On July 27, 2017, staff of the securities regulatory authorities in each of Ontario, Québec, Alberta, Manitoba and New Brunswick (CSA Staff) published Multilateral CSA Staff Notice 61-302 Staff Review and Commentary on Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions (Notice) setting out CSA Staff’s views on material conflict of interest transactions regulated by Multilateral Instrument 61-101 Protection of Minority Security Holders in Special Transactions (MI 61-101). The Notice provides a helpful consolidation of the current thinking of CSA Staff on a number of issues that arise frequently in these transactions, including the effective use of a special committee of independent directors, compliance with the enhanced disclosure requirements of MI 61-101 and matters concerning fairness opinions. The Notice also formally alerts capital markets participants to the fact that CSA Staff is conducting real-time reviews of continuous disclosure documents filed in connection with material conflict of interest transactions to assess compliance with MI 61-101 and identify potential public interest concerns.
The Notice, which is the first time the CSA has released a detailed publication on conflict of interest transactions since MI 61-101 and its companion policy were adopted in 2008, will be of interest to public company boards and their advisors given the frequency with which MI 61-101 issues arise in Canada and the complexity of those issues.
The key takeaways from the Notice include the following:
- CSA Staff is reviewing all material conflict of interest transactions for compliance with MI 61-101 and fairness to minority security holders.
- CSA Staff expects boards of directors to express a view as to the desirability of a transaction to minority security holders, not simply whether a transaction is in the interests of the issuer.
- Where a fairness opinion is provided, CSA Staff expects discussion of the structure of the financial advisor’s compensation arrangement and details regarding the methodology, information and analysis underlying the opinion.
Background to 61-101: How does it work and what is it trying to accomplish?
MI 61-101 is an important feature of Canadian securities law aimed at mitigating risks to minority security holders in certain specified types of transactions. It is responsive to the realities of Canadian capital markets where a large number of public companies have significant or controlling shareholders and non-arm’s length transactions are common. MI 61-101 attempts to level the playing field between related parties and minority security holders in circumstances where the related party may have superior access to information or be in a position to exert significant influence. One of the key principles underlying MI 61-101 is that all security holders should be treated in a manner that is fair and that is perceived to be fair.
MI 61-101 regulates four types of transactions:
- Issuer Bids. Where an issuer offers to repurchase its securities (other than non-convertible debt).
- Insider Bids. Where an insider, such as an existing significant shareholder, offers to acquire additional voting or equity securities that would trip the 20% take-over bid threshold.
- Business Combinations. An amalgamation, arrangement or other reorganization as a consequence of which the interest of a holder of an equity security is terminated without the holder’s consent and where there is also some sort of related party relationship.
- Related Party Transactions. Certain specified transactions between an issuer and a related party of the issuer, including where the issuer acquires or sells assets, leases property, acquires a related party or assumes or otherwise becomes subject to a liability of the related party.
Depending on the type of transaction, MI 61-101 mitigates risks to minority security holders through four key mechanisms:
- the requirement to prepare and disclose a formal valuation from an independent valuator;
- approval of disinterested security holders (i.e. the “majority of the minority” vote);
- enhanced corporate governance through the use of a special committee of independent directors; and
- enhanced disclosure.
Guidance on Special Committees
Although MI 61-101 only requires the use of a special committee of independent directors in connection with an insider bid, it has become prevalent in Canada to use a special committee as a corporate governance mechanism to address conflicts. A board of directors will generally establish a special committee to discharge its fiduciary duty under applicable corporate laws to act honestly and in good faith with a view to the best interests of the corporation. The Notice provides some helpful guidance around what CSA Staff consider to be an effective use of a special committee of independent directors, including the following:
- When to use. It is advisable to use a special committee for all material conflict of interest of transactions, even where there is no technical requirement under MI 61-101 to do so.
- Timing and effectiveness. A special committee should be established early on in the process, and not after a proposed transaction has been substantially negotiated. The special committee should take an active role and conduct a robust review of the circumstances leading to the transaction, available alternatives and the transaction itself.
