PROXY CONTESTS AND CORPORATE CONTROL

Transcription

1 PROXY CONTESTS AND CORPORATE CONTROL

2 PROXY CONTESTS AND CORPORATE CONTROL Bob Brenner, senior managing director at Kroll, oversees the firm s Investigations and Disputes practice in North America. In this capacity, Brenner frequently works with boards of directors, management, their counsel, and advisers in contests for corporate control. Corporate Board Member sat down with Brenner to talk about the many complex issues surrounding corporate contests, and what boards need to know ahead of time to ensure they are protected and have all the tools necessary for good decision making when shareholders come forward with demands. To open the conversations around these issues, Corporate Board Member asked Brenner to describe three potential scenarios that would likely involve some prickly situations surrounding corporate contests. The following three scenes will help set the stage for the discussion that follows. Scenario A An activist fund initiates a proxy fight against a mining company claiming mismanagement of assets. It claims that the board lacks the technical expertise to properly assess what management is doing. The company fights back by demonstrating that two proxy candidates put forth by the activist falsified credentials in the field and a third worked at mines with a history of serious mine safety violations. Scenario B A minority shareholder seeks control of a company by replacing the entire board of directors with a slate of his own. The company fights back by demonstrating that the entire slate was beholden to the minority shareholder through personal, contractual, employment, or vendor relationships. This supports the company s argument that the investor was trying to wrest control of the board without actually purchasing a controlling interest. Scenario C A shareholder launches a proxy fight and demands a seat on the company s board, alleging a pattern of self-dealing and inappropriate related party transactions. The incumbent board fights back by demonstrating that the shareholder nominee intentionally had omitted a prior board membership. Although he had resigned from that prior board with an innocuous public statement, he admitted, in a little-noticed attachment to an 8k, that he had resigned at the request of the company and agreed to repay profits gained from an inappropriate related party transaction. These are vivid examples, Bob. What do they tell us about corporate contests and how to prepare for them? The stakes are high, and whether you are the aggressor or with the company, what you say better be able to withstand scrutiny. Accurate information can be as potent as many legal remedies, if used as part of a coordinated strategy. Knowing how to obtain and use facts in real time is often the difference between winning and losing. BOB BRENNER SENIOR MANAGING DIRECTOR KROLL So, let s step back a minute. When you talk about corporate contests, what exactly do you mean? In general, the term corporate contest refers to several different situations in which a shareholder(s) or other corporate entity tries to force a change of control in a company. The two most common situations where we get involved are proxy fights and takeover attempts. Proxy fights generally arise in two types of situations. In the first, an existing shareholder(s) seeks board representation to change corporate behavior or governance because the 2 P R O X Y C O N T E S T S A N D C O R P O R AT E C O N T R O L

3 shareholder is unhappy with the company s performance and the unwillingness of the board of directors to alter course or change the status quo. Typically, such a contest begins after quiet, protracted negotiation between the board/management and a prominent shareholder, during which the shareholder expresses ideas for change or displeasure with policy or direction and is rebuffed. The second type of proxy fight, which we describe as opportunistic, does not start with an existing investment or position. Instead, it is marked by a rapid accumulation of stock by a new shareholder. The shareholder, or group of shareholders, acquires the stock on the premise that the board and/or management is failing to maximize the company s assets. If the new shareholder can pressure the company to change policy, management, or board composition, fine. If not, they are prepared to force the issue. Activist investors have had great success in these types of corporate contests. Typically, they target companies that have seen a decrease in share price over time. The well-funded activist investor claims to be ready, able, and more than willing to roll up its sleeves and implement change. Historically, outright unsolicited or hostile takeover bids have formed a large part of the corporate contest world. In the case of a takeover bid, one corporate entity offers to buy another, frequently a competitor or an entity with a good synergistic fit. In far fewer instances, an activist shareholder may desire to purchase the outstanding shares of an entity from existing shareholders in order to obtain control of that entity so that it may effectuate immediate change. These types of contests are rarely launched by activist funds as these efforts require large amounts of capital to be sunk into one investment, a tactic that hedge funds generally try to avoid. True hostile takeover bids have declined in recent years. What are some of the most common corporate issues that give rise to contests for corporate control? Maximizing shareholder value is the common battle cry for corporate contests, whether you are referring to a proxy fight or an outright takeover. The aggressor normally states its belief that the board and/or management has failed to maximize shareholder value, usually by failing to increase earnings or raise the company s stock price. Failure to deliver or increase shareholder value is the headline. However, that is often a catchall for specific complaints: (a) the board s or management s unwillingness to make management changes or explore business direction alternatives after several quarters of poor performance; (b) failed integration after an acquisition; (c) excessive management and board compensation; (d) lack of sufficient technical expertise to understand what management is doing; (e) lack of independence from management; or (f) poor corporate governance all follow from this theme. When either existing shareholders or activist investors get to the tipping point where they believe they can do better than the company and believe they can garner additional support, the contest begins. What is the role of an investigator in contests for corporate control? Quite simply, it is to arm the client with specific and accurate information to go into battle with arguments that will carry the day. Working in conjunction with legal counsel, management, board committees, proxy solicitors, and other advisers, our job is to develop information that allows our clients and their advisers to accurately assess their adversaries and the overall situation and to provide ammunition to support the legal and public relations strategy that stems from that assessment. P R O X Y C O N T E S T S A N D C O R P O R AT E C O N T R O L 3

