Ten Steps to Take to Prepare a Company for the New Age of Shareholder Activism & Prevent It from Being a Sitting Duck This Proxy Season
Over the past few years, shareholder activism has been on the rise if not surging. In 2007, according to data from research firm, FactSet SharkWatch, there were 501 activist campaigns, which represented a 17% increase from 429 campaigns the previous year. In many of the recent proxy contests and other activist campaigns, companies have found themselves caught off-guard, unprepared and quite vulnerable to the latest tactics employed by hedge funds and other activist shareholders seeking to exert substantial pressure and influence over the company’s day-to-day operations, with the “stated” overall goal of enhancing shareholder value. The threats posed by this new breed of shareholder activists are now commanding the close attention of boards of directors and senior management teams of public companies as they wrestle with how best to prepare for these new types of threats and how best to respond to them.
As the 2008 proxy season approaches, many companies will once again be targeted by hedge funds and other activist shareholders pursuing a variety of agendas and employing a variety of tactics. Amazingly, even though there has been extensive coverage in the business media about the numerous companies that have been targeted and/or caught off-guard by activist shareholders, many companies will find themselves “sitting ducks” for activist shareholders. In a number of these cases, had these companies been proactive in assessing how vulnerable they were to activist shareholders and in preparing for the possibility that they may become the target of one or more activist shareholders, they could have easily avoided becoming “easy prey.”
In this article, we will provide you with 10 steps you can take to prepare a public company for the new age of shareholder activism and prevent it from being a “sitting duck” not only this proxy season, but in the future as well.
1. Review corporate governance documents
This includes both the certificate of incorporation and the bylaws. With respect to the certificate of incorporation, the provisions (or in some case, the absence thereof) that deserve careful scrutiny would be provisions relating to how the size of the board is fixed, how directors are elected (annually or on a staggered basis), removal of directors, cumulative voting, the ability of shareholders to take corporate actions by written consent, the ability of shareholders to call special meetings and amendments to the bylaws). Because shareholders cannot unilaterally seek to amend the certificate of incorporation, in many cases, there are provisions that you would prefer be addressed in the certificate of incorporation rather than the bylaws. An example of those would be how the size of the board is set, who can fill vacancies that may arise in the board of directors and the vote required to amend the company’s bylaws. In other cases, unless the certificate of incorporation specifically denies shareholders a particular right, such as the ability to take actions by written consent, shareholders have that right irrespective of any contravening by-law provision so it is critical that the certificate of incorporation address the issue. While it is helpful to identify and analyze vulnerabilities in the certificate of incorporation, that analysis is less helpful in the near-term due to the length of time and various issues related to seeking shareholder approval for an amendment to the certificate of incorporation such as the anticipated reaction of institutional shareholders and the proxy advisory firms. Accordingly, in the near-term, the governing document that deserves your closer focus and attention is the bylaws. Generally, a company can amend its bylaws with only board approval. Of course, there are some provisions, such as the implementation of a classified board that require shareholder approval, but most bylaw amendments do not require shareholder approval. Among the provisions in the bylaws that should get careful scrutiny are the provisions relating to shareholder proposals, nominations of directors, who can call special meetings of shareholders, the removal of directors, who can fill vacancies arising on the board of directors, and the vote required to amend the bylaws.
Advance notice and nomination provisions — Ensure that the company’s bylaws contain state-of-the-art provisions relating to advance notice of shareholder proposals and advance notice of nominations. Avoiding surprises should be a significant priority for any company concerned that it may become the target of an activist shareholder. In general, unless the company’s bylaws provide otherwise, shareholders have the right to make proposals, including nominations for directors, for consideration by their fellow shareholders. These proposals can generally be made as late as the day of the annual meeting, in fact, even during the annual meeting. This means that if a shareholder had voting control over a sufficient number of shares, the shareholder could literally walk into the annual meeting, make his proposal, which could include a nomination of an opposing slate of directors, and vote enough shares to ensure that his proposal is approved. Even if the shareholder does not have enough votes “locked up” to just walk into the annual meeting and vote for his proposal, management would be caught off guard and would not have had the opportunity to actively solicit proxies in opposition to this proposal. Avoiding this kind of surprise is relatively easy through the adoption of advance notice and nomination bylaws. There is generally no requirement for such a bylaw to be submitted for shareholder approval (board approval alone is sufficient).
