Shareholder activism is and will continue to be a prominent feature of the corporate landscape in the United States. Following a wave of corporate scandals in the early 2000s (most memorably Enron Corporation), there was a sea change in US corporate governance. Subsequently enacted federal regulations that focus on corporate governance have dramatically changed the face of US corporate boards of directors; shareholder engagement has become an expectation for companies; and a number of other legal and cultural changes have increased the power of shareholders of US public companies.
Shareholder activism historically referred to an asset class of hedge funds that raided and agitated US publicly traded companies. In present times, however, there is broader recognition that shareholders more generally have a desire to engage with management and boards of directors regarding governance reforms and other aspects of a company's business. This trend has caused the lines between the traditional shareholder activists and other shareholders of public companies to blur, thereby diluting the brand of shareholder activism. There is now an increased expectation that shareholders will seek to have more influence over governance and strategic decisions made by public companies, although it is still the case that certain activist campaigns become a public display of the differences of strategic vision between the shareholder activist and its subject company.
Although the term 'activist' may have become diluted by more types of shareholders entering the mix, the increased acceptance of activism in the corporate landscape has by no means decreased its frequency. As of 2019, the total number of activist campaigns had been remarkably consistent over the prior five years, with an average of approximately 272 campaigns announced per year.2 Largely due to the covid-19 pandemic, public activism campaigns were down approximately 30 per cent from January to August 2020 as compared to the same period in 2019, although campaign numbers have since rebounded.3
In any event, the statistics for public campaigns do not tell the entire story: for every public activist demand, there may be another activist campaign that never becomes public knowledge. Success by activist hedge funds in raising capital and increased support from prominent institutional investors, combined with activists achieving their objectives and gaining board seats at public companies (through both settlements with companies and proxy contests), has fuelled increased activity. As a result, US public company boards of directors and management teams have continued their focus on understanding shareholder activism as well as working to prevent, and preparing to respond to, activist campaigns.
Legal and regulatory framework
The legal and regulatory framework relating to shareholder rights, activism and engagement in respect of US publicly traded companies primarily comprises federal laws and regulations, and state corporations laws. US public companies also must comply with the listing rules of their stock exchange (either the New York Stock Exchange or the Nasdaq Stock Market), which include corporate governance requirements. Additional sources of practice with respect to shareholder activism and engagement include proxy advisory firms and guidelines set forth by other investment community members. Taken together, the applicable laws and regulations, as well as other influential sources of practice, govern the means by which a shareholder activist pursues an activist campaign and the structural defences against shareholder activists available to US public companies.i Federal laws
Federal securities laws relating to shareholder activism and engagement include the Securities Act of 1933, the Securities Exchange Act of 1934 (the Exchange Act), the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the Dodd-Frank Act). The federal securities laws, and the rules and regulations promulgated thereunder, are administered by the Securities and Exchange Commission (SEC). A key focus of the federal securities regulations is on disclosure and ensuring that shareholders and the market have the information required to make fully informed investment decisions.
The Exchange Act provides the SEC with broad authority to regulate the securities industry. Pursuant to Section 13(a) of the Exchange Act, the SEC requires periodic and current reporting of information by public companies, and companies must consider these disclosure requirements in reporting on corporate governance matters. Section 13(d) of the Exchange Act requires reporting by persons who have directly or indirectly acquired beneficial ownership of more than 5 per cent of an outstanding class of a company's equity securities. An activist investor that crosses the 5 per cent threshold must file a report with the SEC within 10 calendar days disclosing its ownership and certain additional information, including its activist intentions. Section 13(d) also governs whether investors are considered a 'group' for purposes of acquiring, holding or disposing of a company's securities, a very relevant consideration for shareholder activists who may form a 'wolf pack' to work together on an activist campaign.
Section 14(a) of the Exchange Act imposes disclosure and communications requirements on proxy solicitations, or the materials used to solicit shareholders' votes in annual or special meetings held for the election of directors and the approval of other corporate actions. Shareholder activists that wage a proxy contest to nominate directors for election in opposition to a company's slate of director nominees must comply with these proxy solicitation rules. These rules apply to, and require the timely filing of, all written communications made as part of the solicitation, including investor presentations, transcripts of speeches and certain interviews, and social media postings. Further, the Exchange Act governs disclosure by anyone seeking to acquire more than 5 per cent of a company's securities by means of a tender offer.
