Could a national securities regulator hinder shareholder activism in Canada?

Canada is the only G20 country without a national securities regulator. Despite coordination among the provinces and territories, the current regime is often thought to encourage shareholder activism – whether by permitting forum shopping for more favourable regulations or given the reality that decentralized efforts mean scarcer resources to combat unwelcome tactics. However, after decades of discussion and debate, the Supreme Court of Canada released a decision late last year which could lead to the adoption of a single regulator, dubbed the Capital Markets Regulatory Authority (CMRA).

While the Supreme Court judgement paves the way for a pan-Canadian regulator, political and practical difficulties (including Alberta and Quebec’s continued opposition to the unified regime) suggest that it will likely be some time before expectations materialize. Nevertheless, we move one step closer to the implementation of a national regulator and relatedly, a new forum for activist investors:

  • A simplified system. Having one body oversee Canada’s capital markets means cross-border securities legislation and streamlined filings. This new framework will allow boards and activists to act quickly and in a cost-effective manner while waging, defending and negotiating activist battles. One can also expect more consistent legal reasoning (in contrast with the Eco Oro decision in which provincial bodies proffered differing views on similar points of law).
  • A platform for meaningful disclosure. A centralized regulator creates the prospect of uniform national rules, and by extension, eliminates the incentive for forum shopping. While strides have been made to require purposeful disclosure, provincial and territorial regulators have generally adopted a conservative approach. For instance, in Ontario, the call for gender diversity on boards and in executive positions was met with “comply-or-explain” requirements, as opposed to quotas. Practically speaking, if a regulator was to implement such requirements, companies refusing to comply could simply relocate to another province or territory where quotas or targets do not exist. A pan-Canadian regulator closes such loopholes and allows for more robust disclosure requirements without the fear of losing company listings. In some cases, this may strengthen the basis upon which activists build their platforms, while in others, it may rid of the need for activist efforts where they serve as a stimulus for change or increased transparency.
  • Stronger regulatory enforcement. A unified regulator equates to an increase in resources that can be devoted to investigation and enforcement. One could imagine the potential impact which stricter and more consistent enforcement might have upon activist contests. For instance, activist short-selling campaigns are on a rapid rise in Canada. Securities regulators are often called upon to investigate companies or silence short sellers whose social media commentary can now move markets. A single regulator may be empowered with a newfound authority and better equipped to investigate and respond to such allegations.
  • Slower reactions to new developments. On the other side of the spectrum, competing provincial interests within the national scheme may mean delayed responses to changes on the ground. New regulations or amendments to legislation will require approval by a council of provincial ministers and the federal Minister of Finance. Any disagreements over proposed changes may thwart the regulator’s ability to react in a timely manner and deliver corresponding guidance. This delay may prolong periods of ambiguity and leave a wide range of options for activist activity in moments of uncertainty.
  • Loss of industry-specific expertise. One of the benefits provided by the current structure is the interaction with a regulator familiar with local industries. Given the geographical concentration of certain industries, provincial and territorial regulators often have industry-specific knowledge. For instance, the Alberta Securities Commission is known for having extensive knowledge of the oil and gas industry. With the consolidation of thirteen Canadian regulators, companies and activists may encounter a panel that lacks context or specialized knowledge required to govern certain proceedings or appreciate industry dynamics.
  • Substantive changes. Some groups have critiqued the proposed legislation for failing to adopt investor protections. Specifically, initiatives previously available at the provincial level may not be assumed by the new federal body. As an example, the CMRA’s current mandate does not include financial incentives for whistle-blowers or an investor advisory panel, both of which are provincial initiatives implemented by the Ontario Securities Commission. Although the CMRA’s mandate is far from finalized, the loss of such programming may heighten the appetite for activist action.

While the Court’s decision certainly serves as a marker of change, the future of securities regulation remains riddled with uncertainty for companies, investors and activists alike. In the interim, perhaps the US experience is telling: despite having one of the strongest and most well-resourced national regulators, the US still has one of the most active markets for shareholder activism in the world. As Canada moves in lockstep with its international peers, chances are, the Canadian experience will prove similar.

Is Governance Going Green? The Influence of Environmental and Social Issues on Corporate Governance and Investing

With the heightened awareness of climate change, wage disparities, gender inequality and the like, the effects of these and other environmental and social (E&S) issues are widespread, extending as far as topics like corporate governance and investing. In fact, in its report entitled “2018 Canadian Proxy Season Review” (the Review), Kingsdale Advisors (Kingsdale) notes a belief among investors globally that “an issuer’s [E&S] activities will impact its financial returns and long-term sustainability” and furthermore, that investors view E&S issues as significant considerations when making investment decisions. The Review highlights some key trends regarding E&S governance (ESG) that appear to support these observations, including the following:

