The Struggle to Rein In Shareholder Activism

Speaker 1:                           Welcome to the Federal group societies podcast, the following podcast hosted by the Federalist Society's Corporation Securities and Anti-Trust and Litigation Practice Groups was recorded on Thursday, April 26, 2018, during a live teleforum conference call held exclusively for Federalist Society members.

Micah Wallen:                   Welcome to the Federalist Society's teleforum conference call. This afternoon we are hosting a discussion on the struggle to rein shareholder activism. My name is Micah Wallen and I'm the Assistant Director of Practice Groups at the Federalist Society. As always, please note that all expression of opinion are those of the experts on today's call. Today, we are happy to have with us, Jason Levine, a litigation at Vincent & Elkins. As well as Lawrence Elbaum, co-head and chief litigator of the Shareholder Activism Practice at Vincent & Elkins. After hearing from our speakers we will go to audience Q&A. Thank you for speaking with us. Jason, the floor is yours.

jason levine:                       Thank you very much Micah and thank you everyone for participating today, uh, Lawrence and I are going to speak about the phenomenon of shareholder activism, we've divided the presentation into two parts, first, Lawrence will provide an overview of what activism is, it's prevalence, it's impact, and at least at a high level, provide some insight in to what corporations may be able to do to protect themselves from activist attacks. And then second, I will talk about pending and proposed legal reforms intended to address or deal with shareholder activism. And offer some thoughts about what appear to be the likelihood of passage and effectiveness of those reforms. So with that, Lawrence please take it away for the first part of our talk.

Lawrence Elbaum:           Thank you, Jason, uh, and uh, thank you, uh, to all- all the members, uh, for- for having us. And, I'm, uh, looking forward to presenting and hopefully some, uh, robust Q&A at the end. Um, uh, as Jason said, uh, I'm a partner, with Vinson & Elkins, um, I'm one of the co-heads of our Shareholder Activism Practice. Um, we, uh, have the largest practice of this kind, uh, in the country. Uh, about 30 lawyers deep, uh, covering a range of disciplines from corporate to litigation to tax, uh, exec comp, uh, labor and employment, uh, et cetera.

                                                Um, we, our group, uh, has topped uh, [inaudible 00:02:28] tables for shareholder activism defense, for the last two calendar years and the first quarter of this year and counting. We are, uh, agnostic to the- to the size of the company we represent. We represent companies that are micro-caps all the way up to mega-caps. And we're also industry agnostic. Um, covering, uh, a- a very wide spectrum of industries all the way from, um, uh, tech companies, uh, to pharmaceutical companies to industrial manufacturing and energy companies.

                                                Uh, so that's a- that's a bit about our group. Uh, I- I grew up as a securities' litigator, uh, the first nine years of my career. And the last three-plus years, I've been doing activism exclusively. I only see courtrooms in the context of shareholder activism. And there are, uh, plenty of reasons why shareholder activism campaigns end up in courtrooms. Um, over the next, uh, 20 minutes or so, I'm gonna cover a few topics, um, the first topic will be just a quick intro into the key players, uh, and themes, uh, and jargon that's used, uh, in the shareholder activism realm. Uh, then I'll discuss, uh, briefly, uh, recent trends in shareholder activism. Um, and then, uh, time permitting, I'll go over, as Jason said, at a very high level, uh, a few suggestions on how, um, we would recommend, uh, companies, uh, and advisors to companies, uh, think about how to best prepare for the continuing rising tide of shareholder activism in the United States.

                                                So there are different types of shareholder activism. Generally, the main type of shareholder activism is what we call economic activism, which is where a shareholder, uh, seeks to get the company sold. Or seeks to get the company to pay a dividend, repurchase, uh, stock, uh, do M&A, not do M&A, so on and so forth. But there are other main themes, uh, that come up in shareholder activism campaigns for economic causes. And those are social activist causes and governance causes. Uh, social activism causes are ones where activists also seek to compel companies to promote social, political, economic or environmental change. Um, and governance activism is, um, is where activists call on the company to implement, so-called best practices related to corporate governance. Um, proxy access, repeal the poison pill, declassify a board, uh, promote gender and ethnic diversity, so on and so forth.

                                                Economic activism in our view is the main thrust of the vast majority of shareholder activism campaigns. But companies that are not, uh, in front of the curve on social and governance activism issues, have low-hanging fruit for activists, uh, to poke at, um, in the context of their economic activism campaign. So none of these campaign themes exclude each other.

                                                So what is shareholder activism? At its core, uh, it's an election contest. Right? Um, just like, uh, we have different election cycles in the United States, uh, where, uh, where- where voters, uh, choose, uh, one slate over another. That's exactly what happens with public companies. Um, a board of directors, um, essentially runs a public company in the United States. And, uh, typically, um, the board of directors or the whole board of directors or a subset of the board of directors is up for election every single year.

