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The rising tide of activist shareholder campaigns

Activism can be very rewarding for shareholders in today's investment climate, and boards and management teams of public companies need to recognize that fact or potentially lose control of their companies.

In recent years, there has been a dramatic increase in the number and success of campaigns by shareholders to change corporate policy or management. One recent study noted a 77 percent increase in proxy fights in 2006 over 2005. That same study reviewed a broad selection of activist shareholder campaigns from 2004 to 2006 and found that shareholders seeking board representation were successful 70 percent of the time and that shareholders seeking management change were successful an astonishing 75 percent of the time.

Several San Diego companies have been the subject of activist shareholder campaigns in recent years, and they are typical of companies that are susceptible to activists.

Companies with depressed stock prices and relatively small market capitalizations make good targets for small- to medium-sized activist funds because it's relatively easy to acquire a significant position in the target without concentrating too much capital before launching a campaign.

Another feature that may attract activist shareholders is excess cash without a plan to use it. In addition to board representation and management changes, the most common shareholder campaigns are elimination of defensive mechanisms (i.e., poison pills), sales of assets, special dividends and share repurchases.

Like many other important trends for public companies recently, increased shareholder activism is being driven by the proliferation and increasing clout of hedge funds. There are now more than 8,500 hedge funds in the United States with more than $1 trillion under management, and some of these funds have adopted activism as one of their key investment strategies.

In contrast to typical public market investors, activist shareholders do not simply hold the stock and rely on the board and management to increase value. They are also different from what is commonly thought of as "private equity" because they rarely acquire a whole company. An activist fund's goal typically is to be the catalyst for meaningful gains to the public shareholder base, after which they frequently liquidate their position and move to the next investment.

A key contributor to the increased activism is an evolving change in shareholder voting patterns. In the past, shareholders gave great weight to the recommendations of management on matters submitted to shareholder votes. Faced with the prospect of almost certain defeat and an expensive process, shareholders sometimes publicly complained about corporate performance, but they infrequently launched campaigns.

Nowadays, the presumption in favor of management is fading, and a well-planned campaign is frequently worthwhile for activist shareholders. The SEC is currently considering proposals to make it even easier for activist shareholders to nominate directors directly in the company's proxy, so this issue is likely to become even more pronounced in coming years.

In light of these developments, management and boards of directors of public companies should consider evaluating their exposure to and defenses against activist shareholders. Of course, the best defense is good corporate performance and a healthy stock price, but not every company can be so lucky.

Moreover, even the best companies will face hard times. Given this reality, every public company should evaluate its corporate structure to ensure that appropriate procedural safeguards are in place to promote dialogue with shareholders rather than confrontation.

For example, the corporation's bylaws should generally include advance notice provisions for shareholder meetings. These provisions require that any candidates for board membership proposed by shareholders be nominated sufficiently in advance of the shareholder meeting to allow appropriate consideration of the candidate's qualifications. Similarly, advance notice of proposals regarding corporate policy will ensure that due consideration is given.

A comprehensive analysis of a company's anti-takeover defense posture will highlight a number of other actions that should be considered, including limitations on shareholder action by written consent, limitations on the rights of shareholders to call special meetings, staggered board terms and poison pills.

Many of these steps are characterized by activist shareholders as "management entrenchment" tools and they are not viewed favorably by important constituencies like ISS (Institutional Shareholder Services). Their absence, however, can lead to abrupt change in some circumstances.

For example, Take Two Interactive recently had its entire board and management removed in a coup by activist shareholders that took only a few weeks. Those shareholders took advantage of the lack of procedural protection in that company's charter documents to accumulate a coalition of shareholders to support new director candidates who were nominated a short time before the annual shareholders meeting.

Management teams and boards of directors need to recognize the changing dynamics that are empowering and emboldening shareholders and be prepared to engage in constructive dialogue with shareholders. If they are not, they'd better be prepared to fight because the shareholders are armed and ready.


Stanton is a partner is the San Diego office of Morrison & Foerster.

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