Dealing with Shareholder Activism
26th Annual Tulane Corporate Law Institute
March 27, 2014
David A. Katz (moderator)
Wachtell, Lipton, Rosen & Katz
Daniel H. Burch
MacKenzie Partners, Inc.
Christopher Cernich
Institutional Shareholder Services, Inc.
Joele Frank
Joele Frank, Wilkinson Brimmer Katcher
Victor I. Lewkow
Cleary Gottlieb Steen & Hamilton LLP
Steve Wolosky
Olshan Frome Wolosky LLP
Three Basic Types of Activists
• Governance activists
• Social issue activists
• Economic activists
1
Governance Activists
• Principal areas of reforms include:
Executive
Compensation
Risk Management
•
Enhanced Risk
Management
Disclosure
Board Responsibility
for Risk Management
and Risk Failures
Mandatory Board-level
Risk Committees
CEO Succession
Planning Disclosure
•
•
Say-on-Pay
Say-on-Golden
Parachutes
Cut Backs on Golden
Parachutes/ Eliminate
Gross-Ups
Clawbacks
Enhanced
Compensation
Disclosure
Independent
Compensation
Committees and
Consultants
Board Structure
•
•
•
Separate Chair/CEO
Director Independence
Elimination of
Classified Boards
Enhanced Board
Structure Disclosure
Board Diversity Policy
Disclosure
Direct Shareholder
Communication with
Independent Directors
Director Elections
•
•
Majority Voting
Shareholder Proxy
Access
Eliminate Broker
Discretionary Voting
Enhanced Candidate
Qualifications
Disclosure
Risk Management
Executive Compensation
Board Structure
Director Elections
Takeover Defenses
•
•
•
•
•
•
•
•
•
•
•
•
Takeover Defenses
•
•
•
•
•
Eliminate Shareholder
Rights Plans
Eliminate Classified
Boards
Lower Threshold for
Shareholder-Initiated
Special Meetings
Permit Shareholders to
Act by Written Consent
Eliminate
Supermajority Voting
Provisions
• Evolving governance regime is derived from federal legislation, SEC rulemaking, state
corporate legislation, stock exchange rules, shareholder proposals, “best-practice”
standards and judicial decisions, principally those of the Delaware Court of Chancery.
• Economic activists often use governance as a means to an economic end
2
Top 10 shareholder proposals in 2013
Shareholder proposal type
Prevalence
(1)
Rejected
Approved
Pending
Average %
voted for
Independent chairman/separate chair and CEO roles
59
54
5
–
31.6%
Stock retention/holding requirement
35
35
–
–
23.7%
Pro-rata vesting of equity awards upon change in control
32
32
–
–
33.6%
Require majority voting in the election of directors
31
15
16
–
57.9%
Repeal classified board
30
3
27
–
78.9%
Allow for or decrease requirement to act by written consent
27
26
1
–
39.9%
Redeem or require shareholder vote on poison pill
21
2
19
–
73.8%
Eliminate supermajority requirements
21
4
17
–
71.7%
Proxy access
12
9
3
–
30.9%
Allow for or decrease requirement to call special meetings
11
7
4
–
44.5%
Source: SharkRepellent Russell 3000 data as of December 31, 2013 – compiled by Credit Suisse.
(1)
Includes proposals that went to a vote. Does not include pending proposals.
3
Social Issue Activists
• Corporate social responsibility is a major concern for companies and boards.
• Over 350 “environmental and social” Rule 14a-8 shareholder resolutions proposed
during the 2013 proxy season, including:
– Political contributions and activity (115)
– Environmental issues (including climate change, energy, other) (80) and sustainability (36)
– Human rights (25)
– Board diversity (24)
– Animal welfare (15)
– Sexual orientation nondiscrimination/EEO reporting (13)
• Enhanced focus on political spending in light of the Supreme Court’s 2010 Citizens
United decision (and affirmation in 2012).
– Petition for rule-making by academic group (including Bebchuk) on political spending disclosure
under consideration by SEC.
• For the 2013 proxy season, ISS updated its voting policy on social and environmental
proposals with a case-by-case recommendation considering whether implementation is
likely to enhance and protect shareholder value and a number of enumerated factors.
• United Nations blueprint to promote human rights in the conduct of global business.
4
What do the typical Economic Activists want?
• Objective: to make the company engage in “value-maximizing” activity (but short-term demands
often conflict with long-term value creation).
Demands
•
•
•
•
•
•
•
•
•
Sale of company or division
Block transaction
Increased merger consideration
New capital structure/allocation
Special dividends
Spin-offs
Management/board change
Compensation reform
New strategies
Tactics
•
•
•
•
•
•
•
•
•
Divide board/management
Request meetings
Threaten public action
Issue open letters “to the board”
Behave aggressively on analyst calls
Threaten withhold campaigns
Oppose strategic/M&A plans
Launch short-slate proxy contest
Offer to buy the company
• Performance is not a defense. One-third of targets outperformed their peers in the 12 months preceding an
activist attack.
• Size is not a defense. Since January 2011, over 75 instances of activist campaigns targeting companies with
$10 billion+ in market capitalization.
• Economic activism often piggybacks on governance activism. Governance issues offer “levers” for activists to
compel events at target companies, and governance activism has made economic activism more effective
(e.g., by eroding takeover defenses).
5
The current Economic Activist landscape

