On July 27, 2017, staff of securities regulatory authorities in each of Ontario, Québec, Alberta, Manitoba, and New Brunswick (together, Staff) published a notice (Notice) setting out the recent experiences and approach of Staff in Ontario and Québec in reviewing insider bids, issuer bids, business combinations and related party transactions (collectively, material conflict of interest transactions), each as defined in Multilateral Instrument 61-101 - Protection of Minority Security Holders in Special Transactions (MI 61-101). In addition, Staff in Alberta, Manitoba and New Brunswick have indicated that they intend to adopt the same approach in reviewing material conflict of interest transactions. The Notice also provides an overview of factors considered by Staff in reviewing the role of a board of directors and/or special committee in material conflict of interest transactions, and provides guidance for issuers, insiders and other related parties who are required to comply with MI 61-101.
MI 61-101 establishes a securities regulatory framework that is designed to mitigate the risks faced by minority security holders in connection with transactions where a related party of a reporting issuer may have superior access to information or significant influence with the issuer, or where a related party may be entitled to a benefit that is not generally available to all security holders. MI 61-101 applies to four categories of transactions, namely: “insider bids”, where an insider of an issuer seeks to acquire more than 20 percent of the issuer's securities; “issuer bids”, where the issuer offers to repurchase equity securities from shareholders; “business combinations”, which involve the termination of an equity security without the holders' consent and which involve a related party component; and certain transactions between an issuer and a related party of the issuer. MI 61-101 is intended to ensure that all security holders are treated in a manner that is fair and perceived to be fair and, depending on the type of transaction, seeks to achieve such objectives through procedural protections for minority security holders, including formal valuations, enhanced disclosure and disinterested shareholder approval (majority of the minority approval) requirements. In achieving the objectives of MI 61-101, Staff has confirmed that it will apply a broad and purposive interpretation of the requirements of MI 61-101 that emphasizes its underlying policy rationale.
The Notice provides key insight into the application of MI 61-101 by Staff with respect to material conflict of interest transactions and confirms that Staff reviews material conflict of interest transactions on a real-time basis to assess and ensure compliance with MI 61-101, and to determine whether a transaction raises potential public interest concerns. Specific items identified as part of Staff's review are: (i) compliance with disclosure requirements; (ii) compliance with the conditions required for reliance on an exemption from the formal valuation and disinterested shareholder approval requirements set out in MI 61-101; and (iii) the substance and disclosure of the process conducted by an issuer's board of directors or special committee in considering a material conflict of interest transaction.
Staff's review will generally commence upon an issuer filing public disclosure documents for the transaction. If, during its review, Staff identifies non-compliance with MI 61-101 or potential public interest concerns, Staff may contact the issuer or the issuer's legal counsel to seek additional information or documentation, which could include special committee meeting minutes, the special committee's mandate and other relevant materials. If Staff remains unsatisfied with its review, it may seek a variety of remedies, including corrective disclosure by the issuer or proceed to enforcement.
The Notice confirms that while the formation of a special committee of independent directors is not mandated by MI 61-101, except in the case of insider bids, the formation of a special committee to ensure that the interests of minority security holders are fairly considered in the negotiation and review of such a transaction is a primary means for managing a conflict of interest. Further, Staff confirms that the formation of a special committee with a robust mandate is advisable for all material conflict of interest transactions.
The Notice provides the following specific guidance with respect to special committees of independent directors in connection with material conflict of interest transactions:
- Timely formation and effectiveness: Special committees should be established early in the process for a material conflict of interest transaction and should be formed before a proposed transaction has been substantially negotiated;
- Composition: The members of a special committee should be independent within the meaning of MI 61-101 and conduct themselves in a manner that is independent of the issuer. The special committee should have the authority and opportunity to discharge its mandate without undue influence from interested parties;
- Role and process: In order to be effective, a special committee should: (i) have a robust mandate; (ii) engage independent advisors; (iii) supervise negotiations with respect to the transaction; (iv) keep accurate records; and (v) ensure non-coercive conduct by interested parties;
- Mandate: A special committee’s mandate should provide the special committee with the ability to:
- negotiate or supervise the negotiation of a proposed transaction (rather than simply review and consider it);
- consider alternatives to the proposed transaction that may be available, including maintaining the status quo or seeking other transactions that would enhance value to minority security holders;
- make a recommendation regarding the proposed transaction or provide detailed reasons why the special committee was unable to make a recommendation; and
- hire its own independent legal and financial advisors, without any involvement of, or interference from, interested parties or their representatives;
- Negotiations: The exact nature of the involvement of a special committee in the negotiations pertaining to a particular transaction will depend on the context. A special committee should negotiate a transaction from the outset or, where a special committee has not been involved in preliminary negotiations, it should not be bound by such negotiations and should be authorized to further review, negotiate and/or consider alternatives; and
- Fairness: It is the responsibility of the board of directors or the special committee to determine whether a fairness opinion is appropriate to assist in making a recommendation to security holders on a proposed transaction, and to determine the terms and financial arrangements for the engagement of a financial advisor. If a financial advisor is retained to provide an opinion with respect to the fairness of the consideration, such opinion does not absolve the special committee of its responsibility to conduct a broader review of the proposed transaction. In addition, the special committee should conduct a thorough review of the fairness opinion and utilize its own experience and knowledge of the issuer to consider the appropriateness of the assumptions and methodologies used by the financial advisor.