Typically, these provisions provide a window period during which shareholders must provide the company with notice that they intend to bring business before, or make nominations at, the annual meeting. The window period is typically keyed off the first anniversary of the immediately preceding year’s annual meeting. A common window period is no earlier than 120 days, and no later than 90 days, prior to the first anniversary of the preceding year’s annual meeting. In addition to the timely notice requirement, the advance notice and nomination provisions typically set forth detailed requirements as to what must be contained in that notice. If the company’s bylaws already contain advance notice and advance nomination provisions, you should review them in light of recent
Right to call a special meeting — Ensure that shareholders cannot call a special meeting. Alternatively, provide that only holders of a specific percentage (e.g., greater than 20%) of the company’s issued and outstanding shares can call a special meeting. The ability of shareholders to call a special meeting can be a useful tool in the hands of an activist shareholder, particularly when shareholders are not able to act by written consent. By being able to call a special meeting, a shareholder can seek to have shareholders approve one or more bylaw amendments and one or more non-binding resolutions such as a resolution calling for the company to dispose of a non-core business or calling for the exploration of strategic alternatives including the sale of the company. In the bylaws, the company should also require the shareholder requesting the call of a special meeting to demonstrate record ownership. In addition, the company should “lock-up” the bylaw provision that addresses who has the right to call special meetings so that a supermajority vote of the shareholders is required to amend or repeal this provision.
Vote required for the removal of directors for cause — Irrespective of whether the members of your board of directors are all elected annually or their election is staggered over three years, the Delaware corporation statute provides that directors may be removed for cause by the holders of a majority of the shares then entitled to vote at an election of directors. Accordingly, leaving aside the issue of how cause is defined, every
Filling of vacancies on the company’s board of directors — A company can lessen its vulnerability to having its directors removed without cause through a consent solicitation commenced by an activist shareholder by amending its bylaws to clarify that in the interim between annual meetings or special meetings called for the election of directors and/or the removal of one or more directors and for the filing of any vacancies in the board of directors, including vacancies resulting from the removal of directors for cause or without cause, any vacancy in the board of directors is to be filled exclusively by the vote of the remaining directors then in office as opposed to allowing shareholders to fill such vacancies. This bylaw amendment would also provide that the board’s appointees would serve for the remainder of the removed directors’ full term.
Vote required to amend the company’s bylaws — The
2. Anticipate who is likely to target the company
While some companies may from time to time be completely caught off guard, particularly if the company has no advance nomination or advance notice bylaws, many companies can often anticipate who is likely to target them. Assuming that the company can anticipate who is likely to target it, it should consider analyzing the personal and business backgrounds and affiliations of the activist shareholder who has targeted the company. If the activist shareholder has identified himself as part of a group, review the track record of the other participants. If any members of the activist shareholder’s group are former employees of the company, review their track records at the company as well as any confidentiality, severance or other agreements with the former employees to see if there are any covenants or other provisions still in effect that could be used to limit or prevent their participation in the proxy contest or consent solicitation.
3. Be the first to prepare a “white paper” on the company
If an activist shareholder were to send the company a “white paper” containing a list of ideas and suggestions for enhancing shareholder value, the company should be able to anticipate what that list may look like. It may even be helpful for the company to have an internal team or an outside consultant actually prepare the type of “white paper” that management would expect an activist shareholder to prepare. Have shareholder returns underperformed those of both the broader market and the company’s peer group index? Are there strategic initiatives that could be undertaken which would be expected to enhance or maximize shareholder value? Has management recently announced any strategic initiatives to maximize shareholder value? Is there a perception that management has become distracted by ancillary businesses and needs to sharpen its focus? Are there non-core businesses that could be spun-off to shareholders, perhaps tax-free or otherwise disposed of? Would the sale of these non-core businesses generate net cash proceeds that could be used to repurchase stock or declare a dividend? Is there significant intellectual property such as patents that can be monetized? Does the company have too much capital locked up in non-core real estate such as a corporate headquarters or other facilities that can be better deployed? Does the company have any large idle cash balances on its balance sheet that could be deployed in growing the business, repurchasing shares or funding a cash dividend? Is executive compensation sufficiently correlated to shareholder value? Are directors sufficiently motivated to enhance shareholder value? How does the company’s margins compare with its peer group? Is the company perceived as operating inefficiently? Are there opportunities to eliminate excessive overhead and engage in significant cost reductions that will not adversely affect the company’s ability to continue to grow? Has the company done any analysis or financial modeling to determine what would be the pro forma effect on the company’s earnings per share if it were to adopt a number of the suggestions that it would expect to be contained in a “white paper” prepared by an activist shareholder? Has the company or its investment bankers performed any financial analysis to determine what the company should be intrinsically worth notwithstanding the valuation of its securities in the public markets?
