Canada: The OSC’s Reasons in Magna Will Affect Future M&A Transactions

Last Updated: February 17 2011
Article by Michael Siltala and Cornell Wright

The Ontario Securities Commission recently released the reasons for its decision in connection with the plan of arrangement implemented by Magna International Inc. in August 2010. Under the arrangement – which attracted significant controversy – the Stronach Trust ceded control of Magna through the elimination of the dual class share structure in exchange for cash and shares valued at approximately C$800 million. The transaction was delayed after the OSC intervened and ordered Magna to provide extensive additional disclosure before shareholders voted on the transaction. Magna subsequently implemented the transaction after its shareholders voted in favour and a court approved the transaction after hearing shareholder objections.

The OSC's decision was released in June 2010. Its detailed reasons provide a number of insights into the Commission's thinking on important M&A issues and are highly relevant at a time of increased regulatory scrutiny and shareholder activism.

Disclosure

The OSC's intervention forced Magna to provide an unprecedented level of disclosure to its shareholders regarding the transaction. The absence of board and special committee recommendations to shareholders as well as the lack of a fairness opinion were clearly relevant to the OSC's conclusion that Magna's circular had "serious and substantive" deficiencies. However, the reasons leave open the question whether the decision could have broader application, requiring issuers that propose complex transactions to provide greater disclosure than they have in the past. Such an expectation would be consistent with demands from investors, who are showing less deference to the judgments of boards of directors in corporate decision making.

The following are some key observations from the OSC's reasons relating to disclosure:

  • If the board makes no recommendation to shareholders, the latter must, to the extent reasonably possible, be provided with substantially the same information and analysis that the board received in considering the issues raised by the transaction.
  • Shareholders are entitled to a meaningful discussion of all of the advice provided to the board by its legal and financial experts. In particular, it is not sufficient to provide a fairness opinion or a summary of the opinion or to state that a fairness opinion was not obtained when the financial adviser provided other advice that is relevant to the shareholders' decision.
  • Disclosure with respect to the transaction must be contained within "the four corners" of the circular provided to shareholders. A company may not rely on any other public disclosure, including regulatory filings.
  • The circular must include a meaningful discussion of the board's analysis of the factors, issues and information it considered, not just a laundry list. In particular, the OSC took issue with the statement that the Magna board did not find it practicable to, and did not, quantify or otherwise attempt to assign relative weight to specific factors as it suggested the board had not attempted to determine what was important to shareholders in the circumstances.
  • The OSC views disclosure regarding the background leading to a transaction, including details of the negotiations between the parties, as key information for shareholders in making their decision. In Magna, the OSC referred to the company's affidavit for the hearing before the Commission as containing the proper level of disclosure.

A U.S. company's proxy circular for this type of transaction would have to be pre-filed with the Securities and Exchange Commission and would be subject to the SEC comment process. If the SEC chose to review the circular, it would likely require that the circular contain disclosures similar to those required by the OSC in Magna. Moreover, in a number of recent Delaware shareholder litigations, the Delaware court has enjoined the transaction pending additional disclosures being made to shareholders.

Financial Advice

The OSC's reasons provide some interesting insights into the role of financial advisers and fairness opinions:

  • The OSC did not challenge the special committee's decision to put the transaction to a shareholder vote without obtaining a fairness opinion, but did take issue with the fact that the committee failed to address and comment on the desirability and fairness of the transaction to the minority shareholders. We assume that the committee's position was affected by the fact that its financial adviser would not provide a fairness opinion.
  • Although, as the OSC acknowledged, the Magna board was not required to obtain a fairness opinion under the Canadian related party rules or otherwise under Ontario securities law, we think the OSC's commentary will further promote the recent trend toward obtaining fairness opinions for all significant transactions and increase the pressure on boards to obtain opinions from financial advisers who are independent.
  • If the board proceeds without a fairness opinion, the OSC expects the company to provide (i) a full explanation regarding the reasons why a fairness opinion could not be obtained; and (ii) a comprehensive discussion of the financial advice that the board received and its analysis of that advice.
  • The OSC confirmed that Magna did not require a formal independent valuation and that, in any event, a valuation would not have assisted shareholders in making a decision, given the economic rationale of the transaction. However, the OSC also stated that if a valuation had been required, it would not have provided exemptive relief, which is consistent with our experience that obtaining exemptive relief can be challenging even when there is good justification. The OSC's commentary is also interesting in that while it says the OSC should hesitate to impose a valuation requirement in circumstances in which one does not otherwise apply, it suggests that the OSC would impose one in "clear and compelling circumstances." The reasons do not elaborate on what those circumstances could be.