Regulation Fair Disclosure (Regulation FD), which aims to promote full and fair disclosure by ensuring that companies do not engage in selective disclosure, requires a public company to make public disclosure of any material non-public information disclosed to certain individuals, including shareholders, who may trade on the basis of that information. Regulation FD applies to discussions between a company and a shareholder activist; therefore, companies must be mindful of this regulation when holding discussions with an activist.
The Sarbanes-Oxley Act, enacted in response to the corporate scandals in the early 2000s, mandated numerous reforms to enhance corporate responsibility and financial disclosures. The Dodd-Frank Act implemented further reforms, including with respect to trading restrictions, corporate governance, disclosure and transparency. Both statutes have had a significant influence on corporate governance, and shareholder activism and engagement.
In addition to the federal securities laws, the Hart-Scott-Rodino Antitrust Improvements Act (the HSR Act) may apply to an investment by a shareholder activist in a public company if the investment exceeds a certain size threshold, currently set at US$92 million for 2021.4 If an activist will cross the size threshold with respect to the amount of voting securities of a company it intends to acquire, the activist is required to make a filing with US antitrust authorities and observe a waiting period prior to completing the transaction. The HSR Act provides an exemption from reporting requirements for acquisitions that result in the acquirer holding 10 per cent or less of a company's outstanding voting securities if made 'solely for the purpose of investment'.5 This investment-only exception has been construed narrowly; it does not apply if an investor intends to participate in and influence business decisions, which is often the case with shareholder activists.6 In July 2016, activist hedge fund ValueAct Capital agreed to pay a record US$11 million fine to settle a lawsuit filed by the US government alleging that ValueAct violated the HSR Act by improperly relying on the investment-only exception in connection with its US$2.5 billion investment in Halliburton Company and Baker Hughes Inc.7ii State laws
State corporations law governs actions by companies in the state's jurisdiction and establishes the fiduciary duty regime that applies to a company's directors and officers. This chapter focuses on corporate law in the state of Delaware because it is the most popular state of formation for legal entities and its laws significantly influence corporate law in other states. Many provisions of the Delaware General Corporation Law (DGCL) govern the relationship between a corporation and its shareholders, impacting the processes by which a shareholder activist may pursue, and a company may defend against, an activist campaign.
The DGCL includes laws governing, among other things, the composition of the corporation's board of directors, annual and special meetings of shareholders, actions by written consent, voting thresholds for approving corporate actions, requests by shareholders for books and records, and appraisal rights. As described further in Subsection (iv), a corporation may use its organisational documents (certificate of incorporation and by-laws) to customise certain elements of its corporate governance to the extent not inconsistent with the DGCL.
All directors and officers of Delaware corporations owe the company and its shareholders fundamental fiduciary duties of care, loyalty and good faith. Subject to certain exceptions, when reviewing a company's decision the Delaware courts apply the 'business judgement rule', which presumes directors satisfied these fiduciary duties, and will not second-guess the directors' decision if it has a rational business purpose. However, enhanced judicial review applies in certain circumstances, including when a board of directors takes defensive measures in response to a perceived threat to corporate control. Under the Unocal test, a board that has implemented a defensive measure has the burden of demonstrating that it had reasonable grounds to believe a threat to corporate policy and effectiveness existed, and that its defensive response was reasonable in relation to the threat posed.8 The Unocal test is particularly relevant to shareholder activism because it applies to defensive measures such as shareholder protection rights plans (poison pills). Shareholder activists may, as part of their campaign strategy, file lawsuits against a corporation and its directors and officers alleging fiduciary duty violations.iii Additional sources of practice
Shareholder activism and engagement are influenced by other sources of practice and various members of the investment community. Although their impact has waned somewhat in recent years, proxy advisory firms such as Institutional Shareholder Services (ISS) and, to a lesser extent, Glass Lewis have an impact on a company's corporate governance policies and may affect the outcome of a proxy contest with a shareholder activist. These advisory firms set forth policy guidelines as well as make recommendations with respect to proposals to be voted upon at a shareholders' meeting, such as director elections, fundamental transactions and other governance matters. As an adviser to many institutional shareholders, ISS is keen on shareholder engagement and is often inclined to take a 'what's the harm' approach and recommend in favour of at least one activist director candidate in a proxy contest for minority representation on the board of directors if the shareholder activist has demonstrated that some change is warranted at the company. ISS recommendations match the ultimate outcome of the vote in a majority of proxy contests. Although the gap between the voting practices of ISS and institutional shareholders has narrowed, large traditional institutional investors such as BlackRock, Fidelity, State Street and Vanguard have generally stopped relying on the analysis of proxy advisory firms and have instead developed internal proxy advisory functions to make decisions in proxy contests and put forth corporate governance initiatives. Given that the stock ownership of many US public companies is increasingly held by a relatively small number of these large institutions, it is critical for both the company and the shareholder activist to garner the support of these investors. Other members of the investment community, such as the Teachers Insurance and Annuity Association of America-College Retirement Equities Fund (TIAA-CREF), the California State Teachers' Retirement System (CalSTRS), and the Council of Institutional Investors, also set forth policy guidelines and express opinions on governance and activism.iv Company defences