4 Working for the targeted company, an investigator might begin by looking at the activist or fund directly. What is their history and modus operandi in similar situations? Are there other funds that they typically align themselves with in such situations? Are such funds likely allies this time? In the past, was the activist merely a short-term holder that sold out after the contest concluded or did the activist stay involved and provide value to shareholders? How did that activism affect shareholders in prior situations where the activist challenged management? Did the stock go up or down? How about business performance? What happened to revenues, profit, market share? This information will allow management to assess whether to engage the activist and negotiate or fight to the end. At the same time, a history of poor outcomes for shareholders where an activist has been involved might provide useful fodder for so-called fight letters and direct arguments to other large investors who are assessing their options. A review of earnings, share price, and number of employees as compared to competitors in the same space during the time of the activist s board tenure on another publicly traded company, for example may demonstrate that the activist s involvement in the past did not increase the shareholder value of that company. Recently, we established just that. In reviewing the history of the activist fund that had attacked our client, we found that in the past it had successfully launched a proxy fight for another company. After gaining control of the board, the fund had orchestrated the sale of most of the company s assets, laid off the majority of the workforce, and then used the company primarily for launching additional proxy fights. Obviously, this was powerful stuff when our client spoke to its own institutional investors about what was in their best interests. At the point when a proxy battle enters a formal stage and an activist has submitted a slate of board nominees, we turn our attention to those individuals on the slate and what the activist discloses about them in SEC filings. The first question is whether the filing is accurate or does it contain material omissions or misstatements? If there are omissions or misstatements, the company may be able to get an injunction and slow the process. Often, time is of the essence and being able to delay the process until all the issues are aired and other investors are persuaded may be an invaluable asset. More important, if there are omissions or misstatements, investigators want to know why. What inconvenient fact is left out or blemish glossed over? How is that relevant to the current challenge? How do you identify issues that will be useful to your client? Whether we are fully integrated into the advisory team or merely working through counsel, it is essential that we start with a deep understanding of the issues at hand and the history of engagement with the parties. What are the positions that each side has staked out? As we look at the individual board nominees, there will be certain general things in their background that would be disqualifiers under any circumstances. However, in most situations, we are helping our client demonstrate that the group as a whole or certain individual members, however accomplished, are demonstrably unsuited for a role at this company at this time. Thus, we begin by throwing a wide net and narrow our focus from there. The first question we ask is: Are there items in a nominee s background that would make him or her ill-suited to serve as a director of any company? Obvious issues include a criminal record, regulatory problems, misstatements or inaccuracies in a résumé, falsified educational background, or allegations of fraud or financial mismanagement. Believe it or not, these issues frequently pop up during the beginning phases of our investigation. For example, it is not atypical for a candidate to omit a company on which he served as a board, if the company experienced financial difficulties or filed for bankruptcy. Also, you would be surprised by the 4 P R O X Y C O N T E S T S A N D C O R P O R AT E C O N T R O L

