By Sabastian V. Niles – Partner, Wachtell Lipton -Corporate Governance, M&A and Shareholder Activism
As the world continues to grapple with the pandemic, activist hedge funds, institutional investors and other stakeholders are intensifying their scrutiny of even well-performing companies, boards and management teams across all industries. Companies who are perceived as waiting until an activist approach, investor challenge or takeover bid to build credibility and showcase a compelling performance track record will find themselves scrambling. And companies that delay developing robust board and management oversight structures and capabilities on ESG, diversity and sustainability issues will be at a significant disadvantage and vulnerable to attacks that target the CEO and board leadership.
This calls for a new activist prevention and defence playbook, with full understanding by the board of directors, that provides room for companies to play offence. The new playbook embraces the important role of boards in assuring investors that their company’s value creation plans, strategic and operating priorities, and ESG and stakeholder policies and metrics are well-suited to driving the sustainable long-term growth in company value and protections against downside risk that investors are seeking. So, here’s what the 2021 proxy season has taught us:
1. Post-pandemic shareholder activism is rebounding at an increasing rate. No company is too big or small, too newly public or too prominent to attract activist attention. Small and large companies alike are at heightened risk of ‘shock-awe-and-ambush’ attacks and takeover threats, and even companies with sterling corporate governance practices and positive financial and operating performance, including outperformance of peers, may be targeted.
2. Investment banks, law firms, proxy solicitors, and public relations advisors continue to represent activists and are encouraging and advising institutional investors and private equity funds on how to act like an activist hedge fund to pressure companies.
3. Many activist attacks target the CEO, chair, lead independent director and committee chairs, pushing for their removal. A new breed of activists claim to support the CEO and target the board as being insufficiently supportive or inadequately constituted. This claim is often disingenuous but requires special approaches to navigate.
4. Dissidents are waging repeated campaigns at the same company, regardless of the outcome of the initial campaign (i.e. settlement or defeat), the economic expense of a proxy fight, and the likelihood of winning on the second (or third, or fourth) try. Wolfpacks are also converging on the same company at the same time. Companies who have settled or resolved one activist situation now face attacks from other activists or the return of prior agitators. Companies that have successfully fended off one proxy contest or activist attack must stay vigilant and be well-advised.
5. Bust-up, break-up and sell-the-company activism is back as a core activist agenda. Unsolicited bidders are considering taking toehold stakes, engaging activist-side advisors, running proxy fight solicitations and working with activist funds to advance takeover bids. Some activists now have the capital to launch their own acquisition proposals, even if only to put the company in play.
6. Companies can remain independent – or pursue a strategic transaction on their own terms – with the right playbook and an openness to reviewing the strategy regularly.
7. Activists may challenge major transactions, but these challenges can be defeated with the right offence. A company’s preferred M&A strategy can be maintained. But a failure to plan for activist challenge to M&A will put the company at risk.
8. Companies may disagree with their investors. Companies that do not agree with the strategies, goals or timelines advocated by their investors will especially need to review their plans for dealing with an increase in activism, preserving board support and achieving alignment with shareholders. Companies will need to attract capital and new investors that are better aligned.
9. The ‘deal points’ in negotiations with activists are evolving. A negotiated resolution may not be achievable on acceptable terms, whether because the activist’s proposals are inimical to the company’s business goals and strategy or because the activist is unwilling to be reasonable in its negotiation. A company’s ability to wage an effective campaign depends on advance preparation, proactive action, good judgement and effective relationships and engagement with shareholders.
10. Activist funds that embrace investor stewardship over activism, support long-term, sustainable value creation and engage in constructive, private dialogues with companies are differentiating themselves. Some activists who approach a company privately can be convinced not to escalate to a public campaign and will be open to constructive engagement. Other activists who approach a company privately first have no interest in constructive engagement with the company and will seek out the media and other publicity as part of their fundraising and pressure efforts.
11. Activist hedge funds continue to source ideas from sell-side analysts and maintain open lines of communication with portfolio managers who are asked to share ‘hit lists’ of possible targets. Company-side relationships with sell-side analysts are important and should be proactively developed. The general counsel should be kept apprised of analyst sentiment as well as broader investor sentiment.
12. Proactive and periodic engagement with institutional shareholders is critical. The failure of a company to maintain regular contact and achieve mutual understanding with, its institutional shareholders, whether indexed or actively managed, will result in a very significant disadvantage in a proxy solicitation.
“Investor expectations for how companies manage climate and ESG risks and opportunities are becoming bolder”
13. Alongside management, the lead director and other independent directors play a key role in a live proxy contest. Prior to a proxy contest, strategies should be implemented to ensure that investors have confidence that the board is itself a strategic asset. The major index funds especially will continue asking for – and often obtain – director-level engagement even in peacetime.