Shareholder Approval

Under the Canadian rules governing related party transactions, the Magna arrangement did not require minority shareholder approval because the value of the consideration being paid to the Stronach Trust was less than 25% of the company's market capitalization. The parties nevertheless decided to implement the transaction only if a majority of the minority shareholders voted in favour. The Magna board's decision to make minority shareholder approval a precondition – even though not strictly required by the related party rules – reflects the recognition that an affirmative disinterested vote is the best pre-emptive defence to a shareholder challenge in court of the fairness of the transaction. In this case, we think this was the only way the parties could have proceeded, given that the Magna board was in effect putting the decision to shareholders and a court would otherwise have been hard-pressed to conclude that the transaction was fair, particularly in the absence of a fairness opinion from a financial adviser. Furthermore, not only was minority approval required as a practical matter in view of the need to establish fairness at the arrangement approval hearing in court, but the OSC said that without the minority shareholder approval requirement, "we have little doubt that we would have restrained it [the transaction] as an abusive related party transaction."

It is interesting to think about how the Magna situation would have played out if it had involved a third-party offer for the voting shares held by the Stronach Trust. M&A practitioners have long speculated on the risk that the OSC would intervene on public interest grounds to prevent the sale of voting shares for a significant premium, a scenario that continues to be pertinent in view of the many companies that remain with dual class share structures that are grandfathered from the TSX "coattail" requirements. In Magna, the subordinate shares held by the public did not have coattail protections and there was no sunset provision applicable to the company's dual class share structure. The OSC stated that, given Magna's public disclosure as to the absence of coattail protections, holders of the subordinate shares had no reasonable expectation that they would share in any control premium being paid for the voting shares. The OSC further stated that the Stronach Trust was legally entitled to sell its voting shares to any purchaser at whatever price it negotiated. This suggests that had the Stronach Trust been selling to a third party for an unprecedented premium, the OSC would not have intervened. The distinction between the sale to a third party and a sale to the company is that the process of negotiating the latter has the potential to be tainted by conflict, given the controlling shareholder's influence over management and the board. It is presumably this element, not the quantum of the premium, that the OSC considered necessitated minority shareholder approval and would have made the transaction abusive but for that approval.

Special Committee Process

The OSC viewed the Magna special committee process as being tainted by the involvement of executive management at the start of and during the process, and regarded the committee's mandate and terms of reference as being too narrow and fundamentally flawed. The OSC's concerns included the following:

  • The OSC took issue with the fact that management took the lead in negotiating the transaction without oversight from the special committee, with the result that the committee was faced with a "take it or leave it" proposition that had been substantially negotiated and agreed to between the company and the Stronach Trust. The OSC's view is that upon learning of the possibility of a transaction, management should have immediately referred the matter to the board so that it could form a committee of independent directors to determine the appropriate response.
  • To the extent that the committee attempted to negotiate, it did so through management rather than engage directly with the Stronach Trust. The OSC did not view the fact that the chairman of the board (a member of the special committee) had had some direct discussions with the Stronach Trust as addressing the potential management conflict. In fact, the OSC referred to it as reinforcing the problem.
  • The OSC took issue with the special committee's mandate, which was limited to considering only the proposal developed by management and did not authorize the committee to negotiate terms or to consider other transactions.
  • The special committee's mandate was only to report to the Magna board on whether the proposal should be submitted to shareholders. The mandate did not authorize the committee to consider broader issues such as whether the proposal was in the best interests of, or was fair to, the shareholders.

M&A practitioners struggle with how broadly to define a special committee's mandate in transactions involving a controlling shareholder. Given the board's conflicts, its decision to limit the authority of a special committee could be challenged. On the other hand, courts have recognized that there is nothing wrong with a special committee acceding to the practical veto that a controlling shareholder has over alternative transactions. However, even when the special committee determines that no viable alternatives exist, it must evaluate the proposed transaction against continuation of the status quo. The OSC's concerns about the limitations on the Magna special committee's mandate echo recent Delaware cases, which indicate that to be effective, a special committee should have the same authority that the full board of directors would have in connection with a third-party transaction.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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