Activists are “value investors on steroids”

New funds recently formed by second generation activists include Marcato, Sachem Head and Sarissa

Pershing Square and Third Point have formed permanent capital vehicles

Activism is a mature asset class generating uncorrelated returns
Few companies
are invulnerable

Well “connected” Boards or insider ownership are only limited deterrents against shareholder activism

Activists have targeted large cap companies with small stakes, including Microsoft, Apple, P&G and Hess
Mainstream
activism

Mainstream investors are increasingly working with activists behind the scenes in a symbiotic relationship

Reduced stigma is associated with supporting activists publicly and privately

Support of mainstream investors is critical in large cap activism

Reduced stigma associated with activism is reflected in high-quality dissident Board candidates

Settlements continue to be the preferred outcome for most activists and target companies
The activism
platform
Recent
developments
Selected activist campaigns (LTM)
Company
Apple
Microsoft
Wal-Mart
Procter & Gamble
PepsiCo
PepsiCo
Dell
Hess
T ransocean
Market
Capitalization ($B)(1) Activist(s)
$431.1
Greenlight, Carl Icahn
295.1
ValueAct
200.5
CalST RS, N.Y. Pension Funds
167.8
Pershing Square
125.5
T rian
104.2
Relational
23.5
Southeastern, Carl Icahn
20.1
Elliott Associates, Relational
20.0
Carl Icahn
Activist goal(s)
Return cash to shareholders
Board seats
Management and Board changes
Management and Board changes
Acquire Mondelez then spin off beverage unit
Spin off of North American beverages business
Opposing proposed buyout
Break up company and Board changes
Return cash to shareholders and Board changes
Source: Public filings – compiled by Credit Suisse
(1)
Market capitalization at time of announcement.
6
Shareholder Activism:
Size/Performance are No Longer a Defense
7
Shareholder Activism: Growing Resources
• Heightened levels of activist activity set to continue.
• More capital, more campaigns.
Estimated Activist Fund Assets Under Management ($ billions)
$100+
$93
$66
$55
$51
$48
$47
$32
$29
$36
$19
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
Q1 2014
8
The number of activist campaigns has increased
Activist campaigns (2000 – 2013)
“Desperate” activists
respond to 2008 meltdown
The birth of modern-day
activism
Source: SharkRepellent. – compiled by Credit Suisse
Note: Data as of December 31, 2013.
9
Activist 13Ds over time
13Ds filed by known activists with specific demands (2007 – 2013)
160
113
78
82
71
74
46
2007
2008
2009
2010
2011
2012
2013
Source: 13D Monitor as of December 31, 2013 – compiled by Credit Suisse
Note: Includes initial 13Ds filed by known activists with specific demands as defined by 13D Monitor.
10
Proxy fight statistics post–2008(1)
Proxy fight outcomes
Dissident election
Settled without
board seats
12%
Total: 468 proxy fights
Total: 160 elections
Dissidents won at least one seat in ~45% of all proxy fights by either settlement or shareholder vote
Source: SharkRepellent data as of December 31, 2013 – compiled by Credit Suisse.
(1)
