Legal Considerations Relating to Shareholder Activism

Legal Considerations Relating to Shareholder Activism May 19, 2016

Legal Considerations Relating to Shareholder Activism Contents I. Activism is the New Normal II. III. IV. Common Activist Objectives Activist Playbook & Potential Activist Plan of Attack Preparing for Shareholder Activism V. Settlement Agreements VI. Involvement of Institutional Investors VII. Rights Plans VIII. Reporting and Solicitation Requirements IX. Regulation FD 2

Activism is the New Normal At the end of 2014, activist funds worldwide had ~$237 billion worth of stock holdings, which only continued to rise in 2015 In 2015, approximately 22% of companies targeted by activists were either mid or large cap companies In 2015, activist investors made 707 new investments in North America alone 2015 Activist Campaigns by the Numbers * Proxy solicitations in 19% of campaigns 59% made public demands related to M&A outcomes 65% of campaigns sought changes to board composition * Includes activist campaigns involving public domestic companies with market caps greater than $1bn occurring from 1/1/15 to 12/31/15 Source: Activist Insight 3

Common Activist Objectives Push for return of capital Increase or initiate share buybacks Increase or initiate dividends Push for spin-offs Push for asset sales Campaign against allocations of capital that do not create shareholder value Push for sale of Company Removal of CEO and/or Board member(s) Proxy solicitations in 19% Add investor representative(s) to Board of campaigns Review and reduce executive compensation and corporate costs 65% of campaigns sought changes to board composition Other governance proposals e.g., Board independence 4

Activist Playbook Strategies Used by Activists Submit shareholder proposals Lobby shareholders for public support early Activist approaches often include criticism of the board and senior management Use press and social media to build publicity Enlist high quality directors as nominees Willingness to incur substantial campaign expenses Litigation to access board minutes in order to gain inside knowledge of board relationships Wage multi-year Proxy campaigns solicitations in 19% of campaigns Make proposals to acquire company Common Criticisms of Incumbent Directors Lack of industry expertise Being over-boarded 65% of campaigns sought Lack of stock ownership changes in the company to board composition Lengthy tenure (ISS states that a tenure >9 years may potentially compromise a director s independence) 5

Potential Activist Plan of Attack Contact IR department as part of background diligence/information gathering Begin a public relations campaign through press releases and news coverage Notify the Company of proposals and/or director nominees to be acted upon at the annual meeting and file a preliminary proxy in support thereof Acquire a stake in the Company (size of stake may be affected by the Company s market cap) Contact other large shareholders to gather support (this is where regular Company communication with large shareholders can pay off) Pursue negotiations of a settlement granting Board representation Call the Company requesting a meeting with management or Board members Send a letter to the Board requesting that certain actions be taken Actively pursue agenda once on the Board 6

Preparing for Shareholder Activism Top 10 Action Items to Prepare For and Respond to Shareholder Activism #1: Execute as best you can #2: Know your shareholder base #3: Communicate your strategy and have messaging ready #4: Monitor for activism in your stock #5: Be alert to other warning signs #6: Understand your company s structural defenses #7: Understand your company s governance challenges #8: Have a response team in place #9: Involve the board #10: Consider conducting a prep session with the board 7

Total Proxy Fights Settlement Agreements Settlements are the Most Common Outcome in Proxy Fights 120 100 80 60 40 20 2 26 25 8 37 2 20 26 14 44 9 33 0 14 18 18 20 10 34 36 4 3 22 20 12 14 8 6 25 27 1 1 2 13 25 23 12 12 14 16 15 14 36 45 40 0 2007 2008 2009 2010 2011 2012 2013 2014 2015 Pending Split Withdrawn Dissident Loses Dissident Wins Settlements Source: FactSet 8

