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Jeffrey Williams
President
Jeffrey Williams & Co

Editor's note: Each month, we ask a Directors & Boards reader to comment on critical issues facing directors today. If you'd like to participate in this section in the future, please email Scott Chase.

What is a fairness opinion?
A fairness opinion is a letter from a financial expert – traditionally the company’s transaction advisor – expressing their view on the financial fairness of the consideration to be received by the shareholders in a corporate transaction. This opinion is delivered to the Board of Directors following a review of the transaction.

Why do Boards get fairness opinions?
Fairness opinions are intended to provide the Board of Directors with an impartial, third party view on value of a transaction and, as importantly, give directors comfort they fulfilled their duty of care. Fairness opinions became a standard ingredient of M&A transactions after the 1985 Delaware court case, Smith v. Van Gorkom, in which the Court suggested that fairness opinions could evidence that a Board fulfilled its duty of care. Boards and their advisors took notice of this judgment as the Trans Union board members were held by the Court to be personally liable for $25 million.

Why are many directors concerned about the independence of their fairness opinion providers?
When the transaction advisor that provides the fairness opinion is conflicted, the validity of their fairness opinion is questionable, and therefore the Board’s legal protection offered by it is seriously jeopardized. Directors are increasingly the objects of litigation challenging their decisions and seeking to hold them personally liable, as successfully seen in the WorldCom and Enron cases. Additionally, courts are increasing the scrutiny with which they review potential conflicts as evidenced by two recent rulings from the Delaware Chancery Court (In Re Toys “R” Us, Inc. and In Re Tele-Communications, Inc.). Directors are therefore recognizing that a second fairness opinion from an unconflicted, independent fairness reviewer provides them extra legal protection and makes good business sense.

Why would some investment banks and advisors be conflicted in providing the Board a fairness opinion?
There are numerous forms of potential conflicts that can impair the credibility of a fairness opinion and its provider but some of the more common include:

Contingent fee arrangements – transaction advisors are almost always engaged subject to generous fee arrangements that are only paid upon the successful completion of a transaction. In In Re: Tele-Communications, Inc., Chancellor Chandler states, “the contingent compensation of the financial advisor, DLJ … creates a serious issue of material fact, as to whether DLJ (and DLJ’s legal counsel) could provide independent advice to the Special Committee” to whom DLJ had provided opinions on the fairness of the deal.

Stapled financing – increasingly, transaction advisors to the seller are simultaneously providing acquisition financing to the buyer, thus effectively working on both sides of the transaction. While not a central tenet to the case, Vice Chancellor Strine addressed this very issue in In Re Toys “R” Us by stating: “That decision [to provide financing] was unfortunate, in that it tends to raise eyebrows by creating the appearance of impropriety.”

Prior advisory services – it is not uncommon for an investment bank to have relationships with parties to the transaction other than its client. As an example, Georgia-Pacific shareholders recently sued to block the company's proposed sale to Koch Industries asserting the directors and officers breached their fiduciary duties by relying on a fairness opinion from an advisor conflicted due to a prior relationship with Koch.

What outside forces are spurring Boards to get independent fairness reviews?
There are several factors driving the increased hiring of independent third-party providers of fairness reviews. First, the courts are increasingly taking notice of the conflicts inherent in investment banks providing opinions, increasing directors’ exposure to potential personal liability. Second, significant institutional investors, particularly pension funds, are speaking out about the conflicts of investment banks providing advice and opinions, and many are calling for a separation of the two. Third, the SEC is considering requiring advisors to increase disclosure in fairness opinions, which will highlight potential conflicts including relationships with other parties to the transaction. Fourth, many advisors are anticipating new rules on this practice and are beginning to proactively revise their own policies and procedures to recommend that their clients acquire a fully independent fairness review.

What are some examples of recent transactions where fairness opinions were called into question and directors faced personal liability?
Two recent situations underscore the importance of conflict-free, independent valuations. In the first, as mentioned above, Georgia-Pacific shareholders sued to block the company's proposed sale to Koch Industries, asserting the directors and officers breached their fiduciary duties by relying on a fairness opinion from a conflicted advisor. The issue of fairness opinions also took center stage in the NYSE-Archipelago merger controversy when a group of NYSE seatholders opposed the deal and sued to block it. The shareholders argued in their case that the two fairness opinions on which the NYSE Board based its evaluation of the deal were invalid because the investment banks that provided the opinions were conflicted. The Court agreed and ordered a new opinion by a different transaction reviewer. This conflict jeopardized the deal and held up its approval for five months.

Both situations could potentially have been avoided if the Boards had sought an independent fairness review from the beginning of their process.

What are some examples of recent transactions where the Board hired an independent firm to provide a fairness review?
In July 2005, the Board of May Department Stores hired an unconflicted provider to review the company’s $11.6 billion sale to Federated Department Stores Inc. In August 2005, the Board of SunGard hired an independent firm to provide an opinion on the $10.4 billion buyout by the Silver Lake-led private equity consortium. In October 2005, Dex Media’s Board hired an independent firm to provide a review the fairness of its $4.2 billion sale to RH Donnelley. In the recently announced $3.0 billion sale of its sensors business, Texas Instruments hired an independent firm to provide a second fairness opinion. Obviously, this trend is gathering momentum.

Jeffrey Williams is President of Jeffrey Williams & Co., a leading independent valuation services firm providing conflict-free transaction fairness reviews, valuation mediation, private company valuation and dispute resolution services. Offering senior-level attention and highest quality service on all engagements, Jeffrey Williams & Co. has worked with clients ranging from international publicly traded Fortune 500 companies to privately held businesses to the U.S. Department of Justice. For more information on the firm, please visit www.williamsnyc.com.

Immediately prior to founding his firm, Mr. Williams was a Partner at Greenhill & Co. and was a lead advisor in the Media, Technology and Telecommunications industries for clients including Compaq Computer Corporation and Chancellor Media Corporation.

Previously, Mr. Williams had a 17-year career at Morgan Stanley & Co. in the Mergers and Acquisitions and Corporate Finance Departments. Mr. Williams served as the head of the company's Telecommunications and Media Group for 12 years, acting as principal financial advisor on transactions valued in excess of $200 billion.

Mr. Williams earned his M.B.A. from Harvard Business School (with distinction) in 1979. He currently serves as a Trustee and Co-Chairman of the University of Cincinnati Foundation, Trustee of the New York-based International Center of Photography and member of the President's Council at Environmental Defense.