E-Proxy, Shareholder Forums, and the New Age of Shareholder Activism
With the 2008 proxy season underway, the debate on shareholder access continues to simmer, shareholder proposals submitted to date are on the increase and shareholder activists continue to engage in a variety of tactics to pressure management. As a result, public companies need to develop a better understanding of the e-proxy and other technology-based rule changes, as well as new trends in the activist area, and be prepared to address issues raised by activists in light of these changes.
The e-proxy rules adopted by the Securities and Exchange Commission in July 2007 have received relatively little interest from activist shareholders and have not been widely adopted by public companies. Based on February information supplied by brokerage services firm Broadbridge (formerly
The e-proxy rules, effective January 2008, permit large accelerated filers to select from two methods for delivering proxy materials to shareholders. The first method is the traditional delivery method utilizing paper copies of the proxy materials and delivery via
The ability to utilize the “notice and access model” also applies to activist shareholders referred to in the e-proxy rules as “other soliciting persons.” The e-proxy rules provide activists with the ability to solicit some shareholders with paper copies, and others through the notice and access model. These rules will enable an activist to incur the cost of printing and mailing for only one page of material if the “notice and access” model is selected as opposed to the cost of printing and mailing a lengthy proxy statement as well as additional proxy soliciting materials. The “notice and access” model available under the e-proxy rules will substantially reduce the printing and mailing costs for activists electing to engage in a proxy solicitation since they are typically only interested in soliciting a target group of institutional investors. This reduction in printing and mailing costs subsequently would reduce the overall costs of a proxy contest for activist shareholders.
The SEC adopted the e-proxy rules in an attempt to relieve some of the pressure from activist shareholders and Congress as a result of the SEC’s two opposing proposals related to the inclusion of certain shareholder proposals in the proxy statements of public companies in response to the Second Circuit Court’s decision in American Federation of State, County and Municipal Employees, Employees Pension Plan v. American International Group (AFSCME v.
Currently, the preparation, printing and mailing of proxy materials which are required to comply with detailed disclosure rules promulgated by the SEC are costly and time-consuming. Activist shareholders argue that this process and its expense limit the ability of shareholders to nominate directors. This limited ability to nominate directors was further frustrated by the SEC’s adoption of an amendment to Rule 14a-8 described above which effectively limited shareholder access to the proxy statements of public companies with respect to proposals related to the nomination or election of directors. As a result, activists are effectively left with the option of waging a proxy contest and soliciting their own proxies to elect their nominees for directors, which was much more costly in terms of time and dollars prior to the adoption of the e-proxy rules.
Activists can also wage “withhold vote” campaigns against the company’s nominees, which activities do not require the compliance with the SEC’s proxy rules. This was the case with the recent Washington Mutual shareholders’ meeting where the Chairman of the Finance Committee resigned after a withhold vote campaign was waged by institutional investors as a result of the thrift’s large losses from subprime and other high risk mortgage investments.
In a related release, the SEC also liberalized the permissible communications among shareholders and between shareholders and their public companies.3 As part of its amendments to Rule 14a-8, the SEC also provided an exemption from the communication limitations contained in the SEC’s proxy rules for online shareholder forums, subject to certain conditions and exceptions.4 The shareholder forum amendments5 permit communications among shareholders as long as they occur at least 60 days prior to the shareholders’ meeting and the activities in the forums are not for the purpose of soliciting proxies for the upcoming meeting. These shareholder forums can provide an inexpensive avenue for activists to present their views on corporate governance and other matters.
The SEC Staff has also drastically increased its issuance of no-action letters granting company requests to exclude shareholder proposals from the company proxy statements. The SEC Staff has permitted the exclusion of shareholder proposals in almost 70% of the cases this year as compared to less than 50% during the 2007 proxy season, based on preliminary information supplied by RiskMetrics Group, a corporate governance consulting and research firm.
Since it is relatively certain that e-proxy technologies, shareholder forums and activist tactics are here to stay – and no company ever knows when it may become the target of activists – every public company should take the following steps to optimize its position if activists target the company.
1. Understand the Advantages to Activists Created by E-Proxy.
The e-proxy rules offer the potential to reduce production and mailing costs, as well as the delivery time, related to the dissemination of proxy materials for annual meetings. Since activist shareholders also have the option to elect not to solicit some shareholders at all, activists can elect to solicit only those shareholders that did not select paper copies. As a result, it is likely that institutional investors who are the target audience of activist shareholders will likely not elect paper copies when they become aware of activist activities. Notwithstanding the foregoing, the provision of paper copies may not be an issue as preliminary reports during this proxy season indicate that shareholders are not generally requesting paper copies of proxy materials from companies utilizing e-proxy. In addition, activists are further aided by the fact that if they are soliciting 10 or fewer shareholders, their activities are not subject to the SEC’s proxy solicitation rules which are expensive and time-consuming to comply with.6
The e-proxy rules will also dramatically reduce the mailing time lag which is critical in proxy contests. In a typical proxy contest, valuable time is lost in the printing and mailing process. E-proxy provides a path to avoid this time lag. Posting of materials to an Internet web site along with email correspondence could provide an invaluable time savings when the annual meeting is quickly approaching. This is a key advantage given the fact that proxy contests frequently involve multiple distributions of materials.