                                                And there's a window of time before the shareholder meeting where elections take place, where, a shareholder activist can make nominations, uh, to put their own slate up against the slate of directors that are incumbent at the company. And it's just like a political campaign. Um, there's mudslinging. Uh, there are nasty ads taken out in newspapers. There are press releases that cross the wire that are nasty. Uh, they're- they're sometimes, they're nasty, uh, ads taken out on television as well. Um, so, there's- there's very little difference, uh, between those two concepts. At the end of the day, um, it's- it's- it's a shareholder who's looking to get his or her or it's, uh, own slate of directors on a board, uh, to effectuate those activism themes that I just discussed, uh, economic activism, social activism, or governance activism.

                                                Um, just very briefly, uh, for those on the phone, um, who- who have seen the movie, um, or- or who are old enough to have appreciated the context of the movie, uh, you know, the movie Wall Street, uh, from the '80s is a good example of, uh, the- the typical raider. Um, that was- that was the brand in the '80s. Hostile takeovers, leveraged buyouts, greenmail, liquidate the company. Um, that brand has gone through a transformation, now 30-plus years later, um, what was called the corporate raider of the '80s is now called shareholder activism, and, what many of the same investors were doing in the '80s, um, uh, to, um, to- to make money in these companies, uh, they're now doing by taking smaller stakes in a company. And trumpeting the notion of increasing value for all shareholders instead of enriching just one party, um, and it's resonated.

                                                There are, um, many celebrity activists out there, Carl Icahn, Paul Singer, from Elliot Management. Keith Meister from Corvex, Jeff Smith from Starboard, there are the marquee names that are out there. Of course, we're up against them, um, uh, every single proxy season. But there are hundreds of other, uh, activists out there, um, attacking public companies, uh, in the US. These include, um, funds with small amounts of money under- under management. They include now, private equity funds. They include family offices. They include former CEOs and former company founders. They include long-term investors, uh, that are trying to effectuate change at companies who have been very stagnant. Um, so we see a wide range of- of activists, all basically pursuing the same theme, which is sell the company, or do something so that we can get a return maximized on our investment.

                                                So when we talk about economic activism, uh, they're- they're really are three main, uh, tools in the- in the activist toolkit. Uh, there's M&A activism, which is, uh, sell the company, spin-off a- a portion of the company, uh, a division of the company. Spin-off assets of the company, um, or activism against or- or for, uh, particular types of, uh, M&A transactions. There's balance sheet activism, um, when companies have a lot of cash on their balance sheet, um, it makes them a particularly easy target for an activist to say, like what happened at Apple a few years ago, pay a special dividend or buy back shares, uh, in the case of other companies.

                                                There's also operational activism, um, most, uh, uh, activists are not engaging in operational activism but you see Carl Icahn and Jeff Smith at Starboard and, uh, and, uh, Paul Singer of Elliott and Nelson Peltz try and do this from time to time. It's really roll up your sleeves, get on the board, um, sit on every single committee, and really figure out how management needs to be changed, you know, what businesses need to be eliminated or added. Um, and, uh, what cost cutting measures need to be pursued. Uh, operational activism takes much longer, um, than a traditional activist, uh, intends, uh, normally to hold on to their investment. It could take years for an operational activism to realize, uh, value. Um, most activists, while they do a lot of research before making their first investment in a company, uh, they're looking to get out, uh, within, say, nine to 18 months of their investment. Um, more often on the earlier, uh side, um, of that investment arc. Um, so, that's why you don't see that much app ... operational activism.

                                                Now, as I mentioned earlier, there is a theme, uh, that you hear about in every single economic activism campaign. And that's corporate governance. Um, so, in, where you have a company that hasn't done a lot of M&A in recent years, they got a lot of cash on their balance sheet, and they got a lot of costs they need to cut, um, if they've got, um, a boar, uh, with no ethnic or gender diversity, uh, with long board tenures with many take over defenses in place, um, perhaps with other not best in class corporate governance issues. Now they're really an activism target.

                                                Um, and you'll- you'll hear just as much, um, in- in a campaign for economic activism around corporate governance because in the same way that you see politicians kissing babies in an election year because voters like to see it. Um, shareholders like to hear about best practices and corporate governance, you hear activists, uh, and companies, um, uh, you know, cloaking themselves in the banner of best corporate governance practices, um, during these campaigns, because not just, uh, the mom-and-pop shareholders that like to hear about it, it's also their major institution BlackRock, Vanguard, Fidelity, um, uh, and- and the proxy advisory firms who I'll explain who they are in a minute, uh, ISS and Glass Lewis. Um, they have a lot of sway over, um, how election results come out and corporate governance practices are very important to them. Uh, uh, they're firm believers that, uh, corporate governance practices, when- when, uh, implemented in- in a best in class form, uh, will- will always result in long-term, uh, value being maximized for a company to shareholders.

