There are few situations a public corporate entity may face more daunting than a proxy contest, and no industry, geography or level of success makes a company immune to such a challenge. The increasingly sophisticated and complex manner in which these contests arise requires management’s dedicated focus and, of course, money to defend against these attacks. Make no mistake the defense of proxy contests is expensive. A recent report indicates that the average cost of a proxy contest through the first half of 2014 was $4.8 million.1 Add to that figure the cost of losing a board seat, which can be devastating to an incumbent’s future board opportunities. Research shows that the mere threat of removal in a proxy contest is connected to losing between $1.3 and 2.9 million in income until retirement for the median incumbent director2, as well as resulting in the loss of an additional board seat over the following three years.3
While every situation is different, and the right response to an unsolicited advance unique, experience shows that management and the board of directors need to be prepared well before an opening salvo in a contest for corporate control. Advanced planning, solid research and assuming a proactive position are keys to prevailing in these battles. Preparation includes the ability to preemptively identify shareholder rumblings and effectively address an unsolicited advance in a timely, knowledgeable and cohesive manner. An organization’s management and board of directors should consider the following in order to most effectively prepare for a contest for corporate control.
Assemble a proxy response team
Every public company should establish a “proxy response team” to assist with navigating through the proxy contest playing field. The team should be comprised of the most knowledgeable internal resources, including the chief financial officer, general counsel and additional senior personnel from the finance, investor relations and cor¬porate communications departments.
In addition to internal resources, external resources should be added to the team. External advisors should include outside counsel, a proxy solicitation firm, public relations experts and investigators to assist with information collection and analysis.
A cadence should be devised for communicating with all team members on a regular basis to encourage continual engagement and ensure that the base knowledge of the team is level and consistent.
Once the team is brought together, the company should begin to plan for an imminent contest. This preparation should include:
- Developing a response plan in the event of unwanted overtures made by a shareholder, hedge fund or other group. The response plan would detail:
- Questions and answers for management and the board of directors to use in response to shareholder or media inquiries, including a “no comment” mandate
- Responsibility for approved messaging from the company, likely the chief executive officer
- Protocol for updating the board of directors on a periodic basis
- Keeping up to date on shareholder-related developments:
- Know your shareholders and speak with them on a regular basis. Introducing management to key shareholders only after a proxy contest is launched can be a recipe for failure.
- Pay particular attention to new shareholders, especially if they seem to be taking a relatively large initial stake. Investigate their portfolio and develop information as to how they have interacted with other companies in the past. Identify past practices and whether they were ultimately “activist” in any of their prior holdings.
- Understand who the company’s investors are, determine whether activists are among them and pay attention to what they are saying, including in public forums where shareholders assemble to discuss companies and their boards.
- For activist shareholders, develop profiles of each and understand their prior approaches, if any, and the likelihood of agitating. Knowing the approach will prepare the company for a timely and credible response and assist with predicting their next move.
- Identify relationships between activist shareholders or alignments in previous contests.
- Monitor Schedule 13D, 13F and 13G filings with the Securities and Exchange Commission to understand ownership positions and changes for material developments.
- Knowing your own board of directors and ensuring they are well-prepared:
- Experience indicates that in most proxy contests, investigation firms are retained to undertake discreet intelligence gathering on boards of directors to preemptively identify weaknesses in their backgrounds and undisclosed relationships and conflicts, or to qualify their board performance, among other things. With an investigation firm in place, activist nominees can be assessed as soon as they are put forward.
- It is therefore essential to ensure that the board is well-versed on its own composition and no surprises are disclosed by the opposition in the contest. A weak director with issues in his or her background may be used as a bargaining chip to settle a corporate control contest by relinquishing that board seat.
- It is important that every board familiarize itself with its corporate governance documents, such as the board’s voting bylaws, processes for nominating candidates and filling board vacancies, and the rules for calling special board meetings. When you are in the middle of a proxy contest is no time to read the bylaws for the first time.
- Boards should be prepared to broadcast governance success, defend salary and option grants, and explain the business necessity of related party transactions in anticipation of being targeted by activists. Such attacks can include apparent or perceived deficiencies in corporate governance practices while attempting to make the connection between those practices and poor share performance, for example.
There are fewer higher stakes business conflicts than an attack on an organization’s board of directors. These contests are expensive, distract from the day-to-day mission of management and the board, and often get personal. A loss can be devastating to the company, and individual board members can see opportunities for seats on future boards dwindle. A key element of the response is having timely, accurate and unimpeachable information at the board’s disposal and a plan to use it effectively. The degree to which a board of directors and a public company successfully defend against an unsolicited and unwanted approach is dependent upon the extent to which the company prepares in advance. While there are no guarantees that a company will prevail, the best chances for success reside in careful planning, preparation and good information.
1 Activism Monthly Lite, September 2014, page 5. http://www.activistinsight.com/research/Activism%20Monthly%20Lite%20September%202014.pdf.
2 “Shareholder Democracy in Play: Career Consequences of Proxy Contests,” Vyacheslav Fos and Margarita Tsoutsoura, Journal of Financial Economics, Volume 114, Issue 2, November 2014, Pages 316-340.
3 Id at 324.
By David Holley, former Senior Managing Director and head of Kroll's Boston Office.