In light of NASD concerns over investment banking firms being allowed to provide fairness opinions on deals from which they stand to collect a material success fee, more boards of directors are looking to independent valuation providers for opinions. The independence of a fairness or solvency opinion provider is a critical issue and one that will not be overlooked by regulators or minority shareholders. In this issue of the Valuation Researcher Alert, we focus on solvency and fairness opinions and the NASD’s proposed ruling regarding fairness opinions.

Solvency Opinions
A solvency opinion is a document stating that a borrower is, and will remain, solvent under the burden of additional debt as a result of a transaction. A solvency opinion is usually provided to protect the security position of the senior lenders and to protect selling shareholders, the board of directors and transaction advisors from having a transaction unravel in a future bankruptcy.

Transactions typically requiring solvency opinions are highly leveraged transactions, capital restructurings, and debt refinancings. Solvency opinions are generally prepared for boards of directors, lenders, buyers and sellers.

As an adjunct to a solvency opinion, VRC will often provide a capital surplus opinion. We are seeing more boards of directors requesting a capital surplus opinion when issuing a significant dividend which states that the value of a company’s equity (surplus) is greater than its (i) stated (par) value and (ii) the amount of the contemplated dividend.

Fairness Opinions
Fairness opinions have become commonplace on most material transactions since the Supreme Court of Delaware’s Smith v. Van Gorkum decision in 1985. In that case, the Delaware court essentially said the board of Trans Union Corporation had breached its fiduciary duty to the company and its shareholders by failing to become informed as to the fair value of the company before voting in favor of a transaction with Jay A. Pritzker. The court went on to say that they “did not imply that an outside valuation study is essential to support an informed business judgment; nor do we state that fairness opinions by independent investment bankers are required as a matter of law.” Regardless of the court’s qualification of its opinion, the financial community adopted the practice of providing fairness opinions on most material transactions.

A fairness opinion is a letter stating whether the consideration offered in a transaction, either by insiders or third parties, is fair to the nonaffiliated shareholders of the company from a financial perspective.

Fairness opinions are typically prepared for independent directors and fiduciaries, buyers and sellers, limited partners, institutional investors, and trustees. Typical transactions triggering fairness opinions are tender offers (LBO, MBO, and going private), large block stock purchases, mergers, divestitures, reorganizations, and hostile takeovers.

Fairness opinions should be based on objective, independent analyses that include not only a valuation, but also a review of the relevant transaction’s financial structure, the type and timing of consideration, and the transaction’s financial and tax consequences.

NASD RULE 2290
In 2004, the NASD expressed concern over conflicts of interest with respect to fairness opinions. At issue was whether investment banking firms should be allowed to provide fairness opinions on deals from which they stand to collect a material success fee. In November of 2005, the NASD issued a notice to its members seeking comments on whether it should propose a new rule that would address procedures, disclosure requirements, and conflicts of interest when members provide fairness opinions in corporate control transactions.

Many of those who submitted comments to the NASD stated a need for disclosure of potential conflicts of interest. In response to comments received on the matter, the NASD proposed Rule 2290, which addresses disclosures and procedures concerning the issuance of fairness opinions. Under Rule 2290, an investment bank that provides a fairness opinion is required to disclose whether it is serving as an advisor on the deal and whether it will receive compensation contingent upon the successful completion of the transaction.

In addition, the ruling requires any member issuing a fairness opinion to have a process to determine whether the valuation analyses used in the fairness opinion are appropriate. The ruling states specifically that, “procedures should state the extent to which the appropriateness of the use of such valuation analyses is determined by the type of company or transaction that is the subject of the fairness opinion.”

Given the increased scrutiny on fairness opinions, boards of directors would be well advised to consider all the qualifications of a fairness opinion provider, including fairness opinion expertise and the independence of the provider. A lesser course of due diligence leaves directors susceptible to lawsuits that question their business decisions because they relied on the opinion of advisors that were conflicted or poorly qualified. Valuation Research Corporation has prepared more than 1,000 fairness and solvency opinions for transactions valued at more than $9 billion. For more information regarding opinions, contact your Valuation Research representative or Bryan Browning at 917-338-5615. VR