Shareholder Activism's New Age

Will current activist tactics, from Twitter to golden leashes to vote buying, mean an even bumpier ride for companies involved in proxy fights?

It could be that not everyone yet appreciates what really happened when Carl Icahn disclosed on Twitter he had acquired a position in Talisman Energy and was considering approaching management about board seats.

In the blink of an eye, he threw out the rulebook for running proxy campaigns in Canada.

This was not a legendary 77-year-old investor trying to look modern by adopting the younger generation's micro-blogging habits. This was a wily campaigner performing alchemy on a shareholder base.

“What it does is it instantly gets the attention of event-driven investors,” says Orestes Pasparakis of Norton Rose Fulbright Canada LLP in Toronto.

“People will follow a Carl Icahn or a [Pershing Square Capital Management founder] Bill Ackman into a stock in anticipation there will be an event such as a new CEO, a sale or a new strategy. This often results in 20 per cent to 30 per cent of the shareholdings changing hands within a week or two, and that changes the shareholder base for the vote.

“If you think about it from the activist's perspective, if you buy 10 per cent of the shares and have another 20 per cent of aggressive like-minded investors who follow you take a position in the stock, all of a sudden you're at 30 per cent, which gives you a good base from which to pursue a board change.”

Pasparakis, co-chair of his firm's Canadian special situations team, says in proxy battles today the decision on whether to go public right up front using social media and the Internet is “the dominant strategic decision in a campaign.”

Using Twitter the way Icahn did also catapults the issue onto the front pages of conventional financial media, a prospect that before Bill Ackman and CP probably would have given most Canadian activists and their advisors hives. But activist funds mounting challenges to the way the board is running the company have started to appreciate just how much it actually changes the dynamic, Pasparakis says.

“As soon as it's announced, people get excited and the stock price starts to go up, which makes the activist look like the smart money. At the same time it also makes them some money right up front, so it provides them with a financial cushion.

“And people suddenly want to know what the board is going to do in the face of these criticisms. They start scrutinizing the company and looking at why the activist is coming in, what changes ought to be made and what the upside is. That puts tremendous pressure on the board.”

Icahn says the best way to win the war is “not to fight.” Is he becoming a peacenik? It seems unlikely. Yet in 2013 he reached deals with seven companies to put at least one member on the board without having to wage a proxy battle. That includes the two board seats he secured on Talisman less than two months after his initial tweet, without another peep.

Is it a trend? With the 2014 proxy season just around the corner, will Twitter and the Internet reduce or even end the kinds of drawn-out bloody corporate battles seen in Ackman's run at Canadian Pacific?

In the US, home turf for hyper-aggressive US hedge funds, the predictions are for more proxy contests. In Canada, the numbers are ambiguous. If the statistics suggest anything, it's that it is at least a year too early to tell.

The 2014 Canadian Proxy Contest Study, recently released by Fasken Martineau DuMoulin LLP, shows the number of proxy contests in 2013 fell to a little over half the number of a year earlier.

“In 2012 we counted 27 contests, which was the high-water mark for the 10-year period,” says Aaron Atkinson in Toronto, one of the report's co-authors. “In 2013 we were running at a little over half that with 16. So we saw a big drop off. The question now is whether 2012 was an anomaly, whether the market conditions were perfect for all this and 2013 is just reverting to the norm. Or is 2013 illustrative of people learning the lessons of 2012, which are that these contests, while wildly entertaining, are very expensive and a huge drag on management, and therefore people are settling before these things become public?”

Atkinson, a partner at Faskens, says he suspects the 2013 numbers were higher than the report's authors were able to confirm using their stated methodology of limiting their analysis to information filed publicly on SEDAR.

“Anecdotally, from the people I talk to, there were a lot of activist situations last year but we didn't hear about them because they were settling before anyone started firing the cannons. I was involved in a couple where companies were approached and the parties settled quietly either by adopting some of the dissidents' proposals or putting people on the board.

“But in instances where people did pull the trigger on a proxy fight we had a greater proportion of settlements last year, which again suggests that maybe people are getting the message that it's better to staunch the bleeding and come to some sort of resolution before it gets out of hand.”

