Risk Disclosure Looming Larger In Merger Deals

A recent settlement with shareholders of First Republic Bank Corp. has put investment bankers on notice that they could be liable if any of the mergers sweeping the industry run into trouble.

Goldman, Sachs & Co., Morgan Stanley & Co., and Salomon Brothers Inc. earlier this month agreed to pay $42.2 million to settle investor claims arising from the 1987 merger that created First RepublicBank Corp. of Texas.

Investor lawsuits claimed that the firms misled them about the riskiness of the merger, which resulted in First Republic's failure 14 months later. This case indicates that "if there is a dropped ball, the shareholders are going to be aggressive," said Brian W. Smith, an attorney with Stroock & Stroock & Lavan in Washington.

In a court filing, the three firms denied any wrongdoing and insisted the settlement was intended to avoid further legal expense "and to put to rest all further controversy." Spokesmen for the three firms declined to elaborate.

The possible precedent set by the First Republic settlement is no doubt on the minds of investment bankers and lawyers working on a host of pending bank mergers, including the marriages of Bank America Corp. and Security Pacific Corp.; NCNB Corp. and C&S/Sovran Corp.; and Chemical Banking Corp. and Manufacturers Hanover Corp.

Opinion Withheld

Indeed, there is speculation that the First Republic litigation contributed to Morgan Stanley's refusal to issue a so-called fairness opinion on Bank of Boston's proposed merger with Shawmut National Corp. Morgan Stanley is Shawmut's investment banker.

"You can be second-guessed for erroneously valuing a portfolio," said Martin Bienenstock, an attorney with New York-based Weil, Gotshal & Manges. Mr. Bienenstock's firm represents Ernst & Young, which is being sued as the successor firm to Arthur Young & Co., which was First Republic's auditor.

Morgan Stanley was the adviser to Republic Bank Corp., Dallas, in its 1987 negotiations to merge with crosstown rival InterFirst Corp. Both companies were suffering severe real estate losses in Texas, but felt that joining together would substantially cut their operating costs and help them survive.

Morgan Stanley and Goldman Sachs, which represented InterFirst, each issued an opinion stating the deal was fair to shareholders. Subsequent regulatory examinations showed that problems at both banking companies were more severe than had been disclosed to shareholders.

Proposed Settlement

The proposed settlement calls for Goldman Sachs to pay investor $20.2 million, Morgan Stanley $15.9 million, and Salomon Brothers $5 million.

Morgan has also agreed to pay an additional $1.1 million to settle a related complaint filed in Houston state court.

Harvey Pitt, a former general counsel to the Securities and Exchange Commission, advises his bank clients to be prepared for litigation whenever they enter into merger or acquisition negotiations.

"There will be more litigation, not only because of the [First Republic] settlement, but also because that's the trend," said Harvey Pitt, a former general counsel to the SEC.

Mr. Bienenstock recommends creating "a paper trail showing that you had experts value every significant loan in the portfolio and that there was full disclosure on both sides."

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.