Underwriters & Financial Advisors

July 20, 2011


A recent decision issued by a U.S. District Court in Indiana has once again raised a question regarding the efficacy of an issuer and/or its board of directors relying on financial advice from an underwriter in connection with the execution of the offering.[1]

Traditionally, issuers preparing for securities offerings have not hired “financial advisors” to assist in such preparation. Any applicable financial advice to the CEO or the board of directors has come from the issuer's finance department, together with the underwriters for the offering. Ormond, however, together with underwriters’ practices subsequent to a decision by the New York Court of Appeals several years ago,[2] has called this practice into question under certain circumstances.

The Ormond case arose out of litigation surrounding the demutualization and IPO of Anthem, Inc. in 2001. In denying in part a motion for summary judgment by the defendants, the district court stated that portions of the record supported the view that a reasonable fact-finder could reach a conclusion that Anthem did not act with ordinary prudence when it approved the final pricing and sizing of the IPO.

The plaintiffs were members of the mutual holding company who elected to have their shares cashed out in the IPO. They alleged that the very high demand for the IPO after the road show should have led to raising of the IPO price, as opposed to simply an increase in the number of shares issued.[3] The initial indications sent to the members of the mutual holding company announcing the demutualization and IPO estimated an IPO pricing range of $25 to $45. At the suggestion of the lead underwriter, Goldman Sachs, the range was subsequently narrowed to $33 to $37, with a final IPO price of $36. The closing price for Anthem on the first full day of trading was $40.90. It closed at $42.90 three days later, the effective date for the plan of demutualization.

In refusing to grant the defendants a motion for summary judgment on a tort claim for breach of fiduciary duty;[4] the court noted that (i) several board members/pricing committee members testified that they did nothing to independently assess Goldman Sachs’ recommendations regarding the pricing and sizing the IPO (even though the record showed that Goldman “stood to gain handsomely from the decisions it advised on”), and (ii) there was no evidence that the Anthem board knew what the Indiana Department of Insurance’s advisors thought about the price and size of the offering when they accepted Goldman Sachs’ recommendation. There was no indication in the record that there was any significant discussion regarding the alternative of using the high demand as a basis for increasing the IPO price, as opposed to increasing the number of shares issued.

This decision raises issues similar to those raised by the New York Court of Appeal’s decision in eToys.

The plaintiffs in eToys alleged that the underwriters, led by Goldman Sachs, had a fiduciary duty to eToys in connection with advising eToys on its initial public offering.[5] In response to the eToys litigation, many underwriters added an acknowledgement provision to their underwriting agreements that require issuers to acknowledge that the issuers are not relying on the underwriters for financial advice. The Anthem IPO pre-dated this market development and, accordingly, the underwriting agreement contained no such acknowledgement.[6]

Thus, in light of market practice subsequent to eToys and the recent decision in Ormond, issuers and their boards of directors should consider the extent to which they may wish to seek independent financial advice in connection with capital markets activities, especially IPOs.

The views of underwriters regarding the economics of an offering may be entirely correct. However, in light of the practice adopted by underwriters in the wake of eToys to disclaim responsibility for financial advice, together with the results of Ormond, issuers and their counsel should carefully weigh whether independent financial advisors should be retained separate and apart from underwriters to help issuers and their boards establish that due care was exercised in executing the offering. Although each decision would be fact specific, in determining whether to retain separate independent financial advisors, issuers and their boards should consider, among other factors, the extent to which there are shareholder constituencies whose interests are not necessarily aligned, the financial sophistication of the board generally, and any pricing committee, in particular, and the existence of conflicts of interest affecting board members or the lead underwriters.

[1] Ormond v. Anthem, Inc., July 1, 2011, U.S. Dist. S.D. Indiana.
[2] EBC I, Inc. v. Goldman, Sachs & Co., June 7, 2005, Court of Appeals of New York (“eToys”).
[3] Anthem’s initial mailing to its members anticipated issuing 76.08 million common shares as part of the demutualization and another 28.6 million shares as a capital raise in the public offering. The public offering was subsequently upsized from 28.6 million to 40 million shares and, eventually, 48 million shares (in each case, not including the green shoe).
[4] Whether Anthem or its board owed fiduciary duties to the members of the mutual holding company was a separate issue in the litigation and the court’s analysis is not addressed in this client alert.
[5] eToys was a poster child of the “dot.com” bubble, with a skyrocketing stock price immediately upon pricing of the IPO. Its stock price subsequently retreated in value shortly thereafter to at or near the IPO price, and bankruptcy followed within two years of the IPO. The plaintiffs alleged that Goldman Sachs purposefully underpriced the IPO in order to deliver value to its buy side customers.
[6] The Ormond decision involved a tort claim against the issuer, Anthem, not Goldman Sachs. All claims against Goldman Sachs had been previously dismissed.