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

By Trevor Zeyl on October 22, 2018 Posted in Compliance, Shareholder Activism

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

By Amanda Ferriss (Toronto) on October 12, 2018 Posted in 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

By Victoria Riley (Toronto) on October 2, 2018 Posted in Corporate Governance, Securities, Uncategorized

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.

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.

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.

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

By Joe Bricker and Peter Valente (Toronto) on September 28, 2018 Posted in Proxy Battles, Securities, Shareholder Activism, Uncategorized

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

By Joe Bricker on September 20, 2018 Posted in M&A, Proxy Battles, Shareholder Activism, Short selling

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).

Norton Rose Fulbright’s Canadian Special Situations Team ranks in the top 10 of global legal advisors for shareholder activist campaigns

By Trevor Zeyl on September 4, 2018 Posted in Proxy Battles, Shareholder Activism

Global law firm Norton Rose Fulbright’s Canadian Special Situations Team has ranked in the top 10 of global legal advisors advising both companies and activists in shareholder activist campaigns and is the only Canadian firm to be represented on the global ranking.

To view the Global Shareholder Activism Scorecard, please click here.

The Buyback Bonanza Makes a Return

By Geoff Mens and Robert Corbeil (Toronto) on August 27, 2018 Posted in Corporate Finance, Securities, Shareholder Activism

Recently, there has been a trend among both Canadian and United States companies to buy back their shares in order to boost stock prices. In the past – most notably during the “Buyback Bonanza” of 2007 – this strategy has been employed by companies as a mechanism to decrease the amount of outstanding shares, thereby increasing the value of the stock.

For years some have criticized share buybacks, asserting that focusing on short term increases in stock prices and profits is detrimental to long term economic growth. They argue that as individuals invest more in the short term, there is less investment to be made in capital improvements such as factories and technology. In their view, this has two negative implications: less investment translates to decreased earnings in the long-term and decreased future growth.

Others argue that short-termism is not a problem or, to the extent it is, is not as harmful to the economy as once believed. Statistics demonstrate that business investment in the U.S. has remained stable between 11-15% of GDP since 1970. Further, many argue that it is in fact economically efficient for executives to invest in their own companies provided that they perceive it to be the most appealing investment opportunity at the time, because companies in turn distribute this capital back to their shareholders who will then reinvest into the market.

However, in many cases, diminishing returns have caused investors and analysts to wonder whether buying back shares is an effective, long-term strategy. While the strategy may be rewarding for companies that demonstrate high sales and earnings growth independently of this tactic, other companies have not been able to reap the rewards of high share prices, despite large sums being spent on buybacks. As a result, analysts have suggested that perhaps that money would be better spent on capital improvements, such as better technology.

In spite of these concerns, we are seeing a strong resurgence in buyback activity in both the US and Canada. In the US, rates are expected to exceed those seen in 2007, where share purchases among S&P 500 companies hit a record number of $589.1 billion. The S&P 500 Buyback Index, which tracks the performance of the top 100 stock repurchasers, has gained only 1.3% this year, which is well under the performance for S&P 500 companies.

In Canada, while data are not as readily available, the trend is especially noticeable in the oil and gas sector, given the relatively low current stock prices in this industry. As the Financial Post has reported, a “disconnect” between depressed equity prices coupled with rising oil prices are spurring significant buyback activity among numerous Canadian oil and gas companies, particularly in Calgary-based companies. Further, the persistent downturn in the industry has motivated companies to reduce operating costs, which has in turn generated free cash to support buyback activity.

The trend is not limited to the oil and gas sector, either: in 2017 and 2018, prominent issuers in other industries also announced a share repurchase program (instance, in the financial services sector, as the Financial Post has also reported).

