Time To Rethink Shareholder Relations As
Joseph B. Frumkin
New York (March 19, 2015, 10:03 AM ET) --
It is clear that
shareholder activism continues to evolve, expand and increase in
influence. There is a growing emphasis, in particular by large mutual
funds and other institutional investors, on shareholder engagement and
shareholder-friendly governance structures that, together with the
increased activity of activist hedge funds and other “strategic”
activist investors, make shareholder engagement and preparedness an
essential focus for public companies and their boards.
BlackRock Inc. and the Vanguard Group, the largest and
third-largest U.S. asset managers with more than $7 trillion in
combined assets under management, have made public statements
emphasizing that they are focused on corporate governance and board
Vanguard recently sent a letter to many of its portfolio companies
cautioning them not to confuse Vanguard’s “predominantly passive
management style” with a “passive attitude toward corporate
governance.” The letter goes on to emphasize numerous corporate
governance principles and to highlight in detail (as discussed further
below) the importance of direct shareholder-director interactions.
BlackRock recently updated its voting policies to make clear that they
are more than just guides to how BlackRock votes — they represent “our
expectations of boards of directors.” The new policies continue an
emphasis on direct interaction between investors and directors.
These sorts of statements by large institutions are becoming more
TIAA-CREF has sent letters to many issuers advocating the adoption
of proxy access provisions, and a number of the largest institutions
last year signed a letter sent to numerous companies in support of the
shareholder engagement principles embodied in the Shareholder-Director
Exchange (SDX) Protocol. These statements and advocacy efforts come
amid continuing high level of shareholder activism at a wide range of
large and small companies.
What all this means is that shareholder activism, in terms of
corporate governance and shareholder relations, has become mainstream.
What began as a targeted effort by a small number of governance
activists, supported by some academics, clearly is now a broad
movement that is redefining the relationship between public companies
and their shareholders. We expect this evolution to continue and
believe that companies and their boards of directors should recognize
that historic shareholder relations models, as well as “traditional”
approaches to responding to shareholder initiatives, may no longer be
Activism has been successful as an asset class, attracting over $200
billion in investor funds, much from pension funds and other
institutional investors. There is an active debate about the long-term
impact of activism, but there is no question that in recent years,
activists in many cases have achieved short-term excess positive
returns, and that activist campaigns have regularly garnered the
support of many traditionally more passive shareholders. As a result
even the largest, most respected companies may be vulnerable.
Companies should take, and many are taking, these developments
seriously. Both directors and executive officers are proactively
considering possible activist initiatives and discussing them at board
meetings. Companies are devoting greater effort to communications with
shareholders and are beginning to arrange for direct communications
between shareholders and outside directors; we expect this trend to
continue. It appears that corporations and shareholders are feeling
their way toward a new relationship with significantly more scope for
engagement. This is a complex process that will take time and vary
from company to company, and today we remain in transition.
Activists often benefit from underdeveloped lines of communication
between corporations and their shareholders, particularly in times of
crisis. Activists may also have benefited from a perceived general
decrease in investor trust in the thoughtfulness and diligence of
boards and managements following the financial crisis. Transitions are
challenging, so what should a public company do to address the
changing environment? Here are some observations:
1. There is no “one size fits all” approach to activism.
Corporations should recognize that every situation is different. Small
differences in circumstances can lead to substantial differences in
options available to optimize outcomes.
Considerations may include, among others, size of equity
capitalization, identity of shareholders, identity and track record of
activist(s), nature and attractiveness of an activist proposal and the
company’s response to the proposal, total shareholder return of the
company in recent years, the media profile of the company and
activist(s), and overall governance profile of the company. The
governance profile includes not only structural defenses, but also
director tenure (which, regardless of its merits, is becoming a more
significant investor consideration), director expertise and
2. Study possible activist lines of attack, consider
proactive communication with shareholders, and be prepared to respond
and preemptively address activist arguments.
