Fairness Opinions and the OSC Ruling — Why Directors Should Care
Helen Mallovy Hicks
William K. Orr
Bill Orr, a partner in the law firm Fasken Martineau, talks about the future usefulness of fairness opinions in light of recent decisions made by the Ontario Securities Commission, and why this might be important — especially in today's economic climate.
Dean: Welcome to Strategy Talks with Dean and Helen, part of the PricewaterhouseCoopers Managing in a Downturn podcast series. I'm Dean Mullett, co-head of our Restructuring and Distress Strategy Group, and a member of our Credit Crisis Task Force.
Helen: And I'm Helen Mallovy Hicks, a Partner in the Advisory Practice of PricewaterhouseCoopers in the Dispute Analysis & Valuations group.
Dean: The current state of the economy is understandably of great concern for most Canadian businesses. This series of audio podcast discussions with a variety of subject matter and industry guests are designed to help your business weather the storm by exploring some of today's hottest issues related to the economic crisis.
Dean: In today's episode we'll be talking about fairness opinions and their future usefulness in OAC decision in the matter of HudBay Minerals.
Helen: By way of background on April 28th, 2009 the OSC released their written decision on the matter of HudBay and as part of their decision under other matters the OSC noted that quote "While the commission does not regulate the preparation or use of fairness opinions, in our view a fairness opinion prepared by a financial advisor who is being paid a success fee, does not assist directors, a special committee or independent directors in demonstrating due care in compliance with their fiduciary duties in approving a transactions."
Dean: Today, we are joined by Bill Orr, partner of Fasken Martineau, to discuss this matter. Bill has substantial experience in advising independent committees of boards of directors on transactions. Bill is joining us from Montreal via telephone today. Welcome Bill.
Bill: Thank you very much, nice to be here.
Dean: To start things off Helen, as the leader of our Canadian fairness opinion practice, perhaps you can share with our listeners what exactly is a fairness opinion.
Helen: So a fairness opinion is a letter report from a financial advisor who may or may not be independent of the transaction. On finding the fairness of the proposed transaction from a financial point of view, so really what a fairness opinion does, it considers what the value of what is being given up is. And what is the value of what is being received and then concludes from a financial point view if that transaction fair. So it's more than just a valuation, because it's a conclusion on the ultimate transaction from a financial point of view, but it's not a valuation. So there is not valuation conclusion disclose and there is no valuation analysis as part of the report. Bill, what do you think the impact of this decision or this reference by the OSC will be on boards of directors and their views on fairness opinions?
Bill: I think the immediate impact is going to be that the boards, or committees of boards, are going to have to think a little more serious about the terms of the engagement they have for their financial advisors, as to where there is a success year or not. So that it will to have to be reflected in the minutes, it will have to be a little clearer that they've taken it into account. To be fair, I don't think there will be that much of a change in what we're doing with fairness opinions with what's happening right now.
Dean: And Bill, what do you think of the OSC comments mean for corporate governance in the due diligence defense? And how do you think board of directors will now go about demonstrating that they have properly carried out their fiduciary duties?
Bill: Well once again, I think that the impact of his, in terms of what the OSC has said is going to be a little more difficult for boards. I don't think it's going to change the practice that much, in terms of how they go about demonstrating what they've done. I still think you're going to want to rely on an expert, and I think you're going to want to have a thorough analysis done by your financial advisor for the boards to tell whether what you're doing is within the range of what would be considered fair by an outsider. Because I think in terms of protecting yourself from liability as a director you're going to want that protection still there.
Helen: Often what we see in practice now, are fairness opinions provided by a financial advisor who is receiving a success fee, and the OSC seems to indicate that that won't be sufficient for exercising your fiduciary duty. Also there are a lot of people that say that fairness opinions are not really worth the paper they're written on. Do you think that there's going to be an increased amount of instance where financial advisors are both providing fairness opinions and there is possibly a second opinion by an independent financial advisor?