While both Canada and the United States seem to be following a similar path on this trend, it is important to reflect on whether the difference in Canadian issuer bid rules and the American voluntary safe harbour provision for stock repurchases – namely, Rule 10b-18 – might impact future activity. Both jurisdictions have implemented limitations on the percentage of share repurchases in a given period of time; however, the limitations of the U.S. are less stringent in that the restriction is on a daily basis. This means that while an issuer’s purchase cannot exceed 25% of the average daily volume, this cap resets the following day. The rules on normal course issuer bids in Canada on the other hand, only allow an issuer to repurchase either 5% of the outstanding shares or 10% of the Public Float, whichever is greater. So far, these differences do not seem to be having a major impact as both countries are seeing the stock buyback trend, but it is worth paying attention to in the coming months.

Overall, the strategy can be a risky one. Indeed, the “Buyback Bonanza” in 2007 was just before the stock market underwent its worst state since the Great Depression. This means that companies should be cautious in resorting to this strategy and consider the (possibly detrimental) consequences. Companies considering buying back shares in the face of distressed balance sheets or minimal free cash should be especially wary of potentially adverse outcomes.

The authors would like to thank Saba Samanianpour and Jessica Silverman, articling students, for their assistance in preparing this post.

Exploring the Link between Gender, Governance, and Shareholder Activism

By Kaitlin Shung on August 10, 2018 Posted in Corporate Governance, Shareholder Activism

A study conducted by global consultancy firm Alvarez and Marsal (A&M) showed that companies with more women on their boards attract fewer activist investors. In particular, the study, which surveyed 1,854 public groups, revealed that companies not targeted by hedge fund activists had on average 13.4 per cent more women on their boards.

Despite being a European study, it appears that the push for diverse governance only seems to be getting stronger across the world, and Canada is no exception. With the passage of Bill C-25, all CBCA companies with publicly traded securities must now disclose how many women and visible minorities are on their boards. In addition, global proxy advisors Institutional Shareholders Services and Glass Lewis have committed to withholding vote recommendations for the Chair of the Nominating Committee (or Chair of the Board) if a company does not have women directors on its board or if it has not adopted a formal written gender diversity policy. Thus, it is important that the boards and management of Canadian companies acknowledge the significance of these trends.

The study highlights an important correlation between women and shareholder activism, and while we do not know if it is causal, there is good reason to believe it could be. The relationship, we think, lies in company performance. Shareholders do not necessarily place emphasis on the ascriptive characteristics of their directors as much as they do the enhancement and profitability of the companies in which they invest. Harlan Zimmerman, a senior partner at Europe’s largest activist investor, Cevian Capital, explained that “boards with a greater percentage of women are not only likely to be more diverse in their thinking, but, by definition, they are less likely to function like an old boys’ club” and that “both of these should contribute to, on average, better performance.” Furthermore, with the additional barriers that women have to overcome to become CEOs, women CEOs can appear to be more competent and women-led firms are thus seen as better managed. Diversity of experience and thought also leads to better risk management and more innovation. With all of these benefits becoming increasingly understood in corporations, if a board has no women on it, it is easier for activists to depict a company as out of touch and use that as leverage to get their foot in the door.

This study emphasizes yet another reason why boards should prioritize diversity in their long-term strategic thinking. Diversity is becoming an increasingly important part of discussions around corporate governance and activists may use this as an opportunity to advance their platforms. It is important that boards and management be attuned to this reality as societal norms around inclusion continue to progress.

The author would like to thank Basmah Osman, summer law student, for her assistance in preparing this post.

OSC Statement of Priorities

By Danny Urquhart on July 27, 2018 Posted in Corporate Governance, Proxy Battles, Shareholder Activism

On July 5, 2018, the Ontario Securities Commission (“OSC”) released its annual Statement of Priorities (the “Statement”) for the financial year to end March 31, 2019. The Statement outlines the most pressing issues that the OSC hopes to address in connection with the administration of the Securities Act, regulations and rules.

While investor protection is a major focal point of the Statement, the OSC also addresses a number of issues that pertain to shareholder rights and proxy contests. As discussed in a previous post, there is a looming question as to whether regulators will implement requirements regarding “say on pay” and executive compensation. In the Statement, the OSC declared that it will not take any imminent action to implement “say on pay” rules, however, they remain committed to monitoring shareholder democracy activities and will continue to evaluate whether there is a need for further action.

