Peeling away the various arguments of stockholder activists and their often larger-than-life personas − and occasional multi-hour conference calls − lays bare the gritty details of the ways stockholder activists actually take positions in their companies and what, if any, notice a company may have of such a position. Activists have applied increasingly complex methodologies to their ownership positions. Discerning where they may pop up next requires nuance and sophistication.
OBJECTIVE: Activists generally have two goals:
Skin in the game: Accumulate a sufficient position so that they carry credibility, or “skin in the game,” with larger institutional investors upon which activists rely for votes – usually 5-10 percent of a company’s equity position and increasingly, whatever it may take to have to a impactful-sounding $1 billion of at-risk capital, and
Buy low; sell high: Accumulate that position with a minimum of fuss – so that their basis is as low as possible. This entails avoiding public disclosure of their position until the very last possible juncture.
Most activists who become significantly involved with a given company will accumulate a position of between 5-10 percent of the company – whether through direct equity ownership or other positions discussed below. Some activists will do less, particularly the embryonic activists who are seemingly emerging from anywhere these days as the area is flush with assets under management. And while some activists may go further in on a percentage basis, they uniformly will rely on large institutions – whether actively managed funds or index funds – to find an activist’s arguments appealing at a stockholder vote.
INSTRUMENTS: To accomplish these goals – and do so deploying the carefully choreographed timing tactics set forth below – activists long ago abandoned the plain vanilla approach of mere equity ownership in favor of a combination of the following:
Common stock. The cornerstone of an activist position remains owning a company’s common stock, accumulated through open market purchases or privately arranged trades. For reasons discussed below, such positions may be spread across a variety of funds controlled by a particular activist.
Options. Activists increasingly use options – to avoid market-moving accumulation of an underlying security, to give optionality to capital at-risk and to maximize an activist’s firepower in its portfolio. For the latter, if an activist spends a relatively modest amount up front on options, it can take a larger potential position and then subsequently decide which position merits actual equity ownership and thus increased deployment of capital.
Derivatives. Activists may engage in “synthetic” equity positions – cash-settled equity swaps – that are private contractual obligations. The interesting downside of such instruments is that every such contract by its nature involves a counter-party. For a material position, such counterparty may suddenly have a very distinct interest in blunting the impact of an activist – particularly where an activist is agitating for short term change that could immediately adversely impact the counterparty’s risk – whether by demanding the company be sold in whole or in parts or that it leverage itself for a special dividend.
TIMING STRATEGY: Three disclosure regimes impact activist positions:
Schedule 13D: An activist has 10 calendar days after tripping the 5 percent beneficial ownership mark to file a Schedule 13D. In an effort to avoid a full listing of an activist’s position (or at least delay the timing of the 13D), in the past some activists asserted that derivative instruments were not captured under the Schedule 13D requirements. Court cases subsequently established that derivatives are disclosable instruments – and the addition of bylaw provisions for many companies that require eventual disclosure make the point largely moot as well.
Hart-Scott-Rodino (HSR): The US antitrust pre-transaction notification filing under the Hart-Scott-Rodino Antitrust Improvements Act of 1974 is generally associated with pre-merger anti-trust clearance. However, it actually applies to any acquisition of “voting securities.” Accordingly, any single entity proposing to acquire in excess of the applicable threshold (in 2015, $76.3 million) must file for HSR antitrust review and clearance prior to acquiring the voting securities. This leads to a few areas of interest:
- Avoiding a filing. An activist may spread its investment over a few different funds to putatively avoid HSR review – while perhaps technically legal, one has to imagine that if used prolifically, the FTC and DoJ will find sufficient means to close that strategy.
- Regulators talking. The regulators from the FTC and DoJ are allowed to speak to economic participants to gauge any level of economic concern from a proposed transaction. For a relatively small purchase in a company where the activist does not have another position in the same industry, it would seem unlikely that regulators would call a competitor to the company and thus start a potential trail of leaks. But if the activist is active in a given sector or there are significant concerns of market concentration or the like, such calls could happen.
- To early terminate or not. The HSR clock runs 30 calendar days from submission of the filing. A filer may request “early termination” of this 30-day period, assuming that the relevant agency (FTC or DoJ) concurs. In doing so, the FTC (as the coordinator of HSR filings) will post the occurrence of the granting of early termination to its website. An activist must weigh the benefits of early termination under HSR, and thus public disclosure, against letting the clock run out. Even if selecting early termination, an activist must lie in wait and hope that news of the filing does not leak before being notified of early termination and pulling the trigger on the equity purchase shortly before website publication. In companies with a market capitalization of over approximately $1.5 billion (derived from 5 percent and the $76.3 million filing threshold in 2015), this means that HSR early termination potentially will be an earlier indicator of a position than a Schedule 13D, which again is due 10 days after the position is acquired.
Charter documents: In response to the advent of more sophisticated derivative positions by activists, many companies have adopted bylaws provisions that require a proponent of a stockholder proposal for an annual or special meeting to disclose not simply equity ownership, or shares held, but any economic position that has the effect of mimicking equity ownership. Companies should carefully evaluate their bylaws for the existence of such provisions and the details required to be disclosed.
MARKET SURVEILLANCE: Besides passively awaiting the filing of a Schedule 13D or scouring the FTC HSR early termination website, most companies will engage in some degree of market surveillance, though the quality and insight of such services varies widely. Companies may receive, for free, reports of large movements in volume or stock trades. Such reports are opaque as to the actual purchaser or seller, which may be behind a financial institution custodian of shares held in street name. However, the value add of a tailored, and correspondingly more costly, surveillance service is to look behind the numbers. Most proxy solicitation firms will offer such services, which harness their insight into which particular activists – or, of equal insight, non-activists, such as fast-moving hedge funds or longer-term fund portfolio managers – use which particular custodians.