Includes proxy fights from January 1, 2009 to September 30, 2013.
11
The number of proxy fights rose in 2013, following a
decline after the financial crisis
Proxy contests(1)
(39%)
17%
(2)
Source: SharkRepellent data as of December 31, 2013 – compiled by Credit Suisse.
(1)
Campaigns where formal notice of dissident proxy is publicly disclosed.
(2)
Seeking more than half of the Board seats.
12
Shareholder support for dissident nominees has
increased in recent years
Vote results
47
57
56
Average
~46% of
fights won
at least 1
seat
32
22
40
42
57%
45%
57%
(1)
47%
45%
38%
35%
(4)
(2)
(3)
Anecdotal evidence indicates many “vanilla” investors wonder “what’s the harm?” of seating a shareholder “watch dog” on the
board
Source:
(1)
(2)
(3)
(4)
SharkRepellent data as of December 31, 2013 – compiled by Credit Suisse.
Includes winning half of the seats sought and campaigns which were settled prior to a vote and after an ISS recommendation was issued.
Includes campaigns that were settled prior to a vote and after an ISS recommendation was issued.
Includes campaigns that were withdrawn prior to a vote and after an ISS recommendation was issued.
Includes 4 campaigns settled post ISS recommendation: Sandridge Energy, Ferro Corp., Hess Corp., Tessera Technologies.
13
ISS has recommended in favor of dissidents
approximately 50% of the time
ISS vote recommendations
47
57
56
40
42%
35%
22
42%
32
42
54%
50%
30%
26%
(1)
(2)
In essence, obtaining ISS support is a “coin flip”
Source:
Note:
(1)
(2)
SharkRepellent and ISS data as of December 31, 2013 – compiled by Credit Suisse.
Percentages based on the total number of proxy fights where FactSet captures the ISS recommendation.
Includes supporting half the dissident slate.
Proxy fights that went to a vote with no ISS recommendation. ISS does not cover targets that are LLPs, LLCs, privately held, or have no
ISS clients as investors.
14
Given the relative dissident success in contests, it’s not
surprising that many targets have decided to settle
“Settlement fever”
41%
38%
32%
44%
47%
37%
42%
The expense and bandwidth requirements of a full campaign are onerous for companies and activists
Source: SharkRepellent data as of December 31, 2013 – compiled by Credit Suisse.
15
Numerous Factors Drive Vulnerability to Activists
Strategic
attractiveness
Financial
performance
“Hidden” values
Capital market
receptivity
Potential buyer
appetite
Factors affecting
potential
vulnerability
Ownership
profile
Structural
defenses
Change-incontrol
provisions
Trading
performance/
market
valuation
Other liabilities
(environmental,
litigation,
pension/ESOP)
16
Activists often make multiple demands
Activist campaign menu
M&A activism
The easiest activist strategy – quick capture of a takeover premium provides attractive
returns over a short term using leverage
 Commence a process to sell the company
 Break-up companies to unlock “hidden” value
1)Elimination of the “conglomerate discount”
2)Focus on high ROIC “core” businesses
 Hold up transactions for sweeteners (“bumpitrage”) or block deals (“snap-back trade”)
Balance sheet
activism
An easy strategy – run a simple screen to identify targets