Another priority for the OSC is to continue exploring the possibility of required disclosure of environmental, social and governance (ESG) factors that measure the sustainability and ethical impact of an investment in a company. Disclosure of ESG factors is currently used as a method of attracting new investors, however, mandatory disclosure could change the dynamic of this new trend of socially conscious investing.

Consistent with its previous statement, the OSC will continue to focus on diversity issues faced by Issuers, particularly the Women on Boards and Executive positions initiative, in the upcoming financial year. Recent developments in securities regulation, including the “Comply or Explain” disclosure requirements in National Instrument 58-101, have supported this movement toward inclusivity. Going forward, shareholders may soon see more female representation when it comes time to elect their Directors.

Although the OSC will not take immediate action on the issues discussed in this post, it continues to monitor shareholder activism and proxy activity, leaving open the possibility for reforms in the future.

The author would like to thank Tegan Raco, summer law student, for her assistance in preparing this post.

Fee-Shifting By-Laws in Canadian Shareholder Litigation

By Michael Viner (Toronto) on July 23, 2018 Posted in Corporate Governance, Proxy Battles, Shareholder Activism

A fee-shifting by-law in the shareholder litigation context, “obligate[s] the plaintiff-shareholder to reimburse the corporation’s expenses (including attorneys’ fees and other costs) when the plaintiff [is] unsuccessful in litigation.”

Shareholder litigation in the United States operates under the “American Rule” which provides that each party is responsible for their own attorney’s fees. Unlike South of the border, in Canada lawyers’ fees are largely recoverable by the prevailing party. The 2008 financial crisis escalated the number of shareholder-initiated suits, especially in the United States. To address this, American corporations have attempted to avoid bearing the cost burden of unsuccessful shareholder initiated litigation. One method which proved successful for ATP Tour Inc. was a fee-shifting by-law. This by-law was unilaterally adopted by the board of directors without express shareholder consent. The purpose of the by-law was to force the shareholder-plaintiff to accept the financial risk when commencing unsuccessful litigation against the corporation.

While fee-shifting by-laws were initially upheld by the Delaware courts in ATP Tour Inc v Deutchser Tennis Bund in 2014, it did not take long for the legislature to respond. After significant controversy and the adoption of similar by-laws by 70 public companies, legislative changes expressly prohibited the use of fee-shifting by-laws.

The introduction of a balanced, as opposed to one-sided, fee-shifting by-law has the ability to deter non-meritorious claims while encouraging meritorious ones. This is much like the Canadian system in which both parties risk legal costs when claiming or defending an action. This is in contrast to the fee-shifting by-law in ATP Tour. In that case, the fee shifting by-law discouraged even claims with merit: the plaintiff-shareholders were unable to recover costs even upon success and were forced to bear the burden of legal costs even if they were partially successful. The all-out ban put in place by the legislature is on the opposite end of the spectrum. Prohibiting either party from benefitting from success in litigation does not provide an early filter for non-meritorious claims.

As mentioned above, Canada ascribes to the “loser pays” model. As a result, concerns about a “chilling effect” on meritorious claims may not have the same ground in Canada for striking down fee-shifting by-laws. However, there still may be room for fee-shifting by-laws in Canada. The attorney fees recovered are almost never on a “full indemnity basis” and generally are within the range of 50-80% (partial to substantial indemnity). This means that a fee-shifting by-law has the potential to ensure full indemnity recovery, if enforceable. That being said, unlike in the U.S., in the Canadian context, an amendment to the by-laws requires the confirmation of shareholders. Therefore, even if a corporation were to adopt a fee shifting by-law, it is unlikely that the corporation’s shareholders would confirm such.

To date, a fee shifting by-law has yet to be tested by the Canadian courts in the context of shareholder litigation.

The author would like to thank Kiri Latuskie, summer law student, for her assistance in preparing this post.