Preparing for shareholder activism
November 2013 | PROFESSIONAL INSIGHT | BOARDROOM INTELLIGENCE
Financier Worldwide Magazine
The impact of shareholder activism in the market, the boardroom and the C-suite continues to grow. High-profile activist campaigns – often involving hedge funds that leverage substantial minority investments to push for change – have attracted extraordinary media attention, along with droves of copycat investors. As hedge funds turn their attention to mega-cap companies that were until recently considered ‘too big to target’, it has become increasingly vital that companies large and small develop individualised game plans for handling potential activist approaches.
Although not all activists seek the same outcomes or use the same tactics, they typically seek to increase the value of their investment by pressing the board and management to make changes they believe will increase the stock price or otherwise return value in the relative near term. Common activist objectives include capital structure changes (e.g., increases in leverage,share buybacks or special dividends),strategic transactions and board/management leadership changes.
Activists often use a company’s short-term performance problems or perceived governance, compensation, ethics or compliance issues to compel the board and management to defend the company’s strategy, performance and leadership. Activist funds have been strategic in attracting support from institutional investors (including pension funds) and proxy advisers by articulating governance reform objectives that resonate with their own.
As activists become more adept at promoting their objectives, which may or may not be in the long-term interest of the company and its shareholders, the challenge for management and the board is to remain prepared to address potential activism, presupposing the value of the initiative. Ongoing attention to the company’s strategic planning and performance, its governance framework, including the quality of the company’s governance rules, and the board’s oversight of risk management are critical.
Public and private tactics
An activist will typically begin an initiative by discreetly accumulating a relatively small but significant amount of company stock. The activist may then approach the company to seek information or negotiate about a particular request. Usually this initial approach is made privately, although activists have different styles and use varied tactics.
A typical private approach – made to management, individual directors or the board – often begins with a phone call or letter requesting a meeting and describing concerns about a particular issue that usually relates to company performance or governance. The activist may ask that the board consider a particular course of action at the outset or develop its request through additional interaction. Where an activist’s private tactics fail or where the activist otherwise determines that media and investor pressure would further the activist’s objectives, the activist may make its intentions publicly known. Potential public tactics an activist may use include shareholder proposals, public letters, proxy contests, acquisition offers and litigation.
Notably, activists often operate in ways that do not trigger real time SEC disclosure. For example, activists may use derivatives to acquire a large stake all at once without prior notice, or work in parallel with other activists but without forming a group holding greater than 5 percent of company stock (to avoid disclosure on Schedule 13D). While activist funds must file quarterly reports (on Schedule 13F) regarding stock held in their portfolios, these reports are not due until 45 days after quarter-end. Therefore, this information is often out of date.
Reduced reliance on takeover defences in recent years, such as classified boards and shareholder rights plans, has made the threat of an expensive proxy contest more effective. Although activists may propose either a full or partial slate of director nominees instead ofthe company’s nominees, partial slate proxy contests are more common and more successful than proxy contests for full slates. Proxy advisers and large institutional investors are more likely to support some change in board composition short of a change in control.
Activist campaigns are often resolved in advance of a proxy contest through settlement agreements. These agreements typically specify actions to be taken by the company, such as nominating one or more of the activist’s representatives to the board, and frequently include a standstill period during which the activist will refrain from certain activities, such as increasing stock ownership or submitting proposals to be included in the proxy statement.
The board’s role and fiduciary duties
The board’s fiduciary duties remain the same during an activist campaign; the board must act in the best interests of the company and its shareholders. The board’s decisions about the company’s business and operations generally are protected by the business judgment rule. However, if in response to an unsolicited approach, a board adopts a corporate defence, such as a shareholder rights plan, courts are likely to apply an enhanced scrutiny standard to evaluate whether the board is fulfilling its fiduciary duties.
In overseeing management’s development and execution of corporate strategy, the board should be aware of alternative strategies or proposals that activists may present and should review them with management. While it is often prudent to engage with an activist rather than see the situation escalate into a public campaign and potential proxy contest, the board is under no specific duty to respond to or engage with an activist, or alter the company’s long-term strategy to achieve short-term shareholder gains.
Operating with directors nominated by activists
Having one or more directors on the board who were put there by agreement with the activist or by proxy contest will likely change board dynamics significantly. Boards should take reasonable actions in advance with advice of counsel to help assure that all directors understand and agree to adhere to policies on board confidentiality and director conduct. In negotiations with activists about adding their candidates to the board, the company should consider including, in an express agreement, limitations on the ability of their candidates once on boardto provide confidential information to the activist.
Boards should also carefully consider requests from directors that are nominated or designated by activists to form committees to explore strategic alternatives or major strategic transactions. These committees may provide benefits by helping to focus the board and may also serve as a ‘release valve’ for activist concerns. However, if these committees are not properly formulated and chartered, they may take over the development of corporate strategy from management and the rest of the board.
Michael J. Aiello is chairman of the Corporate Department and Holly J. Gregory is a partner at Weil, Gotshal & Manges LLP. Mr Aiello can be contacted on +1 (212) 310 8552 or by email: firstname.lastname@example.org. Ms Gregory can be contacted on +1 (212) 310 8038 or by email: email@example.com.
© Financier Worldwide
Michael J. Aiello and Holly J. Gregory
Weil, Gotshal & Manges LLP