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The Wall Street Journal  

February 8, 2005

HEARD ON THE STREET

Wall 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 acquisitions.

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."

FAIR OR FOUL?
 

[xx]  Checkup Prompts Search for Second Opinions 1
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 Page One: Opinions Labeling Deals 'Fair' Can Be Far From Independent 2
12/29/04
 
 Page One: NASD Scrutinizes Conflicts in Bankers' 'Fairness Opinions' 3
06/11/04
 
 

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' practices.

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."

Write to Ann Davis at ann.davis@wsj.com4

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