Special Situations team publishes article on abusive short selling in Globe and Mail

Orestes Pasparakis and Walied Soliman, co-chairs of Norton Rose Fulbright’s Canadian special situations team, and Joe Bricker, associate, have published an article highlighting the growing problem of abusive short selling in Canada and calling for legislative reform. The article ran in the Globe and Mail on Saturday, January 19 and can be viewed here. 

Global and Canadian Trends of Corporate Governance in 2019 and Beyond

Recently, public company boards are facing increasing scrutiny and greater expectations from various stakeholders, particularly in light of society’s elevated concerns regarding corporate culture, gender equality and climate change and sustainability. In its report entitled “2019 Global & Regional Trends in Corporate Governance” (the Report), Russell Reynolds Associates noted that in 2019 “[t]he demand for board quality, effectiveness, and accountability to shareholders will continue to accelerate across all global markets.”  The Report discussed five major global trends that are expected to define the corporate governance landscape in 2019:

  • Improved board quality and composition continues to be the essence of corporate governance. Shareholders will continue to prefer a board that is independent, diverse, competent and subject to regular review, and push for enhancing board succession. In 2019, companies should expect shareholders to increasingly vote against the nominating committee chair if the board has no female members. With a greater focus on the board’s competencies, there will be a continued push for greater disclosure of the skills and experiences of directors relating to the company’s industry and strategy. Additionally, there is also pressure, predominantly from U.S. institutional investors, to ensure that effective board succession and evaluation practices are in place, including employing independent firms to assess board quality and effectiveness. In Canada, almost 40% of TSX-listed companies have no women on board, and beginning in 2019, proxy advisor firms, such as Institutional Shareholder Services, recommend withholding votes for directors involved in nominations for widely institutionally-held TSX-listed companies that have no gender diversity policies nor female representation on board. Furthermore, while the Canadian Securities Administrators’ instruments and policies relating to diversity speak only to gender diversity, large investors are beginning to focus on a broader level, including race and ethnicity diversity.
  • Greater emphasis on the oversight of corporate culture. Culture and reputation are significant factors in shaping the value of a company. In assessing a company’s culture, shareholders will continue to be interested in understanding how the board interacts with management, including the mechanisms in place to identify potential issues.
  • Prioritizing long-termism over shareholder primacy. Corporations are considering the demands and values of a broader set of stakeholders and incessant environment, social and governance (ESG) changes are moving corporations away from the theory of shareholder primacy. This switch follows the growing desire of institutional investors to actively collaborate with various stakeholders in an effort to produce long-term, sustainable growth.
  • ESG is a critical issue. Climate change and sustainability have become fundamental considerations in evaluating companies and making investment decisions for many investors. While in the U.S., companies are placing growing emphasis on addressing ESG issues, Canadian companies should be more proactive and should establish and develop ESG policies, and ensure that the board is qualified to assess and handle the related issues.
  • Activist investors continue to impact boards. As investors continue to implement various activist strategies to accomplish their end goals, activists are no longer being exclusively branded as hostile antagonists. Indeed, some activists are becoming more constructive with management, and more boards are becoming “their own activist”, proactively initiating independent evaluations to identify their strengths and weaknesses. In Canada, shareholder activism is increasing and while traditionally evident in industries such as basic materials, energy and banking, expansion into sectors such as blockchain and cannabis can be reasonably expected. The elevated number of proxy contests commenced by former insiders and founders is also expected to persist.

