A “wolf pack” is a loose association of hedge funds (and possibly some other activists) that stop just short of forming a “group” (which would require disclosure under Section 13(d)(3) of the Williams Act once the “group” collectively held 5% or more of any class of the stock of the engaged firm). The essence of the “wolf pack” is conscious parallelism without any agreement to act in concert. The market can quickly recognize a “wolf pack” once its leader crosses the 5% threshold and files its Schedule 13D, and the market responds more enthusiastically to a “wolf pack” than to other activist investors, running up on average 14% in abnormal returns on the date of its public appearance. Also, the “wolf pack” acquires substantially more—at least 13.4% in on recent study. But this may understate, as researchers cannot know how many allies the wolf pack leader has. In the Sotheby’s proxy litigation last year, the CEO of a prominent proxy solicitor, testifying as an expert witness, estimated that hedge funds then held over 32% of Sotheby’s (a mid-cap sized firm).This is a near control block.
The key advantage of joining a “wolf pack” is that it offers near riskless profit. The hedge fund leading the pack can tip its allies of its intent to initiate an activist campaign because it is breaching no fiduciary duty in doing so (and is rather helping its own cause); thus, insider trading rules do not prohibit tipping material information in this context. If one can legally exploit material, non-public information, riskless profits are obtainable, and riskless profits will draw a crowd on Wall Street.
 For a fuller review of these tactics and the legal and market developments that made the “wolf pack” possible, as well as the concept of “group,” see John C. Coffee, Jr. and Darius Palia, “The Impact of Hedge Fund Activism: Evidence and Implications” (available at http://ssrn.com/abstract=2496518)(Oct. 2014).
 See Becht, Franks, Grant and Wagner, supra note 1, at 32. [Full cite: Marco Becht, Julian Franks, Jeremy Grant and Hammes F. Wagner, The Returns to Hedge Fund Activism: An International Study, (available at http://ssrn.com/abstract=2376271)(March 25, 2015).]
 Daniel Burch, CEO of Mackenzie Partners, so testified in the Sotheby’s litigation that hedge funds then held an estimated 32.68% of Sotheby’s. On the basis of the “threat” this constituted, the Chancery Court upheld a special “discriminatory” version of the poison pill. Third Point, LLC, the lead activist, held only 9.62% of Sotheby’s, thus showing the size of the allies that the “wolf pack” leader can assemble. See Third Point, LLC. v. Ruprecht, 2014 Del. Ch. LEXIS 64 (May 2, 2014).
It seems to me that there are several ways of responding to the wolf pack phenomenon.
First, amend Exchange Section 13(d) and the rules thereunder so that conscious parallelism requires filing a Schedule 13D. There is evidence that "wolf pack activity appears to be ostensibly uncoordinated—i.e., no formal coalition is formed—a fact that is usually attributed to an attempt by the funds to circumvent the requirement for group filing under Regulation 13D when governance activities are coalitional." Instead of requiring the SEC and/or the target to undertake the difficult task of proving that ostensibly uncoordinated activity is in fact coordinated, we should amend Section 13(d) to force wolf packs to disclose. After all, isn't sunlight the best disinfectant? In addition, as Wachtell Lipton has been urging for a long time, the 10 day window for filing Schedule 13Ds should be shortened to 2 business days.
Second, courts should be more receptive to arguments that wolf packs constitute a group that "may be liable under Section 16(b) if, in the aggregate, the group’s holdings exceed ten percent of the company’s nonexempt, registered equity securities."
Third, and perhaps most important, the Delaware courts should validate wolf pack poison pills:
... a traditional poison pill follows the federal securities laws in determining when shareholders are considered a “group” and would generally aggregate their ownership if, and only if, they entered into an agreement to act in concert with respect to their stock in the company. There is no definitive legal authority on whether a poison pill would be legally valid if it aggregated stock ownership of investors who patterned their behavior after one another, but did not have an agreement to act in concert. To avoid potential litigation, companies generally utilize the 13D definition of “group” in their shareholder rights plans although this means that their poison pill may not be an effective weapon against a wolf pack.
The Sotheby’s case may cause practitioners to rethink the desirability of adopting a wolf pack pill. Sotheby’s found that the acquisition of stock by members of a wolf pack could be a threat to the corporation based on a pattern of behavior the court described as “conscious parallelism.” The same analysis may also justify a wolf pack clause in a poison pill.
