On Thursday, July 27, 2017, staff of the Ontario Securities Commission and its counterparts in Québec, Alberta, Manitoba and New Brunswick (Staff) published important guidance on Staff’s expectations of market participants, including boards and their advisors, in material conflict of interest transactions. The guidance highlights the important role of public company directors in such transactions, including conducting a sufficiently rigorous and independent process while appropriately addressing the interests of minority security holders and ensuring detailed public disclosure of the board’s review and approval process. In addition, the guidance confirms that Staff are actively reviewing such transactions “on a real-time basis” to assess compliance, to determine whether a transaction raises potential public interest concerns, and, if appropriate, to intervene on a timely basis prior to any security holder vote or closing of the transaction.
“material conflict of interest transactions” and “minority security holders”
Staff note that a “material conflict of interest transaction” is a transaction governed by Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions (MI 61-101) that gives rise to substantive concerns as to the protection of minority security holders, being equity security holders who are not “interested parties” in the transaction. For example, a transaction pursuant to which an insider of the company acquires the company would be considered to be a material conflict of interest transaction. Among other things, MI 61-101 prescribes detailed procedural safeguards when a company undertakes an insider bid, issuer bid, business combination, or related party transaction, including enhanced disclosure and, absent an exemption, a requirement to obtain “minority approval” (essentially an affirmative vote by a majority of the votes cast by minority security holders) and a formal valuation of the subject matter of the transaction. In interpreting MI 61-101, Staff note that they apply a “broad and purposive interpretation” to these requirements that emphasizes the instrument’s underlying policy rationale.
Staff are reviewing material conflict of interest transactions in “real time”
Staff confirm that they play an active role as soon as a material conflict of interest transaction is announced:
- Upon filing of a disclosure document for a transaction, such as a proxy circular, bid circular or press release, Staff will initiate a review focussing on compliance with disclosure requirements, compliance with conditions for any exemptions, and the substance and disclosure of the process conducted by the board or special committee, including whether the process employed by the board in negotiating and reviewing a proposed transaction (including the existence or non-existence of a special committee of independent directors) raises concerns that the interests of minority security holders have not been adequately protected and whether that process is adequately disclosed.
- If Staff identify potential issues of concern, the issuer or its counsel may be requested to provide additional information, which may include information that is generally not otherwise publicly disclosed, such as mandates, board and committee minutes, and work product associated with a formal valuation.
- Staff may pursue remedies such as seeking corrective disclosure, appropriate orders (including, if necessary, temporary cease-trade orders), or enforcement action.
Staff view a special committee as one of the “primary means” of managing conflicts
The guidance makes clear that, in Staff’s view, a special committee of independent directors with a “robust mandate” can ensure that the interest of minority security holders are appropriately considered and is therefore advisable for all material conflict of interest transactions. In addition to a special committee’s role in alleviating conflicts, Staff note a special committee-led process serves a pragmatic purpose as well in that such a process should reduce the risk of complaints or intervention in the transaction by securities regulators. Staff also provide a number of expectations as to how an appropriately constituted special committee should function:
- Timely Formation: a special committee should be formed in a timely way, preferably in advance of a transaction having been substantially negotiated, so that the committee can conduct a “robust review” of the transaction and alternatives;
- Independence and In Camera Deliberations: a special committee should be comprised solely of independent directors and, while it is appropriate and often necessary to involve non-independent parties (such as management) to assist the committee, non-independent parties “should not be present at or participate in the decision making deliberations of the special committee”;
- Indicia of a Well-Run Process: indicia of a well-run special committee generally include a “robust” mandate, the engagement by the committee of independent advisors, supervision over or direct conduct of negotiations, accurate record-keeping, and non-coercive conduct of interested parties;
- Scope of Committee Mandate: a special committee’s mandate should not be narrowly circumscribed nor should the committee fail to fulfill the scope of its mandate; Staff expects a committee’s mandate to charge the committee with negotiating or supervising negotiations, considering alternatives, making a recommendation (or providing detailed reasons for the absence of a recommendation), hiring its own independent legal and financial advisors (notably “without any involvement, or interference from, interested parties or their representatives”);
- Role of Committee in Negotiations: where a special committee has not been involved in preliminary negotiations, Staff believe it is critical that the committee “not be bound by any such negotiations” and that other aspects of the role of the committee be robust, such as a mandate to review, negotiate further and consider alternatives;
- Fairness Opinions: where a special committee obtains a fairness opinion, the committee should not accept its conclusions without examining the underlying assumptions and methodologies nor should the committee’s conclusion as to overall fairness rest solely on the opinion as to financial fairness — “a properly mandated and effective committee should generally consider the transaction from a broader perspective”; and
- Coercive Conduct by Interested Parties: a special committee should be permitted to function “free from undue influence, coercion or threats, whether express or implied”, so interested parties involved in a transaction are expected to cooperate with the special committee and “refrain from conduct that could be construed as improper or coercive”.
