What people who write fairness opinions have at stake and what that means for investors and financial managers.
Even though almost every SEC filing disclosing a change in corporate control includes a fairness opinion, these documents do very little for investors--the group disclosure is supposed to inform. Fairness opinions developed as legal protection for members of boards of directors against possible shareholder challenges to their decisions. However, the investment bankers typically preparing such opinions often have an inherent bias in favor of ratifying the transactions.
When reviewing a fairness opinion as part of due diligence, investors and financial executives--especially CPAs in business and industry--need to know that these opinions can be highly subjective. Accordingly, they should consider the credentials and motives behind a fairness opinion while weighing its merits and temper the conclusions they draw from it. In the words of Phil Clements, CPA, the New York-based global leader of corporate value consulting at PricewaterhouseCoopers, "A fairness opinion is never a substitute for due diligence."
WHAT IS A FAIRNESS OPINION?
A fairness opinion is a written and signed third-party assertion certifying--some would say rationalizing--the price of a proposed deal involving a tender offer, merger, asset sale or leveraged buyout. It usually discusses the price and terms of the deal in the context of comparable transactions, drawing attention to strategic considerations that might make a particular transaction worth more or less than others. In many ways, it is an explanation of the deal price arrived at by the negotiating parties.
For investors and financial executives, the most useful fairness opinions are detailed, well reasoned and convincing without being too restrictive about what might be fair. Rather than say the exact price of a deal is equitable, a typical fairness opinion outlines a range of fair prices. The actual deal price should fall in that range. Nonetheless, those reading fairness opinions should remain skeptical.
Fairness opinions almost never are required as a matter of law although such avowals became customary after January 1985, when the Delaware Supreme Court ruled against the directors of Trans Union Corp. in Smith v. Van Gorkom. Aggrieved shareholders of that company had accused the company's directors of accepting a paltry sum when the company went private in a leveraged buyout. Justice Horsey's majority opinion on the case concluded that the directors hadn't bothered to inform themselves adequately about the company's value before agreeing to sell it. The court opened a safe harbor by implying that the liability could have been avoided had the directors elicited a fairness opinion from anyone in a position to know the company's value. Instead, they had relied solely on the unwarranted assertions of Trans Union's CEO, Jerome Van Gorkom.
The boards of American corporations got the message. According to John C. Coffee, Jr., a securities expert teaching at Columbia Law School in New York, the fairness opinion became the established standard "as a minimum precaution."
In addition, fairness opinions sometimes are used in contexts outside the SEC's jurisdiction. For example, insurance commissioners in Massachusetts recently called on PWC to assess whether a demutualization plan by an insurance company was fair to policyholders, according to that firm's Clements.
WHO WRITES FAIRNESS OPINIONS?
Van Gorkom emerged as "a full employment act for investment bankers," Columbia's Coffee says, only half-jokingly. Since the law seldom requires fairness opinions, no specific credentials are needed to write them. Traditionally, investment bankers have written most of them, but the high fees and low risks have attracted new competition-consultants and some CPA firms, for example. The new competitors may offer more independence, lower prices and different credentials. …