John Coffee reports that:
[A] recent study suggests that there may be real, but long-term, costs from hedge fund activism for the economy as a whole. These researchers took the stocks included in the Wall Street Journal’s and FactSet’s Activism Scorecard and trimmed this sample down to just those campaigns launched by activist hedge funds. Then, they followed those firms that successfully avoided a takeover. They found that these firms, even though they survived the activists’ engagement intact, were forced to curtail their investments in research and development by more than half over the next four years. Specifically, R&D expenses in this sample fell from 18% of sales to 8.12% of sales over that period. Nor was this a general secular trend, because in a random sample of firms not engaged by activists, they found that research and development expenditures rose modestly as a percentage of sales over the same period.
Although still a preliminary study, this finding should not surprise, because it confirms what activists say they are doing. Trian Fund made clear that it wanted to reduce DuPont’s expenditures on R&D. Similarly, when Pershing Square Capital and Valeant Pharmaceuticals made a bid for Allergan last year, Valeant announced that, if successful, it would cut R&D at the combined firm by 69%. Although most pharmaceutical companies typically spend about 20% of their revenues on R&D, Valeant spent only 2.7% of its revenues on R&D. Its business model was to milk acquired companies like cash cows for their cash flow.
This pattern of cutting R&D expenditures (even at companies like DuPont that have historically profited from R&D) may make sense for investors who will be long gone within a year or so.
 See Allaire and Dauphin, supra note 1, (finding an average decline in R&D expenditures as a percentage of sales from 17.34% in 2009 to 8.12% of sales in 2013). [Full cite: Yvon Allaire and Francois Dauphin, “Hedge Fund Activism: Preliminary Results and Some New Empirical Evidence” (Institute for governance of public and private corporations, April 1, 2015).]
 Id (finding a modest increase in R&D expenditures from 6.54% of sales in 2009 to 7.65% of sales in 2013).
 See Joseph Walker and Liz Hoffman, “Allergan’s Defense: Be Like Valeant,” The Wall Street Journal, July 22, 2014 at B-1.
 See Joseph Walker, “Botox Itself Aims Not to Age,” The Wall Street Journal, May 19, 2014 at B-1.
But it sucks for the rest of us.
I await a reply from the activists' academic apologists.
John Coffee observes of the recent DuPont proxy fight:
... that the governance professionals at pension funds and mutual funds now favor (or at least are open to) the idea of a divided, factionalized board. Putting Nelson Petz on DuPont’s board struck many of them as a low-cost means, with little downside risk, of keeping DuPont “in play” and signaling the shareholders’ desire for more spinoffs and less investment in long-term capital projects, including research and development.
I think that's correct, but the question is why shareholder activists and other institutional investors have developed a tolerance--if not an outright preference--for factionalized boards?
My own view is that factionalized boards are generally bad news. We know a fair bit about factionalized boards from observations of boards elected by cumulative voting. As I observed in The New Corporate Governance in Theory and Practice:
Granted, some firms might benefit from the presence of skeptical outsider viewpoints. It is well accepted, however, that cumulative voting tends to promote adversarial relations between the majority and the minority representative. The likelihood that cumulative voting results in interpersonal conflict rather than cognitive conflict thus leaves one doubtful as to whether firms actually benefit from minority representation. There will be a reduction in the trust-based relationships that cause horizontal monitoring within the board to provide effective constraints on agency costs. There also likely will be an increase in the use of pre-meeting caucuses and a reduction in information flows to the board.
So where's the evidence that short slates nominated by shareholder activists will produce better results?
Actually, the WSJ headline is somewhat misleading. What Donatiello and Pitt actually address in their provocative op-ed is the influence of proxy advisory services ISS and Glass Lewis. They argue that:
Voting decisions are often effectively controlled by proxy advisory firms—namely, Institutional Shareholder Services and Glass Lewis. There is considerable evidence that a “no” recommendation from such firms translates into about a 30% “no” vote by institutional shareholders. ...
While proxy advisory firms claim they merely advise and do not make voting decisions, their influence is unmistakable.
Donatiello and Pitt find that influence worrisome (as do I):
Proxy advisory firms have no financial interest in shareholder votes. They rarely understand the companies on which they report, their competitive situations or their strategic challenges. They use opaque processes, and they often solicit consulting fees from the same companies on whose issues they advise, without disclosing specific arrangements. Most important, proxy advisory firms claim no duty to the shareholders whose votes they effectively control. ...
