Activism
The way
activist investing works in the U.S. is generally that an activist
investor quietly buys up a chunk of a company’s stock, announces that
she owns the stock, and goes to the company’s managers asking them to
change something about their strategy or operations. Sometimes the
managers agree, there is a productive conversation, the activist helps
the company improve, the stock goes up and eventually the activist
sells at a profit. Sometimes the managers disagree, and the activist
tries to pressure them into doing what she wants. She might wage a
public campaign, writing open letters explaining her position. She
might talk to other shareholders — big institutional holders who don’t
wage activist campaigns themselves but who own a lot of stock — to
persuade them that she is right. If lots of shareholders agree with
her, but the managers still don’t, she might launch a proxy fight: She
will nominate some people to the company’s board of directors and try
to get them elected to replace some of the existing directors. If
enough other shareholders vote with her, her candidates will win and
join the board and presumably do the things she wants. Hopefully the
things she wants are good and the stock will go up and she will sell
at a profit.
Sometimes
this doesn’t work: Managers ignore the activist, other shareholders
disagree with her, she loses the proxy fight, etc. Other times it sort
of works, but is bad: The company does what the activist wants, or at
least enough to make shareholders satisfied, but it turns out to be
wrong and the stock goes down.
In general
though it seems obviously good that activism exists.
For one thing, it often does make companies more valuable: An activist
shareholder, who owns a big chunk of the company and only makes money
if the stock goes up, will sometimes have better incentives and
motivations than a chief executive officer who owns less of the
company and collects a large salary even if the stock goes down.
More
fundamentally, though, activism is one of the few ways that
shareholders can exercise real power over the companies that they
theoretically own. As we often
discuss around here, if a company’s board and managers want
to ignore their shareholders, they mostly can. The only ways that
shareholders in the U.S. can actually fire the
board and CEO of a public company are (1) a proxy fight or (2) a
hostile takeover.
They don’t do that
very often. But this is the background that
makes other, softer forms of pressure work. If BlackRock Inc. calls up
a company and says “we are a big shareholder and we’d like you to
reduce your greenhouse gas emissions,” the executives will generally
listen to BlackRock and care what it thinks, because they know that,
if they don’t, BlackRock will become disgruntled, and if enough big
shareholders become disgruntled enough an activist might show up and
win a proxy fight. (Sometimes the disgruntled big institutional
shareholders will quietly invite an
activist to show up; this is informally
called an “RFA,” or “request for activist.”) There just
isn’t that much that BlackRock can do on its own: The board controls
the company, board elections are not competitive (outside of proxy
fights) and most of what shareholders vote on is non-binding;
BlackRock has a lot of shares, and so a lot of votes, but it can't do
much with them. But if an activist shows up, BlackRock — or other
shareholders — can vote out the board. And the managers know that,
which is why they feel the need to keep shareholders happy.
“Keep
shareholders happy” is a very generic goal. Historically it meant
things like having high profits. Later it meant things like doing
stock buybacks. Increasingly, it means doing good environmental,
social and governance things, as big shareholders become more
diversified and more focused on ESG. And when companies don’t do
the ESG things that shareholders want, there will be ESG
activists and proxy
fights, because activism is the enforcement mechanism that
shareholders use to influence companies.
Recently,
though, the U.S. Securities and Exchange Commission has proposed some
rules to … stop activism? This seems bad, and also like a strange
priority for the SEC to have.
Even stranger
is SEC Chair Gary Gensler’s stated
reason for getting rid of activism. Gensler thinks activism
is bad because:
-
Activists
buy stock in the target company quietly, before they do activism;
-
When they
do activism — or even when they just announce their plans to do
activism, or just announce that they bought stock — the stock goes
up;
-
The people
who sold them their stock, before the activism, don’t get the
benefit of that stock-price increase.
Or in
his words, from January:
|
“I would anticipate we’d have
something on that,” Gensler said, adding that he is worried about
“information asymmetry.” …
“It’s material nonpublic information that there’s
an activist acquiring stock, who has an intent to influence and generally
speaking, there’s a pop if you look at the economics from the day they announced
… there’s usually a pop in the stock at least single-digit percent,” Gensler
said. “So the selling shareholders during those days don’t have some material
information.” |
This is a
weird complaint! If an activist buys 5% of the stock quietly, and then
announces that she owns the stock, and the stock goes up, she gets 5%
of the gains — and the other shareholders, the moms and pops and index
funds and corporate insiders and whoever else, get the other 95%. Yes
the shareholders who sold her the stock missed out on the gains, but
they sold the stock voluntarily. Yes there was an “information
asymmetry,” in that the activist knew she was buying the stock to do
activism and the selling shareholders did not, but there is a similar
information asymmetry in every stock transaction: When I buy stock, I
know who the buyer is (me) and why I am buying, but the person selling
me the stock does not.