As 2019 begins, it is also worth considering what changes can be expected in corporate governance over the ensuing decade. In his paper “Corporate Governance 2030: Thoughts on the Future of Corporate Governance”, Stilpon Nestor identified four key drivers that will shape corporate governance over the next ten years:

  • Diversity. Diversity in all respects will continue to increase and “portfolio directors”, whose value lies in their ability to challenge constructively, will be increasingly prominent on boards, particularly in private companies where this practice is currently only at a baseline level.
  • Disclosure. The future of public company disclosures might become more streamlined. Private companies, in order to attract a greater number and diverse block of investors, will embrace the public market disclosure requirements, and essentially become quasi-public.
  • Data. The evolving ability of data providers to collect, organize and analyze high quality governance data will enable shareholders and potential investors to gauge a board’s efficacy through quantifiable metrics.
  • Development Financial Institutions (DFIs). The recent coordination of DFIs to develop and actively commit to better corporate governance has become a significant driver of change. Continuous improvements in this area will yield significant results in many individual investees, which in turn might serve to benefit all the companies in the investee’s immediate network.

There is no question that in the coming years there will be significant changes to the corporate governance landscape, both globally and in Canada. As we enter 2019 and look forward to the new decade on the horizon, it will be interesting to follow which predicted corporate governance trends actually emerge and which factors prove to be the greatest drivers of this change.

The author would like to thank Neil Rosen, articling student, for his assistance in writing this legal update.

Walied Soliman interviewed in “Creating a Unified Vision — How Some Activists are Working with Boards and Management”

Walied Soliman, Global Chair of Norton Rose Fulbright and co-chair of the firm’s Canadian special situations team, was recently interviewed in a piece by Skytop Strategies (view here). The piece draws on recent experiences to discuss how shareholders activists and boards often work together to achieve shareholder value after reaching a settlement and averting a proxy contest.

 

CEO Activism: A Double-Edged Sword?

In a recent study published on SSRN by the Rock Center for Corporate Governance at Stanford University, authors David F. Larcker, Stephen Miles, Brian Tayan and Kim Wright-Violich argue that CEO activism – the practice of CEOs taking public positions on environmental, social and political issues not directly related to their business – is a “double-edged sword”: CEOs who take public positions might build loyalty with employees, customers or constituents, but these same positions can inadvertently alienate important segments of those populations.

The authors – who aimed to better understand the implications of CEO activism by examining its prevalence, the range of advocacy positions taken by CEOs, and the public’s reaction to activism – canvassed all public statements in national media and corporate transcripts made by the current CEOs of all companies listed in the S&P 500 Index.

Key findings from the study include:

  • Very few CEOs take activist positions in the national media. Among S&P 500 companies, only 28% of CEOs made public statements about social environmental, or political issues either personally or on behalf of the company. Only 10% made these statements clearly on a personal basis. Among the broader set of S&P 1500 companies, the incident rate of CEO activism falls: only 12% made statements personally or on behalf of the company, and only 4% clearly made these statements on a personal basis.
  • With 50% of activities CEOs promoting an increase in gender, racial or sexual-orientation diversity or equality, diversity is the most frequently advocated issue, followed by environmental issues (41%), immigration and human rights (23%), other social issues (19%) and political issues (17%).
  • Any perception of widespread CEO activism might be driven by a few vocal outliers. Most CEOs who take positions due so narrowly regarding one or two issues. Only a few are repeat activists.
  • Although CEOs comment on public issues more frequently on Twitter than on national media, the incident rate is still fairly low. Only 11% of S&P 1500 CEOs have active personal Twitter feeds, and only 4.6% of CEO tweets can be considered activist.
  • With respect to the public’s view of CEO activism, while self-reported purchase behavior is often unreliable, the high degree of public sensitivity to CEO activism suggests that CEOs who take public positions might foster loyalty with some but inadvertently alienate others.
  • Public reaction depends on what issue the CEO activism was about. The public is most in favour of CEO activism about environmental issues (e.g., clean air/water, renewable energy, sustainability and climate change) and generally positive about “widespread social issues” (e.g., healthcare, income inequality and poverty), but least in favour of activism about contentious social issues (e.g., gun control and abortion), politics and religion.

