In the biggest U.S. merger this year, J.P. Morgan
Chase & Co. announced last January it would acquire Bank One Corp.
To assure investors it was paying a fair price, J.P. Morgan told them in
a proxy filing it had obtained an opinion from one of "the top five
financial advisors in the world."
The in-house bankers at J.P. Morgan endorsed the $56.9
billion price -- negotiated by their boss -- as "fair."
But during the negotiations, Bank One Chief Jamie Dimon
had suggested selling his bank for billions of dollars less if, among
other conditions, he immediately became chief of the merged firm,
according to a person familiar with the talks. That suggestion wasn't
accepted by J.P. Morgan.
To some J.P. Morgan shareholders who are now suing over
the deal, it raises the question: Did Morgan's in-house evaluators
endorse a higher price to keep CEO William Harrison in power longer?
"Only by retaining a conflicted financial adviser could Harrison control
the process and justify paying more than was necessary for Bank One,"
the investors said, in a pending suit in Delaware Chancery Court.
J.P. Morgan denies that assertion, according to a
spokesman, who said that executives at the bank would have no comment.
J.P. Morgan, which had disclosed its use of an in-house advisory team,
says it made sense to use bankers intimately familiar with its business,
and that the board's lawyers said it wasn't necessary to get another
opinion. The bank says it negotiated the best deal possible given that
it didn't want to hand immediate control to a newcomer. It also says
that other shareholders -- from Bank One -- have sued claiming the price
was unfairly low.
Boards of directors get "fairness opinions" to show
they've independently checked out the price of a deal, thus giving
themselves some legal protection from unhappy shareholders. But it is an
open secret on Wall Street that fairness opinions can be anything but
opinion tells a company's board that a deal's terms are fair
Legal protection from an investor claim that a deal was done
without due care.
few hundred thousand dollars to a few million.
• Bankers may have
incentive to call a deal fair because most of their
advisory fee is paid only if deal closes.
• Bankers' fee is
tied to the deal's price.
• Bankers may
support a deal where executives will personally profit,
in hopes of securing future work.
• Bankers use
financial data supplied by client that wants deal to go
• When deal maker
is a bank, its own bankers often write the fairness
Investment bankers frequently write fairness opinions
for clients with whom they have longstanding business ties and with whom
they hope to continue having relationships. Indeed, an opinion is
commonly written by the very bank that suggested the merger or
acquisition in the first place -- and that now is acting as adviser on
In such cases, the investment bank stands to collect a
far larger fee if the deal goes through than if it does not. If it goes
through, the advisory bank will collect a "success fee" that dwarfs the
opinion fee. And, in a further incentive to bless high-priced deals, the
success fee is usually tied to the deal's price.
As if these potential conflicts weren't enough, when
the merging parties are financial firms, the parties typically get their
fairness opinions not from outsiders but from folks right down the hall.
Now, securities regulators may weigh in. The National
Association of Securities Dealers has launched an enforcement inquiry
into conflicts that can arise with fairness opinions. The NASD is also
seeking comment on potential new rules requiring more disclosure of the
financial incentives that bankers and their clients have for endorsing
deals. There isn't any move to do away with the opinions.
Fairness opinions often vet prices that were set by
company executives who, the bankers know, have strong financial
incentives to push through a deal. The opinions often are crafted at the
last minute, as bleary-eyed bankers scramble to cobble together
projections to justify the final price at an impending board meeting or
In the case of Bank of America Corp.'s recent
purchase of FleetBoston Financial Corp., Bank of America called in
Goldman Sachs Group as adviser the weekend before the deal was
announced. Goldman got $25 million for providing advice, including $5
million for a fairness opinion. Morgan Stanley, which advised
Fleet, also collected $25 million, an undisclosed part of it for its
fairness opinion. The $47.7 billion deal closed April 1.
"Fairness opinions are one of the highest profit margin
businesses on Wall Street. In the BofA-Fleet deal, profitability must
surely be setting new heights," said Thomas Brown, a hedge-fund manager
with a Web site that follows bank stocks, in a column after the deal was
announced. Believing that BofA overpaid, Mr. Brown contended that "the
large dollar payment was necessary to get the names of two prestigious
firms to provide fairness opinions on a questionable transaction."
A spokeswoman for Bank of America says it paid a
premium for Fleet because "we saw value in Fleet that wasn't reflected
in its market price," adding that "investors have also seen this value."
