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

The SEC rule requiring a universal proxy card in director election proxy fights becomes effective today [September 1].  The resurgence of activism is already in progress, and the universal proxy card may significantly facilitate some proxy contests in which an activist is seeking to elect one or more directors to a company’s board to replace incumbent(s).  It will also affect proxy contest strategies, tactical considerations and the behavior of proxy advisory firms assessing competing director slates.  As stated by ISS in its report on the universal proxy card:

The indisputable fact about the universal proxy card (UPC) is that it is a far superior way for shareholders to exercise their voting franchise than the two-card system that has dominated proxy contests for decades.  But like the kid that receives the hot new toy at Christmas, only to become frustrated by its complex instructions, proxy advisors and investors will have to carefully navigate the first few UPC contests. Although UPC contests will increase the workflow of institutional investors, many funds have ramped up teams to evaluate these situations in recent years, so they are likely well prepared for this shift.

As we have previously noted, regardless of industry, size, performance or “newness” to the public markets, no company should consider itself immune from activism.  No company is too large, too new or too successful.  Even companies that are respected industry leaders and have outperformed the market and their peers have been, and are being, attacked.  And companies that have faced one activist may be approached, in the same year or in subsequent years, by other activists or re-visited by the prior activist.  The past two years of substantial economic, societal and market shifts have created new vulnerabilities and opportunities for activists and for companies.

Although asset managers and institutional investors will often act independently of activists, the relationship between activists and asset managers and investors in recent years has encouraged frequent and aggressive activist attacks.  A number of hedge funds have also sought to export American-style activism abroad, with companies throughout the world now facing classic activist attacks.  In addition, the line between hedge fund activism and private equity continues to blur, with some activist funds becoming bidders themselves for all or part of a company, and a handful of private equity funds exploring activist-style investments in, and engagement with, public companies.

Traditional activism, focused on short-term profit, stock price and total shareholder return (TSR), continues alongside a new form of activism emphasizing climate and other environmental, employee/human capital, social and governance (ESG) considerations.  The activism landscape has also evolved to include dual purpose activists who combine both TSR and ESG arguments, as well as “pincer attacks” from ESG and TSR activists acting independently or in concert against the same company.

The outcomes of recent economic and ESG-related proxy fights, activism campaigns and non-public activist approaches across industry sectors  underscore the importance of advance preparedness to anticipate, prevent and respond to an activist attack.  This includes not only the more traditional governance and economic components of activist campaigns, but also the ESG themes that some activists have been deploying in their attacks (including and subsequent to the Exxon proxy fight successfully waged by ESG activist Engine No. 1 last year).  The new universal proxy card rule only increases the importance of being prepared.

For many years, we have been updating this memo based on recent developments, evolving trends and our experiences avoiding, defusing, resolving and prevailing in contested situations and proxy fights to provide the most cogent and current advice to our clients and friends.  Summarized below is a snapshot of some of the tactics and themes deployed by activists, followed by a checklist of matters to be considered in putting a company in the best possible position to prevent, respond to or resolve an activist attack.

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.  We have long sought to correct this loophole, and potential reforms are under consideration.

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 strategy and portfolio, how it is balancing growth and profitability, margin priorities and pressures, its ESG issues and strategy, and its governance and executive compensation.  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, credible strategies can prevail against an activist by making its case to the rest of its shareholders.  A well-advised corporation should also play offense in anticipation of activism and in resolving activism.

Many investors increasingly expect companies to at least seek to engage constructively with activists.  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 in response to the activist will depend on advance preparation, strong alignment between the board and management, proactive action, good judgment and effective relationships with shareholders.

Advance Preparation

Create Team to Deal with Activism:

Shareholder Relations:

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

Monitor Trading, Volume and Other Indicia of Activity:

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 is based on the firm’s memorandum, “Dealing with Activist Hedge Funds and Other Activist Investors,” dated September 1, 2022.

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