Settlement Agreements Negotiated Settlements - Negotiated settlements are prevalent - Settlement may occur in conjunction with other board or governance changes (e.g., existing directors or management stepping down) - Common terms include: Board representation (including committee rights) Standstill Non-disparagement - Negotiated peace usually lasting for one or two annual meetings Pros: - Can avoid an ugly and timeconsuming fight while maintaining stability - Can win over activist to publicly support board and management - May deter other activists from joining the fray - Can contribute positive ideas Cons: - Settlement is generally viewed publicly as an activist victory - Even if an activist gets a few seats on a board, they can wield disproportionate power within the boardroom - Activist board members inherently protected by same defenses as incumbents - May result in board dissension and board debates may become public 9

Settlement Agreements 2014 Board Representation Analysis Category Average Board Seats Granted 2.4 Total Board Size* 11.5 Percent of Board* 21.3% 2015 Board Representation Analysis Category Average Board Seats Granted 1.8 Total Board Size* 11 Percent of Board* 17.4% 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% *Following settlement agreement Common Settlement Provisions (since 1/1/2014) 91% 91% 91% 88% Standstill Period Voting Agreement Non-Disparagement Min and/or Max Ownership *Following settlement agreement 74% 59% 29% Committeeships Other Initiatives Expense Reimbursement * All data represented here is derived from settlement agreements filed in campaigns involving US-traded companies with market capitalizations of at least $1 billion between January 1, 2014 and December 31, 2105, comprising 12 agreements filed in 2014 and 22 agreements filed in 2015. 10

Involvement of Institutional Investors Institutional investors want more interaction, less reaction, and are showing increased willingness to support activist investors in certain situations. State Street s 2015 proxy voting guidelines state that State Street may withhold votes from directors if overall and/or individual director tenure is excessive, if a nominee sits on six or more public boards or if directors have ignored a shareholder proposal that had previously received majority support, amongst other possible reasons. BlackRock s 2015 proxy voting guidelines state for the first time that Blackrock may not support a board s director nominees if it feels that the board has not been responsive to shareholder concerns relating to lengthy director tenures, poor meeting attendance, and/or lack of diversity in board composition. In March 2015, Vanguard sent a letter to its portfolio companies urging them to keep their boards substantially independent of management and letting companies know that Vanguard intends to not remain idle in the face of governance issues at its portfolio companies. Sources: WSJ, Vanguard, BlackRock, State Street 11

Rights Plans: Purposes Also known as poison pills if triggered, allows shareholders other than potential acquiror to buy preferred shares at a substantial discount, which dilutes the acquiror Provide Board with adequate time to consider and respond to unsolicited takeover proposals Increase Board s bargaining power and flexibility when dealing with potential acquirors Prevent the acquisition of a controlling interest that would preempt Board consideration of alternatives Limit the use of abusive takeover tactics Prevent bidders from acquiring large positions from uninformed stockholders who might cash out before recognizing the true value of their shares Provide an incentive for bidders to negotiate with Board 12

Rights Plans: Legal Considerations A board adopting a defensive measure such as a rights plan must satisfy both prongs of the Unocal (1985) test in order to gain protection of the business judgment rule Must show reasonable grounds for belief that a danger to corporate policy and effectiveness existed Satisfy burden by showing good faith and reasonable investigation and that rights plan was adopted in response to a reasonably perceived threat to corporate policy and effectiveness Presence of a majority of outside independent directors favoring the defensive measure coupled with reliance on advice of legal and financial advisors constitutes prima facie showing of good faith and reasonable investigation Must also show that adoption of measure was reasonable in relationship to the threat posed (i.e., proportional to a reasonably perceived threat) Delaware decisions have upheld the ability of a board to use a rights plan to address acquisitions of substantial, but not controlling, positions by activists 13

Rights Plans: Disadvantages Use of rights plan is opposed by many institutional investors, stockholder activists, and proxy advisory firms Increased pressure for companies to terminate rights plans ISS recommends against the re-election of all directors of a company (with the exception of new director nominees, who will be evaluated on a case-by-case basis) if the board of directors of such company adopts a rights plan with a term of more than 12 months, or renews any existing rights plan without stockholder approval. A commitment or policy that puts a newly-adopted pill to a binding stockholder vote may potentially offset an adverse vote recommendation Many companies have decided to follow an on-the-shelf strategy Rights plan is kept ready for quick implementation at such time as the company faces the actual threat of a hostile bidder 14

