The last 2.5 years have been hell for Corporate America. Executives and boards had to deal with the Covid-19 pandemic, social unrest, political instability, supply chain disruptions, inflation, war in Europe and numerous other issues. Amid these challenges, it is all too easy to lose sight of another looming threat on the horizon: shareholder activism.
Unfortunately for Corporate America, activist investors have not been idle during this time. While most were forced to stand down at the beginning of the pandemic, since that time activists have raised record amounts of capital. Experts believe that private investment funds have at least $200 billion of dedicated activism capital at their disposal, and activists have started to deploy it aggressively. Based on Bloomberg, activist campaigns against U.S. targets were up by 10 percent during the first half of 2022, and campaigns on companies with a market capitalization of $1 billion or more increased by 36 percent compared to last year.
The recent market volatility, even a potential recession, is unlikely to deter activists. In fact, this is an environment in which shareholder activists thrive. Activists are typically able to capitalize on market disruptions by initiating positions at lower prices, particularly those industries that have been most impacted, providing more upside than downside potential. In addition, a low share price provides activists with more ammunition to attack incumbent managements and boards.
The SEC’s Universal Proxy as Accelerant
If the situation was not already concerning enough, the SEC added more fuel to the activism fire when it recently adopted the so-called “universal proxy” rules. While the rules appear fairly technical at first glance, they are nothing less than the most dramatic rule change for proxy contests in a generation. These rules will go into effect for shareholder meetings after August 31, 2022.
Under the current proxy rules, a company and a dissident shareholder have different proxy cards. Importantly, a company’s proxy card may include only the board’s slate, and a dissident’s proxy card may not include the option to vote for any of the board nominees that the dissident is challenging. As a result, currently shareholders cannot “mix and match” nominees across slates for all practical purposes. The new universal proxy rules will change all of this. They require that all proxy cards list all of the company’s nominees and the dissident’s nominees, i.e., shareholders will be able to “mix and match” across slates by authorizing votes for any combination of the board’s and dissident’s nominees.
This seemingly innocuous change will have a dramatic impact on the shareholder activism landscape in the U.S. Previously, we had “slate contests” where investors had to decide whether to support the company or the dissident. By contrast, the new universal proxy rules set up a “candidate contest,” where shareholders can choose preferred individual nominees. This will make proxy contests into campaigns about the individual directors and, in turn, proxy contests will become more personal. The practical effect is that there will be a greater likelihood of at least a partial dissident victory in proxy contest. There is a higher chance that the highly influential proxy advisory firms, ISS and Glass Lewis, will recommend voting for at least one dissident nominee. Similarly, vote splitting by institutional investors will become more common. Many activists will demand more board seats in negotiations and will make limited settlements with activists harder to achieve.
How Should Companies Prepare?
Executives and boards ought prepare for an activist challenge in the near future by following these best practices of advance preparation:
1. Retain a specialized activism response team with extensive proxy fight experience to be on standby.
2. Prepare a “break the glass” communications plan with “shelf” press releases and media statements in the event an activist attacks publicly.
3. Establish an “early warning” system that monitors trading activity and other indicia of activist activity.
4. With the assistance of outside advisors, evaluate the strategy, capital allocation, performance, shareholder base and corporate governance of the company like an activist would.
5. Ask experienced proxy fight counsel to review the company’s legal defenses to assess potential enhancements, including potential bylaw amendments to mitigate the effects of the new universal proxy rules.
