Keith E. Gottfried is a partner at the law firm of Morgan, Lewis & Bockius LLP and leads its shareholder activism defense practice. Gottfried advises public companies and their boards of directors on how best to prepare for and respond to activist shareholder campaigns, unsolicited takeover offers, and other contests for corporate control.
Christopher P. Skroupa: Can you tell me a little about your shareholder activism defense practice and what type of engagements you get involved in?
Keith E. Gottfried: Our shareholder activism defense practice is focused on advising public companies of all sizes with respect to preparing for, and/or, responding to proxy contests, special meeting demands, consent solicitations, withhold campaigns, vote-no campaigns, shareholder proposals and other activist shareholder campaigns. Our shareholder activism defense practice also advises public companies on strategies for lessening a company’s vulnerability to activist shareholders, strategic communications, board composition enhancement programs and other corporate governance and board advisory matters.
We also advise public companies and their boards of directors on strategies and best practices for thoughtfully engaging with activist shareholders, to help our clients avoid costly and distracting activist campaigns. Many of our activist defense engagements are with companies that are new to our firm and – while they may use another law firm for their day-to-day securities compliance issues – have sought us out specifically for our specialized activist defense experience. We have handled activist defenses across the United States and abroad in a wide array of industries including apparel, automotive parts, banking, biotechnology, casual dining, consumer goods, energy, financial services, industrials, life sciences, manufacturing, real estate / REITs (real estate investment trusts), retail, shipping, software and telecommunications.
In recent years, our shareholder activism defense practice has firmly established itself as one of the leading shareholder activism defense practices in the country, frequently looked to by public companies and their boards of directors concerned with being in the cross-hairs of an activist investor, and our shareholder activism defense practice is ranked near the top of most of the major league tables for activist defense law practices; based on the number of publicly disclosed activism defense situations we have been involved in during the relevant period.
Skroupa: Based on your activist defense experience: once an activist investor’s nominees are added to a board – whether pursuant to a proxy contest or a negotiated settlement – what kinds of risks does the board face?
Gottfried: Where an activist investor’s nominees are elected to a board of directors pursuant to a proxy contest, a company’s board faces a host of risks and challenges. These include the following:
- The activist investor’s nominees may seek to represent the interests of the activist investor – rather than those of all the company’s shareholders – and will seek to further primarily the activist investor’s agenda;
- That the activist investor’s nominees may share confidential information relating to the company with the activist investor;
- That the board may be fractured into two camps;
- That the activist investor’s nominees may seek to co-opt other directors to work with them to further the activist investor’s agenda;
- That the board’s ability to cohesively work together may be adversely impacted;
- That the activist investor’s nominees, even if a minority of the board members, may seek to assert a disproportionate amount of influence and control over the board’s agenda;
- That the activist investor’s nominees may seek to drive other board members off the board;
- That the activist investor’s nominees may seek to terminate the Chief Executive Officer, or other senior executives, and may seek to create a narrative to justify such terminations; and
- That the activist investor’s nominees, in order to further the activist investor’s agenda, may choose to make demands on the officers and employees of the company in a manner that can be unduly disruptive to the company’s operations and personnel, and therefore adverse to the interests of the company.
Skroupa: Why is it more advantageous for a board to have the activist investor’s nominees added to the board pursuant to a negotiated settlement agreement, rather than a proxy contest?
Gottfried: If a board is going to have activist nominees added to its membership, there are many advantages in having those nominees added to a board pursuant to a negotiated settlement agreement. These include the following;
- The board can interview the proposed nominees in advance, review their qualifications, assess any potential conflicts and determine the suitability of the proposed nominees to serve on the board and serve the interests of all shareholders;
- To the extent that the board believes that the activist investor’s proposed nominees are not suitable, it can seek to negotiate with the activist for alternative nominees;
- The settlement agreement can be structured to provide for a period of time between signing of the agreement and the appointment of the nominees to the board such that the company can develop a thoughtful onboarding and integration process;
- The settlement agreement provides the company the opportunity to have the activist investor commit on behalf of the proposed nominees that they will comply with all policies, processes, procedures, codes, rules, standards and guidelines applicable to members of the board, as in effect from time to time, including the company’s code of conduct, and policies on confidentiality, ethics, hedging and pledging of company securities, public disclosures, stock trading and stock ownership, and that the proposed nominees will be required to strictly preserve the confidentiality of non-public company business and information, including the discussion of any matters considered in meetings of the board whether or not the matters relate to material non-public information; and
- The company can negotiate the extent to which the proposed nominees are to fill newly-created vacancies on the board as a result of the board’s enlargement or will be replacing one or more directors who will be asked to resign from the board or not stand for re-election.
Skroupa: Are there actions a board can take in advance of an activist investor’s nominees joining the board, whether pursuant to a negotiated settlement agreement or a proxy contest, to mitigate the risks attendant to having an activist investor’s nominees on the board?
