maybe all is not fair in love and investment banking.
For the last several months, regulators have been on Wall Street's
back about "fairness opinions," those conflict-ridden fig leaves that
banks provide to clients to justify a proposed merger or acquisition.
The National Association of Securities Dealers has just finished
gathering comments from the public on how to change the practice and is
expected to set new rules for fairness opinions soon, possibly in
concert with the Securities and Exchange Commission.
Fairness opinion reform is a contentious issue on Wall Street. After
all, it represents a big business - and is a big part of an even bigger
business, merger advice. Typically, investment banks that advise a
company on a deal also issue a fairness opinion proclaiming that the
deal is fair to shareholders and within the parameters of market values.
You don't have to be Eliot Spitzer to see the conflict of interest here:
banks are paid on a contingent basis for their advice, so they only get
paid if the deal gets done. That's a mighty big incentive to
rubber-stamp a deal - any deal - as "fair."
Most shareholders probably don't realize that fairness opinions were
never meant to be fair. They're really just insurance policies for
boards of directors to protect themselves against shareholders who sue.
The genesis of fairness opinions is a 1985 Delaware Supreme Court ruling
that said ordering up an opinion from a bank was a valid way to defend
against accusations that a board did not provide its "duty of care."
Ever since, boards have routinely asked for fairness opinions on most
So, as regulators consider reforms, here's one way to start the ball
rolling: any company's disclosure about receiving a fairness opinion on
a deal should come with a disclaimer that fairness opinions should not
be considered when voting on a transaction. The disclaimer should also
point out that a reason the board requested a fairness opinion was for
protection against shareholder lawsuits. By stating this upfront, much
of the conflict is diffused.
But there's more that can be done. Companies should also disclose the
fees they are paying banks for their advice and for the fairness
opinion. They should also reveal what other business relationships they
have with the banks and the total amount in fees paid to the bank for
the last three years.
Banks usually don't like to disclose the fees they have received -
often company filings say the adviser was paid a "customary fee." It is
not that the banks don't want the shareholders or the public to see that
they are getting paid a fortune. The dirty little secret is that they
often don't want the public or their competitors to know how
embarrassingly little they are getting paid, doing the work for a
pittance just to get credit in those all-important Wall Street rankings
known as league tables.
As part of the reform measures, corporate directors should also be
required to pledge that they have been presented with not just the
fairness opinion but also with all of the potential conflicts of
interest with the bank providing the opinion. This way, shareholders
will know that the directors did their evaluation with all the proper
information and took into account the possible conflicts when
considering the advice of the advisers. Such a step would also help
protect the directors, too.
Beyond simple disclosures, there are a couple of areas where even
more change must occur. Banks that have connections to both sides of a
deal should not be allowed to provide an opinion at all. For example, a
number of banks act as advisers to a seller and also lend money to the
buyer to finance the deal. This is called staple financing in the
industry's parlance, and this column has been critical of the practice
The appearance of a conflict is so blatant, it's farcical to believe
that a fairness opinion from a bank playing both sides could provide any
comfort to shareholders and any protection in court for board members.
The same goes for banks providing fairness opinions to themselves on
J. P. Morgan Chase wrote its own fairness opinion for its $58
billion acquisition of Bank One - c'mon, guys.
Wall Street may initially blanch at these reforms, but they could
turn out to be a boon for business: companies are more likely to ask for
second and third opinions from different banks just to cover themselves
- and that could produce fairness opinions that are really fair.