14. Media outlets tend to favour the ‘shareholder rights’ and ‘us versus them’ mantra of activists. A proactive public relations campaign from the outset is critical. Social media and retail investor forums are now proxy fight battlegrounds.
15. Institutional investors, ISS and Glass-Lewis are updating proxy voting guidelines and ‘quality scoring’ methodologies very late in the game, after companies have already made substantive governance and disclosure decisions and with limited opportunity for company input, review and response. Reform is needed in this area, but companies need to prepare for surprises.
16. Investors are now willing to surprise companies with 11th-hour adverse votes, driven by portfolio managers seeking to send a message regarding financial and operating performance and stewardship/proxy voting teams dissatisfied with a company’s ESG, sustainability, diversity, equity and inclusion (DEI), and governance profiles. Investors are no longer waiting for a company to receive (or ignore) a shareholder proposal before pressing for change.
17. Investors will withhold their votes from, and vote against, key directors even in the absence of a traditional proxy fight to compel attention. Such votes are not necessarily referenda on individual director qualifications nor a personal rejection and can be managed. But boards are also being threatened with across-the-board ‘withhold votes’ against directors if the company fails to implement any shareholder proposal receiving a majority vote, even if directors believe that the proposal would be inconsistent with their fiduciary duties and the best interests of the company. These issues can also be handled with the right approach.
18. Funds leveraging ESG, DEI and sustainability-related themes are attracting substantial capital. They are also achieving the institutional investor and proxy advisory support necessary to influence board composition and changes in company strategy and disclosures. The large institutional investors and asset managers will continue to face tremendous pressure themselves to show progress and attention to ESG issues.
19. Activists are reframing a company’s strategic, operational, financial and ESG problems as board-level governance and oversight failures. ESG matters are being reframed as a core enterprise risk driving operational underperformance and sub-optimal capital allocation decisions. ISS and institutional investors are willing to accept such a reframing.
20. Investors will continue to back E&S shareholder proposals at record levels. It is harder to convince the major shareholders to vote against a shareholder proposal where the funds agree with the overall thrust of the proposal. In some cases, the better course for many proposals is to negotiate them out and convince the proponent to withdraw rather than letting the matter go to a controversial vote.
21. The strategic threats from multi-front ESG/TSR (total shareholder return) activist ‘pincer attacks’, targeting boards and management, will continue. Investor expectations for how companies manage climate and ESG risks and opportunities are becoming bolder, and investor coalitions are becoming more effective. Many companies are choosing to lead in these areas rather than fall behind. ‘Scope 3’ emissions have emerged as a flashpoint, and more investor education and company-investor alignment around objectives, challenges and time horizons are needed.
22. ISS and Glass-Lewis continue to wield outsized influence and are not accepting company input on draft reports to help ensure the accuracy and integrity of recommendations. Companies that adapted with us early to this change fared better, and new strategies for engaging with proxy advisory firms, tailoring disclosures and convincing investors to override proxy advisory firm recommendations can be effective. Adverse proxy advisory firm recommendations can be managed effectively without letting ISS or Glass-Lewis dictate what makes sense for a company.
23. ISS and Glass-Lewis and institutional investors may discount strategic and governance changes that are initiated after an activist has surfaced. Periodically, and at least annually promptly after each annual meeting, a company should review its strategies, portfolio, oversight structures and governance in light of the priorities of its long-term investors and potential activist perspectives and consider appropriate adjustments.
24. A long-term oriented and nimble private sector, backed by long-term oriented and responsible institutional investors, remains America’s core engine for economic growth, shared prosperity, national competitiveness, R&D and innovation successes and sustained employment. Short-term oriented activist attacks, ill-advised financial engineering and inattention to ESG, diversity and sustainability shortcomings remain threats.
25. As the new paradigm of corporate governance is embraced, a renewed attitude of partnership – rather than confrontation – must guide relationships between companies and their major institutional investors.
About The Author:
Sabastian V. Niles is an internationally-recognised partner at Wachtell, Lipton, Rosen & Katz where he focuses on rapid response shareholder and stakeholder activism and preparedness, takeover defence and corporate governance; risk oversight, including as to ESG, cybersecurity and crisis situations; US and cross-border mergers, acquisitions, buyouts, investments, divestitures and strategic partnerships; and other corporate and securities law matters and special situations. Sabastian advises worldwide and across industries, including technology, financial institutions, media, energy and natural resources, healthcare and pharmaceuticals, construction and manufacturing, real estate/REITs and consumer goods and retail.