Barclays Plc is leading investment banks in a retreat from a form of leveraged buyout financing that has made the firms and their clients vulnerable to allegations of a conflict of interest.
Barclays changed its policy following a February opinion from a Delaware judge, who said the bank deceived Del Monte Foods Co. when it advised the company on a sale and failed to disclose its plans to also arrange funding for the buyer until late in the process. That funding, also known as sell-side financing, allowed Barclays to collect about twice as much in fees than it would have gotten from just offering M&A advice.
Since the Del Monte opinion, no firm has offered sell-side financing for a U.S. public company buyout valued at more than $1 billion, according to data compiled by Bloomberg. In the previous 2 1/2 years, it was offered about 40 percent of the time for deals of that size. At least nine major investment banks, including Barclays, have reviewed their lending practices, said people familiar with the matter, who declined to be identified because the discussions are internal.
“This was a big hit to a bank’s reputation and got the attention of every bank across Wall Street,” said Larry Hamermesh, professor of corporate law at Widener University in Wilmington, Delaware. “It does seem like the banks are exercising across-the-board caution after Del Monte.”
Barclays says it disagrees with the judge’s statements on Del Monte and has safeguards in place when it is advising sellers on transactions.
In the Del Monte takeover, Barclays was paid $23.5 million as an adviser for Del Monte and $21 million to $24 million for financing provided to a buyer group led by New York-based KKR & Co., according to the Delaware lawsuit.
Chancery Court Judge James Travis Laster said in his Feb. 14 opinion that Del Monte would probably have hired another bank if it knew Barclays planned to “double-dip” for fees. The bank was added as defendant in the shareholder lawsuit along with Del Monte and the buyer group after the judge’s comments. All the defendants deny the claims against them.
Barclays will decide whether to keep its new rule on sell-side financing in place after the court reaches a final decision, said the people familiar with the matter, who declined to be identified because the policy isn’t public. Regardless, the bank will continue to provide buyout financing to acquirers when it is advising closely held targets, since there is no risk of litigation from public shareholders, the people said.
“Barclays has always had multiple established safeguards with respect to financing in sell-side transactions, including prior internal transaction review by senior executives, written client authorization and the addition of a second independent adviser,” said Kerrie-Ann Cohen, a spokeswoman for Barclays Capital, the investment banking unit of London-based Barclays. She declined to comment on the bank’s willingness to provide financing in the wake of the opinion.
“As industry standards and legal guidelines evolve, Barclays will continue to ensure its policies meet Delaware Court requirements, industry best practices and its own high standards in this regard,” Cohen said.
After the judge’s opinion, Credit Suisse Group AG, Bank of America Corp., JPMorgan Chase, UBS AG, Goldman Sachs Group Inc., Deutsche Bank AG, Morgan Stanley and Citigroup Inc. have reviewed their own policies on financing buyouts when they also have a role advising sellers, said people with knowledge of the situation. Lawyers at competing banks talked with each other and came to a consensus to be more careful about providing sell-side financing on public-to-private deals, the people said.
Credit Suisse has added a new layer of review when providing sell-side financing that requires senior bankers to sign off on any such funding, said one person. Bank of America, JPMorgan and Morgan Stanley met with outside lawyers and told bankers that sell-side financing should only be pursued if the client insists on it or the financing is difficult to find in the market, other people said. The firms are also asking clients to hire a second adviser, usually a smaller boutique investment bank, early in the sale process, the people said.
Spokesmen for the banks declined to comment on their internal reviews of the policies.
“The bar has been set extremely high for a sell-side bank to provide financing,” said Peter D. Lyons, a partner at Shearman & Sterling LLP in New York, which has advised banks on the matter since the Del Monte decision. “If a client asks them to do it, then they will think long and hard about it and explain to the client all of the conflicts.”
Clients and their boards also want to avoid sell-side financing, though they may ask their bankers to revisit the practice if deteriorating capital markets make funding more difficult to obtain, Lyons said.
Sellers often choose to have their adviser offer financing to prospective buyers because it can help ensure a deal’s completion. Sell-side financing can be justified if it benefits the seller, especially if the company wants to keep the process confidential, according to bankers.
The last major public transaction that used this type of financing was the sale of Emergency Medical Services, announced in February, to Clayton Dubilier & Rice LLC for $3.2 billion. Bank of America advised EMS and arranged financing for Clayton Dubilier.
‘Client’s Best Interest’
“Our role is to get the best price and terms for our client, the seller,” said Stefan Selig, executive vice chairman of global corporate and investment banking at Bank of America. “If everything a banker does is always consistent with that goal, then potentially providing financing to a buyer can, in fact, be in the client’s best interest.”
On EMS, Bank of America provided staple financing, a type of sell-side financing in which bidders are offered a pre- arranged funding package. Total industry fees from staple financing accounted for almost a quarter of the $2.2 billion banks made globally from debt underwriting for leveraged buyouts last year, according to researcher Freeman & Co.
Since then, a group including Apax Partners LLP agreed to buy Kinetic Concepts Inc. for $4.98 billion. JPMorgan advised Kinetic on the sale, and didn’t offer or provide sell-side financing, according to company filings. In six other deals, sell-side financing wasn’t offered, the filings show.
By comparison, in the 30-month period between Lehman Brothers Holdings Inc.’s 2008 bankruptcy and the Del Monte decision, sell-side financing was used five times in 20 deals with an enterprise value of more than $1 billion, according to company filings. Three other times the financing was offered and not used.
“People do want more information and more comfort and are asking more questions,” said Victor Lewkow, an M&A partner at Cleary Gottlieb Steen & Hamilton LLP.
In the Del Monte lawsuit, shareholders originally accused Del Monte directors of breaching their duties in handling the sale effort and accused the buyers of aiding them.
Plaintiffs in the case intend to take testimony from Barclays’ top investment-banking executives in depositions in September and October. The group includes Hugh “Skip” McGee, head of investment banking; Ros Stephenson, co-head of corporate finance; and Joseph McGrath, head of leveraged finance.