Institutional shareholder activism has often been viewed as a positive corporate governance tool to ameliorate shareholder collective action problems and keep management teams and boards of directors in check, particularly for large public companies with a widely dispersed group of shareholders. Typically, an activist shareholder (ranging from large individual stockholders to institutional investors) will use their equity stake in a corporation to put public pressure on management through proxy battles, publicity campaigns, shareholder resolutions, and sometimes even litigation. The goals of the activist can vary, sometimes it starts as a way to fight a potential merger or management buyout transaction, or as a way to protect the minority from being squeezed out at too low a price, it has even been used as a way to lower executive compensation. Recent examples of institutional shareholder activism, however, should make us question whether this method of corporate governance has gone largely unchecked and has morphed into a weapon that actually destroys overall shareholder value rather than protect it. Non-institutional shareholders and regulators need to be wary of the goals of some institutional activists – particularly activism sponsored by large institutional investors and hedge funds.
The first example worth exploring is the 2013 Dole Food management buyout. Dole, controlled by its buyer David H. Murdock, offered a price of $13.50 per share, initially viewed by analysts and shareholders as too low a price. ((See Steven M. Davidoff, A New Form of Shareholder Activism Gains Moment, N.Y. Times, Mar. 4, 2014, http://dealbook.nytimes.com/2014/03/04/a-new-form-of-shareholder-activism-gains-momentum.)) Eventually, the deal passed with just 50.9% of the public shareholders supporting the deal. ((See id.)) Immediately after abstaining from the deal, approximately 25% of Dole’s shareholders have exercised their appraisal rights. ((See id.)) Appraisal rights are aimed at protecting shareholders in a company – if a shareholder thinks the takeover price is too low, the shareholder can seek a higher price in court. ((See id.)) Appraisal rights also help remind the buyer, management, and the board not to undercut shareholders lest holding up the transaction for years in court in appraisal proceedings. ((See id.)) Dole Food has shown us that appraisal rights have reappeared on Wall Street but not necessarily for the purpose of providing the average non-institutional shareholder the best price for their stock. ((See id.)) Large institutional hedge funds may have a completely different incentive for exercising appraisal rights and encouraging other smaller shareholders to do so. Subsequent to Dole management’s announcement of the buyout transaction, four hedge funds – Fortress Investment Group, Hudson Bay Capital Management, Magnetar Capital, and Merion Capital purchased roughly 14 million shares in Dole and all have since exercised their appraisal rights in the Dole transaction. ((See id.)) Appraisal rights tend to be expensive to exercise and largely unpredictable in court which historically made them unpopular, but, for a hedge fund with a lot of cash they may have a serious benefit – a high statutory interest rate. ((See id.)) Under Delaware law, shareholders are generally entitled to statutory interest on appraisal awards at a rate equal to the Federal discount rate plus 5% from the closing date until the award is actually paid. ((Kirkland & Ellis, Appraisal Rights – The Next Frontier in Deal Litigation? (2013), available at http://www.kirkland.com/siteFiles/Publications/MAUpdate_050113.pdf.)) Today, that rate would equal approximately 5.75%, a significantly high interest rate when considering the average returns of the market. The statutory interest rate provides hedge funds an incentive to push shareholders toward voting against a deal and exercising their appraisal rights rather than accepting a deal and cashing out which may in some circumstances be in their best interest long term.
Another recent example of shareholder activism that needs to be examined with a critical eye is William A. Ackman and Pershing Square Capital’s billion dollar bet against Herbalife. ((See Michael S. Schmidt, Eric Lipton, and Alexandra Stevenson, After Big Bet, Hedge Fund Pulls the Levers of Power, N.Y. Times, Mar. 9, 2014, http://www.nytimes.com/2014/03/10/business/staking-1-billion-that-herbalife-will-fail-then-ackman-lobbying-to-bring-it-down.html.)) In 2012, Ackman and Pershing Square took a $1 billion financial position called a short against Herbalife, a bet that will only pay off if Herbalife’s stock drops – the further the stock tanks, the more Ackman stands to gain. ((See id.)) Since then, Mr. Ackman has been accused of using every weapon in his arsenal to bring ruin to the company and drive down the stock price. ((See id.)) Many have criticized Herbalife’s business practices as a company that sells vitamins and health supplements through independent distributors to lower-income Latinos or African-Americans. But none more so than Ackman who asserts that the company is simply a pyramid scheme that stays afloat through constantly recruiting new distributors. ((See id.)) While some may consider Ackman’s concerns and efforts regarding Herbalife legitimate, many consider his attack just a new method to derive profits from hedge fund activism. Ackman has not stopped short of pressuring state and federal regulators to investigate Herbalife, his group has organized protests, news conferences and letter-writing campaigns in several states against the company, paid $130,000 to civil rights organizations to join his efforts by helping him collect names of people who claim to have been victimized by Herbalife, persuading four members of Congress to join the cause, and the list goes on and on. ((See Dealbook, Ackman v. Herbalife, a History, N.Y. Times, Mar. 10, 2014, http://dealbook.nytimes.com/2014/03/10/ackman-versus-herbalife-a-history/.)) Few would question Ackman and other similar shareholder activists if the goal was to simply spread the truth about a business with immoral practices but if that was sole goal – why take a billion dollar bet against the company? Many would argue and I would agree that Ackman’s tactics seem to be an attempt to move Herbalife’s stock price to vindicate his investment philosophy, a form of shareholder activism that needs to be questioned and potentially regulated.
During the 1980s and 1990s when we saw the rise of large institutional shareholders, the idea of shareholder activism to protect minority rights seemed revolutionary – finally a fantastic way to help dispersed groups of shareholders exercise their rights and effectively dissent from the board or management in a large publicly held company. But today, in a market that is significantly controlled by the likes of hedge funds such as Pershing Square or private equity funds like Fortress, we can no longer trust that the goals of institutional shareholder activists align with those of other non-institutional shareholders with the interest of protecting overall shareholder value. It might be high time for Congress and the SEC to start investigating shareholder activism efforts by institutional investors and consider putting some safeguards in place.
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