Comprehensive disclosure is a baseline expectation
Staff expect that disclosure for a material conflict of interest transaction generally requires a thorough discussion of the board’s review and approval process, the reasoning and analysis of the board and/or special committee, including their views as to the desirability or fairness of the transaction, reasonably available alternatives, and the “pros and cons” of the transaction. Staff provide some specific guidance on four disclosure items, including expectations regarding disclosure of financial analysis that suggest a potential enhancement of current market practice:
- Background and Process: disclosure of the background to the transaction should be meaningful and provide a full discussion of the review and approval process — the disclosure should therefore provide sufficient context, meaningfully discuss the board/committee process and rationale for supporting the transaction, disclose dissenting views of directors, and should balance the discussion of advantages of the transaction against potential concerns with respect to the transaction and available alternatives;
- Desirability or Fairness of Transaction: issuers are reminded of existing guidance in the companion policy to MI 61-101 to provide detailed disclosure, including that the directors disclose their “reasonable beliefs as to the desirability or fairness of the proposed transaction”; however, Staff also note such disclosure should address the interests of minority security holders and not be limited to whether the transaction is in the best interests of the company. Staff also expect the disclosure to “contain a meaningful discussion of the analysis provided by advisors” and how that advice was considered;
- Board/Committee Recommendation: while securities laws do not mandate that the board or special committee make a recommendation to security holders, it is expected that those circumstances in which no recommendation is made will be “exceptional” and, in those circumstances, Staff believe that security holders should be provided “with substantially the same information and analysis that the Special Committee received in considering and addressing the legal and business issues raised by the proposed transaction”. The board is also expected to, among other things, explain its decision to not make a recommendation and the basis on which the board expects minority security holders to vote in the absence of a recommendation.
- Fairness Opinions: in light of recent court decisions, including the decision of the Yukon Court of Appeal in InterOil, there has been some debate as to the appropriate level of disclosure concerning fairness opinions, including whether the financial analysis underlying the opinion should be disclosed. Staff are of the view that where a fairness opinion is obtained for a material conflict of interest transaction, the disclosure document, such as the proxy circular should:
- disclose the compensation arrangement of the opinion provider, including whether the fee is a flat fee, or one contingent on the delivery of the opinion or the successful completion of the transaction;
- explain how the board or special committee took into account the compensation arrangement when considering the financial advice;
- disclose any other relationship or arrangement between the financial advisor and the issuer or an interested party that may be relevant to the perceived independence of the advisor’s advice or opinion;
- provide a clear summary of the methodology, information and analysis (including, as applicable, financial metrics, and not merely a narrative description) underlying the opinion sufficient to enable a reader to understand the basis for the opinion; however, Staff also caution that the security holders should not be “overwhelmed” with too much information;
- explain the relevance of the fairness opinion to the board of directors and special committee in coming to the determination to recommend the transaction; and
- if the financial advisor is requested to provide a fairness opinion but is unable or unwilling to provide one, an explanation should be given as to the advisor’s reasons for not providing the opinion together with an explanation of how the committee and board took that decision into account and its relevance to any recommendation made to security holders.
While the guidance appears to be largely in keeping with prevailing views as to “best practice” in material conflict of interest transactions, it is notable that Staff suggest more substantial disclosure as to the financial analysis of the transaction than would customarily be provided in the absence of a formal valuation. The guidance also provides a timely reminder that material conflict of interest transactions can be expected to receive enhanced scrutiny by many observers and interested parties, including shareholders, analysts, courts, regulators, governance advocates, and the press. A well-run process can take additional time and, in the short term, impact costs; however, such a process can be a worthy investment as it should assist the directors in properly discharging their duties and may increase deal certainty for all parties involved.