

[Federal Register: April 11, 2006 (Volume 71, Number 69)]
[Notices]               
[Page 18395-18401]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr11ap06-149]                         

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SECURITIES AND EXCHANGE COMMISSION

[Release No. 34-53598; File No. SR-NASD-2005-080]

 
Self-Regulatory Organizations: National Association of Securities 
Dealers, Inc.; Notice of Filing of Proposed Rule Change and Amendment 
Nos. 1, 2 and 3 thereto to Establish New NASD Rule 2290 Regarding 
Fairness Opinions

April 4, 2006.
    Pursuant to Section 19(b)(1) of the Securities Exchange Act of 1934 
(``Act'') \1\ and Rule 19b-4 thereunder,\2\ notice is hereby given that 
on June 24, 2005, the National Association of Securities Dealers, Inc. 
(``NASD'') filed with the Securities and Exchange Commission (``SEC'' 
or ``Commission'') the proposed rule change as described in Items I, 
II, and III below, which Items have been prepared by NASD. On November 
30, 2005, NASD filed Amendment No. 1 to the proposed rule change.\3\ On 
January 25, 2006, NASD filed Amendment No. 2 to the proposed rule 
change.\4\ On March 1, 2006, NASD filed Amendment No. 3 to the proposed 
rule change.\5\ The Commission is publishing this notice to solicit 
comments on the proposed rule change, as amended, from interested 
persons.
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    \1\ 15 U.S.C. 78s(b)(1).
    \2\ 17 CFR 240.19b-4.
    \3\ In Amendment No. 1, which supplemented the original filing, 
NASD modified the scope of the proposed rule change and made certain 
clarifications to the rule text following discussions with 
Commission staff.
    \4\ In Amendment No. 2, NASD added clarifying language to the 
rule text following discussions with Commission staff.
    \5\ Amendment No. 3 was a technical amendment and replaced and 
superseded the original filing, as amended, in its entirety.
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I. Self-Regulatory Organization's Statement of the Terms of Substance 
of the Proposed Rule Change

    NASD is proposing to establish new NASD Rule 2290 to address 
disclosures and procedures concerning the issuance of fairness 
opinions. Below is the text of the proposed rule change. Proposed new 
language is in italics; proposed deletions are in brackets.
* * * * *

2200. COMMUNICATIONS WITH CUSTOMERS AND THE PUBLIC

* * * * *

2290. Fairness Opinions

(a) Disclosures

    Any member issuing a fairness opinion that may be provided, or 
described, or otherwise referenced to public shareholders must 
disclose, to the extent not otherwise required, in such fairness 
opinion:
    (1) whether such member has acted as a financial advisor to any 
transaction that is the subject of the fairness opinion, and, if 
applicable, that it will receive compensation for:
    (A) rendering the fairness opinion that is contingent upon the 
successful completion of the transaction;
    (B) serving as an advisor that is contingent upon the successful 
completion of the transaction;
    (2) whether such member will receive any other payment or 
compensation contingent upon the successful completion of the 
transaction;
    (3) whether there is any material relationship that existed during 
the past two years or is mutually understood to be contemplated in 
which any compensation was received or is intended to be received as a 
result of the relationship between the member and the companies that 
are involved in the transaction that is the subject of the fairness 
opinion;
    (4) the categories of information that formed a substantial basis 
for the fairness opinion that was supplied to the member by the company 
requesting the opinion concerning the companies involved in the 
transaction and whether any such information in each such category has 
been independently verified by the member; and
    (5) whether the fairness opinion was approved or issued by a 
fairness committee.

(b) Procedures

    Any member issuing a fairness opinion must have procedures that 
address the process by which a fairness opinion is approved by a firm, 
including:
    (1) the types of transactions and the circumstances in which the 
member will use a fairness committee to approve or issue a fairness 
opinion, and in such transactions where it uses a fairness committee:
    (A) the process for selecting personnel to be on the fairness 
committee;
    (B) the necessary qualifications of persons serving on the fairness 
committee; and
    (C) the process to promote a balanced review by the fairness 
committee, including review and approval by persons who do not serve on 
or advise the ``deal team'' to the transaction;
    (2) the process to determine whether the valuation analyses used in 
the fairness opinion are appropriate, and the procedures should state 
the extent to which the appropriateness of the use of such valuation 
analyses is determined by the type of company or transaction that is 
the subject of the fairness opinion; and
    (3) the process to evaluate whether the amount and nature of the 
compensation from the transaction underlying the fairness opinion 
benefiting any individual officers, directors or employees, or class of 
such persons, relative to the benefits to shareholders of the company, 
is a factor in reaching a fairness determination.
* * * * *

II. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

    In its filing with the Commission, NASD included statements 
concerning the purpose of and basis for the proposed rule change and 
discussed any comments it received on the proposed rule change. The 
text of these statements may be examined at the places specified in 
Item IV below. NASD has prepared summaries, set forth in sections A, B, 
and C below, of the most significant aspects of such statements.

