Independent fairness opinions are critical.

Is there a conflict of interest in the following situation?

The Roper Company just signed a letter of intent to be acquired for $100 million by a large buyout firm. The Roper Company has been in play for almost 2 years and all involved are eager to see the transaction completed.

This particular deal with the buyout firm has been in the works for nearly six months, with a lot of time invested by Roper's executives, lawyers and investment bankers. The bankers stand to make $1 million on the transaction, so they're anxiously awaiting the final close of the deal.

Two weeks before the deal is scheduled to be announced to the company's public shareholders, the corporate attorney for Roper reminds the chairman of the board that they still need to obtain a fairness opinion.

"Not to worry. We'll have our investment bankers give us a fairness opinion, just like they did on our last deal. We'll just throw them a little extra money, in addition to their $1 million contingent fee for representing Roper in the transaction."

Freeze-frame. The answer to the question posed at the beginning of this article is a definite yes. By any objective standard, the investment banker has a material conflict of interest. It's doubtful that any judge or jury, especially in today's current environment of heightened focus on independence and conflicts of interest, would regard this arrangement as anything more than an attempt to create the illusion of objectivity.

As previously noted, the investment bankers stand to make a lot of money on this deal, but only if it closes. How, then, can they be objective in determining whether the transaction is fair to Roper's public shareholders?

The simple, inescapable answer to that question is that they can't and won't.

For years--decades, really--the standard, accepted way of getting a fairness opinion was to have the investment banker on the deal prepare it. The tide is now beginning to turn. For example, New York attorney general Eliot Spitzer, who led the attack on Wall Street's research conflicts last year, said earlier this year that conflicts in fairness opinions have caught his eye. Although he's busy with mutual-fund cases right now, he's expected to pursue the issue of independence eventually.

A fairness opinion is a letter, typically provided to a company's board of directors, addressing the fairness of a proposed transaction to a particularly constituency from a financial point of view. Usually, the constituency is the company's public shareholders, given that they need an independent party to make sure they are getting a fair shake.

The trend toward independence is only now starting to affect investment banking firms, as shareholders and their lawyers question the bankers' objectivity in situations where they stand to gain from consummation of a deal.

It's easy to understand why the deal bankers were often used to provide the fairness opinion. First and foremost, the company and its advisors don't want any outsiders coming in messing with their deal, or possibly even objecting to it. Secondly, the current investment bank is familiar with the company and the transaction and no one needs to waste time and energy getting them up to speed. The final reason is money. The deal banker will often throw in a fairness opinion for a relatively small incremental fee.

For decades, such conflicts were considered acceptable since the investment banker's dual role was never challenged by the courts in any real way. But there has been a sea change in the way regulators, courts and litigators are interpreting independence and conflicts of interest.

Since the enactment of Sarbanes-Oxley there is a greater sensitivity and focus on corporate governance issues, and greater expectations for independence by board members and their advisors alike. The legal aspect of doing deals now includes a greater focus on procedure and expanded disclosure requirements.

It's true that directors consider factors beyond those addressed in a fairness opinion in deciding whether a proposed transaction is in the best interest of the company's shareholders. But the fairness opinion provides a critical element of support for a board's deliberation process and recommendation.

In the past, fairness opinions in M&A transactions not involving conflicts of interest were typically not perceived to be an important part of the board's deliberation process or a critical element of legal protection for the transaction. Conventional wisdom held that boards were unlikely to be held liable if there was no self-dealing, if it acted on an informed basis, in good faith and in the best interest of shareholders.

Today, the fairness opinion that the board relies upon in its decision-making process is more important than ever. Equally important is the independence of the provider of the fairness opinion. An independent financial advisor providing a fairness opinion is paid whether or not they find that a deal is fair; there's no contingency involved.

Furthermore, there has been a recent surge in the percentage of strike suits files in M&A transactions. Regardless of a board's actual deliberation process, a lawsuit is filed claiming that the directors did not fulfill their fiduciary duty to shareholders. The result can be greatly increased costs in M&A transactions.

Because directors do not have a crystal ball to assure perfect decision-making and outcomes, they must adopt a more conservative approach to doing deals, dotting all the i's and crossing all the t's. Board meetings should be conducted with greater attention to detail to assure that directors are following appropriate processes and procedures to minimize the possibility of lawsuits.

Selection of an objective, knowledgeable and experienced investment banker to provide the fairness opinion, rather than one with a stake in the deal, will go far toward providing the protection a board needs in these litigious times.

Sheryl L. Cefali is a managing director in the Los Angeles office of Duff & Phelps, LLC a national investment banking and financial advisory firm. Her practice area includes fairness opinions and valuation opinions for publicly traded and closely held companies.