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A Fair Deal -- But For Whom?


Even a first-time homebuyer knows the drill: Don't take the word of a real estate agent that the price is fair. As everyone knows, the agent gets a big commission to make sure the sale closes -- no matter the price. Instead, get an appraiser who has no financial stake in the sale. Lenders won't even fork over the money unless an independent appraisal is in hand. But when publicly traded companies change hands, objectivity can be in short supply. In fact, in many cases the investment bank that brought a deal to a company is the same firm signing off on the fairness of the price -- and collecting a fat fee when the transaction is closed.

Such "fairness opinions" underpin mergers and acquisitions of any size on Wall Street. Some are written by independent firms unconnected to the deal, but the majority aren't. And the conflicts of interest inherent in them -- with banks racking up millions of dollars in fees by acting simultaneously as agents and appraisers -- have been an open secret on the Street for years.

Critics can point to a raft of other problems, too: The opinions are loaded with legal disclaimers. They are often out of date by the time shareholders vote on the deal. And they are so narrowly focused on the specifics of the agreement being evaluated that they don't even address whether directors could have secured a better deal. Says Charles M. Elson, corporate governance professor at the University of Delaware: "These are inherently unfair documents."

Now the tide may be turning against these tainted opinions. New York Attorney General Eliot Spitzer, who led the attack on Wall Street's research conflicts last year, said earlier this year that fairness opinions have caught his eye. With his plate full of mutual-fund cases, he hasn't taken any action, but he's expected to pursue the issue eventually. The Securities & Exchange Commission is also interested. "This issue isn't going away," says Arthur H. Rosenbloom, a managing director of New York-based CFC Capital LLC, which prepares fairness opinions only for fixed fees and not for contingency payments.

UNDER THE RADAR

If fairness opinions are so problematic, why do lawyers for boards of directors insist on them? Simple: They give directors a shield in court when unhappy shareholders sue. The opinions are evidence that the directors checked with outside experts to make sure that the deal is fair to the shareholders whom they represent. They became popular after a Delaware court found a board of directors negligent in 1985 for approving in two hours the sale of a company at a lowball price. Today, corporations print the opinions, complete with pages of sophisticated-looking analysis, in the proxy statements they send to shareholders urging them to approve the deals.

But valuing a business is a very subjective process. That means there's lots of wiggle room to make sure the numbers produce the answer that greases the deal. "You begin with science, and then you end up with art and judgment calls," says Rosenbloom.

Consider AXA Financial Inc's (AXA). $1.5 billion offer for insurance company MONY Group Inc. (MNY). on Sept. 17. MONY shareholders would get a 7% premium on where the stock had been trading, but the price was still far below the value of MONY's net assets. Three major shareholders complained that the price was too low, but MONY's investment bank, Credit Suisse First Boston (CSR), had issued a fairness opinion saying the price was right. How so? First, according to the proxy, it marked down MONY's assets, relying on the views of MONY managers who would be in line to cash out with golden parachutes if the deal closes. CSFB, which noted MONY's poor past performance, said it was worth far less than the median paid for assets in insurance transactions in the past five years. If the deal is signed, CSFB will reap a $15 million fee, the proxy says. CSFB declined to comment.

Some of the more dubious opinions involve smaller companies that slip under the radar of institutional investors (and the financial media). In May, Johnstown (Pa.)-based Crown American Realty Trust got a $386 million stock offer from Pennsylvania Real Estate Investment Trust, a rival owner of shopping centers in the mid-Atlantic states. Wachovia Securities (WB), serving as Crown's banker, found that the offer was fair, even though it carried a discount rather than a takeover premium -- it was worth 4% less than Crown's average stock price the previous four weeks. The agreement, which shareholders approved overwhelmingly on Nov. 11, will also cut the dividend yield to Crown shareholders from 8% to 7.2%, according to Gregory P. Taxin, chief executive of proxy-voting consultant Glass, Lewis & Co. in San Francisco.

Wachovia, which stands to earn $4 million when the deal closes this month, justified the price with anything but precision: It came up with three different price ranges broad enough to accommodate almost any conceivable offer. And, says Taxin, Wachovia used different valuation methods than it had last year to appraise another REIT, Apple Suites Inc. "It appears Wachovia is selecting methodologies that serve the purpose of reaching a preordained conclusion," says Taxin. Says Wachovia spokeswoman Amy Hyland: "As a firm, we stand by the integrity of our fairness-opinion process."

For their part, investment bankers defend fairness opinions. They write the opinions knowing that they will face scrutiny from sophisticated institutional investors. And they say they manage the conflicts by having special committees of top officers review the opinions. What's more, courts have generally agreed that because the opinions are written for directors, the banks have no obligation to shareholders. Some bankers say hiring independent appraisers to write the opinions would only stall deals and add to the risk of insider trading.

But these arguments carry less weight now. Corporate directors are essentially under orders from regulators to question the motives of virtually everyone hired by their companies. Marjorie Bowen, managing director at Houlihan Lokey Howard & Zukin in Los Angeles, a boutique investment-banking firm that does not receive contingency fees with 90% of its opinions, says directors at big companies considering deals are now asking more often for independent advice than they were a year ago.

Some critics want to turn to the home-appraiser model. Elson, the Delaware professor, recently joined with Rosenbloom to circulate a paper arguing for professional standards for deal appraisers, much as real estate appraisers have standards that they must honor if they value a property financed by a bank. Will investment banks go for it? Maybe, especially if Spitzer and the regulators in Washington give them a nudge. By David Henry in New York


Steve Ballmer, Power Forward
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