Being Fair to Fairness Opinions for Directors

Directors are periodically asked to make tough decisions
about the strategic direction of a company and its leadership. A fairness
opinion can help bolster or extrapolate on those decisions.

Fairness
opinions are not required under Delaware law or federal securities law.
However, they have become staples in corporate mergers and acquisitions
activity ever since the Delaware Supreme Court’s 1985 decision that directors
of Trans Union were grossly negligent in approving a merger without adequate
inquiry and expert advice.

In its
decision, the Delaware Supreme Court did not specifically mandate that
companies obtain a fairness opinion, but stated it would have helped the board
carry out its duty of care regarding the firm’s value and the fairness of the
proposal.

Sometimes, fairness opinions and the transaction to which the opinion address are controversial.

The directors of Tesla Motors Inc. faced a decision in 2016 to approve a merger with SolarCity Corp., which was hemorrhaging red-ink. Complicating the decision were the dual roles and ownership held by Elon Musk, who owned about 18% of Tesla and 22% of SolarCity and chaired both boards; he recused himself from the decision. Other directors had various ties to both companies and Musk.

A cursory
review of the proxy and prospectus indicates that both boards took steps to
ensure the decision process was proper, including hiring financial advisors who
provided fairness opinions.

It seems that the merger may have not gone well from the vantage point of Tesla shareholders. SolarCity shareholders, on the other hand, received a lifeline given a dire liquidity situation. The legal aftermath has been litigation alleging the board breached its fiduciary duties in approving the merger. The advisors’ role likely will be closely scrutinized as the litigation progresses.

Investment
bankers are hired to get deals done. They provide connections, advice and
negotiate deals in conjunction with, or in place of, insiders. Sometimes the
same bankers that negotiate a deal provide the fairness opinion; other times, a
second advisor with no incentive fee on the line does so.

The second
advisor may be especially important if the transaction is contentious, subject
to intense scrutiny or entails potential conflicts. For example, Piper Jaffray Co.
self-advised in its pending acquisition of Sandler O’Neill + Partners; JMP
Securities issued a fairness opinion to Piper Jaffray’s board of directors.

While much of an advisor’s role will be focused on providing analysis and advice to the board leading up to a meaningful corporate decision, the fairness opinion has a narrower scope.

What is opined is the fairness of the transaction from a
financial point of view of the company’s shareholders, as of a specific date
and subject to certain assumptions. If the opinion is a sell-side opinion, the
advisor will opine as to the fairness of the consideration received. The
buy-side opinion will opine as to the fairness of the consideration paid.

A fairness
opinion does not opine on the course of action a board should take, whether the
contemplated transaction represents the highest obtainable value, where a
security will trade in the future or how shareholders should vote.

The U.S.
Securities and Exchange Commission has weighed in, too, obliquely via the
Federal Register (Vol. 72, No. 202, Oct. 19, 2007). The Financial Industry
Regulatory Authority, the self-regulatory body overseeing securities firms, proposed
rule 2290 (now 5150) regarding disclosures and procedures for the issuance of
fairness opinions by broker-dealers. The SEC noted that the opinions served a
variety of purposes, including as indicia of the exercise of care by the board
in a corporate control transaction and to supplement information available to
shareholders through a proxy.

Fairness opinions
are not valuations. However, they should be backed by rigorous fundamental
analyses of the transaction, the process leading to the transaction, the ranges
of value derived from multiple valuation methods and the investment attributes
of the acquirer’s shares, if the consideration entails the issuance of common
shares and other forms of non-cash consideration.

Fairness also depends upon one’s vantage point. Some deals are not what some would consider fair, and therefore should not be occurring; sometimes, a transaction is a close call.

Timing
matters too. Transactions that were negotiated in mid-2007 and closed in 2008
may have felt wildly generous to the seller as conditions deteriorated.
Likewise, deals negotiated in mid-2012 that closed in 2013, as markets
appreciated, may have felt like sellers left money on the table.

Fairness opinions are not
substitutes for boards’ informed decision-making, but they should be a factor
boards consider when making a momentous decision to sell, pursue a significant
acquisition or other such transactions.