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Boston College Law School

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Thursday, June 28, 2007

The NASD's Fairness Opinion Rules (RIP?)

Does anyone remember the rules proposed by the NASD to govern the issuance of fairness opinions?  Back in November 2004, the NASD sent a minor shock wave through the investment banking community by promulgating a notice to members requesting comment on whether to propose new rules “that would address procedures, disclosure requirements, and conflicts of interest when members provide fairness opinions in corporate control transactions.”  More specifically, the NASD requested comment concerning methods to “improve the processes by which investment banks render fairness opinions and manage inherent conflicts.”

The NASD put forth three reasons for requesting comment.  First, the disclosure mandated under SEC regulation for fairness opinions could be perceived as insufficient “to inform investors about the subjective nature of some opinions and their potential biases.”  Second, fairness opinion are by nature subjective and consequently there has arisen a “perceived tendency” that these opinions often support management.  Finally, unaffiliated stockholders sometimes do not receive the benefits in a corporate control transaction that management, directors or other employees do; the NASD hypothesized that this disparity may create biases in favor of the transaction if the people involved in the current or future hiring of the investment bank are those with a differential benefit.

The NASD subsequently proposed Rule 2290 in response to its solicited member comments. Rule 2290 was announced and filed with the SEC for approval on June 22, 2005.  Well, that was 2005.  Since that time, the rule has been stuck in the SEC approval process.  Presumably at SEC behest, it has been amended three times since then.  The latest amendment was on June 7, 2007 (access the rest of the amendments here). 

The broad scope of intended topics in the initial notice to members led some to think that the NASD would finally act to address many of the deficiencies in current fairness opinion practice.  However, the initially promulgated rule was a disappointment, and after three amendments at the SEC's behest it has now been watered down into meaninglessness. The NASD ultimately did not go so far as to require member investment banks to disclose “any significant conflicts of interest” as it initially considered. Instead, disclosure requirements in the Rule with respect to contingent consideration and relationships largely overlap with current federal securities law. There are two other disclosure obligations in the Rule concerning opinion committees and independent verification of information.  These will likely be met with more boiler-plate responses – a practice which the Rule effectively permits. Furthermore, in the amending releases the NASD also watered down the Rule in its interpretation; removing a good bit of the potential for it to go beyond SEC regulation. For example, the NASD took the position in the amending releases that disclosure of contingent compensation and material relationships under the Rule can be descriptive and not quantitative; a statement as to whether it exists or not sufficient. Yet, the number is the important element here: if the amount is high it has more potential to result in bias. In addition, the Rule does nothing about the subjectivity inherent in fairness opinion preparation. It simply addresses the conflicts issue with redundant disclosure requirements that permit the investment banks to engage in the same practices as before with little, if any change.

Given the current state of the Rule, the NASD would be better to simply pull it until such time as the SEC is more willing to contemplate reform.  Unfortunately, the SEC does not appear ready to act any time soon on these issues.

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