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For most of his long career as a Wall Street attorney, Martin Lipton has been the man to call when companies find themselves under attack. He is a master tactician, famed for his ability to outfox the wiliest corporate raider or hostile bidder.
Now in the sixth decade of his career, the takeover defence attorney is fighting as hard as ever. Yet despite his efforts, today’s activist hedge fund managers are having great success in forcing their demands on reluctant companies.
The battles do not always go the hedge funds’ way, as Dan Loeb has found at Sony and Carl Icahn has learnt at Apple and eBay. But look deeper, to the battles behind the battles, and it is clear that Mr Lipton and his supporters are on the back foot.
The intellectual winds have shifted after a decade bookended by the Enron fraud and the financial crisis and characterised by a drip of revelations on boardroom pay and perks. Institutional investors have been persuaded that company management has no monopoly on wisdom and that boards meant to oversee them might themselves be in need of oversight. “I’m in a minority, yes, but I wouldn’t say that I was beleaguered,” Mr Lipton says with a note of defiance.
More hedge funds today are styling themselves as activists and they are notching up significant victories. Their demands can vary widely, from the sale of a company to share buybacks to an operational shake-up. They may apply their pressure in private, as Jeff Ubben’s ValueAct did to ease out Steve Ballmer as chief executive at Microsoft. Or they may do so in public, as in Nelson Peltz’s campaign to make PepsiCo split off its snacks business. But they have in common a belief in their analysis and a determination to force change, even if it means storming their way on to corporate boards.
Success has attracted more money to the sector. Assets sit at a record $74.2bn, according to eVestment – and with Bill Ackman’s Pershing Square teaming up with a hostile bidder for Botox maker Allergan this week, the activists’ ambitions are growing.
The legal, regulatory and intellectual skirmishes taking place behind the scenes are setting the new rules which are shifting the odds in favour of the activists and away from the corporations.
There are a half dozen or more of these fights raging. At issue are the acceptable use of poison pills, changes to corporate voting rules and the arcana of company bylaws, the role and power of proxy advisers and what hedge funds must disclose about their stakebuilding – and when.
“I’m still prepared to do the best I can to make sure that the playing field is level,” Mr Lipton says. “We’re not asking for protection; we’re asking for a level playing field.”
In this debate, the playing field that is level to one man is uneven to another. “The first wave of attacks on activism focused on convincing shareholders that active shareholder engagement was somehow bad for them,” says Barry Rosenstein of Jana Partners, which has taken on managements at Safeway, McGraw Hill and Agrium, among others. “Having failed at that, defenders of underperforming boards have launched a second wave focused on rule changes and technical defences. In the long run I doubt this will be any more successful.”
These campaigns are sometimes fought with the fervour of a crusade. On one side are those, like Mr Lipton, who believe activists are exacerbating the markets’ tendency to focus on the short term.
“Virtually every activist attack involves reduction in assets, reduction in invested capital, reduction in R&D, reduction in future capex and, most significant for the economy, reduction in employment,” says Mr Lipton. “Is it good, appropriate national policy to permit Carl Icahn to scream at one company after another to try and get them to do something that will create profits for Carl Icahn?”
On the other side, activists’ supporters say a company’s owners need to be engaged for capitalism to work efficiently. The activists add that they have longer-term horizons than traditional fund managers who are obsessed with quarterly performance.
What Mr Lipton is to corporate defence work, Paul Roth is to the activists. Known as the “dean of the hedge fund bar”, Mr Roth says activists tend to show up for a reason – and with a plan.
“Companies that are doing poorly are the ones that tend to get targeted,” says Mr Roth. “A well thought out business plan for a company that has become somewhat entrenched in its thinking can result in all shareholders over time becoming substantially enriched.”
Both sides profess to want a dialogue of ideas. But how sensitive directors are to shareholder opinion can depend on how easy it is for shareholders to vote them out if the board stands in their way. For this reason, activists and the largest institutional shareholders have joined forces to fight for better tools to unseat directors.
In this, the Securities and Exchange Commission tried but failed to help. It proposed in 2010 that dissident shareholders be allowed to place their own nominees on the ballot for board elections. But the US Chamber of Commerce and the Business Roundtable mounted a successful legal challenge. Fights for proxy access are instead sporadic, company by company.
Calpers, the California state pension fund, has also been putting resolutions to annual meetings demanding boards institute majority voting for elections so that unopposed directors must win at least half the vote to secure their place. While 84 per cent of S&P 500 companies now have majority voting, the number is well below half among smaller companies.
“Suffrage is being fought for in the land of the free and the home of the brave,” says Anne Simpson, head of corporate governance at Calpers.
There is even tussling over how exactly the rules get changed. Boards can usually change corporate bylaws unilaterally but if shareholders want to alter them they require a supermajority, which is difficult to achieve.
Schulte Roth Zabel, Mr Roth’s firm, sued directors of Bob Evans Farms, the restaurant chain, in January on behalf of activist Sandell Asset Management after the Bob Evans board overturned bylaw changes that had just been approved by shareholders. That case settled when the company reversed course. Lawyers are now looking for another opportunity to test the issue in court.
It is not just the US judicial system that can arbitrate these skirmishes. When Wachtell Lipton, Mr Lipton’s firm, was hunting last year for ways to repel activist advances, it hatched a plan that would make it harder for them to nominate alternative board candidates. The manner of its defeat revealed the power of another organisation that has its finger on the scales: Institutional Shareholder Services, a proxy adviser.