The spokeswoman says BofA believes Goldman was compensated fairly.
Representatives of Goldman and Morgan Stanley declined to comment.
Goldman bankers familiar with the deal say the fee reflected years of
efforts to help BofA identify acquisition candidates.
Investment banks defend fairness opinions, noting that
their own interests sometimes are aligned with those of shareholders.
For example, in cases where the bank is advising a takeover target, it
and the shareholders both benefit from a high price. The bank's fee is
based on the deal's price.
The opinions "are a very useful tool for boards of
directors," says Marjorie Bowen, national director of investment bank
Houlihan Lokey Howard & Zukin's fairness-opinion practice. Though "there
is perception that they are rubber-stamped, people who are not involved
in the procedural aspect of processing and reviewing a fairness analysis
don't understand how seriously the investment banking community takes
NASD Vice Chairman Mary Schapiro says investors place
trust in the opinions without realizing how conflicts may have colored
the authors' judgment. The NASD's scrutiny of the opinion process comes
as mergers-and-acquisition activity is robust; December saw the highest
dollar volume of deals world-wide of any month in more than four years.
Fairness opinions became more common after the Delaware
Supreme Court said in 1985 that they could help a board demonstrate its
"duty of care" in evaluating a transaction. Companies involved in deals
now feel they need to get a fairness opinion as legal protection.
Bankers who write the appraisals don't work from
scratch. They typically use financial projections supplied by the client
and don't vouch for the data. That's one reason attempts to sue
securities firms that provide fairness opinions have often failed.
Courts have noted that they don't constitute formal recommendations to
To say whether a deal is fair, bankers compare it with
others of similar size in the same industry. They may look at the price
as a multiple of earnings, of book value (assets minus liabilities) or
of measures particular to an industry. The banker has plenty of leeway
in choosing how to make the analysis. The method is usually explained in
a proxy statement. The letter itself merely says the price is fair.
If bankers find it hard to conclude that a deal is
fair, they'll often have private discussions with the client.
Here are some issues that have sparked controversy over
The Numbers Game
Fairness reviews can be quite subjective, and bankers
have many ways to slice the data. Consider the projections Piper
Jaffray Cos. used to declare a valuation fair in a battle over Best
Lock Corp., founded before the Depression by a janitor who had invented
locks with a master key and an interchangeable core. Controlling
shareholder Russell Best, a grandson of the founder, bought out minority
shareholders of Best Lock in 1998, triggering a long legal battle.
The board -- Mr. Best and his wife -- said they had the
right to buy out other shareholders without a vote because they
controlled the company. They used a value for the whole company of $58
million. They said this was on the "highest point of the recommended
ranges" presented by Piper Jaffray.
Shareholders sued Best Lock and its board. They alleged
in a Delaware Chancery Court that Piper had agreed to consult with Best
Lock's attorney about the valuation method and not to investigate
further what others might be willing to pay.
Best Lock gave Piper several sets of projections to set
a price. The most pessimistic put future revenue growth at 7%, according
to the suit. That is what Piper used, the suit said, even though Best's
auditors had provided data to a lender describing 10% annual growth in
the 1990s, and even though net income for 1997 was running ahead of
The suit said Piper wouldn't get the last $325,000 of
an advisory fee if it didn't justify the price Mr. Best was willing to
pay. Piper declined to comment. It wasn't a defendant in the shareholder
In 2002, long after Mr. Best had completed the buyout
and just before a trial was set to begin, he sold the company to Stanley
Works. The price was $310 million, of which, according to people
familiar with the matter, about $100 million went to repay Best's debts.
Mr. Best said at the time that the business was more valuable because it
had grown through an acquisition. He settled shareholder litigation for
an estimated $52 million. In total, the minority shareholders got about
triple the compensation that had been endorsed as fair four years
before. Mr. Best couldn't be reached to comment.
Fairness opinions frequently ignore deals the client
company is simultaneously doing with its executives.
A year ago, BSB Bancorp Inc. of Binghamton, N.Y.,
announced it would be acquired by a smaller competitor for $337.6
million. Just before the announcement, BSB's board amended
"change-of-control" agreements for executives. The result was that its
chief executive, Howard Sharp, collected a "severance" package of about
$1.64 million, in addition to his retirement benefits of $2 million,
according to the acquiring bank -- even though the acquirer hired him at
a $450,000 annual salary.
