It’s a question that comes to mind from time to time when a big corporate takeover fails to work out as planned: What about all that high-priced financial advice the firm was paying for? How could they all get it so wrong? And more to the point, why don’t companies do anything about it?
The answer is succinct: Accountability but not liability.
That’s the phrase used by one of the country’s prominent mergers and acquisitions lawyers, to describe the relationship between a financial adviser and a corporation receiving that advice.
“It’s their opinion. And their opinion is always at a certain date, and based on certain industry-standard metrics,” said the lawyer, noting that the metrics include discounted cash flow analysis and a comparison of multiples from previous transactions.
“But the outputs are only as good as the inputs,” noted the lawyer. And those inputs often come from management where the adviser relies on the information provided and uses professional judgment to reach a conclusion on the transaction’s fairness.
Another M&A lawyer noted that the buyer is meant to be the industry expert, not the adviser whose role is to provide high level financial advice. “They don’t go into realistic synergies, they can’t find out, for example, the quality of the target’s inventory control systems. They are getting paid the big fee, [but] it doesn’t meant that they are doing lots of work,” he said, noting that if a transaction doesn’t pan out as expected, the advisers can suffer reputational damage. “If people perceive the value of their work to be shoddy, then they won’t get hired.”
So what about adviser negligence, an area that seems to have potential for an action by the corporation against the adviser?
“If you have true conflicts of interest or egregious errors, then it’s fair game to have liability,” for the opinion, added a M&A lawyer. “The standard for negligence is very high and in Canada there have been very few, if any, examples of a company suing.”
In the U.S. there are more examples, though the prominent cases are those brought by shareholders against an adviser. And those cases typically involve an undisclosed conflict of interest by the adviser.
And because the adviser’s view is time dated, the opinion doesn’t look forward. In other words the opinion can’t determine whether the buyer is making a good investment.
And there’s reason to be skeptical: a 2011 report titled, The Big Idea: The New M&A Playbook, and published in the Harvard Business Review noted that despite the trillions of dollars spent annually on acquisitions “study after study puts the failure rate of mergers and acquisitions somewhere between 70% and 90%. As to why this occurs the study notes “companies too often pay the wrong price and integrate the acquisition in the wrong way.”
And because it’s a point in time, the opinion from the adviser doesn’t consider the possibility of, for example, an economic downturn, of a commodity cycle crash, or a new technology.
If it did then there’s a fair chance that Barrick Gold, would not have agreed to outlay more than $7 billion to buy copper producer Equinox Minerals in 2011; and that Kinross Gold would have spent $7.1 billion to acquire the balance of Red Back Mining in 2010. Both deals resulted in large writedowns. “The opinion from the adviser is not a guarantee,” noted one lawyer.
Let’s give the final word to legendary investor Warren Buffett. At this year’s Berkshire Hathaway annual meeting in reference to investment consultants he was quoted saying this: “There’s been far, far, far more money made by people in Wall Street through salesmanship abilities than through investment abilities. There are a few people out there that are going to have an outstanding investment record.”