                                                So, uh, in the past, uh, 15 years, um, shareholder activism campaigns in the United States, uh, that are publicly reported have quadrupled. There, uh, about, uh, 50 or so campaigns, uh, uh, per year, pre-2000 ... 2003 and before 2003. Uh, we're expecting this year to- to have, uh, over, uh, 300 campaigns. Um, now, these are publicly reported campaigns. There are a lot of campaigns that get resolved without a formal securities filing. Um, if you add up the- the number of public and private campaigns, uh, each year, we're probably looking at about 400 campaigns, maybe 500. There are about 4000 public companies, uh, in the United States, so we're talking about at least 10% of corporate America being targeted each year.

                                                Most companies that are getting targeted for activism campaigns, um, in the US, um, are sub-10 billion dollar market cap range. So let's say, large-cap down to, uh, micro and nano-cap. But we are seeing more activism, uh, at the much larger companies, for example, Proctor & Gamble, uh, last year. Uh, GM, uh, is another example. However, not every activism campaign results in a proxy contest which is, um, a vote at the ballot box. Um, or nominations being made, um, for directors at an annual meeting. A lot of campaigns settle before an activist actually nominates people to a board. We do see about 80% of nominations, uh, and potential proxy fights actually happening, um, uh, at the, um, uh, billion dollar and under range, uh, in the United States. It's because most larger companies, uh, stay away from the headline risk, um, of having, uh, an open kimono, um, in the court of public opinion, um, in the middle of proxy season. Uh, they're quicker to settle in- in- in many instances. Proctor & Gamble went to the ballot box.

                                                Um, I mentioned ISS and Glass Lewis earlier, uh, I- I should explain who they are, uh, they play, uh, perhaps the most pivotal role, um, in many shareholder activism campaigns. So ISS stands for Institutional Shareholder Services. Glass Lewis is Glass Lewis. Um, they're proxy advisory firms. So what are proxy advisory firms? So the large financial institutions, um, in the country, uh, Blackra ... BlackRock, Vanguard, Fidelity, State Street, T. Rowe Price, uh, so on and so forth. Um, they, are invested in virtually every single public company, um, in the US. Um, they get therefore thousands of proxy statements each year. Um, and- and all those public campaigns that I mentioned, um, they have to figure out how to vote on those campaigns. Um, portfolio managers don't have the time, uh, to manage portfolios and read proxy statements and make decisions and, these institutions have set up governance departments to make voting decisions. But the governance departments at these large institutions are also overwhelmed. So they give way, and they take, uh, that take cues from proxy advisory firms. Institutional Shareholder Services, ISS and Glass Lewis.

                                                ISS and Glass Lewis take a look at every single contested campaign in a public company each year, um, that's gonna go to a vote at the ballot box and the [inaudible 00:17:49] meeting and they make a recommendation after reading all of the, uh, statements by the activist and statements by the company and investor presentations, about why each side should win. Um, they take, uh, either phone calls or in-person meetings with the activist, um, and the company, um, and they ultimately make a recommendation several weeks before a company's annual meeting where the election takes place. And these large institutions that I mentioned heavily rely on, uh, the determinations of ISS and Glass Lewis, which many times, can sway up to 30 - 40% of a company's shareholder base depending on its size. Sometimes the influence diminishes in much smaller companies, but as you move up in market cap, you move up in ISS/Glass Lewis in influence.

                                                They are, in- in many ways, more important than a judge, uh, more important than the SCC, which oversees proxy contests, uh, like hawks. Um, they're in many ways more important than the portfolio manager that first made the investment in your company. So they- they're critical and historically ISS, um, had not been company friendly. Uh, in recent years, they've been- they've been making recommendations more than 50% of the time, slightly more than 50% of the time in favor of companies, uh, and against, uh, activists. Uh, Glass Lewis has a reputation for being, uh, more company friendly, about 60% of the time, um, sometimes, even more, uh, their finding and recommending in favor of a company slate over and activist slate.

                                                So a lot of proxy fights, um, end up, uh, not going the distance, I mentioned earlier. Uh, they settle. Uh, they settle before they go to the ballot box. A lot of times they settle after ISS and Glass Lewis make recommendations, but a- a lot of times they settle even before then. Um, so if- if an activist is- is- is losing, um, by a wide margin, typically they'll pack up their bags and go home and, uh, maybe issue a press release taking a victory lap for all the good the company has done, um, since they've launched their campaign. But if an activist is winning and ISS and Glass Lewis has recommended and now, you know, uh, the vast majority of the shareholder base, um, is, uh, is recommending, um, uh, is swaying in favor of- of, uh, of the activist. Um, sometimes on the defense side, I'll get a phone call from the activist's lawyer and they want to talk settlement.