A. Self-Regulatory Organization's Statement of the Purpose of, and 
Statutory Basis for, the Proposed Rule Change

1. Purpose
    NASD notes that a fairness opinion addresses, from a financial 
point of view, the fairness of the consideration in a transaction. 
Fairness opinions are routinely used by directors of a company in 
corporate control transactions to satisfy their fiduciary duties to act 
with due care and in an

[[Page 18396]]

informed manner. Although not required by statute or regulation, 
fairness opinions have become commonplace in corporate control 
transactions following the 1985 Delaware Supreme Court case of Smith v. 
Van Gorkom,\6\ in which a corporate board was held to have breached its 
fiduciary duty of care by approving a merger without adequate 
information on the transaction, including information on the value of 
the company and the fairness of the offering price.
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    \6\ Smith v. Van Gorkom, 488 A.2d 858 (Del. 1985).
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    NASD notes that, while a fairness opinion addresses the fairness, 
from a financial point of view, of the consideration involved in a 
transaction, it does not indicate whether the price of a particular 
transaction is the best price that could be attained. Rather, it opines 
on whether the price is ``fair'' or within an acceptable range of 
values. A fairness opinion is prepared for a company's board of 
directors; however, it is often provided to shareholders as part of 
proxy materials. Inasmuch as a fairness opinion is not required by 
regulation or statute, the board of directors determines whether to 
obtain a fairness opinion, the scope of such opinion, and the party 
preparing such opinion.
    NASD has been concerned that the disclosures provided in fairness 
opinions may not sufficiently inform public shareholders about the 
potential conflicts of interest that exist between the firm rendering 
the fairness opinion and the issuer. Among these conflicts are fees 
that the firm rendering the fairness opinion will receive upon the 
successful completion of the transaction (either from advisory fees or 
fees for the fairness opinion itself), as well as other material 
relationships between the firm and the issuer (including, but not 
limited to, serving as an underwriter, lender, market maker, asset 
manager, or providing research coverage).
    NASD notes that, under the SEC's proxy rules, which apply to 
issuers, certain disclosures about potential conflicts of interest are 
provided to public shareholders. NASD believes that complementary rules 
for disclosure aimed at broker-dealers rendering fairness opinions 
would be beneficial. In addition, NASD believes that broker-dealers 
should develop greater specificity in their written supervisory 
procedures to guard against conflicts of interest in rendering fairness 
opinions. To that end, NASD is proposing to identify specific 
procedures that must be addressed by each firm that renders a fairness 
opinion.
    Paragraph (a)(1) of the proposed rule change sets forth the 
requirement for a member to disclose in any fairness opinion that may 
be provided, or described, or otherwise referenced to public 
shareholders, whether it has acted as a financial advisor to any 
transaction that is the subject of the fairness opinion, and, if 
applicable, that it will receive compensation for: (A) Rendering the 
fairness opinion that is contingent upon the successful completion of 
the transaction, or (B) serving as an advisor that is contingent upon 
the successful completion of the transaction. Paragraph (a)(2) would 
require disclosure of whether such member will receive any other 
payment or compensation contingent upon the successful completion of 
the transaction. Paragraph (a)(3) would require disclosure of whether 
there is any material relationship that existed during the past two 
years or is mutually understood to be contemplated, in which any 
compensation was received or is intended to be received as a result of 
the relationship between the member and the companies that are involved 
in the transaction that is the subject of the fairness opinion.
    NASD intends that the disclosures contemplated by paragraphs 
(a)(1)-(3) of the proposal be descriptive rather than quantitative. In 
particular, paragraphs (a)(1) and (2) do not require firms to specify 
the amount of compensation for rendering the fairness opinion, serving 
as an advisor or otherwise, that is contingent upon the successful 
completion of the transaction. For purposes of the proposed rule 
change, NASD believes that it would be sufficient for investors to be 
informed that such contingent compensation relationships exist. 
Similarly, NASD intends that the disclosures in paragraph (a)(3) 
pertaining to ``material relationships'' also be descriptive rather 
than quantitative.
    Paragraph (a)(4) would require disclosure of the categories of 
information that formed a substantial basis for the fairness opinion 
that was supplied to the member by the company requesting the opinion 
concerning the companies involved in the transaction and whether any 
such information has been independently verified by the member. 
According to NASD, such disclosure must inform investors about the 
categories of information (such as projected earnings and revenues, 
expected cost-savings and synergies, industry trends and growth rate) 
that formed a substantial basis for the fairness opinion, and with 
respect to each category, whether the member has independently verified 
the information supplied by the company.
    Finally, paragraph (a)(5) would require disclosure of whether the 
fairness opinion was approved or issued by a fairness committee and 
informs investors of whether the fairness opinion was the product of a 
fairness committee.
    Paragraph (b)(1) of the proposed rule change contains the 
procedures members must follow in issuing a fairness opinion, including 
the types of transactions and the circumstances in which the member 
will use a fairness committee to approve or issue a fairness opinion, 
and, in such transactions where it uses a fairness committee: (A) The 
process for selecting personnel to be on the fairness committee; (B) 
the necessary qualifications of persons serving on the fairness 
committee; and (C) the process to promote a balanced review by the 
fairness committee, including review and approval by persons who do not 
serve on or advise the ``deal team'' to the transaction.
    The procedures in paragraph (b)(2) would require members to have a 
process to determine whether the valuation analyses used in the 
fairness opinion are appropriate. In addition, the member's procedures 
should state the extent to which the appropriateness of the use of such 
valuation analyses is determined by the type of company or transaction 
that is the subject of the fairness opinion. Finally, paragraph (b)(3) 
would require members to have a process to evaluate whether the amount 
and nature of the compensation from the transaction underlying the 
fairness opinion benefits any individual officers, directors or 
employees, or class of such persons, relative to the benefits to 
shareholders of the company, is a factor in reaching a fairness 
determination.
    NASD intends to announce the effective date of the proposed rule 
change in a Notice to Members to be published no later than 60 days 
following Commission approval. The effective date will be 30 days 
following publication of the Notice to Members announcing Commission 
approval.
2. Statutory Basis
    NASD believes that the proposed rule change is consistent with the 
provisions of Section 15A(b)(6) of the Act, which requires, among other 
things, that NASD rules must be designed to prevent fraudulent and 
manipulative acts and practices, to promote just and equitable 
principles of trade, and, in general, to protect investors and the 
public interest. NASD believes that investors and the public interest 
will benefit from additional disclosure of potential conflicts of 
interest in connection with fairness opinions rendered by broker-