Also though:
If you get rid of activism, then activism won’t ever cause stock-price
increases (because it won’t happen), so nobody will
get the benefit of it! The 95% of shareholders who would have
benefited from activism won’t, and the 5% who would have missed out
will still miss out.
I am being a
bit hyperbolic, but not, I think, that hyperbolic.
Gensler seems to have decided that it’s bad that an activist can buy a
lot of stock in secret, and would like to crack down on it, so new
rules will require activists to disclose their presence and intentions
before buying too much stock. This is something that corporate
managers and their lawyers have wanted for years — my old law firm,
Wachtell, Lipton, Rosen & Katz, has been pushing
it for over a decade — but it is bad for activists. It is
expensive to do activism, run proxy fights, etc., and activists do it
because they can make money. They make money by buying at the
pre-activism price, hopefully pushing the price up, and then selling
at the post-activism price. If they have to do most of their buying at
the post-activism price, then they can’t make money so they won’t do
activism.
There are two
different SEC rule proposals that are designed to accomplish this. The
more obvious one is the
proposal to change the beneficial ownership reporting rules
that govern when investors need to disclose their stock holdings.
(Activists disclose their holdings on a form called Schedule 13D, and
these are often called the “13D rules.”) The way the rules work now is
that, if you acquire 5% or more of a company’s stock, you need to
disclose your holdings within 10 days. This gives you time to go above
5%: If you acquire 5% of the stock on Day 1, you can buy some more on
Days 2, 3, etc., until you file your Schedule 13D on Day 10. So you
might own 9% or more of the stock by then. (Activists tend not to go
above 10%.) The SEC proposal would cut this down to five days. Gensler:
|
Investors currently can withhold
market moving information from other shareholders for 10 days
after crossing the 5 percent threshold before filing a Schedule
13D, which creates an information asymmetry between these
investors and other shareholders. The filing of Schedule 13D can
have a material impact on a company's share price, so it is
important that shareholders get that information sooner. |
This
is a change, but not a particularly important one; most activists
don’t actually use the full 10 days anyway.
The
subtler but more important change is the SEC’s proposal
to require public disclosure of swaps positions.
A total return swap is a contract between a bank and an investor (a
hedge fund, etc.) referencing some underlying stock;[1]
the bank agrees to pay the investor however much the stock goes up,
and the investor agrees to pay the bank however much it goes down.[2]
This gives the investor a position that is economically equivalent to
owning the stock: She makes money if the stock goes up and loses money
if it goes down. But she does not actually own
the stock. (The banks will often hedge these swaps by buying the stock
for themselves, though this is not contractually required or always
true.)
Late last year the SEC proposed
a new rule “to
require any person with a large security-based swap position to
publicly report certain information related to the position.” We talked
about it at the time; the SEC’s discussion of the rule
focused on (1) weird stuff in the market for credit default swaps and
(2) the blowup at Archegos Capital Management, which lost a lot of
money using total return swaps. The SEC’s proposed rule says that if
you buy more than $300 million of a stock on swap,[3] you
have to publicly disclose your position within one business day. There
seems to be a vague idea that this would somehow have prevented the
Archegos blowup, though I am not sure how. (The concern with Archegos
was that nobody knew about all of its swaps positions, but that seems
false — in fact its bankers were
quite aware of its huge concentrated positions — and in any
case the SEC already
has rules requiring reporting of swap positions to
the SEC, though not to the public.)
But this rule is also very
bad for activists. Many activists, when they are quietly buying up
stock in a target company, don’t actually buy stock. Instead they buy
the stock on swap. There are various reasons to do this — you can
potentially get better financial and leverage terms from a swap than
from buying the stock directly — but there is one particularly
important one. There is a U.S. antitrust rule (the Hart-Scott-Rodino
Act, or HSR) that requires
activists to notify the target company and wait 30 days
before buying more than $101 million of a company’s stock. Here is a
summary, from a comment
letter filed this week on the SEC’s proposal by a group
called the Council for Investor Rights and Corporate Accountability[4]:
|
Under current law, the HSR Act
generally prohibits an activist investor from acquiring voting
securities with a value in excess of $101 million without making a
filing with the appropriate governmental agency, notifying the
target company of the making of such filing, and waiting a period
of at least 30 days before it can continue to acquire additional
voting securities of the issuer. In many cases, this notification
threshold is well below the minimum position size that an activist
investor needs to acquire to make the investment of its time,
resources and capital worthwhile. The HSR Act, however, is focused
solely on the acquisition of voting securities and therefore
activist investors have long used [swaps], typically cash-settled
[swaps], to accumulate their desired sufficient economic position
without the need to make an HSR Act filing. The Proposed Rule
would make this long-standing approach irrelevant, as it would
compel public disclosure of the [swaps] position thereby tipping
management and the board of directors of the target company to the
investment and allowing them to take measures (including possible
public disclosure to run up the stock price) to the detriment of
the activist investor. |
Here
is another
comment letter from Elliott Investment Management LP, which
does a lot of activism:
|
In our activist investments, as well
as our non-activist investments, our firm frequently acquires
cash-settled [swaps] as part of the overall mix of securities in a
given position. This approach allows us to buy a portion of our
position and gain economic exposure without triggering the kind of
“herding” behavior that often accompanies public disclosure, and
without notifying the company before our ideas have fully matured.