Finally, e-proxy will likely revolutionize the way proxy contests are waged. Insurgents wishing to propose a short slate of directors to counter management’s nominees could utilize a standardized notice of the availability of proxy materials and web posting of a proxy statement to quickly and cost-effectively accomplish this purpose. In addition, since the modus operandi of activist hedge funds seems to be targeting a group of public companies with respect to a particular proposal such as “Say on Pay” or majority vote campaigns, the ease of e-proxy can facilitate these initiatives.
Given these clear advantages, it appears more likely than not that activists will embrace the new e-proxy rules. As a result, companies facing activist activities need to be prepared to use e-proxy as well in order to avoid being placed at a significant tactical disadvantage in a proxy contest.
2. Educate and Solicit Retail Shareholders When Utilizing E-Proxy
One of the unintended consequences of the e-proxy experience thus far during the 2008 proxy season has been the connection between e-proxy and the lack of voting by retail shareholders whose shares are held in street name. There has been a significant decrease in voting for companies using e-proxy by the shareholders whose shares are held in brokerage accounts. Broadbridge reports that retail voting has decreased to about 23% when companies utilize e-proxy.
This phenomena requires that companies devote some time to educating their retail shareholder base about e-proxy and voting their shares prior to a proxy contest or withhold vote campaign where maximum participation from the street may be needed. In addition, soliciting shareholder votes from those shareholders who hold their shares in street name may also be necessary until these retail shareholders are more receptive to e-proxy and vote. To the extent the SEC approves the New York Stock Exchange proposal to eliminate discretionary voting by brokers, the solicitation of the shares held in street name will be essential.
3. Evaluate the Pros and Cons of Participation in Shareholder Forums.
Management needs to carefully consider whether or not to participate in shareholder forums. Concerns regarding compliance with Regulation FD and insider trading (or potential tipping liability) can significantly curtail what management is permitted to say. The best advice is likely to avoid these forums entirely. If the decision is made to participate in an online shareholder forum, consideration must be given to the structure of the dialogue to avoid the above-referenced issues. In addition, management needs to be very careful about what they say as the activist will be prepared to use management’s words against them at a later date.
4. Be Prepared for "Withhold Vote" Campaigns.
Activists can also accomplish goals similar to those achieved in a proxy contest without actually waging one. This is particularly true in the event the company has adopted a majority vote bylaw provision as is the case with many large public companies which adopted such provisions in light of pressure from activist shareholders in recent years. During the 2008 proxy season, there was an increase in withhold vote campaigns often referred to as “vote no” campaigns, where activists do not actually solicit votes for their own director candidates but disseminate letters to public company shareholders encouraging them to vote against some or all of management’s nominees. In a withhold vote campaign, activists do not have to comply with the SEC’s proxy solicitation rules because they are not actually soliciting proxies for a slate of directors as is the case with a proxy contest, but merely engaging in a letter writing and PR campaign against the company’s slate of directors. In addition, since a withhold vote campaign is not a shareholder proposal, activists do not have to comply with advance notice bylaw provisions adopted by most public companies. Public companies faced with these “vote no” campaigns must address activist claims in compliance with the SEC’s proxy rules. This means all materials utilized by the public company will be deemed additional solicitation materials under the SEC’s rules and must be filed with the SEC.
Withhold vote campaigns will likely remain popular as they are extremely inexpensive as compared to a proxy contest and frequently result in similar effects. Companies faced with withhold vote campaigns should be prepared to utilize e-proxy to reduce the timeframes involved in circulating additional materials in response to “withhold vote” campaigns and actively solicit shareholders.
5. Identify Activists in Your Company's Stock.
Many companies are caught off guard as they are not even aware that an activist hedge fund has taken or increased its position in the company’s stock. Since no one likes to be surprised by activist funds that operate in stealth mode before they strike, company management should regularly monitor changes in the company’s shareholder base with an eye toward those activities that may signal activist interest. Close attention should be given to unusual stock purchases, as well as the accumulation of large blocks of stock, as this may be evidence that activists are increasing their positions. This information can be obtained from publicly filed documents such as Schedule 13Ds and 13Gs and Form 13Fs, as well as conversations with proxy solicitors and others, who keep careful tabs on the activities of these activist funds. In addition, third-party offerings such as the monitoring services of Hedge Fund Solutions can provide an excellent source of information on the activities of activist funds.
