Shareholder activist strategiesStrategies
What common strategies do activist shareholders use to pursue their objectives?
The strategies employed by activist investors vary depending on the intended goal. Key tactics include:
- Deal activism - either by pushing for a merger, sale or divestiture transaction by the target company or after announcement of such a transaction, exercising shareholder rights to appraisal in hopes of getting a higher price, encouraging a topping bid by a third party, trying to influence the combined company or the integration process or trying to scuttle the deal.
- Operational activism - advocating for cost-cutting measures, strategy change, portfolio review or management turnover, in each case, often in combination with a proposal to replace the CEO and/or members of the board of directors.
- Financial engineering or balance sheet activism - demanding a target company undergo a capital structure change in the form of buying back shares, declaring a special dividend, or overhauling the company’s tax planning.
- ESG activism - advocating for environmental, social and governance change, including eroding a company’s takeover defences to facilitate economic activism goals.
- ‘Short’ activism - accumulating a short position and combining it with negative public campaigns, white paper publications, among others.
These more conventional tactics are often coupled with more innovative approaches, such as economic arrangements among funds, partnering with a hostile third-party bidder, calling special meetings for ‘referendums’ and combining traditional proxy fights with ‘vote no’ campaigns. Some activists have looked to the courts in their campaigns by using litigation to extend director nomination deadlines or to challenge the target company’s decision in proxy fights. Activists have also been known to employ new methods to engage retail shareholders, including using social media and redoubling engagement efforts with institutional shareholders and proxy advisers.Processes and guidelines
What are the general processes and guidelines for shareholders’ proposals?
A shareholder may propose that certain business be brought before a meeting of shareholders by providing notice and complying with applicable provisions of state law and the company’s by-laws and charter. The company’s ‘advance notice’ by-laws will generally set forth the time requirements for delivering the proposal (for example, that the proposal be received by the company’s corporate secretary not more than 90 days and not less than 60 days before the meeting), other procedural requirements (such as a description of the ownership and voting interests of the proposing party) and limitations on the types of proposals that can be submitted (for example, that a proposal may not be submitted that is substantially the same as a proposal already to be voted on at the meeting). It is often costly to submit a proposal in this manner because the soliciting shareholder must develop its own proxy materials and conduct its own proxy solicitation. However, serious fund activists seeking to effect a change in the company’s strategy or to nominate directors do proceed in this manner under the by-laws of the company rather than relying on Rule 14a-8.
Under Exchange Act Rule 14a-8, a shareholder may submit a proposal to be included in the company’s proxy statement alongside management’s proposals (avoiding the expense of developing independent proxy materials and conducting an independent proxy solicitation). Rule 14a-8 sets forth eligibility and procedural requirements, including:
- that the proposing shareholder has continuously held, for at least one year by the date the proposal is submitted to the company, the lesser of US$2,000 in market value or 1 per cent of the company’s securities entitled to vote on the proposal and continue to hold those securities through the meeting date;
- that the proposal be no longer than 500 words; and
- that the proposal be received at least 120 calendar days prior to the anniversary of the date of release of the company’s proxy statement for the previous year’s annual meeting.
If the shareholder has complied with the procedural requirements of Rule 14a-8, then the company may only exclude the proposal if it falls within one of the 13 substantive bases for exclusion under Rule 14a-8 (eg, that the proposal would be improper under state law, relates to the redress of a personal claim or grievance, deals with a matter relating to the company’s ordinary business operations, relates to director elections, has already been substantially implemented, is duplicative of another proposal that will be included in the company’s proxy materials or relates to a specific amount of cash or stock dividends). A company will often seek ‘no action relief’ from the SEC staff to exclude a shareholder proposal from the company’s proxy materials on one of the bases of exclusion listed above. If ‘no action relief’ is not granted, a company could, but rarely does, seek a declaratory judgment from a court that the shareholder proposal may be excluded from the company’s proxy statement.
Shareholder 14a-8 proposals are often precatory or non-binding, and do not require implementation even if the proposal receives majority support. Shareholder proposals may, however, be binding if the proposal is with respect to an action reserved for the shareholders (for example, a proposal to amend the by-laws may be binding depending on state law and the company’s by-laws).
In recent years, even precatory proposals have become an effective way for shareholders to compel change, because ISS and Glass Lewis will generally recommend that shareholders vote against directors who do not promptly implement the expressed will of the shareholders.
May shareholders nominate directors for election to the board and use the company’s proxy or shareholder circular infrastructure, at the company’s expense, to do so?
The right of shareholders to nominate candidates for election as director is considered a fundamental element of corporate democracy. That right, and the process to be followed to exercise it, is typically contained in a company’s by-laws. Companies are not, however, required by state or federal law to permit shareholders to use the company’s proxy infrastructure, at the company’s expense, to nominate directors for election to the board. For many years, there were efforts by shareholder activist groups to require companies to give shareholders access to the company’s proxy statement to nominate their candidates. This culminated in the adoption by the SEC of Exchange Act Rule 14a-11, which would have granted proxy access (limited to 25 per cent of the board) to 3 per cent shareholders who have held their shares for at least three years. However, this rule was struck down by the federal courts in 2011.
