Eric Talleyat Berkeley, and the Berkeley Business Law Journal, put together a great conference on April 4, 2014 on shareholder activism, and I scratched out the following thoughts for our panel. We were supposed to talk about the prospects for further regulatory and legal developments governing or motivating shareholder activism. First, though, consider what legal rules facilitate activism – and when you do that, you discover that any change is likely to be marginal at best. Given my working definition of shareholder activism – using share ownership to promote concerted action, by large numbers of shareholders, to exercise the legal rights of shares – the following are key legal rules that enable this to occur:
- Putting aside the unusual case of dual class capital structures, stockholders will have one vote per share;
- They will be entitled to vote on the election of directors at annual meetings;
- They will be entitled to vote on mergers and, at least in Delaware, those transactions will require approval from a majority of the outstanding shares – and maybe even a majority of public or minority shares, in the case of a going private transaction;
- Putting aside the currently unusual situation of a stock for stock deal, stockholders will have the right to seek a judicial appraisal of their shares.
All of these features of our legal system that do so much to facilitate shareholder activism have virtually no chance of being eliminated or changing in any dramatic way.
So where do I expect to see regulatory and other legal movement in relation to shareholder activism? Two possible areas of change have been discussed at the federal level:
- Disclosure of a 5% ownership position as required by Section 13(d) makes block acquisitions more expensive, so we’re seeing renewed pressure from Wachtell, Lipton and others arrayed against shareholder activists to close the 10-day window in which share buying can continue, past the 5% level, without public disclosure – and perhaps, while fellow activists are tipped off about the activity before the investing public generally. And we’re seeing their opponents, like Lucian Bebchuk, pressing in the other direction, urging that activism by large blockholders is beneficial to investors generally, and the incentives to accumulate such share blocks shouldn’t be impaired. So will the window ever get closed? It’s been talked about, again and again, for my entire professional life, and nothing’s ever been done about it, so forgive me for being skeptical that anything will be done now. Perhaps more plausibly, there will be further development of the law of groups and common beneficial ownership based on concerted activism. Certainly those who would prefer to discourage activism would prefer to see this body of law develop more aggressively, but again, this idea has been around for a long time and at least so far activists have been well counseled enough to have avoided serious scrapes with 13(d).
- Shareholder access to company proxy statements for shareholder proposals, under Rule 14a-8, is a handy activist tool, but we’re now seeing renewed efforts to trim back its availability, by raising minimum ownership requirements and raising the bar for repeat proposals that don’t get a lot of support when first proposed. These efforts may be less aimed at activists, though, than at the John Cheveddens of the world. In any case, I’m not optimistic that a consensus will form to do anything on this subject either, or that it in any event would limit the use of 14a-8 by a well-heeled activist.
Much more interesting to me are two state corporate law battlegrounds. The first one involves various aspects of the right to nominate directors. Running short slates is, of course, a powerful tool in the shareholder activism kit, and a perennial source of friction as management and activist tectonic plates continually collide. And there have been a number of recent tremors along that fault line:
- Shareholder activist Third Point has a suit pending in the Delaware Court of Chancery seeking relief against Sotheby’s poison pill. It owns almost 10% of the company, and the directors have adopted a pill that would prevent acquisitions of over 10%, with two notable exceptions: (i) for acquisitions of over 50% pursuant to an all shares all cash tender offer, and (ii) for persons who buy up to 20%, as long as they confirm that they don’t seek to influence control of the company. Third Point’s suit claims that the pill is intended not to deter inadequate takeover bids (which is what one usually thinks a poison pill is for), but to impede its effort to elect three dissident directors. Its challenge is set for a preliminary injunction hearing shortly, before the company’s May 6 annual meeting. The use (or potential use) of the pill to deter a proxy contest is old news, but this latest chapter is written against the backdrop of the shareholder activist story, as opposed to the more traditional takeover bidder story.
- In the last year or so, we’ve seen initiatives by activists seeking to elect candidates to the board to sponsor performance compensation for their nominees. Corporate managements and their supporters have pushed back, in a number of ways. They criticize these arrangements as improper influences on directors (compromises their independence, it is said, or misaligns their incentives relative to those of stockholders generally). And for a while last year many corporations were adopting bylaws that purported to disqualify director nominees who were parties to such shareholder-sponsored compensation packages. In the face of negative recommendations from ISS, though, some of these companies have repealed those bylaws, but the battle is still being fought. Maybe some day the validity of one of these bylaws will come before the Delaware courts – but I sort of doubt it, honestly; it’s pretty rare to see validity issues actually go all the way to the litigation mat.
- In the longer run, I predict other battles along the electoral fault line. The extent to which boards can adopt bylaws that more generally limit an activist’s right to nominate director candidates is a very undeveloped topic (despite a limited effort on my part in a recent article to explore the subject). Over time I expect we’ll see disputes about the validity and enforceability of other director qualification bylaws and maybe even minimum share ownership requirements for the right to nominate.
So much for battles over electing directors. M&A is the other major battleground for shareholder activists, and there have been at least two notable areas in which this conflict has played out:
- The first area also involves voting. There have been some notable successes in shareholder activist efforts to resist going private transactions. The most famous one, of course, was the Dell acquisition, which saw fierce resistance led by Carl Icahn. The deal ultimately went forward of course, but with at least modest price bump. And according to one recent source, 71% of activist initiatives in 2013 succeeded in either raising the deal price or terminating a deal, compared to just 25% in 2012 and 19% in 2011.
- The other area for shareholder activism in relation to M&A has hit practically epidemic proportions, and is best illustrated in the Dole going private transaction. I’m referring to the increasing shareholder activist use of statutory appraisal rights. So I’ll talk briefly about why the increase has occurred, and then suggest some possible pushback that we might see or already be seeing.
- The key to it is the rule established in Delaware (back in the Salomon Brothers v. Interstate Bakeries case in 1989) that one can buy shares after a deal is announced and still demand appraisal for the newly acquired shares, as long as you’re the holder on the date of the demand (which can be as late as just before the merger vote). This practice has been described, plausibly, as “arbing appraisal rights.” Other attractions include the fact that prejudgment interest is presumptively set by statute at 5% over the federal funds rate – maybe not such a great long-run return on equity, but a darn sight better than market interest rates. Finally, the risk of getting an appraisal award that’s less than the merger price is not mythological, but it’s not all that salient either, especially in deals like going private transactions, that don’t involve an acquisition by an independent strategic bidder.
- So what’s the push back likely to be? Some have suggested that Delaware needs to fix its rule that shares acquired after deal announcement are entitled to appraisal, and to reduce the assertedly overcompensatory prejudgment interest rate in appraisal cases. More immediately and practically, I think you’re likely to see even more use of appraisal outs in merger agreements, where the acquirer gets to walk if appraisal demands exceed a specified percentage of the shares. Andrew Noreuil at Mayer Brown in Chicago put together a nice chart showing that use of such outs actually declined, from 23% of all deals in 2006 to 4.4% in 2012; but it’s on the upswing again (8.2% last year), and I expect that acquirers are going to be even more aggressive about demanding these outs, at least at some level (an out at 10% seems to be the most common so far).