On Wednesday ASIC released its much anticipated regulatory guides on the content and independence of Independent Expert’s reports. Much criticism has surrounded the publication and content of Independent Experts reports, with many repeating the old adage that the reports are neither independent, nor expert.
Most takeovers and schemes include an expert’s report in documentation sent to shareholders, generally, to reinforce the board’s view of a transaction (the reports are only legally required in certain situations, like when the bidder owns 30 percent of the target). There have been very few instances in which an Independent Expert will take a contrary view of a transaction to the board of the company paying the bill.
This circumstance arose pertinently in the recently aborted Consolidated Minerals scheme of arrangement (to facilitate a merger with Pallinghurst). The Independent Expert hired by ConsMin (which backed the scheme) recommended that shareholders vote in favour of Pallinghurst’s offer which valued ConsMin at $2.33 per share. Less than a year later, two bids of $4.50 have been placed for the same company.
In Regulatory Guide 112 – Independence of Experts ASIC noted that “the Corporations Act contains indicators that an expert must be, and must appear to be, independent in the provisions requiring an expert report.”
ASIC continues, stating that:
Previous and existing relationships may threaten, or appear to threaten, the independence of an expert. The objectivity of an expert may also be compromised or called into question, if the expert has an interest in the outcome of the transaction that is subject of its report.
ASIC then states that certain parties, such as directors or lawyers or other advisers to the company being valued should “seriously consider declining an engagement”.
The ASIC guide does not however overcome the biggest image problem surrounding expert’s reports – that is, how can an expert be independent, when they are selected and remunerated by the very same company which they are assessing? An independent expert who regularly comes up with valuations which contradict management’s wishes will, in all likelihood, find it difficult to capture future engagements.
In addition, ASIC specifically allows the commissioning company to receive a “draft copy” of any report for “factual checking”, there would certainly be at least an apprehension that the report isn’t entirely independent. (That is not to say that target companies compel Independent Expert’s to alter their report, but it doesn’t look great. For example, one suspects a bank valuing a house for the purposes of a mortgage would never allow the vendor to view and comment on a draft valuation).
Further, Independent Experts usually come up with a valuation by using a discounted cash flow model. As any finance student will attest, DCF modals are extremely subject to certain assumptions (specifically, forecast growth rate and discount value). Tinker with these assumptions only slightly, and a valuer can come up with pretty much any valuation they like.
To create a true independent expert, the expert should not be selected by a target company, but rather, by a truly independent body like the Takeovers Panel (who would need to select an expert from a panel within say 24 hours of an expert being requested). Until then, or until shareholders start to see Independent Experts regularly contradicting the views of management, they provide little, if any value.