6. Assess Your Company's Vulnerabilities and Implement Plans to Address These Shortcomings.
Since virtually every company has an Achilles’ heel, and identifying the vulnerable aspects of the company’s operations from a financial, corporate governance and operational perspective is not only helpful for risk management and internal control purposes, but critical in this age of shareholder activism. Since activist shareholders will be quick to point out the company’s shortcomings and how the activist thinks these issues should be addressed (which usually involves the sale of the company), company management will be in a better position in dealing with activists if they have not only identified these issues and potential problems but also put plans in place to address or correct them. This process should be undertaken with an eye toward implementing strategies that would enhance long-term shareholder value.
7. Focus on Maintaining Good Corporate Governance.
In the event of a proxy contest, good corporate governance may not help, but clearly a poor corporate governance record can hurt a company significantly in a battle with an activist hedge fund. Many hedge funds have increasingly attacked companies not only for operational and performance issues but for their corporate governance shortcomings as well. In this regard, companies should not only adopt but strive to maintain a good track record on corporate governance issues. This process should commence with a review of current corporate governance policies by an experienced corporate governance attorney.
8. Become Familiar with the Modus Operandi of Activist Funds.
Since hedge funds control some $1.8 trillion in assets globally, of which approximately three-fourths of such amount represents
The strategies employed by activist funds in prior transactions is publicly available from a host of sources but is something often overlooked by companies. In addition to the new e-proxy rules, the arsenal of activists’ tactics includes forging alliances with other institutional investors, withhold vote campaigns, shareholder proposals, and proxy contests or consent solicitations, including proposing a short slate of directors to counter the company’s nominees. In addition, activists have been increasingly litigious if companies attempt to block their shareholder proposals. This litigation often results in changes in law7 or the necessity of making changes to a company’s bylaws or other corporate governance documents.8 Without an understanding of the activist mindset, it is not possible for a company to be proactive in its approach to activists.
9. Respond to the Changing Investor Landscape—Enhancing Shareholder Value.
Given the changing investor landscape and the rise of shareholder activism, companies should remain vigilant and be prepared to respond appropriately. In this regard, a company should be ready to react to activist attacks by formulating a response prior to activist intervention. Since the best defense is often a good offense, it is critical that management be in a position to respond quickly and from a position of strength. This requires advance planning and the formulation of the company’s strategies to enhance shareholder value which can be accomplished as part of the company’s annual business planning process.
If this strategy is agreed upon in advance following the company’s review and understanding of the activist’s investment strategy and tactics, the company will be in an enhanced position when forced to address activist claims. This strategy should include decisions regarding whether to adopt certain corporate governance related measures such as majority vote provisions prior to an activist’s request. Additionally, company management should carefully consider (and not ignore) suggestions made by activists if those suggestions make sense in light of the company’s long-term objectives and strategic direction.
10. Communicate Strategies to Investors.
The company’s strategy should also include the communication of its plan to enhance shareholder value to its investor base. This will enable the company to garner support for the company’s plans among large shareholders before they are approached by an activist. Reaching out to shareholders after being confronted with an activist attack has proven to be less effective than regular contact with these large investors. This ongoing dialogue with institutional investors will be critical for two reasons. First, management needs to stay “tuned in” to investor concerns. Second, each company needs to continually educate stockholders on the company’s plans and views about the future.
In this new age of shareholder activism, changes in technology have enhanced communications abilities, making proxy season more and more challenging each year. With e-proxy and shareholder forums, companies must appreciate the advantages they provide to activists and be ready to respond. This requires an understanding of the mechanics and legal issues raised by shareholder forums and e-proxy, as well as activist shareholder tactics and the ability to respond quickly not only from a mechanical perspective but also from a substantive perspective. This would involve the creation of a team of advisors including specialized attorneys, proxy solicitors and public relations professionals experienced in the ins and outs of e-proxy as well as proxy contests. Since the e-proxy rules will reduce the time lags in proxy contests and activists will likely continue to engage in withhold vote campaigns and proxy contests, preparation of an action plan and strategies ahead of activist action is critical. Staying informed and prepared is key to successful results when activists come calling.
Notes
- 462 F.3d 121 (2d Cir. 2006).
- 17 C.F.R. 240.14a-8(i)(8).
- See SEC Release 34-57172, Electronic Shareholder Forums (January 2008).
- See Rule 14a-9, 17
CFR § 14a-9, which states that the anti-fraud rules continue to apply to activities in a shareholder forum. - See Rule 14a-2(b)(6) and SEC Release 34-57172 (January 2008).
- See generally, Rule 14a-2(b)(2).
- For example, see recent SEC amendments to Rule 14a-8 (17
CFR § 240.14a(i)(8)) adopted by the SEC (Release No. 34-56914) in response to the Second Circuit Court’s decision in AFSCME vs.AIG . - See the Delaware Court of Chancery decision in JANA Master Fund, Ltd. V.
CNET Networks, Inc., interpreting the advance notice provision of a public company’s bylaws to apply only to nominations and proposals that are intended to be included in a company’s proxy materials pursuant to SEC Rule 14a-8 which necessitates a review of advance notice bylaws.