                                                Now, they're about to get three, four, uh, maybe a control slate on the board, um, but they're asking for a settlement, and it might seem counterintuitive, uh, take- take the victory at the ballot box and, you know, thump your chest and- and issues a press release and, uh, get great marketing for a hedge fund. Well, there are a few reasons why I get that phone call. Number one, uh, the- the activist realizes that it and its candidates, um, for the board are now gonna need to start mending fences, um, in- in the aftermath of a nasty campaign, uh, you not gotta break bread with the people that you've been spitting at for sometimes many months, sometimes many years. Settlement is a good way to achieve that objective.

                                                Um, if an activist is going for less than a majority of a company's board, um, settlement is very important. A victory at the- a victory at the ballot box, um, for an activist, just puts their minority slate on the board. That's it. The board then can, uh, with a majority of the board members, form committees, um, and do all important board work through their major committees, and- and create basically a shadow board. Through a settlement, especially a settlement where the activist has a lot of votes in its favor, the activist can demand for its designees on the board the mini-designation where the real work gets done and they can ensure that they're doing the real work alongside the other board members.

                                                And lastly and more importantly, and most importantly, I believe expense reimbursement. Um, shareholders do not like it, um, and it- it sometimes is viewed as contrary to Delaware law for example, where a lot of companies are incorporated. For an activist to join a board, um, with its candidates and then for that newly constituted board to reimburse the activist for its campaign expenses. If an activist settles with the company before a vote at the ballot box, um, typ ... typically there's less blowback from shareholders about the quantum of that settlement. And, you know, oftentimes, activists arrangements with their own investors provide that legal fees and proxy fight expenses come out of the activists' own, um, uh, general partnership, um, uh, budget. Which means it comes out of the activists' own pocket. Uh, getting the expense reimbursement, therefore, we find is very important.

                                                I'm just gonna turn, uh, quickly to a few more topics. Um, and then I'll turn it over to Jason. Um, so, there are different levels of hostility, um, that we see, uh, during the arc of an act ... an activism campaign. Um, initially, the activist will spend many months, uh, diligencing an investment, um, and then they'll start the stake building phase. Um, they'll buy, uh, straight equity, they'll by derivatives, maybe they'll buy with other groups of activist investors, and there're different ways, uh, to monitor, uh, uh, whether an activist is building a stake in your company. The reporting regimes are- are- are- are delayed, and they're not completely accurate. Um, uh, but they're generally, they're- they're can be, uh, antitrust filings, there can be securities filings that, uh, certain types of activists ... certain types of funds with certain types of stakes in a public company have to- have to make. But a lot of stakebuilding happens under the radar.

                                                After an activist has established stake, um, you hit the engagement phase. Um, and typically engagement versus private engagement. You get a phone call. You get a private letter. Activist wants to meet, uh, with executives, board members, sometimes they're bumping into board, uh, board members at cocktail parties or charity events, to try to solicit, um, or e- elicit, rather, um, neg ... negative statements about the company they can use in their campaign. Uh, where private engagement doesn't, uh, permit an activist to achieve, uh, the objective that it- it is, uh, championing for other shareholders, it will move into the public engagement phase. And the public engagement ranges, uh, from calls, uh, uh, in- investor, uh, phone calls where activists, uh, uh, uh, jump into the call and ask, uh, questions. Sometimes they plant research analysts on to earning calls to ask questions. That's the most, um, muted type of public engagement.

                                                Uh, activists can also make their own public statements. They could issue their own press releases. They could issue, uh, public letters, uh, to the board. Um, uh, releasing the letter to all shareholders. And lastly, they could issue what we call whitepapers, which are, thought pieces ranging from, you know, 15 to 20 slides all the way up to hundreds of slides as we saw Starboard, uh, do in the case of Darden, uh, talking about, the- the- the- the quantity of salt, uh, in the water, uh, in the pot, used to make pasta at Olive Garden. Some activists get very granular and pride themselves on- on, uh, extremely detailed and scathing, uh, whitepapers. If public engagement doesn't, uh, result in, um, uh, a capitulation by the company or a settlement or the activist going away, then you have a proxy fight.

                                                Um, a proxy fight starts with, uh, nominations for directors coming in. Timely, uh, properly disclosed, um, several months before a company's annual meeting typically. Um, uh, director nominations can also come with shareholder proposals for the board to, um, uh, conduct and implement other, uh, types of reforms. Uh, I mentioned earlier, uh, that I used to be a full-time securities' litigator, uh, and that does come, uh, very handy, um, in the context of shareholder activism campaigns, 'cause there often is litigation.

