Why is a Lawsuit Filed for Every Deal? See Below. Part II

February 18, 2011

Earlier, I posted about how lawsuits are filed for every public deal, and that evidence showed that companies that went private filed for IPOs that eventually reaped large benefits for management.  Now, if mergers are marriages, then the matchmakers are the large investment banks.  The investment banks are constantly trolling for possible deals (or in bank-speak “strategic alternatives”) that may make sense for Company A, and then “pitch” Company A with possible targets/buyers.  If Company A is open to a merger/buyout, the bank will reach out to the companies it identified to try and consummate some sort of a deal.  How the process is supposed to work, is that the bank will help present options to Company A’s board that will maximize shareholder value.

But, the investment banks get large fees for this work that are entirely contingent on a successful deal, giving investment banks incentives to close deals.  Banks also receive publicity for being involved in these deals.  And, for some deals, the investment banks also finance the deal reaping more fees for that debt.   Competition for these deals is hot among banks, and banks are not shy about trying to maximize fees for each deal.   The most recent example where this practice was scrutinized was in the Del Monte foods buyout litigation.  The NY Times Dealbook described the investment bank’s (Barclays in this case) actions:

After making this pitch, Barclays used its relationship with Del Monte to secure representation of the company in exploring its strategic alternatives, including a possible sale. Barclays then recommended that Del Monte limit its sale process to a small group of private equity firms that included the ones that the bank had pitched.

This first process was terminated by the Del Monte board after it decided to maintain its independence. Barclays kept trying. Vestar and K.K.R. had signed confidentiality agreements with Barclays that precluded them from teaming up to bid without Del Monte’s approval. Nevertheless, Barclays arranged for Vestar and K.K.R. to make a joint bid. But Barclays did not disclose to Del Monte that it knew that Vestar and K.K.R. were working together, even though this constituted a violation of the private equity firms’ agreements with Del Monte.

While the price was being negotiated, Barclays, albeit with Del Monte’s permission, switched sides and also advised K.K.R. and the buyout group on its financing. Barclays made $23.5 million for advising Del Monte on the sale. In addition, by providing financing to K.K.R., Centerview and Vestar, Barclays will receive another fee of $21 million to $24 million. Because Barclay’s dual representation constituted a conflict, Del Monte hired Perella Weinberg to provide a second, independent fairness opinion for another $3 million.

Basically, Barclays rigged the bidding process so that it would be able to get fees for advising both sides and financing part of the deal.  Vice Chancellor Laster recognized this manipulation (despite noting that the Del Monte board apparently worked in good faith):

Barclays secretly and selfishly manipulated the sale process to engineer a transaction that would permit Barclays to obtain lucrative buy-side financing fees.  On multiple occasions, Barclays protected its own interests by withholding information from the Board that could have led Del Monte to retain a different bank, pursue a different alternative, or deny Barclays a buy-side role.
VC Laster also noted that the “patina” of the deal seemed normal, but only investigation into non-public documents through the discovery process revealed Barclays’ actions.
So, with all the criticism about shareholder merger litigation, this is one (among many) examples of shareholders’ scrutiny uncovering manipulation and fraud.

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