By Brian Fenske and Trevor Pinkerton of Norton Rose Fulbright
Over the past few decades shareholder activism has grown into a major focus for investors and public companies, and in 2015 the explosion of activist investor efforts has not abated. Activist investors agitate for corporate change through their status as shareholders. They focus on various corporate issues, including corporate governance, mergers and acquisitions, cash dividends and stock buybacks, spin-offs, company strategy, and operations. Virtually any public company, large or small, can be the target for shareholder activism, so it is imperative that company management and board members take active steps to anticipate and proactively address an activist investor campaign. These ten steps will help your company begin to analyze and respond an activist investor before the need arises.
1. Know Activist History and Current Activist Efforts
Know your history. Since the 1980s activist investors have been a disruptive and controversial reality in the market place. Investors often follow patterns and seek similar goals, and management has at least 35 years of history from which to learn. To avoid repeating other company's mistakes and to anticipate investor efforts, management should stay abreast of current white papers, bi-yearly activist investor reports, and articles regarding recent activist shareholder tactics. In addition, once an activist has been identified, there are reports available that detail which companies they have publicly targeted previously and their tactics and results.
2. Learn What Advisory Firms Such as ISS and Glass Lewis Recommend
Activist investors pay attention to the recommendation of shareholder advisory firms such as International Shareholder Services and Glass Lewis. The board and management should be aware of these firm's recommendations on corporate governance, as the company's other major shareholders will be paying attention to overlap between these advisory bodies recommendations and the proposals of any activist investor.
3. Review the Company's Governing Documents
The articles of incorporation and bylaws of the company should be reviewed with the company's attorneys periodically to determine if there are structures in place that either draw activist investor fire or can be used to defend against an activist investor. Examine these corporate governance provisions by balancing a need for protection against hostile and destructive activists with an acceptance of ISS supported "best practices" that will remove some of activist shareholders' favorite corporate governance target recommendations. Adopting provisions such as advance notice; chairman control of meetings; board favorable adjournment mechanisms; record holder requirements for proposals and nominations; exclusive board right to fill vacancies; forum selection, fee shifting, and arbitration provision; and board removal requirements are some of the many ways that companies can modify their governing documents to allow sufficient time and leverage to adequately consider activist shareholder recommendations. However, any change to governing documents should be carefully considered in light of ISS recommendations and with the benefit of outside counsel.
4. Examine the Company's Financials from the Activist Perspective
Is your company undervalued? The determination that a company is undervalued has been the prime motivating factor for corporate raiders and activist investors since the 1980s. Management needs to examine the company's financial statements from an activist investor perspective with an eye toward the short term gains that activist investor seeks through spin-offs and divestitures. Is market value lower than book value? Is there a major disparity in performance between business segments? Are the company's business segments actually synergistically linked? Are the company's earnings commensurate or lower than its competitors? Answering questions like these honestly and objectively, and with input from the other members of senior management, will help bring the truth to light. Senior management's day job likely is not picking undervalued targets. The investor's is. But self-identifying as a potential target can make that first phone call from an activist investor a little less surprising and make management more prepared to react.
5. Critically Examine Board Composition and Performance
The composition of the company's board of directors is a frequent target of shareholder activism. Management and the board should examine the board's composition to identify potential weak points and lapses in performance. Have any board members consistently missed meetings? Does the board have a range of ages and applicable expertise? Are the prior qualifications and biographies of all the board members commensurate with the size and peer group of the company? Management should also work to identify rifts in board cohesion, as activists will often try to split board loyalty or play the board against management. Management and the long tenured board members should work to build chemistry between the members of the board and between the board and management, which is the fruit of honest dialogue, frequent communication, and an environment of trust.
6. Identify and Interview a Possible Defense Team
Once you have received "the call" from an activist investor, you want to be able to turn to senior management and say, "Call our team." Not, "Who do we talk to now?" Finding, interviewing, and retaining, reputable, effective, and appropriately priced advisors takes time. It is a process that is best performed with a cool head and a clear eye to budgeting, rather than during the emotionally heightened environment of an activist campaign. Your law firm and financial advisors should all be made familiar with the company's plan to respond to activist investors, and the company should also interview proxy solicitation and public relations experts in advance. This slate of advisors should help the company create the early stage response plan and provide sample timelines and strategies to respond to various activist recommendations.
7. Develop a Strategy, Budget, and Timeline for Pro-Active Defense
Use the advisors that the company identifies to chart out a strategy, budgets, and timelines to respond to activist shareholders. Having budgets and timelines in place will increase speed and efficiency when an activist actually shows up, and should be cheaper to produce, at least in skeleton form, without the pressure of an actual investor. Advance production of these tools also enables the board and management to make sure that they are on the same page from the moment of initial contact with the activist.
The board should also consider which board members are well suited and willing to form a special committee tasked with responding to an actual activist event. Forming a special committee will avoid cumbersome full board meetings and increase the committee's flexibility to respond to the activist in a timely manner. A settled communication plan between the board and the employees is also beneficial as it will help limit multiple points of contact with the activist and the media.
8. Learn the Signs of an Activist Investor
Activist campaigns take several forms - they may be conducted via private negotiations with the board and management or publically through media outlets and public securities filings. The company should monitor Schedule 13D filings with the U.S. Securities and Exchange Commission, as these can contain a wealth of information regarding shareholders who take a large stake (over 5%) in a public company. Activists are required to disclose information about their holdings, investment purpose, and their group of investors. However, many activists may agitate before their holdings reach the thresholds for 13D filing. The company's management should pay attention to attendees at annual meetings, shareholder positions, participants on earnings calls, and books and records requests from minor shareholders. In addition, activists also often fail to properly file 13Ds when they should, which gives the target company ammunition in the potential fight.
9. Listen to Your Shareholders, Including the Activist
The activist investor may be out for greenmail, but they might also have some good ideas. As with all board and management decisions, the board members and executives must exercise their fiduciary duties by making reasoned and well-informed business decisions that benefit the company and its shareholders. Most activist investors are successful individuals who have made a good deal of money identifying things that boards and management teams have missed. In order to make well-reasoned business decisions, the board and the executives should carefully listen to, understand, and consider the activists demands. Then implement the recommendations that make sense.
But do not be afraid to reject activist demands that do not make sense for the company's industry, market position, or values. While many activist investors have improved a company's returns, the radical and unfounded demands of other investors have resulted in catastrophic losses, unsustainable leverage, or have weakened the company's competitive position. If the board perceives that the activist's demands, after careful review, are detrimental to the company's shareholders as a whole, it should reject them and defend against the investor.
10. "Pride Goeth Before Destruction"
Approaching the reality that an activist investor may appear among the company's shareholders, examining the company in advance with an honest and objective eye, and considering the activist's recommendations dispassionately and without hubris will help the board and management make intelligent and responsible decisions when an activist investor does call the CEO. Prideful and unconsidered commitment to current strategy and a knee-jerk reaction to preserve the status quo may unintentionally result in bolstering the activist's case.
A board and management team that has prepared for the advent of an activist investor campaign and taken an honest appraisal of the company's financials, governing documents, and board composition will be much better positioned to thoughtfully analyze and then accept or reject an activist's proposal. Advance preparation, through budgeting and strategizing, should save the company money during the heightened emotions of a battle with a shareholder activist and enable better decision making.