A company's best defence against shareholder activism is strong financial performance, a solid record of shareholder engagement and adoption of corporate governance best practices. A company must also adopt a proactive strategy to anticipate and prepare for the potential for an activist campaign, including actively monitoring the company's shareholder base and conducting regular and thorough reviews of the company's business plan, strategic alternatives and intrinsic value. In the current environment, in which there is now an expectation that shareholders will be more involved in governance and strategic decisions made by public companies, it is crucial for companies to maintain a positive dialogue, relationship and credibility with its shareholders, particularly key institutional investors and other large holders. Practising consistent shareholder engagement, including articulating the company's current and long-term vision for creating shareholder value and practising good governance, will pay dividends for the company in terms of both understanding investor concerns and securing support in the face of future shareholder activism campaigns. A shareholder activist may face an uphill battle if the company already has a strong relationship with, and the support of, its large institutional shareholders.
The prevalence of shareholder activism in the United States has created an entire cottage industry of firms, such as proxy solicitors, dedicated to helping companies monitor their shareholders and set up meetings with institutional investors. Investment banks and law firms also have groups of professionals dedicated to activist preparation and defence. A company facing an activist investor requires a core response team of outside advisers, including a law firm, proxy solicitor, investment bank and public relations firm. The most prepared companies create these teams in advance and establish procedures that are ready to be implemented on a moment's notice should an activist appear. In addition to monitoring a company's shareholders and facilitating shareholder engagement, a company's adviser team can assist the company with 'thinking like an activist' by routinely assessing the company's strengths and vulnerabilities to activism, reviewing its structural defences, and keeping current on the evolving corporate governance practices and preferences of its shareholders and the broader market.
Companies have structural governance defences that may protect them against shareholder activists. The value of any particular structural defence will depend on the specific activist situation and no defence will fully protect a company against activism. As mentioned above, a company may customise certain governance elements in its organisational documents. For example, most public companies have by-laws that require a shareholder to provide advance notice and certain information to the company before it is permitted to nominate a director for election to the company's board of directors or propose business before a shareholders' meeting, and these by-laws eliminate the possibility of surprise from last-minute proposals. Companies also specify in their by-laws that the board of directors has the sole right to determine its own size and fill vacancies, both of which prevent activist shareholders from filling the board of directors with their preferred candidates. Companies may also restrict its shareholders' ability to call special meetings or take actions by written consent, either entirely (which is becoming less common) or below certain ownership thresholds.
Some companies have adopted even more stringent structural defences, such as having two classes of stock (one of which has additional voting rights and is not publicly traded, limiting an activist's ability to obtain voting power) or creating a classified board of directors (directors are divided into three classes with staggered, multi-year terms, making it more difficult for an activist to replace board members). Companies may also adopt a poison pill, which can be triggered by the company to dilute the equity and voting stake of a shareholder that has purchased over a certain percentage of the company's stock by allowing all other shareholders to purchase additional shares at a steep discount. Most large US companies have abandoned these harsher defences in light of scrutiny from the institutional investor community and proxy advisory firms. It is recommended that companies keep a poison pill 'on the shelf' and ready to be implemented in response to a threat from a particular activist (see the Unocal defensive measures discussion in Subsection (ii)), although the company must weigh the possibility that it will lose some credibility in the market even if it successfully blocks an activist campaign.9
The DGCL Section 203 includes an anti-takeover provision that prevents a corporation from entering into certain business combination transactions with an interested shareholder (generally one that owns more than 15 per cent of the company's stock) for three years after becoming an interested stockholder unless the business combination is approved in the manner prescribed by the statute.
The HSR Act requires an investor to provide written notice to a company before acquiring shares that are subject to the HSR Act's filing requirements, which may serve as the first warning to the company that an activist intends to take a significant stake in the company and advocate for change, or alternatively that an existing shareholder has altered its intentions with respect to the company from passive to active and plans to increase its stake.