Sunday, April 11, 2010

Investment Banks Sometimes Have Conflicts? (Was World War II A Conflict?)

Vignette #1, several years ago: A large client company engaged a then-name brand investment bank, now defunct, to assist with the company's sale. Conventional terms: the bank would be paid a fee at closing based on a percentage of the sales proceeds. After a few meetings with a prospective buyer negotiations reached an impasse over price and several material terms.

Shortly after impasse the lead investment banker called the client stating that the prospective buyer wanted to renew negotiations, would "come off" its negotiating position, and wanted to meet again with the client and both parties' lawyers to state its concessions and see if price and terms could then be agreed upon.

The client agreed to meet to hear the concessions. No surprise. Schedules were revised to accommodate the meeting, airplane tickets purchased, and the client's expectations for a sale to the prospective buyer revived.

At the meeting the client arrived eager to hear the forthcoming "better offer." Quickly it became obvious that the investment banker had told both parties - the client and the prospective buyer - that the other party wanted to meet and at the meeting would make concessions. Although the banker tried to finesse matters - and claimed to have misunderstood, etc. - quickly also both the client and the prospective buyer figured out the banker's ploy.

Although we couldn't get inside the investment banker's head to know his thinking exactly, our best guess was as follows. The banker, having identified no other prospective buyers likely to be able to close during the extended term of the banker's engagement, concluded that the downside of a calculated misrepresentation was more than offset by the notion that if he could get the parties in a room then there was at least some chance a deal might ensue. And a deal, of course, meant an investment banking fee - and no deal meant no fee. And if the parties were at impasse then the chance of a fee was zero. And since the client was selling itself, the prospect of a long-term relationship with the client also was zero. (We doubt that the banker's firm's reputation entered into his calculus.)

Result: a furious former client, an unhappy prospective purchaser, no deal ... and no investment banking fee. (A long, long while later the client did enter into a definitive agreement to sell itself. The mischievous investment banker had long been gone from the scene, his "stated term" and "protection period" having expired, and his having had no pre-closing contact with the buyer. Guess who faxed a letter a day before closing claiming a fee and threatening to seek to enjoin the sale if not paid?)

Vignette #2, also several years ago: Conventional terms again: the investment bank would be paid a fee at closing based on a percentage of the sales proceeds. After awhile a deal became inevitable, for reasons for which you'll just have to trust this blogger. A price, however, was fully up for negotiation. Similar to situations where real estate brokers representing sellers have diminished incentive to stretch for the last dollar, the bankers, it could be argued, did not "stretch" because the marginal benefit of doing so wasn't worth the incremental effort and incremental extra time to closing (ahem, to fee payment) that would result from the stretch.

The vignettes above come to mind as a result of Warren Buffett's 2009 letter to shareholders, touching on the sometimes significant conflicts created by customary contingent terms for investment banking advisory fees. The letter is linked below, followed by an Andrew Ross Sorkin NYT article about Mr. Buffett's view of investment banking conflicts and prescription for one type of conflict.

By the way, after dealing with investment bankers and their lawyers I have learned (after longer than it should have taken) that "it's customary" means both (1) "I don't have a plausibly logical way to justify what I want or answer your question" and (2) "this is a great deal for me and a not so good deal for your client [or you]." (This is similar to the way children learn that their mother's saying "well, we'll see" means "no.")



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