Securities class actions, which often have cross-border elements, are facing threats on a number of fronts in Canada
Sinking share prices are leading shareholders on both sides of the border to launch proxy battles. But these days, in Canada, it is quite likely to be a US shareholder in the thick of the action, challenging the establishment on a range of issues from board shake-ups to the right to requisition shareholder meetings.
Canada’s capital markets, once as courteous as the Mounties on Parliament Hill, are becoming known for bruising proxy contests.
“The hallmark of recent Canadian proxy battles is they’re nasty, brutish and long,” says litigator Orestes Pasparakis, co-chair of the Canadian special situations team at Norton Rose Fulbright Canada LLP. “Recent developments have encouraged a very aggressive and litigation-focused response.
“Proxy battles have come to Canada with vigor and no company is immune from attack. What we’ve seen in the past two years is that even big companies, relatively well-run companies, are being attacked.”
While the country has had its share of proxy contests over the years, with a couple of notable exceptions they were confined to small-cap companies, often junior miners.
Not anymore. Within a 12-month period in 2012–2013, three of Canada’s 30 largest companies went through proxy fights. If you take the country’s six big banks out of the equation (they are tightly regulated) that is one in eight, a high proportion.
In each case, the challenge was brought by a US hedge fund.
New York’s Pershing Square Capital Management took on Canadian Pacific Railway, a Canadian icon whose share price had languished for six years. The bitter and at times highly personal fight took seven months, but Pershing won the board and management changes it was seeking.
New York hedge fund JANA Partners LLC also came north, waging an acrimonious and ultimately unsuccessful 10-month campaign to force the management of Canadian fertilizer giant Agrium Inc. to break up the company.
Most recently, New York-based Mason Capital Management LLC fought a drawn-out contest with Telus Inc., one of Canada’s large telecommunications companies, over the company’s planned conversion of its dual-class share structure in a court battle that turned into open warfare over empty voting.
Well-capitalized US hedge funds with a track record in successful activism have definitely changed the tone, says Kent Thomson, head of the Litigation Department at Davies Ward Phillips & Vineberg LLP, who acted in all three cases.
“There’s a willingness to engage in battles and to challenge conventional wisdom, and to pursue matters through proxy battles and through the courts if necessary to try and effect change.”
It’s no accident of geography that US shareholder activists are coming across the border, says Pasparakis. “US funds, in particular, have come to Canada and begun to pursue proxy battles because of the laxer rules in Canadian securities laws that make them more desirable.”
The threshold at which investors have to disclose their holding to regulators is 5 percent in the US. In Canada, it is 10 percent, giving activists more time before being forced to decloak a position.
Canadian regulators are looking at changing that to match US requirements. But for now, anyone looking for a primer on how Canada’s more shareholder-friendly rules can be used to advantage need only look no further than the recent high-stakes battle in Telus. The contest saw Mason use what Thomson describes “financial engineering” to mount its attack, leading to the first pronouncement from a Canadian court on empty voting — a growing controversy.
Telus found itself in a proxy fight in 2012 as a result of its outdated share structure.
The Vancouver-based telecommunications giant had acquired a company more than a decade earlier that had a large foreign shareholder base. The acquisition pushed its foreign ownership to over 33 percent.
Federal law in Canada requires telecommunications companies to maintain at least two-thirds Canadian share ownership so, to get around the problem, Telus created a dual-share structure. Foreign investors were given non-voting shares, which normally traded at a discount of about 5 percent.
By 2012, the largest foreign investor had long since sold off its position and with its foreign ownership down around 20 percent, Telus no longer needed a dual-share structure. The company decided to consolidate the shares to improve liquidity, especially on the New York Stock Exchange where only the non-voting shares were traded.
It announced it would convert the shares on a one-for-one basis — potentially a windfall for holders of the non-voting stock. The plan needed a special majority of two-thirds of both classes of shareholder because it involved amending the company’s articles.
The price difference between the two classes of share immediately narrowed with the announcement. In New York, Mason saw an opportunity to arbitrage the situation.
The hedge fund started buying common shares and shorting the equivalent value of non-voting shares. It built its position to about 19 percent of Telus’s voting stock. It also borrowed almost 11 million common shares and 21.5 million non-voting shares for the short-sale and hedging strategy.
Borrowing shares just before the record date and repaying them immediately after can be used to pull together a large voting position at very little cost.
Mason intended to use its position to vote against the arrangement, and profit from the premium historically attached to the voting shares when the unified share proposal was defeated or withdrawn.
The company went on the offensive, portraying the hedge fund as an “empty voter” that was using financial engineering to vote nearly C$2 billion worth of stock with only a C$25 million net economic stake.
Still, as Mason hoped, the 19 percent stake was enough to scupper the plan. Telus withdrew the proposal on May 8, but said it remained committed to the idea. It would just find another way to get it done.
Stepping back, it could be argued that the real arbitrage by Mason was of Canadian securities rules.
Under Canada’s Alternative Monthly Reporting System, once institutional investors report that they have hit the 10 percent threshold, they only have to refresh their reporting at months’ end — and if they change their position by at least 2.5 percent.
From court records, it appears in some months that Mason held its position at the beginning of the month, sold it off in the middle of the month, then built it back at the end of the month. The fund was not required to report any of the trades because its position hadn’t changed materially at month’s end.
