The Activist Investing Annual Review 2020

Josh Black is Managing Editor, and John Reetun and Eleanor O’Donnell are Financial Journalists at Activist Insight Ltd. This post is based on an Activist Insight memorandum by Mr. Black, Mr. Reetun, Ms. O’Donnell, Jason Booth, Iuri Struta, and Dan Davis. Related research from the Program on Corporate Governance includes Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here); The Long-Term Effects of Hedge Fund Activism by Lucian Bebchuk, Alon Brav, and Wei Jiang (discussed on the Forum here); and Who Bleeds When the Wolves Bite? A Flesh-and-Blood Perspective on Hedge Fund Activism and Our Strange Corporate Governance System.

2019: An Overview

By some measures the slowest year since 2015, 2019 might look like the end of that boomlet. Although not the first down year in recent memory (2017 was too), the 839 companies publicly subjected to activist demands worldwide and the 666 investors making those demands were both four-year lows.

Yet the type of activist involved belies that impression. In 2015, 32% of investors making public demands had a primary or partial focus on activism. In 2019, the comparable figure was 23%. Concerned shareholder groups have taken up a lot of the slack but the activist toolkit has become frequently used by institutional investors and occasional activists too. In these pages, we make the case that private equity firms are increasingly being drawn into competition with activists that requires them to ape some of their strategies.

For years, onlookers have debated how much room activism has to grow. On the one hand, there will always be laggards—relative underperformers. On the other hand, many speculated that the “low-hanging fruit” was mostly picked over, forcing activists to adopt more operational strategies.

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Accelerated Diversity—A New Paradigm for Addressing Short-Term Obstacles to Board Membership

Bill Poutsiaka is a Financial Services Consultant and Founder of Enterprise Driven Investing, LLC.

Introduction

Goldman Sachs recently announced a new policy stating they will not underwrite the IPO’s of firms having only white male board members. This policy is a natural, but different, follow-on to SSGA’s initiative a few years ago requiring at least one female on the boards of companies in which they invest. Various measures have been taken in recent years to improve board diversity, especially by more visible companies such as those included in the S&P 500. Goldman’s action expands this visibility by adding firms at earlier stages in the evolution of their capital strategy. Good governance is no less applicable to companies at these moments, nor well before them.

While select measures, including some related to gender, have shown meaningful gains, overall progress in achieving diversity more widely has been slow. [2] Although helpful, many actions taken do not alter the root causes of small percentage gains. Promising programs, such as customized management training initiatives, do address root causes and have yielded results, but they require extended lead times.

There is a complementary strategy that would address near-term obstacles, accelerate diversity and, therefore, improve governance quality for organizations of all sizes and with various missions. This approach recognizes the value of all groups, and the interests of all entity stakeholders. Implementation has two steps, neither of which reduce standards: (1) Revising specific board membership policies and the selection process to increase their relevance; and (2) Critically assessing how, why, where, and when all groups add value in today’s governance ecosystem.

I have summarized the five components of this call to action below:

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The Strategic Audit Committee: a 2020 Preview

Krista Parsons is Managing Director and Robert Lamm is Independent Senior Advisor at the Center for Board Effectiveness, Deloitte & Touche LLP. This post is based on their Deloitte memorandum.

Introduction

To anyone familiar with the role and responsibilities of audit committees, it will come as no surprise that the audit committee is sometimes called the “kitchen sink” committee. That is because at many companies, any topic that isn’t clearly the responsibility of another committee or the full board frequently ends up on the audit committee agenda.

Due to this and other factors, the audit committee agenda is usually jam-packed, and audit committees need to be strategic, prioritizing the matters they handle and using their time efficiently and effectively. The need for this strategic approach will almost surely increase in 2020, as the number and complexity of issues faced by boards and audit committees continue to grow.

Priorities

A big part of being strategic is the setting of priorities—determining which matters the audit committee should focus on, and how best to execute its responsibilities.

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Stewardship and Collective Action: The Australian Experience

Tim Bowley is a Sessional Lecturer in the Faculty of Law at Monash University and Jennifer G. Hill is Professor and Bob Baxt AO Chair in Corporate and Commercial Law in the Faculty of Law at Monash University. This post is based on a chapter in Global Shareholder Stewardship: Complexities, Challenges and Possibilities (Dionysia Katelouzou and Dan W Puchniak eds, Cambridge University Press, forthcoming). Related research from the Program on Corporate Governance includes The Agency Problems of Institutional Investors by Lucian Bebchuk, Alma Cohen, and Scott Hirst (discussed on the Forum here); Dancing with Activists by Lucian Bebchuk, Alon Brav, Wei Jiang, and Thomas Keusch (discussed on the Forum here); Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the forum here); and The Specter of the Giant Three by Lucian Bebchuk and Scott Hirst (discussed on the Forum here).

