Marty Lipton's War on Hedge Fund
Michael D. Goldhaber, The
March 30, 2015
In November 2012, the corporate law guru who is most revered by
managers faced off against the corporate law guru who is most feared
by managers, at the Conference Board think tank in New York, in a
friendly debate that was about to turn hostile. Martin Lipton has
defended CEOs against all comers since forming Wachtell, Lipton, Rosen
& Katz 50 years ago. Lucian Bebchuk, a Harvard Law School professor,
champions the "activist" hedge funds that assail CEOs in an
intensifying struggle for control of America's boardrooms.
Speaking with a thick Israeli accent ("Vock-tell is wrong"), Bebchuk
argued that shareholder activism helps companies in both the short and
long term. Lipton, whose voice carries a trace of Jersey City ("The
bawd is right"), countered that activism is awful for companies and
the economy over the long run. "Nor do I accept [your] so-called
statistics," said Lipton fatefully. "Your statistics are all based on
things like 'What was the price of the stock two days later?'"
As Lipton finished the thought, Bebchuk twitched his foot. He unfolded
his right leg over his left knee, and then reset his body. He licked
his lips, pressed the button of an imaginary pen with his thumb, then
lunged for a pad and started scribbling with a real one. Thus was born
"The Long-Term Effects of Hedge Fund Activism," the paper that turned
a genial debate into a nasty war over the direction of corporate
America. (It's to be published in June by the Columbia Law Review.)
At 83, Lipton is a blue chip stock. He's one of two people to make
every list of the 100 Most Influential Lawyers in America since it was
launched by the National Law Journal 30 years ago. (The other is
Beltway legend Thomas Hale Boggs Jr., who died last September, just
months after ailing Patton Boggs merged with Squire Sanders.) Wachtell
Lipton remains The Am Law 100's runaway leader in profits per partner,
as it has been for 15 of the past 16 years.
Lipton is most famous as the inventor in 1982 of the "poison pill"
defense to corporate takeovers, which enables a company to dilute the
value of its shares when a hostile bidder draws near. He's also
heavily identified with the "staggered board," which deters takeovers
by spreading the election of a board's directors over several years.
It's often forgotten that Lipton helped to pioneer the concept of the
corporation that undergirds corporate social responsibility. In his
seminal 1979 work, "Takeover Bids in the Target's Boardroom," Lipton
argued that directors should protect the interests of not only
shareholders, but all who have a stake in the company: creditors,
community members and most notably employees. Lipton's whole career
(and much of Wachtell Lipton's business model) has been organized
around these few ideas. His lifelong goal has been to safeguard
managers against hostile takeovers and, increasingly, activist
campaigns conducted in the name of shareholders.
Lucian Bebchuk, age 59, likes to attack blue chip stocks. His
astonishing success has made him the only law professor listed among
the 100 Most Influential People in Finance by Treasury and Risk
magazine. A lowly student clinic led by Bebchuk—the Shareholder's
Rights Project—has destaggered about 100 corporate boards on the
Fortune 500 and the S&P 500 stock index since 2011. As a critic of CEO
compensation, Bebchuk paved the way for the Dodd-Frank Act rules that
give shareholders more "say on pay." Shareholder activism has drawn
him into debates with Lipton in 2002, 2003, 2007, and more or less
continually since 2012.
In 2012, Lipton still referred to Bebchuk with senatorial decorum, as
"my friend," and teased him about reenacting the Hamilton-Burr duel.
But something soon changed. Perhaps Lipton was disturbed by the effort
to debunk his deepest belief about the long-term effects of activism.
Or perhaps what changed were the tides of fortune. For the only thing
that the two can agree on is that, in Lipton's words, the "activist
hedge funds are winning the war." And so the iconoclast is no longer
amusing to the icon.
With a revolving cast of big-name partners, Lipton has churned out
ever more frequent and vicious memos. He called Bebchuk's paper
"extreme and eccentric"; "tendentious and misleading"; and "not a work
of serious scholarship." He gleefully noted that a sitting SEC
commissioner called another paper by Bebchuk so "shoddy" as to
constitute securities fraud. (Thirty-four professors rallied in
Bebchuk's defense and jumped on the commissioner for abusing his
power.) Bebchuk and Lipton lobbed posts back and forth on the Harvard
corporate governance blog with "na-na-na-na-na" titles. "Don't Run
Away From the Evidence" led to "Still No Valid Evidence," which led to
"Still Running Away From the Evidence."
When Lipton was recently asked what he'd say to Bebchuk over a cup of
coffee, he could no longer contemplate the idea: "I am afraid that
professor Bebchuk is so invested in, and obsessed with, his mistaken
views as to business and the economy that any conversation about
governance and activism over a cup of coffee, or other venue, would be
a waste of time."