What happened? Activist hedge funds fighting for board representation have typically paid their candidates a fee to stand for election, given the time and potential bruises involved in a bitter proxy fight. But when two hedge funds, Jana and Elliott Management, proposed last year that they would also pay some of their nominees a bonus if the funds made money, institutional investors grew nervous about diverging incentives and disharmony in the boardroom. Sensing an opportunity, Wachtell Lipton proposed that companies ban director candidates from taking any payment at all, even a fee to stand. It drafted a bylaw provision that had been adopted by three dozen companies within a few weeks.
ISS is the largest of the proxy advisory services, which recommend how shareholders should vote in director elections, say-on-pay votes and the panoply of shareholder proposals that come up at annual meetings. Many small pension funds and institutional investors without the resources to assess every vote typically follow the recommendations of ISS or rival services such as Glass Lewis. Some recommendations are estimated to have the ability to influence up to one-third of the votes at certain companies.
ISS went into battle against the Wachtell Lipton plan. It recommended withholding votes for the re-election of directors of Provident Financial, one of the first companies to adopt it. Faced with this nuclear option, Provident backed down. Of the 33 companies that adopted the bylaw, two-thirds have since reversed course. Mr Lipton concedes the idea has died.
ISS has signalled it will use its power again. Directors of boards that ignore shareholder votes will find themselves with a negative recommendation when they are next up for election, it says. That could sharply alter the balance of power between boards and shareholders.
The proxy advisers’ increased leverage, and greater determination to use it, has put them in the line of fire of corporations and their lobbyists, who have been trying to persuade the SEC to curb their power, or at least to complicate life for them by bringing them under new regulatory oversight.
“The question is whether ISS, which owns no stock, should have the power of a $4tn voter,” a Wachtell Lipton partner told a roundtable convened by the SEC last December.
ISS says its policies on corporate governance issues reflect its regular surveys of institutional investors, hedge funds and companies. Critics say ISS is squarely in the activists’ camp. The SEC is considering rules that would force the company to be more explicit about whether it is doing consulting work for the hedge funds, on whose proposals it is also making recommendations.
Chris Cernich, an ISS director, insists it makes such disclosures to clients already and has Chinese walls between its research and consulting divisions. “Hedge funds are pretty frustrated with us a lot of the time, too,” he says. “We recommend against a lot of hedge funds, including hedge funds that buy research from us.”
Wachtell Lipton also appealed to the SEC to force activists to come clean about their stakebuilding earlier. Funds have to publicly reveal a stake of more than 5 per cent but they have 10 days to do so after passing that threshold. Together with buying during that grace period, Mr Ackman and other activists targeting JC Penney in 2010 suddenly emerged with 27 per cent of the retailer under their control.
The idea of speedier disclosure rules has been supported by Dan Gallagher, an SEC commissioner, and by Leo Strine, the chief justice of Delaware, where most large public companies are incorporated. Mr Lipton, however, does not sound hopeful that the SEC will act. “I think it’s probably dead.”
His pessimism over this and other battles behind the battles is the result of a December speech by Mary Jo White, the SEC chairman, in which she lauded activists. It reads like a personal rebuff to Mr Lipton’s view of the world.
“It was not so long ago that the ‘activist’ moniker had a distinctly negative connotation,” Ms White said. “It was a term equated with the generally frowned upon practice of taking an ownership position to influence a company for short-term gain. But that view of shareholder activists, which has its roots in the raiders of the 1980s takeover battles, is not necessarily the current view and it is certainly not the only view.”
Mr Lipton will keep fighting, however, and perhaps his biggest battle of all is the one for public opinion. He is heartened that Larry Fink, BlackRock chief executive, urged companies to look past demands for short-term financial engineering and invest for the long term, even while BlackRock and other institutions make common cause with activists to boost shareholder democracy.
“I think we’ve made some progress with institutional investors,” Mr Lipton says. “Not enough, but some. The other thing is to try to change the view of people who are essential to ultimate change in regulation. The battle is still there. Certainly I haven’t lost it.”
Sotheby’s: Search for an antidote to the poison pill
Daniel Loeb’s campaign to force himself on to the board at Sotheby’s has been among the most deliciously rude of this year’s crop of activist battles. Mr Loeb called the auction house “an old master painting in desperate need of renovation” and said executives “feasted on organic delicacies and imbibed vintage wines” at shareholders’ expense. Sotheby’s says Mr Loeb would be a “disruptive” director with “no relevant skills”.
As the two sides try to win over a majority of shareholders, another struggle will affect not just Mr Loeb’s Third Point fund but the balance of power between activist hedge funds and company managements.
An unwanted investor who is building a stake in a company can be stopped dead in his tracks if a board resorts to a poison pill, a potent defence tactic invented by Martin Lipton in 1982.
Third Point will ask a Delaware court next week to rule that Mr Lipton’s creation has been taken too far and that Sotheby’s is using it illegally to subvert shareholder democracy.
The pill has been upheld by numerous courts as a legitimate way to protect shareholders from a single investor taking effective control of a company without paying a takeover premium. It allows a company to issue unlimited amounts of new shares to existing investors so that no matter how many he buys a raider can never have more than a certain percentage of the shares outstanding.
Just as modern medicines can be engineered to home in ever more closely on the triggers of a disease, the poison pill has been refined to target activist investors ever more narrowly.
They have been imposed at increasingly low ownership stake thresholds in recent years. At Sotheby’s passive shareholders are given an exemption and allowed to hold up to 20 per cent of the company while Mr Loeb and other activists are limited to 10 per cent.
The two-tier system is an “improper attempt by the directors of Sotheby’s to entrench themselves in office”, Mr Loeb argues.
The ultimate winner of the battle for Sotheby’s board seats may have little resonance beyond the auction house’s long-suffering shareholders.
The winner in court, however, will tilt the playing field for or against activism, with consequences for many battles to come.