The Faskens report reviews data from 117 completed contests between January 1, 2008 to December 31, 2013. Atkinson says because the role of Twitter and the Internet is so new, it is not among the criteria examined in the report.

“We didn't look at all the platforms people used, but we did look at whenparties went public with the potential fight. And so definitely our findings have been that activists that take the message out early and get out in front of the issuer tend to have greater success rates.”

Kathleen Keller-Hobson, a mergers and acquisitions partner at Gowling Lafleur Henderson LLP in Toronto, says anyone acting for listed companies should be paying extremely close attention.

“One piece of advice if you're acting for an issuer is to have an advisor who's monitoring what's happening on social media because the activist funds are using Twitter to get their message out and once that activist has emerged and says what their position is, it's a case of both sides communicating why they think their position is better.

“It all comes down to a very important communications battle. Social media has become very, very important on that front.”

Where old-style proxy wars were fought in the last couple of years, tactics emerged that have people – and now regulators – talking. It starts with golden leashes.

The concept was introduced in the fight between Agrium Inc. and Jana Partners, an American hedge fund and its largest shareholder. When the fertilizer maker rejected Jana's suggestion that the company spin off its retail business to boost shareholder returns, Jana responded by putting forward its own independent directors to serve on Agrium's board.

And Jana did something no one on either side of the border had seen before. It offered to pay its nominees a percentage of any profit it earned on any Agrium share increase over a three-year period, provided the nominees succeeded in winning a board spot and the share price went up. That private compensation would be in addition to the amount the company pays all its directors for their services.

The rationale was that it's very difficult to get qualified people to stand as dissident nominees knowing their record and reputation will be savaged in the media. Critics of the arrangement said it would keep Jana directors on “golden leashes.” Jana said its nominees would only “stand to gain to the extent that all shareholders gain.”

Jana fought back, accusing Agrium of vote buying. It said the company was offering to pay investment advisors 25 cents a share, up to $1,500, if their clients voted their shares in favour of existing directors provided Agrium's slate won the contested board election.

The Canadian Coalition for Good Governance (CCGG) finds both practices troubling developments for the area of shareholder democracy.

Golden leashes create a divergence of interests on the board, says Stephen Erlichman, the coalition's executive director. “The issue about golden leashes as it occurred in the Jana-Agrium proxy fight was that there were what I'd call wrong incentives being given to the Jana nominees to make decisions over a relatively short time frame — at most three years,” says Erlichman. “That caused an internal conflict in the CCGG's view between what the Jana-nominated director might do to get that compensation, versus what might be in the best interests of the company over the given time frame.”

Erlichman, who is also a partner at Faskens in Toronto, asks what would happen if the board had to choose between two versions of a project: One would be completed in two-and-a-half years and provide an internal rate of return of X; the other would provide an internal rate of return of 2X but take five years to complete.

“Is the Jana-nominated director going to vote for the one that increases his internal payout, or for the second one that may be better for the company but is not going to do much for the stock price until it actually comes to fruition at the end of five years? It creates a Balkanized, dysfunctional board where some directors can potentially get millions of dollars each and other directors are going to get just whatever the directors' fees are. It also takes over the board's prerogative to decide the compensation of directors because, for some, a big payout comes from a third-party shareholder.”

The coalition, which represents 46 investors with more than $2-trillion under management – more than half of Canada's retirement savings – is so bothered by both issues that once the fight was over, it privately reached out to securities regulators urging them to act.

“We wrote and asked them to look into both vote buying and golden leashes,” confirms Erlichman. “We asked them to take a public stance. The CCGG wanted to let Canada know that the practices as they occurred in the Jana-Agrium proxy fight are not acceptable.”

Golden leashes have quickly become one of the hottest topics in corporate governance.

In a client memo, Wachtell, Lipton, Rosen & Katz – well known for its defence work – warned of “poisonous conflicts” in the boardroom by creating a “subclass of directors who have a significant monetary incentive to sell the corporation or manage it to attain the highest possible stock price in the short-run.”

The firm recommended companies adopt a bylaw barring any candidate who stands to receive an outside payment from serving on the company's board, and even suggested draft wording. The Wall Street Journalreported in November that in the past six months, at least 26 companies had followed that advice.

