Dr Ami de Chapeaurouge – de Chapeaurouge + Partners
Aside from cases of bumpitrage – extracting a higher price for a minority holdout position in the aftermath of a public takeover by exploiting certain loopholes in German legislation – and activist short-selling, ‘traditional’ shareholder activism has been strong.
In Germany, equity shareholder activism stands for non-control minority investments in undervalued or poorly managed public companies by one or several investors, investment partnerships or activist funds, based on strategic objectives and tactical measures that are carefully formulated in advance, such as value restoration to the benefit of all shareholders, enhanced corporate governance monitoring and increased operative efficiency as outcomes.
An additional emphasis is on the process of persuasion of target leadership and fellow shareholders about the superiority of an activist strategic plan for the company, compared to the roadmap of the incumbents, to demonstrate alignment, culminating in the threat of a proxy fight and lending such an activist campaign some bite in the event of a breakdown of negotiations with target management. The credibility of the threat of a possible proxy contest has been given a boost by the success of the Active Ownership Capital (AOC) v. STADA Arzneimittel AG (STADA) campaign in August 2016. The success of this intervention notwithstanding, a negotiated style of creating value by bridging differences in target strategy analysis between activist and incumbent management is thus far more prominent tactical route in the German marketplace.
Two styles of shareholder activism: negotiated (Germany) v. escalation (US/UK)
There are two styles of shareholder activism prevalent in the world today, on one hand, the US escalation model of a crescendo of ever more aggressive tactical steps as part of an activist intervention strategy, culminating in a proxy fight and litigation against the incumbent board, also known as disruptive activism. While many such confrontations end up in settlements or other forms of compromise, the threat of winning a long-slate proxy fight whereby the entire board is replaced by an insurgent slate remains a powerful and intimidating activist tool. In the US, activism revolves around seeking board representation or a change in corporate control via proxy fight (without an accompanying takeover bid) and promoting what activist investors consider a more shareholder-friendly composition of the board of directors; hence a proxy contest occurs when shareholders believe managerial slack and flawed strategic vision by the current leadership have served as the catalysts for lack of performance and undervaluation (Crawford and Zaramian 2018, de Wied 2018). From 2013 through the 2018 proxy season, there were 700 US-based contentious activist situations. Out of 700 activist situations, approximately 520 were settled or withdrawn, leaving more than 150 proxy contests.
In Germany, by contrast, a heavily negotiated, behind-the-scenes style has proved effective, also known as collaborative activism. The singular AOC v. STADA test case evidences for Germany that after almost 20 years of trying, an individual supervisory board member can be removed via a proxy contest in Germany after all – the first success out of eight attempts to date in a total of 450 activist campaigns, where 200 public companies were targeted by approximately 100 mostly foreign activist funds. However, over the years, about 20, or more similar, albeit negotiated, successes and outcomes of replacing supervisory board members or even management board members are a reminder that a discreet, informal persuasion and negotiation strategy with the incumbent management board and supervisory board proves a more effective activist approach.
Once a critical letter to the management board or white paper is published (examples are Elliott Advisors UK Limited 26 July 2019 letter to Scout24 AG, Petrus Advisers 12 September 2017 and 27 February 2018 letters to Commerzbank AG, its February 2018 White Paper, and its AGM questions to comdirect Bank AG, published in May 2018), a negotiated outcome becomes virtually impossible as target leadership will circle the wagons (see Chart 2, below).
Significant adjustments of activist tactics and strategy
In Germany, activist hedge funds as protagonists of the engaged shareholder movement proved adaptive to the sceptical legal culture and became effective minority investors. Most campaigns have not come to light in the press since target company management and supervisory boards preferred to compromise and activists themselves have shunned the public limelight, press or social media so as not to risk undermining their efforts of translating informal influence in favourable negotiated outcomes, which is in contrast to more robust activist practices in the US and in the UK. They pursue the following twin objectives: first, they play a role as fiduciaries of the rate of return interests of their own investor base, such as pension funds, banks, and insurance companies; second, in their self-understanding that all boats should rise in a tide, they also represent the interests of passive retail investors who, without the support of their zeal, presumably would fall through the cracks.
Their operating philosophy has become increasingly conversational and focusses
on seeking early influence on the market valuation reflected in the stock price of the respective companies they are invested in. Their methods have become quite subtle, with nuanced demands (see Chart 1, below). In reality, it is mostly the supervisory board that interfaces with shareholders, even though shareholder dialogue is deemed the sole prerogative of the management board, pursuant to section 76 of the German Stock Corporation Code (AktG).