                                                But litigation is normally, uh, brought by the shareholder against the company. Um, shareholders don't like to see companies suing other shareholders. ISS and Glass Lewis, when I mentioned, they're very important, also don't like to see it. Um, if a company does have a really good reason to sue a shareholder, our view is, um, uh, sue as quickly as you can, and make sure you're gonna win that lawsuit, uh, because if you lose that lawsuit, you've lost in the court of public opinion and if you bring the lawsuit, um, and it's- it's not abundantly clear that it is a winning lawsuit, you've also lost in the public opinion, sometimes, just suing, uh, is a loss in the public o- opinion for a company altogether.

                                                Activists sue to compel shareholder meetings. They sue to access a company's books and records and a shareholder list. They- they sue to dismantle legal defenses, and they sue to reverse board decisions. However, there is something available to litigators, um, in the context of a proxy fight that is absolutely not available in the context of a litigation in court. And that is, ex parte communications with the equivalent of the judge overseeing an activism campaign. That's- that's- that's the SEC examiner. SEC appoints an examiner to oversee every single activist campaign. And we are permitted to reach out to that examiner, in writing, confidentially, uh, over the phone confidentially, to point out every single, uh, written statement, uh, that the activist has made that violates the federal securities laws or the proxy rules promulgated under the federal securities' law. And the proxy examiner, um, in place by the SEC will then reach out to the activist and say, "Hey, you need to tone down your rhetoric or I'm not gonna let you solicit votes for this annual meeting."

                                                Activists can write the same letters, make the same phone calls to the SEC, they're always made without the other side present. If- if I were to go into court or Jason were to go into court, uh, and ask the judge for relief without, uh, without the other side present, uh, I'm sure, we're- we're all aware that that's- that's sanct ... n- not sanctioned and sanctionable, um, uh, and could- could- could result in- in penalties and disbarment, um, it's a ... it- it's a ... it's something that's obviously not done in the context of litigation.

                                                So there- there are a few, um, uh, advance preparation items, um, that I just wanted to gloss over quickly, 'cause I know I'm getting a bit short on time here. Um, the best defense for a company, uh, means putting the right team together. Uh, obviously, uh, I think I've made clear the role that a law firm, uh, plays here. Um, but law firms typically co-lead the defense of a proxy fight. Develop strategy. Develop legal defenses. Briefs the board on fiduciary duties. Ensures compliance with the securities laws and state corporate law, review all communications. Handles all litigation. Drafts all proxy material. Uh an investment bank also typically co-leads, uh, depending on the size of the company and the complexity of the- of the activism campaign an investor bank will co-lead, um, and assist, um, in, uh, developing, uh, the issuer's response to the activists', uh, campaign themes. They'll also assist in negotiations. Uh, there are specialty public relations firms, um, that have activism, uh, response team. Um, uh, they're terrific, they're a part of every campaign. It's very important to have, um, a- a crisis firm like that on board to draft press releases, write fight letters, make the investor decks that go to ISS and Glass Lewis and other major shareholders.

                                                And lastly and probably more ... most importantly, a proxy solicitor. Um, t- this, these are the firms, um, that- that, um, uh, call shareholders, knock on their doors, bump into them wherever they need to bump into them, to make sure that they're filling out their voting cards in favor of the company, or in the case of the activist, make sure they're filling out the voting cards in the case of the activist. Uh, in some campaigns, uh, like in Proctor & Gamble, companies will hire multiple proxy solicitors to make sure they're covering as much ground as possible.

                                                And lastly, um, prep, um, there are a few things that companies should be doing after getting their team together. The first thing the company should be doing is preparing a financial self-evaluation, at least, sit down with your law firm and your PR firm and maybe your investment bank and write the five toughest questions that an activist can ask today. And, figure out what the answer to those questions are. Figure them out in peacetime.

                                                Over governance analysis, look- look at the company's corporate governance, uh, through the lens of an activist. Through the lens of ISS and Glass Lewis who are going to be making a determination that can sway your shareholder base. Look at corporate governance through the lens of, uh, your major institutional shareholders. Analyze your structural defenses. Companies have by-laws and articles of incorporation, um, they have other corporate governance guidelines and practices that are adopted. It's best to look at those in peacetime through the lens of an activist. Um, every word means something different when you're in a proxy fight. Every comma, every period, is- it- it takes on a completely different context. Um, there are 20 or 30 items that we typically identify in by-laws and- and corporate governance practices in peacetime that we tell companies to change, um, that don't cost them any brownie points with their investors, but when they're in a fight, they're glad they have made those changes.

                                                Proxy solicitors can also conduct what's called stock surveillance, um, I'd mentioned that the securities and anti-trust reporting requirements are inadequate. Uh, proxy solicitors have stock surveillance programs, um, I'm not gonna bore everyone with how- how they work, but, a lot of it is art and not science, uh, a lot of it's art and science, some of it's voodoo. Uh, but, um, proxy solicitors can monitor your shareholder base and get a whiff of whether, uh, an activist is making a large accumulation and let you know so that you have time to prepare.

