The Role of Financial Advisors

Kevin MillerAlston & Bird LLP90 Park Avenue

New York, New York 10016Tel: (212) 210-9520Fax: (212) 922-3840

kevin.miller@alston.com

The Role of Financial AdvisorsTransaction Broker

Transaction Broker Investment banks are often a source of ideas regarding potential acquisition

and divestiture opportunities.

Market Intelligence Strategic and Financial Ideas

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The Role of Financial Advisors Financial Advisor

Financial Advisor Investment banks assist clients in understanding and evaluating the financial

aspects of proposed transactions.

Valuation Financial Implications Fairness Opinions

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The Role of Financial Advisors Transaction Facilitator - Sellside

Transaction Facilitator Sellside - by assisting sellers in:

determining the appropriate sales process (e.g., auction v. exclusive negotiation); preparing an offering memorandum for distribution to potential buyers; preparing and implementing the sales process or marketing plan; screening potential buyers; obtaining confidentiality agreements from potential buyers; coordinating a data room and other activities associated with potential buyers’ due diligence

activities; communicating with potential buyers, including responding to proposals and bids; evaluating proposals received from potential buyers; and structuring and negotiating the sale.

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The Role of Financial Advisors Transaction Facilitator - Buyside

Transaction Facilitator Investment banks assist clients in getting deals done. Buyside - assisting buyers in:

structuring a proposal; communicating with the seller; conducting diligence; and

negotiating the acquisition.

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Fairness Opinions

What Are They? An opinion with respect to whether the consideration paid or received in a transaction is fair from a

financial point of view to the party or persons paying or receiving the consideration.

Why Does a Board Want One? To help the board demonstrate that it gathered all reasonably available information in fulfilling its

fiduciary duty of care in approving the transaction. When Are They Required?

They are not required under Delaware law or the Federal Securities Laws. Most companies will obtain them in connection with transactions requiring shareholder approval and many companies will obtain them in connection with transactions of a certain size or significance (i.e., if sufficiently material to the company).

When Do Boards Need Them Delivered? Generally at the meeting at which the board approves the transaction.

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Fairness Opinion Considerations

Fairness opinions are not a substitute for the exercise of business judgment by a board and senior management – the scope of a fairness opinion is limited to an evaluation of the fairness of the consideration to be paid or received from a financial point of view.

The benefits of a fairness opinion are limited if rendered after the transaction is authorized by the board.

The key for boards is to gather all reasonably available information and to act in good faith on an informed basis. A detailed financial presentation and discussion with the board is often more valuable than a two- or three-page fairness opinion.

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Fairness OpinionsWhat They Say

What Do Fairness Opinions Say: In connection with a divestiture, a Fairness Opinion addresses the fairness, from a financial point

of view, to the seller of the consideration to be received by the seller. In connection with an acquisition, a Fairness Opinion addresses the fairness, from a financial

point of view, to the buyer of the consideration to be paid by the buyer. Only in connection with transactions where the stockholders of a company receive consideration

will a Fairness Opinion address the fairness, from a financial point of view, to the holders of common stock of the company of the consideration to be received by such stockholders in the sale. Certain stockholders may be carved out.

Fairness Opinions only address the fairness “from a financial point of view” of the consideration being paid or received by a party actually paying or receiving consideration.

Fairness Opinions speak of a specific date, and opinion providers generally disclaim any duty or obligation to update or reaffirm their opinions. Note: In re Southern Peru Copper Corp. S’holder Derivative Litig., C.A. No. 961-CS (Del. Ch. Oct. 14, 2011).

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Fairness OpinionsWhat they don’t say

What Fairness Opinions Don’t Say: They do not address the relative merits of a particular transaction as compared to

alternative business strategies. They do not address the company’s underlying business decision to pursue a

transaction. They do not constitute a recommendation to stockholders on how to vote or act with

respect to a transaction.

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Fairness OpinionsWhat they don’t say (cont.)

What Fairness Opinions Don’t Say (cont.): They do not typically address the allocation of the aggregate consideration to be received

among holders of different classes of capital stock. But see In re Tele-Communications, Inc. S’holders Litig., No. CIV.A. 16470, 2005 WL 3642727, (Del. Ch. Dec. 21, 2005).

They do not typically address the fairness of consideration to be received by holders of preferred stock whose rights are typically contractual or quasi-contractual.

They do not typically address any other terms of the transaction or agreements entered into in connection with the transaction or otherwise, like: lockups, termination fees, severance agreements, no shop provisions, financing arrangements, etc.

They do not address the price at which a buyer’s stock will trade after giving effect to the transaction or the price at which buyer or seller stock can be purchased or sold at any other time.

