Friday, December 7, 2007

True Story

A recent DealBook article questioning the independence of fairness opinions made me chuckle yesterday. It also made me recall an incident from my halcyon past, when I was a bright-eyed, bushy-tailed young investment banker deeply involved in a rather large and rather prominent merger between two publicly traded companies.

As is sometimes the case, the proposed merger had come about in a rather circuitous fashion. My client had been talking to a smaller third party about acquiring them when the eventual merger partner intervened in an attempt to prevent the acquisition. (They wanted control of the small fry themselves.) The two CEOs met over brandy and cigars to hash out a compromise, one thing led to another, and they both decided they had so much in common they set a wedding date right there. We bankers were called in the next day to paper over the deal and put lipstick on the pig, but the particular porker had already been picked out.

For various reasons I will not bore you with here—just in case the SEC Enforcement Division is still reading—it also happened to be the case that, while the other party was approximately twice the size of my client, my client had the upper hand in negotiating the merger. The exchange ratio was set, the various "social issues" (like who got the CEO title and the cutest personal assistant) were nailed down, and the bankers trundled off to our respective Fairness Opinion Committees to get internal sign off on the deal.

Now, for those of you who are not in the know, a "fairness opinion" is something a party to an M&A transaction requests from an investment banker. It usually takes the form of a letter, clotted with all sorts of equivocations, qualifications, and other legalese and supported by reams of analysis on the deal, comparable transactions, and the like, which boils down to Investment Bank XYZ representing to the Board of Directors of Client Company ABC that the transaction under consideration is "fair from a financial point of view." The actual origins of this little deal artifact are lost in the mists of time, but its purpose is very clear: it provides yet one more piece of paper for the Board of a public company to cover its ass, usually from attacks by disgruntled shareholders who feel the Board and management have sold their company down the river.

The clever TED reader will have already figured out that, as such, a fairness opinion is not really an investment banking document at all. It is a legal safeguard, pried kicking and screaming out of the investment bank by the client's corporate lawyers to make sure that someone other than their client is at least potentially on the hook if the deal is challenged. You can just imagine the hissing and spitting, biting and gouging, and other lawlerly shenanigans that take place between company lawyers and the investment bankers over the wording of a fairness opinion, with the lawyers wanting the investment bank to say as much as possible and the investment bankers wanting quite the opposite.

Because investment banks realize that they face some (contestable) legal liability from issuing a fairness opinion, they usually require that the bankers working on the deal prove its "fairness"—at least to the standards of a fairness opinion letter—to a committee of senior M&A bankers who are not otherwise involved in the transaction. In theory, at least, if the deal bankers cannot prove the deal is fair to their client's shareholders, the committee will not approve the letter, and the investment bank has to tell its client it cannot issue one. You can just imagine how much fun that conversation is to have with your client.

So, in the case of the big merger I was telling you about, the final deal was so lopsided in my client's favor that the Fairness Committee meeting was actually rather uncomfortable. I mean, there was no question that the deal was "fair" to my client's shareholders—in the same way that Genghis Khan was adept at striking "fair" bargains for food and supplies from villages his ravening hordes galloped through—but my committee bankers were seriously worried that the other party's investment bank would not be able to say the same. They signed off nonetheless, simply warning the deal team that we might face demands to retrade terms once the other party's Board got the bad news.

Well, it turned out their concern was for nought. The deal sailed through the other party's bank's Fairness Committee, and the Boards made a joint announcement of the proposed merger the following Monday. Problem solved.

Oh, and the other party's investment bank issuing the opinion? Goldman Sachs, of course.

Which is why I find all this hoohah about the independence of fairness opinions rather amusing. You do not really think there is some objective measure of "fairness" in an M&A deal, do you? Do you really think Fidelity Investments and Legg Mason derive a great deal of comfort and guidance from the investment banks' fairness opinion letters filed with a merger agreement?

Not being a lawyer myself, I have never really understood the putative value of these pieces of paper. Either a deal was negotiated in good faith, at arms length, with a rigorous price discovery process, or not. If it was, then of course it was fair: it was the best deal the Board could get for their shareholders at the time. If not, well ... And you will be sure to find this out in the legal discovery process should someone with enough standing and enough outrage challenge the deal in court. I can guarantee you that no Delaware judge worth his salt will take a look at a Goldman Sachs fairness opinion letter and say, "Well, that's settled, then."

Certainly the investment banks have never thought fairness opinions had much value. Parse it how you will, a bank which is getting an advisory fee to close a deal has always thrown in the fairness opinion for free. Investment banks will charge for a fairness opinion if they are brought in specifically for that purpose and that purpose alone—an "independent, third party" look—but they'd all much rather have the success fee. And the DealBook article makes that clear.

No truer words were spoken than those offered by the professional shareholder mentioned at the article's close:
Consider this cynical comment from an unnamed buyside equity analyst who took part in Thomson’s survey. Asked if companies should hire an independent third party to render an additional fairness opinion, the analyst said: “It would not introduce additional integrity into an already flawed process. It would only add to the number of pigs feeding at the trough.”

So here is some free advice to all my friends in Corporate America and the lawyers who advise them from someone inside the sausage factory: Skip the "independent" fairness opinion and spend your time and attention running a rigorous M&A process that will stand up to the light of litigation. You'll save some money, and you'll cover your ass in far more effective armor than empty boilerplate.

© 2007 The Epicurean Dealmaker. All rights reserved.