Rights Plans: Mechanics Company issues to stockholders a dividend distribution of one purchase right for each outstanding share of common stock Initially, the purchase right entitles stockholder to purchase one one-thousandth of a share of a new series of preferred stock One one-thousandth of a share of such preferred stock is functionally equivalent to one share of common stock Rights initially trade with shares of common stock and are not evidenced by a separate certificate Rights generally not exercisable until the rights plan has been triggered 15

Rights Plans: Mechanics Exercise Price initially set at a multiple of current market price of common stock Set by board when rights plan is adopted, usually with advice of the company's financial advisors Typically based on estimate of the long-term future value of the company s common stock Rights plan triggered when a person crosses specified ownership threshold Usually between 10% and 20% for traditional rights plans Once a person or group acquires beneficial ownership of shares in excess of trigger threshold, rights may be exercised Certain synthetic interests in securities created by derivative positions are treated as beneficial ownership to the extent actual shares of the company s common stock are directly or indirectly held by counterparties to the derivatives contracts 16

Rights Plans: Mechanics Once triggered, rights turn into the right to acquire shares of common stock of the company (a flip-in ) or of the acquiring company (a flip-over ) Flip-in Holders of purchase rights can buy common stock of the company at a 50% discount to current market price Flip-over Occurs if, after the rights plan is triggered: there is a merger with a third party or more than 50% of the company's assets or earning power is sold or transferred Holders of purchase rights can buy common stock of the acquiring company at a 50% discount to current market price In both the flip-in and flip-over scenarios, the triggering stockholder s purchase rights are voided, resulting in significant economic dilution Threat of dilution provides the deterrent effect intended by rights plan 17

Rights Plans: Additional Features Exchange Instead of implementing the flip-in, the board may cause the company to exchange one share of the company s common stock for each purchase right Triggering stockholder does not participate because its rights are void Exchange results in fewer shares being issued than via flip-in and, as a result, less dilution Dilution is not dependent on cash exercise of rights and therefore more certainty is present Redemption Board may redeem rights prior to a person crossing the specified ownership threshold Redemption price set at nominal amount ($0.01 per purchase right) 18

Rights Plans: Illustrative Dilutive Effect Assumes: Hostile bidder acquires 10% of common stock Pre-trigger stock price of $50.00 per share Rights exercise price of $250.00* 100,000,000 shares outstanding pre-trigger Company X Pre-Trigger Flip-in Post-Trigger Exchange Number of common shares outstanding: 100,000,000 1,000,000,000** 190,000,000 Number of common shares held by acquiring person: 10,000,000 10,000,000 10,000,000 Percentage interest held by acquiring person: 10% 1.00% 5.26% * An exercise price of 5x assumed market price is within the normal range, but exercise price will be set by the board when a rights plan is implemented ** If there are not sufficient authorized shares of common stock under the charter, the rights plan allows for substitution of other securities or assets in lieu of shares of common stock 19

Rights Plans: Implementation Timing Day 1 Adoption of plan by the Board of Directors Company enters into rights agreement with rights agent (usually same as transfer agent) Notify stock exchange Establish new series of preferred stock Press release announcing adoption, record date, and distribution date Filing of Form 8-K (along with a copy of the Rights Plan) Filing of Form 8-A Day 11 (or thereafter) Record date for determination of stockholders entitled to receive rights After record date Rights agent mails to rights holders a summary of the rights, along with a letter from the Chief Executive Officer or Chairman of the Board of Directors 20

Reporting and Solicitation Requirements Hart-Scott-Rodino Act The HSR Act requires an acquiror and target to file notifications with the Federal Trade Commission and the U.S Department of Justice (and observe a waiting period) when a transaction results in the acquiror holding voting securities of an issuer valued in excess of $75.9 million Passive Investor Exemption One commonly applicable exemption to the HSR filing requirement allows any person to acquire and hold up to 10% of the outstanding voting securities of any issuer (without regard to the dollar value of such holding) so long as the acquisitions were made solely for the purpose of investment The HSR rules define an acquisition solely for the purpose of investment to mean the acquiror has no intention of participating in the formulation, determination, or direction of the basic business decisions of the issuer or any affiliate of the issuer A passive investor that acquires more than $75.9 million worth of stock and, relying on passive investor exemption, does not make HSR Act filings can change its mind and decide thereafter to play a more active role. But after changing its mind the investor cannot acquire any additional shares without first making an HSR filing 21

