When the French government wanted to sell part of its stake in media company Thomson in 2002, it did so at an unprecedented rate for a privatization. Not for Thomson the rigmarole of a long prospectus and city-by-city roadshows: the ¤1.1 billion deal took just 24 hours to market and sell. Compare that with energy and transport company Alstom’s secondary offering in early 2001, one of the last follow-on deals in France to be fully marketed. That took two weeks.
Tough markets are driving this rush to accelerated book building, which bankers say have been intensifying in the first months of 2003. Opportunities to do deals are scarce and short. Bankers can’t wait while their lawyers pore over a company’s documents and write a carefully worded prospectus. One deal in three is now sold within 48 hours, according to investment banking research firm Dealogic. But some say bankers are rash to by-pass due diligence on these offerings.
“The question is, how much due diligence you do versus what investors expect you to do,” says a banker at a US firm in London. “One view is that if you don’t have documents you can’t be liable. But you can still be accused of not asking the issuer the right questions.”
A US lawyer, also in London, says: “On an accelerated deal it is harder to establish that you did look where you should have. There is a concern that compressed timeframes will lead to an embarrassing screw-up.” Already, he says, at least one bank has received an unwelcome surprise when an issuer announced revised earnings within weeks of an accelerated deal. The lead bank knew nothing of the company’s troubles.
If bankers sell a stock in a company that then reveals news that causes its share price to fall, investors will expect them to buy back the stock. On an accelerated deal there is no prospectus with a long list of risk factors to point to. So banks can’t say: “We told you this might happen.” On a several hundred million dollar offering where the stock price halves, the exposure would be fearful. Investors might even suspect the bank of knowing something it didn’t tell them. An underwriter accused of insider dealing could face triple damages in court. The more volatile the stock, and the less the bank knows about the issuer, the more risky the deal.
A slippery slope
“I don’t know of any legal blow-ups yet. But maybe it is a ticking time bomb,” says an in-house lawyer and equity specialist at a leading investment bank in London. “In the past it was typical only to do accelerated deals for large well-capitalized household names. But we are on a slippery slope. Firms are now doing deals for smaller names. The question is where you draw the line and why?”
Many bankers insist that they do carry out due diligence before they launch transactions. But calculations about the hours spent investigating a company simply don’t add up. On a normal secondary offering lawyers will spend a minimum of two weeks checking a company’s documents for legal liabilities such as lawsuits or contractual obligations. This means setting up a data room in the issuer’s buildings and staffing it with lawyers working around the clock. Accelerated deals happen so fast there is not time even to collect the paperwork that lawyers normally check.
On an accelerated offering a bank might have an afternoon and an evening to ask whatever questions it has about an issuer, according to one in-house lawyer. There is time only to talk to management, ask the bank’s own analysts about the company and perhaps read through any public documents. “That is nothing like proper due diligence,” he says. Worse still, bankers may deliberately avoid tricky questions lest they find out something they would rather not know. “You want to be comfortable that you know the company well, but you must be careful you don’t end up in possession of possible inside information,” the lawyer says. If a deal goes wrong, ignorance could be a bank’s best defence, a fact that clashes head on with the whole idea behind due diligence.
So why are bankers taking such risks? The answer for many is simple: their jobs depend on it. Banks are pitching harder than ever for business. Companies prefer accelerated deals because they do not take up management time and give issuers more certainty about price. “A deal in the hand is better than a marketed deal at a higher price,” says one lawyer. Because speed is what clients want, banks are promising ever-shorter schedules.
New rules in Europe designed to combat insider dealing might help. According to Linklaters partner Peter King, companies listed on the London Stock Exchange, for example, are obliged to disclose immediately any information that would affect their share price.
Nevertheless, the bankruptcies of Enron and WorldCom, and accounting irregularities at Xerox and Ahold, suggest bankers sometimes know less than they need to about clients. Euronext recently launched an investigation of Ahold relating to its alleged failure to comply with continuing disclosure rules.
Certainly, many bankers feel clients are forcing them to take risks they are not wholly comfortable with. Perhaps issuers’ in-house counsel should be worried also. Companies can face lawsuits too. While banks have institutional relationships with clients that would enable them to buy back shares should a deal go wrong, issuers could find they have no equivalent means to salvage their reputations.
Rob Mannix (rmannix@iflr.com) is editor of International Financial Law Review.
