Mergers & Acquisitions
The Dangers of Over-Reliance by Shareholders and Directors on Fairness Opinions issued by Financial Advisors
April 15, 2008
Most readers will be familiar with at least the outline of the Bear Stearns “bailout” by J.P. Morgan, facilitated by the federal government. The investment bank (and alleged merger experts) at Lazard Ltd. gave the directors of Bear Stearns, a financial institution whose liquidity concerns on Wall Street had brought it to the edge of bankruptcy, written assurances on Sunday, March 16, 2008 that J.P. Morgan’s offer of $2 per share was a fair price for all the assets and liabilities of Bear Stearns. It has since become common knowledge that, in the absence of any such purchase by J.P. Morgan, Bear Stearns would have been forced to file for bankruptcy court protection from creditors as early as the next morning.
Just eight days later, after public outcry and a near revolt by certain large shareholders of Bear Stearns who felt that J.P. Morgan had engineered a fire sale to the detriment of existing Bear Stearns shareholders, the very same bankers at Lazard told the same board of directors that a revised offer of $10 per share – five times the amount initially offered and vetted – was somehow also fair. This has led some corporate governance commentators such as Jim Naughton to conclude with a common sense question: “If $10 a share is a fair price, how could $2 be a fair price as well?”
The entire issue of fairness opinions is brought into sharp focus by these events. Because the process of arriving at an enterprise value is inherently subjective, investment banks have substantial discretion that is vulnerable to abuse. Lazard arguably had less of an incentive to provide an accurate valuation of Bear Stearns’ financial condition and more of an incentive to provide a fairness opinion in support of the party inviting the opinion. The fact that the board of directors of Bear Stearns were obviously eager to strike a deal with J.P. Morgan at the agreed-upon initial price (until public reaction provoked a rethinking) was not lost on Lazard. But Lazard’s commitment to deliver another fairness opinion at the higher, second price put it in an awkward and unavoidable predicament. Somewhere, class action shareholder derivative lawsuit specialists are celebrating.
The preliminary conclusion for impartial observers? Obtaining a fairness opinion in connection with merger transactions does not relieve directors from the responsibility of exercising their best business judgment in light of all the circumstances and in accordance with the best corporate governance practices. To do otherwise is tantamount to sticking your head in the sand like an ostrich.
Marcus Klebe