The Skinny on Fairness Opinions

Contrary to popular belief, fairness opinions are not required by law when companies are involved in deals. In fact, they are not really valuation opinions, or even a determination of the best price. Nor do fairness opinions serve as validation that a specific transaction is the best possible deal from the shareholders’ point of view.

Yet board members are increasingly giving them greater credence in deal deliberations. That’s because they can provide important legal cover for the board that it is acting in a fair manner and using sound business judgment. Although a fairness opinion is, by its nature, of limited scope and purpose, its usefulness as an additional level of due diligence can be enhanced if board members actively engage with financial advisors to understand the scope of the fairness opinion, challenge its conclusions, and appreciate its inherent limitations.

Fairness opinions can help directors gain clarity into the soundness of a deal and underscore their duty of care to shareholders. However, they should not be seen as a good governance panacea and do not absolve directors from considering other factors in their deal deliberations. Nor are they a substitute for independent business judgment and scrutiny. The more involved the board is with its advisors throughout the process, the more insight it will glean to help it make the right business decision.

Getting At What’s Fair

Two recent developments affecting fairness opinions are worthy of closer attention by board members: a decision by the U.S. 7th Circuit Court of Appeals involving Credit Suisse and the recent adoption of the new rule (FINRA 2290) by the Financial Industry Regulatory Authority, a non-governmental regulator of securities firms.

The first sheds light on financial advisors obligations and responsibilities, and the advisors terms of engagement when they rely on the management of the advisor’s client (the seller in the Credit Suisse case) for financial information. In the Credit Suisse case, the court found that the bank acting as financial advisor to the buyer (a trust known as HA 2003 Liquidating Trust) was not grossly negligent and had fulfilled its responsibilities under the terms of its engagement when it delivered a fairness opinion based on financial projections provided by manage-ment of the seller. Subsequent to closing, the target company failed to achieve those expected results. The court found that Credit Suisse acted appropriately and in accordance with the terms of its engagement even though management had access to conflicting financial projections provided by another outside advisor that stood in stark contrast to the information management provided to Credit Suisse. The court ruled that Credit Suisse “did not write an insurance policy against managers’ errors of business judgment” and had acted appropriately in relying on the financial information provided by management without independently verifying that information and in accordance with its terms of engagement.

Additionally, because the Credit Suisse engagement agreement did not provide for updates, the court found that Credit Suisse had no obligation to update its fairness opinion between the time the fairness opinion was delivered and the deal closed, even though market conditions had deteriorated dramatically during that intervening period.

This decision highlights the importance of understanding the potential limitations of a fairness opinion created by the specific scope of work carried out by the financial advisor and the quality of information underpinning its analysis. When engaging financial advisors, boards should consider the context of the fairness opinion analysis and the potential limitations of that analysis.

Increased Disclosure

FINRA Rule 2290, adopted late last year, was the outcome of a process initiated a few years ago to review the role of fairness opinions in corporate control transactions. The basic question FINRA aimed to address was whether existing proxy disclosure requirements mandated by the Securities and Exchange Commission (SEC) are sufficient to inform investors about the subjectivity that goes into rendering fairness opinions as well as the potential for insider or advisor biases.

Rule 2290 does not actually prescribe methodology or the type of transactions requiring a fairness opinion. It does, however, prescribe additional disclosure requirements and procedures that FINRA member firms must follow when issuing fairness opinions.