A look at the adviser-corporation-client relationship: Just advice and no guarantees

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.”

Financial Post
bcritchley@nationalpost.com

Top Banking Committee Democrat Reprimands Loretta Lynch For Going Easy On Wall Street

WASHINGTON ― Rep. Maxine Waters (D-Calif.) sent a sharply worded letter to Attorney General Loretta Lynch on Friday, calling on the government’s top lawyer to rescind a drug money laundering settlement with HSBC and bring criminal charges against the British financial titan’s employees.

Under the standards of Beltway etiquette, it’s a provocative move for a Democratic congresswoman in a leadership position ― Waters is the ranking member of the powerful House Financial Services Committee ― to publicly challenge a sitting Democratic cabinet member. But Waters’ letter is particularly biting for another reason: Lynch was personally in charge of the HSBC investigation that infuriated financial reform advocates in December 2012, while she was U.S. Attorney for the Eastern District of New York.

“I have long criticized the apparent two-tiered American justice system that subjects low-level criminal offenders to harsh prison sentences that completely upend their lives and compromise their futures, while allowing the perpetrators of major financial crimes to be largely shielded from criminal prosecution,” Waters wrote Friday.

The HSBC deal, known technically as a deferred prosecution agreement or DPA, settled charges that the company laundered $881 million for the Sinaloa and Norte del Valle drug cartels and violated U.S. government sanctions against Iran, Libya, Sudan and other countries. The bank paid the feds $1.9 billion and no bankers were prosecuted. Waters wasn’t happy at the time, and needled then-Attorney General Eric Holder about the deal in 2013. 

But roughly two years after Lynch finalized the deal, reports surfaced showing that an HSBC whistleblower had turned over information to the DOJ suggesting that the firm’s Swiss unit had engaged in massive tax evasion efforts. The documents reached the department during Lynch’s money laundering investigation, which never mentioned anything about tax evasion; Lynch said her office never saw the documents.

This year, Lynch’s money laundering settlement suffered further embarrassment after the official appointed to monitor HSBC’s money laundering reforms reported that the company still isn’t up to snuff.

“More than halfway into a five-year DPA that is set to end next year, HSBC’s compliance program is still ineffective at catching and stopping federal banking law violations,” Waters wrote to Lynch. “This is unacceptable.”

HSBC was in congressional crosshairs last week when House Financial Services Committee Chairman Jeb Hensarling (R-Texas) published a 282-page report on the HSBC settlement, alleging that Holder had personally insisted on not prosecuting bankers, arguing that doing so would jeopardize the global financial system. Hensarling and Waters are typically partisan enemies and ideological opponents. He wants to dismantle the 2010 Dodd-Frank financial reform law, while Waters wants to strengthen it. But on the “too big to jail” problem at least, Waters apparently sees no need to distance herself from her typical foe.

“I implore you to revisit and reconsider HSBC’s DPA,” Waters wrote, “and to pursue the prosecution of the HSBC employees that have thus far avoided facing justice.”

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