The Shadow Chancellor's Notebook by Orlando Plumbe

WSJ.com - Heard on the Street

Link: WSJ.com - Heard on the Street.

Federal securities regulators have a message for hedge funds thinking of using a clever maneuver to influence corporate mergers: Don't buy up shares to vote on deals if you're not at risk of losing money. The Securities and Exchange Commission is considering bringing a civil enforcement action against Perry, a big New York hedge fund, which tried such a maneuver, according to a letter Perry sent its investors this week.

Expectation Gap for Fairness Opinions

Gretchen Morgenson's full frontal attack on fairness opinions in todays NYT Mirror, Mirror, Who Is the Unfairest? - New York Times, points out well known problems in the way many fairness opinions are prepared, but it also based on a false premise that these fairness opinions carry a lot of weight with shareholders in deciding on whether to vote in favor of a merger.

But one conflict lives brazenly on, safe from even the most assiduous reform efforts. That enduring unfairness is related to, of all things, the fairness opinion. Fairness opinions are produced by Wall Street banks and are intended to assure the directors of companies involved in a merger, acquisition or other deal that its terms are fair to shareholders. But the opinions can be problematic. That's because the bank affirming the fairness of the transaction is often the same one that proposed the deal - and that stands to reap millions in fees if it goes through. When J. P. Morgan Chase paid $58 billion to acquire Bank One last July, the fairness opinion was supplied by - who else? - J. P. Morgan Chase. However laughable they may be, fairness opinions continue to be used to justify transactions and to provide legal cover for directors fearful of being sued if a deal goes bad.

First, fairness opinions are not pinpoint estimates. They usually express a range of value of the company being acquired, concluding that the merger consideration is within that range. The assumptions on which they are based can usually be found in the Form S-4 the acquiring party issues in connection with the merger. Those assumptions can be scrutinized by the shareholders and if the assumptions are ridiculous that is pretty easy to see. Second, it is not clear that any shareholders, particularly big institutional shareholders put much stock in them at all. Indeed, one doubts that Gillette's less fit a shareholder come up with Warren Buffett, away much on the fairness opinion in deciding whether to vote in favor of the merger. If this is so, why do the fairness opinions at all? I think the answer is that the fairness opinion does provide a small procedural check to prevent mergers being rushed through a board at grossly inadequate consideration. The modern fairness opinion process came out of the 1985 VanGorkum decision by the Delaware Supreme Court. In VanGorkum, the merger decision went through the board with the speed of the midnight special. Fairness opinions or seen as a day to ensure worth the boards made adequate review of merger decisions before voting on them. Thus, the fairness opinion does not give you an exact value, but the does slow down and focus the board at a critical juncture. They probably achieve this limited purpose reasonably well.

Fiduciary Outs and MAE Clauses

The April 29, 2005 decision by Vice Chancellor Noble in Frontier Oil v. Holly has imlpications ofr both "fiduciary out" amd MAE clauses in merger agreements:

Frontier’s efforts to obtain payment of the break-up fee are, at least up to a point, not without equitable appeal. Holly, although it is concededly a close question, could not (or, at least, it did not here) prove that Frontier breached its warranties under Section 4.8 or 4.19 of the Merger Agreement. Holly, however, at least from early July 2003, was not going forward with the Merger under the express terms of the Merger Agreement. Because of the escalation in (or recognition of) the value of its pipeline assets, a difference far in excess of $16 million, Holly would have, and, at least arguably, should have, escaped from the Merger Agreement and paid the break-up fee. (That is, Holly recognized that if it guessed incorrectly as to whether the Beverly Hills Litigation would be perceived by a judicial officer as having an MAE, it could be found liable for perhaps $150 million; Instead, the complaint sought an award of “substantial damages” for repudiation and for breach of the covenant of good faith and fair dealing. It is clear that Frontier did not consider the break-up fee as the equivalent of “substantial damages.” would have provided Holly with an incentive to pay the break-up fee.) All of that may be accurate, but Frontier, in August 2003, was not content to accept or to seek the break-up fee. It wanted the benefit of its bargain. By its very conduct, it terminated the Merger Agreement under which it might otherwise have obtained the break-up fee. The fiduciary out is designed to allow for an orderly disentanglement of merger partners when the directors’ fiduciary duties require it. Frontier, by orchestrating the August 19 Phone Call and by launching this litigation, disrupted that process. Frontier made its choices; one consequence of those choices is that it now has no claim to the break-up fee.