An extract from The Shareholder Rights and Activism Review, 5th Edition

Key trends in shareholder activism

i Shareholder activists

Shareholder activists primarily fall into two categories: hedge fund activists and Rule 14a-8 activists. Hedge fund activists are investors whose investment strategy is to identify what they consider to be vulnerabilities at certain companies and purchase a sizeable minority stake in those target companies with the view that changes they recommend and agitate for, if successful, will increase shareholder value and result in a financial gain for their investment portfolio. Rule 14a-8 activists are shareholders that submit proposals to companies under Rule 14a-8 promulgated under the Exchange Act, a rule that requires a public company to include a shareholder proposal in its proxy materials for a shareholders' meeting if certain requirements are met by the shareholder. A company's preparation for and response to activism will differ depending on the type of shareholder activist it faces.

Hedge fund activists are the main focus of this chapter. Hedge funds pursuing activist strategies have had tremendous success in raising capital in recent years, with aggregate assets under management of hedge funds engaged in activism exceeding US$100 billion since 2014. Each hedge fund activist has its own strategy, objectives, personality and frequency of engaging in activism. Some activists, such as Carl Icahn and Third Point, are long established, while others are second generation. The investment horizon of an activist hedge fund can range from very short-term to somewhat longer-term. Certain hedge fund activists invest their own funds, whereas others invest third-party funds. Additionally, an activist hedge fund's redemption policy (e.g., whether investors have the right to redeem their funds quarterly or have longer-term 'lock up' commitments) may impact its behaviour and investment strategy.

Rule 14a-8 activism is often socially driven, with the activists including retail shareholders, advocates of social issues (e.g., environmentalists), religious organisations, pension funds and a variety of other groups. During the 2019 proxy season, corporate governance-related proposals continued to represent approximately half of the Rule 14a-8 proposals voted on, and approximately 21 per cent of these proposals received sufficient shareholder support to pass. Other 2019 Rule 14a-8 proposals included environmental, social and political (ESP) proposals as well as compensation proposals, which have a very low pass rate. However, ESP proposals continued to gain momentum in 2019, with the ESP proposals that went to a vote receiving record average support of 28 per cent and a record nine proposals passing. The vast majority of Rule 14a-8 proposals are targeted at S&P 500 companies.

Traditional institutional investors such as BlackRock, Fidelity, State Street and Vanguard may be considered shareholder activists as well. The concentration of ownership among these large institutional investors has continued to grow. As at December 2019, one of BlackRock, Vanguard or State Street was the largest single shareholder in 438 companies out of the S&P 500 and collectively the three firms owned 19.2 per cent of all shares in the S&P 500. These institutions have developed internal proxy advisory functions and are displaying an increased willingness to directly express their views on governance matters in recent years. These investors are long-term shareholders by nature, and their inability to exit investments nimbly increases their incentive to advocate for changes that will increase enterprise value and protect their investment. Traditional institutional investors also increasingly support activism, although in certain cases there may be a tension between the institutional investor's long-term outlook and a shareholder activist's short-term focus.

In recent years there has also been a noticeable blending of investment strategies by investors with historically distinct investment strategies, particularly activist hedge funds and private equity firms. While certain activist investors such as Paul Singer of Elliott Capital Management and Carl Icahn have long been selectively acquisitive due to their size, other activist investors are also starting to employ private equity-like strategies. For their part, some private equity firms have recently taken up their own form of activist investing, including acquiring minority stakes. Despite their historical differences, private equity firms and hedge funds share a common ultimate objective of acquiring an ownership stake in a company they consider to be undervalued, effecting certain changes at the company designed to boost value, and then realising a return on their original investment by exiting the company at a higher valuation. Other traditionally passive investors could also move towards an activist approach, paving the way for a further convergence of investment strategies.