Bill: I think there are a few questions involved in what you just asked. To answer the last one first - Will there be more use of second opinions? I think there will be for sure. I think that we've seen that happening in any event when you have a financial advisor who is getting a large success fee. I think on deals that are large enough so that the parties can afford it, very frequently now we're getting a second opinion from someone who doesn't have that success fee and someone who is more perhaps independent in terms of giving fairness opinions. I think that for example, people like PwC, I think the accounting firms may find this, and I think that the accounting firms and non-bank-owned independent dealers are thinking that this is going to lead to an increased practice of their giving fairness opinions. I think we've already been seeing this before the OSC even got here to say this.
One area though where I disagree with the OSC is this sentence was very definitive that it does not assist directors in meeting their fiduciary duties. I personally think that's wrong, because if you got a financial advisor who's been deeply involved in a transaction whether it's an auction transaction or helping to find a buyer or whatever it may be. I think the boards have become more sophisticated in knowing that their opinion may be tainted if they've got a large success fee hinging whether or not the deal happens. But you still want these dealers to come in and give a very detailed analysis to the board as to why they think it's fair and the fact that they're getting an X number of dollars as a success fee doesn't really count much for the board analysis as to whether it's fair - because they're really looking to see whether it's fair for their share holders or other stake holders.
Helen: So what you're saying really is that for the financial advisor, fairness opinion probably provides two things. One, it helps them with a detailed analysis that they might be considering or ought to be considering in terms of fairness. But it's also maybe asking the financial advisor to put sort of put their money where their mouth is; put their opinion on the line in writing if that's the advice they're giving — to put it in writing.
Bill: I think that's exactly right, although there are many cynics out there that say, as you said, it's not worth the paper it's written on. I think most bankers, most accounting firms, most financial advisors don't want to blow their reputation on one particular deal because they're so anxious to get the success fee that's pending on this one transaction. And if they know that the disclosure document is going to include their fairness opinion and that their name is going to be all over it because the board is going to say, "Well you know we relied on XYZ financial advisor for fairness opinions." I think people are going to be careful about what they say. Maybe I'm being too naïve about this, but I do think that it is helpful in meeting your fiduciary duties and meeting the standards for directors, if you have the advisor putting in form of a fairness opinion and not just advice just reflected in the minutes.
Dean: Now Bill, the OSC points out that fairness opinions are not regulated. That being the case, how do you see companies using them and does it vary from one company to the next? One board to the next? And are they are a particularly useful tool and should a board be giving them certain thoughts on how they can make them more useful?
Bill: I think they're useful in many different ways and it varies from transaction to transactions. And sometimes it varies from the sophistication of the board. Sometimes they're being used sometimes as merely a negotiation tool. They'll go in when they're negotiating a deal and say, "We're not going to be able to get a fairness opinion on this, and without that we won't do the deal." You want to be careful that the other side doesn't have access to your financial advisor to really say, "Would you give a fairness opinion on this?"
Because sometimes you might, but I think the board really uses them for a lot of different reasons. I think that one of them is to protect themselves from liability. It's always nice to have an outside expert who may have more expertise in financial matters than the members of the board do collectively. To say, someone else who is independent also said it's fair, relying at least in part on that. I think it's dangerous if you're relying entirely on a fairness opinion on an advisor and particularly so, I think it's always has been but it's probably been pointed out now more so because of the HudBay paragraph.
You can't just rely on someone particularly if they have some other vested interest like the success fee. But I think the boards are still going to be using these and I think that the can be a useful tool. It's all a question, and I wish the OSC had said that in terms of more or less definitively saying that it's a concern that may or not be something on which the directors can rely. Or that it may or may not always helpful in meeting their fiduciary duties. My view is that, in front of a court, that having a fairness opinion is certainly a lot more helpful to have it then to not have it.
Dean: Bill, do you think that perhaps given what's happened in the equity markets, the volatility that's being there and perhaps some of the pain felt by some of the various stake holders that maybe just the whole level of scrutiny intensifies as we manage through this period?
Bill: I think that's probably right. I think people are very concerned about the kind of scrutiny of what's going on in the marketplace. Two years ago when the M&A markets were going so gangbusters so long as there was these great big deals in the press, your smaller deals would barely get noticed. And I think these days the deals that are out there are being scrutinized a lot more carefully.
