Banker Loyalty in Mergers and Acquisitions

Andrew F. Tuch is Associate Professor of Law at Washington University School of Law. This post is based on an article authored by Dr. Tuch, and is part of the Delaware law series, which is cosponsored by the Forum and Corporation Service Company; links to other posts in the series are available here.

As recent decisions of the Delaware Court of Chancery illustrate, investment banks can face conflicts of interest in their role as advisors on merger and acquisition (“M&A”) transactions. In a trilogy of recent decisions—Del Monte[1] El Paso [2] and Rural Metro [3]—the court signaled its concern, making clear that potentially disloyal investment banking conduct may lead to Revlon breaches by corporate directors and even expose bank advisors (“M&A advisors”) themselves to aiding and abetting liability. But the law is developing incrementally, and uncertainty remains as to the proper obligations of M&A advisors and the directors who retain them. For example, are M&A advisors in this context properly regarded as fiduciaries and thus obliged to act loyally toward their clients; gatekeepers, and thus expected to perform a guardian-like function for investors; or simply arm’s length counterparties with no other-regarding duties? [4] The Chancery Court in Rural Metro potentially muddied the waters by labelling M&A advisors as gatekeepers and—in an underappreciated part of its opinion—by also suggesting they act consistently with “established fiduciary norms.” [5]

In my article Banker Loyalty in Mergers and Acquisitions, forthcoming in the Texas Law Review, I examine this question of how best to characterize M&A advisors—as fiduciaries, gatekeepers or arm’s length counterparties. This question is relevant to determining what courts can rightly require of corporate directors in discharging their own fiduciary obligations when confronted with conflicted M&A advisors. The prevailing scholarly view resists characterizing M&A advisors as fiduciaries, or at least regards them as only nominal fiduciaries, putting faith instead in the power of contract law and market constraints to discipline errant bank behavior. I claim that fiduciary doctrine performs an indispensable role in shaping M&A advisors’ conduct, providing a theoretical account of the M&A advisor as a fiduciary. The article then develops an analytical framework for assessing what liability rules will most effectively deter M&A advisors from acting disloyally and, using this framework, evaluates recent Delaware case law.

Are M&A advisors fiduciaries, gatekeepers or arm’s length counterparties?

The article examines the character of a client’s relationship with its M&A advisor, grounding its analysis in theories focused on clients’ reasonable expectations of loyalty and clients’ capacity to contractually specify and monitor M&A advisors’ conduct. The factual description emphasizes the partisan role M&A advisors perform for their clients and the often adversarial setting in which deals occur, one in which each principal has its “own” advisors, where even amicable relations among principals can quickly deteriorate, and in which bargaining occurs against the canvass of a potentially hostile deal. It also emphasizes the superior expertise and experience of M&A advisors relative to their clients, as well as bankers’ representations of themselves as “trusted advisors”—claims that are consistent with the end-game quality of these deals, the sensitive non-public client information advisors possess, and the magnitude of fees they command. Relying on client expectations and the difficulty of contractually articulating and monitoring advisors’ conduct, the article characterizes M&A advisors as fiduciaries of their M&A clients and, therefore, as obliged to act loyally in the absence of informed client consent. Critically, the implication is not that M&A advisors, as fiduciaries, should always act loyally, eschewing conflicts of interest—because not all conflicts will harm clients. Rather, it is that M&A advisors should act loyally during the course of a deal, unless they obtain their client’s informed consent to conduct that would otherwise breach their fiduciary duties.

The article also addresses claims portraying investment banks as arm’s-length counterparties or as adequately constrained by market forces. Focusing on claims that clients, as sophisticated actors, can protect themselves without the need for fiduciary protections, the article points to clients’ likely inability to accurately perceive the risk of advisor disloyalty and their lack of sophistication relative to their M&A advisors, who have greater expertise and experience as well as mandated training and registration—as broker-dealers—to provide M&A advisory services.

Are M&A advisors also gatekeepers? While actors may perform both fiduciary and gatekeeping roles, they rarely do so simultaneously. A fiduciary must act loyally toward its client in the absence of informed client consent; by contrast, a gatekeeper, as conventionally conceived in legal literature, performs a guardian-like role for investors, exercising its influence over its client to deter wrongdoing, typically the commission of disclosure errors. To buttress its role, a gatekeeper must often act independently, eschewing conflicts that may compromise its independence from its client—rather than those that promote its loyalty toward it client.