Return capital to shareholders (share buyback, special dividend)

Record high cash on balance sheets, but subject to repatriation tax leakage
“Operational”
activism
The hardest and rarest strategy – requires industry experience and patience
 Focus on income statement (“private equity disintermediation”)
 Change management, including direct attacks on CEO (“alpha by decapitation”)
 Rationalize cost structure (SG&A, R&D) and maximize ROIC
Governance
activism
A means to an end, not an end in itself

Replace directors via a proxy fight or public or private pressure

Push for governance “best practices”
Selected Campaigns
The more actionable value levers, the more attractive the target
17
Recent activist campaigns for board control (select examples)
GrafTech / Milikowsky Group
Health Management Associates / Glenview
• Directors Nominated: 5 (of 7) director candidates nominated by dissident
• Directors Nominated: 8 (of 8) director candidates nominated by dissident
• Ownership Stake: 11.2% stake
• Ownership Stake: 15% stake in HMA and 9.6% in Community Health
• Rights Plan: Expired prior to fight; not renewed
• Pill: 15%
• Current Status: Ongoing; Milikowsky claims he was forced off the Board on
insider trading-related charges and plans to fight for his own Board seat
• Current Status: Glenview's consent solicitation seeking to remove all HMA directors
and replace them with 8 dissident nominees was successful; HMA ultimately entered
into a definitive merger agreement with Community Health
Cliffs Natural Resources / Casablanca Capital LP
• Directors Nominated: 6 (of 11) director candidates nominated and proposed
CEO put forth by dissident
• Ownership Stake: 5.2% stake
• Rights Plan: No
• Current Status: Cliffs postponed the record date for its 2014 annual meeting;
Cliffs disclosed that it offered Casablanca to appoint two directors on the Board
and a third mutually agreed upon director to be named at a later date; Casablanca
rejected the settlement offer and its proceeding with proxy solicitation
CommonWealth REIT / Corvex / Related
• Directors Nominated: 7 (of 7) director candidates nominated by dissident
• Ownership Stake: Dissidents together have a 9.6% stake
• Rights Plan: 10%
• Current Status: Corvex / Related received written consents from 81% of
shareholders to remove entire CWH Board of Trustees
Aaron’s / Vintage / Starboard
• Directors Nominated: Vintage nominated 5 (of 10) director candidates nominated;
Starboard later nominated 4 (of 10) director candidates
• Ownership Stake: Vintage and affiliate funds owns 10.1%; Starboard position not
public
• Pill: No
• Current Status: Pending
Intevac / Voce / Becker Drapkin
• Directors Nominated: Voce nominated 3 of (7) director candidates; Following
Voce’s nominations, Becker Drapkin approached the Company regarding interest in
Board nominations
• Ownership Stake: Voce has an 0.49% stake in Intevac, Becker Drapkin has a 4.5%
stake
• Pill: No
• Current Status: Ongoing; Intevac agreed to add Matt Drapkin to the Board; Voce
decided to move forward with nomination of three director candidates
…In addition to a significant number of private situations
- While settlements are generally on the rise, activists seeking control are more resistant to a settlement - In the 11 contests where Board control was at risk, ISS supported partial dissident slates in seven contests, a
full dissident slate in two contests, and management’s full slate in two contests 18
Shareholder Activism in M&A Situations
•How will significant shareholders respond to the announced
transaction?
•Does the merger agreement provide any conditions that an activist
can exploit?
– Supermajority shareholder approval requirements
– Class votes
– Appraisal rights conditions
– Third party consents as a condition
– Special regulatory approvals
• Be wary of games played with appraisal rights
• Analyze the situation like you would with a potential interoper
• Is there any particular “hold-up” value?
19
What to do before the activist shows up
• Establish and leverage core team
– Management, lawyers, bankers, IR/PR, proxy solicitors
– Conduct regular update calls
• Assess and address vulnerabilities
– Operational / strategic weaknesses
– Structural defenses
– Corporate governance policies
– Key proxy deadlines
• Track peer performance
– Proxy advisory firms (e.g. ISS) and activists use relative performance to make their case
– Key metrics include: 1-, 3-, 5-yr stock performance, ROI, executive compensation comparisons, governance