                                                Um, I mentioned the importance of having a PR firm that has activism experience on board. Um, they can prepare all the standing, uh, press releases and talking points. Um, and- and help prep, uh, for major meetings with shareholders. Uh, they also can conduct shareholder perceptions surveys, uh, so you could figure out whether or not you have an issue while you're in peacetime.

                                                Uh, and lastly, um, uh, one thing that V&E does with the advisors that I mentioned before, we sit down with public companies, uh, and their boards and we go through exactly what I just went through over the past 25 minutes, uh, to brief them on, uh, what they need to know and what they need to be considering, um, in the context with shareholder activism in 2018. But we also take them through a mock proxy fight exercise. I mentioned private engagement, public engagement, proxy fight, settlement earlier, um, we have, um, hypothetical, um, material that we put together that we put, uh, uh, board and management, uh, through, um, to even better prepare them, um for the day an activist comes knocking on their door.

                                                I'm gonna hand it back over to Jason now.

jason levine:                       Uh, thanks, Lawrence, very much. And let me say, I- I personally have done that boot camp that Lawrence was describing and it's- it's a great exercise and one that- one that can definitely be very advantageous to public companies. Uh, so I will talk briefly about several, uh, legislative proposals, and at least one regulatory proposal that- that address activism at the federal level. I'll try to keep this pretty brief, though, so that they're time for questions. So let me talk about two legislative proposals first. Both of which have been- have been raised in the House. They've gone to Committee in the Senate, and they've not advanced beyond Committee in the Senate, at least to my knowledge to date.

                                                Uh, the first is called the financial choice act, uh, which passed the House in June of last year. By way of background, currently, a shareholder owning either $2,000 or one percent of a company's outstanding shares, that it held for at least one year, can put a shareholder proposal up for a vote at a corporate annual meeting. So the Financial Choice Act would eliminate that $2,000 threshold, meaning, that a shareholder would need to own at least one percent of a company's outstanding shares to put a proposal up for vote. Obviously, in all cases, that's gonna be significantly larger monetarily than $2,000 and the Bill would also expand the timeframe for holding this stock to three years.

                                                Now, opponents of the Bill, say that this would reduce the ability of shareholders to make requests of corporate boards through shareholder proposals or resolutions and might silence small shareholders who sometimes have good ideas. Whereas proponents of the Bill say that it would prevent a large number of frivolous proposals being made year after year.

                                                This really goes to the heart of several of the types of activism that Lawrence was talking about, uh, now the Bills heightened ownership threshold would be unlikely to have much impact on the shareholder activism of the sort that Lawrence was discussing, which typically involves institutional shareholders with larger, often substantially larger than one percent ownership stakes. Uh, but the extended three year ownership period could definitely have some effect, because many of the activist hedge funds, need or at least want to preserve the ability to basically cut and run. And so they don't necessarily keep their holdings for three years, they might not even keep their holdings for three years in the majority of cases. So to the extent that hedge fund strategy involves more than short-term holding periods, or excuse me, involves essentially only short-term holding periods, uh, their ability to engage in activism would definitely be impacted adversely by this bill. Um, but again it- it sits in the Senate and has no vote scheduled that I am aware of.

                                                Uh, the next piece of legislation in the House is the Corporate Governance Reform and Transparency Act which passed in December of 2017. And this has also been referred to the Senate where it sits in Committee. This Bill deals with proxy advisor firms and it would re ... such as ISS and Glass Lewis, which Lawrence talked about earlier. This would require them to register with the SEC and would also impose registration and operational requirements on these firms, including, for example, a requirement that they provide accurate current and reliable information along with their proxy voting recommendations. They have to have a compliance officer. And they would need to provide financial statements, annual reports, and disclosure of their voting policies, given their importance, as Lawrence described it, you can see where there might be some sense to this requirement. The Bill would also require the SEC to develop regulation that prohibit unfair, coercive, or abusive practices by proxy advisory firms, also subjectivity there. And also provide annual reports on the SEC's website regarding its supervision of these companies. And notably, this Act, uh, the Financial Choice Act, uh, would also have required proxy advisory firm registration. So this seems to be kind of a hot topic on Capitol Hill.

                                                Those who are pro ... proponents of the Bill including the US Chamber of Commerce and the Business Round Table, uh, assert that it will help address concerns about the incredible influence that the proxy firms have over public companies and activism campaigns. Opponents of the Bill including the Council of Institutional Investors, which is a trade group whose members include, ISS and Glass Lewis, uh, that organization said that the Bill would just increase costs for pension plans and other institutional investors who use these proxy firms, because ultimately the firms would just pass along their increased compliance costs. Uh, but again, this Bill is in the Senate and has no vote scheduled.