[[Page 18397]]

dealers. NASD also believes that members should develop and adhere to 
more detailed procedures to mitigate potential conflicts in rendering 
fairness opinions.

B. Self-Regulatory Organization's Statement on Burden on Competition

    NASD does not believe that the proposed rule change will result in 
any burden on competition that is not necessary or appropriate in 
furtherance of the purposes of the Act, as amended.

C. Self-Regulatory Organization's Statement on Comments on the Proposed 
Rule Change Received From Members, Participants, or Others

    The proposed rule change was published for comment in NASD Notice 
to Members 04-83 (November 2004). Twenty comment letters were received 
in response to the Notice.\7\ Of the twenty comment letters received, 
twelve were in favor of the proposed rule change, seven were opposed, 
and one expressed no opinion.
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    \7\ Letter from Lerner College of Business and Economics, 
University of Delaware dated Nov. 24, 2004; Letter from Ohio Public 
Employees Retirement System dated Nov. 30, 2004; Letter from Ohio 
Retirement Systems dated Dec. 9, 2004; Letter from Charles M. Elson, 
Arthur H. Rosenbloom, and Drew G.L. Chapman dated Dec. 21, 2004; 
Letter from The Canadian Institute of Chartered Business Valuators 
dated Jan. 6, 2005; Letter from American Federation of Labor and 
Congress of Industrial Organizations (``AFL-CIO'') dated Jan. 10, 
2005; Letter from Kane & Company, Inc. (``Kane'') dated Jan. 10, 
2005; Letter from Standard & Poor's Corporate Value Consulting 
(``S&P'') dated Jan. 10, 2005; Letter from Council of Institutional 
Investors dated Jan. 12, 2005; Letter from The Committee on 
Securities Regulation of the Business Law Section of the New York 
State Bar Association dated Jan. 26, 2005; Letter from Cravath, 
Swaine & Moore LLP dated Jan. 31, 2005; Letter from HFBE Capital, 
L.P. dated Jan. 31, 2005; Letter from Signal Hill Capital Group LLC 
dated Jan. 31, 2005; Letter from Sutter Securities Incorporated 
dated Jan. 31, 2005; Letter from California Public Employees' 
Retirement System (``CalPERS'') dated Feb. 1, 2005; Letter from 
Davis Polk & Wardwell (``David Polk'') dated Feb. 1, 2005; Letter 
from Dewey Ballantine LLP dated Feb. 1, 2005; Letter from Houlihan 
Lokey Howard & Zukin (``Houlihan Lokey'') dated Feb. 1, 2005; Letter 
from Securities Industry Association dated Feb. 1, 2005; and Letter 
from The Special Committee on Mergers, Acquisitions and Corporate 
Control Contests of the Association of the Bar of the City of New 
York dated Feb. 1, 2005.
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    In Notice to Members 04-83, NASD solicited comment on whether to 
propose a new rule that would require disclosures and procedures in 
connection with conflicts of interest when members provide fairness 
opinions in corporate control transactions. Although Notice to Members 
04-83 did not contain specific rule text, it proposed the following:
    1. Any fairness opinion rendered by a member and contained in a 
proxy statement shall describe a clear and complete description of the 
material conflicts of interests in issuing the opinion, including the 
nature of any contingent compensation that the member would receive 
upon successful completion of the transaction.
    2. The member would be required to disclose in the fairness opinion 
the extent upon which it either relied on the information supplied by 
the company or independently verified such information.
    3. The member would need to maintain written policies and 
procedures that, with respect to the issuance of fairness opinions, 
address:
     the approval process by the member; if the member uses a 
fairness committee, then the level of experience for committee members, 
how balanced approval is undertaken and whether steps have been taken 
to require review by persons whose compensation is not directly related 
to the transaction;
     the manner by which it will be determined that the 
appropriate valuation process will be used in light of the nature of 
the transaction and the types of companies that are involved; and
     whether, in a particular transaction, the relative 
compensation to company insiders versus shareholders is a factor in 
reaching a fairness determination.
    One of the central elements of Notice to Members 04-83 was that any 
fairness opinion rendered by a member and contained in a proxy 
statement describe a clear and complete description of the significant 
potential conflicts of interests in issuing the opinion, including the 
nature of any contingent compensation that the member would receive 
upon successful completion of the transaction.

A. What Constitutes a Conflict of Interest?

    Many commenters recognized the need for disclosure of potential 
conflicts of interest, although several commenters took issue with the 
term ``conflict of interest'' and instead preferred the term ``material 
relationships'' as used in SEC's Regulation M-A. Notice to Members 04-
83 focused on potential conflicts arising from serving as advisor to 
the transaction, such as receiving a contingency fee for a completed 
transaction. Many commenters believed that a success fee, either for 
the fairness opinion or the transaction in question, should be 
disclosed. One commenter noted that potential conflicts of interest may 
arise under many other circumstances, including serving as an 
underwriter, lender, market maker, asset manager, or providing research 
coverage.
    Several commenters noted that existing rules of the SEC and common 
law currently require extensive disclosure in connection with fairness 
opinions and urged NASD to make sure its rules were consistent with 
these existing requirements. There was some support for a rule that 
``complements'' existing disclosure requirements. NASD believes that 
the proposed rule change is consistent with existing SEC requirements. 
In the proposed rule change, NASD would require disclosure of ``whether 
there is any material relationship that existed during the past two 
years or is mutually understood to be contemplated in which any 
compensation was received or is intended to be received as a result of 
the relationship between the member and the companies that are involved 
in the transaction that is the subject of the fairness opinion.'' This 
disclosure is based on the requirements in Item 1015(b)(4) of SEC's 
Regulation M-A.\8\ NASD has not sought to require firms to identify 
``any significant conflicts of interest'' as originally proposed in 
Notice to Members 04-83.
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    \8\ 17 CFR 229.1015(b)(4).
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    While the rule text of paragraph (a)(3) of the proposed rule change 
was modeled after Item 1015(b)(4), NASD does not intend to construe 
this section to require quantitative disclosures of the compensation 
from each material relationship. For purposes of the proposed rule 
change, NASD believes it will be sufficient for investors to be 
informed about the material relationships that exist.
    NASD also notes that the proposed rule change differs slightly from 
Item 1015(b)(4) in that the proposed rule change applies to a material 
relationship between ``the member and the companies'' involved in the 
transaction, whereas Item 1015(b)(4) applies only to the member (and 
its affiliates) and the company (and its affiliates) for which the 
member is rendering the fairness opinion. NASD believes that investors 
should be informed of material relationships between the firm authoring 
the fairness opinion and the companies involved on both sides of the 
transaction. Moreover, given the narrative (i.e., non-quantitative) 
focus of this paragraph, NASD believes the additional disclosures are 
not likely to be burdensome on firms or confusing to investors. NASD 
notes, however, that unlike Item 1015, Rule 2290 does not reach to 
affiliates of such companies. NASD intends to review the comment 
letters received by the SEC before determining whether to amend 
paragraph (a)(3) to include affiliates.