Some critics cried foul, including John Cheevers, an
independent stockbroker in nearby Endicott, N.Y., who had put clients
into BSB stock. He protested to BSB's board that it was selling the bank
for a little over two times book value, while other banks were being
sold for more than three times "book." In addition, the premium BSB
shareholders got was reduced by the fact that part of it was in cash,
triggering a tax bill.
One unhappy BSB shareholder was Rudy Cechanek, an
83-year-old retired engineer who had about $300,000 in BSB stock. He
thought BSB could have fetched a higher price, and he was livid when he
learned that top executives of BSB would get millions of dollars.
BSB got a fairness opinion from investment bank Keefe,
Bruyette & Woods, with which it had an existing relationship. In finding
the sale fair, Keefe Bruyette didn't discuss the payments to BSB's chief
executive. Keefe was able to collect the largest part of its $2.7
million advisory fee only if the deal went through.
"The fairness opinion really bothered me," Mr. Cechanek
says. "The words were there, but the shareholders weren't being treated
very fairly. It was written more to protect the executives who were more
interested in getting the deal done."
Keefe Bruyette declined to comment. Mr. Sharp didn't
return messages left at his home and office. The acquiring bank,
Partners Trust Financial Group Inc. in Utica, declined to comment but
told analysts the deal would over time greatly improve the combined
company's growth prospects. A bank analyst at Ryan Beck & Co., Anthony
Davis, says the price was "discounted for a reason" -- BSB's history of
having poorly performing loans -- and was arguably a good price.
Peter Siris, a hedge-fund manager and longtime investor
and corporate director, says he was blindsided by a bad fairness opinion
when he served as a director of Crown American Realty Trust, a
real-estate investment trust in Johnstown, Pa.
In anticipation of selling Crown, its chairman and
chief executive, Mark Pasquerilla, asked Wachovia Corp.'s
investment bankers in 2002 to structure certain transactions with the
CEO and his family. Crown retained another investment bank, Ferris,
Baker Watts Inc. in Washington, D.C., to render a fairness opinion on
these transactions. They included property swaps and certain cash-flow
obligations that Mr. Pasquerilla owed to Crown. They needed to be
resolved before Crown could be sold.
"The bankers gave us a big fancy book detailing that
everything was fair," Mr. Siris says, and in a telephone board meeting,
directors gave preliminary approval to execute the complex transactions.
But after the vote, Mr. Siris says, he was bothered that "the deal
seemed to benefit the CEO more than the company" by giving him favorable
Mr. Siris and other outside directors retained a lawyer
and notified the Crown CEO they wouldn't give final approval without
additional analyses. These directors, says the lawyer they hired, James
Spitzer, "were concerned about the impartiality of the investment
bankers, who stood to gain $4 million on the deal and had allegiance to
Mr. Spitzer told Wachovia he saw a conflict because one
of its bankers had handled other work for a Pasquerilla family company.
Wachovia would get only a fraction of its $4 million advisory fee if the
deal didn't go through, said someone familiar with the arrangements.
Wachovia offered a new investment-banking team that
hadn't done past work for the family. Mr. Siris, acting as the lead
director at Crown, says he gave this new team a fresh mandate: "You
report directly to the board, not to the CEO. I want an honest fairness
opinion, not one that justifies a bad deal."
Ferris Baker defended its process. "We go through a
rigorous quality-control process on our fairness opinions, and this is
the first I've heard that there was a problem. I'm not conceding there
was a problem," said Ferris Baker's head of investment banking, Richard
Wachovia helped restructure transactions with the CEO's
family and wrote a fairness opinion declaring the revised terms "fair"
to Crown shareholders. Crown had meanwhile been negotiating to be sold
to a rival shopping-mall owner, Pennsylvania Real Estate Investment
Trust. The terms of this sale also were revised, and Wachovia declared
the new ones "fair" as well. They provided about a 25% better price than
before, according to Mr. Siris. In May 2003, Crown's board approved the
sale of the company to Pennsylvania REIT.
"It would have been so easy to be seduced by a fairness
opinion that cheated shareholders," Mr. Siris says. "It took a lot of
work to get the right opinion."
Mr. Pasquerilla, the former Crown CEO, declined to
discuss the deals' specifics but said, "We were all in agreement at the
end of the day. Our board was a tough board; they did the right thing.
This has been a good transaction."
Write to Ann Davis at
and Monica Langley at