Keith Chatwin, a partner at Stikeman Elliott LLP in Calgary, says golden leashes clearly raise the possibility of conflict of fiduciary duty, which requires directors to act in the long-term best interest of the corporation. “There may be a misalignment there. Do you want to create a circumstance where you put those at odds with each other?”

That said, some people, including Edward Iacobucci, Osler Chair in business law and a professor at the University of Toronto, say there may be advantages to private compensation for dissident directors. Iacobucci wrote, in a working paper released in December, that these payments provide the dissident directors with additional incentive to maximize value for all shareholders; the important thing is that they be disclosed so everyone knows the score.

Despite the blowback against Jana, Chatwin says he expects to see golden leashes used in coming proxy battles. “You know how things work. Once someone's tried something typically, if it's marginally successful, others will try it.”

That probably goes for vote buying as well.

Vote buying, or the more neutral term of dealer solicitation, the way it played out in Agrium has been raising eyebrows because it can be viewed as directors using the company's cash to entrench themselves.

The practice of paying brokers to get their clients to vote in a proxy contest or M&A has been around a long time but the incentive was traditionally offered to make sure shares were voted — not tied to them being voted one way or the other, says Keller-Hobson of Gowlings.

She believes the way it was used by Agrium raises ethical questions and says “there is a fairly prevalent view that it is not appropriate.” Judging from the buzz in governance circles, she says, she is doubtful it will be used again soon.

“I think people would tread more carefully next time. Jana wasn't happy about it and I wonder whether one wouldn't bring an oppression action on the basis that that is not appropriate from the corporation's view, not a proper use of corporate funds.”

But Chatwin of Stikeman Elliott is not so sure. He says it comes back to the business judgment of the board. “If the board determines the circumstances justify whatever legal means are necessary to ensure that the direction of the company they've charted is adhered to, then that's within their discretion to determine. If they think certain shareholders don't understand the value proposition that the board has put in place and that management is executing, and they think they can drive the vote more powerfully through an economic incentive, then perhaps they think this is the right way to go.”

He also says what Agrium did was not buying votes in the truest sense. “The company's not paying shareholders to tender their shares. You're paying the advisor to make the effort to communicate with the individual on whose behalf they hold the shares, to convince them to vote. Might they be more persuasive about the virtues of existing management if they receive an incentive to be so? Perhaps. It does raise potential conflict concerns. But from a board perspective, I don't know if that would necessarily compromise the discharge of my duties to the corporation.”

Chatwin acknowledges he has been involved in a proxy situation where the payment of an increased fee for a successful vote has been used. He's not bothered by it. What does disturb him far more is the lack of oversight over independent proxy advisory firms like Institutional Shareholder Services Inc. (ISS) and Glass, Lewis & Co. LLC. He says that has to change.

The prominence of proxy advisory services has increased so dramatically that having an ISS or any other of the large ones on your side or against you can tip the tide in a proxy contest.

The firms hold enormous sway because they are assumed to have done a correct analysis before making their recommendations, says Chatwin. He questions whether that's always the case, noting “delving into the methodology by which services like ISS and Glass, Lewis reach their conclusions just isn't done. It's a bit of art and a bit of science. We've all represented issuers in the past where we've seen a No recommendation where we didn't anticipate it. Trying to go back through those processes to determine why the No was obtained and … explain the circumstance to the advisory firm and get them to reverse it has been a very unenjoyable experience.”

Given the “incredible havoc” a recommendation can wreak, he says, issuers want a regulatory mechanism that ensures the advisory firms adhere to a standard of diligence and provides a way to appeal or at least understand them. “No one is really assessing the credentials they have to be viewed as professionals. Do they have to be CAs to run analytics to determine the impact of incremental options issuances on the relative dilution of the issuer? No, not as far as I know. Do they need to be lawyers? Not as far as I know. Then what are their qualifications? We rely on them for a great deal of expert advice.

“At least one case that I've been involved with, the decision was in error. Having them correct that process, and making that correction or change of heart communicated to shareholders in time in what is an abbreviated proxy process, was impossible.”

Chatwin, who sits on the Alberta Securities Commission's Securities Advisory Committee, says the topic has been discussed numerous times, “and, by and large, the consensus would be some sort of regulation is advisable.”

