A Houlihan Smith fairness opinion is an effective risk management tool and determines whether the terms of a deal are fair to shareholders, particularly minority shareholders. Lawyers, accountants, consultants, and the other advisors stress the importance of a fairness opinion as a shield against shareholder dissension. In change-of-control transactions, a fairness opinion increases the probability that the Directors’ decision will be protected by the business judgment rule. An independent fairness opinion may also help to encourage shareholders to approve a proposed transaction.

The omnipresent threat of litigation emphasizes the utility of fairness opinions in providing evidence that fiduciaries acting in the best interest of shareholders may take shelter under the business judgment rule, protecting directors from legal liability. Most state corporate statues entitle directors to rely on the advice of independent experts selected in good faith and reasonable care.

A fairness opinion determines a range of values within which a proposed transaction is fair, impartial, and just for all interested parties including minority shareholders. A fairly priced transaction should fall within this range. Selling shareholders may prefer to transact at the high end of the range while the acquiring party may prefer the low end of the range.

Although not explicitly required by law, the Securities and Exchange Commission often requests fairness opinions when reviewing proxy materials. Fairness opinions have two main objectives:

• To provide a decision-maker with essential information
• To act as an element of proof that the decision-maker used reasonable business judgment in making a decision on behalf of others.

The business judgment rule promotes the ability of a Board of Directors to defend its decisions as sound business judgment and to escape liability in the event of dissident minority shareholders lawsuits. The employment of independent investment bankers serves the dual role of facilitating the decision-making process and provides evidence that the Board compiled with the business judgment rule. The acquisition of a fairness opinion defends the Board’s decision from litigation, and limits the extent to which controversial decisions may be legally challenged.

Public companies have traditionally derived the greatest benefit from fairness opinions. Companies are often times composed of a diverse group of shareholders as well as several outside Directors who are aware of the fiduciary responsibilities of top decision makers, increasing the risk of class action suits. However, owners and directors of private companies also seek fairness opinions for significant transactions.

Private companies often have complex capital structures and different classes of ownership. Such diverse interests highlight any family ownership issues among large numbers of shareholders; any dissenting minority shareholder group is a risk to the success of a transaction. The value of a fairness opinion from an independent financial advisor is particularly clear to the board of directors of a private company. Boards of private companies often have little, if any, outside representation; a fairness opinion from an independent advisor introduces an objective perspective that is free of conflicts and interests.

Both the buyers and the sellers in a transaction benefit from a fairness opinion, especially if shareholder approval is required to complete the transaction. Selling companies should secure fairness opinions early in the process to allow sufficient time for superior bids to be presented by outside parties. The fiduciary duty of a company’s board of directors falls under intense scrutiny in the course of a change-of-control transaction. Minority shareholders also rely on fairness opinions in the course of asset sales, subsidiary spin-offs, and joint ventures.

The fairness opinion becomes indispensable in the event of a management buyout. It is clear that the interests of management are often contrary to those of shareholders, many believe that managers cannot serve this dual and sometimes conflicting role as agent for both the buyer and seller. The management buyout is certainly the textbook example of the utility of fairness opinions.

As an amendment to the Securities and Exchange Act of 1934, Rule 12E-3 governs share repurchases in going-private transactions. The amendment attempts to regulate some of the conflicts of interest facing management in management buyout situations. Specifically, the rule applies to share repurchases by pubic companies resulting in (1) withdrawal of listing on public stock exchanges; (2) withdrawal of quotation in an inter-dealer quotation system; or (3) fewer than 300 shareholders. If one of these conditions is met, Rule 13E-3 requires that the firm going private file a Schedule 13E-3 (Going private transaction by certain issuers).

Schedule 13E-3 requires disclosure of the following information:

• Disclosure of offers by unaffiliated parties within the previous 18 months,
• Alternatives to the MBO that were considered,
• Disclosure of the position of outside directors,
• Detailed discussion of the fairness of the transaction, and
• Inclusion of any fairness opinion.

FINRA’s new Rule 2290 regarding fairness opinions, obligates member firms of FINRA to 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 relationship 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.
• Rules 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 offers, 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.

These rules were passed in an effort to assure that fairness opinions are objective and independent.

Other Important Case Law

• See Sealy Mattress Co. of N.J. v. Sealy, Inc., 532 A.2d 1324 (Del. Ch. 1987). The court stated “in its merger with its parent corporation the subsidiary’s board established no independent committee, sought no fairness opinion, consulted no independent counsel, and deliberately attempted to manipulate valuations of its stock.
• See Kahn v. Lunch, 669 A. 2d 79 (Del. 1995). Court emphasized the use of an independent committee and outside independent counsel to negotiate a transaction on behalf of the board of directors.
• See In re Cysive, Inc. Shareholders Litigation, 836 A.2d 531 (Del. 2003). The burden of proof shifted to Minority Shareholders with the use of a Special Committee and Independent Legal Counsel and Financial Advisors.
• See Gesoff v. IIC Industries, 902 A.2d 130 (Del. 2006). The fiduciary duty of the special committee to exercise their authority and appoint truly independent advisors in highlighted by the Court.