Responding to shareholder activism in USA

Company response strategies

What are the fiduciary duties of directors in the context of an activist proposal? Is there a different standard for considering an activist proposal compared to other board decisions?

The fiduciary duties of directors are governed by state corporation law. Directors have basic fiduciary duties of loyalty (not putting their own interests above those of the company) and due care. Directors’ decisions are typically reviewed under the default standard of the ‘business judgment rule’, which is a presumption, absent evidence to the contrary, that disinterested and independent directors acted on an informed basis and in the honest belief that the action taken was in the best interest of the company. As such, board decisions are not easily overturned. When a company receives an activist proposal, the same principles apply and the board must review and consider the proposal to determine whether it is in the best interest of the company and its shareholders.

In Delaware, in certain instances, a board’s action in response to an activist proposal may be subject to an enhanced level of judicial scrutiny. If the board adopts defensive measures after a takeover or similar proposal is launched or threatened, the decision may be reviewed under the heightened Unocal standard, under which the directors must show both that reasonable grounds for believing there to be a danger to corporate policy and effectiveness and that the defensive measure was reasonably proportional in relation to the threat. Generally, the board has wide latitude to take defensive measures within a range of reasonableness, so long as such measures are not coercive or preclusive. Actions that impede the shareholder franchise (for example, if an activist is seeking to replace a majority of the directors and the board increases the board size to deny the activist a majority) are liable to be overturned by the courts (under the Blasius line of cases).

What advice do you give companies to prepare for shareholder activism? Is shareholder activism and engagement a matter of heightened concern in the boardroom?

Our advice is always situation-specific; that being said, principles for responding to activists include:

• Everything should go through the CEO (or, if applicable, chair of the board) - all executives and directors should refer activist and takeover approaches, overtures and conversations to the CEO. It is essential that the company speak with one voice. The CEO should keep the board of directors informed and solicit director input for decisions and reactions. Activists may try to contact directors directly, in which case, directors should keep in mind that all conversations are ‘on the record’ and any comments may be used by the activist in their proxy and press materials.
• Maintaining board unity is essential - a unified, supportive board is essential to producing the best outcome, whether the goal is resisting an activist agenda or negotiating the best possible settlement. It is critical to avoid having an activist drive a wedge between management and the board. Honest and open debate should be encouraged, but kept within the boardroom.
• Except in ‘clear conflict’ situations, special committees with additional financial and legal advisers are not advisable - special committees usually hinder board unity, overemphasise the role of advisers, deprive directors of the most valuable source of information and do not enhance directors’ legal protection in non-conflict situations. ‘Clear conflict’ means the involvement of interested directors or senior management being on the other side of the transaction.
• Act and speak as though everything you do and say will be made public - appreciate that the public dialogue is often asymmetrical; while activists can, often without consequence, make personal attacks and use aggressive language, the company cannot respond in this manner. Any sign of discouragement, self-criticism of performance or execution or sign of dissension in the boardroom will be used against the company.
• The board has time and flexibility in responding and plenty of legal latitude - with respect to activism, the board has no special duty to implement an activist’s proposals. The board’s general fiduciary duties apply to decisions made in contemplation of or in reaction to shareholder activism. When considering an activist’s proposals and criticisms, it is the board’s responsibility to make decisions in the best interests of the company and stockholders.
• Remain focused on the business - activists and takeover approaches can be distracting and time-consuming for a board and management, but continued strong performance of the business, though not an absolute defence, is one of the best defences.

What defences are available to companies to avoid being the target of shareholder activism or respond to shareholder activism?

Structural defences

Many of the structural defences that, under state law and a company’s charter and by-laws, may be available to companies to resist a hostile takeover bid can also improve the company’s ability to resist an activist attack. However, in recent years, most large corporations have given up many of their defences. For example, if a company has a staggered board, an activist can only win a minority of the board seats in any one election cycle. If a company does not have a staggered board, an activist can propose to take control of the board (and we are increasingly seeing efforts to do so). Whereas most S&P 500 companies had a staggered board 15 years ago, about 90 per cent today do not. Because a staggered board has to be provided for in the company’s charter, companies that have given up their staggered board are unable to implement one now.