Ultimately, the authors identify a number of important questions relevant to corporate governance that may be of interest to directors, including:

  • How widespread is CEO activism? The common perception is that CEO activism has increased, but empirical evidence suggests that CEO activism is actually a fairly limited practice.
  • How well do boards understand the advocacy positions of their CEOs? Survey data shows that the costs of CEO activism might be higher than many CEOs, companies or boards realize.
  • Are boards involved in decisions to take public stances on controversial issues, or do they leave these to the discretion of the CEO? Given that a public stance taken by a CEO has the potential to impact the commercial performance of an organization, should boards be more engaged in these decisions?
  • How should boards measure the costs and benefits of CEO activism? Should a board that determines the net impact of CEO activism to be negative prevent the CEO from being an activist, and if so, how?
  • How accurately can internal and external constituents distinguish between positions taken proactively and reactively (i.e., made in response to external criticism or pressure) by a CEO? From a board perspective, should this distinction matter?

The author would like to thank Scott Thorner, articling student, for his assistance in writing this legal update.

The Digital Dilemma: Cybersecurity and Boardroom Best Practices in the Technological Age

Earlier this year, Commissioner Robert Jackson Jr. of the US Securities and Exchange Commission declared that cybersecurity is “the most pressing issue in corporate governance today.” Indeed, widespread digitization has fundamentally transformed the way that people do business, ushering in new heights of efficiency and connectivity. It has also created significant risk management issues for public companies in all sectors, from securing consumer information to responding to data breaches.

However, despite the growth of digitization and its concomitant risks for public companies, it appears that many board members still rely on outdated and unsafe software to protect sensitive materials and respond to crises, according to a recent Forrester report titled “Directors’ Digital Divide: Boardroom Practices Aren’t Keeping Pace With Technology.”

The report’s key risk findings and corresponding recommendations are as follows:

  • Over 50% of internal board communications happen over personal email. Instead, board members should be using management/board portal software that includes features such as closed-loop chats and virtual deal rooms.
  • Almost 30% of board members reported losing/misplacing a phone, tablet, or laptop in the past year. Employing software that can wipe devices remotely is one of many strategies to help safeguard against security breaches that stem from missing tech.
  • Boards are failing to use available technology to solve governance responsibilities and attract talent. Technology can help streamline day-to-day activities, such as preparing reports and optimizing meetings, as well as big-picture governance concerns, such as understanding key risks areas and charting operations. Management software that tracks environmental, social, and governance (ESG) performance can also help bolster ESG practices, the promotion of which can draw upcoming talent.
  • In crisis situations, current technology practices are sometimes hindering as opposed to helping boards. 30% of boards experienced a crisis situation in the past two years, highlighting the need for board management software that facilitates quick action and implementation and allows for secure internal communications.At the end of the day, boards must set the tone on cybersecurity from the top down. When board members do not take cybersecurity seriously (by using unsecured, personal devices to communicate sensitive board information, for example), this increases the risk of cybersecurity incidents and sends the wrong message to shareholders and consumers. But equally importantly, it signals a lost opportunity for forward-thinking, proactive leadership. In an era of increasing scrutiny on cybersecurity-rated issues from governments and regulators, board members should be leveraging their positions and influence by leading the way on best practices for cybersecurity and data protection.

Click here for more information about cybersecurity and data protection in Canada, including a video on Canada’s new Digital Privacy Act and how it will impact public companies.

In the face of cybersecurity risks, boards that are committed to good corporate governance and prudent risk management should think about using suitable governance technology and implementing enterprise governance solutions to provide oversight and ensure data privacy. In a previous post on this blog, we outlined steps that boards should take to prepare for cybersecurity crises before they arise.

The author would like to thank Sarah Pennington, articling student, for her assistance with this legal update.

Holding up the deal: the threat of “bumpitrage” to M&A

Considering the robust global M&A markets of the last few years, it is unsurprising that activist investors have increasingly sought to leverage these transactions for their own gain. To that end, shareholder activists have developed a variety of M&A-related strategies. Most commonly, they either seek to catalyze transactions by pressuring companies into a merger or acquisition, or to scupper deals that would otherwise have gone ahead. Another commonly-used strategy involves agitating for better deal terms. Often referred to as ‘bumpitrage’, the activist investor purchases shares in a company that is subject to a takeover bid, and then rallies other shareholders around the idea that the current bid is insufficient and ought to be renegotiated. In many cases, the mere threat of obstructing shareholder approval is sufficient to motivate a target board to renegotiate the equity terms of the deal.

