On October 11, 2007 the SEC approved FINRA’s new Rule 2290 regarding the preparation of fairness opinions and the disclosures required in fairness opinions.1 The rule, which began to take form in 2004 and was opened for comments in early 2006, was fast tracked for approval by the SEC. While Rule 2290 is officially applicable only to member firms of FINRA, it is likely to become a market standard by which all fairness opinions are evaluated.
The purpose of the new rule is to address increasing concerns that disclosures provided in fairness opinions may not sufficiently inform shareholders of potential conflicts of interest that may exist among the parties to a deal, those advising on the deal, and those opining to the fairness of the deal. Unfortunately, avoiding the appearance of a conflict is not quite the same as avoiding a conflict. While the new rule provides for added transparency, it does not eliminate potential conflicts of interest.
The portion of the new rule related to disclosures [2290(a)] is applicable if the FINRA member issuing the opinion “knows or has reason to know that the fairness opinion will be provided or described to the company’s public shareholders” and covers the following general topics:
The new rule also contains a section [2290(b)] that delineates certain written procedures an issuing firm must develop (and of course follow) in the preparation of a fairness opinion. The majority of these procedures relate to the use of a fairness committee.
1. The issuing firm must develop written procedures for determining the circumstances under which a fairness committee must approve a fairness opinion. When a committee is deemed to be appropriate, the firm must also have developed and followed procedures concerning the following:
a) The issuing firm must have a written procedure which is used to select the personnel that comprise the fairness committee.
b) Those procedures must specify the qualifications required for persons to sit on the fairness committee.
c) The process must promote a balanced review of the opinion, and the review should involve personnel who are not on the deal team to the transaction. If the firm issuing the opinion is not involved in the transaction as an advisor, then it follows that those persons reviewing, as well as working on, the fairness opinion will not be on the deal team.
2. The issuing firm must also create procedures with which to evaluate the appropriateness of the valuation analyses used in the fairness opinion. The addition of this rule demonstrates that FINRA recognizes the importance of valuation technique in rendering a fairness opinion.
Several conclusions can be drawn from the new FINRA rule. First, FINRA is clearly attempting to provide shareholders with more information and allow them to make their own decisions regarding the existence of conflicts. However, it appears to still be the responsibility of various parties to the transaction and their advisors to ensure that no conflicts exist, or at the very least, are minimized. Despite the new disclosure rules, any time the advisor on a deal prepares the fairness opinion or any time compensation for preparation of the fairness opinion is on a contingent basis, there exists the possibility for real or perceived conflicts of interest.
Further, FINRA pays significant attention to “quality control” issues within the issuing firm. While some of these issues would be rendered moot if FINRA would simply disallow firms with potentially large conflicts of interest from preparing the fairness opinion, the focus does indeed center on what is in the best interest of the shareholder.
Mercer Capital is well equipped to deal with the new FINRA rule for a number of reasons. We do not perform fairness opinions for a contingent fee and in instances where we act as an advisor on a deal, we will not perform the fairness opinion ourselves. In addition, Mercer Capital is very familiar with the concept of “committee review,” having used committees to tackle complex valuation problems for years. It is almost certain that a fairness committee at Mercer Capital would have at least one member with a respected industry credential (CFA, ASA, CPA/ABV, etc.) and possibly several members. Mercer Capital’s experience as an independent business valuation firm means that a client can be certain that any valuation analysis developed in the preparation of a fairness opinion will be both appropriate and objective.
1 FINRA stands for the Financial Industry Regulatory Authority. This organization was formed in July 2007 through the consolidation of the National Association of Securities Dealers (NASD) and the regulation, enforcement and arbitration functions of the New York Stock Exchange.
Reprinted from Mercer Capital’s Value Matters (TM) 2008-03, published March 25, 2008.