Independent experts have become increasingly nervous on independence and process points since the Australian Securities and Investments Commission (ASIC) required a replacement independent expert in Billabong, apparently based on independence concerns raised by ASIC in that case.
Experts are acutely conscious of ASIC’s expectation that the expert keep specific records of interactions between the expert and the commissioning parties/their advisers and that ASIC will be undertaking random checks on this in 2014. However, some experts are taking a more extreme approach to independence, including by limiting their interactions with parties other than the commissioning party, to a point which may be counterproductive.
- In 2013, ASIC allegedly required Billabong International to terminate the appointment of an expert opining on a debt/equity rescue package and commission a new report after ASIC became concerned that the expert’s independence had been tainted with 'opinion' material from an interested party.
- Post-Billabong, experts are clearly feeling the pressure of an increased level of ASIC scrutiny of the process from engagement of the independent expert to release of its report.
- ASIC is undertaking reviews of independent experts’ files to assess whether independence has been maintained - and assessing the adequacy and content of experts’ records of interactions with the commissioning and other interested parties.
- Some experts are now being overly cautious by refusing to engage on factual matters with parties other than the commissioning party. Whilst the approach is intended to maintain independence, there is no reason an independent expert should not seek input from interested parties where appropriate to confirm factual accuracy.
The turning point: Billabong International
The very lengthy process undertaken by Billabong International to overcome its financial woes took a further unexpected twist in November 2013, when ASIC rejected an advanced draft of an independent expert report (IER) commissioned by Billabong.
After numerous approaches, Billabong had finally agreed a debt and equity rescue package with US hedge funds Oaktree Capital and Centerbridge Partners. Billabong was preparing for a shareholders meeting to approve the proposal and had commissioned an independent expert to opine on whether the proposal was fair and reasonable to shareholders.
With only a month before shareholders were due to vote, Billabong suddenly postponed the meeting citing “a delay in obtaining an independent expert’s report acceptable to ASIC”.1 It was reported that the independent expert had adopted a more favourable view of the proposal after receiving more information, of an opinion rather than factual nature, from an interested party, which prompted ASIC to require Billabong to terminate the expert’s appointment and commission an entirely new IER.2
ASIC has been proactive in reviewing independent expert reports in recent years. It is now almost unheard of for an independent expert report to pass through an ASIC review process without some changes being required. But post-Billabong, ASIC’s level of scrutiny of the expert’s process and engagement with parties has increased – and experts are clearly feeling the pressure as they have recently been tightening the management of their engagements.
The rise of the IER
For certain proposed transactions that may treat minority shareholders differently or that have an element of conflict (for example, a takeover where the bidder has an interest of more than 30% of the target shares or a related party transaction), the Corporations Act requires an IER to be commissioned, to opine on whether the proposed transaction is fair and reasonable or in the best interests of affected shareholders.
Even in circumstances where an expert report is not statutorily required, the trend of boards voluntarily commissioning an IER is steadily growing, as boards see increasing value in the report as a protection mechanism for both the shareholders and the board itself. For example, an independent expert report is customary in shareholder schemes of arrangement.
The independence of independent experts - ASIC Regulatory Guide 112
ASIC’s view as to what constitutes ‘independence’ of an expert is set out in ASIC’s Regulatory Guide 112 “Independence of experts” (RG 112).
ASIC suggests at RG 112.25 that an expert should consider declining an appointment in circumstances where there is, or could be, a conflict of interest because the expert:
- is an officer of the commissioning party or an interested party,
- has a substantial interest in or is a substantial creditor of the commissioning party,
- has a material financial interest in the transaction,
- has participated in strategic planning work for the commissioning party either in connection with the transaction or more generally, or
- has provided professional services to the commissioning party of a strategic or operational nature.
Although these circumstances are intended only to be a ‘guide’, in practice it is highly unusual that an expert would accept an appointment where one of those circumstances existed.