The Proposed Rule will eliminate that approach. Instead, the new
disclosure regime contemplated by the Proposed Rule gives activist
investors three potential paths: (1) purchasing cash-settled
[swaps] up to the new (and very low) reporting threshold, or
triggering a filing that would significantly limit the prospect of
a sufficiently profitable investment (with concomitant loss of
confidentiality, and thus of intellectual property) far earlier
than is currently the case, (2) acquiring common stock and
triggering a notification under the Hart-Scott-Rodino Antitrust
Improvements Act of 1976 at what, for most public companies, is
a de minimis level of ownership, or (3) deciding to stop pursuing
activist opportunities entirely.
By forcing investors to choose one of these paths,
the new disclosure regime will have a perverse chilling effect on exactly the
kind of engagement with companies that is most likely to create value for all
shareholders and the U.S. market generally. If an activist with a successful
track record of creating sustainable value is forced to make a public disclosure
prematurely, then “herding” behavior by new entrants into the stock may make the
securities too expensive, preventing an economically worthwhile position from
being built and thereby pricing the activist out of the investment. |
And
here is a
comment letter from Harvard Law School professor Lucian
Bebchuk:
|
For hedge fund
activists that accumulate economic positions in a target with
significant market value through equity swaps, the Equity Swap
Rule would lead to disclosure of the activist’s potential interest
in engaging with the company at a much earlier time and stage of
accumulation than under current rules. Disclosure at such an early
stage would curtail the ability of such activists to accumulate a
position prior to their initial disclosure. Such early disclosure
would also enable management to start engaging in defensive
actions much earlier than under current rules. Altogether, for
such activists, the Equity Swap Rule would substantially reduce
their payoffs and considerably discourage their activities. |
Activists worry that, if
they can’t buy more than $300 million of stock on swap (roughly
1% of the median S&P 500 company), or more than $101
million in actual stock, they will not be able to quietly build a
meaningful position in a large public company. They will have to
disclose their involvement before buying most
of their position, which will push up the price of that position,
which will make it uneconomical to do activism. If the expected value
of Elliott’s activism in a $20 billion company is $4 billion, and
Elliott can buy 5% of the stock at the pre-activism price ($1 billion
worth) and then do the activism, it will in expectation make a 20%
return on its investment ($200 million) and other shareholders
will make $3.8 billion. If Elliott has to disclose its intentions
first, the stock will trade up 20% to reflect the expected value
of Elliott’s involvement, Elliott will have to pay $1.2 billion for
its position, and in expectation it won’t make any money.[5]
So it won’t do the trade.
This concern is perhaps a
bit exaggerated: You can still buy a little stock
quietly, and you could imagine finding ways around the rule. In the
SEC’s rule proposals there is a strange distinction between “swaps,”
which are covered by the proposed swaps rule and have to be disclosed
one business day after you reach $300 million, and “cash-settled
derivatives,” which are covered by the proposed 13D changes
and have to be disclosed five business days after you reach 5% of the
stock. A swap is a
cash-settled derivative, and there is no sensible reason why you would
distinguish between these things. Presumably banks and hedge funds
will try to find ways to characterize their trades as “cash-settled
derivatives” rather than “swaps.” (My understanding — not legal
advice! — is that if you call a thing a “cash-settled forward,” it
will count as a swap, but if you call it a “cash-settled call option
with a strike price of $0.10,” it will count as a derivative. Those
are all the same thing, economically.)
Meanwhile the proposed 13D
rules also seem bad for activists. Not so much because they require
disclosure of 5% stock ownership within five days, but because they
change how the SEC thinks about “groups.” A group, as a technical term
in securities law, is bad. You don’t want to be in a group. If two
shareholders are part of a group with each other, then their share
ownership is added up for the purposes of the 13D rules; if I own 3%
and you own 3% and we are a group then we’re over 5% and have to
disclose our stake. We have to file our Schedule 13D jointly, which
means that we’re both responsible for what it says about how many
shares we each own and what our plans are. Even worse, if our shares
add up to more than 10%, we are subject to Section
16 rules, which limit our ability to sell the stock.