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Financial Analyses Underlying Fairness Opinions

Valuation Analyses Selected Companies Analysis Selected Transactions Analysis Discounted Cash Flow Analysis Contribution (Stock Consideration)

Other Analyses and Considerations Historical Stock Trading Analysis Premiums Paid Analysis LBO Analysis Merger Consequences – accretion/dilution

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Potential Conflicts

Sellside Advising contemporaneous sellers of similar assets Prior, contemporaneous and future relationships with potential buyers (e.g., Art Technology, Del

Monte, Simonetti, Zenith, Dole Food) Attempts to market company prior to engagement (e.g., Del Monte, Zale)

Buyside Advising multiple buyers for the same or similar assets

Sellside/Buyside Advising both a seller and a buyer (e.g., NYSE/Archipeligo)

Sellside Advisory and Buyside Financing Winning Bidder Finance (e.g., Toys ‘R’ Us, Del Monte, Morton’s Restaurants) Stapled Finance (e.g., Emergency Medical Services, Rural/Metro)

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Potential Conflicts (cont.)

Financial Interests Contingent fees / Fee structures (e.g., Art Technology, Atheros, Louisiana Municipal Police

Employees’ Retirement System v. Crawford) Investment or ownership interests in parties (e.g., El Paso, Simonetti) Call Spread transactions previously entered into in connection with unrelated convertible debt

offerings underwritten by its current financial advisor that may trigger substantial payments to its financial advisor (e.g., Amerigroup, Illumina)

Other potential conflicts Two classes of stock (e.g., relative fairness and allocation – TCI, John Q. Hammons,

Hallwood Realty)

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Regulatory Scrutiny of Investment Bank/Financial Advisor Relationships and Actual and Potential Conflicts of Interest

The Securities and Exchange Commission and FINRA Item 1015(b)(4) Regulation M-A promulgated under the Securities Exchange Act of 1934, as

amended, generally requires disclosure in merger proxies and certain other filings disseminated to stockholders of companies with registered equity securities in connection with M&A transactions of: “any material relationship that existed during the past two years or is mutually understood to be contemplated

and any compensation received or to be received as a result of the relationship between (i) The outside party, its affiliates, and/or unaffiliated representative; and (ii) The subject company or its affiliates …” (emphasis added)

FINRA Rule 5150(a) requires FINRA members to include disclosure in publicly disclosed fairness opinions regarding: “any material relationships that existed during the past two years or that are 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 any party to the transaction that is the subject of the fairness opinion” (emphasis added)

Note: Differences in timing and scope of SEC and FINRA disclosure rules

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Judicial Scrutiny of Investment Bank/Financial Advisor Relationships and Actual and Potential Conflicts of Interest

Disclosure of material relationships and actual and potential conflicts of interest has received increased attention given the recent rise in aiding and abetting breach of fiduciary duty claims based in whole or in part on alleged inadequate disclosure of material relationships and conflicts to the board.

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Judicial Scrutiny of Investment Bank/Financial Advisor Relationships and Actual and Potential Conflicts of Interest (cont’d)

The Delaware Courts are concerned about the disclosure of material relationships between financial advisors and transaction participants.The Delaware Courts

Chief Justice Strine has noted that:“Banks with the least number of potential conflicts (i.e., boutique banks) are not necessarily the best advisors for a target company..." http://www.paulhastings.com/publicationdetail.aspx?publicationId=2191.

“[T]here is a difference between the typical conflicts that involve a bank or lawyer working semi-regularly on engagements for key players, such as private equity firms, and more unusual, more material conflicts.” (“Documenting the Deal: How Quality Control and Candor Can Improve Boardroom Decision-Making and Reduce the Litigation Target Zone,” available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2577356)

And others have observed that: “The Delaware courts are undoubtedly cognizant and respectful of the fact that the most effective advisory services are often rendered by bankers with relationships that run broadly and deeply in the relevant industry. In general, the courts are not seeking to dictate the choice of adviser, but rather are promoting transparency and supervision.” http://blogs.law.harvard.edu/corpgov/2012/05/31/delaware-decisions-data-points-not-doctrine/.

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Judicial Scrutiny of Investment Bank/Financial Advisor Relationships and Actual and Potential Conflicts of Interest (cont’d)

The Delaware Courts (cont’d) But VC Laster has recently questioned whether certain relationships may pose a direct,

non-waivable conflict:

“[the Court]: ‘[W]hy isn’t the answer on that that you get the inference that [the Board’s decision to go forward with PLX’s Financial Advisor as its financial advisor] wasn’t a decision falling within the range of reasonableness. That means to go forward with [PLX’s Financial Advisor] having a direct concurrent relationship representing the opposite party to the deal; that that even might be such a direct conflict that it would be non-contractable. You at least get that inference at the pleadings stage, which is where we are.…” In re PLX Technology S’holders Lit., CA No. 9880-VCL (Del. Ch. April 15, 2015) (Transcript of Oral Argument).