4. Be prepared to defend the company’s board nominees
In any situation where the company’s nominees for election to the board of directors will be competing with an opposing slate, the company should be prepared to defend its choice of nominees and explain why they are qualified to serve on the company’s board. Do the company’s nominees have knowledge of the company’s industry? Have the company’s nominees previously served in senior management positions at a public company? If a nominee does not have a business background, is it clear how that nominee’s background would be helpful to the company? Do the company’s nominees have sufficient literacy in financial and accounting matters? Do the company’s nominees serve on the board of directors of any other public companies? Are the company’s nominees able to commit a sufficient amount of time and focus to the company? Do the company’s nominees have any “baggage” that can adversely reflect on the company or which may be a time consuming distraction for the company? What board committees would the company’s nominees be expected to serve on and are they qualified to serve on those committees? What is the average tenure of the company’s board members? If the company has significant longevity on its board, is the company prepared to explain why its board is not in need of fresh perspectives, ideas, viewpoints and insights as well as new energy as the company seeks to confront the challenges that lie ahead? Is there a perception that the board has become somewhat “clubby” and insulated?
While there is no litmus test for who is qualified to serve on the board of directors of a public company, in a contested situation, the company should expect that the background and qualifications of its nominees will be thoroughly scrutinized, almost as though they were candidates for public office. In the past, it has not been uncommon for an activist shareholder to hire a private investigation firm to research the backgrounds and check resumes of incumbent board members and/or nominees. Has the company considered performing similar due diligence on its nominees to learn in advance what would be potentially learned by an activist shareholder?
5. Make the case for why the company should remain independent
Among other things, the company should expect that an activist investor will seek a review by the company’s board of strategic alternatives to enhance or maximize shareholder value which, naturally, may include the possible sale of the company. The company should be prepared to explain to its shareholders why they will be better off if the company remains independent. Can the company show how its current strategic and operational initiatives, over the long-term, will produce significantly more shareholder value than the current valuation attributed to the company by the trading markets? Would the company be particularly difficult to integrate into a larger company? Would some of the company’s key talent be expected to depart the company if it were to lose its independence? Is the company prepared to promote its long-term prospects as an independent company? Are there risks associated with the company remaining independent that are likely to be highlighted by activist shareholders? Does management understand those risks and can it explain how it is prepared to mitigate them? Are members of the company’s senior management team prepared to “hit the road” on short notice and make the case to shareholders as to why the company should remain independent?
6. Have the company demonstrate a commitment to best practices in corporate governance
An activist shareholder who is prepared to spend hundreds of thousands of dollars, if not millions of dollars, to wage a proxy fight, consent solicitation, or request that a special meeting of shareholders be called, is not generally motivated down this path because of his concerns about the company’s corporate governance rating. Given the significant amount of capital that the activist shareholder has invested in the company, his principal focus is more likely on how to enhance shareholder value. Nevertheless, the company should expect that an activist shareholder who has targeted the company will attack the company’s corporate governance practices and attempt to demonstrate how the company’s current corporate governance practices adversely affect shareholder value. Among other things, the company should expect that an activist shareholder will argue that management’s compensation is not sufficiently tied to shareholder value and, if management does not have significant stock ownership, that management’s interests are not sufficiently aligned with those of the shareholders. If there are any related party transactions, irrespective of the fairness or appropriateness of such transactions, the company should expect those transactions to be scrutinized and most likely criticized. In response to an attack on the company’s corporate governance practices, the company will need to be able to show how, under the stewardship of the company’s current management and board of directors, the company is committed to best practices in corporate governance. To be properly prepared, the company’s corporate governance practices should be closely examined to determine whether there are opportunities to improve its corporate governance profile.
7. Have a plan for winning the “hearts and minds” of shareholders
If the company was to become involved in a proxy contest or consent solicitation, much of the battle will be fought via press release, letters to shareholders or “fight letters,” advertisements in the major print media and, in the brave new world that we live in, on the Internet. Both the company and the activist shareholder will be seeking to win the “hearts and minds” of shareholders. The activist may put forth a “plan” for how he believes shareholder value can be enhanced. He will also attempt to show how management has mismanaged the company and is responsible for the company’s lackluster performance. The company should not only be able to anticipate and rebut the arguments and assertions that the activist shareholder will make, but it also needs to have ready its own elevator pitch and talking points as to why shareholders should support existing management. Can the company explain to its shareholders how it is executing on an effective strategic plan? Can the company explain to its shareholders how the company’s board and management are more likely to create value for shareholders than the team proposed by the activist shareholder? Or, how electing the company’s nominees will enhance shareholder value? What can the company point to by way of accomplishments that would be compelling to shareholders? What has been the company’s stock performance over the past three years? If the company has experienced challenges in recent years, can management defend how it dealt with these challenges? How can the company convince shareholders that it is committed to enhancing shareholder value? Can the company defend all of its recent acquisitions? If the company was previously subject to an investigation by the Securities and Exchange Commission or other regulatory agencies (e.g., stock option backdating, accounting irregularities, etc.), or recently had to restate its historical financial statements, can it successfully persuade shareholders that such issues are firmly in the past and that appropriate corrective action has been taken to prevent these types of issues from recurring? How can the company convince its shareholders that management is credible and can be trusted to keep its promises and commitments? How can the company show that management’s interests are aligned with those of shareholders? Can the company demonstrate how its current corporate governance practices are designed to promote shareholder value?
