The accelerating evolution in fairness opinions. (Advertising Supplement: Banking & Finance).

The collapse of Enron and the unraveling of its accounting firm, Arthur Andersen, have created momentum for dramatic changes in financial reporting, public disclosure and accountability.

Boards of directors are under increasing scrutiny to take more responsibility for their companies' actions and to do a better job of looking out for investors' interests. The SEC is under pressure to improve the timing and amount of public disclosure and to address independence issues for public companies to prevent another Enron fiasco.

As a result, fairness opinions, until recently little more than an afterthought in many transactions, are now taking on new importance.

Most significantly, the SEC's expectation today for disclosure in public company transactions is fundamentally different from the past. In fact, the amount of disclosure for most public company transactions has expanded to include a level of detail historically found only in going-private transactions. This trend is greatly affecting the role of the fairness opinion in public company transactions.

At a minimum, the SEC now expects any investment banking firm rendering a fairness opinion to provide enough information to enable a company's directors and shareholders to make their own independent judgment regarding a transaction's fairness. The exact requirements appear to be a work in progress, but it's likely that the SEC will require any proxy statement to include:

* The background and events leading up to the transaction;

* The purpose of the transaction;

* Alternative transactions considered and the reasons for their rejection;

* A discussion of the transaction's merits;

* A statement on whether the subject company filing the statement reasonably believes that the transaction is fair or unfair to unaffiliated security holders.

* A detailed discussion of the material factors that led the board of directors to the conclusion that the transaction was fair or unfair.

Because the board will most likely be required to describe the factors that were important in determining that the transaction was fair, most boards want to state that they were advised on these factors by their financial advisor as part of the fairness opinion process.

Boards should obtain a fairness opinion from a firm that is reputable, experienced and independent. A fairness opinion that is prepared by experts who have a financial stake in whether or not a transaction occurs will have little, if any validity in the event of litigation. For a fairness opinion to provide maximum protection for the board, the advisor rendering the opinion must be free of any conflicts of interest.

It's essential that adequate time be allowed for the preparation of a fairness opinion, realizing that the events and the timing leading up to the transaction will be disclosed in the proxy. Engaging a financial advisor at the eleventh hour and receiving a last-minute opinion will raise doubts in the minds of investors and the SEC. In contrast, bringing in an advisor early in the process indicates a desire for a comprehensive fairness analysis and will, not incidentally, provide greater legal protection for the board.

Written documentation should be obtained from the financial advisor. A detailed written presentation is essential, for it enables board members to analyze all aspects of the proposed transaction. The SEC won't accept fairness opinions without supporting documentation, and board members shouldn't either.

RELATED ARTICLE: 2003 Investment Outlook: Hope On The Horizon

The turbulent stock market, economic uncertainty, corporate accounting issues and ongoing international concerns injected a healthy dose of investor fear into the marketplace in 2002, at times overshadowing positive developments concerning the economy and corporate earnings. While some of these factors--especially the fear of terrorism and the possibility of a confrontation with Iraq--cloud our view of 2003, we see number of encouraging signs that lead us to believe that prospects for the economy and the equity markets will brighten in the year ahead.

* Economy should experience moderate growth. Looking at the numbers for 2002, the economy grew at a respectable average rate of three percent. Looking ahead we see this growth continuing and even accelerating during the second half of 2003, given the current low interest rate environment and the likelihood that Congress will take additional action to stimulate the economy. We see unemployment- which held just under six percent for the majority of 2002 -continuing to decline, provided the economic recovery stays on track. Inflation, however, might increase slightly because of increased pressure on the dollar, resulting in higher prices for imported goods.

* Stocks should strengthen. While the economic recovery continues to gather steam, it has helped support earnings growth in seven of ten S&P sectors by the third quarter of 2002. However, the market by and large has overlooked this positive development, choosing instead to focus on what seemed to be a relentless string of bad news events. The promising outlooks for the economy, corporate earnings, and job growth, combined with the attractive value of stocks--especially versus bonds--lead us to believe that 2003 will be a year of investor confidence building. Going forward we see investors recognizing the earnings strength of cyclical companies and de-emphasizing exposure to more defensive sectors such as healthcare and consumer staples.

* Bonds: It's time to guard your gains. The turbulence in the equity markets led many investors to seek refuge in the fixed income market. This, combined with another round of rate reductions by the Federal Reserve, helped push Treasury yields to their lowest levels in more than 40 years. Because bond prices move in the opposite direction of their yield, bond investors holding fixed income securities in this declining interest rate environment have enjoyed significant portfolio gains. However, as the economy picks up momentum in 2003, interest rates will likely increase leading to rising bond yields and falling bond prices. Fixed income investors should be thinking of strategies to help guard their holdings from price erosion.

While fears of war, corporate wrongdoing, and stock market dips will continue to play on investors' minds, it's important to remember that the outlook for the next twelve months contains a number of bright spots. We've seen evidence of sustained economic growth, corporate earnings are improving, and stocks are attractively valued. Talk to your financial consultant about what you can do to position your portfolio to take advantage of the pending recovery.

This article was provided by A.G. Edwards & Sons, Inc., Member SIPC.

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