Friday, October 19, 2007
On Oct 11, the SEC approved FINRA's new proposed Rule 2290 regarding fairness opinions (see the SEC approval here; the FINRA rule release here). The eighth extension of the comment period for the Rule was to run until the end of the month. However, the SEC approved the rule on an expedited basis. This is a bit odd -- this rule has been pending for three years, why the rush now?
The Rule obligates member firms of FINRA adhere to the following requirements when preparing and issuing fairness opinions:
- Rule 2290(a)(1) requires that when a member firm acts as a financial advisor to any party to a transaction that is the subject of a fairness opinion issued by the firm, the member must disclose if the member will receive compensation that is contingent upon the successful completion of the transaction, for rendering the fairness opinion and/or serving as an advisor.
- Rule 2290(a)(2) requires that a member firm disclose if it will receive any other significant payment or compensation that is contingent upon the successful completion of the transaction.
- Rule 2290(a)(3) requires that member firms disclose any material relationships that existed during the past two years or material relationships that are mutually understood to be contemplated in which any compensation was received or is intended to be received as a result of the relationship between the member and any party to the transaction that is the subject of the fairness opinion.
- Rule 2290(a)(4) requires that members disclose if any information that formed a substantial basis for the fairness opinion that was supplied to the member by the company requesting the opinion concerning the companies that are parties to the transaction has been independently verified by the member, and if so, a description of the information or categories of information that were verified.
- Rule 2290(a)(5) requires member disclosure of whether or not the fairness opinion was approved or issued by a fairness committee.
- Rule 2290(a)(6) requires member firms to disclose whether or not the fairness opinion expresses an opinion about the fairness of the amount or nature of the compensation from the transaction underlying the fairness opinion, to the company’s officers, directors or employees, or class of such persons, relative to the compensation to the public shareholders of the company.
- Rule 2290(b)(1) requires that any member issuing a fairness opinion must have written procedures for approval of a fairness opinion by the member.
As I commented before on this Rule:
The broad scope of intended topics in the initial notice to members led some to think that FINRA 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. FINRA 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 as set out in Item 1015(b)(4) of Regulation M-A. 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 FINRA also watered down the Rule in its interpretation; removing a good bit of the potential for it to go beyond SEC regulation. For example, FINRA 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.
The only novel aspect of this Rule is the requirement it places on member firms to disclose whether or not the fairness opinion expresses an opinion about the fairness of the amount or nature of the compensation from the transaction underlying the fairness opinion, to the company’s officers, directors or employees, or class of such persons, relative to the compensation to the public shareholders of the company. I have read and re-read this provision and the FINRA commentary upon it. While the purpose can be easily surmised—addressing inordinate retention and compensation paid in connection with change of control transactions—I look forward to learning how the investment banks implement this provision, because I honestly do not know how they can or will other than via the usual boiler-plate response. In any event, this requirement misapprehends what a fairness opinion does and opines to. Retention and other compensatory arrangements do arguably result in a lower price to acquiree stockholders, but do not affect whether the ultimate price itself is fair within the financial parameters of the value of the corporation or the consideration paid. To rephrase the point, the price can be financially fair in a corporate control transaction but the retention and other compensatory arrangements still egregious. Trying to analyze them together scrambles the egg. FINRA should have addressed these issues separately.
Ultimately, FINRA and the SEC would have done better to address the real problems with fairness opinions (their subjectivity, etc.) rather than piling on more and largely meaningless procedural strictures. For more on this see my article Fairness Opinions.