Other provisions of a company’s corporate profile that implicate its vulnerability to an activist attack are whether shareholders can call a special meeting, or act by written consent, which determine whether the company is only vulnerable at its annual meeting or throughout the year.

Most companies have adopted by-laws providing for advance notice and other requirements for shareholder proposals and director nominations, that provide some advance warning of an attack. If a company’s charter permits shareholders to act by written consent, the board cannot eliminate that danger but can implement a by-law requiring a shareholder who wants to act by written consent to ask for a record date, in a process that can also provide a few weeks of notice of a consent solicitation.

The board can still implement a shareholder rights plan (also known as a ‘poison pill’) to prevent an activist or group of activists acting in concert from acquiring stock in the company above a specified threshold, but that level is typically set at 15 or 20 per cent and activists generally do not need to go that high to have an effective attacking platform. Some states also have anti-takeover statutes that may discourage hostile acquirers or activists going over a specified threshold of ownership. For example, Delaware (along with several other states) has a ‘moratorium’ anti-takeover statute that restricts a shareholder that has acquired 15 per cent or more (but less than 85 per cent in the same transaction) of the company’s outstanding shares, without approval of the board, from engaging in certain business combination transactions with the company for a period of three years.

The effectiveness of the available structural defences will vary depending on the situation. There are no defences that make a company immune to shareholder activism. Sometimes the very existence of one or more of these defences can actually create a vulnerability in an activist situation because the proxy advisory firms and major institutions dislike structural defences such as staggered boards and will support an activist to protest what they consider imperfect governance.

Other defences

Aside from traditional structural defences, the best defensive measures that a company can take (aside from keeping its stock price high) is to maintain active outreach and engagement with the company’s core, long-term shareholders. Understanding investor concerns and maintaining an ongoing dialogue can not only identify potential areas of vulnerability for the company but also help boards in avoiding public shareholder activist campaigns and securing shareholder support if faced with one. Additionally, companies and boards should continually monitor corporate governance benchmarks and trends and compare the company’s corporate governance practices to evolving best practices to stay abreast of hot topic issues and address any potential vulnerabilities.

Do companies receive daily or periodic reports of proxy votes during the voting period?

During a contested situation, it is not unusual for companies to receive frequent updates on proxy vote tallies. Even in uncontested situations, for relatively routine annual shareholder meetings, companies will often choose to receive periodically updated reports on proxy voting (if for no other reason than to confirm that they will have a quorum).

Historically, Broadridge, which is the single largest agent collecting vote tallies, would provide the vote tallies both to the shareholder proponent and the company. However, in May 2013, after certain brokers objected to the release of this information to shareholder proponents, Broadridge changed its policy to provide vote tallies to the shareholder proponent only if the company affirmatively consents. Proxy rules are currently silent on preliminary vote tallies despite calls by various interest groups for SEC rulemaking on the subject. We would also note that some companies have received Rule 14a-8 shareholder proposals regarding vote tallies - namely keeping the interim vote tallies confidential, even from the company, in certain situations. Depending on the language of the specific proposal, it may be possible to exclude the proposal on ‘ordinary business’ grounds. Of the shareholder proposals that have gone to a vote, none received majority support; however, certain institutional investors, such as Vanguard, have indicated support for confidential voting. Certain companies have responded by adopting a policy on interim vote tallies, allowing Broadridge to provide non-public interim tallies to qualifying shareholders in certain situations.

Is it common for companies in your jurisdiction to enter into a private settlement with activists? If so, what types of arrangements are typically agreed?

It is not uncommon for companies to enter into settlements with activists in order to end proxy fights and activist campaigns. Depending on the form of the settlement, the terms are sometimes publicly disclosed or filed by the company. The type and terms of the arrangement vary depending on the activist’s demands. Typically, the agitating activist will receive a number of board seats as part of the settlement. Starboard Value led the way in 2018, winning 29 board seats exclusively through settlements with target companies (out of a total of 161 board seats won by activists last year). In campaigns where the activist has demands or proposals other than seating new directors, the settlement will usually involve the implementation of one or more of the activist’s demands, either in its entirety or tailored in some way to be more acceptable or feasible for the company, usually in addition to the appointment of certain activist-approved directors on the board.