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Judicial Scrutiny of Financial Advisors

“I think it should be clear to everyone, as I’ve tried to explain to a group of interested investment bankers, that the Delaware Courts are not interested in a regulatory scheme that governs the conduct of investment bankers. You should be reminded of the fact that the prism through which we operate is post-decision scrutiny of director conduct, so the issue is what do the directors need to know, what have the directors done or omitted to do, that directly impacts the discharge of their duty of loyalty and care. So the focus is on the extent to which they make an inquiry or should make an inquiry of investment bankers before they hire them to be able to rely upon the opinion of the investment banker. Those cases [Del Monte and El Paso] are not an attempt by the Delaware Courts to tell investment bankers how they should conduct their business.” Former Chief Justice Steele at the Penn State/City Bar M&A Institute, September 2012

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Judicial Scrutiny of Financial Advisors – Rural/Metro

“[O]ur holding is a narrow one that should not be read expansively to suggest that any failure on the part of a financial advisor to prevent directors from breaching their duty of care gives rise to a claim for aiding and abetting a breach of the duty of care.191” RBC Capital Mkts. v. Jervis, No. 140, 2015, (Del. Nov. 30, 2015)

__________“191 In affirming the principal legal holdings of the trial court, we do not adopt the Court of Chancery’s description of the role of a financial advisor in M & A transactions. In particular, the trial court observed that ‘[d]irectors are not expected to have the expertise to determine a corporation’s value for themselves, or to have the time or ability to design and carryout a sale process. Financial advisors provide these expert services. In doing so, they function as gatekeepers.’ Rural I, 88 A.3d at 88 (citations omitted). Although this language was dictum, it merits mention here. The trial court’s description does not adequately take into account the fact that the role of a financial advisor is primarily contractual in nature, is typically negotiated between sophisticated parties, and can vary based upon a myriad of factors. Rational and sophisticated parties dealing at arm’s-length shape their own contractual arrangements and it is for the board, in managing the business and affairs of the corporation, to determine what services, and on what terms, it will hire a financial advisor to perform in assisting the board in carrying out its oversight function. The engagement letter typically defines the parameters of the financial advisor’s relationship and responsibilities with its client.” (emphasis added)

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Judicial Scrutiny of Financial Advisors – Rural/Metro (cont’d)

So how does the Delaware Supreme Court’s ruling in Rural/Metro fit in?

“The trial court, in a lengthy analysis of aiding and abetting law and tort law, held that if a ‘[i]f the third party knows that the board is breaching its duty of care and participates in the breach by misleading the board or creating the informational vacuum, then the third party can be liable for aiding and abetting.’ We affirm this narrow holding.

“It is the aider and abettor that must act with scienter. The aider and abettor must act ‘knowingly, intentionally, or with reckless indifference …[;]’ that is, with an ‘illicit state of mind.’ To establish scienter, the plaintiff must demonstrate that the aider and abettor had ‘actual or constructive knowledge that their conduct was legally improper.’ Accordingly, the question of whether a defendant acted with scienter is a factual determination. The trial court found that, ‘[o]n the facts of this case, RBC acted with the necessary degree of scienter and can be held liable for aiding and abetting.’ The evidence supports this finding.…

“Here … the claim for aiding and abetting was premised on RBC’s ‘fraud on the Board,’ and that RBC aided and abetted the Board’s breach of duty where, for RBC’s own motives, it ‘intentionally duped’ the directors into breaching their duty of care.” RBC Capital Mkts. v. Jervis, No. 140, 2015, (Del. Nov. 30, 2015)

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Identifying Investment Bank/Financial Advisor Relationships and Actual and Potential Conflicts of Interest

When and how to disclose relationships/actual and potential conflicts of interest: Outset of engagement (e.g., single bidder process) Once limited number of likely buyers identified Prior to management presentations or second round of bids (e.g., if broad auction)

How to disclose to the board: Verbally

Evidentiary concerns if recollections differ Writing

Creates contemporaneous written record Where to disclose:

Engagement letter - See forthcoming “Financial Advisor Engagement Letters: Post-Rural/Metro Thoughts and Observations” by E. Klinger-Wilensky and N. Emeritz at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2604250

Memo to Board of Directors Board book

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Identifying Investment Bank/Financial Advisor Relationships and Actual and Potential Conflicts of Interest (cont’d)

Examples of what may need to be disclosed: Investment or ownership interests in parties (e.g., Simonetti, El Paso, Amerigroup)

Both financial advisor and senior deal team members

Prior, contemporaneous and future relationships with potential buyers (e.g., PLX, Dole Food, Art Technology, Del Monte, Zenith) How far back and how much information (types of services and fees) – summary/aggregate v. deal-by-

deal? What about confidential/material non-public information re: current/future mandates?

