Chancellor Strine rebuked Goldman Sachs and El Paso CEO Doug Foshee on the record and agreed with disgruntled shareholders that the sale process was likely tainted by breaches of fiduciary duty, but in the end, the Chancellor declined to enjoin a stockholder vote on the proposed $31 billion acquisition of El Paso by Kinder Morgan.
The opinion, issued February 29, 2012 in the case of El Paso Corporation Shareholder Litigation in the Chancery Court of Delaware, has been widely cited and discussed for its criticism of Goldman Sachs and Foshee for maintaining conflicts of interest through the negotiation process with Kinder Morgan. In that regard, the opinion is instructive to conscientious boards, management and professionals.
The Court found significant conflicts affecting the independence of El Paso’s long-time financial advisor, Goldman Sachs. At the time of the Kinder Morgan offer, Goldman affiliates owned 19% of Kinder Morgan and controlled two of the company’s board seats. In addition, Goldman Sachs’s lead banker advising El Paso owned an interest in approximately $340,000 of Kinder Morgan stock. (The El Paso board was aware of Goldman’s institutional conflicts, but not those of the senior banker.) Although the El Paso board took a number of actions with the intent of mitigating the Goldman conflict, the Chancellor found that Goldman nevertheless influenced the El Paso board in the transaction.
In light of El Paso, best practices for boards should include seeking greater disclosures from financial advisors and senior bankers that will be leading an engagement, including any interests they may have in potential or actual bidders. Financial advisors should also be required to regularly update the board on such matters. And where material conflicts do exist, boards need to be willing to isolate the self-interested professional from the transaction.
The El Paso board allowed Goldman to continue to represent it with respect to consideration of a spin off of the natural gas and oil exploratory and production business (representing approximately 60% of the entire business). The Chancellor found that Goldman, by “keeping its hand in the dough of the spin-off,” was improperly involved in influencing the board where its only viable options were the spin off and the Kinder Morgan merger. Strine found Goldman’s valuation of the spin-off to be “suspicious in light of Goldman’s huge financial interest in Kinder Morgan.”
For Foshee’s part, he had been charged with sole responsibility for negotiating with Kinder Morgan, while at the same time failing to disclose to the El Paso board that he and other members of the management team were themselves considering a potential bid to buy El Paso’s valuable exploratory and production business from Kinder Morgan after it acquired El Paso. Strine found that Foshee’s consideration of such a play while he was charged with selling the company as a whole damaged his credibility and called his loyalty and the agreed sale price into question. The Chancellor indicated a number of times in the opinion that if Foshee would have properly disclosed his personal interest, the board could have taken proper measures. Boards that direct senior management to lead sale negotiations should require adequate specific representations or certifications regarding any actual or potential management conflicts, and should consider appointment of a special committee or adoption of mechanisms by which to regularly monitor management and the sale negotiation process.
Chancellor Strine further cautioned boards that fee arrangements with financial advisors should not establish financial incentives that themselves suggest a conflict of interest or otherwise lead to an inference that the advisor’s impartiality was compromised. Morgan Stanley was brought in as independent financial advisor to represent El Paso in the Kinder Morgan merger, but Morgan Stanley’s negotiated fee arrangement provided that it would only receive a fee if the El Paso board moved forward with the Kinder Morgan deal. Thus, Morgan Stanley had a strong financial incentive to see the board pursue the Kinder Morgan deal instead of objectively considering alternatives.
Finally, the case is instructive to boards negotiating deal protections. The El Paso board had a fiduciary out, but it did not apply in the case of a separate sale of its exploratory and production business. That was problematic because a competing bid was likely to take the form of a separate bid for the exploratory and production business, the Chancellor found. Chancellor Strine also counseled that a break-up fee should not be negotiated relative to the sale of the entire company but also relative to the potential sale price of separate business units where the sale of separate businesses is a potentially “valuable alternative to the Merger.” In El Paso, the break-up fee and a right to match competing offers by Kinder Morgan may have prevented or limited competing offers, according to the Chancellor.
In related news, on March 16, 2012, the Wall Street Journal reported that Goldman Sachs Group Inc. is reviewing its internal policies and rules that require its bankers to disclose financial holdings to clients. Goldman said the review was being undertaken to strengthen those policies, according to the Journal.
On March 6, 2012, shortly after the El Paso opinion was issued, the Journal also reported that El Paso’s counsel Wachtell, Lipton, Rosen & Katz had advised the El Paso board not to use Goldman in any capacity in connection with the Kinder Morgan sale. The El Paso board engaged Goldman to handle the spin off of the exploratory and production business against counsel’s advice, according to the Journal.