  • Demographic changes appear to influence the role of E&S considerations in investment decisions. Millennials comprise increasing proportions of issuers’ shareholders and, according to a study by the Responsible Investment Association (RIA) cited in the Review, they are 65 percent more likely to consider a company’s E&S history in their investment decisions as compared to their parents. On a similar note, other studies have shown that women, whose share of private wealth is expected to double by 2024, are more “sympathetic” to ESG issues than men.
  • Investors and shareholders in the United States and Canada demonstrate pronounced interest in E&S matters. In 2017, only four E&S proposals in the US passed whereas at the time of the Review in 2018, eight such proposals had already passed. Canada, where the market is comparatively smaller, is notably open to ESG proposals despite exhibiting a decline in the net volume of such proposals (as compared to 2017). Moreover, according to the RIA, so-called “responsible investing” comprised 38 percent of the Canadian investment industry and according to an RBC Global Asset Management survey, approximately 67 percent of institutional investors take ESG factors into consideration when investing or voting.
  • Prominent institutional investors and activists demonstrate greater support and endorsement of ESG issues and related proposals. As prominent institutional investors and activists alike increasingly recognize a relationship between ESG and positive outcomes such as long-term returns and growth, they have become more vocal in their support and endorsement of ESG issues and related proposals.

If the above trends continue, issuers may be more motivated to ensure that they are equipped with measures to effectively deal with these proposals and to continue to appeal to investors. In the Review, Kingsdale discusses some measures that issuers may employ. For example, issuers could increase transparency and disclosure to shareholders regarding their readiness for addressing E&S issues and could reconstitute their boards to ensure that they are comprised of individuals proficient in managing and responding to E&S issues. A previous post also discusses some measures that issuers can take.

In sum, looking into 2019, it will be interesting to see how issuers adapt and respond to a changing corporate environment where investors and shareholders alike appear to be more attuned to E&S issues.

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

Corporate Governance in the Age of Passive Investing

In recent years there has been a marked increase in passive investing, consisting of investing in exchange traded funds and index funds. Widely dismissed when first launched in the mid-1970’s, index funds are now estimated to account for approximately 20% of global aggregate investment fund assets. In the next five years, they are expected to surpass actively managed funds in the United States. Proponents of passive investing hailed Warren Buffet’s win of a bet against a prominent hedge fund manager that his investment in an index fund would outperform the latter’s hand-picked investments over a 10-year period as another sign that the prime days of active money management are numbered.

While index funds continue to grow in popularity amongst investors, the growing significance of passive investing has caused concern amongst some market observers over its potential systemic effects. One concern frequently raised is that passive fund managers will also be passive owners, as they do not have adequate incentives to engage with and hold company management accountable. This decline in accountability is predicted to cause corporate governance standards to slide.

Observers who believe that passive fund managers lack incentive to challenge company management typically point to several factors. For starters, passive fund managers are unable to voice disagreement with company management by selling their shares in a particular company which could diminish their leverage over company boards. Further, because passive funds principally compete with one another on management fees and invest in hundreds of companies, they have a disincentive to hire analysts to track management performance in specific companies as it would be too costly with minimal benefit.

Passive fund managers argue that despite the perceived disincentive to participate in corporate governance matters, the reverse is true. They claim that their long-term outlook requires a greater focus on corporate governance issues compared to active managers. While they acknowledge that their inability to sell shares in a specific company creates unique challenges, they suggest that their long-term ownership of assets and growing importance in the markets provides them with a number of effective strategies to solve corporate governance issues. In a recent study, Jill Fisch, Asaf Hamdani, and Steven Solomon explore these strategies, three of which are outlined below.

First, passive funds can influence governance by voting at shareholder meetings. Traditionally, it was assumed that passive funds would either neglect to vote or would simply side with company management. However, evidence suggests that passive funds cast their votes and often have a swing vote in proxy contests. Over the last few years, a number of the largest passive investor groups have supported shareholder resolutions requiring greater disclosure related to climate change, executive compensation, and gender diversity.

Second, the size of passive funds allows them to engage directly with company management. Passive funds increasingly seek ongoing dialogue with management, allowing them to influence board decision-making behind the scenes while avoiding the reputational fallout that may accompany traditional shareholder activism. Given the extent of passive funds’ shareholdings, corporations tend to be responsive to these outreach initiatives.

Third, the importance of passive funds in capital markets gives them a platform from which they can influence broader conversations about corporate governance. Passive fund managers can promote their stance on corporate governance issues through annual letters, media appearances, discussions with regulators, and lobbying efforts.

As passive funds continue to grow in size, their role in shaping conversations on corporate governance issues will further expand. Market participants, particularly company boards and activist shareholders, will need to pay close attention to what they have to say.

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


Webinar – Corporate governance, shareholder activism, and hostile M&A: Key developments in 2018 and a look ahead

Walied Soliman and Orestes Pasparakis, co-chairs of Norton Rose Fulbright’s Canadian Special Situations team, will host a 60-minute webinar on corporate governance, shareholder activism, and hostile M&A on Tuesday, February 12, 2019 at 12 p.m. EST. To sign up, please click here.

Our Special Situations team played a leading role in some of the most complex and high-profile corporate governance, shareholder activism and hostile M&A matters of 2018. The webinar will highlight some of the key trends and developments in 2018 and trends taking shape in 2019.

This will be essential viewing for directors and executives at public companies, investment management professionals, corporate and M&A practitioners, and in-house counsel–be sure to join.

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.