Reporting and Solicitation Requirements Hart-Scott-Rodino Act Activities likely not considered passive include: Nomination of board candidates Proposal of corporate action requiring shareholder approval Soliciting proxies Being a director or having an officer or director in common with the target Permissible passive activities include: Voting Acquisition of additional shares not conferring control Requests for information 22

Reporting and Solicitation Requirements Schedules 13D and 13G When Is a Shareholder Required to Make a Schedule 13D Filing? Acquisition of ownership of any class of registered voting equity securities in excess of 5% Must file within 10 days after acquisition of such securities Schedule 13D, Item 4 Disclosure Requirements Purpose of the acquisition of the securities Description of any plans or proposals that would result in certain material changes (e.g. sales or dispositions of stock or assets, extraordinary corporate transactions) Amendments to Schedule 13D for Material Changes Change in ownership greater than 1% Changes in Item 4 plans 23

Reporting and Solicitation Requirements Schedules 13D and 13G Schedule 13G Certain passive investors may file the less onerous Schedule 13G In order to file a Schedule 13G, a passive investor must certify that the investor has not acquired the securities with any purpose, or with the effect of, changing or influencing the control of the issuer, or in connection with or as a participant in any transaction having that purpose or effect A passive investor that determines than an investment is held with a control related purpose or effect must file a Schedule 13D within 10 days A Schedule 13D must also be filed once a passive investor s beneficial ownership equals or exceeds the 20% threshold 24

Reporting and Solicitation Requirements Section 16 Reporting Requirements and Liability Reporting Requirements Any shareholder that owns more than 10% of the outstanding shares of a publicly traded company must file a Form 3 with the SEC within ten calendar days after crossing the 10% threshold Form 3 reports all shares, options and other interests in the equity securities of the issuer held by the 10% + shareholder Section 16 also requires 10%+ shareholders to file a Form 4 to report further changes in their holdings on the second business day after the transaction is executed Liability for Short-Swing Profits Section 16(b) of the Exchange Act imposes liability on insiders (i.e., officers, directors, and greater than 10 percent beneficial owners) for any profits realized by them on short-swing trading transactions (i.e., a purchase and sale, or a sale and purchase, both occurring within a period of less than six months) in any class of equity securities of the issuer (of which they are insiders) that are registered with the SEC under Section 12 of the Exchange Act 25

Reporting and Solicitation Requirements DGCL Section 203 For Delaware companies, Section 203 of the DGCL prohibits any shareholder of at least 15% of outstanding shares from engaging in a business combination without board approval AND supermajority shareholder approval, unless the board had previously approved the business combination or transaction that resulted in the shareholder reaching 15% Companies may opt out of DGCL Section 203. 26

Reporting and Solicitation Requirements Solicitation Rules The solicitation of proxies is governed by Section 14 of the Exchange Act and Regulation 14A under the Exchange Act The rules and regulations impose detailed requirements on any person who solicits shareholder support to take action at an annual or special meeting of shareholders. Requirements include: Filing preliminary proxy materials with the SEC for the Staff s review and comment before a proxy can be given to shareholders for execution Proxy statement must include information about the soliciting party, its ownership in target securities, and its reasons for the solicitation. Before definitive proxy materials with a proxy card are mailed to shareholders, a dissident shareholder can communicate with other shareholders, but any written materials must be filed with the SEC the day they are first used. All written materials used with shareholders and filed with the SEC are subject to US antifraud rules and are likely to be reviewed by the SEC SEC rules provide some exemptions from the proxy rules for limited solicitations, including solicitations of 10 or fewer shareholders or solicitations in which a proxy card is not mailed. These exemptions have limited use in campaigns involved large targets with a broad shareholder base. 27