This increasingly informal aspect ofthe dialogue between shareholders and corporations has been addressed recently (in 2017) by both the ‘Guidelines for the Dialogue between Investor and supervisory board’ by the German Corporate Governance Code (GCGC) and on part of the Shareholder Rights Directive to be transposed into German law via ARUG (II). GCGC section 5.2 reads: “The chairman of the supervisory board should be prepared – within reasonable boundaries – to discuss topics related to the tasks of the supervisory board.”
Elucidation of Chart 1
Point of departure of a five to 10 per cent minority investment and activist campaign is frequently that an institutional investor is dissatisfied with the governance record
or value of a portfolio company and contacts an activist hedge fund to do something about these deficiencies; or an activist fund by itself reaches similar conclusions and may be joined informally by other funds (wolf pack). Our findings suggest that in 80 to 90 per cent of their campaigns, activists pursue a compromise within informal channels of communication outside an AGM. Targets are receptive to protect their reputation. Only when activists fail to be heard will they turn to publicity, coalition building for AGM voting purposes, and a proxy fight, or litigating against a company.
Seeking information concerning the target by meeting informally, frequently and with greater intensity with management board and certain supervisory board members, which have to abide by equal treatment-of-all-shareholders (section 53a German Stock Corporation Act (AktG)) and insider trading rules (Articles 7, 14 MAR); persuasion of target to embrace activist investment thesis and follow demands, such as an activist nominee supervisory board seat; conclusion of an investment agreement concerning entire catalogue of activist demands; a more aggressive posture of convincing target leadership to go along with activist demands by merely threatening (rather than going public and actually going through with such plan) to build majority coalition to replace supervisory board members (section 103, paragraph 1, 2nd sentence AktG) or to decline exoneration and hold vote of non-confidence for a management board member (factually subverting her/his ability to serve); an activist seeks publicity in only 20 per cent of the cases; even rarer is the escalation of an AGM vote via proxy fight (one successful precedent out of eight attempts) or suing the target company in court.
Activists attempt from the very start to communicate meaningfully with the corporate leadership, regardless of being management or supervisory board members, in order to exert informal influence. The reason is their preference for a unitary board line of communication, supported by the growing debate as to the legitimacy for the chairman of the supervisory board and audit committee chair, in consultation with the management board, to engage in investor dialogue. It is through personal relationships that they attempt to influence the management board and supervisory board composition and value creation strategy. This informal approach is the standard or ‘new normal’ in activist attempts to gain influence over German public portfolio companies (Turu (2015).
Informal or factual influence is every act by a shareholder not tied directly to the weight of their formal shareholding position that bears some influence on certain formal corporate decisions and corporate strategy of a public portfolio company. With their usual average shareholding range between five and 10 per cent, by resorting to informal tactics predicated on personal relationships with members of both boards, activists enjoy the advantage of influencing corporate decision-making directly, with a built-in timing and flexibility advantage, independent of an AGM setting, and their actual weight expressed in the percentage of their stock position in the company, and defy easy classification.
Any communication between company and activist is subject to the mandatory equal treatment of all shareholders, pursuant to section 53a AktG. This only means that if other shareholders do so demand during an AGM, management is compelled to disclose to them any information shared with activists beforehand so long as the piece of information conveyed to such activist investors was tied to their being shareholders of the company, pursuant to section 131, paragraph 4 first sentence AktG. From this may be inferred that informal one-on-one discussions are admissible with the result that all other shareholders have no general right to find out the contents of such meetings outside an AGM.
Management and supervisory boards are prohibited from sharing inside information with activists pursuant to Articles. 7, 8, 10, 14 MAR unless there are overriding justifications. It is permissible to explain the business model and deepen an activist’s understanding of company strategy– below the threshold of giving away company secrets.
Informal nomination or replacement of supervisory/management board members
In the event that an activist harbours the plan to assume a supervisory board position (such as Cevian did with respect to Demag Cranes and Bilfinger Berger), it will commence informal negotiations with the company. The members of the supervisory board are nominated, elected and placed in position (‘bestellt’) by the AGM (according to sections 101, paragraph 1; 119, paragraph 1 No. 1 AktG), if there are not certain rights of shareholders to have a supervisory board member representing their interests appointed or supervisory board members are being selected pursuant to the rules of labour codetermination.
As a practical matter, both informal suggestions as well as formal AGM nominations of new supervisory board candidates are usually agreed upon behind the scenes with the management board, the chairman of the supervisory board or at least an important supervisory board member beforehand behind closed doors, especially in the event of a formal nomination (Bader and Georgieff (2015).
