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Feature

Matthew Wirgau
Michael B. Rizik Jr.
Wirgau & Rizik L.L.C.

A New Fairness in Fairness Opinions

FINRA Rule 2290 is a long-overdue step in the right direction to address the transparency problems with fairness opinions.

By Matthew Wirgau and Michael B. Rizik Jr.

Since the Smith v Van Gorkom case was decided over 20 years ago, fairness opinions have been derided as being unfair or an expensive waste of time. Things have finally changed...and in a very big way.

The SEC has approved Financial Industry Regulatory Authority (FINRA, formerly the NASD) new rule 2290 that effectively requires an expanded fairness opinion. Critically, it addresses conflicts of interest and procedures surrounding the issuance of fairness opinions.

First, the new rule applies to a FINRA member who issues a fairness opinion or serves as an advisor to a transaction. However, if the business community’s reaction to Sarbanes-Oxley is any indication, it probably will be followed voluntarily by non-members.

The new disclosure and procedure requirements are designed to prevent fraudulent and manipulative acts and practices, promote fair and equitable trade, and protect the public’s and investors’ interest without burdening competition.

It emphasizes transparency. A fairness opinion:

must disclose facts and circumstances surrounding certain real or potential conflicts of interest.
must disclose past and potential future relationships between the member and any party to the transaction. This includes prior or contemplated relationships that may influence the issuer because of past or future potential financial gain.
must describe information or categories of information the issuer has independently verified, if it forms “a substantial basis” for the opinion. The rule does not mandate independent verification by the member. Still, once independent verification is undertaken, the nature and extent to which the member relied upon the information as a basis for the opinion comes into play. The “substantial basis” qualifier leaves the rule open to criticism over its numerous subjective judgment calls.
must disclose whether or not a fairness opinion was approved or issued by a fairness committee. FINRA believes this applies to any committee to study deal’s fairness, whether it is formally known as a “fairness committee” or otherwise.
must disclose whether the opinion articulates 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.” This addresses the agency problem between the shareholders (the real owners) and senior management of the company.

It also requires adopted written procedures outlining:

the types of transactions and circumstances in which a fairness committee is used.
the selection of fairness committee personnel.
the qualifications of fairness committee members.
the process for a “balanced review” by the committee, including people not on the deal team.

Clearly, the rule is attempting to create as many checks and balances as possible within the board of directors and its committees.

Finally, it requires written procedures

“to determine whether the valuation analyses used in the fairness opinion are appropriate.”

This places greater emphasis in the opinion on what previously was known as the “fairness analyses,” the underlying financial valuation of transaction. The rule is silent on whether the fairness opinion must include the analyses in the opinion, attach it as an exhibit, or merely refer to it and its location.

One may rightly criticize this rule as failing to address the real problems with fairness opinions — specifically, their subjectivity and failure to provide more guidance on use of best practices. However, new rule 2290 is the long-overdue step in the right direction since Smith.

It is more imperative today than ever for boards, managers, and investors to protect themselves from costly litigation, negative press, and bad deals by demanding a fairness opinion issued by an independent and disinterested professional firm.

Matthew Wirgau is the managing member of Wirgau & Rizik L.L.C. and owner of Midwest Financial Services Inc., an investment banking firm in Bloomfield Hills, Mich. Michael B. Rizik Jr. is a member of Wirgau & Rizik L.L.C. and partner in the law firm of Rizik & Rizik in Grand Blanc, Mich. The authors can be contacted at mwirgau@mfsib.com or lawyers@riziklaw.com.