On July 27, 2017, the Canadian Securities Administrators (CSA) published Multilateral Staff Notice 61-302 Staff Review and Commentary on Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions, which reported on the review of material conflict of interest transactions by staff of the applicable CSA members (Staff) and discussed Staff’s views on the role of boards of directors and/or special committees, as well as disclosure obligations, in the context of material conflict of interest transactions.
Issuers party to material conflict of interest transactions must now be informed by the additional guidance provided by Staff, and their conduct will undoubtedly be measured against Staff’s expectations, as expressed in the notice.
The term “material conflict of interest transaction” includes insider bids, issuer bids, business combinations and related party transactions, but not transactions that are incidentally captured by Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions (MI 61-101), such as transactions that are business combinations only as a result of employment-related collateral benefits.
REVIEW OF MATERIAL CONFLICT OF INTEREST TRANSACTIONS
Staff reviews material conflict of interest transactions on a real-time basis to assess compliance with MI 61-101. The reviews are initiated upon the filing of the disclosure document relating to the transaction (such as an information circular, bid circular, press release or material change report). Staff will consider the following in a review of disclosure documents relating to a material conflict of interest transaction:
a. Whether disclosure requirements that enable security holders to make informed decisions have been complied with, including whether the enhanced disclosure required by MI 61-101 has been provided
b. If a formal valuation is required, whether it complies with MI 61-101 and the issuer included either a summary or the entirety of the valuation in its disclosure document
c. If minority security holder approval is required, whether or not the issuer has excluded all parties that are not properly part of the minority
d. If an issuer states that it is relying on an exemption from the formal valuation and/or minority approval requirement in MI 61-101, whether the disclosure document provides a reasonable basis on which to conclude that the exemption is available
e. Whether the process employed by the issuer’s board of directors in negotiating and reviewing a proposed transaction (including whether a special committee of independent directors exists) raises concerns that the interests of minority security holders have not been adequately protected and whether that process is adequately disclosed.
Upon identification of non-compliance, Staff may seek one or more of the following remedies: timely corrective disclosure or other actions on the part of the issuer; appropriate orders under securities legislation in relation to the transaction (such as a cease trade order); or enforcement action in certain circumstances.
ROLE OF SPECIAL COMMITTEES
A special committee is not required to be constituted under securities law, except in connection with insider bids subject to MI 61-101. However, Staff recommends that a special committee be constituted for all material conflict of interest transactions (subject to limited exceptions).
Staff discussed the following key components to a special committee’s effectiveness:
a. Timely Formation and Level of Involvement: The special committee should be formed prior to a proposed transaction being substantially negotiated. It should not be passive and should conduct a robust review of the circumstances leading to the transaction, alternatives to the transaction and the transaction itself.
b. Composition: The special committee should be comprised entirely of independent directors. While Staff acknowledges that non-independent directors or other persons possessing specialized knowledge may be invited to meet with, provide information to, or carry out the committee’s instructions, such persons should not be present at, or participate in, any decision-making deliberations of the committee.
c. Role and Process: The role and process of special committees in the context of a material conflict of interest transaction should generally include a robust mandate, the engagement of independent advisors, involvement in, or supervision over, negotiations, accurate record keeping and non-coercive conduct by interested parties.
d. Mandates: Staff generally expects a special committee mandate to include the ability to:
i. Negotiate or supervise the negotiations (rather than simply review and consider a transaction)
ii. Consider alternatives
iii. Make recommendations
iv. Engage its legal and financial advisors.
A mandate should not limit a special committee to considering only a proposal developed by executive management in conjunction with a related party or whether a transaction should be put to security holders for a vote.
e. Negotiations: Staff recognizes that the special committee may or may not be directly involved in negotiations. Where the committee is not involved in negotiations, it is important that the board of directors and special committee not be bound by any such negotiations and that other aspects of the role of the committee be robust, such as its mandate to review, negotiate further and consider any available alternatives.
f. Fairness Opinions: Staff noted that it is the responsibility of the board of directors and special committee to determine if an opinion as to whether a proposed transaction is fair from a financial point of view is necessary to assist in making a recommendation to security holders. If an opinion is to be obtained, it is the responsibility of the board and committee to determine the terms of the financial compensation of the fairness opinion provider (flat fee, a fee contingent on the delivery of the final opinion or a fee contingent on the success of the transaction). However, Staff cautioned that the special committee should consider the fairness of a proposed transaction from a broader perspective than just from a financial point of view, as provided in the fairness opinion, and that the special committee cannot substitute a fairness opinion for its own judgment as to whether a transaction is in the best interests of the issuer.
The disclosure document provided to security holders in connection with a material conflict of interest transaction should contain sufficient detail to enable them to make an informed decision in respect of the transaction. Staff noted that any tactical or self-serving disclosure intended primarily to further the interests of a related party in the transaction is inappropriate.
Staff expects that the disclosure in the context of a material conflict of interest transaction should contain a thorough discussion of:
a. The review and approval process
b. The reasoning and analysis of the board of directors and/or special committee
c. The views of the board of directors and/or special committee as to the desirability or fairness of the transaction
d. Reasonably available alternatives to the transaction, including the status quo
e. The pros and cons of the transaction.
Staff advised that the disclosure document should contain a meaningful discussion of the analysis provided by advisors and how such advice was considered by the board and the committee. Notably, Staff also advised that where a board or committee discloses its reasonable beliefs as to the desirability or fairness of a transaction, 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 issuer.
Finally, where a fairness opinion is obtained for a material conflict of interest transaction, Staff believes that the disclosure document should:
a. Disclose the compensation arrangement, including whether the financial advisor is being paid a flat fee, a fee contingent on delivery of the final opinion or a fee contingent on the successful completion of the transaction
b. Explain how the board or special committee took into account the compensation arrangement with the financial advisor when considering the advice provided
c. Disclose any other relationship or arrangement between the financial advisor and the issuer or an interested party that may be relevant to a perception of lack of independence in respect of the advice received or opinion provided
d. 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, without overwhelming security holders with too much information
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.
We wish to acknowledge the contribution of Madison Kragten to this publication.