Ethan Allen, Hedge Fund Activism and Prevailing Over Conventional Advice and Practice

Jim Carlson (Mayer Brown)

Ethan Allen and its management prevailed a few weeks ago against an intense hedge fund activist campaign to remove its entire board of directors.

An analyst of one of our larger shareholders, the Gabelli funds, observed “I’ve never seen a company mount a better campaign against an activist investor than Ethan Allen did… Farooq Kathwari did a good job of implementing their strategy and tactics, to the point where people might study this as an example of how management can push back against an activist investor.” To explain, the Ethan Allen management and board directly engaged and listened to our shareholders. We went contrary to Wall Street advice or conventional practice, despite recognizing that hedge fund activists generally win about 90% of the proxy campaigns they initiate, especially when supported by Institutional Shareholder Services, as ours were.

When the activist aggressively surfaced, so too did expensive Wall Street banking, legal and proxy advisors soliciting Ethan Allen, with upfront fees totaling about $10 million, and several million more as success fees if the activist were defeated. The hedge fund activists knew of this typical cost imposed on a targeted company, and cite its burden to urge concession to their demands at the outset. For Ethan Allen, it wasn’t clear what real benefits such Wall Street advisors offered, and from a fiduciary perspective, we saw no justification in burdening our company with large upfront fees and such success fees should our shareholders decide the activists’ views were best for our company.

Ethan Allen instead decided to talk directly with our shareholders, including the activist shareholder, without the use of intermediaries, respecting that the shareholders collectively owned the company and would decide its future. Without Wall Street advisors, our management with Board participation wrote and prepared our shareholder presentations and communications for our investors. Our CEO, CFO and several directors spoke at length directly with shareholders representing about 85% of our outstanding shares. Many supported us, not all, and some support came with pointed, but good advice. Contrary to the conventional view that institutional investors are not engaged, every single investor wanted a concise presentation directly from management and the board outlining our competitive strategy and market differentiation, our growth strategies and our capital allocation plans in view of those strategies, and our plans to address technology and other disruptive forces and opportunities in the market. Each had thoughtful feedback and follow-up inquiries. We found there were no secrets that only Wall Street or the club of special advisors know, no special inside doors for inside advisors. Stockholders were eager to engage in discussion and appreciative of the time invested in this by the board and management. Contrary to commentator criticism, we found that most of our major institutional investors were focused on long-term strategy and value creation, and they were acutely aware of commentator criticism and suspicious of short‑term financial engineering for speculative short term gain. In our case, it was primarily the activist investor and Institutional Shareholder Services, and those shareholders who outsource their proxy governance voting to them, who supported financial engineering to fund large share buybacks and so fuel short-term financial returns.

While we were talking to our shareholders, the activist hedge fund pressure on Ethan Allen and its people was coordinated, personal, local and immense. For our CEO and CFO, in a very flat management operating company structure, responding to the hedge fund activist diverted more management time and resources than our prior initial public offering or managing through the early years of the great recession. The activist publicity campaign against Ethan Allen was intended to create business uncertainty and inevitably created questions from our key business relationships and associates in considering whether to continue making long-term commitments to our company. These typical activist tactics risk our Ethan Allen business and so our shareholder values. It’s very difficult to see how this disruption improves Ethan Allen now or in the long term for the benefit of our shareholders. Some of our investors acknowledged the typical immense Wall Street advisor costs and how they might be isolated and reported as an unusual expense, and more generally acknowledged to us, that it’s not worth it in the long term, you should exit the U.S. public stock markets, just as almost half of U.S. public companies have done so in the recent decade.

We engaged fully and directly with our shareholders and the activists, without the expense, tactics and choreography of Wall Street advisors, and prevailed this year. Going forward, we expect to be closely followed by our institutional investors, who will expect continued direct engagement by Ethan Allen. We also recognize that our current activist shareholder will likely continue their tactics, or if not them, any of many other activist hedge funds following the same playbook, so this engagement may become a constant campaign consuming management time.

For Ethan Allen, the disruption of hedge fund activism, fought back by Wall Street advisors, seems a terribly expensive, consuming, value risking process that could be replaced by simple, direct engagement with our shareholders. Contrary to conventional wisdom about institutional investor disengagement, we came to appreciate the insights and engagement of our institutional shareholders. We had frank and open discussions with our shareholders on many areas of corporate governance including executive compensation, board composition, proxy access and capital allocation, respecting that nobody has all the best insights, including ourselves, and it’s important to listen. For institutional investors, the conventional wisdom is that hedge fund activism and takeovers may have become the only available forum for shareholders to express their views as to corporate strategy and governance. However, our Ethan Allen experience offers an alternative where effective direct engagement by management and the board can prevail and ultimately may provide more meaningful on-going engagement by shareholders for longer-term company value creation and shareholder alignment.

The preceding post comes to us from Jim Carlson, who is an adjunct professor teaching securities and capital market regulation at the New York University School of Law, an adjunct professor at New York University Leonard N. Stern School of Business, a partner at Mayer Brown and a director at Ethan Allen.