                                                And as for regulations, there's at least one that's potentially significant that's been floating around Washington since right around the election. In October of 2016, the SEC proposed universal proxy cards. Now, by way of background, under the current rules, as Lawrence alluded to, shareholder voting by proxy in contested board elections must choose from two competing slates of directors on rival ballots. You've got the one that's supported by management and the one that's supported by activists. Shareholders who attend the meeting, however, can vote however they want. They can cast their votes for a mix of directors from both ballots.

                                                So in October of 2016, the SEC proposed rules that would mandate the use of so-called universal proxy cards by public companies. Those rules would allow shareholders, who vote by proxy, to vote for any combination of nominees for board seats, whether they're backed by activists or corporate management as if they were voting in person, so they could mix and match among the slates. Uh, now there was a 60-day comment period that wrapped up in January of 2017 and since then, there's really not been any movement on the proposal. The impact of the proposal on activism, which as Lawrence noted, often focuses on replacing board members, it's somewhat tricky to assess. To the extent that activists usually seek to change only a small number of board members, say less than half, it would seem that they would prefer the universal proxy card, because that would allow shareholders to more easily identify the specific candidates being targeted for replacement and their proposed replacements, uh, presumably increasing the odds of success for at least some of those replacements.

                                                And prominent activists like Bill Ackman of Pershing Square and others have publicly called for universal proxy cards for this specific reason, to let shareholders choose the particular directors they prefer rather than having to vote for one slate or another. Based on the composition of the SEC right now, uh, including one Republican Commissioner who previously voted against the adoption of these universal proxy cards back in October of 2016, uh, it seems unlikely that this will be adopted by the SEC anytime soon, but again, this is something to be on the lookout for.

                                                And last, and actually, appears I have a couple of minutes to mention one final item, also potentially subject to change is the SEC rule regarding what's called Schedule 13D, uh, so currently the SEC requires investors or groups of investors to publicly report their stakes in a company within 10 days of acquiring a five percent of a public company's share, when they have plans to discuss strategic options for the business, like a sale of the business that economic activist might undertake. That report is called the 13 ... a Schedule 13D, now, activist position is that they need the 10 days, if not more than 10 days, to accumulate their position further, kind of covertly, so they can buy shares at somewhat lower prices that make their campaign active to them in the first place or attractive to them in the first place.

                                                Uh, because once the Schedule 13D is filed, share prices tend to increase. Uh, but corporate defense attorneys at several prominent firms, including one of our competitors in New York, uh, as well as a handful of Democratic lawmakers, including Senator Elizabeth Warren, have been pushing for a system that shortens the disclosure window. And this is sort of a case of strange bedfellows since one would expect Senator Warren to be more pro-activist than this. Uh, but she and other Democrats who have taken the same position, uh, would like to see the window condensed to four days, meaning disclosure of five percent stake in a public company would need to be made within four days of hitting that benchmark as opposed to 10 days. And at least one prominent corporate defense, uh, attorney, at a different firm has publicly called for the disclosure to even be quicker. And so it'll be interesting to see whether this notion, uh, gets ... gains any traction with the SEC. And certainly shortening the disclosure window would be advantageous to companies, uh, who'd be more quickly and easily able to identify activists than with the 10-day period.

                                                So ultimately, it's possible that some quote anti-activist legislation will be enacted but it doesn't seem imminent and it seems unlikely in this election year. Likewise, the relatively pro-activist universal proxy card proposals seems to be dead in the water, whereas, the possibly anti-activist change in 13D is peculating among thought leaders on Capitol Hill and in New York.  And if anything, therefore, I suppose one could conclude that the legal tide is turning incrementally and slowly against shareholder activism, um, either despite, or perhaps because of its rise in recent years, uh, but I would have to say, it doesn't seem that this is a purely partisan issue, which is somewhat surprising in our current climate.

                                                With that, I will stop and I think we can see if there are any questions.

Micah Wallen:                   Thank you, Jason and Lawrence, for those opening words, let's go to audience questions. While we're waiting for questions to come in, Lauren and Jason, what- what would recommend or what are the top three mistakes that current companies are making when these activists that we've talked come knocking on their door, per se?

Lawrence Elbaum:           Uh, Jason, it's Lawrence, I'll- I'll, uh, I'll take that.

jason levine:                       Okay.

Lawrence Elbaum:           Um, you could ... you can chime in, um, so, uh, there are a lot of mistakes, uh, uh, off the top of my head, the three things I see companies doing that put them in- in the worst position possible from the proxy fight perspective are number one, ignoring the activist. Um, so, remember, uh, we've gone over now, several times how important ISS and Glass Lewis are in contested director elections. If a company is in front of ISS and Glass Lewis making its case three weeks before a contested vote of why the incumbent directors need to stay in place. If that ... if the company is that far along in the campaign, they get on the phone with ISS and Glass Lewis, they get in person with ISS and Glass Lewis, I've listened into these phone calls. I've sat in these meetings.

