22 March 2019 - Article
First published in the_ Harvard Law School Forum on Corporate Governance and Financial Regulation_, December 18, 2015.
Recently, our client, a NYSE-listed publicly traded firm, successfully defended against a proxy contest brought by an activist fund that in the first part of this year acquired 5.5% stake in the company. Following on earlier indications that it would do so, the fund notified the company in September that it intended to nominate six individuals for election to the seven member board of directors at the 2015 annual meeting of stockholders to be held in November. At the meeting, stockholders elected all seven incumbent director nominees and flatly rejected all of the fund's six nominees, despite ISS's recommendation in favor of three of the fund's nominees and Proxy Mosaic's recommendation in favor of all six of the fund's nominees. These results offer key lessons to companies under attack by dissidents, notwithstanding strong activist pressure with backing from ISS or other proxy advisors. Focus on Stockholder Value Creation: Business Strategy, Business Execution and Plans for Success The most important strategy for a company under attack by an activist is to defend itself with a well-crafted message that articulates a stockholder value creation strategy, founded on sound execution, industry dynamic and competitive principles, that logically lays out the company's plans to achieve success. An activist (as compared to the company) is inherently disadvantaged in its knowledge of the competitive landscape and business drivers of the company's industry and the plans that the company has to create value for its stockholders. The company's likelihood of success is greatly enhanced to the extent that the company can spell out the challenges and opportunities for the business and how the company is uniquely positioned, or will be uniquely positioned upon implementation of credible and actionable current plans, to meet those challenges and realize upon those opportunities. A company's operating success and achievement of financial milestones during the proxy contest can also be factors validating (or undermining) the company's message. Focus on Stockholder Rights: Good Governance and Stockholder Enfranchisement Often, an activist will seek to buttress its case for change at the board of the company by publicly identifying and criticizing the company for provisions in corporate documents and executive compensation arrangements that have the effect or appearance of entrenching the board or enriching management even in the absence of stockholder value creation. Sometimes, these provisions or arrangements have been in effect for many years, have never before been a concern of stockholders or have become outdated with the passage of time as practices and standards have evolved. When these provisions or arrangements are identified, it is important for the company to maintain its focus on acting for the benefit of stockholders and promptly take action or propose for stockholder action changes to eliminate legitimate concerns. For example, among other things, our client extended the date for its annual meeting to give a full opportunity for the activist fund to make its case and for stockholders to consider both the fund's case and the company's plans and goals. Our client also submitted for stockholder approval an amendment to its charter to eliminate a provision that was perceived to be a “dead hand” entrenchment device. These actions enabled the company to draw stockholders back to the key business strategy choices at hand and avoid being distracted by tangential issues that would appear to undermine the company's message about its stockholder oriented focus. Know the Activist: Diligence its Nominees and Strategy for the Company As mentioned above, an activist (as compared to the company) is inherently at an informational disadvantage and that disadvantage can be compounded unless the activist is willing to devote substantial resources (with true operational experience) to industry and its diligence and analysis. Accordingly, the activist will often articulate a strategy or assemble a group of nominees that has superficial appeal but is nonetheless fundamentally flawed. Engaging with the activist to gain a clear understanding of its knowledge of the business and industry and the effort that it has (or has not) invested in developing its business case for change as well the drivers behind its activism can be key factors in enabling the company to differentiate its strategy and the likelihood of success for its strategy and reinforce the message that it is focused on sustainable stockholder value creation. Solicit and Be Open to Stockholder Input It is also important for the company to solicit and be open to constructive input and criticism from stockholders. It is not unusual for the activist to try to paint the board and its nominees as being out of touch with stockholder concerns and solely focused on management entrenchment. The board (within and outside of the context of a proxy contest) should be engaged with stockholders and give serious consideration to their views. For example, our client engaged with the fund on more than 20 occasions, in addition to meetings with other stockholders. Despite assertions to the contrary, it was difficult for the fund to make credible claims that the company was insulated from stockholder views against this factual record. Avoid Being Reactionary While the board should take stockholder views into serious consideration, it is important for the company to exercise its independent judgment and pursue the business strategy that best maximizes value for all stockholders, as opposed to short-term goals of the activist. It is very tempting to read the campaign propaganda of an activist and want to immediately rebut those claims. However, this can be counterproductive, as it distracts the company and stockholders from the fundamental issues. Our client resisted this temptation and focused its efforts on business execution and clearly and succinctly articulating its strategy and objectives for the company, rather than hastily responding with rebuttals to each claim by the fund. Know the Activist's Record Given the extent of activism by some funds over the past years, the performance of companies in which the activist has had a hand is fair game for the company. It can be difficult for an activist to make a principled argument about long-term investment strategy and return, if the activist is known to repeatedly seek short-term gains and propose business strategies that are consistent with this short-term view. The company successfully demonstrated that the fund's strategies had not provided value to its previously targeted companies. Given the stated desire of many activists to obtain reimbursement for expenses related to the proxy contest, the lack of successful performance at other targeted companies can be a significant deterrent to broad stockholder support. Integrity and Candor Stockholders appreciate and respect integrity and candor. Above and beyond the requirements of securities laws and fiduciary duties to be truthful and accurate, stockholders are savvy and can discern half-truths, omissions and deception. For example, cherry-picking comparison companies, comparison periods or financial metrics undermines the credibility of any proponent. Our client was very diligent about stating its case in a clear and truthful manner, and allowing stockholders to draw their own conclusions. Ultimately, our client's convictions and understanding of the principles described above led to a highly successful outcome.
This post is based on a Withers memorandum written by Mr. Barker, Clyde Tinnen, and Michael Rueda.