Street's 'Fairness Opinions'
Draw Fire From Calpers
By ANN DAVIS
Staff Reporter of THE WALL STREET JOURNAL
February 8, 2005; Page C1
The nation's largest public pension fund said
regulators should bar investment banks from judging whether mergers and
acquisitions are fair to shareholders when they also act as a main
adviser that stands to reap big fees if a deal goes forward.
The proposal by California Public Employees' Retirement
System came as other big investors also demanded that the National
Association of Securities Dealers overhaul its rules governing the
process of producing what are known as fairness opinions, which critics
say is riddled with conflicts of interest. Wall Street firms defended
how the opinions are produced, saying they have strict guidelines to
ensure the integrity of their views.
The NASD released comment letters yesterday that added
to a growing debate over the lucrative but controversial business on
Wall Street of rendering fairness opinions in mergers and acquisitions.
The self-regulatory organization for brokerage firms has proposed
limited rule changes to require more disclosure of "significant"
conflicts of interest by investment banks and what firms are doing to
counteract those conflicts. The review comes amid a boom in mergers and
In an interview, NASD Chairman Robert Glauber said
officials believe more disclosure "is the best way of dealing with these
conflicts." He added that calls for an outright ban on acting as both
adviser and arbiter of fairness "would be a very different rule from the
spirit of what was put out for comment."
Some investor activists say the NASD proposal doesn't
go far enough. Echoing Calpers, the investment office of the AFL-CIO, or
American Federation of Labor and Congress of Industrial Organizations,
called changes in the system long overdue and said the process had
become tainted by "egregious conflicts." Calpers oversees $180 billion
in pension-plan assets and unions affiliated with the AFL-CIO sponsor
pension plans with more than $400 billion in assets.
The two investor groups took aim at the dual role that
big Wall Street firms routinely play as both the adviser to companies
involved in mergers and acquisitions and as provider of an opinion
blessing the deal as "fair" to shareholders. Bankers wearing both hats
often make the lion's share of their fees only if a deal gets done.
"There is a very large incentive for an investment bank to find that a
transaction is fair, regardless of the circumstances, when the bank will
receive the bulk of its fee only if the transaction is successful,"
Calpers Chief Investment Officer Mark Anson wrote.
Such fees, which can reach tens of millions of dollars,
are known as "success fees." Fairness opinion fees can range from tens
of thousands dollars to several million. Critics say fee-hungry bankers
rubber-stamp the deals their clients want, sometimes acquiescing to
ill-conceived transactions that ultimately erode shareholder value or
force thousands of unnecessary layoffs but that may enrich top
executives of the companies involved. Fairness opinions have become the
standard tool used by corporate boards to protect themselves against
lawsuits and investor criticism of a deal's terms. The feud over the
opinions was the subject of two Page One articles in The Wall Street
Journal last year.
Among other things, the NASD is considering requiring
bankers to publicly state whether the company executives they are
working for might be biased toward a deal because they will receive
juicy post-merger bonuses. In addition, the NASD is considering policing
how bankers settle on valuation methods in their fairness opinions. Its
enforcement arm also has been conducting a probe of Wall Street firms'
A series of missives from the main securities industry
lobbying group and mergers and acquisition attorneys, meanwhile,
effectively declared the status quo adequate and suggested -- albeit
politely -- that regulators butt out or make only minor changes.
"A company...typically believes it important to receive
a fairness opinion from the financial advisor that has advised it on the
relevant transaction because that advisor is most familiar" with the
company and the deal terms and special considerations, said the
Securities Industry Association, Wall Street's main lobbying group. The
SIA said it spoke for a task force of major investment banks including
Goldman Sachs Group Inc., Morgan Stanley, Merrill Lynch
& Co., Lehman Brothers Holdings Inc., UBS AG and the
Credit Suisse First Boston unit of Credit Suisse Group.
The securities group said that, while it believes
further regulation isn't necessary, it wouldn't object to "a properly
tailored rule" on disclosure of conflicts. But because each deal is
unique, it said the NASD "should not endeavor to define" what
constitutes a significant conflict. It said it opposes requiring bankers
to disclose how special deal bonuses for executives might make them
biased in favor of a deal, saying boards of directors oversee
compensation. Second-guessing directors' judgments "would not ultimately
enhance the M&A process," the group said.
The SIA stressed that, in cases when bankers don't
believe a deal's terms are fair, "financial advisors do, in fact, advise
companies when they would be unable to deliver a fairness opinion upon
contemplated terms." It said those deals "are either renegotiated or
abandoned (usually before any disclosure is made to the public)."
While supporting increased disclosure, Calpers's Mr.
Anson said the NASD should "consider taking stronger measures,"
including requiring banks to disclose "whether, in the bank's reasonable
opinion, a materially better price could have been obtained." Currently,
fairness opinions are much more limited and say they don't purport to
evaluate better options.
Another sticking point is how bankers come up with a
"fair" price range. There are a variety of choices bankers can make to
set the range, such as which competitors to include in comparisons and
which performance metrics best indicate a company's value. Typically,
bankers rely on data provided by company executives and say they don't
independently verify it. Calpers called for the NASD to require
disclosure of "all material assumptions used to generate the opinion."
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