A fairness opinion is an effective, often necessary, risk management tool that determines whether the terms of a transaction are fair to stakeholders from a financial point of view. In significant change of control or capital transactions, obtaining a fairness opinion facilitates the decision-making process. The purpose of the fairness opinion is to provide an objective standard against which directors, shareholders, and other interested parties may measure proposals and opportunities concerning their company. Such opinions also help insulate directors from the charge that they violated their fiduciary duties by facilitating their invocation of the business judgment rule.
Fairness opinions are often issued by investment banks which have arranged or negotiated a transaction. Typically, however, most of the investment banks’ fee is contingent upon the successful closing of a transaction. Thus, the investment banker’s fairness opinion may be perceived to be biased even if the transaction is fair.
Since FINRA’s approval of amended Rule 2290 in 2007, the use of second opinions has become extremely important in any sale of a company with numerous shareholders, both private and public. Rule 2290 forces firms to disclose certain financial information and potential conflict situations when issuing an “independent” fairness opinion included in a proxy statement.
The Delaware Court of Chancery issued an opinion in August of 2013 on In re Morton’s Restaurant Group Shareholders Litigation, where a second opinion was issued, demonstrating that a second financial advisor can help to overcome challenges which call into question the fairness/legitimacy of a potential deal. Previous cases led to opinions by the Delaware courts that gave increased importance to second opinions as a means to solidify the credibility of fairness opinions written by conflicted primary financial advisers. Such cases include Parnes v. Bally Entertainment, C.A. No. 15192-CC (Del. Ch. Feb. 23, 2001), and S. Muoio & Co. LLC v. Hallmark Entertainment Investments, C.A. No. 4729-CC (Del. Ch. Mar. 9, 2011).
But it was in In Re Morton’s case that the Court emphasized the legitimacy of a second opinion, compared to previous sentiment that second opinions were merely “rubber stamps.” Additionally, in In re Morton’s, the Court suggested factors to consider in evaluating the effectiveness of a second financial advisor. Those factors include, but are not limited to:
- the degree to which the board was active in assessing the effects of potential conflicts of interest for the primary financial advisor;
- how active the second financial advisor was in the sales process and its level of independence;
- whether the situation causing the conflict can be viewed as a benefit to the company and its stockholders;
- the relative compensation arrangements of first and second advisors, to what extent compensation is contingent on the deal and whether the first advisor’s compensation was adjusted due to the necessity of a second advisor.
Merger challenge litigation has increased dramatically in recent years. It is in the best interest of the board of directors, which can be held personally liable, to obtain a second opinion when selling a company, particularly when the principal advisor has a real or perceived conflict of interest. In 2013, the biggest issuers of fairness opinions were bulge bracket investment banks. There is an inherent conflict of interest for investment bankers that both advise a company through a merger and provide fairness opinions – the banker could be viewed as tainted.
When compensation is tied to the execution of a deal, an independent second fairness opinion provided by a conflict-free fee-based service provider, such as Houlihan Capital, should be utilized. As a fee-based, cost competitive, independent service provider, we have provided many second opinions for clients in the process of a merger or buyout transaction.
Houlihan Capital is a leading, solutions-driven valuation, financial advisory, and boutique investment banking firm committed to delivering superior client value and thought leadership in an ever-changing landscape. The firm has extensive experience in providing objective, independent and defensible opinions of value that meet accounting and regulatory requirements. Our clients include some of the largest asset managers, private equity funds, hedge funds, fund administrators, and both public and private operating companies, who benefit from our comprehensive valuation and financial advisory services. Houlihan Capital is a Financial Industry Regulatory Authority (FINRA) and SIPC member, committed to the highest levels of professional ethics and standards.
For more information on providing independent second opinions, please visit www.houlihancapital.com or contact Paul Clark (pclark@houlihancapital.com) at 312.450.8656.
