New guidance from securities regulators highlights the importance of companies establishing strong, effective special committees of independent directors to review conflicted transactions and providing comprehensive disclosure to protect the interests of minority shareholders in these deals.
A notice that regulators in Ontario, Quebec, Alberta, Manitoba and New Brunswick published on Thursday details their approach to reviewing corporate transactions that involve a material conflict of interest — such as insider bids, issuer bids and related party transactions — in which the interests of minority shareholders could be adversely impacted.
“Our regulatory framework is designed to protect minority shareholders in these situations by setting out requirements for enhanced disclosure, formal valuations and majority of minority shareholder approvals. We felt the time was right to outline our views on these areas, given observations from staff reviews, developments in market practice, as well as the decisions of securities regulators,” says Naizam Kanji, director of the Ontario Securities Commission’s (OSC) Office of Mergers and Acquisitions.
“Our focus is on informing market participants about our reviews and what we expect from the board of directors and special committee during a conflict of interest transaction,” he adds.
In particular, the notice sets out the regulators’ view on the creation of special committees of independent directors to review these deals. The regulators note that while special committees are only required for insider bids, “staff are of the view that a special committee is advisable for all material conflict of interest transactions.”
The notice points out that an independent special committee that’s free from interference by insiders “can ensure that the interests of minority security holders are appropriately taken into account and may thereby alleviate the conflicts that underlie material conflict of interest transactions.” This, in turn, may reduce the likelihood will run into shareholder, or regulatory, opposition.
The notice also sets out considerations for establishing an effective special committee instead of a committee that’s designed to give the appearance of objective review rather than an actual independent review.
For instance, it notes that regulators have seen instances in which special committees are formed after a proposed transaction has largely been negotiated, or in which the committee appeared to be passive and failed to conduct a robust review of the circumstances leading to the transaction, possible alternatives, and the transaction itself.
To that end, the notice provides guidance on the proper composition of special committees, the processes they should follow, the appropriate mandate for these bodies and the role of financial advisors and fairness opinions. It also provides guidance on the enhanced disclosure requirements that have been adopted in the securities rules, which aim to address the asymmetry of information that may exist when minority shareholders are asked to approve a conflicted transaction.
“Minority security holders should receive the disclosure necessary to make an informed decision and that tactical or self-serving disclosure intended primarily to further the interests of a related party in the transaction is not appropriate,” the notice says.
This should also include adequate disclosure of the background to, and approval process for, a transaction, it says. It also notes that there must be adequate disclosure regarding the terms of fairness opinions.
“Our reviews raised concerns for us with the scope and quality of disclosure in respect of conflict of interest transactions and, in some cases, the transaction review process conducted by a board or directors or special committee. We expect market participants to review, recommend and disclose information about conflict of interest transactions with a view to ensuring that minority security holders are treated fairly,” says Kanji.
The notice indicates that the regulators’ views reflect the recent experience of their staffs in Ontario and Quebec in reviewing conflicted transactions; it also outlines the approach to reviewing transactions that regulators in Alberta, Manitoba and New Brunswick intend to adopt.
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