Activist Shareholders: Care and Feeding

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It is rare for a group of directors, such as the National Association of Corporate Directors/New England, to invite into its midst a so-called “activist shareholder.”  At the February 11th breakfast meeting, however, the group was addressed by Gregory Taxin, a co-founder and former CEO of the proxy advisory firm Glass Lewis and presently manager of an activist investment fund focused on small and mid-cap US public companies. 

Taxin pulled few punches.  He advised the directors that “you work for me, the shareholder.”  He reminded them that they are held to a fiduciary standard.  He stated that activism is a positive force in the capital markets and that activist shareholders should not be treated as an enemy, half-jokingly blaming Attorney Martin Lipton as the culprit. 

He noted that some shareholders have good ideas and do their homework and should not be met with immediate resistance.  Activists shareholders look for operational missteps without board reaction, and also for “stale boards” with historical hangers-on not providing added value. 

Directors should not feel that they have a “job” that is being threatened by shareholders, since they work for the shareholders and their duty is to maximize shareholder return.  He admonished directors to talk to all shareholders, not just activists, and find out what they really think. 

The biggest fireworks (to the extent fireworks ever break out at meetings of directors of public companies) arose when an audience member challenged the concept of activism, claiming that activist shareholders are short term investors who push hard for increased dividends, massive stock redemption plans and other actions that will bring immediate increase to the share price to the detriment of the interests of long term shareholders. 

Taxin fired back: there is no such thing as a long term investor;. everyone is economically rational or they are a bad fiduciary; the best way to create short term value is to make best long term decisions; best long term decisions increase projected future cash flow, which is discounted back to determine the present value of a share of stock.  The little old lady who invests and holds for the long haul does not even exist.  Everyone is a short term investor.

Hot Accounting Issues for Public Boards

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What are the accounting issues most often being encountered by public companies filing annual reports with the SEC?  The following trends were noted at the February 11th meeting of the National Association of Corporate Directors/New England:

  • Request for detail as to effective tax rate as compared to the United States corporate rate of 35%, explaining variances above or below that rate. 
  • Discussion of the judgments applied to adjustment to valuations of balance sheet assets. 
  • Explanation of why a registrant believes that earnings held offshore are not subject to a balance sheet entry showing a deferred tax liability (why is the company saying that it does not intend to bring money held offshore into the United States?). 
  • More detailed segment reporting for different businesses. 
  • Discussion of assumed rate of return in funding retirement plans, measured against historical performance. 
  • Discussion of the judgment reached in not marking down goodwill (which must be reviewed annually for comparison of carrying value to fair value). 
  • Clearer labeling of non-GAAP financial reporting. 
  • Greater clarity in the accounting treatment of investments in China, Russia, India and other places where foreign direct ownership is limited and where companies enter into joint venture agreements. 
  • Increased focus on the robustness of internal financial controls, driven by PCAOB focus. 

A few years ago there was an effort to seek “convergence” of United States accounting principles (GAAP) with international accounting (IFRS).  Full convergence lacks steam; the different accounting systems have reached agreement on specific areas of reporting but full convergence is now viewed to be “a long way off.”

Board Issues: M& Litigation; Confidentiality

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What are the legal trends affecting board governance of public companies?  This question was explored at the February 11th meeting of the National Association of Corporate Directors/New England. 

The biggest story by far: in M&A transactions exceeding $100,000,000 in value, based upon the last available statistics (2012), litigation occurred 93% of the time and the average number of cases filed was about five.  Almost all these cases settled, generally based upon increased disclosure and payment of legal fees, and generally without increased dollar remuneration to the shareholders.  There is a serious question as to whether this practice is in fact value added, or simply a money machine for plaintiff law firms. 

One defensive approach is for corporations to require that shareholder suits and derivative suits be brought in a single court, generally designating Delaware Chancery.  The Delaware courts have upheld the enforceability of these provisions.  Many companies going public now include such a provision in bylaws.  If the Delaware Chancery is without jurisdiction, litigants must use another appropriate Delaware court or the Federal court sitting in Delaware.  Placing all litigation in one court facilitates settlements; Delaware also is thought to be increasingly unfriendly to this kind of litigation.

There was a discussion of board confidentiality.  This generally is reflected in: establishing insider trading prohibitions; enforcement of SEC Regulation FD, requiring simultaneous disclosure of material corporate facts to all, rather than selectively.  However there is growing focus on more sensitive kinds of information: the texture of board discussions, especially what positions were taken by specific directors. 

