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Apr 06, 2020

How boards can prepare for post-pandemic activism

Periods of equity market turmoil often lead to increased activity. Frank Aquila and Melissa Sawyer offer advice for boards on making sure they are ready

The Covid-19 pandemic has caused significant volatility in the equity markets, with companies across different sectors experiencing sometimes precipitous declines in share prices coupled with significant changes in share ownership. Public companies often experience an uptick in activist demands and unsolicited offers after such periods of exceptional turbulence. The 2008 financial crisis, for example, was followed by a significant increase in unsolicited offers, proxy contests and event-driven activism.

Activist investors may focus their attention on companies that have been particularly impacted by the pandemic, including those that already have significant activist representation in their stocks and those facing new vulnerabilities.

Although public company boards and managements are understandably focused on managing the immediate and critical issues associated with the unprecedented crisis affecting their employees, customers and communities, in the longer term boards and management may need to expend substantial energy preparing for:

  • Unsolicited takeover bids and short-selling
  • Proxy contests, including through special meeting and written consent campaigns
  • Activist demands that combine the activist’s primary investment theses with criticism of the company or management’s Covid-19 preparedness and response.

Any advance planning on the part of a public company to prepare for these potential consequences of the pandemic will likely contribute to the company’s ability to effectively manage its near-term and long-term relationships with its shareholder base.

To prepare for activism and unsolicited bids, companies should work closely with their internal and external advisers to plan for responding to a potential activist’s or bidder’s demands, including by engaging with institutional investors, regulators and other stakeholders, as well as monitoring changes in the legal and regulatory environment.

The Covid-19 pandemic may leave companies more susceptible to unsolicited takeover bids. Declining share prices at many public companies may incentivize a rise in unsolicited proposals, as lower share prices decrease the cost of gaining an equity position in a company.

Furthermore, due to general socioeconomic uncertainty and potentially constrained alternative buyers, some companies may experience obstacles to a board-supported or negotiated strategic transaction, such as a merger, spin-off or securities offering. This may limit the number of viable options the board can present to shareholders as attractive alternatives to an unsolicited offer. Convincing shareholders that depressed share prices do not justify selling the company for less than its intrinsic value may be particularly challenging in a volatile environment.

That task may be further exacerbated by changes in a company’s shareholder base, as investors that have recently acquired shares at lower prices could be more receptive to an unsolicited offer that does not fully value the company.

In light of recent market fluctuations, public companies may also see an increase in short-selling as investors attempt to capitalize on volatility in share prices. Some short-selling activity may be accompanied by the publication of the short-seller’s investment thesis and criticism of the company, which often accelerate declines in share prices.

Proactive steps a company can take to avoid these challenges include:

  • Working with its proxy solicitor to monitor changes in its shareholder base

Careful monitoring is particularly important when equity values are depressed, because whether or not an antitrust filing is required under the Hart-Scott-Rodino Act (HSR Act) is based on a dollar (not a percentage) threshold for the value of voting securities acquired. The current HSR threshold of $94 million is sufficiently high in relation to some companies’ depressed stock prices that an activist may be able to accumulate a substantial stake without having to make an HSR Act filing.

Therefore, unless the activist’s or potential bidder’s stake surpasses 5 percent and a Schedule 13D filing is required, the company may not be on notice that its shares are being accumulated by the activist or bidder. Even if a Schedule 13D filing requirement is triggered, the activist or bidder still has a 10-day window to disclose its position. Short-selling activity may be particularly difficult to detect, as SEC rules do not mandate disclosure of a short position and also permit an activist short-seller to close out a disclosed short position at any time after publication, even at a price different from the activist’s stated valuation

  • Reviewing the company’s projections and business plans and working with its financial advisers to identify alternate counterparties and strategies

A clear view of the company’s future plans and the strategic opportunities available to the company will help management and the board prepare to defend the company’s stand-alone value if faced with an unsolicited bid or a publicity campaign from a short-seller

  • Providing regular updates on business planning to the board

Taking steps to ensure alignment on the company’s prospects and intrinsic value, as well as to promote cohesion among the members of the board and management, is especially critical to a successful defense against an unsolicited bid

  • Considering takeover defenses

With counsel, companies should explore the advisability of adopting additional takeover defenses such as shareholder rights plans. Among other things, an appropriate set of takeover defenses will provide a company’s board additional time and leverage to fully and adequately consider the fairness of a bid for the company, as well as to engage with its shareholders

  • Engage with regulators

Companies in regulated industries may also consider proactive engagement with regulators to address any increased risks of an unsolicited offer and any meaningful accumulation of its shares in an activist’s or hostile bidder’s hands.

A proxy contest is always a substantial drain on the time and resources of a company’s board and management. It would be particularly distracting for a management that is already working hard to respond to the impacts of Covid-19 – but if there have been significant changes in the shareholder base of a company due to Covid-19 volatility, it could be more vulnerable to a proxy contest even if it has recently defeated a proxy contest from the same activist.

