Fairness Opinions and Deep Pockets

Last month, the seventh circuit court of appeals absolved Credit Suisse of the liability that lawyers for a bankrupt corporate estate tried to attach to it on the basis of a fairness opinion.

Fairness opinions are, in general, something of a racket. They seem designed as security blankets for timid executives. They certainly aren't meant as money-back guarantees.

The case I have in mind had its origin in the irrational exuberance of the late 1990s and the bursting of that bubble in 2000. A company called HA-LO Industries seems to have had a nice, profitable, though undramatic business selling promotional products (such as coffee mugs with another company's logo).

In the go-go Clinton/Greenspan years, this wasn't good enough. They wanted to get into something hip, dotcomish. HA-LO CEO John Kelley became enamoured of an internet start-up called Starbelly.com, which had an e-commerce system on which it hadn't yet made any money. It was burning through its venture capital but, on the plus side, it was named for a Doctor Seuss story as you can see here! So what could go wrong?

So Kelley decided to buy Starbelly for a deal that combined stock swap with cash. The cash portion was for more than $70 million, and more than HA-LO had on hand. So he and his company went to CSFB (as it was known then, now Credit Suisse) to try to structure a loan. Credit Suisse also provided a "fairness opinion," which said: "as of the date hereof [January 17, 2000] the merger consideration is fair to HA-LO from a financial point of view."

They also went to an auditor, Ernst & Young. But they didn't get any security blanket there. E&Y told HA-LO that Starbelly's earnings projections were unrealistic.

The Nasdaq composite index, the best single metric of the high-tech sector of the economy at that time, peaked about two months after HA-LO got its fairness opinion.

In April, before the deal had closed, but with hi-tech stock prices headed dramatically down, a major investor asked HA-LO to seek a new fairness opinion. HA-LO declined.

The deal closed in May. It never did pay off. Indeed: fourteen months later, HA-LO filed for bankruptcy court protection. The bankrupt company's Trust then litigated, seeking to get some cash from the presumably deep pockets of Credit Suisse. Their argument? it should have volunteered an updated opinion after the Nasdaq peak, even though (a) it had only contracted to provide one opinion, (b) it had provided that one, (c) and that opinion was on its face date-specific.

Judge Easterbrook, for the seventh circuit, refused to go along with this proposed exercise in bank robbery. Good for him.

Easterbrook alludes to the controversy over fairness opinions. He writes that some people believe that the Delaware Supreme Court has encouraged companies incorporated in that state to seek expensive worthless opinions, thus doing harm to the interests of the shareholders of the companies that seek them. Still, as the federal appellate court observed, that's none of his concern.

"If the Supreme Court of Delaware had held in a tort suit that all of HA-LO's promotional mugs must be shipped in crates made of inch-thick steel, to prevent all risk that pottery shards from breakage in transit could escape and injure anyone, that would geatly increase the costs of doing business and injure HA-LO's investors but wouldnot support an award of damages against the sellers of steel crates."

I like that analogy.