Do-It-Yourself Shareholder Activism - A Risky Venture

January 24th, 2012
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Contributed by: Derek D. Bork, Thompson Hine LLP
Recent years have seen a significant rise in shareholder activism in the United States. Activist investors have increasingly been successful in pressing for meaningful governance and strategic changes at many public companies and in obtaining board representation, and often full board control, at many of these companies. Some reports have also indicated that activist investors have achieved increased returns from their activist efforts. At the same time, the success of activist investors has seemed to spawn a growing, but more risky, practice—activism undertaken without professional assistance, or what might be called “do-it-yourself activism.”

Many hedge funds and institutional shareholders are effective at communicating with companies on a day-to-day basis without the need for professional guidance, and the larger of these types of investors would typically not even think of engaging in an activist campaign without careful planning and professional assistance. On the other hand, smaller funds and individual investors sometimes enter the activist arena with a go-it-alone approach. We have seen a pattern of these types of investors getting tripped-up, most often by failing to develop a sound strategy for their campaign but, even worse, in some cases violating the law. If you decide to pursue an activist campaign, we would advise that you consider taking the following steps:

Engage a Proxy Solicitor

When our firm works with an activist, one of the first things we advise is to engage a proxy solicitor, or at least to have an initial consultation with one. A critical part of any activist campaign is to obtain an understanding of how a company’s shares are held and how the company’s shareholders are likely to vote on matters that you may put before them. For example, there is a significant difference between a shareholder base that includes a handful of shareholders together holding a majority of a company’s shares and a shareholder base that consists of thousands of shareholders each with only a handful of shares.

It is also important to understand the voting policies of institutional shareholders and the proxy advisory firms, and which institutional shareholders will follow or be influenced by the recommendations of the proxy advisory firms and how they will ultimately decide how to vote. An experienced proxy solicitor can help you put together this picture of a company fairly quickly.

The information that a proxy solicitor can provide is critical to the formulation of the strategy for an activist campaign. You might in some cases be able to obtain enough information about a company and its shareholders without a proxy solicitor, but it is not likely to be the most efficient and effective approach. The cost of a proxy solicitor can be modest, and they might even take your engagement on a contingent fee basis. A proxy solicitor is a “must” in a large activist campaign, but we believe they are just as important and can add significant value in any campaign.

Get Legal Assistance

Many of the activities involved in an activist campaign seem simple enough—acquiring a position in a company, talking with management, contacting other shareholders, writing public letters, issuing press releases, etc. However, each of these activities can trigger a variety of legal issues that may cause serious problems for an investor.

When acquiring a position in a public company, an investor needs to consider its SEC filing obligations, including a Schedule 13D when a 5% stake is acquired and Section 16 filings when a 10% stake is acquired, and the investor will need to consider the disclosure of any derivative or similar positions. In some cases, an HSR filing may be required. A Schedule 13D requires an investor to disclose its intentions with respect to the company, and SEC liability can follow if you fail to accurately disclose your activist efforts or plans. If you are speaking with other shareholders or coordinating your actions with them, you may need to file a Schedule 13D together as a “group.”

When communicating with other shareholders, activists also need to avoid engaging in an illegal “solicitation” under the federal proxy rules, which can occur through public statements or releases or through contacting more than a small number of shareholders. Activists should be careful that any public statements or releases do not contain accusations or statements that are defamatory, which might run afoul of SEC regulations or trigger a lawsuit against the activist. Anonymous postings on a message board or shareholder forum are not immune—your identity can be found through litigation. Activists should also be careful when buying or selling shares of the target company during a campaign, which could require disclosure in SEC filings and might raise insider trading issues. Selling shares during a campaign could also result in the recapture of trading profits under Section 16 of the Exchange Act.

The target company and its board will typically monitor an activist’s activities and filings very closely, and in many cases will report any disclosure deficiencies or legal violations to regulators. A legal problem arising in an activist campaign will not only damage the campaign, it could be detrimental to a hedge fund or other institution’s ability to raise funds in the future and could cause serious harm to an individual’s career, perhaps preventing future service as a public company director or officer.

Legal advice is necessary to avoid these problems, but it is also important to help guide an activist through a state’s corporate code, the target company’s governing documents and any other relevant instruments such as a poison pill; this is where an activist’s potential avenues of attack and a company’s defenses are found. The legal provisions found here are complex, and the way they work together is not always straightforward. A knowledge of applicable case law is fundamental to an understanding of how these provisions work and whether they are enforceable. As an example, in one campaign we encountered a target company with a by-law provision stating that a director could be removed by the other directors, which on its face could be a favorable provision in an activist campaign; however, this type of provision is likely unenforceable in most states. As another example, by-laws sometimes provide for a staggered board but they do not typically state what happens if you collapse the staggered board. (Directors’ terms are not typically cut short in that case.) There are countless other examples.

If an activist investor succeeds in negotiating for corporate governance or strategic changes with a company or obtaining one or more board seats, these points should typically be documented in a settlement agreement or other agreement that protects the investor and binds the company and its board. Without such an agreement, there are many ways a company can undermine the significance of a board seat or other concessions it has made, and an activist’s leverage against the company declines considerably once its campaign is suspended. Legal counsel can assist in crafting an agreement that protects what the investor has achieved with the company.

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