policies
• Consider need to ramp up IR / PR efforts and sharpen roadshow presentation
– Goal is to ensure large base of supportive investors and other third parties
– Use planned events (e.g. earnings) to reinforce progress against benchmarks and metrics
– Consider increasing frequency of momentum (“positive”) announcements – operating milestones, key hires,
new guidance, etc.
20
What to do before the activist shows up (cont’d)
• Identify and cultivate third party supporters
– Institutional investors
– Sell-side / industry analysts
– Customers, business partners
– Business / trade organizations
– Traditional shareholder advocates (aka the “corporate governance gurus”)
• Refresh media relationships
– Conduct interviews around planned corporate events (e.g. earnings) or other “easy wins” (e.g.
project announcements)
• Identify spokespeople and conduct training as appropriate
– Independent board representative(s) will be needed in addition to management
Simply good investor relations – blocking and tackling
21
Advance preparation is critical
• Stay one step ahead
– Core hedge fund strategy is to create a wedge between the company and its shareholders through
embarrassment or suggestion of ideas that management supposedly missed
• Look at your business the way a short-term financial investor would
– What past decisions (e.g., acquisitions) is the activist likely to focus on?
– What value does the activist perceive; what approach does the activist propose for “unlocking”
value?
– Analyze “capital allocation” strategies and alternatives (“excess cash” on balance sheet)
– Much better if done during “peacetime”
• Build and maintain credibility with shareholders and analysts before activists
surface
• Consider the takeover landscape in your industry
– Who might be tempted to acquire you for operational or synergy reasons or as a result of industry
dynamics?
22
Advance preparation is critical (cont’d)
• Be alert to early warning signs, such as:
– Extremely pointed questions during Q&A
– Analyst reports suggesting structural changes
– Changes in shareholder base – stealth acquisitions
– What has the activist done in the past?
• Be ready for the first phone call
– Company can spend years recovering from mistake made in the first conversation
– Establish internal and external teams, including advisors
23
Activist Hedge Fund “Playbook”
Build Stake
•
Apply Pressure
Accumulate initial stake (may
include “hidden” economic
ownership amassed through
derivatives)
•
•
Seek Control Influence
Request meetings with
management and/or Board
•
Demand Board seats
•
Launch short-slate proxy contest
•
Send private letters threatening
public action
•
Aggressive 13D disclosures
File HSR
•
Issue open letters to Board
•
•
Continue to build stake
Aggressive use of derivatives
(“riskless voting”)
•
•
File 13D
Become aggressive with
management on analyst calls
•
Make public bear hug (rarely)
•
Team up with other institutional
or activist shareholders (“wolf
pack”)
•
Threaten “withhold the vote”
campaign
•
Commence tender offer (rarely)
•
Threaten to agitate against
Board’s preferred strategic
alternatives or to vote against
Board-approved M&A activity
•
Seek to stir up third-party
interest and rally other investors
24
What can the Board expect?
• Opposition
– Company, Board and management team go under a microscope
– Greater scrutiny by investors and media
– No strategy or statement goes unchallenged
– Directors and management open to public criticism
• Similar to a political campaign
– Battle for shareholder support / votes
– Rhetoric can often be heated
– Third party advocates needed
– Strategic, “rapid response” communications required
• Critical to stay on message and control the forum for delivery
• Need optimal coordination to succeed
Everything you say can and will be used against you in the court of
shareholder opinion
25
What can the Board expect? (cont’d)
• Taking the “high road” on the record is key to the public relations strategy
– Need to maintain consistency of message along with rapid response
– Deal with responses to dissident’s attack points – initially indirectly and at times more pointedly
• Board will be kept informed of dissident activity and proxy communications
– Press releases, media coverage, analyst reports, SEC filings, etc.
• Key strategic discussions to be made in close cooperation with the Board
• Board representatives should join management in attending ISS meeting and select