[[Page 18398]]

    Several commenters asked NASD to ``take stronger measures'' to 
address conflicts in connection with fairness opinions, including 
requiring ``independent'' fairness opinions rendered by outside experts 
that are not connected to the transaction. One commenter recommended 
prohibiting investment banks from receiving success fees for 
transactions in which they issue fairness opinions. And another 
commenter urged an outright ban on arrangements in which part of an 
investment bank's fee for rendering a fairness opinion is contingent on 
the transaction closing.
    NASD has considered carefully those comments urging stronger 
measures such as an independent fairness opinion or a prohibition on 
success fees. As a starting point to its analysis, NASD notes that 
fairness opinions are not required by regulation or statute; a board of 
directors determines whether to obtain a fairness opinion, and if so, 
what the scope of a fairness opinion shall be and who shall prepare 
such opinion. In addition, NASD believes that, to the extent that a 
board of directors wants a fairness opinion from a firm not serving as 
an advisor to the transaction, or to structure payments without a 
contingency fee, it can do so.
    NASD notes that arguments that independent fairness opinions or 
those without a success fee component offer advantages may be well-
founded. However, it is NASD's view that such matters are more 
appropriately situated within the purview of the board of directors and 
state corporation law. NASD believes that disclosure and procedures 
constitute the appropriate course in mitigating potential conflicts of 
interest in the rendering of fairness opinions, not otherwise limited 
under applicable law, by NASD members.
    Moreover, NASD believes that the lack of consensus among those 
commenters urging NASD to take stronger measures supports the more 
uniform course of disclosure and procedures. Whereas CalPERS asked NASD 
to prohibit ``investment banks from receiving `success' fees for 
transactions in which they issue fairness opinions,'' \9\ the AFL-CIO 
sought only to prohibit ``arrangements in which part of an investment 
bank's fee for rendering its opinion is contingent on the transaction 
closing.'' \10\ Some commenters, such as Kane, want to forbid firms 
with a certain threshold amount of securities business with a company 
from rendering a fairness opinion, whereas AFL-CIO ``do[es] not believe 
the mere existence of a business relationship with a company should 
disqualify an investment bank from providing a fairness opinion.'' \11\
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    \9\ CalPERS, at 2.
    \10\ AFL-CIO, at 3.
    \11\ Id., at 1.
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    As NASD noted above, fairness opinions are obtained by boards of 
directors to satisfy their fiduciary duties to act with due care and in 
an informed manner. NASD further notes that a fairness opinion is not 
an automatic defense to a claim that a board breached its fiduciary 
duties. Courts regularly examine the circumstances surrounding a 
fairness opinion to determine whether it can be relied upon by the 
board in satisfaction of its fiduciary duties. Thus, NASD notes that 
boards of directors must today take into account whether an issuer's 
relationship with an investment bank compromises the purposes for which 
the fairness opinion is sought. NASD believes that the disclosure 
standards in these proposed rules would be an important aid to an 
issuer's board in making that determination.

B. To Whom Should Disclosure be Made?

    Some commenters believe that the proposed rule change should only 
require disclosure of potential conflicts by the member to the board of 
directors, citing concerns about breach of confidentiality if 
relationships between the member firm authoring the fairness opinion 
and its issuer client were publicly disclosed. Others believe that 
disclosure should be made more broadly, including in the fairness 
opinion itself, so that any reader of the fairness opinion can assess 
the conflicts associated with such opinion. NASD believes that, in 
general, a board of directors already is in a position to become 
informed about the potential conflicts with an investment bank that it 
chooses to render a fairness opinion. NASD notes, however, that 
investor-shareholders typically do not occupy the same such position. 
As stated in Notice to Members 04-83, NASD's concern is that investors 
may not be sufficiently informed ``about the subjective nature of some 
opinions and their potential biases.'' Accordingly, the proposed rule 
change requires disclosures by any member issuing a fairness opinion 
that may be provided, or described, or otherwise referenced to public 
shareholders. The requirements attach to any such fairness opinion 
issued by a member, regardless of whether it is included in proxy 
materials.