The question of director positioning also arose in the context of directors who are designated to represent particular investor constituencies.  Although there is a general rule of confidentiality at the board level, a designated director is expected in fact to report back to the shareholders designating that director.  Many companies have adopted a practice of seeking confidentiality agreements with designated directors, restricting the kinds of information that may be disclosed, and sometimes requiring the sponsoring shareholders to sign similar confidentiality agreements.  There are difficult issues of enforcement in the case of violation. 

Lastly, it was noted that the New York Stock Exchange, has abandoned its 50% quorum requirement, now simply requiring that a “significant level” of shareholder participation (at least one-third) is required.

Developments Affecting Public Company Boards

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This is the first of a series of four blogs reporting on corporate board developments.  These posts are based upon remarks at the February 11th breakfast meeting of the National Association of Corporate Directors/New England.  This first post relates to developments in the operation of boards of public companies. 

Gender diversity.  Although boards of all Standard & Poor’s Index Companies over the last five years increased from 12% to 17% female, the gap is obvious notwithstanding compelling documentation that diverse boards simply perform better.  In Europe, where gender diversity is sometimes mandated, companies are beginning to recruit qualified United States women for service overseas. 

Age, Term Limits.  There is an increasing trend to impose age limits on boards, although few boards have instituted term limits.  Most boards in larger public companies have enacted declassification and imposed majority voting, developments which favor shareholder activism and which are now cascading into mid-tier and lower-tier public companies. 

Risk.  The perennial major issue for boards: risk oversight.  Much of this effort is confined to committees, and the question therefore is: does the whole board get a complete understanding of its risk profile?  The boards tend to get into risk only through discussions of strategy. 

Proxies.  For the next proxy season, can we be informed by the past?  Last year, proposals for dividing CEO and chair functions passed 30% of the time; proposals affecting executive compensation (such as changes in option policy and holding periods) passed 23% of the time; majority voting proposals 60% of the time; declassification 80% of the time; private ordering of inclusion of shareholder-proposed candidates for directorships passed one-third of the time. 

Social Media.  Many boards these days are seeking experts in the use of “social media.”  This is liable to drive a younger cohort of directors.  The question was asked: will this effect built-in long term board members, who have a lot of ramp time before retirement?  One comment was in the negative; this type of person will not become entrenched.  To my mind, an optimistic view of human nature.

How to Price a Stock

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Most of us invest.  We read the business news, we read the national and international political news, we rely on research and analysts and our personal observation of trends, products and the like.  It seems we are missing important data, however.

We should be reading the gossip columns.

Astute readers of the Wall Street Journal may have seen an article which convincingly ties the divorce status of CEOs to stock price.  (Thanks to Frank, one of my co-members of the National Association of Corporate Directors, for pointing this out to me, as I seemingly was not astute enough to notice it myself.)

Divorce that create the risk that a CEO must split his/her stock with the divorcing spouse can be a negative, as it suggests an overhang of shares for sale in the market.  Is there a pre-nup?  What is the law of the State applicable to the divorce, does it create community property?

A more subtle risk inheres in the perceived attitude of the divorced CEO whose personal wealth typically has been clipped.  The fear is that that CEO becomes more risk-adverse.  Some evidence is noted to the effect that cash bonuses and stock grants increase following a divorce, reflecting board perception that incentives for risk-taking must be increased following “a loss of wealth.”

Should we expect a new disclosure section mandated by the SEC?

Relief for (some) Finders

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For decades, the SEC  (and state securities regulators) have interpreted the broker/dealer registration requirements to cover “finders,” who were deemed to be broker/dealers (in the business of selling the securities of others) and who thus had to be registered as such.  The registration was tedious, expensive, opened the finder to continuous disclosure, and most importantly was irrelevant to the functions the finders were performing. 

Finders generally operated in two spheres: raising capital for companies by the sale of securities, and engaging in the sale of businesses. 

The SEC on January 31st issued a so-called “no action letter” materially impacting the analysis relating to finders working on the sale of a company.  (The SEC action does not address the continuing interpretation of the law where finders retained to sell company stock  are classified as brokers.) 

Simply put, the SEC letter says that the SEC staff will not take enforcement action against finders in the sale of a business for failure to register as broker/dealers, in the following circumstances:

  • The general business of the finder is to arrange acquisition transactions, whether structured for the sale of assets or for a stock transaction, between privately-held companies. 
  • The buyer must “actively operate” the target after the transaction. 
  • The standard for “actively operate” is very broad; the buyer must end up with 25% of the vote or equity, and the finder itself cannot put together a group of buyers in order to reach that threshold. 