Lipton blames "short-termist" hedge funds for America's economic
stagnation and inequality since the financial crisis. He even touts a
study blaming them for the financial crisis. His memos on activism are
themselves obsessive, overgeneralized, and over-the-top. They also may
Age of the activist investor
it has become a common meme that we live in the "age of the activist
investor." Estimated assets under activist management in 2014 ranged
from $120 billion to more than $200 billion. On the low end, that's up
269 percent since 2009, or 4,344 percent since 2001, according to the
Alternative Investment Management Association, a trade group.
Activists attract funds because they win. Nearly three-quarters of
activist demands were at least partially satisfied in 2014, according
to the data collector Activist Insight. Ernst & Young says that half
of S&P 500 companies engaged with activists in 2013. But even that
understates their impact, because the way to pre-empt an attack is to
adopt their mindset. Boston Consulting Group advises companies to "be
your own activist."
Wachtell is rare among top law firms in categorically refusing to
advise activist hedge funds. It helped 20 companies to quell activism
in 2014, and Wachtell dealmakers spend an increasing amount of time
playing firefighter. Lipton put the portion of his time devoted to
manning the fire hose at 25 to 30 percent. Daniel Neff, one of the
co-chairmen of the firm, estimates that activism consumes about 20
percent of his own time; he had answered an alarm from a Fortune 200
CEO just before we spoke.
Lipton urges directors to go through a "fire drill" at least once a
year, practicing how they would respond to an activist demand.
Sometimes the fire drill takes the form of play acting. Who gets to
play billionaire activist investor Carl Icahn, they wouldn't say.
The Wachtell lawyers didn't see the comic potential because they take
activism so seriously, and so personally. When asked if the tone of
their memos was perhaps a touch Scalia-esque, Steven Rosenblum, the
mild-mannered corporate co-chairman, replies that activists are far
more shrill. "They are flat-out uncivil, rude, loud and obnoxious," he
says. "They are incredibly unpleasant and total bullies. People should
not conduct themselves that way." Sabastian Niles, a young counsel
whom Lipton jokingly calls the firm's activist defense department,
says that over the past three months, three separate activists had
said to three CEO clients of Wachtell: "I will destroy you" if they
didn't do XYZ.
Lipton rose to prominence in the 1980s defending against corporate
raiders like Icahn, when they needed to win an outright majority of
the board to gain corporate control. For Lipton, the only difference
between corporate raiding and modern activism is that the Icahns of
the world figured out how to get their way with only 2 percent of the
share register. To seize effective control of the board, activists
harness the voting power of the largest investors. Their secret is
that giant stock funds outsource their votes to proxy advisory firms,
which routinely side with activists. And thanks in no small part to
Bebchuk, there are few staggered boards left to retard shifts in
The activist trend has snowballed in recent years for several reasons,
some observers say. First, share ownership has consolidated among a
handful of giant asset managers, so the top few shareholders can swing
control of the board. Second, the giant asset managers are rapidly
losing market share to low-fee Exchange Traded Funds (ETFs). That
makes the institutional investors desperate to show high immediate
returns. So instead of activists going hat in hand to the
institutions, the institutions now approach the activists with
"requests for activism." This practice is so common that there is even
a name for them in the industry: RFAs.
Whether all this is for good or evil, or both, depends on which
narrative you accept. According to the hedge fund narrative, activists
champion little-guy shareholders against fat-cat CEOs of lousy
companies, who feed at the corporate trough with their cronies. "Wachtell
has a great business defending corporate America and particularly
Lipton himself," says Marc Weingarten of Schulte Roth & Zabel, the
dominant firm for activists along with Olshan Frome Wolosky. "It gives
no credit to what activists are clearly doing, which is making
managers more focused on maximizing shareholder value than on
self-aggrandizement and lining their own pockets."
According to the corporate narrative, activists are billionaire
hedgies who are out to make a quick buck, while driving great
companies and the economy into a ditch. Studies find that activists
typically hold a stock for only nine months before bailing out. In
that short time, they will aim at all costs to hack employment, R&D
and capital expenditures; overload the company with debt; return money
to shareholders through dividends and buybacks; and, as the ultimate
goal, goose the stock through M&A activity. "At bottom, every activist
campaign is one or two steps to sell the company," says Wachtell's
There's truth to both perspectives, as shown by the two 2014 activist
deals profiled elsewhere in this issue. Both involved takeovers—for
while Neff may overstate matters, Activist Insight confirms that 49
percent of last year's activist campaigns made public demands related
to M&A outcomes. In the CommonWealth
REIT deal, the Icahn protégé Keith Meister appears to have
created real value for shareholders by throwing out the father-and-son
directors to whom the CEO had given exclusive power to manage the
REIT's real estate, and who were botching the job.
