Shareholder activism and takeover defence
November 2022 | TALKINGPOINT | SECTOR ANALYSIS
Financier Worldwide Magazine
November 2022 Issue
FW discusses shareholder activism and takeover defence with Kai Liekefett, Derek Zaba, Beth Berg, Jessica Wood and Reuben Zaramian at Sidley Austin LLP.
FW: Could you provide an overview of developments and key trends you are seeing in the shareholder activism space? How would you describe activity levels over the past year or so?
Liekefett: The most significant development in this space this year in the US, and probably in a generation, is the US Securities and Exchange Commission’s (SEC’s) adoption of the so-called ‘universal proxy’ rules, which apply to meetings after 31 August 2022. Under the previous rules, a company and an activist had separate proxy cards and shareholders could not easily ‘mix and match’ nominees across both slates. The new universal proxy rules changed this; as such, both side’s candidates will be on both proxy cards, if the activist satisfies several requirements. This seemingly innocuous change will have a dramatic impact on the US activism landscape and, importantly, on how companies and activists are going to prepare for proxy fights moving forward.
Zaba: The impact that the universal proxy rules will have on the upcoming proxy season will be significant. Even before taking this rule change into account, we have already seen an elevated level of shareholder activism this year. Notably, there was a 23 percent increase in campaign launches during the critical first quarter of this year and a 45 percent increase in campaign launches in the second quarter. The selection of companies and the types of campaigns that were run by activists were driven, in large part, by the uneven market meltdown that occurred across various industries. We are now seeing significant interest in big-ticket names and bigger plays for companies and board seats, some of which is public, but much of it is behind the scenes.
Berg: From a company’s perspective, the implementation of the universal proxy rules should serve as a reminder not only of heightened investor expectations in this market but also that boards are able to bring corporate practices and policies in line with defensive best practices for the benefit of the company and all its shareholders. Now is the time to review board composition, as well as bylaws and other governance policies and to reassess vulnerabilities from a business and strategic perspective.
Wood: It is no surprise that M&A-related activism has accelerated in the last year; nearly one-third of all activism campaigns in the first quarter included an M&A component. We have seen activists taking both sides of the argument, in some cases pushing for the sale of a company and in other cases agitating against an existing deal. Despite an overall softening of markets amid inflation pressure and geopolitical conflict, there is little sign of activists backing down in their transaction demands.
“Advance notice bylaws continue to be the fulcrum for most activist engagements during proxy season.”
FW: To what extent is today’s volatile geopolitical and economic landscape influencing shareholder activism?
Liekefett: We are currently in a prolonged inflationary environment with significantly lower valuations and substantial market volatility. This is likely appealing to many activist investors who recognise that there is currently significant upside potential. Share prices have retracted from recent highs. This makes it less expensive for an activist to build a significant stake. The low share prices can also provide credibility to an activist’s investment thesis. In addition, fear of a deeper global slowdown has meant that companies with downside protection and low volatility are being assigned a premium. These facts have created a prime opportunity for activists to target larger companies, taking bigger positions than they had previously been capable of, with potentially less downside risk due to the higher intrinsic and reputational value of larger, established companies.
Zaramian: Although most activism campaigns take place in the US, Europe and Asia were burgeoning playgrounds for activist investors prior to the pandemic. Activism levels in both regions today are markedly below where they were previously. Both homegrown and foreign investors have historically been more cautious about the companies they target in these regions, and the ongoing war in Ukraine and global inflationary concerns have further weakened investment opportunities for the moment.
“There is a large contingent of companies today trading at low multiples, and activists are homing in on potential M&A outcomes in the post-pandemic world.”
FW: What are some of the common factors typically leading activists to target certain firms and launch campaigns?
Zaba: Activists are not unlike typical value investors focused on key factors such as discount to intrinsic value, sustained underperformance captured by total shareholder return (TSR) decline, unfavourable benchmarking against peers and a lack of focus in business strategy, which is often evident through large structures or detractive business segments. We have also seen founder-led companies become particularly vulnerable to operational activism campaigns. The key question is, can the changes implemented as a result of an activism campaign effect a meaningful return on investment?