Staff notes that the enhanced disclosure requirements in MI 61-101 constitute one of the fundamental protections imposed by MI 61-101, and attempts to address the asymmetry of information that may exist when minority security holders are asked to consider and approve, or tender into, a material conflict of interest transaction.
The Notice provides that issuers and insiders discharging their duties under MI 61-101 are expected to ensure the fair treatment of minority security holders and fully comply with the "spirit and intent" of MI 61-101. In light of this requirement, the Notice provides the following guidance for ensuring that an issuer and/or its insiders comply with such obligation:
- Disclosure standards: The disclosure should include a thorough discussion of: (i) the review and approval process that was undertaken; (ii) the reasoning and analysis of the board of directors and/or special committee; (iii) the views of the board of directors and/or special committee as to the desirability or fairness of a proposed transaction; (iv) reasonably available alternatives to a proposed transaction, including maintaining the status quo; and (v) the pros and cons of a proposed transaction;
- Disclosure regarding background and process: The disclosure should include a fulsome discussion of: (i) the context and background to a proposed transaction; (ii) the board of directors’ or special committee’s process and their rationale for supporting a proposed transaction; (iii) dissenting views of directors in respect of a transaction, if any; and (iv) potential concerns with a proposed transaction or available alternatives to the transaction to ensure the presentation of balanced disclosure;
- Desirability or fairness of transaction: The disclosure should contain a meaningful discussion of the analysis provided by the advisors and how the board of directors and special committee considered the advice provided in concluding that the transaction should be recommended to security holders. The 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 as required under corporate law; and
- Recommendations: In the exceptional circumstances where a board of directors determines not to make a recommendation as to how minority security holders should vote or tender their securities, there should be a high level of disclosure such that minority security holders are provided with equivalent information and analysis to the special committee to enable security holders to consider a proposed transaction.
Financial advisors and fairness opinions
While MI 61-101 does not require a fairness opinion in connection with material conflict of interest transactions, Staff asserts that if a fairness opinion has been obtained, the disclosure document should:
- disclose compensation arrangements with the financial advisor, 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 proposed transaction;
- explain how the board of directors or special committee took into account the compensation arrangement with the financial advisor when considering the advice provided;
- disclose any other relationship or arrangement between the financial advisor, and the issuer or other interested party that may be relevant to a perception of lack of independence in respect of the advice received or opinion provided;
- provide a clear summary of the methodology, information and analysis underlying the opinion so as to enable a reader to understand the basis for the opinion; and
- explain the relevance of the fairness opinion to the board of directors and special committee in coming to the determination to recommend the transaction.
Additionally, if a fairness opinion is requested and a financial advisor is not able or willing to provide one, the disclosure document should set out the financial advisor’s reasons for not providing the fairness opinion, and explain how the special committee and board of directors took the financial advisor's decision into account and its relevance to any recommendation made to security holders concerning the transaction.
The Notice advises issuers and their advisors of Staff's real time review of continuous disclosure documents that are filed in connection with material conflict of interest transactions, and provides clear guidance with respect to Staff's perception and consideration of various issues that frequently arise in connection with such transactions that fall within the purview of MI 61-101, including the utility of a properly-constituted special committee, required compliance with the enhanced disclosure requirements imposed by MI 61-101 and disclosure in connection with fairness opinions.
Directors and officers of issuers that are considering material conflict of interest transactions should carefully consider the guidance provided in the Notice, as such transactions are often fraught with uncertainty and subject to heightened scrutiny, and the Notice provides beneficial guidance with respect to Staff’s expectations.