It is essential that managements, boards and advisers thoughtfully
consider possible activist lines of attack before the attack surfaces.
They should evaluate whether any actions that might be advocated
should be implemented and, if not, develop a clear explanation for why
doing so is not advisable. This process should be rigorous and
fact-based and should seek to anticipate activist counterarguments to
the company’s position. The company should also consider proactively
informing investors about its analysis of alternatives to create
value, including previewing for investors why some superficially
appealing actions are not advisable.
Materials (talking points, communications to shareholder, other
investor or analyst presentations, etc.) should be prepared in advance
of any approach that explain in clear language why pre-identified
activists ideas are not advisable. Although the amount of effort
devoted to preparation of materials may vary from company to company,
once an activist gets traction with shareholders, it can be difficult
to turn things around, so preemption, and, if preemption is not
possible, speed of response, is essential.
3. Prepare the Board of Directors.
Managements and advisers should keep the board apprised on possible
activist avenues of attack, intended company responses and current
trends in activism generally and tactics in particular. Many companies
are doing this to some extent today, but the process should become a
regular part of the annual board calendar and be integrated with board
discussions on strategic planning and capital allocation. If an
activist emerges, a high level of board involvement and cohesion will
be essential and the mechanics for that should be established in
4. Understand the consequences of the governance emphasis
by institutional investors.
Index funds are the ultimate long-term investors; they own the market
and their obligation to their investors is to support an environment
that creates the best chance to maximize, permanently, the overall
value of public equities. Thus, index funds are showing a particular
focus on how companies are governed.
These fund managers have decided that one way to maximize value in an
enduring way is to focus on the quality of corporate governance. The
good news is that this gives public companies a path to obtaining the
support of these funds, which control an ever-increasing proportion of
the votes at public companies. It also reduces the influence of proxy
advisory firms. The bad news is that procuring this support, at this
point, can require significant adherence to a sort of “check the box”
litany of governance initiatives, not all of which are appropriate or
advisable for every company.
But companies should focus carefully on these initiatives, and their
relationships overall with these investors, because their support
often will be decisive in any activist campaign. These fund managers
will be inclined to support boards and managements that they believe
are properly selected for their experiences, expertise and
independence, have demonstrated an openness to shareholder engagement,
and have demonstrated an appropriate level of oversight over corporate
affairs, and, in the case of directors, of management and management
This is also the basis on which increased director interaction with
shareholders can be helpful to demonstrate the appropriate functioning
of a particular board. We would expect over time the governance
expectations will assume a less “check the box” and more nuanced
approach, but for now they are relatively formalistic.
5. Consider appropriate structures for board oversight of
and involvement in shareholder engagement.
As noted above, the board should be kept apprised of shareholder
outreach efforts, feedback from shareholders, and trends or
developments regarding shareholder activism. The regularity and format
of these postings will vary from company to company, as will the
formality of board structures and processes for overseeing these
areas. The Vanguard letter referred to above, although acknowledging
that there is no one-size-fits-all engagement strategy, suggests that
the creation of a “shareholder liaison committee” as a possible means
to facilitate board-shareholder communication. In addition, the SDX
letter referred to above, which was signed by a number of large
institutions, advocates the creation of a formal shareholder
It is likely that many companies will determine that these sorts of
formal measures are not necessary or appropriate. Even so, companies
and boards should consider how best to effect the board’s oversight of
shareholder engagement, and where appropriate, contribute to that
engagement. Some companies may determine that, while a stand-alone
shareholder liaison committee is not necessary in their particular
circumstances, the mandate of their governance committee could be
formally expanded to cover oversight of shareholder engagement. Even
if no formal changes are made, a company should take steps to make
sure that regular postings and presentations on shareholder engagement
matters are included on the agendas for the board or relevant
As companies have expanded their shareholder engagement efforts, both
within and outside of activist situations, a frequent topic of
commentary has been the involvement of directors in meeting directly
with shareholders. Practice has varied significantly, depending
largely on the predilections of particular directors and the expressed
interest of key shareholders in these meetings. To date, most
companies have made these decisions in an ad hoc manner, and until
recently, overall direct board-shareholder discussions have been
relatively unusual outside of a takeover or other crisis situation.