Wood: There is a large contingent of companies today trading at low multiples, and activists are homing in on potential M&A outcomes in the post-pandemic world. Companies that have had large declines in TSR where there are natural strategic buyers, or where they fit the profile of a typical private equity target, are particularly vulnerable.
Zaramian: The other gating factor that most activists think about is feasibility. Is a successful campaign possible based on the parameters of the company’s governance policies, the company’s willingness to engage, and its existing shareholder base? Activists carefully review a company’s charter, bylaws and corporate policies to determine their rights as shareholders and the notice and timing requirements established by advance notice provisions. Irrespective of whether the activist has prior experience engaging with the company, it must determine whether it is willing to invest the time and resources to take its nominations or proposals all the way to a vote if the company is not willing to settle. Activists also need to consider what other investors think about the company, its management team and the board, and whether current investors are pleased with the company’s performance and strategic direction. In addition, with the new universal proxy rules, activists will need to consider how their candidates will stand up individually against the board’s nominees. Institutional investors are often willing to vote against board nominees at companies that have lagged on thoughtful board refreshment or implementing governance best practices.
“Now is the time to review board composition, as well as bylaws and other governance policies and to reassess vulnerabilities.”
FW: Are there any steps companies can take in advance to prepare for shareholder activism in an attempt to avoid it or mitigate disruption?
Berg: With a growing number of public companies in the US engaging with an activist each year, companies should prepare for the inevitability of shareholder activism on an ongoing basis. Aside from having a robust record of systematic board refreshment, one of the most critical preparation steps is assembling a winning team of advisers, comprised of legal counsel, a financial adviser, a public relations firm and a proxy solicitor, with deep experience in customising solutions and dealing with a range of activists through different types of campaigns and themes. Equipping the board with expert advice will give directors the confidence to address and respond to the various ways in which an activism situation can play out in light of the company’s circumstances. From management’s perspective, having trusted advisers in place before an activist shows up lets the executive team focus on running the business with minimal distraction.
Zaba: One of the best ways to foresee and possibly pre-empt activist criticism is having a strong investor engagement programme with good disclosure about the efforts the company is making to have meaningful interactions with voting constituencies. This includes, of course, portfolio managers and analysts. It also includes proxy voting teams at index funds and, in some cases, the proxy advisory firms. Importantly, once an activism situation is underway and the company is out soliciting votes, these constituencies will look to their prior interactions together, assessing the frequency and depth of engagement, as well as the company’s responsiveness on key issues. The best example of this is feedback on directors. It is important to understand whether shareholders believe the board has the right mix of skills, experience and diversity of perspectives to effectively govern in the context of the company’s needs. With universal proxy cards now on the table, it is essential that companies are attentive to the perspectives of these key constituencies about board composition.
Zaramian: Ensuring that a company’s policies are in line with best practices and the latest defensive technologies is more important than ever. Advance notice bylaws continue to be the fulcrum for most activist engagements during proxy season. Serving as the ‘last line of defence’, advance notice provisions institute disclosure and procedural requirements that apply equally to all shareholders, and failure to abide by them can invalidate a shareholder’s notice of nomination or proposal. Typical advance notice bylaws require that proponents disclose their ownership stakes and other material interests, their investment strategy or objectives, and detailed information about the background of their proposed nominees. These bylaws continue to evolve alongside evolving activist tactics. Companies that do not regularly assess their defences against shareholder activism are urged to start.
Liekefett: It is important to note that the new universal proxy rules are an overlay to each company’s advance notice requirements and that both sets of rules must be satisfied to make use of the universal proxy regime. However, despite additional disclosure and timing requirements, the new rules contain few protections against misuse by shareholders. Companies are mitigating the potential for abuse by adopting bylaw provisions that seek to address some loopholes in the new universal proxy rules.
“The ability to pit fresh nominees directly against long-tenured directors on a proxy card is a gamechanger.”
FW: What advice would you offer to companies that find themselves in the crosshairs of an activist?
Berg: Assuming that you have assembled a team of advisers and have your structural defences in order, in many cases the best first thing a company can do in its engagement with an activist is simply listen. Ideally, an activist will approach the company privately before publicising its concerns or broadly sharing its thesis with other investors. In those cases, the company can understand the activist’s perspectives, as it would with any other investor. In a situation where an activist launches a public campaign without any forewarning to the company, having a response plan in place helps the company decide how, if at all, to address the activist’s comments and demands, and in what timeframe. In either scenario, taking a disciplined approach to early conversations and giving the activist a private platform to present its concerns is not only the right thing to do but also helps demonstrate engagement, which proxy advisers and institutional investors like to see.
