In a March 3, 2016 article in the Wall Street Journal entitled “Firms Ask: Are Our Bankers Conflicted”, the writer, Liz Hoffman, highlights the growing concerns of clients in the mergers and acquisitions arena resulting from advisors who have conflicting, or apparently conflicting, loyalties. When a company is up for sale and hires an investment banker to represent it, it wants to make sure that the banker’s loyalty is completely uncompromised and that it is committed to procuring the highest price possible. Thus, if that investment banking firm also represents potential bidders for the company, that is a problem. Companies are becoming more and more sensitive to this issue so that even the appearance of conflict may disqualify a banker from an assignment. Adding to the problem is the growing consolidation in the banking industry which is creating larger institutions with larger client bases and broader product lines thereby creating more and more conflicts and deeper and deeper financial entanglements.
Ms. Hoffman describes how officers and directors of many companies are taking extraordinary efforts to vet out and avoid conflicts of interests as they see potential liability to shareholders should they engage advisors whose loyalties, and therefore performance, can be second guessed after the fact. In fact, over two dozen shareholder lawsuits have been filed targeting bankers since 2014 claiming the financial advice given was tainted as a result of conflicts of interest. One executive quoted in the article summed up the problem. “The question you ask is: ‘Will your bankers be working as hard as they can for you if they’re trying to do business everywhere else?’”
In order to minimize the chance of conflicts, prior to engaging their advisors, investment banking clients are now starting to require potential advisors to respond to detailed questionnaires, which have been prepared and reviewed by legal counsel, to identify potential business relationships which could compromise, or even appear to compromise, the objectivity of their advice. Specifically, before hiring an investment bank to help sell the company, the company is asking how much the bank has earned from potential bidders in recent years. According to the article, “Bankers in many cases are bristling at the heightened scrutiny” because “their answers [to the questionnaires] might prompt the company to hire a different bank.” If there are other qualified bankers who have no chance of conflict, why go with the one who does?
As a result of the growing concern for conflicts, companies are now sending record amounts of work to smaller, boutique investment bankers who don’t have as many financial entanglements and, as a result, are less likely to be in a position of conflict with their clients. As the large investment banks continue to grow and expand their service lines, the chances of them having meaningful business relationships with any given company increases and the materiality of that relationship grows. Thus, being all things to all people is starting to become a negative. Firms want a dedicated advocate whose loyalties are uncompromised and motives unchallengeable more than they want someone who does everything for everyone including their competitors and adversaries.
This increasing sensitivity to conflicts of interest is equally applicable to the real estate brokerage industry which is also experiencing rapid consolidation. Brokers and brokerage firms are well aware of the conflicts of interest that are inherent in their ever expanding, full service business. Specifically, the majority of large firms represent both landlords and tenants in the same market and even in the same transaction. The largest full service brokerage firm in the world acknowledged this problem in its own 10-K Securities Filing.
“Our company has a global platform with different business lines and a broad client base and is therefore subject to numerous potential, actual or perceived conflicts of interests in the provision of services to our existing and potential clients. For example, conflicts may arise from our position as broker to both owners and tenants in commercial real estate lease transactions. We have adopted various policies, controls and procedures to address or limit actual or perceived conflicts, but these policies and procedures may not be adequate and may not be adhered to by our employees. Appropriately dealing with conflicts of interest is complex and difficult and our reputation could be damaged and cause us to lose existing clients or fail to gain new clients if we fail, or appear to fail, to identify, disclose and manage potential conflicts of interest, which could have an adverse effect on our business, financial condition and results of operations…There can be no assurance that conflicts of interest will not arise in the future that could cause material harm to us.”
Likewise, some brokers are finding it impossible to practice with divided loyalties and are going public with the true dilemma dual agency poses. Just last week, a senior executive from one of the largest full service brokerage firms left to join a large, tenant only firm. In giving the reasons for his move in the press, he acknowledged the difficulty with dual representation platforms: “If you’re doing your job as a tenant advisor, you probably will bloody some noses in the process” he said. That creates a major conflict and problem for the broker because he goes on to say, “If you’re a full- service firm, you’re also thinking about getting the next listing from the owner.” It’s not good business to make an owner mad while representing a tenant if you really want that owner’s next deal too.
Over the past five to seven years there has been a significant amount of consolidation in many industries as companies strive to grow their revenues and capture more and more business. The problem is, you can’t really service everyone when some clients have adverse interests or diametrically opposed business objectives and they are sitting on opposite sides of the negotiating table. As the Wall Street Journal article confirms, shareholders and boards of directors across the country are becoming more and more sensitive to these conflicts of interest because they may be called upon to justify why they hired an advisor whose objectivity was compromised or advice was tainted. As a result, companies are taking precautions to vet and prevent future conflicts of interest when engaging their advisors. Whether its requiring the advisor to disclose the extent of its financial relationships with potential adverse parties in advance of the hiring decision or simply hiring advisors who are much less likely to be in conflicted positions, the way companies are conducting business is starting to change.
Real estate has often been slow to adapt to changes in the way business is conducted. However, given what’s at stake for officers and directors, individuals tasked with selecting their tenant broker are going to have to justify the conflicts they expose their companies to or find better ways to avoid them in the first place. Given the potential liability and opportunity for second guessing, they probably don’t want to have to explain after the fact why the brokerage firm they hired to represent their interests was also representing their landlord.
For more information contact Glenn Blumenfeld