Alerts and Updates

SEC Approves FINRA Rule Regarding Potential Conflicts of Interest in Fairness Opinions

November 29, 2007

Investment or other transaction banks typically issue fairness opinions regarding the fairness of a proposed merger, acquisition, sale or other transaction. Rule 22901 is intended to inform stockholders of potential conflicts of interest that may exist in the issuance of fairness opinions by FINRA members. FINRA is concerned that existing disclosures provided in fairness opinions may not adequately alert the shareholders to potential conflicts of interest that may exist between the firm issuing the fairness opinion and the parties to the proposed transaction.

The Rule imposes both disclosure requirements and procedural requirements on issuers of fairness opinions, including requiring member firms to maintain written procedures with respect to the approval of fairness opinions. While the SEC disclosure requirements apply only when the member firm knows or has reason to know the fairness opinion will be provided or described to the subject company's shareholders,2 the SEC has suggested that fairness opinions prepared for use by such a company's board of directors should include these disclosures because "the fairness opinion is usually included in materials provided to public shareholders."

The Rule requires:

Disclosure Requirements

  • Contingent Compensation. A member firm is required to disclose if it will receive compensation contingent upon successful completion of the transaction for the services in rendering the fairness opinion and/or serving as an advisor to any party to the transaction. Additionally, a member firm is required to disclose if it will receive any other significant payment or compensation3 that is contingent upon the successful completion of the transaction.
  • Material Relationships. A member firm must disclose any material relationships4 that existed during the past two years or that are mutually understood to be contemplated in which any compensation was received or is intended to be received as a result of the relationship between the member and any party to the subject transaction.
  • Independent Verification of Information that Formed a Substantial Basis for the Fairness Opinion. A member firm must disclose if any information that formed a substantial basis5 for the fairness opinion that was supplied to the firm by the company requesting the opinion concerning companies which are parties to the transaction has been independently verified by the member firm, and if so, a description of the information or categories of information that were verified.6
  • Use of a Fairness Committee. A member firm must disclose whether or not the fairness opinion was approved or issued by a fairness committee.
  • Compensation to Officers, Directors or Employees. A member firm must disclose whether or not the fairness opinion expresses an opinion about the fairness of the amount or nature of the compensation to any of the company's officers, directors or employees, or class of such persons, relative to the compensation to the public shareholders of the company.7

Procedural Requirements

A member firm issuing a fairness opinion must have written procedures for approval of the firm's opinion, including the following:

  • Procedures for Use of a Fairness Committee. The types of transactions and the circumstances in which the member will use a fairness committee to approve or issue a fairness opinion, and in those transactions in which it uses a fairness committee: (a) the process of selecting personnel to be on the fairness committee; (b) the necessary qualifications of persons serving on the fairness committee; and (c) the process to promote a balanced review by the fairness committee, which shall include the review and approval by persons who do not serve on the deal team to the transactions.8
  • Procedures Regarding Valuation Analyses. The member firm is required to adopt procedures addressing the process to determine whether the valuation analyses used in the fairness opinion are appropriate.

For Further Information

Many member firms will need to review and possibly revise their internal procedures and modify their fairness opinion practices in order to comply with Rule 2290. Should you have any questions regarding the effects or implementation of the Rule 2290 requirements, please call one of the members of the Securities Law Practice Group or the lawyer in the firm with whom you are regularly in contact.

Footnotes

  1. The Securities and Exchange Commission ("SEC") recently approved Rule 2290 of the Financial Industry Regulatory Authority ("FINRA," formerly known as the National Association of Securities Dealers, or "NASD"), which addresses additional disclosure requirements in connection with the issuance of fairness opinions by investment banks. The Rule is effective for fairness opinions on December 8, 2007.
  2. See Release No. 34-56645.
  3. "Significant payment or compensation" is payment or compensation that a reasonable reader of the fairness opinion would have an interest in knowing about in order to assess whether the member authoring the fairness opinion has a potential conflict of interest, but would not include de minimis fees such as trading fees or small incremental fees from account assets or activity. FINRA intends the disclosures required under the Rule to be descriptive, not quantitative, and, to that extent, has chosen not to establish a monetary threshold so as to avoid establishing a de facto standard for such payments.
  4. The Rule does not define the term "material relationships."
  5. The Rule does not define the term "substantial basis."
  6. There is no requirement that the member firm verify such information provided to it, but that if the member firm does, in fact, independently verify the information, this fact must be disclosed. If no such independent verification was performed by the member firm, then a blanket statement to that effect will suffice.
  7. The opinion recipient, however, may wish to disclose whether it has conducted an examination regarding the compensation paid to those individuals and cross reference the company's most recent compensation disclosure and analysis (CD&A).
  8. Whether a person is considered to be part of the deal team requires an analysis of the particular facts and circumstances, and depends on the nature and substance of such person's contacts with and the advice rendered to the member firm. It shall not be determined by whether such person is included on all document distributions or participated in certain meetings. The Rule does not require that a member firm's fairness committee be comprised primarily of persons not serving on the deal team. Rather there should be enough persons (not necessarily committee members) who do not serve on the deal team in order to provide a balanced review.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.