NASD Launches Inquiry Into Fairness Opinion Conflicts: Some experts believe the study could lead to a ban on the writing of fair-price opinions by deal advisers

Concern about the propriety of fairness opinions rose as a National Association of Securities Dealers (NASD) probe into this common m&a tool became public in June. NASD is a major self-regulatory body for brokerage firms, whose investment banking arms are key providers of opinions designed to determine whether an acquisition generates a fair price for selling shareholders. As part of its inquiry, the securities organization sent letters to several banking firms requesting information about recently issued opinions in an effort to determine whether any involved conflicts of interest were present. Potential conflicts arise from a common, albeit controversial, practice of assigning a deal financial adviser to also deliver the fairness opinion, i.e., using the investment bank that stands to profit from a deal’s successful conclusion to also review whether the price of the deal is fair. Corporate governance and shareholder advocates long have derided that type of double duty. New York State Attorney General Eliot Spitzer’s office has said in the past that it is considering investigating fairness opinions. Jill Fisch, a law professor at Fordham University, says that fairness opinions are an area where a longstanding business practice is at best suspect and where there is a clear need for a regulator to step in and see whether there are issues that need to be addressed. Spitzer identified many of the problems in these business practices, and other agencies like NASD are playing catch-up, she notes. “All of the regulatory agencies are now aware that a lot of the standard business practices in the securities industry are unfair to investors,” she says. Investment banker Ben Howe, a principal at Americas Growth Capital, says, “I’d like to see a case where an investment bank that has a huge fee contingent on a deal closing comes back with a fairness opinion that says the price is no good.” Fisch says she expects increased disclosure requirements to be among the first recommendations growing out of the NASD probe. “Increased disclosure is a first step as the agency tries to figure out how bad the conflicts are.” She points to the regulatory steps taken to separate audit and non-audit services rendered by accounting firms as a possible template for NASD and other regulatory actions to bust conflicts on fairness opinions. “Disclosure requirements are a common first step in looking at these problems,” she adds. “They are minimally intrusive and give you a basis for any next step.” Another securities law expert, Ted Guth of the law firm Guth Christopher says that the NASD and any other regulatory bodies that look into the independence of fairness opinions probably would consider mandating two types of disclosure. One rule would require disclosure of any other fees that bankers who provide the opinion are getting. He suggests that any investors who don’t already know about these kinds of conflicts haven’t been reading their prospectuses closely. A second and more far-reaching type of disclosure would involve making public information about any management conflicts tied to the completion of a deal. These might include bonuses, stock vesting, and other perks that grow out of deal consummation. Any NASD proposal on rules for fairness opinions would have to be seconded by the SEC, which suggests that bankers and attorneys aren’t likely to be hit with changed rules immediately. An example of an investment bank advising a deal party and delivering a fairness opinion as well can be seen in Merrill Lynch’s work on the recent $7.9 billion acquisition of Mandalay Resort Group Inc. by MGM Mirage Inc. Eventually, regulators may require reforms that go beyond disclosure. One direction might be to require that fairness opinions be issued by banks that have no other involvement in a given deal. Other securities experts have advocated just getting rid of the documents altogether. Charles Elson, an attorney and professor of corporate governance at the University of Delaware, has said that because of their inherent subjectivity, he’d prefer that companies cease relying on them. Fairness opinions became common features of virtually all deals involving sales of publicly held targets after the famous Smith v. Van Gorkum decision by the Delaware courts in the 1980s. The courts ruled that even though a target accepted a bid with a 50% premium over the stock price, directors did not do enough market checking to ensure that it was the best bid available. Copyright 2004 Thomson Media Inc. All Rights Reserved. http://www.thomsonmedia.com http://www.majournal.com