Is the Price Right?

IT'S TIME TO RETHINK the fairness opinion. Given the NASD's current efforts to flush out possible conflicts of interest among those who prepare fairness opinions, this is a good time to breathe new life into the idea.

How? The first step is to broaden the scope of the fairness opinion to assess not only the financial terms of the deal but also the process by which it came about. The second is to ensure that whoever issues a fairness opinion takes a truly independent look at the deal. Taken together, these steps could make fairness opinions worth something more than the paper they are written on. They may also help to assure shareholders that directors really do have their interests in mind.

In reality, the fairness opinion is nothing more than an insurance policy offering directors a first line of defense against the plaintiff's bar with angry shareholders in tow. Interestingly, although the law does not require that directors obtain fairness opinions, they have become so routine in recent decades that, in any major transaction, it is rare for companies not to commission one and sometimes two or more fairness opinions. Even so, fairness opinions remain a defensive tool, and for good reason, given the aggressiveness of shareholders and the impetus toward disclosure in Sarbanes-Oxley.

Fairness opinions now look at results, not processes. They should do both. Indeed, the firm issuing a fairness opinion should:

Conduct a "blind" market test of the deal, taking care to preserve the confidentiality of the deal. This could include contacting other companies that have done similar deals in the same or related industries and asking what impact certain hypothetical numbers might have had on their deal—the hypothetical numbers being something like those of the deal at hand.

Construct a narrative of the negotiations leading up to the signing of the letter of intent. This should include inspecting the paper trail and interviewing all parties to the deal on both sides, including directors, officers, lawyers, accountants and investment bankers, to determine how the deal came about and whether the parties negotiated at arm's length. Depending on the circumstances, the fairness opinion might only note the firm's satisfaction as to the aboveboard nature of the negotiations or, in the alternative, it could lay out the full narrative and let shareholders decide.

Probe for conflicts of interest among all of the parties to the deal. This would include checking stock holdings among directors and others, formal or informal side deals, severance agreements, deferred payments, golden parachutes, employment agreements, and the like, and possibly seeking signed statements from all parties affirming for the record that they have no conflicts of interest.

Check for hidden value on the asset side of the balance sheets of the parties to the deal—and for possibly hidden danger on the liability side. This could include appreciated assets such as real estate purchased in the past or trademarks or other intellectual property carried on the books at nominal value.

Some of the work outlined here would duplicate the duediligence efforts on both sides of the deal, but the difference is that the goal here would be to inform shareholders, not directors, of the wisdom of the deal.

Fairness opinions ought not to come from firms doing other business with the parties to a particular transaction—for example, investment banking firms advising on a deal. Clearly, the potential exists for an investment bank's deal advisers to lean on those who prepare a fairness opinion to bless a deal so the firm can book the fee.