The global financial crisis gave rise to competing narratives about shareholders and their engagement in corporate governance. According to one narrative, which was common in the United States, shareholders were complicit in the crisis, by placing pressure on corporate managers to engage in excessive risk-taking to increase profitability.

An alternative narrative prevailed in other jurisdictions, such as the United Kingdom and Australia, where the real problem was perceived to be lack of shareholder participation in corporate governance. According to this narrative, greater engagement by shareholders is a beneficial corporate governance technique.

Institutional investor stewardship codes (“stewardship codes”), which now exist in many jurisdictions, embody this second, more positive narrative regarding the role of shareholders in corporate governance. Stewardship codes reflect the growing importance of institutional investors in capital markets, and a belief that increased engagement by institutional investors can improve corporate decision-making and provide protection against inappropriate risk-taking by corporate managers.

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Proposed Amendments to Financial Disclosure and Guidance on Use of Metrics in Management Discussion and Analysis

Mark S. Bergman is a partner at Paul, Weiss, Rifkind, Wharton & Garrison LLP. This post is based on his Paul, Weiss memorandum.

On January 30, the U.S. Securities and Exchange Commission (the “SEC”) published proposed amendments (the “Proposed Amendments,” available here) to modernize, simplify and enhance certain financial disclosure requirements set forth in Regulation S-K. The Proposed Amendments cover Item 301 (Selected Financial Data), Item 302 (Supplementary Financial Data) and Item 303 (Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”)). Concurrently, the SEC also published separate guidance (the “MD&A Guidance,” available here) highlighting certain disclosure considerations when including performance indicators or other metrics in an MD&A.

The Proposed Amendments and the MD&A Guidance follow on from a series of recommendations in the SEC staff’s Report on Review of Disclosure Requirements in Regulation S-K (available here), mandated under Section 108 of the Jumpstart Our Business Startups Act. The modifications and recommendations reflected in the Proposed Amendments and the MD&A Guidance aim to improve “the quality and accessibility of registrant’s presentation of financial results and performance metrics” with the goal of assisting investors’ capital allocation decisions, while reducing registrant’s compliance burden and costs. The Proposed Amendments include conforming amendments to Forms 20-F and 40-F, as appropriate (since these Forms do not cross-reference Regulation S-K as do the Forms for domestic registrants).

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Financial Institution Developments

Edward D. Herlihy and Richard K. Kim are partners at Wachtell, Lipton, Rosen & Katz. This post is based on their Wachtell memorandum.

Last week, the Board of Governors of the Federal Reserve System approved a final rule to codify its standards for determining whether one company has control over another. The final rule takes effect on April 1 and completes the process that the Federal Reserve began last April by issuing a proposal seeking public comment. Despite extensive industry input that urged the Federal Reserve to take a more expansive view, the Federal Reserve generally dismissed the comments received and largely adopted the control rule as initially proposed. Although this was disappointing to many in the industry, the impact of the control rule will nevertheless be significant with clear winners and losers. Beneficiaries of the final rule include investors in banks, including private equity and activists, who are permitted more board seats and governance rights than under the prior policy. Conversely, banks looking to invest in fintech and other companies, as well as fintech companies seeking to own banks, did not receive the flexibility that they had been seeking.

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Delaware’s Position on Director Independence: a Change in Approach?

Gail Weinstein is senior counsel and Steven Epstein and Warren S. de Wied are partners at Fried, Frank, Harris, Shriver & Jacobson LLP. This post is based on a Fried Frank memorandum by Ms. Weinstein, Mr. Epstein, Mr. de Wied, Brian T. Mangino,  Andrew J. Colosimo, and David L. Shaw, and is part of the Delaware law series; links to other posts in the series are available here. Related research from the Program on Corporate Governance includes Independent Directors and Controlling Shareholders by Lucian Bebchuk and Assaf Hamdani (discussed on the Forum here).

In McElrath v. Kalanick (Jan. 13, 2020), the Delaware Supreme Court upheld the Court of Chancery’s decision that dismissed a derivative suit brought by a stockholder of Uber Technologies, Inc. (“Uber”) for damages arising from Uber’s 2016 acquisition of Ottomotto LLC (“Otto”). The Supreme Court agreed with the Court of Chancery’s determination that a majority of the Uber directors in office at the time the complaint was filed were independent and had not acted in bad faith–and, therefore, that pre-suit demand on the board to bring the litigation would not have been “futile” and so was not excused.
Key Point

  • The decision, in our view, does not necessarily suggest a change in the Delaware courts’ recent approach in determining director independence in the demand futility context. Delaware has consistently applied long-established principles for determining director independence. In recent years, however, when applying those principles in the demand futility context, the courts have appeared to more readily find non-independence than they had previously. Some commentators have suggested that the decision signals a return to the seemingly stronger presumption of independence of the past. While that is possible, we do not read the decision that way (as discussed below).
  • Separately, the decision reinforces that there continues to be a high bar to a finding of bad faith by directors–and that this, in combination with exculpation provisions, continues to make it highly unlikely that independent directors would have personal liability for alleged fiduciary breaches except in the most egregious cases.

