Coverage of the Citigroup-Wachovia-Wells Fargo situation has revealed many fundamental misunderstandings of various aspects of the debacle, such that I wanted to offer my thoughts on a few points that have been curiously misstated:
1. A discussion of “fiduciary outs” is a bit of a non sequitur here. Across the ‘net, legal experts have been opining about how Wachovia has the fiduciary obligation to take the best deal available. I have two responses to that: (A) The Citigroup deal is different in form than the Wells Fargo deal, so we cannot compare them both on price alone and claim the Wells Fargo deal is “better” than the Citigroup deal. Citigroup only proposed to acquire SOME of Wachovia’s assets, leaving Wachovia with a viable business. The combined value of what Citigroup was paying and what Wachovia was retaining may well be higher than what Wells Fargo was offering for all of Citigroup. Particularly since Citigroup was willing to bid up its price. Therefore, it is not an “apples to apples” comparison in this case that would allow armchair quarterbacks to simply say “the Wells Fargo deal is better – Wachovia board has a fiduciary out.” (B) Courts have not always let boards out of a deal when a better deal presents. If the board signed the best deal they could get under dire circumstances, courts will support the deal. Think of the uncertainty that courts would create if such was *not* the case. No bidder would ever risk making a bid for a troubled target.
2. The Wells Fargo deal does indeed involve government or taxpayer subsidization. Part of how Wells Fargo is touting its offer as better is by claiming it does not burden the taxpayer or the government. That is a bit disingenuous, however. Part of the reason why Wells Fargo is now willing to acquire Wachovia is because the IRS announced last week that it will allow Wells Fargo to offset its income by all of Wachovia’s losses. Wells Fargo has the income available to do this; Citigroup does not. You tell me – isn’t there a government and/or taxpayer cost to Wells Fargo paying a whole lot less in taxes than it normally would due to the new IRS rule allowing for the deduction of all of Wachovia’s losses? Who is going to make up that tax shortfall? I imagine either the government or other taxpayers. Therefore, it is disingenuous for Wells Fargo to say its deal has no government or taxpayer cost.
3. The Citigroup deal will not directly cost taxpayers money, nor does it necessarily involve government help. Wachovia is claiming that the Wells Fargo deal is the better deal because it does not burden the government or the taxpayers like the Citigroup deal does. That is a misstatement, if not a falsehood. In addition to my above point about the Wells Fargo deal’s burden, the Citigroup “burden” is only hypothetical at this point. The FDIC agreed to backstop Wachovia’s losses if they occur. Some say the magnitude of losses Wachovia will have to take due to mortgage defaults is grossly overstated, so the FDIC might not have to backstop anything. Further, even if the FDIC has to make good and cover for Citigroup some of Wachovia’s losses, this does not involve the taxpayer’s money, contrary to the media (and Wachovia’s) hype. The FDIC is funded by BANKS who pay insurance. The money is collected and pooled by the FDIC to cover situations exactly like this. It is not taxpayer money that is being spent any more than it is taxpayer money being spent when you get into a car accident and ask your insurance company to pay your claim. FDIC stands for “Federal Deposit INSURANCE Corporation.”
4. Section 126(c) of TARP (the federal bail-out act) does not void the Wachovia-Citigroup Exclusivity Agreement. All Section 126(c) does is preclude an exclusivity agreement from imposing liability on a third party (deal jumper, second bidder for a target) for jumping the deal that is subject to the exclusivity agreement. Wachovia’s argument that 126(c) provides the basis on which a court can invalidate the Exclusivity Agreement is contrary to the text of the statutory provision. The confusing point, however, is that the statutory provision at issue is titled “Unenforceability of Certain Agreements.” It should have been titled “Unenforceability of Certain Agreements Against Deal Jumpers.”
5. Wachovia desperately needed Citigroup a week ago, and Citigroup helped Wachovia stay afloat last week. If a court sends Citigroup away with nothing despite the fact that Wachovia clearly breached its Exclusivity Agreement, that will send a message to other solvent banks not to be the first to step in to save a failing bank. That is not a good message to send to solvent banks in this economy, where it is likely that more banks will fail before the year is out. According to the complaint Wachovia filed in federal court over the weekend, the FDIC told Wachovia a week ago it was going to seize the bank if a suitor did not buy it out. Wells Fargo, which had indicated interest in Wachovia that weekend, walked away at the end of the weekend. Robert Steel, the CEO of Wachovia, said he then went to the board with two options: (1) file for bankruptcy or (2) accept a Citigroup offer.
6. Wachovia and Citigroup had more than merely the hope of a deal. The media and some commentators harp on the fact that Citigroup and Wachovia had only a “mere term sheet.” The FDIC obviously thought Wachovia and Citigroup had something more than a hope of a deal as the FDIC held off seizing Wachovia on Citigroup’s word that it would try to hammer out the details of a final deal by October 6, 2008.
7. There are three lawsuits pending in this case (or there will be as soon as complaints are officially filed), and none of them are determinative. Citigroup asked New York State courts for relief this weekend. Justice Ramos issued an order extending the Exclusivity Agreement, and an appellate judge reversed that order because Ramos signed the order at his Connecticut home. Then Wachovia sought relief from the Exclusivity Agreement in the Southern District of New York late Saturday night, and Judge Koeltl set a hearing for Tuesday. Late Sunday, Wachovia investors filed suit in Mecklenburg county in North Carolina, and a state judge there issued an injunction prohibiting Citigroup from trying to enforce the Exclusivity Agreement on the basis that it was destabilizing Wachovia’s Wells Fargo deal and therefore Wachovia’s viability. I have not yet seen this North Carolina order, but I am scandalized. Apparently North Carolina state judges have no respect for the law of contracts and simply have a sense of rough justice. Rough justice is fine for the People’s Court on t.v., but it is not fine for big bank deals involving sophisticated parties.
8. Section 126(c) was in the bill pending the ultimately failed vote a week ago when the Citigroup-Wachovia deal was announced. Rodg Cohen from Sullivan & Cromwell surely knew the provision was pending (he represented Wachovia). Word on the street is that Citigroup officials were caught off guard when this provision was adopted on Friday, essentially undercutting their tortious interference claims against Wells Fargo. If the Citigroup officials were caught off guard, dare I suggest Davis Polk (who represented Citigroup) was asleep at the wheel? In light of last year’s United Rentals case, the spate of failed private equity deals, and last year’s litigation raising these exact same issues, how could Davis Polk missed this point?