Midwest meeting of minds
Lively roundtable discussions at the IR Magazine Corporate Secretary Think Tank – Midwest in October gave investor relations (IR) and financial communications professionals, corporate secretaries, M&A lawyers, proxy solicitors and other attendees an opportunity to learn about and share best practices for handling activist investors, social media and cyber-security.
Now that activism is a widely accepted form of engagement with boards and management teams, and large institutional investors are increasingly welcoming of activist involvement in the companies they own and are even passing ideas to them for where companies are vulnerable, IR officers and corporate secretaries have to be all the more vigilant in how they communicate, not only with activists but also with all large shareholders.
While no issuer is immune, activist funds target only companies with clear vulnerabilities, noted an attending proxy solicitor (who remains nameless as Corporate Secretary Think Tanks operate under the Chatham House rule of anonymity). This means IR and legal teams need to look at their firm’s governance profiles, capital allocation strategies and board composition to ensure there aren’t weaknesses for activists to exploit.
‘The corporate secretary has a duty to look at the board,’ the proxy solicitor said. ‘If all your board members have been there for 15 years, are they really still independent? You have to refresh the board on a regular basis. If you don’t, activists will do it for you.’ IR departments need to monitor which investors are accumulating significant numbers of shares and consider when to proactively engage with them before they approach the company with suggestions, he added.
Equally essential is that IROs be aware of how activist funds operate. Pershing Square Capital Management, for example, has a 20-point test for gauging management’s responsiveness to shareholder requests, said the chair of the M&A practice at a major law firm. First, a junior staffer at the fund calls the IR department requesting some recent 10Q filings and the latest proxy statement. The IR officer who takes the call must not show any annoyance and direct the caller to the website for such readily available information. The response at that first level of engagement is often a red flag for activist investors.
‘The IRO is the first line of defense for many firms,’ the lawyer said. ‘It’s that level of engagement that’s important. The dynamic between the IRO, senior management and the board is really critical to the passing on of the intelligence and information [IROs] get.’
While directors are generally more sensitized to risks associated with activism, the M&A lawyer said he’s still surprised by the number of boards whose main stance toward activists is: ‘Why do we even talk to these people?’
IROs and the legal team need to have two kinds of dialogue with the board on an ongoing basis. The first concerns what’s happening in the activist community in general; the second focuses on where the company’s vulnerabilities lie, which requires working with the CFO.
Perhaps most critical is that management is out talking with large investors that may then be less receptive to activists’ arguments for improvement as any concerns they have are being addressed by the firm in advance.
The power of negotiation
Educating boards on how to negotiate with activists is also critical. Issuers and their advisers must figure out from the start what specific goal an activist is pursuing. Proxy settlements usually revolve around those goals, said the head of a financial communications firm. Along with specific items like ousting a CEO or spinning off a business unit, activists are pressing for protection around their demands, the M&A lawyer added. If a spin-off will take several months, they often want a director on the board who can monitor progress toward that goal; sometimes they want a contractual commitment for that course of action, such as a public announcement.
Settlements can also focus on philosophical governance issues such as changes in board structure or a commitment to repealing the shareholder rights plan. Firms can buy off younger activists early on by giving them an easy win, which saves them the expense of raising money for an extended contest and gives them credibility for future fights, the lawyer added.
To minimize potential disruption when an activist director joins a board, companies need to be careful which committees they are allowed to serve on. Having an activist on critical committees such as compensation or nominating & governance can disrupt management. Often there is also long-standing friction among directors that a savvy activist can exploit.
Communication within the rules
The session on social media addressed reducing risks by creating a clear policy to guide employees’ and managers’ use of these new channels. Boards must be educated about how social media can serve as a powerful business strategy tool and be aware that customers and shareholders increasingly expect companies to use it for communication, said a partner at a law firm that advises companies on governance.
‘Using [Twitter] raises more issues about [the SEC’s anti-fraud] rule 10b-5 than most of us are accustomed to seeing,’ she said. ‘It requires additional forethought and planning and often linking to your forward-looking statements and disclaimers.’ CEOs need to be trained how to communicate company news in a balanced way instead of sharing only positive developments when using social media, she added.
To avoid running afoul of Reg FD, companies must advertise the social media channels they ‘are going to use, not may use,’ the partner emphasized. The point is to create recognized channels that companies can confirm the investment community is also using, she said.
Keeping abreast of cyber-risk
Much of the discussion about cyber-security exposure focused on insurance policies and when to involve board members in those decisions. Boards were originally consulted about insurance only in instances of business interruption that ended up affecting the firm’s financial statement, said the cyber and social media leader at a risk management and insurance provider.
‘With recent cases, creative plaintiff attorneys are filing D&O lawsuits against directors and officers for breach of fiduciary duty for not addressing this issue appropriately,’ he explained. ‘It’s a D&O issue, so it’s a board-level issue, regardless of whether directors are personally liable.’ Because threats are as likely to originate internally as externally, companies should ensure their insurance for social media or cyber-risk covers any kind of threat, he added.
After a data breach cost TJX Companies more than $250 million in damages in 2005 and 2006, the retail sector realized its vulnerability to cyber-security threats. ‘The biggest exposure for retailers is having to pay for reissuing of credit cards to all of a bank’s customers,’ said the chair of the audit committee at an IT firm. Many companies are taking out cyber-insurance policies just to qualify for government contracts, which now demand evidence of such coverage before contracting with a company, he added.