Typically, proxy contests to replace incumbent directors with an activist’s slate are voted on at the annual shareholders meeting. For most US public companies, the window for shareholders to submit a proposal for the company’s 2020 AGM has passed, mitigating to some extent the near-term risk of an annual meeting proxy contest. But a proxy contest or other shareholder demand remains a more immediate risk for issuers that have non-calendar year-end fiscal years, or an advance-notice period tied to disclosure of the annual meeting date if they have not yet announced the date of an upcoming annual meeting.

In the aftermath of the Covid-19 pandemic, some activists may act opportunistically to undertake the additional costs and risks of conducting a proxy contest even when the annual meeting window has closed through special meeting demands and written consent campaigns. Therefore, companies whose governing documents allow shareholders to call special meetings or act by written consent need to be cognizant of when shareholders are allowed to make proposals or nominate directors after the window closes for the annual meeting.

Many companies’ governance documents mandate blackout periods ranging from 90 to 120 days following their annual meeting, during which shareholders may not call a special meeting or act by written consent. These blackout periods give management an opportunity after the annual shareholder meeting to focus on operational issues and prepare defensive strategies.

Companies that have special meetings or written-consent provisions should also review the scope of actions that are allowed to be taken at a special meeting or by written consent, including whether or not directors may be removed or elected. For example, some companies have special-meeting provisions that would permit the company to exclude a shareholder-requested action that was already substantially addressed at a shareholder meeting or within a specified period of time since the annual meeting.

Companies should also check the ownership thresholds for calling a special meeting or taking action by written consent. For example, most companies only allow special meetings to be called by one or a group of shareholders holding in excess of a certain percentage, with that threshold often ranging from 10 percent to 25 percent of total outstanding shares. With depressed share prices, it would be easier for an activist, or a group of activists, to meet the threshold for calling a shareholder meeting.

Over the coming months, there may be an increase in activist demands that combine the activist’s primary investment theses with criticism of a company’s or its management’s Covid-19 preparedness and response. These criticisms could add fuel to an activist’s publicity campaign as part of an unsolicited bid, short-selling thesis, proxy contest or other type of activism.

In anticipation of these potential criticisms, a company should consider preparing shelf response decks or other relevant materials, so that it can swiftly counter a publicity campaign launched by an activist. An expeditious and persuasive response in these situations is critical, particularly as companies have very few, if any, other effective tools to respond to false, incomplete or misleading public statements issued by activists.

A compelling narrative may also help the company in its engagement with institutional investors and regulators, who may need additional assurances in these unprecedented and sensitive times. Of course, as always, the company should be mindful of Regulation FD in making these communications.

Management should also consider whether the company’s public disclosures provide a cohesive narrative regarding company leadership’s efforts to respond to and mitigate the crisis. Presenting a consistent message to the market – one that is specific to the company and the challenges it is facing – will be essential to the success of a company’s activism preparedness. Presenting key developments contemporaneously will be more effective in gaining shareholder confidence than a retrospective narrative.

Many companies are already providing substantial disclosure related to Covid-19. Such disclosures may include revising earnings guidance, announcing the cutting of dividends or executive pay, or presenting the ways in which Covid-19 has affected – or may affect – a company’s business. Companies and management teams are making these disclosures across a variety of platforms, including SEC filings, press releases, public videos and social media postings.

Boards and management are well advised to work closely with their communications and investor relations teams in order to ensure the company’s messaging about its response to Covid-19 is as effective and organized as possible across platforms.

In preparing a narrative relating to Covid-19’s impacts, companies should consider not only the impact on shareholder value, but also how the interests of other stakeholders may impact shareholder value. For most companies, shareholder value is linked closely with the welfare and safety of employees and the communities in which the company operates, as well as the sustainability of the company’s supply chain and other relationships.

Many companies have been forced to lay off employees, otherwise curtail operations and cut costs in order to mitigate the risks of Covid-19. A recent Boston Consulting Group survey of portfolio managers and other investment professionals finds that 89 percent of respondents believe it is important for companies to prioritize building key business capabilities to create advantage, drive future growth and be better positioned to bounce back after the crisis, even if that means lowering earnings-per-share guidance or delivering below-consensus estimates.

Ensuring those key business capabilities are in place means companies should be responsive to customers, employees, suppliers and the communities in which they operate so they are able to drive shareholder value over the medium to long term as the crisis subsides.

With some relief from Washington, DC in the form of the CARES Act, boards and management should consider how they can use all available resources in order to weather this crisis and transition back to regular operations.

The most effective narrative for any company is one that is tailored to its particular situation, its shareholder base and the specific challenges the company and its stakeholders face. ISS recently published its climate proxy voting guidelines, which illustrate the importance of company-specific Covid-19 disclosures.

The guidelines recommend case-by-case voting on shareholder proposals requesting reports on the impact of health pandemics on companies based on their potential geographic exposure, and support of their employees’ healthcare through healthcare policies, benefits and access, as well as their donations to relevant healthcare providers.

Although ISS generally recommends a vote against shareholder proposals seeking the establishment, implementation and reporting on a standard of response to pandemics, it may recommend a vote in favor of those proposals if companies have significant operations in the affected markets and have not adopted policies and procedures comparable with industry peers.

Frank Aquila and Melissa Sawyer are partners with Sullivan & Cromwell LLP.