ESP parameters are increasingly playing a prominent role in the public discourse of both Rule 14a-8 activists and institutional investors. Recently, several of the largest institutional investors reaffirmed this trend with clear statements that they continue to be focused on issuers' 'purpose,' how corporations treat their employees, communities and other stakeholders (not just shareholders), and similar concepts. BlackRock's Larry Fink has described 'purpose' as 'a company's fundamental reason for being – what it does every day to create value for its stakeholders'. In his 2020 annual letter to CEOs, Fink wrote that 'purpose is the engine of long-term profitability.'

ii Target companies

Hedge fund activists target companies in which they think there is potential to increase shareholder value, and often look for traditional red flags such as stock price underperformance, operational challenges relative to peers, significant unused cash on the balance sheet, perceived management weakness, multiple business lines, undervalued assets or perceived excessive executive compensation. However, more recently, shareholder activists have also been targeting companies that have performed in line with or better than their peers. A company's liquidity and size of its market cap can play a role in its susceptibility to activism; it is inherently more difficult for a shareholder activist to amass a large enough stake to influence a company with illiquid stock or a large market cap. Nevertheless, activists have been successful with small stakes (under 1 per cent) and have targeted even the largest and most well-run companies, proving that no company is immune to activism. On average, approximately 10 per cent of the activist campaigns in each of the past five years targeted companies with market caps of greater than US $10 billion. However, given the capital required to acquire a significant stake in large-cap companies, only a small number of prominent activist investors consistently target Fortune 100 companies. Activists have targeted a wide variety of industries, with investment vehicles, pharmaceutical companies, software companies and other commercial service providers being the most targeted industries since 2014.

iii Activist campaigns

The general consistency of the data in recent years suggests that activism will continue to be an important consideration for companies going forward. Shareholder activists pursue a variety of objectives, including pursuing a company's sale to a third party (or conversely seeking to block a planned merger), pushing for another type of fundamental transaction such as a spin-off, balance sheet demands such as dividends or share repurchases, operational and capital structure demands, and governance demands. Shareholder activists frequently pursue multiple objectives in the same campaign, with governance demands – particularly board representation or seeking changes in management – often used as a means of achieving economic objectives. Mergers and acquisitions activity was a particular focus of activists in 2019, more than ever before, demonstrated by activists both calling for companies to initiate a sale or divestiture process and opposing previously announced transactions.

Shareholder activists utilise a number of different strategies to achieve their objectives, depending on factors such as the activist itself (many have a consistent modus operandi) and the subject company's defensive posture. The standard activist 'playbook', though not applicable to every campaign, follows a series of escalating tactics with the key objective of creating an impression of inevitability. A shareholder activist often begins a campaign by engaging in a private dialogue with the company's management before its stake in the company becomes public. If successful, these discussions can avoid further agitation by leading to either an informal or formal settlement between the company and the shareholder activist. If private discussions fail, the shareholder activist may initiate a public campaign to apply pressure on the company through press releases, open letters to management, the board of directors and shareholders, issuing white papers presenting its investment thesis and analysis, and using other means of communication to rally the company's other shareholders to support its cause. Shareholder activists are also adept at using media, including social and alternative electronic media, to their advantage.

The shareholder activist may then threaten and eventually initiate a proxy contest for representation on the company's board of directors. Shareholder activists seek to gain representation by either replacing only a minority of the company's directors or, in more extreme – but not less common – scenarios, trying to replace at least a majority of the board of directors (a control slate contest). If a shareholder activist is well funded, it may also commence a lawsuit (sometimes in conjunction with other tactics) to obtain information from the company, reverse board decisions or redeem the company's poison pill, among other claims. As discussed further in Subsection (i), shareholder activists do not usually make an offer for the entire company, although hostile offers have been made by hedge fund activists in past campaigns and prominent activist hedge fund Elliott Management (Elliott) has established a private equity arm.

iv Paths to resolution

Activist campaigns continued to achieve high levels of success in 2019. Shareholder activists place a high value on the public perception of a successful campaign, including a partial victory or settlement, even without achieving an outright win for all of its demands. Partial success can entail the shareholder activist receiving at least one board seat (either through a settlement or proxy contest that goes to a vote) or the company agreeing to pursue one of the activist's economic objectives.