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Shareholder Governance, “Wall Street” and the View from Canada

Gesta Abols and Brad Freelan are partners at Fasken Martineau DuMoulin LLP. This post is based on their article published in The American Lawyer. Related research from the Program on Corporate Governance includes Toward Fair and Sustainable Capitalism by Leo E. Strine, Jr. (discussed on the Forum here).

The Business Roundtable, a group of executives of major corporations in the United States, recently released a statement on the purpose of a corporation that reflects a shift from shareholder primacy to a commitment to all stakeholders. While the statement seems radical to some, it is consistent with recent Canadian corporate law. Boards of directors in Canada have had to make decisions incorporating the concepts expressed in the Business Roundtable statement for over a decade.

The primary concern expressed by those opposed to a shift from shareholder primacy is that it undercuts managerial accountability, thereby resulting in increased agency costs and undermining the overall effectiveness and efficiency of corporations. The experience in Canada suggests such concerns are largely overblown.

A stakeholder-based governance model rejects the idea that corporations exist principally to serve shareholders. Instead, a stakeholder-based governance model requires the consideration of various stakeholder groups to inform directors as to what is in the best interest of the corporation.

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CEO Stock Incentives Increasingly Tied to Stock Ownership and Retention

Dan Leon is a senior associate and LaToya Scott is an associate at Willis Towers Watson. This post is based on a Willis Towers Watson memorandum by Mr. Leon, Ms. Scott, Robert Newbury, and Erik Nelson. Related research from the Program on Corporate Governance includes Paying for Long-Term Performance by Lucian Bebchuk and Jesse Fried (discussed on the Forum here); and Share Repurchases, Equity Issuances, and the Optimal Design of Executive Pay, by Jesse Fried (discussed on the Forum here).

New findings confirm what we’ve long known: many companies are adding retention requirements to prevent executives from quickly selling equity earned through long-term incentives (LTI) post-vesting.

Willis Towers Watson’s Global Executive Compensation Analysis Team reviewed ownership guidelines and retention policies in effect during 2010, 2015, and 2019 among the S&P 500 and found that the number of companies with retention requirements has jumped from 35% in 2010 to 64% in 2019, approximately an 83% increase. This dramatic growth suggests that stock retention requirements could become as nearly universal as ownership guidelines.

The trend tracks companies’ practice of using stock ownership guidelines to require executives to own a specific amount of company shares to better align the interests of investors and executives. The most recent driver of this practice occurred in September 2019 when the Council of Institutional Investors (CII) suggested that ownership guidelines and retention policies should be included as part of an executive compensation program focused on building long-term (at least five years) shareholder value. Previously, in 2015, Institutional Shareholder Services (ISS) began to formally account for these policies while evaluating and scoring a company’s equity compensation plan.

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Securities Class Action Filings—2019 Year in Review

Alexander “Sasha” Aganin is senior vice president at Cornerstone Research. This post is based on a report by Cornerstone Research and the Stanford Law School Securities Class Action Clearinghouse.

Executive Summary

For a third consecutive year, the number of new class action securities filings based on federal statutes remained above 400. Most notably, core filings surged to record levels. Market capitalization losses, as in 2018, surpassed $1 trillion.

Number and Size of Filings

  • Plaintiffs filed 428 new class action securities cases (filings) across federal and state courts in 2019, the most on record and nearly double the 1997–2018 average. “Core” filings—those excluding M&A filings—rose to the highest number on record.
  • Federal and state court class actions alleging claims under the Securities Act of 1933 (1933 Act) helped push filing activity to record levels. The number of 1933 Act filings themselves reached unprecedented levels.
  • Disclosure Dollar Loss (DDL) decreased by 14 percent to $285 billion in 2019.
  • Maximum Dollar Loss (MDL) also fell by 9 percent to $1,199 billion.
  • In 2019, eight mega filings in federal courts made up 52 percent of federal core DDL and 21 mega filings in federal courts made up 71 percent of federal core MDL. Both of these percentages track closely with historical averages. Filings with a DDL of at least $5 billion or an MDL of at least $10 billion are considered mega filings.

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