5 number of people who lie about their employment or education. Once the obvious is out of the way, we get more targeted. Even in this next phase, there are certain general things we are looking for. Most often we want to know whether the nominee or slate as a whole lacks the qualifications to sit on the board in question; whether the slate or individual nominee lacks independence; whether the individual s position on the board in question would cause a conflict of interest with his or her other business interests or investments; or, finally, whether the nominee has the same shortcomings or has been accused of the same failings as those being attributed to the incumbent board. These general questions need to be answered with an eye toward the issues in dispute in the contest at hand. For example, as we began this discussion, in one recent situation, an activist group was accusing a mining company of mismanaging assets, investing in properties in the wrong parts of the world, and being overly optimistic about yield potential. The argument was put forth that the board lacked the technical knowledge to assess what management was doing. Thus, the question as to whether the insurgent slate itself had superior expertise was front and center. In that context, when we established that one nominee who claimed to have a degree in metallurgy had falsified his résumé and a second who claimed an MBA actually had an MPA with no business component, we accomplished three things at once. One, we demonstrated that the filing was false and misleading. Two, we raised issues about the integrity of two nominees. Three, and most important, we poked holes in the activist s central argument that its slate would be more technically proficient. Similarly, the general question of independence must be viewed in context. Recently, one of our clients was facing a challenge from a shareholder with a large minority stake. Our research demonstrated financial, personal, and employment ties and obligations between most members of the proposed slate and entities controlled by the shareholder such that it could effectively control the board while holding less than 20% of the stock. Again, this was a fact of concern for other shareholders wary of such consolidation of control. FIVE KEY TAKEAWAYS FOR BOARDS 1. Keep an ear to the ground for trouble brewing; a proxy contest can happen at any company. 2. Review your corporate bylaws and shareholder rights plans. 3. Ensure any deficiencies in corporate governance practices are addressed that could make the company vulnerable to attention. 4. Know your directors and their allegiances. 5. Identify a defense team ahead of time, including internal and external resources. P R O X Y C O N T E S T S A N D C O R P O R AT E C O N T R O L 5

6 How does the information you develop get used in the context of a contest for corporate control? I have seen our work used in everything from litigation, to proxy filings, to public relations campaigns, to 13D filings, to investigative pieces in the New York Times. Our findings may find their way into a complaint or a request for a temporary restraining order or as a rebuttal to a proxy filing. They may also work their way into a public relations strategy. For example, in a recent takeover bid, the aggressor s chief executive officer made numerous statements during the contest about what the future for the target company would look like post-takeover. He repeated several times during interviews and in press releases that there would be no layoffs after the acquisition and integration. Our investigation determined that the CEO had made similar announcements during his advances in eight other acquisitions and in each case, the target company was forced to lay off employees. Our client successfully used this information to counter the CEO s no layoffs campaign. This was particularly powerful given that employee pension funds were counted among the company s institutional investors. In another recent matter, we were retained by a target company to ward off unsolicited advances by a competitor seeking to take over the company at a greatly diminished share price. During the course of our work, we investigated a number of government contracts that the target company had with foreign governments. What we learned was that if the acquisition was successful and integration completed, many of the contracts the hostile company had with foreign governments would be in conflict with contracts our client maintained with the U.S. military. Once this and other information was made public, the aggressor was forced to abandon its efforts. Can management or a board of directors prepare for a contest? What do you advise? First and foremost, corporate control contests should not be viewed by any board of directors as something that only happens to other companies. Reflecting upon a number of contests I have been involved in over the years, it seems that no industry, geography, or level of success places a company fully off limits. So acknowledging that a contest is possible is the first step. After that, it is important that every board of directors familiarize itself with its corporate governance documents, such as the board s voting bylaws, processes for nominating candidates and filling board vacancies, and the rules for calling special board meetings. The middle of a proxy contest is no time to read the bylaws for the first time. I also recommend keeping an ear to the ground for early warning signs that trouble is looming. That is, maintain a constant understanding of what is being said about the company and by whom. Know your shareholders and speak with them regularly. Pay particular attention to new shareholders, particularly if they seem to be taking relatively large initial stakes. Spend a little time understanding their portfolios and how they have interacted with companies in the past. Understand who the company s investors are, determine whether activists are among them, and pay attention to what they are saying. With regard to activist shareholders, understand their track records in prior corporate contests, what the catalysts were to their actions, and make an effort to predict their likely moves. There are strategies that can be employed at an early stage that become less effective once an overture has been made by an activist, either publicly or privately. For example, several years ago, Louisiana-Pacific Corp. amended its shareholder rights plan to include derivatives when calculating beneficial ownership to trigger its poison pill. Monsanto Co., Pfizer Inc., and 6 P R O X Y C O N T E S T S A N D C O R P O R AT E C O N T R O L