Wood: Reserving emotion and avoiding defensive arguments initially can be very difficult, but it generally sets a better tone for the engagement and may open the door to an amicable resolution before the situation escalates. Often, the parties can find enough common ground to build a settlement that avoids the time and expense associated with an extended proxy fight. Even if the company does not believe a settlement outcome is likely, settlement discussions can shed light on the parties’ respective priorities and demonstrate to other investors that the company is willing to engage constructively with its shareholders.
“We are going to see more campaigns and proxy contests, but we are also going to see an increase in settlements for director seats.”
FW: What are you predictions for shareholder activism leading into the next proxy season?
Liekefett: We are going to see more campaigns and proxy contests, but we are also going to see an increase in settlements for director seats given the uncertainty about how proxy adviser recommendations and ‘split’ voting will play out under the universal proxy regime.
Zaba: Many activists will propose more candidates, and, in some cases, they will be highly skilled, credible and diverse director candidates to run against the most vulnerable incumbents. The ability to pit fresh nominees directly against long-tenured directors on a proxy card is a gamechanger.
Berg: Companies that are intentional and realistic about vulnerability assessment and that engage in routine board refreshment will be better insulated than companies that have been comfortable with the status quo.
Wood: Operational and ‘governance’ campaign themes will resurface, and activist investors who want to engage on the ‘environmental’ and ‘social’ prongs of environmental, social and governance (ESG) campaigns will be more deliberate after several seasons of opportunistic demands.
Zaramian: Macroeconomic factors will further strengthen existing headwinds and further depress share prices, potentially highlighting new investment opportunities for activists.
Kai Liekefett is a partner in New York and co-chairs Sidley’s shareholder activism and corporate defence practice. He has over 20 years of experience in corporate law in New York, London, Germany, Hong Kong and Tokyo. He spends 100 percent of his time on activism campaigns, proxy fights and hostile takeovers. In the last five years, he has been involved in over 100 proxy contests, more than any other defence attorney in the world, and approximately 25 percent of all late-stage US proxy fights. He can be contacted on +1 (212) 839 5300 or by email: kliekefett@sidley.com.
Derek Zaba is a partner in the Palo Alto and New York offices and co-chairs Sidley’s shareholder activism and corporate defence practice. He counsels companies on a variety of matters, including activism defence/proxy contests, activism preparedness, takeover defences, shareholder engagement and corporate governance. Over the past two decades, he has been involved in dozens of activist campaigns and proxy contests in various advisory and principal capacities. He can be contacted on +1 (212) 839 5300 or by email: dzaba@sidley.com.
Beth Berg is a partner in the firm’s Chicago office and has over 21 years of experience advising public and privately held companies and boards of directors with respect to public and private mergers and acquisitions, spinoffs, corporate governance and SEC disclosure matters. In addition, she has an active practice advising companies in connection with shareholder activism, proxy contests and unsolicited tender offers/takeover defence. She can be contacted on +1 (212) 839 5300 or by email: bberg@sidley.com.
Jessica Wood is a partner in the firm’s New York office, where she focuses her practice on corporate and securities matters, including public and private mergers and acquisitions, private equity transactions, corporate governance, capital markets and shareholder activism. She is an active member of Sidley’s shareholder activism and corporate defence practice, advising public companies on shareholder activism campaigns, hostile takeover and other unsolicited bids, corporate governance and strategic investor relations. She can be contacted on +1 (212) 839 5300 or by email: jessica.wood@sidley.com.
Reuben Zaramian is a senior managing associate in Sidley’s New York office where his practice focuses on shareholder activism, corporate defence and corporate governance. He advises public companies on investor engagement, takeover defences, board matters, governance practices and environmental, social, and governance (ESG) issues. He also frequently advises on Section 13 and Section 16 reporting and liability matters. He can be contacted on +1 (212) 839 5300 or by email: rzaramian@sidley.com.
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