C. Verification

    As NASD noted above, the proposal in Notice to Members 04-83 would 
require a firm to disclose in a fairness opinion the extent upon which 
it either relied on the information supplied by the company or 
independently verified such information. Nearly every party commenting 
on this provision stated that firms as a matter of course already 
disclose in the fairness opinion that they do not independently verify 
information provided by the issuer. While most commenters did not 
believe that there was any need for an NASD rule given current 
practices, the commenters did not oppose NASD rulemaking so long as it 
did not create a requirement for firms to verify information before 
rendering a fairness opinion. Many commenters stated that the terms of 
engagement for rendering a fairness opinion do not call for independent 
verification of information provided by management, and that other 
entities, such as forensic accountants, would be better skilled to 
verify data. S&P suggested that fairness opinions include disclosure of 
the information provided by management upon which the opinion is based, 
and could take the form of a ``List of Documents Relied Upon,'' similar 
to that which accompanies an expert's report in commercial 
litigation.\12\
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    \12\ S&P, at 2-3.
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    The proposed rule change would not require a member to 
independently verify data provided by the issuer. NASD agrees with 
commenters that the scope of a firm's obligations in rendering a 
fairness opinion is set forth in the terms of engagement with the 
client, and it is not required that such terms call for independent 
verification. NASD believes, however, that, to the extent categories of 
information (such as projected earnings and revenues, expected cost-
savings and synergies, industry trends and growth rate) that were 
supplied by the company requesting the opinion formed a substantial 
basis for the fairness opinion, and information in each such category 
was not independently verified, readers of the fairness opinion should 
be apprised of this fact. Accordingly, the proposed rule change 
requires members to identify categories of information that formed a 
substantial basis for the fairness opinion and with respect to such 
information, whether any such information in each such category has 
been independently verified by the member. NASD notes that the proposed 
rule change goes beyond current practices in which firms

[[Page 18399]]

state, for example, ``[w]e have not independently verified the accuracy 
and completeness of the information supplied to us with respect to the 
[client] and do not assume any responsibility with respect to it.'' 
\13\ According to NASD, blanket statements that members have not 
verified information will not by themselves comply with the proposed 
rule change; members must identify information that formed a 
substantial basis for the fairness opinions and disclose whether such 
information was independently verified.
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    \13\ Houlihan Lokey, at 4.
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D. Written Policies and Procedures