High amounts of trading can also make it extremely difficult to trace who actually has the right to vote shares that are bought and sold between the record date and the meeting date.
Normally, the borrowed shares are entitled to the vote but shareholders may not even realize their stock has been loaned to third parties and, as a result, the shares can be voted more than once.
The Telus proxy battle flamed back to life in the summer of 2012 when CDS Clearing and Depository Services Inc. and CDS & Co., the holder of Mason’s Telus shares, requisitioned a shareholders’ meeting. If the share consolidation was going to be done, Mason wanted better terms.
It was proposing four new resolutions including one that would prevent the company from exchanging non-voting shares at a ratio of less than 1.08 non-voting shares per common share. Another – which was only to be considered if the first one didn’t pass – was identical but with a less favorable exchange ratio.
Telus formally declined the meeting request, claiming it was defective, the same day it had obtained an order from the Supreme Court of British Columbia granting it leave to hold its own shareholders meeting.
The company was proposing a new arrangement to collapse the dual-share structure. The shares would be exchanged on a one-for-one basis but, unlike the first proposal, it would not require an amendment of the company’s articles or a change in its capital structure, which meant it needed just a simple majority, not a two-thirds vote.
In granting Telus the order, the court declared the CDS meeting request was not in compliance with the Business Corporations Act or Telus’s articles of incorporation and that, as a third party, CDS was not entitled to requisition a shareholder meeting.
As an aside, BC’s Supreme Court sharply criticized the hedge fund for the “empty voting” tactic, calling the practice “a challenge to shareholder democracy.”
CDS and Mason turned to the BC Court of Appeal and won.
In a finding that is bound to please shareholder activists fighting to force a company to put their vision to a vote, the appeals court found that a requisition for a shareholders’ meeting need not identify the beneficial owner of the shares used to call the meeting in order to be valid.
“What the court said is it doesn’t matter whether a shareholder has sold off a beneficial interest to somebody else and they’ve got no interest in the company any longer; they have the right to exercise the vote and requisition a meeting,” says Craig Ferris, a litigator at Lawson Lundell LLP in Vancouver.
The appeals court also addressed the issue of empty voting, touching on Crown EMAK Partners, LLC v. Kurz from the Delaware Supreme Court.
Noting while the problem of empty voting had been identified in cases as well as legal literature, the justices said, “Telus has not pointed to any authority that suggests that courts have inherent jurisdiction to control abuses. Courts are entitled to intervene only when they have specific authority to do so under statutory provisions.”
While Mason’s limited financial stake raised “a strong concern” that its interests are not aligned with the economic well-being of the company, the court said there is no indication that the hedge fund was violating any laws, “nor is there any statutory provision that would allow the court to intervene on broad equitable grounds.
“To the extent that cases of ‘empty voting’ are subverting the goals of shareholder democracy, the remedy must lie in legislative and regulatory change.”
There are fairly few recent decisions in proxy litigation in Canada and nothing at all, until now, on how to proceed when a shareholder’s economic interest in the company has been decoupled from its voting rights, says Stephen Schachter, QC, of Nathanson, Schachter & Thompson LLP, who argued for Mason.
“The [Telus] case is significant in a Canadian context as it was the first case in which the courts have commented on the concept of empty voting,” he says from Vancouver, “so it’s an interesting case even though no determinations have been made at the highest level; it didn’t get to the Supreme Court of Canada.”
The two sides continued legal sniping after the appeal court decision, but once Telus shareholders voted for the one-to-one swap, both sides agreed to abandon the court challenges.
Craig Ferris says Telus is also interesting because Mason “tried to pull American concepts across the border. But the court essentially threw it back into the legislative arena, to the politicians.” That’s not surprising, he adds, because Canada is a less-developed jurisdiction in terms of shareholder activism and its courts are more conservative.
“Shareholder activism is a growing trend but the ground is pretty unplanted in certain respects so, right now, our judges are taking a more limited role than they do in the US. You can make arguments in the course of a proxy fight but there is little jurisprudence to support them.”
Mark Gelowitz, chair of the National Corporate Governance and Securities Litigation Group at Osler, Hoskin & Harcourt LLP, believes that is changing.
He says a proposal being considered by Canadian securities regulators to allow boards to install poison pills and keep them in place up to a year – with shareholder approval – will likely lead to more proxy action.
“What that’s going to create is a shifting of the litigation tactics in relation to poison pills, because what bidders will need to do, essentially, is fight a proxy battle on the shareholder vote to accept or reject a poison pill.
“It’s actually pretty early days on proxy litigation issues so far. But what I see in the future is as we get more and more of this, we’re going to have a ramping up of litigation in relation to those shareholder-meeting issues driven by an increase in activist investor activity.”
Pasparakis says another avenue he sees opening up is entrenchment suits based on actions a board takes before a proxy battle. “Say the activist represents 50 percent of shareholders and the company has 40 percent, the board might decide to issue 20 percent in new shares to a ‘friend,’ tilting the numbers so the company wins.
“The dissident would say that’s oppressive, and there’s quite a bit of litigation around that kind of dilutive or entrenching transaction. People thought those kinds of transactions were dead but recently there’s been success — which is only going to encourage them.
“Proxy battles are a developing area in Canada, and we’re seeing more and more litigation, so we can also expect to see more and more guidance from the courts on this difficult area.”