The right to make nominations about supervisory board membership is vested in the supervisory board itself, pursuant to section 124, paragraph three, first sentence AktG. It is decidedly not the management board that may make such proposals to the shareholders before an AGM vote; in this way, the management board has no influence on the nomination or election of those persons that are called upon to supervise the management board in its discharge of management duties pursuant to section 111, paragraph 1 AktG. The supervisory board may not enter into a contractual arrangement with a third party, such as an activist investor, before it has met its own set of due diligence obligations towards nominating an appropriate candidate for the membership spot.
“It remains noteworthy that in Germany most activist interventions never become public since target company leadership and activists both prefer to settle and conclude non-disclosure agreements”
If these negotiations and conversations do not lead to the desired result preferred by the activist, it will – in Germany – rarely seek a public forum to express its displeasure. They lend a certain punch to their requests by setting forth a scenario of supporting alternative candidates for both boards. If a fund has accumulated sufficient voting power with the help of other, like-minded investors, the mere threat of such a scenario may sway reluctant supervisory boards and prompt a change of mind and help realise the desired outcomes.
Since activists only have indirect, structural voting power to remove or replace supervisory board members, once they can convey the impression of marshalling sufficient votes they may make the supervisory board think. The AOC proxy fight success plays a significant role as to the necessary credibility of such a threat.
As far as removing and replacing unwelcome management board members, activists in Germany dispose of even less, purely informal, influence. We know of about 20-plus such similar events in Germany, at times involving the management board, however mostly attaching to successful informal, negotiated nominations or replacements of supervisory board members (Thamm 2013).
So, under German law, activist shareholders may not instruct the management board with regard to how they run the company and its business; yet they are still indirectly in a position to exert influence and secure the appointment of a management board member with more accommodating views and disposition towards their own plans, by first selecting supervisory board members whom they know to vote with them in crucial matters and who, no doubt, will appoint new management board members according to the preferences of the activist. Such removal of a management board member by the supervisory board before the end of their term (section 84, paragraph 3 AktG) depends on a dismissal for good cause.
When it comes to vital disagreements as to strategy and policy, a supervisory board that is heavily influenced by an activist hedge fund is placed in the position to recall a management board member for cause. Activists increase the pressure by withholding confidence or refusal to discharge such management board members during an AGM vote; which would damage their standing at first with the supervisory board. Thereby activists attempt to increase the pressure on those management board members to withdraw or risk being removed by the supervisory board. The activists signal to such board members that a majority of the shareholders disagree with his/her philosophy and wish to see them resign or removed from their positions should they refuse to support the activist strategy for the company.
In the past, the position of the management board was at risk of falling for a bluff as they often did not fully know who their shareholders were and needed to rely on surmise and voluntary disclosure to gauge the actual voting power of an activist fund, given the lack of transparency before the adoption of the Shareholder Rights Directive.
This dimension of indirect replacement power as to management board members, i.e. effectively having them recalled before the end of their regular term due to deep-seated differences of opinion about the appropriate future strategic course of a company, rests on the alleged intolerable atmosphere (Unzumutbarkeit) of their continued position and is a corollary of the growing influence of activism on German public corporations, as evidenced empirically in the doctoral dissertation by Thamm (2013) and Thamm/Schiereck (2014) – and borne out also by experience. It has further been studied capably by Stefan Brass in a 2010 PhD thesis supervised by Professor Theodor Baums, and analysed by Schockenhoff (2015, 2017).
In summary, the preconditions of the revocation of the appointment as a member of the management board are much more complex than a simple activist demand for recalling her/him before they served their full term and activist pressure on the supervisory board. While it is true that the final determination about such premature dismissal rests with the supervisory board and the threshold of such independent judgment is quite high, the impact of a no-confidence vote and withholding of discharge during an AGM can be quite devastating to the standing of a management board member with the supervisory board so as to sway the decision in direction of the preferences of the activist hedge fund.
Elucidation of Chart 2
It remains noteworthy that in Germany most activist interventions never become public since target company leadership and activists both prefer to settle and conclude non-disclosure agreements; and that only about 20 per cent of the activist campaigns become public knowledge because a controversy flares up, spilling into the public domain. Escalation and publicity are usually synonymous with loss of activist influence that structurally relies on persuasion and subtle forms of pressure in view of high shareholder population concentration, where only sound reasons will sway controlling shareholders or dominating blockholders to go along with activist value ideas.
Once activists get the impression that target management and supervisory boards block communication or do not adequately consider their value propositions, a checklist of assertive-aggressive methods can be activated and launched. These moves are self-explanatory. It is counterintuitive that the German legal literature is almost exclusively focussed on those activist fights where publicity is sought and a confrontation such as a proxy fight or litigation are in the offing (Chart 2), whereas in 80 per cent of all cases, in reality, informal persuasion is the predominant approach to seek changes to corporate strategy, value creation, governance, and compensation as focal points of activist dissent (Chart 1).