1. Fairness Opinion Committee
    NASD solicited comment on whether to require written procedures 
governing the approval process by the member, including whether it uses 
a fairness committee, the level of experience for fairness committee 
members, how balanced approval is undertaken and whether steps have 
been taken to require review by persons whose compensation is not 
directly related to the transaction. Most commenters believed that 
firms already had procedures in place governing fairness opinions. 
Notwithstanding this fact, several commenters supported a well-tailored 
rule in this area. Commenters believed that NASD rulemaking should, 
however, provide the flexibility to allow each firm to determine the 
best manner of implementing effective and efficient procedures for 
reviewing and approving fairness opinions. Several commenters opposed 
any rule in which NASD would mandate specific procedures that must be 
followed. These commenters believed that the firms themselves--and not 
NASD--should determine what policies and procedures should be followed 
in rendering a fairness opinion.
    NASD believes that the proposed rule change is both well-tailored 
and flexible enough to allow firms to determine how to best implement 
effective and efficient procedures for reviewing and approving fairness 
opinions. The specific requirements were discussed in Item II.A.1 
above.
2. Valuation
    NASD also solicited comment on whether to require written policies 
and procedures on the manner by which it will be determined that the 
appropriate valuation process will be used in light of the nature of 
the transaction and the types of companies that are involved. The 
commenters generally were concerned about any NASD rule that would 
interfere with the selection of the best methodology for a transaction.
    NASD does not believe the requirement in the proposed rule change 
to have written polices and procedures concerning the process to 
determine whether the valuation analyses used in the fairness opinion 
are appropriate, nor the requirement that procedures should state the 
extent to which the appropriateness of the use of such valuation 
analyses is determined by the type of company or transaction that is 
the subject of the fairness opinion, will interfere with a firm's 
ability to select the most appropriate methodology for a transaction. 
NASD believes that the procedures developed by the firm should be 
designed to allow the firm to identify and use the correct valuation 
methodology. In addition, NASD believes that the procedures should 
prevent the use of a particular valuation methodology at the behest of 
an interested party when such methodology is inappropriate.
3. Relative Compensation
    Finally, NASD solicited comment on a requirement for broker-dealers 
to have a process to evaluate whether the relative compensation to 
corporate insiders versus other shareholders in a contemplated 
transaction is a factor in reaching a fairness opinion.
    On the one hand, certain commenters felt the proposal did not go 
far enough. There was a view that change of control provisions that are 
a part of any transaction should be disclosed to shareholders as a 
material factor to be considered as part of the proxy process because 
often times such payments may be ambiguous or may not be expressly set 
out in the deal terms of a transaction.
    With respect to these commenters, NASD believes the purpose of the 
proposed requirement in this area is misunderstood. According to NASD, 
the proposed rulemaking, as it pertains to dealing with the factor of 
relative compensation in the fairness opinion process, is driven by the 
regulatory goal of ameliorating this potential conflict through 
procedures reasonably designed to consider whether in fact such 
conflict exists and to what extent it may bear on the determination 
that a transaction is fair. NASD states that it is not intended to 
fashion additional substantive legal requirements more appropriately 
addressed, in NASD's view, by state corporation law and the federal law 
and rules concerning proxies. It is NASD's view that subjecting this 
potential conflict to the rigor of appropriately and reasonably 
designed procedures is an appropriate prophylactic with respect to a 
factor that may or may not weigh on the determination that a 
transaction is fair.
    On the other hand, other commenters felt that management's 
interests in change of control transactions were not an applicable part 
of the fairness opinion process because the appropriateness of 
management compensation was beyond the scope of the fairness opinions, 
was difficult or impossible to quantify, in many cases rested upon 