The SEC has been looking at it and the Canadian Securities Administrators (CSA) is expected to issue a policy containing recommended practices and disclosure very soon. Chatwin believes some form of regulation is inevitable.

Here's something else that may be inevitable — and it hasn't hit the radar screens of many yet.

Until now, shareholder activism has been confined to governance and business matters; issues like share structure, board makeup, director independence, splitting the role of the CEO and chair, and financial underperformance of the company.

But the last couple of years have seen the emergence of a new factor in the way listed companies do business and there are questions about whether it will show up in the proxy arena.

It involves corporate social responsibility.

Just a few years ago, corporations saw issues such as environmental practices, human rights and sustainability as ethical matters. These days, they are more likely part of the company's overall risk-management strategy.

The big question is whether social or policy goals will make it on to mainstream shareholder activist agendas and, if they do, whether large institutional investors will support them.

There are specialty funds such as NEI Ethical Funds, with $5.5-billion in assets under management, which already pursue a CSR agenda. Robert Walker, vice president of ESG Services at NEI Investments, says NEI plans to meet with senior management at more than 30 companies in which it holds positions this year to talk about social and environmental concerns.

The fund will be talking to Apache Corporation about conducting a strategic environmental assessment on the impact of hydraulic fracturing on Aboriginal communities. It will be talking to Suncor about its operations in the oil sands. NEI executives will be meeting with Domtar to discuss sustainable forest management, and with Johnston & Johnston Inc. to discuss linking compensation to environmental, social and corporate governance.

They'll also sit down with Loblaw, Lululemon, Canadian Tire and others to discuss greenhouse gas emissions and worker safety in their supply chains.

NEI is willing to throw its weight around if companies are unresponsive, says Walker, although “not in the way US-style hedge-fund activists do.

“We tend not to call people nasty names in the press. We don't use the annual general meeting as an opportunity for political theatre. We do it, if we need to, through filing a shareholder resolution, which would embarrass the company publicly. Typically, that gives us some leverage as most companies prefer not to deal with shareholder resolutions at the AGM so they'll often move an issue to the front burner to address our concerns.”

Where NEI doesn't get results, he says, it's willing to unwind its position. “We do it very reluctantly but we do from time to time. Most recently we felt the need to conclude an eight-year engagement we had with Enbridge, and that was over the Northern Gateway Pipeline in British Columbia. We divested last year on that basis. It's not the kind of story we prefer to tell, we prefer to talk about our success stories.”

The links between corporate social responsibility and share performance are becoming ever more clear.

A 2010 Harvard Business School paper, The Impact of Corporate Social Responsibility on Investment Recommendations, looked at companies' CSR policies and the link to sell-side analyst recommendations.

Authors Ioannis Ioannou and George Serafeim concluded that while CSR strategies were perceived as destroying value and had a negative impact on analyst recommendations a decade ago, today analysts are more likely to recommend a stock as a “buy” for CSR-strong firms, which suggests it is a value creator.

So if a company's environmental, employment or social practices are seen as hurting its share performance, how long before it becomes a matter for shareholder resolutions (which the company is legally obliged to include in its circular) or fodder in proxy challenges?

Here's where it gets really interesting.

A parallel issue that's quickly coming to the fore is giving regular shareholders access to the proxy process to put forward board nominees. The Canadian Coalition for Good Governance is looking into it and preparing to take a position, says Executive Director Erlichman. “We have no proxy access in Canada other than this provision in most of the corporate statutes that says that if you're a 5 per cent shareholder you can do a shareholder proposal to nominate a director. It's used very rarely and it allows the company, if it wants to, to attach the proposal as an appendix to its proxy circular and not put it together with all the other director candidates. So it's not an effective way to have proxy access in Canada.”

Allowing all shareholders to nominate their own director, regardless of the size of their position, may create too much noise, he says, so “it may just end up being major shareholders who get proxy access. But we need to have a workable system. Companies will not be happy with proxy access, as a general rule, even though it's being done in some other countries in the world today.”

No kidding.

It may be a few years away but when hardcore activists, CSR issues and proxy access meet, there is the potential for a combustible combination. Get ready for some fireworks. Watch Twitter for more.

Sandra Rubin is a Toronto-based writer and strategic consultant.