By Associate Professor Michael Legg, UNSW

The Delaware Supreme Court in its landmark decision in Revlon, Inc v MacAndrews & Forbes Holdings, Inc 506 A2d 173 (Del 1986) observed that the potential sale of a corporation has enormous implications for corporate managers and advisors, and a range of human motivations, including but by no means limited to greed, can inspire fiduciaries and their advisors to be less than faithful to their duty to pursue the best value for the company’s shareholders.

In 2012 this story of fiduciary duties, conflicts of interest and human frailty in pursuit of personal profits at the expense of shareholders was alleged by a number of US pension funds who were shareholders in El Paso Corporation.

The shareholders brought a class action against a number of El Paso directors, Kinder Morgan Inc and Goldman Sachs & Co over the sale of El Paso’s business to Kinder Morgan.

Conflicts of interest were rife with Goldman Sachs having acted on both sides of the transaction.  Goldman Sachs held a 19.1% equity interest in Kinder Morgan and controlled two board seats whilst also advising the El Paso Board on the sale.  The shareholders alleged that Goldman Sachs favoured the sale to Kinder Morgan as it would increase the value of its investment.  Further, Goldman's lead banker working for El Paso, Steve Daniel, personally owned Kinder Morgan shares. Goldman Sach's tried to cabin the conflict by bringing in a second investment bank, Morgan Stanley, but that bank only got paid if El Paso went forward with the sale to Kinder Morgan, which was to Goldman Sach's advantage.  Moreover, Goldman Sachs was due to receive a $20 million fee for its advice - that it was not supposed to be giving because it had a conflict.

The CEO of El Paso, Mr Foshee, who negotiated the sale did not disclose to the board that he was also approaching Kinder Morgan CEO with the idea that Kinder Morgan then on sell the exploration and production component of El Paso's business to Foshee.  The CEO of El Paso knew that Kinder Morgan planned to sell the exploration and production business as part of the financing of the entire transaction.  Foshee's 'velvet glove negotiating strategy' appeared to be the result of his own self-interest in not driving up the price of a business he hoped to subsequently buy.

The shareholder were unsuccessful in obtaining an injunction in relation to the merger.  However, the Delaware Chancellor Strine observed that:

The concealed motives of Foshee, the concealed financial interest of Goldman’s lead banker in Kinder Morgan, Goldman’s continued influence over the Board’s assessment of the spin-off, and the distortion of Morgan Stanley’s incentives that arose as a result of El Paso management’s acquiescence to its Goldman friends’ demands leave me persuaded that the plaintiffs have a reasonable probability of success on a claim that the Merger is tainted by breaches of fiduciary duty.

When anyone conceals his self-interest – as both Foshee and Goldman banker Steve Daniel did – it is far harder to credit that person’s assertion that that self-interest did not influence his actions. That is particularly true when a court is reviewing the actions of businessmen and investment bankers. People like Foshee and Daniel get paid the big money because they are masters of economic incentives, and keenly aware of them at all times.

Unsurprisingly the class action was subsequently settled for $110 million (including Goldman Sachs not receiving its $20 million advisory fee), although $26 million went in lawyer's fees and litigation expenses. 

This comedy of conflicts has been subject to global scrutiny with the media reporting on the continuation of conflicts for investment bankers despite the harsh lessons of the global financial crisis.  The settlement further raises public awareness of investment bank's inability to avoid or manage conflicts of interest and may yet fortify governments into regulatory action.  However, the class action also suggests novel remedies for dissuading conflicts of interest, namely the loss or recoupment of any fees linked to the conduct that creates the conflict of interest.  Nonetheless, questions still remain as to whether such monetary sums are sufficiently large to enforce the demanding standards of a fiduciary duty.  As Chancellor Strine observed investment bankers are masters of economic incentives.  Presumably as the transaction was consummated Goldman Sach's investment in Kinder Morgan has increased in value as planned.