It is common for a company and shareholder activist to settle and enter into a cooperation agreement. A typical cooperation agreement provides the shareholder activist with minority board representation and includes customary standstill restrictions for the benefit of the company, such as prohibiting the activist from soliciting proxies in opposition to management prior to the company's next annual meeting. In many cases, companies conclude that settling with a reputable activist is preferable to expending significant time and resources on a protracted and distracting proxy contest. A company's board of directors has an interest in appearing firm but open-minded about an activist's credible suggestions to its other shareholders and the investment community at large. Most shareholder activists also have an interest in creating working relationships with the company's board of directors and building a public reputation for playing fair, which can facilitate future negotiations with the company and the future subject companies.

Companies must recognise that providing a shareholder activist with board representation is simply the beginning and not the end of the company's discussions with the activist. Once the shareholder activist is represented on the board of directors, it will most likely seek changes that it believes are in the best interests of the company and its shareholders. In addition, the presence of the activist's director designees may alter boardroom dynamics. Activist designees that receive board seats also stay on the boards for long periods. Since 2010, prominent activist fund insiders who became directors following a settlement agreement stayed on the relevant board for an average of approximately two years longer than the minimum provided for in the settlement agreement, and many insiders in this subset are still on the relevant board.

Recent shareholder activism campaigns

Although there are many recent US shareholder activism campaigns worthy of discussion in this chapter, this section highlights two campaigns by US activist hedge funds against US public companies that helpfully demonstrate the varying nature and objectives of shareholder activists.

i eBay/Elliott and Starboard Value

In January 2019, Elliott published a letter revealing a 4 per cent stake in eBay Inc. (eBay) and outlining Elliott's 'Enhancing eBay Plan' to unlock value-creation at the company. The plan called for, among other things, divestment of eBay's Stubhub and eBay Classifieds Group franchises and renewed focus on eBay's core Marketplace business. Starboard Value LP was also reported to have a large position in eBay and to have urged the same changes at the company. On 1 March 2019, eBay announced that it had entered into cooperation agreements with both Elliott and Starboard, pursuant to which it would immediately add two new directors to the board, with Elliott also having the right to privately recommend to the company an additional independent director later in the year. eBay also announced a strategy review of its asset portfolio, including Stubhub and eBay Classifieds Group. In September 2019, eBay's CEO resigned after disagreements with the new board. In announcing the leadership transition, eBay noted that its strategic review of StubHub and Ebay Classifieds Group continued to move forward. On 25 November 2019, eBay announced an agreement to sell Stubhub to Viagogo for a purchase price of approximately US$4.05 billion in cash. The deal closed in February 2020.

ii EQT Corporation/Rice Investment Group

The year 2019 saw the first successful use of a universal proxy card for a control slate in the US when a shareholder group led by Toby Rice and Derek Rice (the Rice Team) prevailed in their proxy contest at EQT Corporation (EQT). In November 2017, the Rice Team sold Rice Energy, the company they had founded, to EQT for approximately US$6.7 billion. In December 2018, after EQT's stock price had fallen more than 50 per cent since the merger and EQT lowered its five-year outlook, the Rice Team began publicly calling for a 'course correction' and for EQT's CEO to be replaced with Toby Rice. In March 2019, the Rice Team nominated a control slate of nine director candidates for election at the 2019 annual meeting, including Toby Rice and Derek Rice. In April 2019, Toby Rice filed a lawsuit against the EQT board of directors, alleging an unfair playing field and refusal by EQT to use a universal proxy card for the election. A universal proxy card is a proxy card in contested elections at listed US public companies that includes the director candidates nominated by both the company and the shareholder activist, which is different from the default in which each side has its own proxy card. EQT and the Rice Team ultimately agreed to adopt a universal proxy card for the annual meeting. In May 2019, EQT announced that it had nominated three new director candidates for election and that three long-tenured board members (including the chairman) would retire. As a result, the Rice Team revised its director slate down to seven nominees (out of 12 board seats). The Rice Team's slate was supported by ISS and several large shareholders, including T Rowe Price and D E Shaw. On 10 July 2019, EQT announced that its shareholders had elected all seven of the Rice Team's nominees as well as the five EQT nominees it supported, with the Rice Team's slate receiving more than 80 per cent of the votes cast at the annual meeting. The board of directors elected Toby Rice as the President and CEO of EQT.