The theory is that if a finder is brokering the sale of a business,  such transaction can be structured either as an asset sale or a sale of securities, depending upon the negotiations between the parties (which depend on business or tax considerations); it seems anomalous to not require a finder to be registered if the parties elect to structure the transaction as an asset sale, but to require registration if the parties elect to utilize securities in the deal. 

There are many subtleties in the SEC’s letter not covered here; the area still remains sensitive.  The SEC letter is strictly limited to specific facts contained in it.  Assertions that I have seen on the internet, that now all business finders are not classified as broker/dealers according to the SEC, are inaccurate;  the SEC specifically says only that the staff will not undertake enforcement action in the limited cases described, but that the SEC is not conceding the legal principle.  Finders need to carefully structure transactions to conform to the SEC letter and, further, there is no assurance that state regulators will see matters the same way (although surely this SEC action will take some wind out of the States’ sails).

The Age of Snowden

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Edward Snowden, the person who leaked the National Security Administration documents, has set off a public dialogue of sweeping proportion,  bringing substantial changes to the way in which the American press operates, and raising questions as to whether laws should be changed with respect to gathering data. 

Addressing a February 3 Boston meeting of the Amicus Club of the Civil Liberties Union of Massachusetts, New York Times writer and Yale Law School lecturer Emily Bazelon exhorted civil libertarians to sometimes embrace the actions of “rabble-rousers” as a counter-balance to excessive exercise of governmental power. 

High points:

In the  FISA courts that pass upon use of this collected data, there is no presentation of an opposing view (the view in favor of privacy), the proceedings are not public and the opinions are not published.  Snowden has allowed us to obtain some of the FISA opinions, which in turn has led to some suggestions, including one on the part of the President, that some sort of representation for the privacy position ought to be integral to the actions of this “court.”

There is pending legislation to affect the powers of NSA, but the future of that legislation is unclear.  Judge Leon, of the Federal District Court in Washington, has opined that the present method of collecting data is probably unconstitutional, noting that the government has never shown that it’s data collection program has actually prevented any particular event.  NSA’s  power was established to gather information in the fight against terrorism, and not for other purposes.

Glenn Greenwald of the Guardian,  the journalist who has been championing Snowden’s position and who first published the NSA information, has challenged the general assumption that a good reporter needs to avoid becoming an advocate for any particular cause, but should maintain a “critical distance.” 

In response to a question concerning unregulated data collection by commercial US enterprises, Bazelon agreed that there was substantial risk that the government would gain access.  The Europeans have a different tradition: skeptical of commercial enterprises generally, they thus are skeptical about their collection of “commercial” data.  She is not optimistic  that there will be a change of United States law with regard to private data collection, although some larger American companies now are pushing for limitations lest the lack of protection impact their international business. 

An informal inspection of the audience for this program indicated that more than 60% of attendees sported “gray hair.”  The attendees, at a lunch-time program in downtown Boston, did not reflect the demographics of the vicinity (not to mention the demographics of Boston at large).  Civil liberties issues, even those in the forefront such as NSA data programs, do not seem to light a fire under “younger generations.”

I’VE BEEN THINKING…

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The app “A Word A Day” noted recently that Stellenbosch as a verb means to be demoted to a useless job without loss of rank.  Comes from the town of the same name in South Africa, which today is wonderful, a Napa Valley on steroids; seems during one of the Boer Wars the Brits parked their worst officers there to perform menial tasks.  I thought that here in the States we stellenbosched our incompetents to Congress.

Speaking of South Africa, as we often do, the Boer War also gave us the verb “maffick” which, as we all know, means a wild celebration.  Seems London mafficked til they dropped when the seige of Maffick was lifted in May, 1900, freeing the English garrison.  I do not use this verb as it sounds mildly obscene, a gestalt no doubt wholly divorced from its origin and meaning but then again, some people can say “hello” in a leering way also.

Why do they put pools in critical care facilities for the elderly?

Why are you not supposed to stand in the airplane galley after the service hours when waiting for the rest room, thus forcing you to place your rump in someone’s face by being required to stand in the aisle?

Why did the Boston Red Sox increase the price of an average seat at the same time they pared their payroll by letting their most exciting player go to the NY Yankees, thereby making their product less appealing and increasing the team’s bottom line even if ticket prices remained static?

Why is it, all of a sudden, that everyone who is dying is younger than I am?  Did they see or feel it coming, and what should I be looking out for?

Is everyone as confused as I am about the Middle East, its religious and ethnic complexities?  I just ordered a large laminated map of the region that I hope to put up on a wall and write down facts with magic marker until I can understand why the bombs are going off where they are.  I could not find a large enough map for the data so I suspect I will need foot-notes.