Gottfried: All board members have the same duties to act in the best interests of all company shareholders, and their duties and obligations should be easily understood. To avoid any misunderstanding, it is extremely helpful for the company to document, in writing, the specific policies applicable to all board members in advance of an activist investor’s nominees joining the board. These written policies would address such areas as the following:
- Confidentiality of company business and information, including the discussion of any matters considered in meetings of the board whether or not the matters relate to material non-public information, unless previously publicly disclosed by the company;
- Interactions with shareholders or securities analysts;
- Interactions with – and comments to – the press;
- Responding to an inquiry, expression of interest, proposal or any other communication from a shareholder, securities analyst, member of the press or other third party relating to the company;
- Requests for information from officers and employees of the company; and
- Proper handling of confidential company and board materials and information.
Skroupa: What are some of the best strategies you have seen in the process by which companies have onboarded an activist investor’s nominees?
Gottfried: Those companies that I have seen have more success than others in onboarding an activist investor’s nominees are those that were very thoughtful and strategic about how they approached the onboarding and integration process. In addition, those companies did not make the mistake of assuming that, just because a new director is nominated by an activist investor and may have some pre-existing loyalties to the activist investor, the new director was not prepared to serve the best interests of all shareholders.
These companies also did not assume that the pre-existing loyalties the activist investor’s nominees came onto the board with could not be challenged so that, once integrated, the activist investor’s nominees would become less willing to further the agenda of the activist to the extent that it interfered with serving the best interests of all shareholders. Notwithstanding whatever distrust a board may have regarding the activist investor’s nominees, it is critical for the board to approach the onboarding process as though the activist investor’s nominees intend to work constructively and in good faith with the other directors to serve the best interests of all shareholders.
To the extent that any of the activist investor’s nominees bring specialized skills, competencies or experiences to the board, the board should consider how best to deploy those skills, competencies or experiences to enhance the ability of the board to create shareholder value. Accordingly, each of the activist investor’s nominees should be appointed to at least one standing committee of the board, assuming they have the requisite skills, competencies and independence to serve on such committee and should be briefed on all the board’s initiatives for improving the company’s operations and driving the creation of shareholder value and given a full opportunity to provide input into those initiatives.
Skroupa: What about some of the more common missteps you have seen in the process by which companies have onboarded an activist investor’s nominees?
Gottfried: Onboarding an activist investor’s nominees is not an easy process and the suspicion and distrust that surrounds the activist investor’s nominees is often difficult to overcome. At the extreme, some boards have only exacerbated the distrust between the legacy directors and the new directors by moving too slowly to integrate the new directors and unduly delaying adding any of the new directors to any of the board’s standing committees. At the far extreme, assuming the activist investor’s nominees make up a minority of the board, forming an executive committee composed of only the legacy directors sends a clear message that the board is not prepared to accept the new directors as equal contributing board members.
Skroupa: Where the addition of an activist investor’s nominees to a board of directors results in a dysfunctional board of directors, what have been the principal factors that contributed to that result?
Gottfried: A number of factors can cause the addition of an activist investor’s nominees to a board of directors to result in a dysfunctional board, including the following:
- The board makes no effort to integrate the activist investor’s nominees with the legacy directors;
- The board makes no or little attempt to overcome the distrust and suspicion it initially had when the activist investor’s nominees were added to the board;
- The board unduly delays adding the activist investor’s nominees to any of the board’s standing committees;
- The activist investor’s nominees demonstrate that they cannot be trusted to preserve the company’s confidential information and are prepared to share such information with the activist investor and others;
- The activist investor’s nominees demonstrate that they are on the board to primarily further a particular agenda of the activist investor, whether that be to remove the chief executive officer, sell the company, cause the company to return more cash to shareholders in the form of dividends or stock buybacks, change the strategic direction of the company, or facilitate the activist investor’s objective of ultimately obtaining control of the company; and
- The activist investor’s nominees demonstrate that they are committed to primarily serving the interests of the activist investor even if those interests are at odds with the best interests of all shareholders.
Skroupa: What is a company’s recourse if the addition of an activist investor’s nominees leads to a dysfunctional board of directors?
Gottfried: To the extent that the addition of an activist investor’s nominees leads to a dysfunctional board of directors, a board’s recourse is very limited. From a practical perspective, once the activist investor’s nominees are added to the board, they cannot be easily taken off the board. Under Delaware law and the laws of other jurisdictions, a board cannot remove directors.
Typically, only shareholders can remove directors though some state corporate statutes allow for a court to declare a director unfit to serve and, accordingly, effectively remove the directors, but that is extremely rare.
Practically, a board’s only recourse may be to form an executive committee of the legacy directors which committee would be delegated with the authority to take almost any action that the board could take except as otherwise provided by applicable law or the company’s governing documents. The formation of an executive committee effectively walls off the activist investor’s nominees from most of the board’s deliberations.
That is certainly not an optimal or preferred path for a board to take. Nor is it a path to be pursued just because the addition of the activist investor’s nominees has led to less “collegiality,” or has split the board into factions where reaching consensus and/or agreement is now more difficult.
The formation of an executive committee is a path that should generally only be pursued when the board believes in good faith that it has no other practical option available for the board to properly function and that the activist investor’s nominees cannot be trusted to:
- Preserve the confidentiality of company and board information;
- Disclose to the other board members all potential conflicts of interest; or
- Comply with their fiduciary duties to act in the best interests of all shareholders.
Keith Gottfried will be speaking in a panel discussion entitled Small Cap Versus Large Cap Companies: Activist Targets, and Why at the Shareholder Activism conference in New York, NY on January 25, 2018.