- Composition. A special committee should be comprised of members who are independent within the meaning of MI 61-101 and who conduct themselves truly independently. Independent conduct will include the absence of non-independent persons in the decision making deliberations of the special committee, and the absence of undue influence or coercion from non-independent persons.
- Scope of mandate. A special committee mandate should be robust and drafted broadly and authorize the special committee to address the key issues relating to the transaction. The mandate should generally include the ability to:
- either negotiate or supervise the negotiation of the 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 recommendations regarding the proposed transaction (or provide detailed reasons why no recommendation is being made); and
- engage its own independent advisors, including legal and financial advisors, without involvement or interference from interested parties or their representatives.
- Role in negotiations. A special committee should either have supervision over, or direct conduct of the negotiations involving, the proposed transaction. Where the special committee has not been involved in preliminary negotiations, the board of directors and special committee should not be bound by any such negotiations and should have the ability to negotiate further.
- Assessing fairness. It is the responsibility of the board of directors and special committee to determine whether a fairness opinion is necessary and to determine the terms and financial arrangements for the engagement of a financial advisor. If a special committee chooses to obtain a fairness opinion, that will not absolve the committee from its own responsibility to thoroughly review the fairness opinion and consider the desirability or fairness of the proposed transaction more broadly. The special committee should bring its own experience and knowledge of the issuer to bear on the assumptions and methodologies used by the financial advisor. Significantly, CSA Staff states that in explaining the fairness and desirability of a transaction, a special committee should also address the interests of minority security holders rather than limit the discussion to whether the transaction is in the best interests of the issuer. This extends beyond applicable Canadian corporate laws which provide that a director’s duty is owed to the corporation and not the shareholders or any specific stakeholder and may require boards of directors to explain the scope of their analysis in conflict transactions.
- Conduct of interested parties. Related parties involved in a transaction should co-operate with the special committee and refrain from conduct that could be construed as improper or coercive. Otherwise, confidence in the special committee process and capital markets generally could be undermined.
- Quality of record keeping. A special committee should engage in accurate and complete record keeping practices. Supporting information like special committee minutes, special committee mandates, work product associated with a formal valuation and other relevant materials could be requested by CSA Staff in the context of its review of a material conflict of interest transaction. In addition, such records are likely to be of assistance in meeting the enhanced disclosure requirements discussed below.
Guidance on Enhanced Disclosure
Enhanced disclosure requirements under MI 61-101 are intended to ensure that all security holders have sufficient information to enable them to make an informed decision on how to vote or whether to tender in respect of a material conflict of interest transaction.
The Notice includes the following guidance for ensuring that an issuer, board of directors or special committee adequately satisfies its enhanced disclosure obligations:
- comply fully with the “spirit and intent” of MI 61-101 to ensure that minority security holders receive the disclosure necessary and sufficient detail to enable them to make an informed decision (and tactical or self-serving disclosure is not appropriate);
- provide a thorough discussion of the reasoning and analysis of the board of directors and the special committee, the views as to the desirability or fairness of the transaction (including a meaningful discussion of any analysis provided by advisors and how that advice was considered), the rationale for supporting a proposed transaction, any reasonably available alternatives to the transaction (including status quo) and the pros and cons of the transaction;
- provide a meaningful and full discussion of the background to and review and approval process for a transaction, including disclosure regarding the context for the proposed transaction, the board of director’s or special committee’s process and rationale for supporting a transaction, any dissenting views and potential concerns and available alternatives to the transaction; and
- in the very rare circumstance where the board or special committee determines that a transaction should be put to security holders without a recommendation on how to vote or whether to tender, include high level disclosure aimed at ensuring that minority security holders have substantially the same information as the board or special committee received as part of its evaluation of the transaction and an explanation as to why a recommendation is not being provided.
