Fairness Opinions in Corporate Transactions
Given that merger and acquisition activity is at a five-year low, it has been difficult to determine the impact of a now nearly two-year old rule that places additional restrictions on fairness opinions issued by deal advisors. The Financial Industry Regulatory Authority (“FINRA”) Rule 2290 requires disclosure of potential conflicts of interest between firms that render fairness opinions and the parties to the corporate transactions that are the subject of the fairness opinions.
The rule is designed to alert shareholders that a fairness opinion regarding a potential transaction is not necessarily rendered by a completely independent third party. FINRA is concerned that shareholders may not be aware that the firm issuing a fairness opinion is often an advisor to a party to the transaction whose compensation may be contingent upon the success of the deal.
The rule addresses this concern by requiring specific disclosures if a member firm issuing a fairness opinion knows or has reason to know that the fairness opinion will be provided or described to the company’s public shareholders. Even if an opinion is prepared only for use by the board of directors of a client, shareholders of the client will now be made aware of potential conflicts of interest – including contingent compensation arrangements – because fairness opinions are usually included in materials provided to public shareholders.
The following disclosures are required by Rule 2290:
- whether the member firm has acted as a financial advisor to any party to the transaction;
- whether compensation for the opinion is contingent upon the success of the transaction;
- material relationships during the past two years between the member firm and any party to the transaction;
- whether the member firm independently verified any of the information that formed a substantial basis for the fairness opinion and was supplied to the member by the company requesting the opinion;
- whether the fairness opinion was approved or issued by a fairness committee; and
- whether the fairness opinion addresses the fairness of the amount or nature of the compensation from the transaction to certain insiders relative to the compensation to shareholders.
Member firms must also ensure that they meet the rule’s procedural requirements for issuing fairness opinions. Member firms that issue fairness opinions must have written procedures regarding the approval of all fairness opinions, not just those that will be provided to shareholders. Additionally, the written procedures must describe when the member firm will use a fairness committee to issue a fairness opinion and the process by which the valuation analyses used in the fairness opinion will be evaluated.
The rule is already in effect and has been approved by the Securities and Exchange Commission. Member firms should review their templates for fairness opinions and the procedures by which fairness opinions are rendered to ensure compliance with the rule.
As deal activity increases, boards of directors of acquiring companies are apt to look more closely at the fairness opinions they are relying on and the implications of relying on an opinion that notes significant conflicts of interest.