The rewards of a successful bumpitrage campaign can be significant: research conducted by Activist Insight reveals that between 2013 and 2017, 18 successful campaigns led to an average increase in consideration of approximately 21%. Yet this approach is not without risk. In the majority of cases, bumpitrage campaigns did not meaningfully improve the initial deal terms offered. Occasionally, these campaigns even resulted in worse deal terms.

Advocates of the strategy claim that in the right circumstances, bumpitrage protects shareholders of target companies by ensuring that bidders pay a fair price for their acquisitions. Proponents also claim that successful campaigns may result in target boards negotiating their initial deal terms more aggressively. Conversely, detractors warn that on a systemic level, the practice is likely to have a chilling effect on M&A, as bidders face additional risk when approaching targets.

Regardless of its circumstantial or systemic merits, the number of bumpitrage campaigns will likely increase in the future. In Canada, a strong M&A environment coupled with changes to Canadian takeover bid rules (available here) have created favourable conditions for this strategy. The minimum bid periods set out in NI 62-104 mean that opportunistic shareholders benefit from minimum periods of time during which they can try to convince fellow shareholders of their story. Moreover, in recent years the Canadian market has drawn increased attention from sophisticated US activists who are often better positioned to identify M&A opportunities.

Canadian boards therefore need to understand and plan for both M&A-related activism generally and bumpitrage specifically. Fortunately, company boards can look to a number of tried-and-true defence strategies developed in the context of M&A activism (some of which are outlined here). What underlies these various strategies is the need to sell existing shareholders on the board’s larger vision before, during, and after the announcement of a transaction. When a board facilitates frequent and open discussion with existing shareholders, and is responsive to any concerns raised, activist investors will face an uphill struggle in holding up transactions.

The author would like to thank Felix Moser-Boehm, articling student, for his assistance in preparing this legal update.

Implications of the Collaborative Model of Corporate Governance

In a recent paper, Jill Fisch and Simone Sepe outline a new model for corporate governance: the Insider-Shareholder Collaborative model.

A Shift Towards Collaboration

Two models have previously dominated the corporate governance discourse: (i) the management-power model and (ii) the shareholder-power model. The former emphasizes a board’s decision-making authority as the corporation’s essential coordinating and monitoring system, the latter emphasizes enhanced shareholder power as the means to hold insiders accountable.

The authors argue these models are outdated since both assume insiders and shareholders are engaged in a struggle for power, when increasingly, the insider-shareholder relationship is collaborative rather than competitive.

The argument is based on the fact that corporate governance has grown increasingly “knowledge intensive” and it is unlikely that any one individual/organization possesses all relevant information required to respond to business challenges. They argue insiders no longer have more information than outsiders and that shareholders often bring new information and insights to the decision-making process. Insiders and outsiders possess partial information not available/known to the other, and aggregation of such information generates value to the firm. Thus, they argue, this trend offers a mechanism for enhancing value, which neither unilateral decision-making model provides.

Flaws in the Collaborative Model

The authors do identify two main risks inherent in this model: (i) misuse of information; and (ii) conflicts of interest. The authors acknowledge there are opportunities for insiders and shareholders to exploit collaboration and further their own interests. For example, shareholders might use information to obtain trading advantages or engage in collusion to the detriment of other stakeholders.

The authors argue that confidentiality agreements and fiduciary duties can be used to help mitigate the foregoing risks. However, upon consideration of the proposed solutions it appears these tools are insufficient.