In the case of
Allergan, the activist
standard-bearer William Ackman made a failed $53 billion run at the
admired maker of Botox. Allergan typically devoted 17 percent of sales
to R&D. It cut that back to 13 percent during the takeover battle, and
the white knight buyer cut it to 7 percent of combined sales. Ackman's
bidder historically held R&D at 3 percent.
"Ackman said this is the most accretive deal he'd ever seen," notes
Wachtell's Neff, who advised Allergan. "Why? Because they would slash
R&D. They took out the best performer in its sector. Allergan didn't
need fixing." For Neff, Allergan is a cautionary tale of killing
innovation. And while Botox isn't exactly a life-saving drug, it is
innovative. The author of "A Culture of Narcissism" might have noted
that America is now too superficial to invest deeply in cosmetic
Despite Allergan, the hedge fund account of shareholder activism
prevails in the press and the legal academy. As Lawrence Fink, CEO of
the giant money manager Blackrock Inc., noted last year in an
interview critical of hedge funds: "The narrative today is so loud now
on the activist side."
Some are searching for a middle ground. Writing in the Harvard
Business Review, Harvard professor Guhan Subramanian laments a debate
characterized by "shrill voices, a seemingly unbridgeable divide
between shareholder activists and managers, rampant conflicts of
interest, and previously staked out positions that crowd out
The outspoken Chief Justice Leo Strine Jr. of the Delaware Supreme
Court ["Tell Us What You Really Feel, Leo," March 2012] relates a
story that lies somewhere in between the two poles. In Strine's
telling, the little-guy investor needs to be protected from the
self-dealing of both company managers and activist money managers.
"The media and academia are captive to intellectual laziness," Strine
says. "It's easier to write a story about the bad, bad managers
against the innocent shareholders, as if it's still 1935. It's much
harder to write about the current complexities of a system of monied
interests (money manager stockholders) versus other monied interests
(corporate managers), and how the poor incentives of that system often
give the shaft to ordinary Americans, both as investors who have to
invest through money manager intermediaries to save for retirement and
college for their kids, and as workers who need employment from
corporations to feed their families."
At 88, Ira Millstein of Weil, Gotshal & Manges is perhaps the only
corporate law guru to outrank Strine and Lipton. ("If I don't have a
long-term perspective at my age, when am I ever going to have one?" he
jokes.) "As far as Marty's concerned, I disagree because he's damning
the whole movement," says Millstein. "I know activist hedge funds that
are in the business of promoting long-term growth. I know other
activists who are only interested in jerking the stock a little bit. I
think there are plenty of both."
Fishing with dynamite
What Bebchuk does in "The Long-Term Effects of Hedge Fund Activism" is
to see which narrative dominates if you ignore the anecdotes and study
the data. Working with University of Chicago-trained financial
economists Alon Brav and Wei Jiang, he tracked the performance of
every activist-targeted company over the long term. Not over two days,
but over five years. Bebchuk writes drily, "When available, economists
commonly prefer objective empirical evidence over unverifiable reports
of affected individuals."
The finding that made Lipton go ballistic is put simply by University
of Chicago professor Steven Kaplan: "When you get these activists
involved, the stock price goes up and stays up, and if anything, the
operating metrics improve. Done. End of story."
To its critics, Bebchuk's paper is far from the end of the story.
Scholars ranging from Columbia Law School's John Coffee Jr. to Yvan
Allaire of the Institute for Governance of Private and Public
Organizations find the data ambiguous and methodologically flawed.
Both attribute any gains by shareholders to a combination of fleeting
takeover premiums and wealth transfers from employees (as the result
of layoffs or wage cuts) or bondholders (as the result of downgrades
or bankruptcies). In other words, Ackman and some shareholders are
getting rich on the back of workers and pensioners.
"I don't agree with Bebchuk, because you can't prove a case with a
number," says Millstein. "I'm not saying he's twisting the numbers,
but he's coming up with the conclusions he believes in the first
place." Says Lynn Stout of Cornell Law School: "He's trying to prove
his own theories."
In Stout's view, Bebchuk is looking at the wrong thing. "He should be
looking at what activists do to the economy as a whole," she says. "If
Bebchuk went to a fishing village, he would find that people catch
more fish with dynamite than nets, and he would conclude that everyone
should fish with dynamite." That doesn't mean the dynamite is good for
the pond. For instance, Bebchuk's study says nothing about the fate of
the many activist targets that disappeared from the sample. By
Bebchuk's own numbers, activist intervention increased the chance of
corporate death over the study period from 42 to 49 percent. "To me,
that says we're dynamiting a lot of fish here," says Stout.
