Investment Dealers' Digest, July 15, 2002 article

INVESTMENT DEALERS' DIGEST

Relationship Or Conflict?
Avital Louria Hahn (avital.hahn@tfn.com)
Jul 15, 2002

Investment banks and their corporate clients have long nurtured close ties, which often include having key executives serve on each other's boards. It has been called "having a relationship."

In today's supercharged atmosphere of corporate scandals, when there are demands for boards of directors to be totally independent, those relationships run the risk of being called something else: "conflicts-of-interest."

Such is the potential of the chummy relationship between eBay Inc. and Goldman Sachs. Meg Whitman, chairman and chief executive of eBay, the most successful Internet company, is also a director on the board of Goldman Sachs, by many accounts Wall Street's most prestigious bank.

Last week, eBay announced it would acquire PayPal Inc. for $1.5 billion in stock. It isn't too surprising to find that eBay chose Goldman Sachs as its banker on the deal. (Morgan Stanley is advising PayPal.)

There's nothing illegal about the arrangement between eBay and Goldman, but some corporate governance experts believe such arrangements have the potential for trouble down the road. And there are several proposals, including one at Nasdaq, that seek to ensure board independence.

For good reason, argue some bankers. "Goldman Sachs has the ability to significantly influence both eBay's condition and Meg Whitman's personal wealth through its provision of financial services, its trading activities and its analyst coverage," said Gary Lutin, an independent investment banker who has led investor initiatives for corporate control and reporting. "Under the circumstances, Ms. Whitman would need to manage the relationship in the context of her responsibility to the interests of eBay and her own wealth. I don't see how that can be done in any way that can be consistent with the director's fiduciary duties to the shareholders of Goldman Sachs."

Some believe Goldman, however, is unlikely to let the relationship influence it. "It would be a very expensive way for Goldman Sachs to ensure business by using one of its board slots to buy investment banking business by putting the CEO of eBay on their board," said Samuel Hayes, Jacob Schiff Professor of Investment Banking Emeritus at the Harvard Business School.

When it comes to Whitman, he thinks the situation is a bit trickier. "It becomes necessary, however, for eBay to demonstrate that they are getting as good a deal from Goldman as they could have gotten from somebody else," explained Hayes.

"Goldman Sachs is arguably one of the best one or two firms on Wall Street," he continued. "It would be hard to criticize eBay for using Goldman unless [the company was] getting a set of terms that was not competitive. It would be important to the shareholders that the management demonstrate that the terms were competitive."

An eBay spokesman defended Whitman's board position, saying that "she carefully considered all possibilities that may develop should she accept the position, and came to the decision that she could competently carry out her responsibilities to each company without compromising either position."

A Goldman Sachs spokeswoman said that the firm has a longstanding relationship as a strategic adviser to eBay that predates Whitman's board appointment. "We have strict guidelines around conflicts and there is adequate proxy disclosure around relationships," she added. Whitman joined Goldman's board in October, 2001.

Goldman's work for eBay goes back to 1998, when it was chosen as the lead underwriter for eBay's $72.5 million initial public offering. In 1994 it led a follow-on offering of eBay stock that raised $1.25 billion, according to Thomson. EBay used Morgan Stanley once, when it acquired Internet Auction Co. Ltd. for $51 million in 2001, but returned to Goldman for the PayPal acquisition.

In addition, Goldman's equity analyst Anthony Noto covers the stock. That, said one banker, could potentially be troublesome for Goldman. "If Goldman Sachs is making a market and providing analyst coverage that influences Meg Whitman's options package, and if the analyst downgrades her stock and she loses $100 million, how ugly is she going to get on the board? This is a problem with all financial services businesses," he said.

Bankers often serve on corporate boards, and corporate officers serve on bank boards. When Salomon Smith Barney got a lead role in the largest IPO ever-the roughly $10 billion IPO for AT&T's wireless unit, bankers noted that AT&T's CEO Michael Armstrong was on Citigroup's board, and Sanford Weill, Citigroup's chief executive, was on the board of AT&T.

"It's not illegal or against any SEC or Nasdaq rules for an individual to sit on the board of a company that does business with your own company," said Paul Hodgson, senior research analyst with the Corporate Library, a corporate governance advocacy organization based in Washington, D.C.

However, he added: "Those companies with the best corporate governance standards would request that either there were no business relationships, or if there were, that there would have to be prior approval from the board of the corporation." Hodgson added that the companies would have to reveal the business relationship in a proxy statement between the CEO and the company that does business with them.

But disclosure or not, some corporate governance experts think that such a relationship could potentially cloud objectivity.

"It used to be that if one person had two masters, that's bad business. If I'm a shareholder in either one of those firms, I would be nervous," said Mark Rubinstein, a finance professor at the University of California at Berkeley. "There may not be any conflict at the moment but [it] may happen later."