CLS Blue Sky Blog

Wachtell Lipton on Dealing with Activist Hedge Funds and Other Activist Investors

Regardless of industry, size or performance, no company should consider itself immune from hedge fund activism.  No company is too large, too popular, too new or too successful.  Even companies that are respected industry leaders and have outperformed the market and their peers have come under fire.  Activists set new records in 2018, targeting the largest number of companies (nearly 300), deploying more capital and winning a greater number of board seats (161) than ever before.

Campaigns by the most well-known activist hedge funds are surging, and there are more than 100 hedge funds currently engaged in activism.  Activist hedge funds have significantly more than $100 billion of assets under management, and remain an “asset class” that attracts investment from major traditional institutional investors.

Although a number of institutional investors are beginning to question whether hedge fund activism should be supported or resisted, and will act independently of activists, the relationships between activists and more traditional investors in recent years have encouraged increasingly frequent and aggressive activist attacks.  Several mutual funds and other institutional investors have on occasion also deployed the same kinds of tactics and campaigns as the dedicated activist funds.  A number of hedge funds have also sought to export American-style activism abroad, with companies throughout the world now facing classic activist attacks.  Many activist attacks continue to be designed to force a takeover, sale or breakup of the target, or a change in management, either immediately or over time.

Elliott Management was the most active and, in many cases, aggressive activist of 2018. The Wall Street Journal noted that Elliott publicly targeted 24 companies in 2018, with Carl Icahn and Starboard runners-up with nine public targets each.  These numbers do not include the increasing number of non-disclosed activist situations against major companies.  The New Yorker published a lengthy profile of Paul Singer and Elliott in August, “Paul Singer, Doomsday Investor,” noting “Singer has excelled in this field in part because of a canny ability to discern his opponents’ weaknesses and a seeming imperviousness to public disapproval.”

It has become increasingly evident that the activism-driven corporate world is relatively fragile and is proving to be unsustainable, particularly when viewed in the broader context of rapidly changing political and social norms and increasing divisiveness across many planes of the social contract. A number of initiatives have been underway to establish a modern corporate governance framework that is calibrated to the current environment. For our part, at the request of the World Economic Forum, we prepared a paper titled, The New Paradigm: A Roadmap for an Implicit Corporate Governance Partnership Between Corporations and Investors to Achieve Sustainable Long-Term Investment and Growth, which was issued in September 2016.  We updated The New Paradigm and discussed it in our memo, Some Thoughts for Boards of Directors in 2019.

In essence, The New Paradigm conceives of corporate governance as a collaboration among corporations, shareholders and other stakeholders working together to achieve long-term value and resist short-termism. While we have seen considerable interest in The New Paradigm and similar initiatives from major institutional investors and other key stakeholders (for example, the Investor Stewardship Group), until such a framework is widely adopted and in the absence of legislation, it is unlikely that there will be any significant decrease in activism. Accordingly, companies should regularly review and adjust their plans to avoid an activist attack and to successfully deal with an activist attack if one should occur. Effective engagement with major shareholders is the essential element of activist defense, and the support of major investors, including the largest index funds, cannot be taken for granted.

The Attack Devices Used by Activists

Current SEC rules do not prevent an activist from secretly accumulating a more than 5% position before being required to make public disclosure and do not prevent activists and institutional investors from privately communicating and cooperating.

Prevention of, or response to, an activist attack is an art, not a science.  There is no substitute for preparation.  The issues, tactics, team and approaches to an activist challenge will vary depending on the company, the industry, the activist and the substantive business and governance issues in play.  To forestall an attack, a company should regularly review its business portfolio and strategy and its governance and executive compensation issues.  In addition to a program of advance engagement with investors, it is essential to be able to mount a defense quickly and to be agile in responding to changing tactics.  A well-managed corporation executing clearly articulated strategies can still prevail against an activist, even when the major proxy advisory firms support the activist.

Given the risks and potential harm of a full-blown battle, in certain situations the best response to an activist approach may be to seek to negotiate with the activist and reach a settlement on acceptable terms, if such a settlement is feasible, even if the company believes it could win a proxy fight.  However, when a negotiated resolution is not achievable on acceptable terms, whether because the activist’s proposals are inimical to the company’s business goals and strategy or because the activist is unwilling to be reasonable in its negotiation, the ability to wage an effective campaign will depend on advance preparation, proactive action, good judgment and effective relationships and engagement with shareholders.  This outline provides a checklist of matters to be considered in putting a company in the best possible position to prevent, respond to or resolve a hedge fund activist attack.

Advance Preparation

Create Team to Deal with Hedge Fund Activism:

Shareholder Relations:

Prepare the Board of Directors to Deal with the Activist Situation:

Monitor Trading, Volume and Other Indicia of Activity:

The Activist White Paper:

The activist may approach a company with an extensive, and in many cases high-quality, analysis of the company’s business and strategy that supports the activist’s recommendations (demands) for:

Responding to an Activist Approach

Response to Non-Public Communication:

Response to Public Communication:

This post comes to us from Wachtell, Lipton, Rosen & Katz. It based on the firm’s memorandum, “Dealing with Activist Hedge Funds and Other Activist Investors,” dated January 24, 2019.

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