Fairness opinions may be vulnerable to conflicts of interest if the firm that is providing the fairness opinion is also providing other services as well, such as merger and acquisition support. Because of the increased scrutiny from regulators and the financial investment communities, boards of directors are proceeding cautiously when considering if the value of the planned merger or acquisition is fair to shareholders.
The original purpose of a fairness opinion was to protect a company’s directors from liability related to fulfilling their fiduciary duties to shareholders in the context of a transaction. Meaning the fairness opinion was the standard tool used to protect directors against lawsuits and investors’ criticisms of a deal’s terms.
More practically, an independent fairness opinion simply puts the board of directors into the safe harbor created by Smith v. Van Gorkam, the famous case in which the court ruled that the board of directors of Trans Union Corporation had not met its duty to the shareholders when it approved a transaction with no outside opinion. According to that ruling, looking outside to another party is enough to provide a nearly impenetrable armor to a board of directors.
In recent months, the NASD, New York Attorney General Eliot Spitzer, the SEC and others have ratcheted up scrutiny on the effects to shareholder value in deals where fairness opinions were issued by the same firm that stands to gain if the proposed transaction occurs. Boards of directors everywhere should be paying special attention, as the results of these investigations and investment policies will likely mean the safe harbor will come under attack.
This idea that the firm providing the fairness opinion should not have a vested interest in the same transaction is not new. Nor is the idea that the party issuing the opinion should be credentialed and apply some standardized and accepted methodology. The Internal Revenue Servicecodified an independence requirement for valuation opinions years ago. The same regulations require those issuing opinions to be “qualified appraisers” and to apply certain standardized methodology. The notion that without such independent and qualified advisors the board of directors somehow protected itself remains questionable.
Because of the recent attention given to this issue, and the advent of Sarbanes-Oxley type scrutiny of nearly all corporate matters, advisors are suggesting that their clients obtain second fairness opinions. In other words, pay twice; once to the advisor with the conflict, and again to an independent advisor. Wouldn’t it be in the interest of the shareholder to pay only once and use the independent and qualified advisor the first time?
In the future, when shareholders feel a transaction was detrimental to them and begin to fire arrows from their quiver toward the board of directors that approved the deal, one of the first volleys will be aimed at the independence of the fairness opinion. We believe that mere disclosure of conflicts will not be enough to protect the board; shareholders will demand complete independence and qualified, standardized analysis.
Boards of directors can avoid this conflict from the onset by hiring an independent firm to provide the fairness opinion. Doing this ensures there are liability safeguards in place and the directors acted in an appropriately informed manner.