                                                The first question that ISS and Glass Lewis will ask is what is your history of engagement with the activist? If your answer is, "Oh, well, we ignored the activist for the first three months that they tried to speak to us, and we didn't talk to them until they issued a public letter." You're not on the track to getting a good recommendation, um, unless your stock price has quadrupled in that particular one, three, five and seven-year period. Um, so, our recommendation is, don't think about whether or not you should be ignoring the activist that's knocking on your door. Think about how the rest of your shareholder base, 95% of the rest of your shareholder base, what do they want to see you doing? You have a fiduciary duty to that activist, even though they're rattling your cage. Talk to them. Listen to them. Prepare to speak with them. Talk to your advisors about how to handle it. We script these, we script these, uh, these initial sessions with activists, uh, several times a week we're doing it. It's like deposition or cross-examination prep. But we do it. It helps build a record of constructive engagement that will help companies in the long run, um, as they, uh, deal with, uh, potential shareholder activism campaigns.

                                                Uh, the other recommendations, of what not to do dovetail, um, a board and company should not take defensive measures in haste. Um, there is a time and a place for a poison pill. There are different types of poison pills. We can have- we can have three sessions on poison pills, I'd be glad to do it. Um, but, they're not right in every single circumstance. It's important, um, when an activist is doing something aggressive for the board and management to understand, um, the threat. To understand what their fiduciary duties are, um, uh, under whatever state law they're operating under. It's most- most often Delaware and Nevada, um, but other states are in the mix too. And the duties vary from state to state. But they also need to consider the effect of the defensive measure they're considering taking in- in- in not only court but in the court of public opinion. Adopting a poison pill doesn't necessarily mean you're gonna win votes. Adopting a poison pill means that they activists or group of activists will not be able to buy any more shares or won't- or won't be able to buy past a certain threshold of shares. Um, that doesn't mean that they're gonna vote for you and it doesn't mean that your other shareholders are gonna vote for you.

                                                So defensive measures, therefore, need to be, um, considered very carefully, there's a time and place for them, um, but they need to be considered in- in- in the context of the entire arch of the campaign. And they need to be done surgically and precisely and it's important to work with the team of advisors to tell the right story about why they've been adopted.

                                                Um, another issue that we see is where management is tasked with dealing directly with an activist but they don't update their board. We have found that, uh, b- boards are very concerned about the rising tide of shareholder activism. But they're also more concerned with finding out that their board seats are being targeted by reading it in the Wall Street Journal, um, on a Monday morning, um, when they find out management knew on Friday afternoon and didn't tell them all weekend. Um, we- we recommend that for shareholder activism matters, that, uh, at least ad hoc group of a few board members, maybe a board chair or a lead independent or nominating and governance committee member and members of management have a task force, um, to deal with these types of issues so they can make determinations on the fly, uh, about who to update and when to update them. Uh, no one likes surprises.

jason levine:                       You know, I would, I would add, I would add to that list, bri ... just two more if I may, um, one failing to monitor the shareholder base adequately. This is something that can be done relatively easily and it's- it's important for companies to have people in their investor relations department who do it. To be able to try to determine who might become an activist, who's accumulating shares. Uh, and whether activists own shares. You can tell from the names, uh, on the shareholder list. And, you know, the second, the kind of larges macros one is, uh, for a company to assume that it won't happen to them. It's a big mistake for a company to assume that for whatever reason the industry it's in, it's market cap, they're a bunch of good people that they won't be targeted by activist and therefore to be blind to the risks and necessary preparation, uh, that's a classic mistake that if made, will often lead to a need to settle on less favorable terms, uh, than you might have been able to get, had you prepared in advance.

Micah Wallen:                   Thank you, Jason and Lawrence. Not seeing any questions lined up, uh, Jason or Lawrence, did, uh, did you want to offer some closing remarks before we close.

Lawrence Elbaum:           It's Lawrence, uh, just wanted to thank everyone, uh, for, uh, for giving us the time and, uh, uh, we're- we're both available to answer any questions, um, that may uh, come up ... come- come up or keep you up at night, uh, after, uh, uh, this call ends.

jason levine:                       Yeah, absolutely, this is Jason, thank you all very much. And, you can- you can find either of us, if you have any questions or concerns or something you'd like to discuss or have us talk about at greater length, we're delighted to hear from you and to do that.

Micah Wallen:                   And on behalf of the Federalist Society I want to thank our experts for their benefit ... for the benefit of their valuable time and expertise today. We welcome listener feedback, by email at [email protected]. Thank you all for joining us. We are adjourned.

Speaker 1:                           Thank you for listening. We hope you enjoyed this practice group podcast. For materials related to this podcast and other Federalist Society multimedia, please visit the Federalist Society's website at fedsoc.org/multimedia.