investor meetings
• Screen phone calls (office and cell)
– Dissidents may try to contact Board members directly, all conversations are “on the record” and
any comments may be used by dissidents in their proxy materials
– Preference is for all communications to be channeled through designated spokespeople
• Board meeting calendars should remain confidential
• Individual directors may be targets of attacks
– Like the Company, directors may be put under the microscope
– Responses to be coordinated by Company and advisors
26
IR Tactics and Considerations
• Regular, targeted one-on-one meetings
– Major vehicle for communicating with investors and sell-side analysts
– No substitute for in-person meeting with a CEO and / or executive team
– Controlled forum for delivering messages
• Large format or group meetings must be carefully considered
– Limit group meetings (including dinners and lunches)
– Level of control is significantly diminished
– Company can be exposed to a “mob” mentality
– Easy for opposition to cause trouble
• Sell-side needs to be educated
27
Key documents in a proxy contest
• Shareholder “fight” letters
– Proxy cards sent by dissident and Company to shareholders multiple times, accompanied by
“fight letters”
– First fight letter includes multiple themes; subsequent letters often single-themed
– Can be used as press releases or 8-K filings
– Consider whether Company letters are public or private (can also use PRs to send to reporters)
• SEC filings
– Letters, press releases, presentations, statements can all be filed as 8-K (Company),
13-D / 13-DA (dissident) or 14A (both Company and dissident)
– 8-K filings are used to “lower the volume”
• Presentations
– Used in meetings with investors and proxy advisory firms
– Helps educate media and other key constituencies
28
Key documents in a proxy contest (cont’d)
• Press releases
– Primary and fastest method to reach all audiences and directly communicate key messages
• Standby statements
– Responsive
• Ancillary communication materials
– Special section on Company website – op-eds, letters to / from government officials, community
leaders, potential third-party supporters, retirees, other constituencies, etc.
29
Typical Proxy Fight Timeline
45 to 40 Days
38 to 32 Days
31 to 24 Days
21 to 14 Days
File definitive proxy materials, issue press release with 1st fight letter;
Mail “stop look listen” letter
Mail 2nd fight letter, issue press release
Mail 3rd fight letter, issue press release
IR / PR
Strategy
ISS meetings; Glass Lewis outreach; issue press release with 4th
fight letter
14 to 7 Days
•One-on-ones
with major
stockholders
10 to 7 Days
•Brief reporters
5 to 2 Days
Day 0
ISS, Glass Lewis decisions: Both parties likely to issue
press releases upon decisions
•Telephone campaign
(if appropriate)
•Final calls / visits with major
investors
Mail 5th fight letter, issue press release
Issue open stockholder letters as
press releases, as appropriate
Stockholder meeting
30
Dealing with Economic Activism Effectively
• Continue to focus on the business
• Renew focus on investor relations
• Anticipate threats
• Review advance notice deadlines for shareholder proposals and nominations to strike
the right “balance”
• Financial preparedness
• Legal/structural preparedness
• Focus on the activist’s agenda, 13D and track record and consider advantages of early
engagement with the activist
• Be prepared to expose fight; do not allow activists to frame the public agenda
• Litigation is commenced infrequently – hard to sue a shareholder
• Negotiation may be a productive path – not all settlements public – consider the
alternatives
31
Responding to the Activist’s Approach
• Key judgment to make is can/will the activist pursue a takeover bid or is it simply
seeking to influence policy?
– Establish a single point of contact and maintain a unified front
– Consider advantages of engaging with the activist early – ignoring them will not make them
disappear
– Communicate open-mindedness and flexibility
 Prepare to explain the rationale for the company’s strategy; demonstrate preparedness
 Be willing to listen
– Be willing to negotiate and/or cooperate if circumstances warrant
 But do not allow activists to wrap themselves in “moral high ground” of corporate governance – expose
short-term motives.
 Activists’ bark is often louder than their bite
 Be sure to consider what is ultimately at stake
– Always think about the record you are creating – how will it play in a proxy contest?
