Lessons from the Wet Seal Consent Solicitation

On Friday, October 5, 2012, the Wet Seal (Nasdaq: WTSLA) made an unusual announcement: a majority of its board had agreed to step down and be replaced by nominees selected by a shareholder. It did so even though its board had been duly elected less than five months prior, on May 16, at the company’s annual meeting.

The board, however, recognized that it was within minutes of being defeated in a consent solicitation fight that our fund had started in September. In less than one month — outside of the usual annual and special meeting process — shareholders had successfully replaced (and, in our view, upgraded) a majority of the board.

This was a resounding victory for shareholders and an unusual exercise of their rights. Shareholders owning as much as 63% of the stock consented to the proposals, which involved removal of four of the five sitting directors and the election of four new directors in their stead. Among the consenting investors were mutual funds, institutional investors, large individual investors, former executives and hedge funds. The stock was held widely and dozens of professional investors consented to the proposals. At least one very large mutual fund was on the verge of adding their consent to the pile (which would have brought the totals into the high 60s) when we elected to deliver the consents to the company.

Consent solicitations are relatively rare. According to data we have seen from Shark Repellent (a division of FactSet), there have been just 26 consent solicitation campaigns at companies with a market capitalization greater than $100 million in the last decade. All but two involved efforts to change the composition of the board of directors. Ten involved a hostile bidder attempting to take control of the board to enable its bid. Including Wet Seal, as best we can tell, there have been just three situations in which a consent solicitation process was used successfully to unseat a majority of the board. (The others were CPI Corp. in 2004 and Vitacost.com in 2010.)

Consent solicitations are rare because they are a difficult tool for shareholders to use. First, under Delaware law, a consent solicitation is only successful if a majority of the outstanding shares on the record date consent to the proposal. This standard is much harder to meet than a plurality standard that applies in most proxy contests. Second, the process is unusual and the banks, brokers and custodians (to say nothing of the investors themselves) are unfamiliar with the mechanics. In our case, several custodian banks chose not to use Broadridge to gather instructions from beneficial owners (in contrast to their universal approach in proxy fights) and instead chose to use their corporate action processing systems. Institutional investors with stock at Northern Trust and BNY Mellon could not use their usual proxy voting mechanics and instead had to fax paper to these custodians; several who tried had trouble. Others were undoubtedly convinced they had voted, but their instructions were not likely followed. Third, Broadridge did not provide an online voting option for individuals or institutions that did not use the ProxyEdge, ISS or Glass Lewis platforms. Instead, investors had to mail their ballot cards back to Broadridge for manual processing. This approach discouraged voting and delayed the tally of results.

All that being said, a supermajority of Wet Seal shares consented to our proposals, demonstrating that this unusual process can be used effectively in the right situation. And, despite the higher vote threshold and operational headaches, we will likely use the process again. Among other things, it allows shareholders to act mid-year rather than waiting for the annual meeting or fulfilling the requirements of calling a special meeting, if such a special meeting process is even available. (In the case of Wet Seal, shareholders could not call a special meeting.) At Wet Seal, we believed that moving quickly was critically important as the company did not have a Chief Executive Officer and we did not have confidence in the ability of the Board to identify, recruit and hire a great executive. A much less important, but still notable, advantage to the consent solicitation process was that the advance notice bylaws for the nomination of directors did not by its terms apply to consent solicitations (at Wet Seal, at least), so we were able to act more quickly and without onerous incumbent-imposed disclosure requirements.

Given these advantages, consent solicitations certainly have their place in the tool kit of activist shareholders. It is important to note that the Wet Seal situation was not one where a board was accused of malfeasance or even objectively bad conduct of any kind. It was, instead, a company that had been under-performing for several years and whose respected directors (including a partner at one of North America’s biggest law firms and two professional investors) did not have directly relevant experience in the company’s sector. In this sense, our complaints were softer than those lodged by activist investors in many other situations. And yet, shareholders of all types consented to the removal without cause of a majority of the board just five months after the directors’ election.

Time will tell whether the Wet Seal consent solicitation was the beginning of a trend of increased use this corporate governance process to affect change at underperforming companies or whether it will stand as an aberrant example of shareholder activism. Either way, directors should know they cannot rest easy, even between annual meetings.