8. Publicize the company’s successes
How is the company perceived in the business and trade press? Has management’s strategic vision and blueprint for the future been properly communicated to the media? Has the company been proactive in publicizing its accomplishments? Should the company consider retaining a public relations firm to assist in telling the company’s story? If the company is already working with a public relations firm, is that firm adequately telling the company’s story? Are there positive stories about the company that are not being told? Is the company sufficiently leveraging its periodic filings with the SEC to communicate the company’s strategy, growth prospects and accomplishments? Are there opportunities to aggressively and proactively increase the company’s coverage in the trade and business press? Is the company sufficiently leveraging its website to provide investors, the media and the public with information about the company and its business? If the company has recently undertaken any strategic initiatives such as acquisitions, has it sufficiently explained the rationale for the transactions?
9. Engage with the company’s investor base
In order to win the shareholder vote in a proxy contest, the company will need the support of its major shareholders. The best time to seek such support is not in the midst of a proxy contest. The company’s management should be actively engaged in an ongoing dialogue with its major shareholders so that they understand the company’s direction, management’s vision and the strategy that is being pursued by management. The company will also want major shareholders to understand the challenges the company is facing, including those that are macro in nature and are not within the day-to-day control of the company’s management. While this open and ongoing dialogue with major shareholders is critical if management is going to be able to retain their support in a contested solicitation, management must be mindful not to engage in any selective disclosure that would cause the company to violate the SEC’s Regulation FD (Fair Disclosure). Regulation FD provides that when an issuer, or person acting on its behalf, discloses material nonpublic information to certain enumerated persons (in general, securities market professionals and holders of the issuer’s securities who may well trade on the basis of the information), it must make public disclosure of that information. The timing of the required public disclosure depends on whether the selective disclosure was intentional or non-intentional; for an intentional selective disclosure, the issuer must make public disclosure simultaneously; for a non-intentional disclosure, the issuer must make public disclosure promptly. Under the regulation, the required public disclosure may be made by filing or furnishing a Form 8-K, or by another method or combination of methods that is reasonably designed to effect broad, non-exclusionary distribution of the information to the public. Accordingly, to the extent that management intends to provide major shareholders with any material nonpublic information, the company needs to either first or simultaneously make such information available to the public on a broad, non-exclusionary basis, such as through a press release or a Form 8-K.
Does the company have an active investor relations program? Should the company retain an investor relations firm? If the company is already working with an investor relations firm, is that firm adequately representing the company? Does management meet regularly with its major shareholders? Has the company’s investor presentation been recently updated? Has it been critiqued? If the company had to prepare an investor presentation tailored to “pitching” investors on how to vote their shares in a proxy contest or consent solicitation, what would be the major talking points? Is the company providing the investor community with sufficient information? Is management participating in enough investor conferences? Are the company’s earnings conference calls well attended? Does the company provide sufficient “color” around the numbers? If the company had to prepare a presentation tailored to “pitching” the major proxy advisory firms to recommend that shareholders support management in a proxy contest or consent solicitation, what would be the major talking points?
10. Have a “rapid response team” ready to go
In the event the company becomes the target of one or more activist shareholders this proxy season, has it identified the internal and external personnel who will form its “rapid response team?” Now is the time to begin identifying personnel within the company who will be the key members of that team. In addition to the company’s chief financial officer and general counsel, the team should include representatives from the legal, finance, accounting, investor relations and corporate communications departments. Externally, in addition to outside counsel, the team should include a proxy solicitor, public relations firm and an investor relations firm. The objective is to have a team ready to go in the event the company is targeted. Once the company is targeted by an activist shareholder, the company’s ability to move quickly will be an essential determinant of whether the company will be successful in avoiding or defeating a contested solicitation. At the time the company first becomes aware that it has been targeted by an activist shareholder, it is likely that the activist shareholder has already been planning its approach and developing its strategy for quite some time.
Conclusion
We fully expect that hedge funds and other activist shareholders will be very visible and active this proxy season and for the foreseeable future and that many companies will find themselves clearly in their “bulls-eye.” We hope that the discussion above will help you to take the necessary steps to both assess and mitigate some of the company’s more obvious vulnerabilities and, consequently, avoid being perceived by an activist shareholder as a “sitting duck.”
Originally published in the April 2008 issue of Wall Street Lawyer (vol. 12., no. 4). © 2008 Thomson/West. Reprinted with permission.