Since the Wall Street Journal has become the rich man’s USA Today as a paper of general news reportage, do you share my growing perception that human beings are fundamentally evil?  Today’s front page reveals that big banks will not lend to businesses, that bonds are weakening, that IBM is sinking faster than first feared, that Target is stopping health coverage for part time workers, that J&J will save $1B by firing people, that polio is back in Pakistan as militants kill vaccination workers, that pilgrims in that country are killed in bus bombings, that the former governor of Virginia and his wife allegedly took bribes, that Russian Islamists promise death in Russia, that in Lebanon another bomb killed 20 because Hezbollah and Iran took a role in Syria (why is there not a political/religious map of the Region, sort of like a score card for a baseball game?), that more surveillance is needed to track nuclear proliferation, that Vatican clerics smuggle money, that credit card theft arises because web-sites for crooks offer openly to sell malware, that women in war-torn Syria are reduced to eating cat and donkey meat, and finally that the latest IPO will finance just what the world most needs, a new nightclub featuring Jagerbombs.  Enough to make you go back to the Boston Herald where all you read about are murders and Ponzi schemes that affect small numbers of people for merely venal purposes. 
Finally, recent statistics from Harvard, announced this very day, show that it is educationally more harmful to hold school during snow storms with sparse attendance than to just plain cancel school and declare a snow day.  Readers are requested not to convey this information to my son, who at ten years of age still likes to remind me continually when he is right and I am wrong about crucial facts.
(“I’ve Been Thinking” is an occasional diversion from postings of legal content, availed of when actual intelligence demands to be provided to readers of this blog.)

 

Biotech, Beer and Baseball

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This past week I joined seven of my partners at the annual JP Morgan Life Science conference in San Francisco.  This is a frenzied gathering of life science and health care companies of all sorts, together with Private Equity firms, VC firms, investment bankers and supporting professional firms including us lawyers.  The goal is to meet, connect and arrange either deals or contacts for future deals.

Many firms have elaborate dinners, or receptions in the high-end art galleries surrounding Union Square.  Our firm, to the contrary, gathers together and receives all comers in the back room of Lefty O’Doul’s bar at 333 Geary.  There we “networked” over dark beer along with lots of other small clusters of people in dark suits.

Although the real business of the conference, and our attendance, is quite serious, I have to tell you a little about Lefty, who was born in San Francisco at the end of the 19th century and played many years for many teams, including the New York (now San Francisco) Giants and the Brooklyn Robins (now the LA Dodgers).  Owner of a life-time batting average of .349, the highest batting average of anyone NOT in Cooperstown, Lefty twice won the batting crown and one year hit .398.  In today’s world, the Yankees would give him a  fifty year contract at thirty Mil a year.

Lefty it seems was also a pitcher, who holds the record for giving up sixteen runs in one inning, aided by numerous errors by the hapless Robins; only two of those runs were earned.  In the old days, there seemed to be no quick hook for struggling pitchers.  He also holds, as a batter, a tie for the greatest number of hits by any player in one season. 

Why not in the Hall?  Seems it was an era of generally high production and Lefty had a couple of years off while he retrofitted from pitcher to hitter. Strangely, Lefty is in the JAPANESE Hall of Fame; seems he had a lot to do with institutionalizing baseball there.

Those fond of Guiness and memorabilia should drop by Lefty’s bar in you find yourself in San Francisco.  It is a slice of nostalgia for baseball fans.  If you find yourself in the back room, try to find a waitress who promises to return with your order;  just a hint from a repeat partron.

FCPA Again — Again

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Seems all I get to post is Foreign Corrupt Practices Act news, but (aside from the regulatory woes of the banking system) the FCPA is the big news for companies outside of financial services.

Today the SEC announced $384 Million in fines against Alcoa, including a $209 Million CRIMINAL fine, for bribing Bahraini officials to get aluminum contracts with a government-operated plant.  The corrupt payments, totalling $110 Million, were made through a consultant to an Australian subsidiary. 

Although the SEC asserted that Alcoa failed to perform due diligence to confirm that these payments were proper, one has to wonder what a large company doing business internationally has to do in order properly to supervise the dealings of intermediaries.  It may well be that whenever you spend over a hundred million dollars you are obliged to go digging, but the case shows how vulnerable US companies are to the business practices of far-flung subs or agents.  The lesson is that a high level of discipline and inquiry, vertically through the organization, is essential; there is no way home office is going to be able to directly police or investigate the myriad transactions that take place daily outside the US.

FCPA applies to all US companies, not just large companies and not just public companies.  Anyone with overseas operations needs to tighten up controls and oversight —  no two ways about it!