Goldman) - filed in state court and then removed to federal district court. The jury heard the evidence and the arguments in this case and found that Goldman had not breached any duties to the Bakers.
If H-P is thinking about going after its advisors for its ill-fated Autonomy deal, it will have to be more successful than the Bakers were in convincing a jury that M&A advisors should bear liability for a deal gone wrong.
Monday, December 3, 2012
The Chancery Court approved a settlement in the El Paso case. Here's the El Paso Settlement. Something I thought was interesting - the transaction attracted 22 lawsuits - 13 in Delaware, 8 in Texas, and one in New York. That's quite a crowd. Then again, the facts in the case were the type that made it an attractive target for litigation. In the settlement, El Paso will pay $110 to the class fund and Goldman will give up its $20 million fee. Plaintiff counsel received $26 million in fees to split amongst all the counsel.
Wednesday, March 7, 2012
The El Paso transaction is getting uglier. Now that the vote has been delayed for a couple of days and Goldman has been publicly dragged out for criticism in dealing with the conflicts of interest, the focus has turned to the lawyers.
On that count, according to the WSJ, El Paso's lawyers say, don't look at us! We told El Paso to dump Goldman and they didn't listen to us:
Energy company El Paso Corp.'s decision to maintain Goldman Sachs Group Inc. as an adviser last year amid deal negotiations was made over the objections of El Paso's legal counsel, Wachtell, Lipton, Rosen & Katz, people familiar with the matter said.
Wachtell urged El Paso not to retain Goldman because, among other things, the bank had a 19% stake in Kinder Morgan Inc.
El Paso raises a legitimate question about the role of legal counsel in managing risks and conflicts in these kinds of transactions. Of course, it's ultimately up to the client which risks it wants and is willing to bear. It may well be that legal counsel is limited to simply raising issues. But, one lesson of El Paso might also be that legal counsel need to be more assertive in pointing out and managing investment banker conflicts when those conflicts generate risks for their corporate clients. With respect to El Paso, one might well think that El Paso's legal counsel should have been more aggressive in ensuring that when El Paso brought in a second investment bank to cleanse the Goldman conflict that the terms of that engagement created more freedom for the second banker to reject the preferred Goldman transaction and propose an alternative.
Conflicts will forever be with us, but we need to be better about dealing with them. Nothing new there, I suppose.
BTW: Steven Davidoff at The Deal Prof has a very good post on the problem of CEO narcissism. It's a real risk and one that legal counsel need to keep in mind. Just another headache for legal counsel...a client who believes they are morally entitled...
Tuesday, September 8, 2009
Foulds, a clerk for Vice Chancellor Parsons, has a paper on conflicts of interest in stapled financing. Stapled financing is a practice in which the seller's advisor offers potential acquirors financing to undertake an acquisition. Of course this is a practice where there are serious potential conflicts of interest because in a competitive setting a seller's advisor has an incentive to favor a buyer who will take the financing over a buyer who won't. The Delaware Chancery Courts have looked warily at the practice and it's been the subject of some discussion by practitioners. Hey, I've even got stapled financing on my list of "to do" papers.
Friday, August 7, 2009
On August 3, 2009, the SEC proposed for comment a new rule under the Investment Advisers Act designed to address alleged “pay to play” practices by investment advisers when seeking to manage assets of government entities.
If adopted in its current form, the new Rule would prohibit investment advisers from
- providing advisory services to a government entity for compensation for two years after the adviser or certain of its associates make a contribution to a government official who can influence the entity’s selection of investment advisers.
- making any payment to a third party to solicit investment advisory business from a government entity.
The proposed Rule will affect virtually all private investment fund managers. It takes aim at alleged “pay to play” abuses in New York and New Mexico and is intended to address policy concerns that such payments (i) can harm government pension plan beneficiaries who may receive inferior services for higher fees and (ii) can create an uneven playing field for advisers that cannot or will not make the same payments.
Friday, June 26, 2009
The internal e-mail disclosed as part of the House Oversight Committee's hearings on the BAC/Merrill deal make for some interesting reading. In the exchange below Scott Alvarez, General Counsel for the Federal Reserve Board, lays out the major legal issues surrounding the last minute "MAC-attack" by Lewis. He correctly identifies the disclosure issue with respect ML's losses as the real hot button legal problem for Lewis.