Though investment banks may perform gatekeeping roles in underwriting securities offerings and providing fairness opinions, the gatekeeping label is inapposite to the M&A advisors’ role under scrutiny. First, the wrong here is inflicted by the M&A advisor upon the client. It arises from the M&A advisor’s disloyalty, such as from compromised advice or other conduct. The gatekeeping template instead targets the wrongs of one actor by imposing responsibilities on another actor (the gatekeeper) to deter those wrongs. In the current context, only if we regard the wrong to be deterred as that of the client (or its directors) could we characterize M&A advisor as a gatekeeper, in consonance with that term’s conventional meaning.

Second, and relatedly, the gatekeeper is a desirable target for liability because of its capacity to monitor and influence, and thereby to deter, wrongdoing by the former actor (often its client). Do M&A advisors have that capacity? In some respects—such as in deterring disclosure wrongs—they surely do. Even if they do have that capacity in other relevant respects, and it’s unclear that they do (at least to the same extent as classical gatekeepers like underwriters and auditors), there is clear tension in subjecting directors to liability for failing to reasonably oversee their M&A advisors, while also subjecting M&A advisors to liability (as gatekeepers) for failing to monitor and influence directors.

Finally, characterizing the M&A advisor as a gatekeeper is inconsistent with also criticizing that advisor for its disloyalty towards it client. Recall that independence—and not loyalty—is typically required of gatekeepers. Together, these reasons suggest a mismatch between the use of gatekeeper theory and the end to be achieved—banker loyalty. If we hold an M&A advisor liable as a gatekeeper, therefore, we do so not for its disloyalty toward its client, but for the conceptually distinct conduct of failing to deter—or, perhaps somewhat analogously, for knowingly participating in—the client’s (or directors’) wrongdoing. At a minimum, conceiving of the M&A advisor as a gatekeeper—and using that as a justification for imposing (aiding and abetting) liability—is a highly attenuated means of ensuring banker loyalty, one with uncertain deterrent effects.

Liability Rules to Deter M&A Advisor Disloyalty

The article develops an analytical framework to assess liability rules to best ensure that investment banks fulfill their fiduciary role. Drawing on optimal deterrence theory, it develops an analytical framework to assess liability rules for their effect in deterring disloyalty by M&A advisors. It disaggregates the M&A client into its core constituencies, its board of directors and body of shareholders. The framework assesses the potential liability of M&A advisors and the individuals serving as corporate directors of M&A clients; it does so by drawing analogies between disloyalty and unilateral accidents as well as between M&A advisors and boards, respectively, and tortfeasors and their economic principals.

This analytical framework begins with the simple case of holding M&A advisors liable for disloyalty toward their clients. The analysis shows that such rules are unlikely to adequately deter M&A advisor disloyalty. This result follows from the risk that directors of M&A clients, or those under their authority, will defeat fiduciary protections owed by M&A advisors by waiving or contractually displacing them or by simply failing to enforce them, perhaps because directors’ interests diverge from those of shareholders or because they want to avoid undermining a deal that, while compromised by an advisor’s disloyalty, may still be better than no deal. Directors’ incentives not to hold advisors to account may be strongest where an advisor’s disloyalty is otherwise unlikely to come to light.

The framework then considers other mechanisms for deterring M&A advisor disloyalty, including liability rules on directors themselves for their oversight of advisors. Under certain conditions, deterrence theory will impose liability on economic principals for the conduct of their agents. This liability is often referred to as enterprise liability or, when liability is strict rather than fault-based, as vicarious liability. In the current context, directors are obvious targets of such liability because of their potential capacity to monitor and influence M&A advisors’ conduct, including by specifying the terms of engagement and by holding advisors accountable for deviant behavior. The article considers the conventional justifications for imposing liability on a principal (here, the board of directors) for the wrongs of its economic agent (here, the M&A advisor), including the insufficiency of a simple liability regime (one imposing liability only on the agent/M&A advisor). In short, the article concludes that the case for directorial liability does not stand on all fours with the paradigmatic case for enterprise liability, but may be plausibly made out.

The article goes on to explain why directors should face fault-based liability (based on their effective oversight or policing of M&A advisors), rather than strict liability. Under a strict liability regime, directors who police effectively—including by undertaking the ex post policing measures of investigating and prosecuting disloyalty—may invite liability since those measures may disclose misconduct that would not otherwise come to light. They would then face a higher expected liability by policing effectively than they would if they did not police effectively, discouraging effective policing. A regime of fault-based liability for directors overcomes this potential problem when fault is keyed to the quality of both their ex ante and their ex post policing efforts (employing a distinction drawn by Professors Jennifer Arlen and Reinier Kraakman). [6]

While the analysis does not lead to a single, straightforward prescription, it suggests the desirability of liability rules akin to primary and enterprise or secondary tort liability. More specifically, it suggests that a regime in which M&A advisors alone faced liability would ineffectively deter M&A advisor disloyalty. Further deterrence would be required, and the ability of directors to monitor and influence M&A advisors suggests the wisdom of imposing directorial liability, although the case is non-standard. If directorial liability is imposed, theory supports imposing fault-based, rather than strict, liability. By design, such a regime would create incentives for directors to monitor and influence M&A advisors, effectively transmitting liability to M&A advisors through various ex ante and ex post measures, thereby helping deter M&A advisor disloyalty toward shareholders.