arrangements that preceded the transaction, and required an expertise 
in executive compensation that is beyond the competency of those 
issuing fairness opinions.
    Again, NASD believes that these comments evidence a 
misunderstanding of the proposed requirement. NASD does not believe 
that broker-dealers issuing fairness opinions should review the 
propriety of preexisting compensation arrangements as such matters 
would be like any other preexisting fixed or contingent liability of 
the corporation that cannot be altered by the terms of any change of 
control transaction. According to the NASD, the intent of the proposed 
requirement is that firms consider the extent to which the differential 
in remuneration between management and other shareholders accruing from 
the deal proceeds, for which there was no prior contractual commitment, 
is a factor in determining the fairness of the transaction to 
shareholders. NASD notes that the proposed requirement does not reach 
the implicit conclusion that such differential payments are a factor as 
to whether a transaction is fair but, in NASD's view, it would be 
equally wrong to conclude that such differential payments are 
inappropriately placed among the factors and indicia that one should 
consider in rendering a fairness opinion. NASD believes it is true that 
a fairness opinion merely states that the transaction is fair and does 
not necessarily represent the best price. However, NASD also believes 
it is true that the considerations surrounding the issuance of a 
fairness opinion are artificially truncated when the total amount that 
a buyer is willing to pay and how such payment is allocated is never an 
appropriate factor in a change of control transaction.

E. Other

    S&P suggested greater transparency in fairness opinion pricing. 
Insofar as the price of many fairness opinions is bundled with other 
advisory services, S&P believed that corporate boards of directors are 
often less willing to procure an independent fairness opinion. S&P 
believed that full

[[Page 18400]]

disclosure of the fairness opinion fee, and in some instances, an 
actual indication of the financial advisor's effort, could be 
meaningful disclosure.\14\ NASD does not believe it should mandate 
disclosure of the price or effort expended in preparing the fairness 
opinion. With respect to price, it is NASD's view that if a board of 
directors believes it would benefit from more detailed information 
about prices, it is in a position to obtain that information from the 
firm as a condition of engaging the firm to perform advisory and 
fairness opinion services. With respect to effort, this seems to NASD a 
potentially misleading metric upon which any reliance would be placed. 
NASD believes that efforts, great or small, expended upon poorly 
conceived procedures are of dubious value. Consequently, NASD believes 
that the appropriate regulatory response is to require members to 
employ processes framed by appropriately and reasonably designed 
procedures.
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    \14\ S&P, at 2.
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    Davis Polk was concerned that NASD rules concerning fairness 
opinions would discriminate against member firms, since fairness 
opinions can be provided by non-broker-dealers.\15\ NASD recognizes 
that firms not subject to NASD's jurisdiction are able to render 
fairness opinions; however, NASD believes that this is not a 
justification for failing to address actual or perceived conflicts of 
interest in the brokerage industry or inadequacies in disclosure by 
such firms.
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    \15\ Davis Polk, at 3-4.
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    Finally, several commenters suggested that existing judicial 
precedent and oversight are more effective controls over the fairness 
opinion process than would be a new NASD rule, and one commenter 
suggested that NASD rulemaking may interfere with standards for 
fairness opinions under corporate law. NASD recognizes and appreciates 
the role of corporate law on the fairness opinion process. As NASD has 
noted above, a fairness opinion must comply with corporate law to serve 
its intended purpose--to satisfy their fiduciary duties to act with due 
care and in an informed manner. While NASD understands its rules 
operate in conjunction with judicial precedent, it does not believe 
that judicial review should exclude NASD rulemaking. NASD notes that 
many aspects of the securities laws are subject to extensive judicial 
review, but that would be an illogical and novel barrier to SEC and SRO 
rulemaking.

