Goldman Sachs Group Inc. (GS) was rebuked by Delaware Chancery Court Judge Leo Strine for “incomplete and inadequate” handling of a conflict of interest, less than 14 months after the bank finished examining its business practices.
Strine, in a Feb. 29 ruling, cited “the disturbing nature of some of the behavior” leading to the terms of pipeline operator Kinder Morgan Inc. (KMI)’s $21.1 billion purchase of El Paso Corp. (EP), Goldman Sachs’s biggest takeover assignment last year. The bank, which stands to get a $20 million fee from El Paso, has a $4 billion stake in Kinder Morgan and two employees on its board, both of whom recused themselves from negotiations.
The ruling contrasts with efforts by Chief Executive Officer Lloyd C. Blankfein, 57, to portray the firm as adept at managing conflicts that arise from its roles as an investor, financier and adviser. Last year’s business standards report, published by the bank after it paid a record sum to settle a fraud accusation by the Securities and Exchange Commission, contained a 10-page section on managing conflicts of interest.
“I would hope there’s a lesson learned,” said Charles M. Elson, director of the Weinberg Center for Corporate Governance at the University of Delaware. “It’s probably not advisable for a bank to be on both sides of a transaction anymore.”
David Wells, a spokesman for New York-based Goldman Sachs, said the firm respects the judge’s opinion and is pleased that shareholders will get to vote on the merger.
“To serve our clients effectively, we offer a full range of services,” he said. “In doing so, we seek to identify and manage any potential conflicts appropriately and we’re keenly aware of the importance of that responsibility.”
Strine “reluctantly” denied the plaintiffs’ motion for a preliminary injunction.
“El Paso stockholders should not be deprived of the chance to decide for themselves about the merger,” he wrote, adding that a future monetary damages claim by the defendants could have “some value as a remedial instrument.”
Mark Lebovitch, a lawyer at Bernstein Litowitz Berger & Grossmann LLP who advised some of the plaintiffs, said it was significant that Strine didn’t rule out the possibility that Goldman Sachs and the other defendants, who included El Paso CEO Douglas Foshee, could still face monetary damage claims.
“Had the judge let Goldman off the hook here without monetary damages, then the message would be that they can do whatever they like and the worst that happens is they get a ‘shame on you’ from a court,” Lebovitch said last night in a telephone interview. “That’s not what happened.”
Goldman Sachs, initially retained by El Paso to advise on the spinoff of an asset, continued to advise the Houston-based firm even after Kinder Morgan bid for the whole company. Some El Paso shareholders sued to block the deal, saying that Goldman Sachs had a financial incentive to advise El Paso management to accept a lower price than it could have negotiated.
Strine, in his ruling, said Goldman Sachs was able to “exert influence” on the sale to Kinder Morgan because the investment bank continued to advise on the spinoff. Goldman Sachs’s conflict was “real and potent, not merely potential,” the judge wrote.
“The record suggests that there were questionable aspects to Goldman’s valuation of the spinoff and its continued revision downward that could be seen as suspicious in light of Goldman’s huge financial interest in Kinder Morgan,” Strine wrote.
“Heightening these suspicions is the fact that Goldman’s lead banker failed to disclose his own personal ownership of approximately $340,000 in Kinder Morgan stock,” the judge wrote, referring to Stephen D. Daniel, a Goldman Sachs partner who is co-head of global energy investment banking in Houston.
While Morgan Stanley was hired to provide independent advice to El Paso, Goldman Sachs “tainted the cleansing effect” of this move by insisting that Morgan Stanley should receive no fee unless El Paso agreed to the takeover by Kinder Morgan, Strine wrote. Goldman Sachs, while saying it didn’t provide advice on the sale to Kinder Morgan, still arranged to get a $20 million fee for the deal, he wrote.
“Goldman should have been foreclosed from getting fees for working on the merger when it supposedly was walled off from advising on that deal,” Strine wrote. “But Goldman’s affectionate clients, more wed to Goldman than to logical consistency, quickly assented to this demand.”
That Goldman Sachs would go to such lengths to obtain a takeover fee undermines its argument that it wasn’t swayed by its $4 billion investment in Kinder Morgan, Strine wrote.
“I cannot readily accept the notion that Goldman would not seek to maximize the value of its multibillion dollar investment in Kinder Morgan at the expense of El Paso, but, at the same time, be so keen on obtaining an investment banking fee in the tens of millions,” he wrote.
Goldman Sachs’s Wells said the firm “stood by our client through this process,” and encouraged El Paso to get “independent views from another adviser.”
“We were also transparent with El Paso about our relationship with Kinder Morgan and the related issues,” he said.
The case is In re El Paso Corp. Shareholder Litigation, Consolidated 6949-CS, Delaware Chancery Court (Wilmington).