The decoupling of proxy voting from the investment process, and in many cases from investor interests, might be less troublesome if it increased shareholder value, but it doesn’t. Research from 2009, also conducted by Stanford’s Rock Center, found that governance ratings by proxy advisory firms have no ability to predict future performance, and that their proxy voting policies are negatively correlated with shareholder value. Proxy advisory firms have offered no research showing that their recommendations do enhance shareholder value.
It's long since time that the government (especially the SEC but also the Department of Labor in its oversight of ERISA plans) reconsider the policies that encourage reliance on proxy advisory services. It's also long since time that the SEC start regulating proxy advisory services, especially given the rampant conflicts of interest inherent in their current business model.
In an editorial, the WSJ today opined that proxy advisory services "have enjoyed far too much influence over companies they don’t own and been subject to far too little scrutiny given their potential conflicts of interest."
From today's WSJ:
U.S. businesses, feeling heat from activist investors, are slashing long-term spending and returning billions of dollars to shareholders, a fundamental shift in the way they are deploying capital.
Data show a broad array of companies have been plowing more cash into dividends and stock buybacks, while spending less on investments such as new factories and research and development.
The Journal lays much of the blame at the feet of activist investors:
An analysis conducted for The Wall Street Journal by S&P Capital IQ shows that companies in the S&P 500 index sharply increased their spending on dividends and buybacks to a median 36% of operating cash flow in 2013, from 18% in 2003. Over that same decade, those companies cut spending on plants and equipment to 29% of operating cash flow, from 33% in 2003.
At S&P 500 companies targeted by activists, the spending cuts were more dramatic. Targeted companies reduced capital expenditures in the five years after activists bought their shares to 29% of operating cash flow, from 42% the year before, the Capital IQ analysis shows. Those companies boosted spending on dividends and buybacks to 37% of operating cash flow in the first year after being approached, from 22% in the year before.
The corporate governance challenge for Canada is to improve the quality of its corporate performance, which has been declining relative to its international peers for decades. This is quite different from the usual assumption that corporate governance is primarily a matter of controlling managerial self-dealing. While important, board monitoring of management is only one aspect of its role in a corporation; research suggests corporate governance arrangements have a significant impact on corporate outcomes, particularly in areas such as innovation where Canada lags.
Third-party proxy advisory firms, which provide advice to institutional investors in Canada on corporate governance matters, have grown in influence over the past decade. As securities regulators consider whether (and how) to treat them, an examination of the assumptions that underlie these advisors’ voting recommendations, and the influence these assumptions have on corporate decision-making, suggest these assumptions create perverse governance incentives and are contradicted by empirical research.
Interesting new study:
Corporate political activity has become one of shareholders' top concerns. We examine whether firms targeted by shareholder proposals show different campaign contributions and lobbying activities compared to non-targeted firms. We also ask whether different sponsors of shareholder proposals target different firms depending on the firms' partisan orientation. Using data on S&P 500 companies during the period between 2007 and 2013, we find that firms that spend more on campaign contributions and lobbying are more likely to be targeted by shareholder proposals. After controlling for firms' financial performance, governance characteristics and ownership structure, we also find that public pension funds and labor unions sponsors are more likely to target Republican-leaning firms, measured by the firms' campaign contributions. This finding suggests that increasing corporate political activity can intensify a tension between management and public pension fund and labor union shareholders and lead to more activism by these shareholders.
Min, Geeyoung and You, Hye Young, Active Firms and Active Shareholders: Corporate Political Activity and Shareholder Proposals (April 30, 2015). Virginia Law and Economics Research Paper No. 15; Virginia Public Law and Legal Theory Research Paper No. 28. Available at SSRN: http://ssrn.com/abstract=2601181
My longstanding conviction that state and local government and union pension funds were using shareholder activism to advance a liberal political agenda appears to be validated, at least in part.
Adam J. Epstein advises the boards of pre-IPO and small-cap companies through his firm, Third Creek Advisors, LLC. He recently offered an assessment of the pros and cons of shareholder activism. Recommended.