III. Date of Effectiveness of the Proposed Rule Change and Timing for 
Commission Action

    Within 35 days of the date of publication of this notice in the 
Federal Register or within such longer period (i) as the Commission may 
designate up to 90 days of such date if it finds such longer period to 
be appropriate and publishes its reasons for so finding or (ii) as to 
which the self-regulatory organization consents, the Commission will:
    A. by order approve such proposed rule change, or
    B. institute proceedings to determine whether the proposed rule 
change should be disapproved.

IV. Solicitation of Comments

    The Commission notes that the NASD's proposal would not require 
firms to quantify in the fairness opinion the amount of compensation 
received that is contingent upon the successful completion of the 
transaction or to be received as a result of any material relationship 
between the member firm and any party to the transaction. The 
Commission requests comment regarding whether the disclosures that 
would be required by proposed Rule 2290(a)(1), (2), and (3) should be 
quantified. Further, we request comment as to whether it would be more 
informative to investors for firms to specifically state that a 
conflict may exist and describe the impact of such conflict rather than 
to merely state that compensation is contingent.
    The Commission further notes that the proposed disclosure of 
material relationships does not extend to relationships with affiliates 
of the member firm. The Commission requests comment regarding whether 
the proposed disclosure obligation should cover material relationships 
between the parties to the transaction and affiliates of the member 
firm providing the fairness opinion.
    In addition, the Commission requests comment as to whether member 
firms should be required to describe what type of verification they 
undertook with respect to information that was supplied by the company 
requesting the opinion that formed a substantial basis for the opinion. 
Further, the Commission requests comment on whether members should be 
required to obtain independent verification of such information.
    We also note that the proposed rule does not require disclosure of 
the procedures utilized by the member firm. We request comment as to 
whether member firms should disclose these procedures in the fairness 
opinion or elsewhere.
    Interested persons are invited to submit written data, views and 
arguments concerning the foregoing, including whether the proposed rule 
change is consistent with the Act. Comments may be submitted by any of 
the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://www.sec.gov/rules/sro.shtml.
); or     Send an e-mail to rule-comments@sec.gov. Please include 

File Number SR-NASD-2005-080 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Secretary, Securities and Exchange Commission, 100 F Street, NE., 
Washington, DC 20549-1090.
    All submissions should refer to File Number SR-NASD-2005-080. This 
file number should be included on the subject line if e-mail is used. 
To help the Commission process and review your comments more 
efficiently, please use only one method. The Commission will post all 
comments on the Commission's Internet Web site (http://www.sec.gov/rules/sro.shtml
).

    Copies of the submission, all subsequent amendments, all written 
statements with respect to the proposed rule change that are filed with 
the Commission, and all written communications relating to the proposed 
rule change between the Commission and any person, other than those 
that may be withheld from the public in accordance with the provisions 
of 5 U.S.C. 552, will be available for inspection and copying in the 
Commission's Public Reference Room, 100 F Street, NE., Washington, DC 
20549. Copies of such filing also will be available for inspection and 
copying at the principal office of NASD.
    All comments received will be posted without change; the Commission 
does not edit personal identifying information from submissions. You 
should submit only information that you wish to make available 
publicly. All submissions should refer to the File Number SR-NASD-2005-
080 and should be submitted on or before May 2, 2006.


[[Page 18401]]


    For the Commission, by the Division of Market Regulation, 
pursuant to delegated authority.\16\
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    \16\ 17 CFR 200.30-3(a)(12).
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Nancy M. Morris,
Secretary.
[FR Doc. E6-5237 Filed 4-10-06; 8:45 am]

BILLING CODE 8010-01-P