Confidentiality agreements, for example, inadequately address how a shareholder may use inside information – these instruments limit a shareholder’s ability to share or otherwise disclose valuable information, however, it would be difficult to monitor how possessing such information directly or indirectly influenced their trading activities. While this gap may be bridged by imposing fiduciary duties to prohibit misuse of information or prevent action that conflicts with the best interests of the corporation, in reality, imposing fiduciary duties upon shareholders is not feasible. Shareholders would never be able to discharge  their fiduciary duties to multiple corporations simultaneously. Therefore, to comply with fiduciary duties under the proposed model, shareholders would necessarily be restricted in their ownership choices. Those shareholders with the newly imposed fiduciary duty would also become accountable to all other shareholders relying on their decision-making capabilities, making their role look more similar to that of an insider (with checks on its power), which negates the concept of the collaborative model.

While it is clear that there is a trend toward collaboration between insiders and shareholders in the context of corporate governance, the matter remains complex and is not easily classifiable as either purely collaborative or competitive.

Digitizing Board Meetings

In the day and age of virtual reality and delivery dinner at the click of a button, it seems almost comical to think that we use sliced bread to explain an invention’s usefulness.

Given today’s unprecedented surge in technology, it is perhaps unsurprising that the EY Center for Board Matters (“EY”) reported digital transformation as one of the most important priorities for boards. However, while it may be tempting for boards to focus on emerging competitors, tech-savvy employees, and the onset of new risks, this transformation can – and maybe should – include digitizing board meetings. Implementing board portals, digital voting, and digital minute-taking procedures are 3 simple transformations that can help increase efficiency.

  1. Board Portals

EY describes a board portal as a collaborative software tool that allows board members to communicate and share documents with one another. The benefits include:

  • Efficiency and Convenience. Central storage of information allows board members to access documents quickly and conveniently. Most portals can be accessed at any time using mobile apps or browsers.
  • Portals can operate as proof of decision-making processes and archives of meeting records.
  • Increased Security. Rather than having board documents at risk when stored on unsecured email accounts, board portals offer security and confidentiality features, including restricted access rights and encryption.
  • Cost Savings. Board portals allow all board members to simultaneously view recently up-to-date documents. The need for printing and binding, and consequently the associated financial and environmental costs, are therefore reduced.
  • Increased Participation in Meetings. Subject to restrictions in the corporation’s by-laws, some portals offer features that allow participants – who may otherwise be unable to attend in person – to join meetings electronically. Improved accessibility can lead to increased participation and more diverse ideas.
  1. Digital Voting

Traditionally, voting takes place by show of hands. Digital voting – the use of technology to cast, count, and record votes – offers many benefits and should be considered as part of a board’s digital transformation.

First, Escribe suggests digital voting enables members to vote for the option they truly think is in their constituents’ best interest. The concern that members may be influenced to vote a certain way “just because everyone else is” is thereby mitigated, and democratization is simultaneously encouraged.

EY identified several other advantages. For example, digital voting can be advantageous when boards are required to make quick decisions. Unhindered by requirements for geographic proximity, digital voting enables board members to vote from anywhere at any time, which is increasingly important in today’s fast-paced and globalized world. Further, making greater use of alternative voting procedures can assist boards in meeting audit-proof documentation requirements. Results are electronically counted and captured, reducing any room for human error.

Before implementing digital voting procedures, board members should be aware of any voting restrictions in the organization’s corporate by-laws.

  1. Digitized Minute Taking

Maintaining accurate minutes at board meetings is important to serve as both a record of legal compliance and a record of what the board has accomplished over a period of time. To make this traditionally labour-intensive task more efficient and accurate, minute taking software incorporates various features to promote accuracy and organization. For example, Diligent, which provides minute taking software for boards, offers the following tools (among others) with its minute-taking software:

  • A feature that adds folder tabs for each meeting topic;
  • One-click access to prior meeting minutes; and
  • Task notification features.

