The Canadian Securities Administrators has published its views and expectations on the role of target boards and special committees in respect of material conflicted transactions governed by Multilateral Instrument 61-101 (MI 61-101), related disclosures and financial advice received by target boards in this context.1 The guidance provided in the notice reflects the results of the review of conflicted transactions, and the deficiencies identified.
What You Need To Know
- The guidance provided in the notice is more prescriptive than MI 61-101 and its related companion policy with respect to the composition, conduct and role of special committees.
- The notice calls for enhanced disclosure to shareholders regarding transactions, setting out the basis for potential challenges to transactions.
- On financial advice and fairness opinions, the notice provides guidance about disclosure in connection with financial advisor compensation and the basis for the conclusions reached in fairness opinions.
- Staff of provincial regulators will review material conflicted transactions in real time, but have not elected to initiate a system for advance review that might avoid amending disclosure and delay.
While the staff notice largely reflects current target practices in respect of conflicted transactions, it is more prescriptive in respect of special committees than MI 61-101 and the related companion policy. In some instances it goes beyond best disclosure practices and articulates—in detail—staff thinking on the way target directors should oversee conflicted transactions. The notice applies only to “material” conflict of interest transactions, meaning MI 61-101 transactions that give rise to substantive concerns as to the protection of minority shareholders and not transactions that are captured incidentally within the scope of MI 61-101, such as transactions that are business combinations only as a result of employment-related collateral benefits.
Although MI 61-101 only mandates a special committee in the circumstances of an insider bid, the companion policy to the instrument urges the use of special committees in other transactions. The staff notice reinforces this position, catching up with current practice, while also acknowledging in certain cases governance arrangements, other than a special committee, may satisfy the need to have transactions overseen by unconflicted directors.
Drawing from Ontario Securities Commission decisions, the notice provides detailed guidance on director independence, the scope of special committee mandates, and the management of conflicted transactions by special committees.2 While prescriptive in tone, the details in the staff notice are generally consistent with current practices of target boards in conflicted transactions.
Staff’s view is that special committees should always have responsibility for the negotiation of a proposed transaction, staff recognizing the exact nature of the special committee involvement will depend on the context of a particular transaction. However, in practice, special committees are not always best equipped to negotiate as opposed to oversee the negotiation of transactions. The notice also states a special committee is free either to recommend a transaction or state why it is not recommending the transaction it negotiated (when in reality the special committee holds de facto veto powers) as a target is unlikely to proceed with a transaction that has been rejected by the special committee. The notice arguably overstates the reasonable role of the special committee, while understating its effect.
The staff notice reiterates the importance of the enhanced disclosure requirements in MI 61-101 given the asymmetry of information that may exist between insiders and shareholders in these transactions. These requirements include thorough disclosure of the context and background of the transaction, the review and approval process, the reasoning of the special committee and the board and their views on the transaction, and the alternatives they considered.
The notice lays out the regulator’s expectations with regard to enhanced disclosure. By doing this, the notice sets the foundations for the regulator’s public interest jurisdiction to intervene in transactions in the future.
Enhanced disclosure can also invite complaints about the transaction—including the conduct of target directors—forming a basis for activist shareholders or other market participants to challenge transactions. The notice sets a high standard for target directors, with the risk that even if they do follow a good process, they may still fall short of staff expectations or be the subject of complaints.
The expectations the notice sets out with respect to disclosure, while particularly relevant to transactions governed by MI 61-101, could affect disclosure practices more broadly in connection with other M&A public transactions.
As anticipated, the staff notice also provides direction to targets on the manner in which they should consider and disclose financial advice, including in circumstances where a fairness opinion has not been obtained. The notice specifies it is the responsibility of the target board to determine whether a fairness opinion is necessary to assist in making recommendations to shareholders and to determine the structure of the compensation paid to the financial advisor, including a success fee.
The staff notice states disclosure with regard to financial advice should include: the financial advisor’s compensation arrangements (but not the actual sums payable) and the board’s consideration of these arrangements; a description of the methodology, information and analysis used by advisors, meeting a standard that allows the shareholder to understand the basis for the opinion without overwhelming with detail; and disclosure of the board’s use of financial advice.
While the financial advice guidance is provided in the context of a notice on material conflicted transactions, it is worth noting it does not mandate a fixed fee fairness opinion nor require fee disclosure of the actual sums payable, putting it at odds with the recent InterOil decisions3. As a result, in the appropriate circumstances, a target board in Canada will be able to continue to rely on a fairness opinion where the financial advisor will receive a success fee without having to seek a second independent fairness opinion or disclose the fee payable to the financial advisor.
However, consistent with InterOil and existing IIROC rules governing financial advisors, the guidance requires summary disclosure of the underlying financial analysis provided by a financial advisor in material conflicted transactions. We think that the same principles animating this guidance could affect market practice in respect of other public M&A transactions if the target board concludes more extensive disclosure of its financial advice is necessary to allow target shareholders to make informed decisions.
Staff Review of Conflicted Transactions
Staff conduct real time reviews of conflicted transactions before they are approved by shareholders or close. Staff reviews can include requesting board documents—mandates, minutes and copies of advice that directors receive—and that review may be initiated by staff or by a complaint. In the most extreme cases, this could lead to administrative proceedings, with the potential for commission intervention that alters or even terminates certain transactions. In other cases, staff reviews could result only in the need for additional disclosure and possible delays.
Unlike U.S. regulators, staff have elected not to require issuers to submit their disclosure for advance review, a process that would allow issuers to address staff concerns before disclosure materials are mailed to shareholders and could avoid the need for additional disclosure. However, a voluntary system of advanced review is one possible result of the more assertive regulation of conflicted transactions reflected in the notice.
2 See: January 2016 publication, Effective Special Committees: Lessons From Courts and Regulators.
3 See: April 2017 publication, Financial Advice Under More Scrutiny in M&A
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