From: Scott Alvarez
To: [Ben Bernanke]
Date: 12/23/08, 10:18AM
Shareholder suits against management for decisions like this are more a nuisance than successful. Courts will apply a “business judgment” rule that allows management wide discretion to make reasonable business judgments and seldom holds management liable for decisions that go bad. Witness Bear Stearns. A different question that doesn’t seem to be the one Lewis is focused on is related to disclosure. Management may be exposed if it doesn’t properly disclose information that is material to investors. There are also Sarbanes-Oxley requirements that the management certify the accuracy of various financial reports. Lewis should be able to comply with all those reporting and certification requirements while completing this deal. His potential liability here will be whether he knew (or reasonably should have known) the magnitude of the ML losses when BAC made its disclosure to get the shareholder vote on the ML deal in early December. I’m sure his lawyers were much involved in that set of disclosures and Lewis was clear to us that he didn’t hear about the increase in losses till recently.
All that said, I don’t think it’s necessary or appropriate for us to give Lewis a letter along the lines he asked. First, we didn’t order him to go forward – we simply explained our views on what the market reaction would be and left the decision to him. Second, making hard decisions is what he gets paid for and only he has the full information needed to make the decision – so we shouldn’t take him off the hook by appearing to take the decision our of his hands.
Let me know if you’d like any more information on this.
From: [Ben Bernanke]
To: Scott Alvarez
Date: 12/23/08, 11:08AM
Thanks, Scott. Just to be clear, though we did not order Lewis to go forward, we did indicate that we believed that [not] going forward would detrimental to the health of (safety and soundness) of his company. I think this is remote and so this question may be just academic, but anyway: What would be wrong with a letter, not in advance of litigation but if requested by the defense in the litigation, to the effect that our analysis supported the safety and soundness case for proceeding with the merger and that we communicated that to Lewis?
From Bernanke's response, it's pretty clear that while the Fed didn't order BAC to close the deal, they probably told Lewis that if he decided not to close the deal that the world economy would implode and it would be all his fault. Hmm. Tough choice. Tough choices like these are just examples of the "Big Deal" in action.
On the other hand, to the Chairman's question about preparing a letter to help with Lewis' potential defense in any lawsuit - through the combined wonders of e-mail and discovery, the letter he thinks might be helpful isn't required!
Recap of Bernanke's testimony:
Sunday, September 16, 2007
I previously celebrated the Reddy Ice deal and the joys of M&A by proclaiming Reddy Ice's slogan "Good Times are in the Bag", the day the company announced that it would be acquired by GSO Capital Partners for $681.5 million in a deal valued at $1.1 billion including debt. I should have known better -- it now appears that the celebration might have been a bit too soon. Last week Reddy Ice filed its definitive proxy statement for the transaction. The transaction history discloses a deal in crisis with Reddy Ice being hit by shareholder protests against the deal by Noonday Asset Management, L.P. and Shamrock Activist Value Fund L.P., the company's results for July coming below budget and recent guidance for 2007, and GSO proclaiming that it needed more time to finance the deal given the state of the debt markets and Reddy Ice.
In light of these problems, the parties ultimately agreed to amend the merger agreement to cap the future dividends Reddy Ice could pay while the transaction was pending, extend GSO's marketing period for the debt financing, move up the date of the Reddy Ice shareholder meeting to October 15, 2007, and reduce the maximum fee payable to GSO if Reddy Ice's shareholders rejected the transaction from $7 million to $3.5 million. Notably, Reddy Ice backed away from its initial position vis-a-vis GSO that it required an extension of the go-shop period and a postponement of the shareholder meeting in exchange for these amendments. For those who don't believe that private equity reverse termination provisions will be a factor in this Fall's deal renegotiations, I suggest you read this transaction history very carefully. The Reddy Ice board specifically cites its fears that GSO would simply walk from the transaction by paying the reverse termination fee of $21 million as a factor in its renegotiation. Note that this amendment still preserves this option.