Guidance on Fairness Opinions
In most Canadian public M&A transactions, the target’s board of directors or special committee will engage a financial advisor to provide a fairness opinion to the effect that the proposed transaction is fair to the issuer’s security holders from a financial perspective. While securities laws do not require that a fairness opinion be obtained, these opinions are commonly used by boards and special committees as one means of discharging their corporate law duty of care in approving a transaction.
Following the decision of the Court of Appeal of Yukon in Interoil, there has been some uncertainty regarding the ability of an issuer to pay a fee to a financial advisor that is contingent on the success of a transaction and the extent to which a financial advisor must include details about the methodology and analysis underlying the opinion in the fairness opinion itself. In its decision overturning the lower court’s approval of a plan of arrangement, the Court of Appeal criticized, among other things, the “short form” nature of the fairness opinion and the fact that the financial advisor was entitled to a success fee.
The Notice provides the following guidance on what should be included in the disclosure document in situations where a board of directors or special committee has decided to proceed with a fairness opinion:
- the arrangement upon which the financial advisor is being compensated (i.e. flat or contingent fee) and an explanation of how the board or special committee took such compensation arrangement into account when considering the advice provided;
- details of the relationship or arrangement between the financial advisor and the issuer or an interested party that may be relevant to a perception of lack of independence;
- a clear summary of the methodology, information and analysis (including, as applicable, financial metrics, not merely a narrative description) underlying the opinion sufficient to enable a reader to understand the basis for the opinion, without overwhelming security holders with too much information; and
- an explanation of the relevance of the fairness opinion to the board of directors or special committee in coming to the determination to recommend the transaction (if applicable).
We expect that compliance with this guidance will result in Canadian fairness opinions (at least those prepared in connection with material conflict of interest transactions) looking much more like the robust and comprehensive fairness opinions prepared by financial advisors in the United States. While the Notice sets out what CSA Staff expects to see in the issuer’s disclosure document, we would expect that both financial advisors and issuers would prefer that these matters be included in the fairness opinion itself. This will ensure that the financial advisor has control over the preparation of the disclosure and that the issuer benefits from protection from liability for expertised materials.
CSA Staff also makes reference to the requirements of the Investment Regulatory Organization of Canada (IIROC) and The Canadian Institute of Chartered Business Valuators with respect to the content of fairness opinions and notes that they each set out a reasonable approach to meeting the appropriate standard for fairness opinions. In our experience, strict compliance with these requirements is inconsistent. For example, it is quite common for a financial advisor to describe the general nature of its fees rather than the precise quantum in accordance with IIROC requirements. The Notice confirms CSA Staff’s view that simply the “compensation arrangement” be disclosed and not the quantum.
Real-Time Compliance Reviews
The Notice alerts capital markets participants to the fact that CSA Staff is conducting reviews of material conflict of interest transactions on a real-time basis to assess compliance with MI 61-101 and identify potential public interest concerns. The review would typically be triggered by the filing of a disclosure document like a circular, press release or material change report. This means that issuers should expect these materials to be reviewed despite the fact that neither MI 61-101 nor applicable securities legislation contemplate a formal review or approval process for these documents. Although CSA Staff has been conducting similar reviews for some time, the Notice confirms that CSA Staff has formalized a process for review.
Reviews will be focused on compliance with disclosure requirements and the conditions for exemptions in MI 61-101 from the formal valuation and minority approval requirements and the substance and disclosure of the process conducted by an issuer’s board of directors or special committee in considering a proposed material conflict of interest transaction. CSA Staff will also take into account any complaints received in respect of a transaction.
In conducting its reviews, CSA Staff will be focused on determining whether the transaction complies with MI 61-101 or raises potential public interest concerns (even where an issuer may technically comply with MI 61-101) and may ask questions of issuers and their advisors and request supporting documentation. The objective of CSA Staff is to identify and resolve any issues before a transaction is approved by security holders or is closed. If an issue arises, CSA Staff are prepared to seek to impose a variety of remedies including corrective disclosure and enforcement action. As a result, it will be more important than ever that disclosure documents are responsive to the requirements of MI 61-101, as there is the risk that remedial disclosure will delay a transaction.