ASIC has a key current focus on the expert not only ensuring it is independent at the time it accepts the role, but also that it maintains independence throughout the engagement. ASIC states at RG 112.42 that it is likely to investigate whether an expert’s independence is lost if one of the following “red flags” occurs during the engagement:
- the expert is present when the commissioning party discusses the development or merits of the transaction,
- the commissioning party, its advisers or any interested party:
- provides instructions to the expert on methodologies to use in the report,
- provides its opinion on, or analysis of, the transaction to the expert, or
- determines what information is relevant for the expert’s report,
- the expert enters into a success fee arrangement or other financial incentive linked to the transaction,
- the expert discusses its preliminary views with the commissioning party or any interested party (ASIC considers it acceptable that drafts of the report be provided for factual checking but that the expert’s analysis of the transaction or methodologies be omitted – RG 112.49), or
- the expert changes its opinion at the suggestion of the commissioning party or any interested party without adequate explanation (ASIC expects that once a full draft report is provided, the report only be altered if there is an error of fact, and any change affecting the expert’s opinion be disclosed in the report – RG 112.52).
ASIC expectations and random checks
A priority for ASIC in 2014 is to undertake reviews of independent experts’ files to assess whether the expert has maintained independence throughout the process. ASIC will be focusing on whether adequate records of communications have been kept, and whether these records demonstrate independence.
Experts are therefore under pressure to record sufficient details of their interactions with parties and their advisers to satisfy ASIC that all its interactions have been above board and not jeopardised its independence.
Are some experts taking too extreme an approach?
A consequence of Billabong and the subsequent scrutiny by ASIC, is the fastidious approach independent experts are now taking in their engagements. Independent experts are, in some instances, refusing to engage on factual matters with parties other than the commissioning party (such as the bidder where the target has commissioned the report). While experts taking this approach appear to be intending to simply be cautious when it comes to independence, we query whether conceptually or practically it is the right approach.
It is clear from RG 112 that the commissioning party and any interested parties must not lobby an independent expert or seek to influence the expert’s opinion or conclusions. However, there is no regulatory policy that prevents experts discussing factual matters with interested parties or providing drafts to those parties to review for factual accuracy. We understand the concern that by discussing factual matters with interested parties or allowing parties to comment on factual accuracy drafts, the expert may expose itself to lobbying. However, the expert can mitigate that risk by appropriately managing and controlling interactions with those parties.
In terms of confirming factual accuracy, we do not see why it would jeopardise independence for the expert to engage with any party which has knowledge of the relevant facts – at least to allow such a party to comment in writing on factual accuracy drafts. It seems odd to limit such interaction to the commissioning party, when the whole point of independence is that the expert is not advising or preferring the commissioning party over anyone else. In fact, it is perfectly legitimate for the same independent expert to provide reports to more than one party on a transaction (as was done, for example, in the Centro restructure). No party “owns” an independent expert.
In this regard, it is relevant to note that the advantages of confirming the accuracy of factual statements have been recognised by the Takeovers Panel which circulates its draft reasons for its decisions to the parties for comments on matters of factual accuracy. If the Takeovers Panel is comfortable with such an approach, there is no reason why experts should not also be comfortable.
In the quest to be truly independent, an independent expert should not limit itself to engaging solely with the commissioning party, but should instead seek input from interested parties where appropriate to confirm factual accuracy.
Experts are right to proceed on the basis that their interactions with parties will be closely scrutinised by ASIC. But independence does not require that the expert not engage with anyone other than the commissioning party. The key is for the expert to identify what inputs it needs to best position the expert to provide its independent view based on correct factual information, to control interactions with parties so that the expert is obtaining relevant factual information rather than opinion or views, and to document its interactions to evidence the independence of that process.
- Billabong International ASX announcement, 4 November 2013.
- ‘ASIC drops Billabong’s ‘tainted’ expert report’, Sue Mitchell, Australian Financial Review, 9 November 2013.
The contents of this publication, current at the date of publication set out above, are for reference purposes only. They do not constitute legal advice and should not be relied upon as such. Specific legal advice about your specific circumstances should always be sought separately before taking any action based on this publication.
© Herbert Smith Freehills 2020