Staff of the securities regulatory authorities in each of Ontario, Quebec, Alberta, Manitoba, and New Brunswick have published commentary on Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions (MI 61-101) which advises of a “real time” review program of transactions to which MI 61-101 applies and puts forward Staff’s views with regard to the use of special committees and fairness opinions. Issuers are reminded that MI 61-101 should be interpreted with a view to its underlying policy purpose.
The Staff Notice recognizes the importance of the formation of a special committee of independent directors in the context of what Staff have called “material conflict of interest transactions”, which include insider bids, issuer bids, business combinations and related party transactions (each as defined in MI 61-101) that give rise to substantive concerns as to the protection of minority security holders. Notably, the Staff Notice states that while special committees are only mandated by MI 61-101 in the case of insider bids, Staff are of the view that a special committee with a broad mandate is advisable for all material conflict of interest transactions as an active independent special committee can:
- Assist in compliance with MI 61-101;
- Mitigate potential public interest concerns;
- Reduce the risk of a transaction being the subject of a complaint to securities regulatory authorities; and
- Minimize the likelihood that Staff will raise procedural issues when reviewing the transaction.
Despite this, the Staff Notice indicates that there may be circumstances where, in the absence of a special committee, a board can both address Staff’s concerns and protect minority security holders, the prime example being where the board of directors is entirely independent.
These benefits are predicated to an extent, however, on the actual mandate and operations of the committee. In this respect, Staff note the following circumstances which may result in a special committee being ineffective:
- Formation after a proposed transaction was substantially negotiated.
- Passive involvement in the transaction.
- Failure to conduct a robust review of the circumstances leading to the transaction and available alternatives.
- Inclusion of non-independent persons in decision making deliberations.
Staff note that the special committee’s mandate should therefore be robust and provide the ability to negotiate or supervise the negotiation of a transaction, consider other available alternatives, make recommendations regarding the proposed transaction and hire its own independent legal and financial advisers. Staff do not believe that the board of directors or special committee should be bound by preliminary negotiations that were conducted without the committee’s involvement.
While MI 61-101 does not require that fairness opinions be obtained in connection with material transactions, Staff comment that it is a board’s and special committee’s responsibility to determine whether a fairness opinion is necessary to assist in making a recommendation to security holders on a proposed transaction. Of note, Staff do not believe that a special committee can substitute a fairness opinion for its own judgment as to whether a transaction is in the best interests of the issuer and its minority security holders given that the transaction should be considered from more than a financial point of view. In addition, it is Staff’s view that the board and special committee are generally responsible for determining the terms and financial arrangements for the engagement of the financial advisor providing the fairness opinion.
Where a fairness opinion is obtained, Staff note that the disclosure document provided to shareholders about the material conflict of interest transaction should, among other things:
- 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.
- Explain how the board or special committee took into account the compensation arrangement with the financial advisor when considering the advice provided.
- Clearly summarize the methodology, information and analysis underlying the fairness opinion so as to enable a reader to understand the basis for the opinion. This should include, as applicable, financial metrics and not merely a narrative description.
CSA Staff note that they will consider whether an issuer has included a summary or the entirety of a formal valuation in its disclosure document. Staff also note their concern that special committees have “failed to consider previous financial work product, including whether such workproduct constituted a prior valuation or material information that needed to be disclosed, and to what extent such work product was relevant to the committee’s recommendation with respect to the transaction.” In light of recent case law, the Canadian M&A community has questioned whether Canadian practice will move toward the inclusion of U.S. style fairness opinions containing more fulsome details. It will be interesting to see how such debate may be impacted by this latest commentary.
Review of Special Transactions
When reviewing a transaction, the determination as to whether a material conflict of interest transaction raises potential public interest concerns and complies with the requirements of MI 61-101 is made by Staff in “real-time”, with the goal of resolving any issues in advance of security holder approval and the closing of the transaction. In undertaking their review, Staff will review disclosure documents, including press releases and material change reports filed in connection with transactions that are exempt from the minority approval requirements of MI 61-101, and consider, among other things, whether any required formal valuation complies with MI 61-101 and whether the appropriate security holders were excluded from minority approval. In reviewing an issuer’s disclosure document, Staff will consider whether the document provides a reasonable basis for relying on an exemption from formal valuation and/or minority approval, where one is being relied upon. Staff may also contact the issuer or its legal counsel as part of the review, and may request supporting information, including work product associated with a formal valuation.
Non-compliance with MI 61-101 may be addressed in any of the following ways:
- Timely corrective disclosure or other actions by the issuer.
- Appropriate orders under securities legislation in relation to the transaction.
- Enforcement action.
As a fundamental component of MI 61-101, enhanced disclosure requirements should provide security holders with sufficient information to enable the making of an informed decision on how to vote or tender in connection with a material conflict of interest transaction. Staff believe that disclosure should include a thorough discussion of:
- The review and approval process.
- The board and/or special committee’s reasoning and analysis.
- The board and/or special committee’s views as to the fairness of the transaction.
- Any reasonably available alternatives to the transaction (including the status quo).
- Pros and cons of the transaction.
Staff note that issuers have often fallen short when disclosing the background to and approval process for the transaction, as well as disclosure regarding a board and/or special committee’s analysis as to the desirability and fairness of the transaction. Staff have also found inadequate disclosure about fairness opinions and outline a list of matters that should be disclosed.
Other Items of Interest from the Staff Notice
In addition to the topics discussed above, the Staff Notice states that:
- A “material conflict of interest transaction” would generally not include a transaction that incidentally falls within the scope of MI 61-101 (for example, transactions considered to be a “business combination” only as a result of employment-related collateral benefits).
- When used in the Staff Notice, a “minority security holder” is an equity security holder of an issuer that is not an “interested party” (as defined in MI 61-101).
- If the board is of the opinion that there is a conflict between the best interests of the issuer and the best interests of its minority security holders, Staff expect such conflict to be explained in the disclosure document, including how it was addressed by the board in deciding to put the transaction to shareholder approval.
- Market participants are referred to IIROC rules and the standards of The Canadian Institute of Chartered Business Valuators, which may apply to parties providing fairness opinions, for guidance on an approach to meeting the appropriate standard for fairness opinions.
Designed to provide fair treatment to all security holders, MI 61-101 regulates business combinations and take-over bids involving certain insiders or related parties and requires enhanced disclosure, independent valuations and majority of minority security holder approvals for prescribed transactions. MI 61-101 has been in effect in Ontario and Quebec since February 1, 2008, and, on June 20, 2017, MI 61-101 was adopted by the securities regulatory authorities in each of Alberta, Manitoba and New Brunswick to be effective July 31, 2017.