WLF reports a great win for common sense:
On April 14, 2015, the U.S. Court of Appeals for the Third Circuit overturned a lower court decision that would have required publicly traded companies to include frivolous and inappropriate shareholder proposals in proxy statements at the company’s expense—and, therefore, at the expense of every other shareholder. In a concise, two-page order, the appeals court vacated the district court’s order, concluding that “Wal-Mart may exclude Trinity’s Proposal from its 2015 proxy materials.” The decision was a victory for WLF, which filed a brief in the case arguing that the proposal was not only excludable under the SEC’s “ordinary business” exception, because it related to Wal-Mart’s ordinary business matters, but the proposal was so vague that neither the company nor its shareholders would be able to determine with any reasonable certainty what actions the proposal would require. The appeals court will issue a more detailed opinion explaining its decision in the coming weeks.
3rd Circuit sides w/ Walmart (v. Trinity) over its to make mgmt decisions per "ordinary business exclusion." Order: http://t.co/1oBkdswFai— Business Roundtable (@BizRoundtable) April 14, 2015
The U.S. Court of Appeals for the Third Circuit will hear oral argument in Philadelphia tomorrow, April 8, in a closely watched case that will determine when individual corporate shareholders can force a corporation to include shareholder proposals in its annual proxy statement. ...
In this case, an activist shareholder sought to include a proposal in Wal-Mart’s proxy materials that would, if adopted, compel the board’s governance committee to review the company’s policies concerning the sale of potentially dangerous or offensive products. WLF argues that the “ordinary business” exception permits exclusion of proposals about the nature of the products the company sells.
The WLF's position has to be correct. If the court goes the other way, the ordinary business exception will have been completely eviscerated. Shareholders will be empowered to micro-manage basic business decisions.
In “Seeking a Cure for Raging Corporate Activism,” published on March 17, 2015, in the WSJ, the author discusses a technique resurrected from the 1980’s that could, on reexamination, be “a bulwark against short-termers who roam the markets, looking to force buybacks or an untimely company sale.” Known as “tenure voting,” the concept would give investors additional votes if they hold their shares for at least a specified period of time, thus rewarding long-term holders by giving them more say in the future of the company than say, short-term hedge fund activists that may favor short-term profits over long-term business strategies.
The author notes a number of problems with actually implementing this proposal, to which I would add the stock exchange one vote/one share listing standards, about which I have written occasionally, principally in The Short Life and Resurrection of SEC Rule 19c-4. Washington University Law Quarterly, Vol. 69, Pp. 565-634, 1991. Available at SSRN: http://ssrn.com/abstract=315375
The UCLA School of Law's Lowell Milken Institute is sponsoring a Private Fund Conference: The Role of Activist Funds. During one session I will be debating the merits of shareholder activism with Patrick Foulis of The Economist, who wrote that magazine's latest paean in favor of shareholder activism.
I'll only have ten minutes to present my basic case, so let me direct interested readers to my latest article on the topic, Preserving Director Primacy by Managing Shareholder Interventions (August 27, 2013), available at SSRN: http://ssrn.com/abstract=2298415, which argues that:
There are strong normative arguments for disempowering shareholders and, accordingly, for rolling back the gains shareholder activists have made. Whether that will prove possible in the long run or not, however, in the near term attention must be paid to the problem of managing shareholder interventions.
This problem arises because not all shareholder interventions are created equally. Some are legitimately designed to improve corporate efficiency and performance, especially by holding poorly performing boards of directors and top management teams to account. But others are motivated by an activist’s belief that he or she has better ideas about how to run the company than the incumbents, which may be true sometimes but often seems dubious. Worse yet, some interventions are intended to advance an activist’s agenda that is not shared by other investors.
Of course, as long time readers know, I have frequently criticized The Economist's coverage of shareholder activism, so here's a trip down memory lane:
Oct 9, 2014 ... The latest edition of The Economist is once again beating the drums for shareholder activism. (As I've said before, I love them despite their ...
Feb 8, 2015 ... The Economist is at it again, with yet another paean to shareholder activism. Or, more precisely,two: The latest print issue has both a leader and ...
Update: For an extended defense of my director primacy model of corporate governance, which I think anticipated Patrick's criticisms of it, see my book The New Corporate Governance in Theory and Practice. For an additional treatment of shareholder activism in the context of the broader set of corporate governance issues of the day, see my book Corporate Governance after the Financial Crisis.
The WSJ reports that the feds are investigating Ackman hirelings for possible manipulation violations in connection with Acumen's efforts to profit by denigrating Herbalife.