The first successful proxy fight (STADA August 2016) resulted in replacing the chairman of the supervisory board; six prior attempts (Babcock Borsig (2002), Volkswagen (2006), CeWe Color (2007), Ehlebracht (2010), Infineon (2010), Balda (2012), and one subsequent attempt (Grammer 2017) had failed.
In spite of only 450 public companies in Germany being listed on the Regulated Market segment of the Frankfurt Stock Exchange (and another 250 corporations being listed on the German OTC segments such as Scale of the Frankfurt Stock Exchange and other regional German exchanges); and although about 60 per cent of all listed German companies are controlled by corporate groups or families or dominated by large blockholders, Germany has, over the past 20 years, emerged as a relatively active market for shareholder activism.
A principal reason for a certain ignorance in New York or London (but even in the local German press and in professional circles) about the relatively widespread occurrence of activist campaigns in Germany is twofold. The rather solid empirical research and published evidence of about 20 teams of economists in the 2008 – 2017 timeframe has been largely ignored; second, public disputes between activists and companies rarely escalate into a proxy fight, a preoccupation of English and US-American activists – we know of just eight cases since 2002, with only one insurgent success (AOC v. STADA); there are also technical legal origins (no right to obtain the actual shareholder list to reach out to them, a muddled approach to voting representatives and proxy cards), as well as cultural reasons and a still existing old-boys-network which render proxy contests an exception.
Flipping perspectives: activist interference with management board authority
Any compromises or settlements between management and activists will raise suspicions from institutional investors for failing to articulate some of their key concerns in public, say, lack of responsiveness to ESG challenges, managerial slackness and value destruction.
Management boards may enter into legally binding investment agreements with activists, in particular, if and when the activist shareholders convince them of the superiority of their ideas as compared to the incumbents’ own plans. In such scenario, they would not surrender their independent business judgement, autonomy and authority. As an alternative, they may prefer a détente that likely will take the form of an unwritten, informal understanding if they feel that an all-out confrontation would be lethal to the corporation. The relevant question is whether the ‘prohibition of pre-commitment’ or equivalent restrictions from fiduciary duties extend to promises made to placate shareholders who threaten to wage a proxy fight (Engert (2019).
Overall, the management board may be ill-advised to give in to poor activist ideas not in the interest of the corporation and its stakeholders: They will perceive it in their reputational interest to observe their fiduciary obligations and oppose, say, paying out a special dividend at the expense of and on the back of mass dismissals, slashing long-term R&D investments, or shelving a well-planned acquisition to grow the business rather than caving in to pressure; even if they run the risk of being defeated by the insurgents and eventually replaced.
About the Author:
Mr. de Chapeaurouge is a founding partner of the Germany-based corporate law firm DE CHAPEAUROUGE + PARTNERS (integrated with the Hamburg and New York corporate and litigation firms Brödermann Jahn RA GmbH and Guzov, LLC). He is admitted to practice in Frankfurt and New York. Having studied at Lausanne/Switzerland and Freiburg/Germany universities, he obtained his German law degrees at Frankfurt University and earned degrees in the United States from Columbia Law School (LL.M.) and Harvard Law School (S.J.D.).
An avid comparitivist and student of the global domination of American and English legal thought and law firm organisation, Mr. de Chapeaurouge practiced for 20 years with some respected firms (among them Skadden Arps, Jones Day, and Germany’s Wessing) in Paris, New York, Chicago and Frankfurt – in the later stages as Corporate Finance and Banking Practice Head – before setting up a Practice of his own (an egalitarian and lean effort as alternative model to hierarchical and bureaucratic firm structures): first in Hamburg and Frankfurt, followed by New York; with a second-stage expansion into Singapore, Hong Kong, Shanghai and Beijing through carefully chosen alliances; and a final third stage extension in London and San Francisco for a global reach – predicated on (i) worldwide relationships in the corporate, financial, and regulatory communities; (ii) on German global economic might and legal doctrinal succinctness; yet (iii) reconciling client needs for legal advice beyond Europe.
Mr. de Chapeaurouge counsels boards, lead directors, independent directors, compensation, governance, nomination, audit committees; as well as management, stockholders and owners on Corporate Governance, international regulatory (such as EU institutional passporting for banks, financial services providers, and funds after Brexit), and shareholder-related matters; and advises them on conflicts of interest, fiduciary duties, Compliance, strategy, and prudent calibration of operational, regulatory and systemic risk (such as cybersecurity threats); he is known as a thoughtful architect of takeover and activist preparedness, marshaling the requisite tactical-legal repertoire and by encouraging effective on- and off-season shareholder dialogue.
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