Attempts to market the company prior to engagement or w/o board authorization (e.g., Zale, Rural/Metro, Del Monte) - Pitches v. ordinary course marketing based on publicly available info?

Ulterior motives (e.g., Rural/Metro)

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“Documenting the Deal”: What lawyers and investment bankers can do to reduce litigation risk

In “Documenting the Deal: How Quality Control and Candor Can Improve Boardroom Decision-Making and Reduce the Litigation Target Zone,” Chief Justice Strine suggests ways to minimize litigation risks in the M&A process (available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2577356): “[T]he focus of my remarks is on what you can do as legal and financial advisors to

conduct an M & A process in a manner that: i) promotes making better decisions; ii) reduces conflicts of interests and addresses those that exist more effectively; iii) more accurately records what happened so that you and your clients will be able to recount events in approximately the same way; and iv) as a result, reduces the target zone for your favorite plaintiffs’ lawyers.”

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“Documenting the Deal”: What lawyers and investment bankers can do to reduce litigation risk (cont’d)

Boards need to: Create a sufficiently detailed contemporaneous written record:

“Despite having the ability to write the play, too many advisors leave out critical parts of the story line, depriving their clients of reliable memory aids in situations where they may be unable to accurately recollect the reasons for decisions they made.”

Consider implications of material relationships between prospective financial advisors and potential counterparties and other interested parties (which may include management):

“If conflicts were surfaced, contained, and addressed, and a strong hand was given to the impartial members of the board, the plaintiffs’ ability to suggest that those conflicts infected the why [certain decisions were made] is impaired. It will therefore be more difficult for the plaintiffs to get the deal enjoined or to press a damages case.”

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“Documenting the Deal”: What lawyers and investment bankers can do to reduce litigation risk (cont’d)

Creating a sufficiently detailed contemporaneous written record:

“[T]he best documentation process builds on itself. If early in the process, board books and minutes are produced in an accurate and complete way, the board will be able to go over its steps again more accurately, assess whether it made any errors, and consider what to do about them. This can involve going over the bidder pool, the reasons for inclusion and exclusion, and whether they are still relevant. This can involve going over the evolution in the financial assumptions that management and the financial advisor were using, to ensure that any changes were principled and based on objective factors untainted by self-interest.”

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“Documenting the Deal”: What lawyers and investment bankers can do to reduce litigation risk (cont’d)

Creating a sufficiently detailed contemporaneous written record (cont’d)

Board meeting minutes Who should take the board meeting minutes? Level of detail

Old style (e.g., “a variety of matters were discussed…”) Transcript (e.g., recording what each person said) Modern minutes (e.g., summary of specific issues and information discussed and decisions/conclusions reached)

Who should review Board, legal counsel, financial advisors v. others (e.g., who weren’t at the meeting)

Timing Preparation of minutes, review of minutes, approval of minutes

Note – How and why do board minutes differ from the description of the “Background of the Merger” summarized in the Proxy?

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“Documenting the Deal”: What lawyers and investment bankers can do to reduce litigation risk (cont’d)

Creating a sufficiently detailed contemporaneous written record (cont’d) Directors should not be complacent:

“Instead of pressing management for answers and learning the company’s business deeply, directors sometimes act more like well-mannered season ticketholders to a stylized interactive theatre, in which performing managers shepherd the audience through ritualized plays, listen to management give set piece reports, ask a few brief questions so as not to disrupt the actors’ timing, and complete a series of management-driven acts, often written not in the blunt, earthy style of an Arthur Miller, but in the opaque, high-falutin style of a jejune drama student in a Master of Fine Arts program.”

Board books (i.e., discussion materials prepared by financial advisors) Ask questions if analysis not clear Ask questions regarding underlying assumptions Ask questions regarding alternative approaches

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“Documenting the Deal”: What lawyers and investment bankers can do to reduce litigation risk (cont’d)

Creating a sufficiently detailed contemporaneous written record (cont’d) Board books (i.e., discussion materials prepared by financial advisors) (cont’d)

Longitudinal changes Chief Justice Strine advocates blacklining v. prior Board book Many banks identify key changes (assumptions, inputs, etc.) in Board books

Changes to management projections Changes to selected companies and transactions used for comparative purposes Changes to discount rate calculation, including methodology and inputs Changes to selected multiple range

Changes identified in footnotes and/or separate “longitudinal change” pages

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