Helen: And as a valuator from a valuation point of view, it's much more difficult to value certain things in today's market, because the markets are so volatile. What's the right price to be using? Trading prices can be depressed and depressed for all different reasons and then if you're looking at precedent transactions there aren't a lot of transactions going on in the market place. The only precedent transactions you have to point to were done when markets were much stronger and a lot more transactions done at possibly quite different prices.
Then if you're looking at a discounted cash flow approach valuation we're looking at forecast where we have far less visibility on really what is the outlook of the business and probably more risk in the business. So a lot of different valuation issues actually that kick in now that might make it more difficult to come to a valuation conclusion to support a fairness opinion.
Bill: I think that's right, and the comparable transactions, you're never quite certain how many of them really may be more distressed valued transactions even if it hasn't been disclosed, they're quite at that level yet. People are a little more desperate for doing more transactions they certainly wouldn't have done now awhile ago.
Helen: Right, lack of good current precedents, because they don't exist or they're done at depressed prices. And lack of good comparable multiples for public training.
Dean: It's interesting when you look at a shock in the market place, which I think as of last fall the market was shocked. And if you think back to the early 2000's and the ENRONS of the world and how regulation changed at that point in time because of the shocks to the system. And then they carried forward as we went through the good times, it would be interesting to see with the shock of the market felt this time whether there will be a change in the regulations around such things as fairness opinions and that will carry through as we move to the next upturn.
Bill: I think that's exactly right. There are types of transactions that are available for people, for people who have pools of money and weren't so directly affected by the shocks to the market place in the fall. People are waiting to make some opportunistic buys and some people because they have the financing and they have the cash that they can do it. And other people who otherwise have really solid balance sheets but are really, really worried about the future of what's happening in their businesses and seeing their volumes go down. Sometimes they're accepting opportunistic transactions that they certainly wouldn't even consider them at those prices before. The regulations, the idea of new regulations coming is certainly a flood of it coming from the United States, whether you're going to see as much of it here — you don't know.
Dean: Now Helen, as a Canadian Leader of the Fairness Opinions Practice, where are you seeing fairness opinions used? And are there areas where you could suggest their value could be improved?
Helen: That's an interesting question because I think what we're seeing is what Bill is seeing, is an increased used of fairness opinions as a corporate governance tool and they're often, where you see them, is in a public domain. Where you don't often see them and what we're seeing is a lot more used of fairness opinions for boards solely. It's something not necessarily going in the public domain. It could actually be a private company transaction where there's multiple share holders, multiple stake holders and they want an independent credible view on whether the transaction is fair and again the board wants it as a corporate governance tool.
We're also seeing an increased number of fairness opinions request by quasi public government entities. So again, a concern whether there's multiple stake holders with different financial types of interest and again the board has a concern as to corporate governance and they want to demonstrate that they have made a good decision. And as Bill points out, it doesn't support the full decision but its one tool that corporate directors and boards are using more and more. The critical thing here is that the fairness opinion needs to be provided by a credible source, a qualified business valuators who have the industry expertise, knowledge of the company and are also independent.
Dean: Clearly what you're saying is that it has to be credible to bring value for a fairness opinion. As the world shrinks because the borders between countries go away, so the brand of the organization that is giving the fairness opinion, sometimes that brand doesn't travel well. In so, with boards being involved being increasingly global businesses with stakes holders around the world, do we see a bit of a change in how boards should be looking at who they're actually engaging do this type of work for them?
Helen: That's an interesting question too Dean. We've heard sometimes where there is a more global transaction with the PwC brand, it is recognized globally, so therefore where an independent boutique, an investment bank might have done a fairness opinion locally, their name doesn't travel globally, so that can be a consideration. So it is a level of credibility but at the end of the day you need to demonstrate as a fairness opinion provider that you do have the expertise in valuing the business at hand.
Bill: And I think we've certainly seen in different transactions where you get someone like PwC that has a global brand, you have investment bankers and although the transaction may be primarily Canadian and it may also involve either North American or a more global perspective. And then you'll find an American investment bank and then a Canadian investment bank being hired, or someone like PwC who crosses all those borders. But I do think that the brand name is important often for who the board decides take comfort in having been advised by.