It is clear that director-shareholder engagement will be a continuing
and increasing area of focus for shareholders. The Vanguard letter and
SDX Protocol stand as clear indications that institutional investors
will press for communications that include outside directors.
It seems unlikely that director meetings will ever be the primary
means for shareholders to interact with companies — given the
oversight function of the board, directors cannot be expected to have
the details as to business matters that shareholders generally wish to
discuss. However, it may become more common for directors to meet with
large shareholders to discuss matters that are within the directors’
purview, including governance structures, executive compensation and
to hear the shareholders’ views directly on other topics.
Even if a company has not received shareholder requests for meetings
with directors, the company should anticipate that such requests will
be coming sooner rather than later. The first step is to discuss the
concept with the board. Ultimately, the level of director-shareholder
engagement, if any, will turn on the comfort level that the board
members have with particular directors engaging directly with
shareholders on particular topics.
Generally speaking, Regulation FD or confidentiality concerns should
not be a bar to shareholder engagement, because these meetings would
not normally involve the disclosure of nonpublic information. Of
course, appropriate steps should be taken (including director
training, accompaniment by legal personnel and/or limitation of topics
discussed) to help avoid missteps.
6. Carefully review corporate bylaws.
Corporate bylaws can establish some useful — and equitable — rules for
the sorts of corporate actions sometimes initiated by activists,
including calling special meetings of shareholders and nominating
candidates for director. Every public company should carefully review
its bylaws with its advisers and consider whether changes are
appropriate. Bylaw changes are an area that requires judgment, and
clearly an area where one size does not fit all. A bylaw change that
would pass unnoticed at some companies may be seen as inflammatory at
Shareholders are increasingly sensitive to board actions, such as
bylaw changes, affecting shareholder rights without prior shareholder
consultation. Specific areas to consider include how far in advance
shareholders must give notice of an intention to make a proposal or
nominate a director at an annual meeting, what disclosure is required
of director nominees, whether there should be qualification
requirements — such as an absence of third-party compensation for
director service — for directors, whether the bylaws should establish
an exclusive forum for shareholder class actions and whether a board
bylaw change should preemptively address proxy access.
This period of transition may be challenging for companies and those
that advise them. Activists seem to be achieving more success than
would appear to be warranted by the strength of their ideas or
proposals for change. At the same time, funds and other institutional
investors are becoming more active in how they reach out to and
interact with their portfolio companies.
This current reality means companies need to ask themselves what they
can do differently to change the existing dynamic so that the better
substantive, value-creating position prevails. In addition to the
concrete steps outlined above, companies also should consider the
increasing concentration in public company share ownership, the
incentives affecting the interests of these owners, especially the
index investors, the demonstrated ineffectiveness of focusing the
substantive debate primarily on “short-termism,” and the reasons for
activist success. This is a complex analysis and, in many cases,
action will be necessary, but undertaking that analysis and making
appropriate adjustments will make it easier to prevent and, if
prevention fails, prevail against, an activist challenge.
—By Jay Clayton, Mitchell S. Eitel, Joseph B. Frumkin and Glen T.
Sullivan & Cromwell LLP
Jay Clayton is a partner in Sullivan & Cromwell's New York office.
Mitch Eitel, based in New York, is managing partner of the firm's
financial services group and co-managing partner of its global general
Joseph Frumkin, also based in New York, is the managing partner of
the firm's mergers and acquisitions practice.
Glen Schleyer is a partner in New York.
The opinions expressed are those of the author(s) and do not
necessarily reflect the views of the firm, its clients, or Portfolio
Media Inc., or any of its or their respective affiliates. This article
is for general information purposes and is not intended to be and
should not be taken as legal advice.
© 2015, Portfolio Media, Inc.