7 Sara Lee Corp. amended their corporate bylaws to force disclosure of empty voting and stock lending when activists seek to nominate directors or propose shareholder resolutions. Boards of directors should anticipate that activists will target apparent deficiencies in corporate governance practices and make the connection between those practices and poor share performance, for example. Boards should be prepared to tout governance success, defend salary and option grants, and explain the business necessity of related party transactions. Make sure you know your own directors and their allegiances. It is our experience that in the most hotly contested takeover fights, both sides engage fact-finding firms to support their efforts. By examining its own board of directors, a company gains an early understanding of any weaknesses that may exist in its directors pasts and avoids surprises in the heat of battle. A company may use a director with issues in his or her background as a bargaining chip to settle a corporate control contest by relinquishing that board seat. If directors recognize that proxy contests or takeover bids are possible, then a board should have a team and strategy already in place to analyze and defend against unwanted advances. The plan should include the identification of internal and external resources to direct the company s response and defense. Internal resources should include the chief financial officer, general counsel, and additional personnel from the finance, investor relations, and corporate communications departments. External advisers should include outside counsel, a proxy solicitation firm, public relations expertise, and investigators to assist with information collection and analysis. Waiting until after a contest is launched to assemble the defense team will cost the board of directors time it cannot afford. It is essential that all team members be familiar with their roles and responsibilities and be prepared to make themselves available for the duration of the contest. Finally, as strategic acquirers, companies and corporate boards may find themselves in the position of making a hostile bid. In those situations, the need for investigative research arises at an earlier stage. Before moving into a public phase, you want to have fully vetted board candidates to make sure you have the right balance of expertise and demographics to keep the discussion on price and value and away from individual issues. The good news is that you have the time to really do your research to avoid surprises. Any final thoughts or advice you'd like to offer to directors on corporate control contests? Kroll s founder, Jules B. Kroll, began our company under the principal that it would assist companies and their boards with resolving their most important and frequently personal business issues. I can think of no more pressing and personal business than assisting a board of directors in winning a proxy contest or takeover bid. These contests can be expensive and can get messy, but often the survival of the company is dependent upon how well a board reacts to the unsolicited and unwanted approach. A loss can be devastating to the company and to its individual board members, not to mention shareholders. Therefore, a key element of the response is having timely, accurate, and unimpeachable information at the board s disposal. P R O X Y C O N T E S T S A N D C O R P O R AT E C O N T R O L 7

8 Kroll, the global leader in risk mitigation and response, delivers a wide range of solutions that span investigations, due diligence, compliance, cyber security and physical security. Clients partner with Kroll for the highest-value intelligence and insight to drive the most confident decisions about protecting their companies, assets and people. Kroll is recognized for its expertise, with 40 years of experience meeting the demands of dynamic businesses and their environments around the world. Kroll is headquartered in New York with offices in 45 cities across 28 countries. The firm has a multidisciplinary team of nearly 4,000 employees globally. Corporate Board Member, an NYSE Euronext Company, is the leading information resource for senior officers and directors of publicly traded corporations, large private companies and Global 1000 firms. The quarterly publication, Corporate Board Member magazine, provides readers with decision-making tools to deal with the strategic and corporate governance challenges confronting their boards. Corporate Board Member further extends its governance leadership through an online resource center, conferences, roundtables and timely research. The magazine maintains the most comprehensive, up-to-date database of directors and officers serving on boards of publicly traded companies listed with NYSE Euronext and The NASDAQ OMX Group Inc. stock exchanges Maryland Way, Suite 250, Brentwood, TN (800) l