Dean: Bill, are there any particular areas that maybe you would suggest would provide the value of fairness opinions?
Bill: Sometimes, the real value of a fairness opinion is how well the board perceives it in terms of being a little bit skeptical and making sure that they've asked the questions, making sure the assumptions are right and making sure that they are comfortable that the work has been done to back up the fairness opinions. It used to be notorious that the fairness opinions would last for one paragraph and saying that I'm a big investment bank and I say it's fair, so therefore it's fair. I think the boards have to really do their homework in asking their questions and they are comfortable in how the advisors have come to that determination.
Helen: And that's both really the quality of the advice that the board gets. Because it's not only the financial advisor but it's they're legal council advising them on to make sure their homework and ask the right questions and do the analysis that's required or ask for the appropriate analysis. Bill, we've talked about this OSC decision and how this reference to fairness opinions comes on page 45 of 50, and it's under matters. It's these two paragraphs and it seems to be, somewhat out of place. Can you give us a background on the OSC decision and why fairness opinions are mentioned here?
Bill: I wish I could give you more background for it. I am surprised that it's there and I think that a lot of members of the securities bar are surprised that it came up in this way. Not to say that I disagree with some of the sentiment in there. The existence of a success fee means that you may not be able to rely on the financial advisor to the extent that you might on someone who is independent who is getting a fixed fee, whether they say it's fair or inadequate. And it surprises me because normally the OSC and other securities regulators in Canada will raise the concern by some sort of a public comment or requesting comments on an issue. Or if they see an issue where they are not comfortable on what's been happening on a practice that's developed, for example on fairness opinions from advisors with success fees.
They would normally raise it and perhaps asks for comment periods or ask for people to give their ideas on it and then develop some sort of policy or put it into some sort of existing instrument. And it's surprising to have it come out in this way in a decision. You can be sure that every litigator who is litigating a securities matter where there is a fairness opinion involved will use that statement and then every litigator who is defending the position is having to have to fight out this argument. The OSC will tell you that there were great pains to say that there is a paragraph later, that the matters discussed in this part were not directly raised in the application, were not address in the parties in their submissions. A very good question is then why did you include it in a decision?
Helen: Yes, one wonders. Do you think that this is maybe a precursor as to regulating fairness opinions?
Bill: I don't think they want to business of regulating fairness opinions. I think that it was a throw away comment saying, "Look, if you're getting too comfortable relying on advisors who have these big success fees in you're also saying that fairness opinions are going to relieve us from liabilities, don't get too comfortable with that." And if it said that, that may be the way to see but they were incredibly definitive in saying that it does not assist you in meeting your fiduciary duties. Which I find frankly think is wrong, but it's also the wrong way to raise the issue.
Helen: Yes, but I think it's going to cost a lot of problems I think going forward for those who are looking to rely on fairness opinions from financial advisors.
Bill: I suspect that it may lead to the kind of process that I have described, that I think it's how they should have started. I suspect that there will be some discussion on this issue now and they will probably have to come out with some statement either in a companion policy to one of the existing instruments or something like that to actually discuss what they mean by it.
Dean: Well thank you Bill for your practical insights. I think that some of what you said today will be of great value to some of our listenership particularly those who are board members. For more information on fairness opinions please pwc.com/ca/fairness.
Dean: This concludes this episode of Strategy Talks, part of the PricewaterhouseCoopers Managing in a Downturn podcast series. I'm Dean Mullett, thank you for listening.
Helen: And I'm Helen Mallovy Hicks. We hope you'll join us again soon for another episode. To download or to subscribe to this podcast series or to find more information on this topic, please visit our Managing in a Downturn website at pwc.com/ca/managinginadownturn.
The information in this podcast is provided with the understanding that the authors and publishes are not herein engaged in rendering legal accounting, tax or other professional advice or services. The audience should discuss with professional advisors how the information may apply to their specific situation. Copyright 2009, PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or as the context requires, the PricewaterhouseCoopers global network or other member firms of the network. Each of which is a separate and independent legal entity.