When the Call is Coming From Inside the House

Activist preparedness exercises are often premised on opportunistic investors launching a public campaign to enlist and rally the support of institutional investors. While we still see this scenario play out regularly, companies underestimate the extent to which activist investors have been informally encouraged or enlisted by other stakeholders including traditional institutional investors, members of the board or management, or private equity suitors.

This is not a new concept. However, in our work with public companies and professional activist investors, the implications of a ‘request for activism’ (RFA) are not always well understood or appreciated, including by the activists enlisted by other investors.

Why a Request for Activism?

• Institutional investors such as pension funds or public mutual funds are typically precluded from nominating directors or waging public campaigns and need an activist to drive a campaign. These investors also want to avoid the reputational scrutiny, internal compliance headaches, and expense of waging an activist fight.
•  Individual board members or members of management may seek the assistance of activist investors to drive board or management change, or a review of strategic alternatives. Board members may be seeking to alter the balance of power on the board, oust an underperforming CEO, or drive a sale process. CEOs for their part, may be bristling at board oversight or seek to effect a management buyout. We have also previously written about the phenomenon of former CEOs enlisting and being enlisted by shareholder activists.
• Potential acquirers including public companies or private equity firms rebuffed by disinterested boards or management teams and unwilling to launch hostile bids, may enlist activist investors to agitate for a sale process that they can then participate in.

Why Does it Matter?

A RFA changes the dynamic of the typical shareholder/board interaction. Understanding the source of an activist investor’s interest in a company can help the target board understand the investor’s underlying motivation for its engagement which may be obscured by conventional demands around governance or capital allocation.

Second, the board can develop a better sense of the activist investor’s support base, particularly when institutional investors are reticent to engage in direct discussions or are otherwise coy about their views of the company. What appears to be a fringe view may be widely held among shareholders, and boards should exercise caution in dismissing those demands or reacting in an overtly aggressive manner towards the activist.

Risks of the Request for Activism

The inability of party enlisting the activist to work in concert or be party to a formal agreement with the activist can frequently lead to a misalignment of agendas. The activist prescription may be broader than a narrow objective that the issuer of the RFA intended. A desire by an institution or a director/officer of a company for an incremental shake up can turn into wholesale board change or drive a premature sale.

Activist investors for their part, take the risk that the RFA may be made to multiple activists with differing agendas, each of whom is also unknowingly competing to buy stock in the market. They also risk losing the support of the enlisting party, either because of a misaligned agenda, or the enlisting party changed their view of the company often as a result of the company taking some incremental action.

Rebuffed suitors enlisting activists face the risk of opening a company up to a full auction process or driving up the share price.

Good People Can Disagree

The party issuing the RFA may feel ignored or marginalized in discussions with the company or fellow directors. Proactive and rigorous shareholder engagement that seeks out criticism, rather than one aimed at placating shareholders, is the first critical step. That engagement must be followed by responsive actions – whether that is to implement shareholder driven change, or to fully articulate why the board is determining not to take an action or to stay the course.

Similarly, open debate at the boardroom table should be encouraged and dissenting views should be respectfully discussed and interrogated. Directors who feel like they are being managed or marginalized may seek to effect change through media leaks or a RFA. Factionalism among directors and a zero-sum approach to boardroom debates also creates future vulnerabilities and drives poor decision making.

It is also critical to have a consistent approach to dealing with potential acquirers or inbound interest. That approach includes designating who handles inbound interest, and how the substance of those inquiries or discussions is communicated back to the board. Messaging to potential suitors should be carefully considered with the company’s financial and legal advisors. A response that appears intransigent or conversely, too equivocal, may invite a RFA, particularly if the suitor believes members of the board or management team disagree with one another about whether to proceed with a sale discussion.

Concluding Thoughts

Shareholder/company conflicts are dynamic by nature. The RFA injects an additional variable that can hinder an accurate threat assessment and response.

Boards and management teams should strive to maintain best practices around engagement with shareholders and other stakeholders including potential suitors.

Activist investors for their part, should continue to exercise diligence when being enlisted by a third party to acquire shares and agitate at a target company.