On July 31, 2017 the staff of regulatory authorities in Ontario, Quebec, Alberta, Manitoba and New Brunswick released Multilateral CSA Staff Notice 61-302 as a follow on from notice MI 61-101 (Protection of Minority Security Holders in Special Transactions) particularly as they pertain to material conflicts of interest such as insider bids, issuer bids, business combinations and related party transactions.
This new guidance from the regulators follows on the heels of the InterOil decision of the Yukon Court of Appeal in November 2016, which highlighted two key points: the need for increased disclosure combined with robust, rigorous and independent fairness opinions.
Furthermore, the Notice stated “Staff found that disclosure concerning fairness opinions was often limited and did not provide security holders with a meaningful understanding of the fairness opinion and how it was considered by the board or special committee”. The Guidance concluded that in cases where a fairness opinion is obtained for a material conflict of interest transaction, the disclosure should:
a) disclose the specifics of the compensation arrangement of the financial advisor
b) explain how the board or special committee took into account compensation arrangements with the financial advisor when considering the advice
c) disclose any other relationship or arrangement with the financial advisor
d) provide a clear summary of the methodology, information and analysis (including as applicable, financial metrics) underlying the opinion
e) explain the relevance of the fairness opinion to the board of directors and special committee in coming to the determination to recommend the transaction
The timing of this new guidance from the CSA, being so close to the InterOil decision will, in our opinion, lead to three significant changes:
Increase in independent fairness opinions
The spotlight on compensation arrangements will result in the increased use of independent advisors. There will be a trend toward boards obtaining two or more fairness opinions; one from the deal advisor and one from a truly independent advisor.
Boilerplate fairness opinions with barely one paragraph of real content will be relegated to the past. Fairness opinion advisors will provide substantially more detail about their approach and the analysis underpinning their opinion.
More fairness opinions on transactions
While the CSA guidance does not make fairness opinions mandatory, it does state however, that if a financial advisor is not willing to provide one, there must be disclosure around why there is not a fairness opinion. This will lead to more fairness opinions on transactions.
In the last year we have seen a significant increase in the number of requests by boards and their legal advisors to provide fairness opinions, and specifically more comprehensive ones. For example, for Banro Corporation we were asked for multiple fairness opinions that considered the fairness of the transaction to each affected group of stakeholders as well as the fairness to the company as a whole.
Home Capital has frequently been in the news over the past weeks. Following an initial investment by Berkshire Hathaway of 19.9 percent, they sought to increase their stake to 38.4 percent in a second tranche investment. On September 12 Home Capital Inc. shareholders voted overwhelmingly (88.79 percent) against an increase in Berkshire Hathaway’s stake. What was significant about this transaction was that three fairness opinions were carried out – two by the financial advisors being paid a success fee and one by an independent advisory firm.
Two the fairness opinions were the standard, short form, boilerplate opinion. The third, the independent fairness opinion, was not. In terms of disclosure we noted the following significant points.
Independent fairness opinion
The fairness opinion provided by the independent financial advisor included substantially more information about the approach and valuation analysis underpinning that opinion, including disclosure of the calculated implied price per common share range, the calculated sensitivities, as well as a summary and discussion of the key assumptions underlying the analysis. Details of price ranges in each of the base case and other scenarios were disclosed including disclosure of the results of value calculations for implied common share value range for both a dividend discount model (a variation on a discounted cash flow model) as well as analysis of a market multiple trading approach. While it did not include the full disclosure that a valuation report would include (for example summary calculations were not included), at 16 pages in total it was substantially different from the standard boilerplate fairness opinions of the past.
In contrast, two investment bank financial advisor fairness opinions were of the standard boilerplate variety. Each was a total of five pages of description of the transaction, standard assumptions and limitations, credentials and relationships with interested parties. One did not contain an independence section as the investment bank did not claim that it was independent. The other investment bank did contain an independence section despite a substantial portion of its fee being related to the success of the transaction. Interestingly, the contingent success fee arrangements were not mentioned in the independence section. In terms of disclosure of analysis, the investment banks’ fairness opinions each contained one-third of a page setting out the approach to fairness, with each considering separate points, and no disclosure of calculations or underlying analysis.
In future, we expect there will be two, and in some cases three fairness opinions requested, such as with Home Capital, to ensure independence and improve the overall credibility of the fairness opinions. Connect with PwC’s specialists in valuations and fairness opinions to explore how an independent financial advisor can help ensure the success of your next transaction.