Bebchuk's supporters say it takes a model to beat a model. So why
doesn't Wachtell fund counterresearch? "If we wanted to phony up a
model, we could do the same thing he does," retorts Lipton. He thinks
the evidence, "empirical, experiential, and overwhelming," is already
on his side.
Roughly 95 percent of S&P 500 profits last year were funneled back to
shareholders through buybacks or dividends, according to a Bloomberg
projection. A study by J.W. Mason of the Roosevelt Institute found
that only 10 percent of profits plus borrowings were being reinvested
in public companies today—compared with 40 percent in the 1960s and
1970s. Perhaps not surprisingly, the Center for American Progress
cites a recent study showing investment by private companies to be
more than double today's rate for public ones. Chicago economists say
that shareholders are allocating all that capital efficiently. Others,
like Pavlos Masouros of Leiden University, think the shortfall in
investment is retarding GDP growth, and amplifying inequality.
Former Treasury Secretary Lawrence Summers is persuaded that hedge
fund activism is a macroeconomic problem. "We are having an epidemic
right now of activism directed at getting management to choke off
investment," he says. "It seems unlikely to me that there has been a
major increase in managerial abuse the last few years. It seems
unlikely to me that American business has been chronically
over-investing the last few decades. That makes me think there is
likely too much aggressive activism," sometimes at the expense of
'How do we fix things?'
Lipton speaks of the lifetime contract between a company and its
employees, and Neff says that philosophy carries over to law firm
management. Wachtell Lipton resisted pressure from some partners
during the financial crisis of 2008 and 2009, and refused to lay off a
single summer associate or staffer. "We would not put a family's
breadwinner out on the street and change his and his family's life so
the partners can make a couple more dollars," says Neff. "That
attitude comes down from the white-haired gentleman."
Some critics find it a bit rich when Lipton echoes liberal think tanks
on distributional inequality. They note that Lipton never met an
executive pay plan he couldn't defend, including the $210 million that
The Home Depot Inc. awarded in 2006 to CEO Robert Nardelli despite its
flagging share price. Lipton's consistent loyalties lie not with
stakeholders, they suggest, but management.
"Has there ever been an issue where Marty Lipton sided with
shareholders against management?" asks Yale Law School's Jonathan
Macey. "I believe the answer to that question is no."
Macey goes further, and queries whether Lipton's loyalty to CEOs
should disqualify his law firm from acting for directors. "Suppose I'm
a director of a public company, and we are faced with activist
investors. Suppose the CEO says, let's hire Wachtell. If I really
thought that law firm took Marty Lipton's radical view"—and Macey
takes pains to say that although it is possible, he does not really
think the firm would do that—"then I think it would be a violation of
the fiduciary duty of loyalty to hire that firm. Because Marty Lipton
is not interested in protecting shareholders; he's interested in
Lipton replies that while his memos speak only for the lawyers who
sign them, they are absolutely consonant with fiduciary duties. All
Wachtell lawyers advise directors to consult with activists, Lipton
said, and sometimes advise them to change business strategy. "I've had
clients with mediocre management," added Neff, "and I said to the
activist: 'OK, you're right, how do we fix things?'"
So would Lipton concede that in a bad company, activists can be good
for the economy? "No!" he shoots back. "They'll push to fire more
people and cut more R&D and go too far. They'll want two times too
much. It's terribly macroeconomically harmful."
Though his memos chronicle every shot fired across the activists' bow,
Lipton knows he's still losing. The only recent development that truly
comforts him is the letter sent to CEOs a year ago by Blackrock's
Larry Fink. "It concerns us," Fink wrote, "that, in the wake of the
financial crisis, many companies have shied away from investing in the
future growth of their companies. Too many companies have cut capital
expenditure and increased debt to boost dividends and increase share
buybacks." As Fink later put it more succinctly, activists "destroy
Fink's opinion matters more than most, because he speaks for $4
trillion in assets.
Lipton will never win his war until institutional shareholders vote
against activists more. He is the first to say so, and others agree.
Chief Justice Strine of Delaware urges institutional shareholders to
tailor their voting policies to their investors' investment
horizons—and to recognize the unique long-term outlook of people
relying on index funds for college or retirement.
That change in mentality could be promoted through systemic reform.
Summers says that policy changes to give long-term shareholders more
voting power or managers more tools to fend off activists deserve
serious consideration. But change could also be achieved through the
exercise of old-fashioned good judgment. "Companies and pension funds
are getting smarter," says Millstein. "If the real investors think the
activists are wrong, then they don't have to go along."
Copyright 2015. ALM Media Properties, LLC.