Regulation FD: Overview Background Regulation FD was adopted in response to selective disclosure of material nonpublic information by companies to securities analysts SEC sought to level the playing field for institutional and small investors Prohibition Neither the company nor its employees may selectively disclose material nonpublic information to certain classes of persons (e.g., shareholders, analysts, investment advisers, investment companies) 28

Regulation FD: Exceptions Exceptions Does not apply to disclosures made: To the media As part of ordinary-course business communications By employees who do not routinely communicate with securities market professionals or investors To a person who owes a duty of trust or confidence to the company (e.g., an attorney, investment banker or accountant) To a person who expressly agrees to keep information confidential By a foreign private issuer Credit rating agency exemption no longer available 29

Regulation FD: Key Considerations Materiality determinations: Material information is that information that a reasonable investor would take into account in deciding whether to buy or sell securities If disclosure is likely to affect share price, it should be considered material Material information can be positive or negative Be particularly sensitive to the following items, which the SEC may deem material: Earnings guidance and projections (including confirmations of guidance) Mergers, acquisitions, tender offers, joint ventures or changes in assets New products or developments regarding customers or suppliers Changes in control or management Events regarding the company s securities (default on debt, stock split, repurchase plan, sales of securities) Form 8-K triggering events Tacit communications, such as a wink, nod, or a thumbs up or down gesture, may give rise to a Regulation FD violation 30

Beth Ising 1050 Connecticut Avenue, N.W., Washington, DC 20036-5306 Tel: +1 202.955.8287 Eising@gibsondunn.com Beth Ising is a partner in s Washington, D.C. office and Co-Chair of the firm s Securities Regulation and Corporate Governance practice group. She also is a member of the firm s Hostile M&A and Shareholder Activism team and Financial Institutions practice group. She advises clients, including public companies and their boards of directors, on corporate governance, securities law and regulatory matters and executive compensation best practices and disclosures. Representative matters include advising on Securities and Exchange Commission reporting requirements, proxy disclosures, director independence matters, proxy advisory services, board and committee charters and governance guidelines and disclosure controls and procedures. Ms. Ising also regularly counsels public companies on shareholder activism issues, including on shareholder proposals and preparing for and responding to hedge fund and corporate governance activism. She also advises non-profit organizations on corporate governance issues. BTI Consulting named Ms. Ising to its 2016 BTI Client Service All-Stars list. The list features an elite group of attorneys recognized by clients for client service excellence. She is a member of the Advisory Board of Northwestern University s Securities Regulation Institute and previously was named a Rising Star of Corporate Governance by Yale School of Management s Center for Corporate Governance and Performance. She also is a frequent author and speaker on securities law and corporate governance issues. Recent publications include an article in the American Bar Association s (ABA) Business Law Today titled Recent Developments Related to the SEC s Shareholder Proposal Rule (2015), the article Top 11 Legal and Regulatory Tips for Boards of Directors published by Corporate Board Member and articles in Insights The Corporate & Securities Law Advisor. Ms. Ising also co-authors a chapter in the treatise A Practical Guide to SEC Proxy and Compensation Rules and contributed to the most recent edition of the ABA s Handbook for the Conduct of Shareholders Meeting. Recent presentations include to the Securities Regulation Institute, TheCorporateCounsel.net, the Practicing Law Institute, Bloomberg BNA, the Society of Corporate Secretaries and Governance Professionals and the ABA. Ms. Ising is Vice Chair of the Proxy Statements and Business Combinations Subcommittee of the Federal Regulation of Securities Committee of the ABA. She previously served as Chair of the Corporate Finance Committee; Corporation, Finance and Securities Law Section of the District of Columbia Bar. Ms. Ising graduated with high honors from the University of North Carolina at Chapel Hill School of Law in 2000. She was a member of Order of the Coif and was inducted into the James E. and Carolyn B. Davis Society. Ms. Ising is admitted to practice in the State of North Carolina and in the District of Columbia and is a member of Gibson, Dunn & Crutcher s Global Diversity Committee. 31

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