On October 17, 2007, the Securities and Exchange Commission (SEC) published its approval of amended Rule 2290 in the Federal Register. The new rule 2290 involves disclosures and procedures related to the issuance of “independent” fairness opinions included in proxy statements. Specifically, any proxy statement that includes a fairness opinion will soon need to disclose:
1. Whether the issuer of the fairness opinion will receive any compensation that is contingent upon the successful completion of the transaction;
2. Any material relationship that existed in the past two years, or that is contemplated in the future between the issuer of the opinion and the companies involved in the transaction at issue;
3. Information that formed a substantial basis for the fairness opinion, and whether such information was independently verified – This is a change from current predominant practice in which the opinion simply states, “We have not independently verified the accuracy and completeness of the information supplied to us with respect to [client name], and do not assume any responsibility with respect to it.” Although the new rule does not require verification, the opinion will need to provide additional detail regarding the opinion’s foundation;
4. Whether the fairness opinion was approved by a committee of the firm issuing the opinion that followed procedures designed to provide a balanced view of the transaction. Such procedures would normally include the process used for selecting the committee, the qualifications of persons serving on the committee, and the nature of the review by persons who are not on the “deal team” to the transaction.
By default, most companies hire the deal’s investment banker to provide the fairness opinion regarding the transaction. Although the fee earned for rendering a fairness opinion is typically separate and not contingent on the transaction closing, the same investment bank usually has a separate significant fee that is completely contingent on the transaction closing. The fairness opinion is needed to complete the deal, so the much larger contingent fee will not happen unless the fairness opinion reaches the desired conclusion. The conflict of interest is obvious. The National Association of Securities Dealers (NASD), and now the SEC, acknowledge this conflict of interest, and are issuing the rule because they are:
“… concerned that the disclosures provided in fairness opinions may not sufficiently inform investor-shareholders about the potential conflicts of interest that exist between the firm rendering the fairness opinion and the issuer. Among these conflicts are fees that the firm rendering the fairness opinion will receive upon the successful completion of the transaction (either from advisory fees or fees for the fairness opinion itself), as well as other material relationships between the firm and the issuer …”
The NASD introduced the possibility of a rule change in 2004. Wall Street’s major investment bankers successfully lobbied against the change, thus accounting for the long delay that has already occurred. However, others (primarily investor groups) proposed stronger measures than what will now be required. The stricter guidelines (that are NOT part of the current rule) include (i) requiring independent fairness opinions from someone other than the investment banker on the deal, and/or (ii) prohibiting investment banks from receiving success fees for transactions in which they issue fairness opinions. The NASD’s milder rule for disclosure only is a victory for the large investment bankers that have these conflicts of interest. The large investment banking firms should be particularly happy with their lobbying accomplishments since the NASD concluded that, “Arguments that independent fairness opinions or those without a success fee component offer advantages may be well-founded.”
What is a Fairness Opinion?
Board members have a fiduciary duty of care that requires them to be reasonably informed when making specific decisions that affect public or minority investors who are not actively participating in the decision. Since most Boards of Directors are not made up of merger & acquisition and valuation experts, they often seek financial advice to assist with their decision making. A formal opinion, most often referred to as a “fairness opinion”, serves as evidence that the board members conducted a process that was sufficient for meeting its fiduciary obligations.
A fairness opinion addresses, from a financial point of view, the consideration involved in a transaction. However, the opinion does not indicate whether the price of a proposed transaction is the best that could be obtained. Instead, the opinion addresses whether the price is “fair”, usually within an acceptable value range. Because fairness opinions are not required, the board of directors determines whether to request a fairness opinion, the scope of the opinion, and who should be engaged.
Although there are many court decisions on fairness opinions, the following are landmark Delaware court decisions:
1. In Weinberger vs. UOP in 1983, the company obtained a fairness opinion, but the opinion was found to be less than necessary because too little attention was paid by the investment banker in the transaction, and the same investment banker was getting a large success fee. The Court focused on the haste of the decision as well as the lack of independence by the investment banker. Because of this, the bulk of the post-Weinberger case law focuses on the question of what constitutes a fair procedure.
2. In Smith vs. Van Gorkom in 1985, the Court imposed personal liability on outside directors because of gross negligence for failing to determining a company’s value before selling it. This occurred despite the fact that the price being paid was an all-cash bid at an almost 50 percent premium over the prior price of the acquired company’s stock. The Court implied that the liability could have been avoided by getting the advice of anyone in a position of knowing the company’s value.
3. The Revlon decision in 1986 established that board members of publicly held companies have a duty to get the highest price for its shareholders once it puts itself up for sale. While it is easy to determine th