Delaware Courts and the Weakening of the Duty of Loyalty: In re El Paso Corp. Securities Litigation (The Alleged Conflicts) (Part 3)

Plaintiffs alleged two conflicts of interest.  One involved the role of Goldman Sachs, the other the role of the CEO of El Paso.

Goldman Sachs, the owner of 19% of shares of Kinder Morgan, had been been retained by El Paso in connection with the original plan to spin off the exploration and production (E&P) business.  With respect to the offer from Kinder Morgan, El Paso hired Morgan Stanley.  Goldman, however, remained the advisor on the proposed spin off and, allegedly, influenced the terms applicable to Morgan Stanley.  As the court found, Goldman:

continued to intervene and advise El Paso on strategic alternatives, and with its friends in El Paso management, was able to achieve a remarkable feat: giving the new investment bank an incentive to favor the Merger by making sure that this bank only got paid if El Paso adopted the strategic option of selling to Kinder Morgan. In other words, the conflict-cleansing bank only got paid if the option Goldman’s financial incentives gave it a reason to prefer was the one chosen.

Defendants argued that Goldman had been sufficiently walled off from the merger negotiation process. The court, however, disagreed, describing the Chinese wall as "not effective."  The role of Goldman in the strategic alternative was viewed as "important" because of the board's need to undertake a relative comparison of the proposed acquisition and the proposed spin off.  Moreover, the court noted "questionable aspects to Goldman’s valuation of the spin-off".  As the court reasoned:

At this stage, I am unwilling to view Goldman as exemplifying an Emersonian non-foolishly inconsistent approach to greed, one that involves seeking lucre in a conflicted situation while simultaneously putting the chance for greater lucre out of its “collective” mind. At this stage, I cannot readily accept the notion that Goldman would not seek to maximize the value of its multi-billion 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.

The shareholders also alleged that the CEO of El Paso had a conflict of interest.  The CEO was responsible for negotiating with Kinder Morgan.  He allegedly wanted to participate in the acquisition of the E&P business once Kinder had acquired El Paso.  The interest was not disclosed to the El Paso board.  As the opinion described:

[The CEO] kept that motive secret, negotiated the Merger, and then approached Kinder Morgan’s CEO on two occasions to try to interest him in the idea. In other words, when El Paso’s CEO was supposed to be getting the maximum price from Kinder Morgan, he actually had an interest in not doing that.

Once the merger price was set, the CEO allegedly approached Kinder about a possible management bid for the E&P business.  Thus, the CEO, while having a duty to "squeeze the last drop of the lemon out for El Paso’s stockholders," had an alleged desire to purchase the E&P business, something that provided "a motive to keep juice in the lemon that he could use to make a financial Collins for himself and his fellow managers interested in pursuing an MBO of the E&P business."

Efforts by defendants to minimize the CEO's potential conflict were not, at the pleading stage, convincing to the court.  While conceding that a trial may show that the CEO was " the type of person who entertains and then dismisses multi-billion dollar transactions at whim," the court suggested that the facts alleged left open the possibility that the CEO:

did not tell anyone but his management confreres that he was contemplating an MBO because he knew that would have posed all kinds of questions about the negotiations with Kinder Morgan and how they were to be conducted. Thus, he decided to keep quiet about it and approach his negotiating counterpart Rich Kinder late in the process – after the basic deal terms were set – to maximize the chance that Kinder would be receptive.

As a result, the court concluded that, at the pleading stage, shareholders had sufficiently alleged a conflict of interest.  

Primary materials in this case, including the opinion, can be found at the DU Corporate Governance web site.

J Robert Brown Jr.