New FINRA Rule 2290
On October 11, 2007 the SEC approved Rule 2290 proposed by the Financial Industry Regulatory Authority (FINRA), the newly-formed combined regulatory arm of the NYSE and the NASD, that imposes new disclosure requirements on member firms issuing fairness opinions and mandates specific fairness opinion procedures. In its rule proposal, FINRA expressed concern that customary fairness opinion disclosures might not give shareholders adequate notice of the potential conflicts of interest that exist between the member firm issuing the opinion and the parties involved in the transaction, and that member firms may not have adequate procedural safeguards in place to manage those conflicts of interest.
The disclosure provisions are contained in Rule 2290(a). Member firms rendering fairness opinions will be required to disclose whether the compensation they will receive is contingent on the successful completion of the transaction, or is being paid for rendering the opinion or for serving as an advisor. The Rule does not require quantitative disclosure of the contingent compensation (although disclosure of the amount of the contingent compensation typically is required under the SEC’s proxy rules). Instead, it requires descriptive disclosure of the existence of a contingent compensation arrangement, in order to highlight to investors that the member firm will benefit financially from the successful completion of the transaction. The Rule also requires disclosure of any material relationships that existed between the member firm and any party to the transaction during the past two years or relationships that are contemplated between the member firm and any party to the transaction, if any compensation was or is intended to be received by the member firm. In addition to the compensation-related disclosures, the Rule requires member firms to disclose whether they have independently verified any of the information forming a substantial basis for the fairness opinion if that information was provided by the company requesting the opinion. Finally, the Rule requires member firms to disclose whether or not the fairness opinion was approved or issued by a fairness committee, and whether the member firm took into account the amount and nature of the compensation that the company’s insiders would receive relative to the benefits to shareholders in reaching its fairness determination.
The new procedural requirements are contained in Rule 2290(b). The Rule requires that any member firm issuing a fairness opinion must have written approval procedures in place, including procedures specifying the types of transactions in which a fairness committee will be used, the process for selecting the committee (which shall include persons not on the deal team) and their qualifications, and the process employed to promote a balanced review of the transaction. The Rule also requires that member firms adopt procedures to address the process of determining whether the valuation analyses used in the fairness opinion are appropriate.
Impact on Fairness Opinion Practice
Many, if not all, of the requirements of Rule 2290 will be familiar to large member firms with extensive fairness opinion practices. The disclosure requirements, in many respects, mirror what is customary fairness opinion disclosure practice, and fairness committee review is standard procedure for many firms already, as a matter of risk management. However, the new Rule removes any ambiguity as to whether disclosure of contemplated compensation arrangements between the member firm and the company is required, and imposes new disclosure requirements regarding independent verification of information provided by the company and relative benefits to insiders and public shareholders. Procedurally, while the fairness committee approach has long been a “best practice” among larger member firms, fairness committee review is now required, and smaller member firms, or member firms without a regular fairness opinion practice, will need to adopt written fairness committee procedures in order to comply.