32
Fiduciary Responsibilities of a Board When
Responding to Activists
• Board as negotiating representative
– Board cannot be passive –should be active and engaged
– Smith v. Van Gorkom: a shareholder vote does not absolve the Board
– Cannot negotiate effectively unless you have the power to walk away
 “Just Say No”
– Directors’ duty in context of a decision to sell control is to obtain the highest value reasonably
available for shareholders (the Revlon rule)
• Takeover defenses enhance Board’s negotiating power
• Board’s responses to activists and proposals not seeking a takeover are subject to
business judgment rule, with the Board able to take into account the long term interests
of the corporation and its shareholders
• If an activist gains minority representation on the Board, the Board still should attempt
to make decisions collectively and collegially, and act as a group – board counsel can
play a critical role here
33
Influential & “independent” outsiders are often
key voices in determining outcomes
• Institutional Shareholder Services (ISS)
– Leading proxy advisory firm in terms of size and influence
– More than 1,200 clients: institutions, mutual funds, corporate and public pension funds, hedge funds, college endowments and other ISS
followers
– Many institutions strictly follow ISS recommendations when voting their shares
– Reviews issues separately with both sides in a proxy contest before releasing its recommendation to clients
– ISS report will be issued approximately 10-14 days before meeting
– Often ISS can significantly influence 20-30% of the vote in a proxy contest
– Recently began opining on tender offers
• Glass Lewis & Co.
– Major competitor of ISS, now owned by Ontario Teachers’ Pension Plan Board
– Many of the largest institutions, mutual funds, index and public pension funds subscribe to Glass Lewis (generally also subscribe to ISS)
– In 2010, Glass Lewis acquired the #3 player, Proxy Governance
– Hosts a public forum called “Proxy Talk” – both sides speak to Glass Lewis clients in select proxy contests (aka public debate)
– Glass Lewis can influence 10% or more of the vote in a proxy contest
– May make different voting recommendations in proxy contests from ISS, but still favors minority representation for dissident shareholders\
• Egan-Jones Proxy Services
– Provides voting recommendations on a few companies
– Usually does NOT meet with either side in proxy contests, but may have conference calls
ISS has generally supported hostile transactions, recommended AGAINST management-supported transactions opposed by
hedge funds or other shareholders, and recommended FOR hedge fund minority slates
34
Proxy Advisory Firms: Is Influence Peaking?
• In July 2013, SEC Commissioner Daniel Gallagher expressed concern about the influence wielded
by proxy advisory firms and lamented the SEC’s role as a “significant enabler” of the tendency of
institutional investment advisers to “view their responsibility to vote on proxy matters with more of
a compliance mindset than a fiduciary mindset.” This was followed by an SEC roundtable.
– On March 19, 2014, SEC Chair Mary Jo White disclosed that the SEC will soon review recommendations for
possible regulatory action targeting proxy advisory firms
• Similarly, the Canadian Securities Administrators (CSA), an umbrella organization of Canada’s
provincial and territorial securities regulators, recently issued an update on their ongoing,
consultative process concerning possible regulation of proxy advisory firms.
– The CSA expects to publish a policy-based approach for comment in the 1Q2014 that would “promote
transparency and understanding” and provide guidance on recommended practices and disclosure.
• Yet, even as the SEC takes note of proxy advisory firms’ influence, the power of ISS and Glass
Lewis seems to be waning, at least slightly.
– With respect to say-on-pay votes, for example, 261 companies received negative ISS recommendations in
2013, yet only 18% failed to win majority approval.
– Moreover, while in 2012, 100 companies reacted to negative vote recommendations from proxy advisors by
filing supplemental materials, in 2013, only 59 companies did so.
– In addition, some major institutional investors (e.g., BlackRock) are increasingly internalizing the function of
proxy analysis and vote determinations.
35
ISS proxy fight recommendations are highly consistent
with shareholder vote preferences
2013 ISS vote recommendations vs. vote results