Here is how the SEC
currently defines
a “group”:
|
When two or more
persons agree to act together for the purpose of acquiring,
holding, voting or disposing of equity securities of an issuer,
the group formed thereby shall be deemed to have acquired
beneficial ownership, for purposes of sections 13(d) and (g) of
the Act, as of the date of such agreement, of all equity
securities of that issuer beneficially owned by any such persons. |
The SEC’s new
proposal would get rid of the words “agree to,” because “an
agreement is not a necessary element of group formation”:
|
These amendments would
make clear that the determination as to whether two or more
persons are acting as a group does not depend solely on the
presence of an express agreement and that, depending on the
particular facts and circumstances, concerted actions by two or
more persons for the purpose of acquiring, holding or disposing of
securities of an issuer are sufficient to constitute the formation
of a group. |
I don’t particularly know
what that means, and I don’t think anyone else does either. But it is vaguer than
the previous rule, and thus more dangerous. In particular: One thing
that activists do, when they are trying to make changes at a company,
is call up other shareholders — big institutional shareholders
who don’t do activism but who have a lot of votes — and try to
persuade them. An activist is not going to, like, sign an agreement
with BlackRock or Vanguard saying that they will work together, but
they might try to talk to BlackRock and say “this is why you
should vote with us.” Under the old rules, they could do that. Under
the new rules, where any “concerted actions” create a group, it might
be riskier for BlackRock to talk to activists. Preventing shareholders
from talking to each other is bad for activism. It is also just bad
for shareholders: If the managers can keep the shareholders separated,
then they have more power to ignore them.
Another part of the new
rules would “specify that if a person, in advance of filing a Schedule
13D, discloses to any other person that such filing will be made and
such other person acquires securities in the covered class for which
the Schedule 13D will be filed, those persons shall be deemed to have
formed a group.” The SEC refers to this as “tipping”: If I tell you
that I’m going to do activism in a stock, and you go buy the stock
before I disclose my activism, then that seems unfair to everyone
else, so the SEC will treat us as a group as a sort of punishment.
Again, though, this seems designed to scare the BlackRocks of the
world away from talking to activists: If BlackRock meets with an
activist, and the activist says “we were thinking of doing activism in
Company X, what do you think,” then is BlackRock locked up from
trading in Company X? If it buys Company X shares, is it in a group
with the activist? What if BlackRock puts out a “request for activist”
in Company X? If the company’s managers want to fight back against the
activist, can they demand records of everyone the activist talked to
in the month before buying her position? The safer move for big
institutional investors might just be to avoid talking to activists,
which will make activism much harder.
Overall the effect of
these rules seems to be to stop activists from (1) making money from
activism and (2) talking to other shareholders. And so there will be
less activism, and corporate managers will have more ability to do
what they want without listening to shareholders.
This is weird! We talked
this week about
the SEC’s huge new proposed climate disclosure regime for public
companies. Basically shareholders of public companies increasingly
pressure them to do better on environmental, social and governance
issues, and the SEC has decided that that is good. So it is helping
shareholders get some of what they want from companies (climate
disclosure), and giving the shareholders more tools to pressure the
companies to do more of what they want (lower emissions, etc.). At the
same time, though, it is reducing shareholders’ ability to actually
pressure companies: It is making activism harder, which makes it
easier for corporate managers to ignore shareholders. The shareholders
can have the ESG things that the SEC wants, but not the ESG things
that they want.
-
Or bond, etc., but here the concern is equities.
-
Or vice versa, if the investor wants to be short,
which is less relevant for activism.
-
Actually the lesser of $300 million or 5% of the
stock, with complicated rules for disclosure of combined
swap-plus-stock positions. For small companies the 5% limit is
binding and basically works like the 13D rules but with a one-day
deadline instead of five days. For large companies, $300 million
just isn’t very much of the stock.
-
Comments on the swaps proposal were due this week,
which is mainly why I’m writing about it now. You can read the
comments
here. A lot of them are from …retail investors talking
about dark pools? That has nothing to do with the proposal, but I
think GameStop may have broken the SEC’s commenting system. But
there are a lot of real ones too. I should add: There are
proposals to change the HSR rules
to exempt most shareholder activism, which I
guess would solve much of the problem here?
-
I mean, really, it can buy like $300 million on swap
at the old price and the rest at the new price (up 20%), for a
blended cost of $1.14 billion and an expected profit of $60 million
(5.3%), but these numbers are all pretty fake.
This column does
not necessarily reflect the opinion of the editorial board or
Bloomberg LP and its owners.
To contact the author of
this story:
Matt Levine at mlevine51@bloomberg.net
To contact the editor
responsible for this story:
Brooke Sample at bsample1@bloomberg.net
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