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The Shareholder Forum™
The Shareholder Forum supports investor interests in corporate
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Initiated in 1999 by the CFA Society of New York (at the time known as
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corporate investment banker
as guest chairman to address the professional interests of its members,
and independently supported by Mr. Lutin since 2001, Forum programs have
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orderly reviews of issues relevant to long term investor interests.
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NOVEMBER 24, 2003
|A Fair Deal --
But For Whom?
Fairness opinions in acquisitions are rife
with conflicts -- and coming under fire
Even a first-time homebuyer knows the drill: Don't take the word of a
real estate agent that the price is fair. As everyone knows, the agent
gets a big commission to make sure the sale closes -- no matter the price.
Instead, get an appraiser who has no financial stake in the sale. Lenders
won't even fork over the money unless an independent appraisal is in hand.
But when publicly traded companies change hands, objectivity can be in
short supply. In fact, in many cases the investment bank that brought a
deal to a company is the same firm signing off on the fairness of the
price -- and collecting a fat fee when the transaction is closed.
Such "fairness opinions" underpin mergers and acquisitions of any size on
Wall Street. Some are written by independent firms unconnected to the
deal, but the majority aren't. And the conflicts of interest inherent in
them -- with banks racking up millions of dollars in fees by acting
simultaneously as agents and appraisers -- have been an open secret on the
Street for years.
Critics can point to a raft of other problems, too: The opinions are
loaded with legal disclaimers. They are often out of date by the time
shareholders vote on the deal. And they are so narrowly focused on the
specifics of the agreement being evaluated that they don't even address
whether directors could have secured a better deal. Says Charles M. Elson,
corporate governance professor at the University of Delaware: "These are
inherently unfair documents."
Now the tide may be turning against these tainted opinions. New York
Attorney General Eliot Spitzer, who led the attack on Wall Street's
research conflicts last year, said earlier this year that fairness
opinions have caught his eye. With his plate full of mutual-fund cases, he
hasn't taken any action, but he's expected to pursue the issue eventually.
The Securities & Exchange Commission is also interested. "This issue isn't
going away," says Arthur H. Rosenbloom, a managing director of New
York-based CFC Capital LLC, which prepares fairness opinions only for
fixed fees and not for contingency payments.
UNDER THE RADAR
If fairness opinions are so problematic, why do lawyers for boards of
directors insist on them? Simple: They give directors a shield in court
when unhappy shareholders sue. The opinions are evidence that the
directors checked with outside experts to make sure that the deal is fair
to the shareholders whom they represent. They became popular after a
Delaware court found a board of directors negligent in 1985 for approving
in two hours the sale of a company at a lowball price. Today, corporations
print the opinions, complete with pages of sophisticated-looking analysis,
in the proxy statements they send to shareholders urging them to approve
But valuing a business is a very subjective process. That means there's
lots of wiggle room to make sure the numbers produce the answer that
greases the deal. "You begin with science, and then you end up with art
and judgment calls," says Rosenbloom.
Consider AXA Financial Inc's (AXA
). $1.5 billion offer for insurance company MONY Group Inc. (MNY
). on Sept. 17. MONY shareholders would get a 7% premium on where the
stock had been trading, but the price was still far below the value of
MONY's net assets. Three major shareholders complained that the price was
too low, but MONY's investment bank, Credit Suisse First Boston (CSR
), had issued a fairness opinion saying the price was right. How so?
First, according to the proxy, it marked down MONY's assets, relying on
the views of MONY managers who would be in line to cash out with golden
parachutes if the deal closes. CSFB, which noted MONY's poor past
performance, said it was worth far less than the median paid for assets in
insurance transactions in the past five years. If the deal is signed, CSFB
will reap a $15 million fee, the proxy says. CSFB declined to comment.
Some of the more dubious opinions involve smaller companies that slip
under the radar of institutional investors (and the financial media). In
May, Johnstown (Pa.)-based Crown American Realty Trust got a $386 million
stock offer from Pennsylvania Real Estate Investment Trust, a rival owner
of shopping centers in the mid-Atlantic states. Wachovia Securities (WB
), serving as Crown's banker, found that the offer was fair, even though
it carried a discount rather than a takeover premium -- it was worth 4%
less than Crown's average stock price the previous four weeks. The
agreement, which shareholders approved overwhelmingly on Nov. 11, will
also cut the dividend yield to Crown shareholders from 8% to 7.2%,
according to Gregory P. Taxin, chief executive of proxy-voting consultant
Glass, Lewis & Co. in San Francisco.
Wachovia, which stands to earn $4 million when the deal closes this month,
justified the price with anything but precision: It came up with three
different price ranges broad enough to accommodate almost any conceivable
offer. And, says Taxin, Wachovia used different valuation methods than it
had last year to appraise another REIT, Apple Suites Inc. "It appears
Wachovia is selecting methodologies that serve the purpose of reaching a
preordained conclusion," says Taxin. Says Wachovia spokeswoman Amy Hyland:
"As a firm, we stand by the integrity of our fairness-opinion process."
For their part, investment bankers defend fairness opinions. They write
the opinions knowing that they will face scrutiny from sophisticated
institutional investors. And they say they manage the conflicts by having
special committees of top officers review the opinions. What's more,
courts have generally agreed that because the opinions are written for
directors, the banks have no obligation to shareholders. Some bankers say
hiring independent appraisers to write the opinions would only stall deals
and add to the risk of insider trading.
But these arguments carry less weight now. Corporate directors are
essentially under orders from regulators to question the motives of
virtually everyone hired by their companies. Marjorie Bowen, managing
director at Houlihan Lokey Howard & Zukin in Los Angeles, a boutique
investment-banking firm that does not receive contingency fees with 90% of
its opinions, says directors at big companies considering deals are now
asking more often for independent advice than they were a year ago.
Some critics want to turn to the home-appraiser model. Elson, the Delaware
professor, recently joined with Rosenbloom to circulate a paper arguing
for professional standards for deal appraisers, much as real estate
appraisers have standards that they must honor if they value a property
financed by a bank. Will investment banks go for it? Maybe, especially if
Spitzer and the regulators in Washington give them a nudge.
Henry in New York