Contrary to conventional wisdom, ISS recommendations are generally in line with the shareholder
consensus
Source: SharkRepellent data as of December 31, 2013.
Note: Includes 36 U.S. contests where ISS provided a vote recommendation for meetings since January 1, 2013. Includes contests that were
settled or withdrawn.
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The recommendation of ISS will be important
in a proxy contest
• ISS governance proxy fight analytical framework – three key questions:
– Have the dissidents met their burden of proving some Board change is warranted?
– If so, is the dissident slate more likely to help create shareholder value?
– Majority contests: the dissidents should provide a detailed plan, which ISS will compare with
the incumbent plan
ISS can impact up to 30% of the vote, so navigating the ISS process, personnel and proxy fight
analytical framework is key to success
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ISS examines a wide range of factors when evaluating
proxy fights
• ISS proxy fight factors
– Long-term performance (TSR vs. market and peers)
– Earnings and cash flow trends (with emphasis on long-term trends)
– Strategic track record of the incumbents (missteps question credibility)
– A crucial business model inflection point (may warrant new blood)
– Strong Board oversight (vs. an “imperial” CEO)
– Board accountability (e.g., anti-takeover provisions, ignoring the will of shareholders)
– Corporate governance “best practices”
– Nominee experience, track record and independence
– Ability to work constructively with incumbents (skeptical about disruption argument)
– Length of ownership (“owners” versus “renters”), but ISS doesn’t blame the messenger
– Market reaction to dissident filing
No one factor predominates – it’s a sliding scale based on specific and unique facts
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Dissident Director Compensation Bylaws
• Practice of activist hedge funds engaged in proxy contests offering special compensation
schemes to dissident director nominees has increased and become even more egregious.
• In order to proactively address the threats posed by such schemes to the integrity of the
boardroom and board decision-making processes, in 2013, 40 companies adopted
bylaws that would disqualify candidates that are party to any such arrangements.
• In January 2014, ISS announced a new policy position that appears designed to chill
efforts to protect against “golden leash” incentive schemes.
– In a new FAQ, ISS warned that if a board adopts “restrictive director qualification bylaws”
designed to prohibit “golden leashes” without submitting them to a shareholder vote, ISS “may”
recommend a withhold vote against director nominees “for material failures of governance,
stewardship, risk oversight, or fiduciary responsibilities.”
– However, ISS noted that it has not recommended voting against directors at companies which
have adopted bylaws precluding director nominees who fail to disclose third-party compensatory
payments.
• Following the announcement by ISS of its new policy, at least 19 companies
subsequently repealed their dissident director conflict bylaws and multiple others are
considering doing so.
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Does Shareholder Activism = Shareholder-Managed
Governance??
Director-managed or shareholder-managed governance
• “The business and affairs of every corporation … shall be managed by or under the direction of a
board of directors…” (Delaware General Corporation Law § 141(a))
• “Shareholder power to adopt governance arrangements should include the power to adopt
provisions that would allow shareholders … to initiate and vote on proposals regarding specific
corporate decisions. Increasing shareholder power to intervene … would improve corporate
governance and enhance shareholder value” (Bebchuk).
Shareholder activist objectives and impact
• Key shareholder activist governance objectives:
– Institute majority voting in director elections
– Declassify board of directors
– Reduce/rescind supermajority vote provisions in charter and bylaws
– Allow shareholders the right to call special meetings
– Require independent board chairman
• Governance activism erodes takeover defenses and board functionality
• Additionally, governance issues offer “levers” for activists to compel events at target companies
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