Shareholder engagement, or activism, has increased tremendously over the past decade, with a few high-profile proxy fights — such as Pershing Square Capital Management’s engagement at Canadian Pacific Railway and Jana Partners LLC’s engagement at Agrium Inc. — garnering headlines.
In 2011, the U.S. hedge fund Pershing Square Capital Management acquired 14.2 per cent of Canadian Pacific Railway’s outstanding shares. One of Canada’s most iconic companies had been underperforming, and following a high-profile proxy fight, Pershing Square emerged victorious, with a new CEO in place at CP, new board members and a new corporate strategy. By the end of 2014, CP’s stock price had jumped to more than $220 from less than $49 per share.
Enhancing the performance of a publicly traded company, holding managers to account and increasing confidence in the securities market are all arguments in favour of shareholder activism, says Mohamed Khimji, a professor at the Queen’s University Faculty of Law and the inaugural holder of the David Allgood Professorship in Business Law. But, says Khimji — who recently won a Social Sciences and Humanities Research Council Insight Grant as principal investigator for the project “Shareholder Democracy in Public Corporations — An Empirical and Economic Analysis” — shareholder engagement is “a bit of a polarizing debate.”
The counter-argument is that “there are a variety of constituencies within corporations with heterogeneous preferences,” he says. “The board’s role is to aggregate all these preferences into collective decision-making for the collective good. Even shareholders themselves are not a homogenous group; some will be sophisticated, some not, and they will want different things … To some extent, we have to think about the impact on society, employees, creditors, suppliers, customers and so on.”
The board of directors, being a smaller body, makes the decisions and charts the course for a company “in a more efficient and less costly manner” and in the best interests of all the various constituencies, he says, while shareholders, with their own immediate interests at heart, may favour distribution of earnings to themselves over longer-term investment in research and development, for example.
Either way, shareholder engagement is “very much a key issue right now, in terms of regulation and corporate governance,” Khimji notes.
Although loud public fights may more often be conducted behind the scenes now — and the targets in Canada more likely to be small-cap companies rather than large corporations such as CP — corporate management teams and their counsel must be vigilant and prepared for that engagement, advise corporate lawyers.
The best advice? “Think like an activist,” says Sharon Geraghty, who practises in the areas of mergers and acquisitions, corporate governance and securities law with Torys LLP in Toronto.
“Look at your company like an activist would,” she says. “Look at the historic return on equity. Consider the record on compensation versus performance. . . . If you are a widely held company and there’s someone who can manage you better, you are vulnerable.”
There is a lot of capital in fund management firms, whose objective is to find hidden value in companies that are poorly managed, says Geraghty. “They will find you. You have to be better, faster, stronger.”
Shareholder activist trends
According to research by Fasken Martineau DuMoulin LLP, formal proxy contests (instances where dissident circulars were mailed to shareholders) last year declined by 20 per cent from what they had been in 2015, representing a continuing downward trend from 2012, which saw 23 such contests. Indeed, the eight formal proxy contests (seven board-related and one transaction-related) that Fasken found for 2016 marked the lowest number of formal contests in the previous 10 years.
“I think people on both sides [target companies and shareholder activists] are settling sooner than they were in the past,” says Bradley Freelan of Fasken in Toronto, whose practice is focused on corporate and securities law with an emphasis on mergers and acquisitions, shareholder activism and corporate finance (Freelan also co-authored the firm’s directors’ handbook on shareholder activism).
“There are fewer fights [now] that become formal proxy contests, which are very expensive and time-consuming for management,” says Freelan. “There’s a good incentive for both parties to want to work out a deal” before a proxy fight ensues; also, management may be picking its public battles more wisely.
Although, so far this year, the numbers have favoured dissidents, who have won a majority of the formal proxy contests, “in the past few years, the issuers were absolutely dominating and winning all these contests outright, and that’s reflective of the fact that they’re more prepared for the fight and picking the fight. When they’re confident, shareholders trust them, they’re prepared to fight and they’re winning.”
In both the Jana Partners-Agrium Inc. and Pershing Square-CP proxy fights, “we learned that the right thesis and target allows you to succeed in Canada,” says Walied Soliman, chairman of Norton Rose Fulbright Canada LLP and co-chairman of its Canadian special situations team. He cited CP as an example of an activist shareholder succeeding and Agrium of the issuer succeeding (in the latter, the Calgary-based agriculture and fertilizer giant defeated U.S. hedge fund Jana Partners’ challenge in April 2013, following a bitter 10-month-long campaign by the dissident shareholder).
“We have learned from fights like the Alberta Liquor Stores’ fight that misreading the mood of your shareholders could result in dramatic changes to a board,” Soliman says of the proxy challenge to Edmonton-based Liquor Stores N.A. Ltd., North America’s largest publicly traded specialty alcohol retailer, from its largest shareholder, Toronto-based PointNorth Capital. (Following an acrimonious proxy fight, six of Liquor Stores’ eight board members were replaced by PointNorth’s nominees last summer; in its bid for shareholder support, Liquor Stores indicated it would financially compensate brokers and advisers if their retail clients voted in favour of management’s preferred directors, as long as the entire slate was elected; the company’s vote-buying scheme was attacked.)
“We’ve learned that in numerous fights in the last few years that logical and patient understandings of the relative strength and weaknesses of each side lead to settlements that make sense, and avoid the cost and distraction of a proxy battle,” says Soliman.
Settle and settle soon
Parties on both sides (targets and activists) are settling sooner than they were in the past, says Freelan. This means that fewer fights become formal proxy contests, “which are very expensive and time-consuming for management. There’s good incentive for both parties to want to work out a deal,” he says.
Generally, the settlements give activists seats on a board of directors, while an early settlement may mean an activist “agrees to take fewer seats than they asked for, in agreement for not circulating proxies,” Freelan says.
Earlier this year, shareholders at both TD and RBC submitted proposals for an enhanced proxy access bylaw to be adopted by the board; consequently, these two banks are now the first public companies in Canada to adopt proxy access policies. And Stamford, Conn.-based Land & Buildings Investment Management, which invests in public real estate and related equities, is asking the Hudson’s Bay Company, of which it’s a shareholder, to consider going private.
To best protect itself from a dissident shareholder challenge, a corporation needs to think like an activist.
“Be in touch with your shareholder base,” advises Heidi Gordon, whose core practice with McCarthy Tétrault LLP in Toronto is advising on M&A and capital markets transactions. “Be regularly, proactively engaging with them.”
Then, develop corporate law solutions that can be used to keep activists at bay, Gordon says, such as putting in place an advance notice bylaw, which establishes more stringent timing and procedures for shareholders’ ability to nominate directors. Advance notice bylaws have been approved by the courts for most types of corporations, including public, and about half of issuers have them in place now; they are now “fairly popular.”
Soliman notes, “We encourage boards of directors to anticipate, in their annual strategic reviews, what possible theses might be advanced against the management team and company, to review the veracity of such theses, to adopt ideas that make sense and to properly diarize why other theses don’t make sense, such that when a thesis is put forward by an activist that is not in keeping with the company’s vision, the company can say no and why.”
The worst response is when an activist engages with a company and the company turns around and says it will consider the activist’s arguments, Soliman says. “It means the company has not been forward-looking, that it has not reviewed its strategic options or thought like an activist.”
It’s the advance preparation that is key to success, M&A and corporate lawyers agree. Don’t be caught off guard. “Complacency is a big issue,” says Geraghty. “Boards should be concerned with performance, explaining [themselves] and having a strategy.”
The best defence against activists, corporate lawyers agree, is with solid company results and performance.