Now Morgan Stanley is objecting to the amendment. MS has agreed to provide GCO with debt financing for this transaction, and MS is claiming that the merger amendment was entered into without its consent thereby disabling its obligations under the commitment letter, a fact MS is reserving its rights with respect thereto. MS agreed to a $485 million term loan facility, an $80 million revolving credit facility, and a $290 million senior secured second-lien term loan facility. GSO and RI are disputing MS's claim and the transaction is not contingent on financing, i.e., unless it claims a MAC GSO has no other choice but to take this position. The MS debt commitment letter is not publicly available but they are likely relying on the following relatively standard clause:
[Bank] shall have reviewed, and be satisfied with, the final structure of the Acquisition and the terms and conditions of the Acquisition Agreement (it being understood that [Bank] is satisfied with the execution version of the Acquisition Agreement received by [Bank] and the structure of the Acquisition reflected therein and the disclosure schedules to the Acquisition Agreement received by [Bank]). The Acquisition and the other Transactions shall be consummated concurrently with the initial funding of the Facilities in accordance with the Acquisition Agreement without giving effect to any waivers or amendments thereof that is material and adverse to the interests of the Lenders, unless consented to by [Bank] in its reasonable discretion. Immediately following the Transactions, none of Borrower, the Acquired Business nor any of their subsidiaries shall have any indebtedness or preferred equity other than as set forth in the Commitment Letter.
I am not involved in the bank finance industry these days, but still, it is hard to see how this amendment is adverse to the position of MS (assuming that the clause in their debt commitment letter is similar to the one above). If anything, the extension of the marketing period is beneficial to MS. The remainder of the amendment does not appear to effect MS except perhaps the dividend provision, but GSO can always fund that if necessary. But, Marty Lipton -- a man much smarter than me -- was recently on the wrong side of this debate when he made a similar argument in the context of the Home Depot supply deal, though that deal was more substantially renegotiated. Ultimately, MS's position is likely similar to one taken by banks in the recent Home Depot and Genesco deals -- they are using ostensible contractual claims to attempt to renegotiate deals that no longer are attractive and they are likely to lose money on. Here, based on a number of big assumptions, MS's claims seem a bit over-stated, though it may be enough to engender a further renegotiation of the deal premised upon MS's implicit threat to walk. Good Times are NOT in the Bag.
Final Note: In a developing market with a number of situationa like this, MS is taking a shot at this strategy with a lower priority client first. I doubt they would take the same position with KKR.
Thursday, June 28, 2007
On the heels of the handwringing on the plight of today's investment banker in Jonathan Knee's the Accidental Investment Banker, William Cohan has an op-ed in today's Financial Times entitled Shed no Tears for the Legendary Wall Street Banker. Cohan, who authored The Last Tycoons: The Secret History of Lazard Frères & Co., writes:
So how are all those overpaid and overworked M&A bankers feeling these days? Not so great, in fact. At the very same moment when they have never been busier - flying round the world in private jets to attend infinitely ponderous and desperately important meetings - M&A advisory revenue has never been more irrelevant to their firms' bottom lines.
He goes on to make the now common observation about the demise of brand-name bankers and the rise of private equity as a force minimizing the need for M&A bankers. And he quotes one corporate lawyer as stating that "Bankers are [now] sitting in coach." Well, there is schadenfraude for you.
But the thing that caught my eye is the common-theme complaint here about advances, technology etc. making the traditional role of M&A investment banker less relevant and the need for reinvention. Well, I think the foregoing need is one that every white collar worker today has to deal with. Blue collar workers are in a worse position as they find it harder to reinvent themselves. Welcome to the real world M&A bankers.
Tuesday, May 29, 2007
Archstone-Smith today announced that it agreed to be acquired by Tishman Speyer and Lehman Brothers, in a transaction valued at approximately $22.2 billion. The group will pay $60.75 per share in cash. Showing yet agin the depths of our capital markets, the transaction is not conditioned on receipt of financing. The CEO of Archstone, R. Scot Sellers, has agreed to stay with the newly-private company and agreed to terms of a new employment agremeent effective upon the completion of the acquisition.
I'll have more once the merger agreement and the terms of the CEO Sellers' new employment agreement are made public.