Shareholder activism is the way in which shareholders leverage their equity stake to put public pressure on a corporation’s behavior. In his keynote address at the 2014 Berkeley Center for Law, Business and the Economy, and Berkeley Business Law Journal Shareholder Activism Symposium, Larry Sonsini, Chairman of Wilson Sonsini Goodrich & Rosati, declared that there has been a noticeable shift from a director-centric model to a shareholder-centric model. Until recently, shareholders were fighting defensive measures and managerial successions. Nowadays they are engaged in battles over corporate sales, spinoffs or corporate sustainability.
As shareholder activists are hunting for new targets, corporations are fortifying their anti-activist provisions by adopting shareholder rights plans, more commonly known as Poison Pills. The poison pill was invented in the 1980s to fight off hostile raiders that intended to take control of a company. Most poison pills are triggered when an outsider, company or individual, acquires enough stock to gain a controlling interest in the target company. In that case, management offers shares to investors at a discount, but not to the hostile acquirer. Therefore, if an outsider wants to gain control of a company, he must first ‘swallow’ the poison pill. Obviously it is very hard to do so, as the hostile acquirer has to purchase more shares than anticipated.
Third Point LLC v. Sotheby’s – poison pill challenged in the shareholder activism scenario
In October 2013, Sotheby’s adopted a poison pill after activist investor Daniel Loeb, founder and CEO of Third Point LLC hedge fund, called for a change of Sotheby’s management and increased its stake in the company. Loeb claimed that Sotheby’s had a lagging performance, a mix of poor corporate governance and management, and that it failed to improve technology. The activist started a website, where he regularly posts views on Sotheby’s desirable future and strategy.
On March 25, 2014, Third Point LLC filed a lawsuit against Sotheby’s to remove the poison pill, setting up an important first test for a new generation of corporate defenses aimed at thwarting activist hedge funds. Third Point alleged that the question presented in the lawsuit has never before been decided by a Delaware court, as the board of Sotheby’s adopted a poison pill directly in response to a stockholder who does not threaten a takeover of the company, but simply seeks minority representation on the board. Further, Third Point alleged that stockholder advocacy, although it might cause a bit of discomfort for corporate directors, is in fact beneficial for corporations and does not pose a threat that might be reasonably perceived to be harmful to the corporate enterprise. The auction house fired back with its most recent SEC filing. Sotheby’s questioned the hedge fund’s motives and defended its shareholder rights plan.
In 1985, the Delaware Supreme Court set a standard, which helps to review the legality of the shareholder rights plan. In Unocal v. Mesa Petroleum the court decided that when a corporate board adopts a poison pill as a defensive measure against the hostile takeover, the board has to show that (1) it is acting against a threat to the company and (2) that the board’s actions are reasonable to the threat posed.
Now, the question is whether the old cases upholding the poison pill will apply in the case of shareholder activism. There are two arguments to be made and they revolve around the definition of “threat” and “control.”
Do shareholder activists pose a threat to the corporation that justifies the adoption of the poison pill?
There is room for argument whether a shareholder activist’s motivation differs a lot from the incentives of a hostile bidder. The latter attempts to encourage, or sometimes even coerce, the shareholders to sell their shares. Then, the primary issue becomes the future independence or even survival of the corporation. Shareholder activists, however, focus on the future strategy of the company and seek alternative solutions to help the company grow in the long term (see recent example involving Juniper Networks).
On the flipside, there are voices saying that shareholder activism, especially hedge fund activism, creates only short-term gains. Moreover, managers have to spend time and money to fend off unwanted activists that only create unnecessary hype around the corporation’s stock. The Chief Justice of the Supreme Court of Delaware, Leo Strine, recently noted that investors turn the corporate governance process into a constant ‘Model United Nations’ where managers are distracted by proposals on various topics proposed by investors with trivial stakes.
Do shareholder activists seek to take over control of the corporation?
As shareholder activists’ strategies differ significantly, the answer to this question would be very context specific. However, such argument could be made in Sotheby’s case. Third Point alleges that it merely seeks minority representation on the board, but on the other hand, it wants the court to at least order the board to allow Third Point to acquire up to 20% of Sotheby’s. Control over a company does not have to be determined by majority stake, for example, 51%. In the case of a public company, it might be significantly less. The hedge fund is already the largest shareholder of Sotheby’s, thus, if it succeeds in obtaining board representation and additional shares, it might be able to exercise some elements of control.
Shareholder activism is currently on the rise and new activist stories emerge every day. There is a high chance that what we see is only a tiny fraction of this phenomenon, as many activist situations are resolved out of the public eye – over a dinner with the CEO, in private negotiations or simply over the phone. Nevertheless, there is a lot of excitement as to the upcoming Delaware court ruling on the matter of a poison pill in the shareholder activism scenario. The hearing on the Third Point LLC v. Sotheby’s case is scheduled for the end of April.