The analysis also shows why directors who waive or contractually displace fiduciary duties or otherwise limit M&A advisors’ liability for disloyalty may act inconsistently with their duties, as may directors who, after discovering disloyalty, fail to hold the responsible M&A advisor accountable for it. The article considers various caveats and extensions to the analysis, ultimately showing why public enforcement is likely to be necessary to effectively deter disloyalty by M&A advisors. The analysis provides no support for aiding and abetting liability on M&A advisors for their disloyalty.

Evaluating Delaware Law

Using this analysis, the Article assesses existing law, focusing on recent Delaware decisions, namely, Del Monte, El Paso and Rural Metro. These decisions conform in important respects to the earlier analysis, most notably by imposing fault-based liability on directors, requiring them to act reasonably in overseeing or policing M&A advisors’ conflicts, and by generally conceiving of M&A advisors as required to act loyally toward their clients. However, they likely fail to adequately deter M&A advisors’ disloyalty. M&A advisors face little risk of direct liability (leaving aside the potential for aiding and abetting liability); corporate directors face little threat of personal liability for failing to reasonably police advisors’ disloyalty; and in neither case does the threatened magnitude of liability compensate for the low probability of sanction.

While further deterrence of M&A advisors’ conflicts is desirable, aiding and abetting liability seems poorly suited to the task of deterring M&A advisors’ conflicts. First, that liability arises not for M&A advisors’ disloyalty (that is, the conduct harming the client, such as by compromising its sale process), but for the conceptually distinct activity of knowingly participating in directors’ failure reasonably to police M&A advisors’ conduct. Second, one can conceive of circumstances when a disloyal M&A advisor harms its client without knowingly participating in directors’ oversight lapses. As Vice Chancellor Laster explained in Rural Metro, knowing participation will be made out “[i]f the third party knows that the board is breaching its duty of care and participates in the breach by misleading the board or creating the informational vacuum…”. What of the (brazenly) disloyal investment bank that doesn’t mislead or create an informational vacuum? It might fall beyond the reach of aiding and abetting liability, however harmful its conflicts.

The analysis also reveals potential gaps in deterrence, most notably in courts’ potential willingness to relieve directors of liability based on their capacity for oversight of M&A advisors, rather than their actual oversight, as well as in transactions outside the scope of so-called Revlon duties. The article proposes modest but potentially significant doctrinal shifts—including subjecting directors’ decisions to limit fiduciary protections to enhanced judicial scrutiny—as well as increased oversight by the regulators tasked with disciplining investment banks, namely the Securities and Exchange Commission and the Financial Industry Regulatory Authority. [7]

The article concludes by examining broader implications of the analysis, focusing on the potential desirability of creating canons of professional responsibility for investment bankers. It also examines the potentially overlapping roles of fiduciary doctrine and contract law in helping directors to satisfy their duties to oversee the conduct of their M&A advisors.

The article is available here.


[1] In re Del Monte Foods Co. S’holders Litig., 25 A.3d 813 (Del. Ch. 2011).
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[2] In re El Paso Corp. S’holder Litig., 41 A.3d 432 (Del. Ch. 2012).
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[3] In re Rural Metro Corp. Stockholders Litig., 88 A.3d 54 (Del. Ch. 2014).
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[4] The Article also considers the possibility of characterizing M&A advisors as both fiduciaries and gatekeepers.
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[5] In re Rural Metro Corp. S’holders Litig., 88 A.3d 54, 88-89 (Del. Ch. 2014) (internal footnote omitted) (claiming M&A advisors “function as gatekeepers” and also suggesting they face liability “to advise boards in a manner that helps ensure that the directors carry out their fiduciary duties …, rather than in a manner that falls short of established fiduciary norms.”).
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[6] See Jennifer Arlen & Reinier Kraakman, Controlling Corporate Misconduct: An Analysis of Corporate Liability Regimes, 72 N.Y.U. L. Rev. 687 (1997).
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[7] As to the authority of these regulators in policing M&A advisors, see See Andrew F. Tuch, The Self-Regulation of Investment Bankers, 83 Geo. Wash. L. Rev. 101, 116-20 (2014), available at
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