Proxy access was thrust back onto the agenda in large part through Rule 14a-8 proposals by individual shareholders, as well as large institutional investors, like the New York Pension Funds. In reaction to the popularity of these proxy access proposals, most large public companies have since adopted proxy access by-laws with standards similar to proposed Rule 14a-11. At the time of writing, approximately 67 per cent of the S&P 500 have adopted a proxy access by-law with most allowing nominations for 20 per cent of the board seats by a shareholder or group of shareholders (up to 20 shareholders) that have held 3 per cent or more of the company’s shares for three years or more. Given the relative infancy of proxy access by-laws and the percentage and holding period to be met, we have not yet seen many instances of shareholders utilising this new option to nominate directors, but these nominations may become more popular in the future.
May shareholders call a special shareholders’ meeting? What are the requirements? May shareholders act by written consent in lieu of a meeting?
Whether a shareholder may call a special meeting depends on the corporate laws of its state of incorporation and its organisational documents. With respect to Delaware corporations, under DGCL section 211(d), a company’s certificate of incorporation or by-laws may authorise shareholders to call a special shareholder meeting. The certificate of incorporation or by-laws would then set forth the procedural requirements for calling a special meeting, including the minimum holding requirements for a shareholder to call a special meeting. At the time of writing, about two-thirds of companies in the S&P 500 do provide for this right in their organisational documents, while a third do not. For those companies that do allow shareholders to call special meetings, the required ownership threshold varies considerably, from as low as 10 per cent to as high as 50 per cent, although 25 per cent is sometimes cited as the most common threshold.
The institutional shareholder groups, and the proxy advisers ISS and Glass Lewis who make voting recommendations to them, generally favour providing shareholders with the right to call a special meeting. In 2018, there was a significant increase in the number of proposals to lower the ownership percentage required to call special meetings (typically from around 25 per cent to as low as 10 per cent, which is the level preferred by ISS and Glass Lewis), but most of these proposals were unsuccessful as most major institutions believe that 20 per cent or 25 per cent is the right level.
Whether shareholders may act by written consent without a meeting also depends on state corporate law and the particular company’s organisational documents. With respect to Delaware corporations, under DGCL, section 228, shareholders may act by written consent in lieu of a shareholders’ meeting, unless the company’s charter provides otherwise. At the time of writing, 70 per cent of S&P 500 companies do not allow their shareholders to act by written consent without a meeting. While ISS and Glass Lewis state that they consider the right to act by written consent an important shareholder right, most large institutions appreciate that, as long as shareholders have the right to call a special meeting if necessary, action by written consent is unnecessary, as well as being potentially destabilising and undemocratic (in that it disenfranchises minority shareholders).Litigation
What are the main types of litigation shareholders in your jurisdiction may initiate against corporations and directors? May shareholders bring derivative actions on behalf of the corporation or class actions on behalf of all shareholders? Are there methods of obtaining access to company information?
Shareholders may initiate two main types of litigation against a corporation and its directors - derivative and direct, depending on the nature and sufferer of the alleged harm. A company’s shareholder can also initiate proceedings against a company to inspect certain corporate books and records of the company.
Shareholders may bring derivative actions on behalf of a corporation where there has been an alleged breach of the directors’ or officers’ fiduciary duty of care, fiduciary duty of loyalty or other wrongdoing. The purpose of a derivative suit is to remedy harm done to the corporation usually by directors and officers. Derivative suits face a number of procedural hurdles, which depend in large part on the jurisdiction in which they are brought. Certain states require that, before a derivative lawsuit is filed, the shareholder make a ‘demand’ on the board of directors to bring the lawsuit on the corporation’s behalf. The demand requirement implements the basic principle of corporate governance that the decisions of a corporation - including the decision to initiate litigation - should be made by the board of directors. If a shareholder makes such a demand, the board of directors may consider whether to form a special litigation committee of independent directors to evaluate the demand. If the board of directors refuses the demand, the shareholder may litigate whether the demand was ‘wrongfully refused’. Certain jurisdictions recognise an exception to the demand requirement where demand would be ‘futile’- namely, if a majority of the board of directors is conflicted or participated in the alleged wrongdoing. In such circumstances, it might be appropriate and permissible for the shareholder to skip the demand process and proceed directly to filing a complaint (in which he, she or it would need to demonstrate that a demand would have been futile).
While shareholder derivative suits are brought for the benefit of the corporation, shareholder direct and class actions address unique, direct harms to the particular shareholder plaintiffs. In the M&A context, it has become common for shareholders to initiate class actions against target companies and their boards of directors, alleging that the target company’s board violated its fiduciary duties by conducting a flawed sale process that did not maximise value for the companies’ shareholders. In such instances, a critical factor in determining the outcome of the litigation will be which standard of review is applicable to the board’s conduct; in other words, the deferential ‘business judgement rule’ or a heightened standard of review that some jurisdictions have adopted (such as Revlon, Unocal or ‘entire fairness’). Many public companies have adopted ‘exculpation’ provisions in their governance documents, which provide that directors cannot be personally liable for damages arising out of breaches of the duty of care. However, a director generally cannot be indemnified or exculpated for breaches of the duty of loyalty, including the obligation to act in good faith.
Aside from derivative suits and direct actions, a Delaware company’s shareholders also have the right, under DGCL section 220, to inspect certain books and records of the company; provided that they have ‘proper purpose’ for seeking such materials. Under DGCL section 220, to be eligible for the inspection right, a shareholder must establish both a ‘proper purpose’ for the inspection - namely, one that is reasonably related to the person’s interest as a shareholder, and that the scope of the books and records sought is no broader than what is ‘necessary and essential to accomplish the stated, proper purpose’. To exercise this right, a shareholder should first make a ‘demand’ on the company. If the company or an officer of the company refuses the demand or does not respond within five business days, the shareholder may apply to the court for an order to compel the inspection.