Recent Delaware cases put investment banker conflicts of interest in the judicial cross hairs. Judges appear increasingly concerned that conflicts of interest may compromise the banker's loyalty and objectivity and undermine the integrity of the sale process.

In two recent Delaware Court of Chancery decisions, Atheros Communications and Del Monte Foods, the judges specifically mentioned "the central role played by investment banks in the evaluation, exploration, selection and implementation of strategic alternatives." In both cases, concerns about the financial adviser's potential conflicts of interest led the court to delay votes on the mergers and require additional disclosure to shareholders. Both cases suggest heightened judicial suspicions about the ethics of investment banking firms.

The case of Del Monte Foods Co. gives the investment banking industry a black eye. One of Del Monte's principal investment banks, Barclays plc, handled several engagements for Del Monte during 2009 and 2010. But Barclays had an even stronger relationship with Kohlberg Kravis Roberts & Co. LP and with other private equity firms. During the past two years, KKR paid Barclays more than $66 million in fees.

In 2009, when Barclays was working for Del Monte on other matters and without Del Monte's authorization or knowledge, Barclays pitched the acquisition of Del Monte to KKR and other private equity firms. When one of them made an unsolicited offer, Barclays secured the engagement as Del Monte's financial adviser. As part of the selection process, Barclays claimed to be well qualified because the firm "knew many of the entities that might be an interested buyer." Needless to say, Barclays didn't disclose that the firm may have put Del Monte in play.

Barclays also did not mention to the Del Monte board during the engagement discussions that the firm intended to seek a role providing buy-side financing. However, Barclays contemporaneous internal documents reflect that, at the appropriate time, Barclays intended to seek the very lucrative buy-side financing work.

According to Vice Chancellor J. Travis Laster, Barclays managed the sale process to maximize KKR's prospects for winning the deal and the investment bank's own prospects for providing the buy-side financing. The court found that "Barclays secretly and selfishly manipulated the sale process to engineer a transaction that would permit Barclays to obtain lucrative buy-side financing fees. On multiple occasions, Barclays protected its own interests by withholding information from the board that could have led Del Monte to retain a different bank, pursue a different alternative, or deny Barclays a buy-side role." In fairness to Barclays, it must be noted that Laster made his findings on an incomplete record and that Barclays did not have an opportunity to fully defend itself.

The lessons of Del Monte include the need for the board of directors of an acquisition target to ask potential financial advisers during the interview process whether the bank intends to seek the buy-side financing work for the transaction, and to discuss the potential conflicts that may result. The directors may also want to ask whether the candidate has previously had discussions with or made presentations to potential buyers regarding acquisition of the company.

In the case of Atheros Communications Inc., the court faulted the company for failure to make robust disclosure in the merger proxy statement regarding the contingent nature of the fee being paid to Qatalyst Partners, the financial adviser to Atheros Communications in connection with its sale to Qualcomm Inc.

Although Vice Chancellor John Noble recognized that contingent fees are now routine in M&A, he clearly believed that Qatalyst's fee, which was 98% contingent upon the deal closing, created "arguably perverse incentives that may influence the financial advisor in the exercise of its judgment and discretion."

In both Atheros and Del Monte, the court delayed the shareholder vote on the merger and required additional disclosure to address the investment banker conflicts.

In light of this increased judicial sensitivity, the board of the potential acquisition target needs to be more diligent regarding banker conflicts during the interview process and more cautious in permitting the banker to provide buy-side financing. The board should also consider the advantages and disadvantages of making the banker's fee contingent upon a deal closing and the implications for the reliability of the fairness opinion. Finally, the company must make full disclosure to shareholders regarding the banker's compensation arrangement in the proxy statement.

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Gardner Davis is a partner and Danielle Whitley is senior counsel in the transactional and securities practice of law firm Foley & Lardner LLP.