Wachtell Lipton: Dealing with Activist Hedge Funds and Other Activist Investors

Despite a short dip at the outset of the pandemic, activism has rebounded and now continues at an ever-growing intensity. As we have previously noted, regardless of industry, size or performance, no company should consider itself immune from activism. No company is too large, too popular, too new or too successful. Even companies that are respected industry leaders and have outperformed the market and their peers have been and are being attacked. And companies that have faced one activist may be approached, in the same year or in successive years, by other activists or re-visited by the prior activist.

Although asset managers and institutional investors will often act independently of activists, the relationships between activists and asset managers and investors in recent years have encouraged frequent and aggressive activist attacks. A number of hedge funds have also sought to export American-style activism abroad, with companies throughout the world now facing classic activist attacks. In addition, the line between hedge fund activism and private equity continues to blur, with some activist funds becoming bidders themselves for all or part of a company, and a handful of private equity funds exploring activist-style investments in, and engagement with, public companies.

While traditional activism focused on short-term profit, stock price and total shareholder return (TSR) continues, a new set of activists has emerged, emphasizing climate and other environmental, employee/human capital, social and governance (EESG-ESG with emphasis on employees) considerations. The activism landscape has also evolved to include dual purpose activists who combine both TSR and EESG arguments, as well as “pincer attacks” from EESG and TSR activists acting independently or in concert against the same company.

The Exxon proxy fight successfully waged by EESG activist Engine No. 1 earlier this year underscores the importance of advance preparedness to anticipate, prevent and respond to an activist attack, including not only the more traditional governance and economic components of activist campaigns, but also the EESG themes that some activists have been deploying in their attacks.

For many years, we have been updating this memo based on recent developments, evolving trends and our experiences avoiding, defusing, resolving and prevailing in contested situations and proxy fights to provide the most cogent and current advice to our clients and friends. Summarized below is a snapshot of some of the tactics and themes deployed by activists, followed by a checklist of matters to be considered in putting a company in the best possible position to prevent, respond to or resolve an activist attack.

The Attack Devices Used by Activists

Aggressively criticizing a company’s governance, management, business and strategy, sustainability and ESG strategies, and presenting the activist’s own recommendations and business and ESG plans, through a “white paper” or other public documents or statements.
Proposing a precatory proxy resolution for actions prescribed by the activist or the creation of a special committee of independent directors to undertake a strategic review to “maximize shareholder value” and/or meet ESG goals, especially with respect to environmental impact.
Demanding an accelerated “Investor Day” at which the company would be pushed to disclose forward-looking projections, financial targets and actions involving the portfolio and allocation of capital.
Recruiting candidates with industry experience (including retired CEOs of major companies or even former executives of the target) to serve on dissident slates, and conducting (or threatening to conduct) a proxy fight to get board representation at an annual or special meeting or through action by written consent.
Orchestrating a “withhold the vote” campaign against the company’s incumbent directors.
Seeking to force a sale of the company by leaking or initiating rumors of an unsolicited approach, publicly calling for a sale, acting as an (unauthorized) intermediary with strategic acquirers and private equity funds, taking positions in both the target and the acquirer, making their own “stalking-horse” bid or partnering with a hostile acquirer to build substantial stock positions in the target to facilitate a takeover.
Leveraging the proxy advisory firms and their recommendations to amplify the activist’s influence.
Communicating with and rallying institutional investors and sell-side research analysts to support the activist’s arguments.
Using stock loans, options, derivatives and other devices to accumulate positions secretly, announce surprisingly large, leveraged economic stakes or increase voting power beyond the activist’s economic equity investment.
Using sophisticated public relations, social media and traditional media campaigns to advance the activist’s arguments.
Investing in significant diligence and third-party consulting services to analyze the target’s strategy, business, operating margins and/or ESG impact.
Seeking to create divisions within the boardroom or between the board and management; several major activists have been successful in achieving such wedges.
Reaching a company’s retail shareholders through Internet forums and social media channels, weekly mailings, telephonic outreach, local newspaper advertisements and user-friendly infographics.
Hiring private investigators to create dossiers on directors, management and key employees and otherwise conducting aggressive “diligence.”
Initiating litigation, including demands for books and records, sometimes concurrently with a proxy fight.
Waging repeated campaigns at the same company, regardless of the outcome of the initial campaign, or joining with other activists to converge on the same company at the same time.

Current SEC rules do not prevent an activist from secretly accumulating a more than 5% position before being required to make public disclosure and do not prevent activists and institutional investors from privately communicating and cooperating. We have long sought to correct this loophole.

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