Conclusion

Where these tools fall relative to sliced bread is a subjective determination. However, objectively speaking, digitizing board meetings through the use of board portals, digital voting, and digital minute taking can lead to increased efficiency and reliability. Before implementing any such procedures, however, be sure to consult the company’s by-laws to ensure there are no restrictions.

The author would like to thank Elana Friedman, articling student, for her assistance in preparing this legal update. 

Kingsdale Releases 2018 Proxy Season Review

Kingsdale Advisors has released its annual Proxy Season Review for 2018. The Review examines trends observed in 2018, predicts issues on the horizon, and provides advice to both issuers and activists in the marketplace.

In what follows, we pick out just a few of the important trends that emerge from Kingsdale’s analysis. The complete report can be viewed here.

Public activist activity remains healthy

Kingsdale counts 29 public proxy contests for the year to date. Though not reaching the high-water mark set in 2015 (55), the 29 public fights so far this year are up by 38%, as compared to the same juncture in 2017 (21).

While public agitation may be less prevalent, behind-the-scenes activity remains as robust as ever. These facts are likely related. Kingsdale estimates that just one third of proxy fights ever become public. Yet it is not clear that this trend toward settlement will continue. Issuers may be increasingly alert to activist campaigns not seriously mounted. Of 50 shareholder proposals submitted so far this year, just one passed (with the rest either failing a shareholder vote, or being withdrawn before such vote). If issuers become less willing to entertain settlement at the first approach of an activist, it is likely that more activist activity will either become public or not occur at all.

Activists are winning less

So far in 2018, activists in Canada have won 50% of proxy contests, compared to a 63% success rate in 2017. This is in marked contrast to the US activist win rate of 72%. It is clear that public companies are becoming increasingly well-defended, and small companies are taking additional pro-active steps to defend themselves.

The relative success of management and activists tends to move in cycles as each side adjusts its tactics for the next proxy season. Kingsdale notes that some of the discrepancy between Canada and the US may be explained by the fact that US activists tend to be better capitalized, and tend to have less power to agitate under US corporate laws (effectively raising the threshold of seriousness for campaigns to go public).

Materials and energy sectors remain top battlegrounds; REITs, and cannabis companies may be next

Given the predominance of energy and resources in the Canadian economy, it is not surprising that these sectors typically account for about half of Canadian proxy fights. Of 94 fights since 2016, over 55% were contained to these two sectors. To date, 2018 has been no different, with 38% of proxy contests in the materials sector and 17% in the energy sector. However, activist success rates in the energy sector have declined significantly from 50% in 2017 to 0% in 2018, and in the materials sector from 77% to 40%.

Kingsdale points to REITs and cannabis companies as potentially ripe targets for activist activity. With cannabis companies in their infancy, volatility, undeveloped corporate governance best practices, and changing shareholder bases may lead to increased activist scrutiny. Similarly, REITs may be vulnerable to activist overtures as a function of their unique statutory regime, management structure and flow-through characteristics.

Instances of activists seeking majority slates continue to trend upward

In 2015 56% of activist campaigns sought to replace a majority of directors. That number has trended up every year since 2015, reaching 79% in 2018 to date. Yet in every year since 2014, activists have enjoyed more success when seeking a minority slate. So far in 2018, minority campaigns won 75% of the time. Majority campaigns won just 33% of the time.

These numbers make clear that activists should carefully consider what they truly need in order to achieve their goals. A minority slate willing to work patiently and constructively with incumbents to increase performance for all shareholders can often be just as effective as majority control—and in any event, is more likely to be the basis for a successful campaign.

Activist Insight Monthly features interview with Co-Chairs of Canadian Special Situations team

This month’s edition of Activist Insight Monthly, which focuses on Canada, features an in-depth interview with Walied Soliman and Orestes Pasparakis, Co-Chairs of Norton Rose Fulbright’s Canadian Special Situations team. The interview focuses on recent trends our team is seeing in the Canadian marketplace, including activist short selling, settlements, and the continued rise of “nice” activists.

The publication can be found here (sign-up required).

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