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

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

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

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

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

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.

Tracking the Rise of Shareholder Activism through Withhold Campaigns in North America

In a recent post about Canadian proxy contest trends, we discussed the growing concern with “The Active Passive investor” and potential issues on the horizon given a surge in the use of “withhold” campaigns. As of late, the prominence of withhold campaigns to signal shareholder discontent to boards of directors in North American markets has seen an even sharper rise.

“Withhold” campaigns

In an uncontested election of directors, management of companies solicit proxy cards or ballots that allow shareholders to either cast an affirmative vote “for” the director candidate of the board, or “withhold” their voting authority. If a shareholder chooses to “withhold authority” on a director nominee, the voting instructions are considered “no” votes, which increases the percentage of shares “withholding” and reduces the percentage of shares voting “for” the uncontested nominee. This makes it more difficult for a nominee to obtain required approval percentage to be acclaimed.

“Withhold” (or “vote no”) campaigns typically involve public solicitation of shareholders to suggest the withholding of their respective votes from some or all the board’s nominee directors. Public news releases initiating withhold campaigns range in complexity depending on the level of solicitation based on the magnitude of change desired. Beyond just signifying dissatisfaction with the board, shareholders sometimes enlist withhold campaigns to target specific directors as proxies for particular corporate governance issues.

Increasing attractiveness and popularity

A formal proxy contest provides a way to drive change, but often at a cost so great (relative to the size of an investor’s holdings) that it limits their use. Some companies restrict shareholders’ abilities to drive change by precluding participation in formal proxy contests. For these reasons, withhold campaigns have naturally become the alternative.

Passive aggressive investors use these campaigns as less disruptive ways to assert pressure on the board to reform themselves before the involvement of an activist investor – akin to a ‘friendly’ attempt to settle a grievance before starting a lawsuit. Essentially, these campaigns have become a powerful tool for catalyzing corporate change in a manner that shows there is still faith that the board will ‘do the right thing.’ withhold campaigns present a low-cost opportunity for shareholders seeking corporate change, and also create new concerns for management that may be vulnerable to shareholder action.

What to look out for

An important characteristic of withhold campaigns is that they leave the ultimate decision up to the board of directors, meaning that withhold campaigns cannot force a board to act. By the same token, the campaign’s strength is that it sends a strong message saying that there is a clear need for change on the board of directors in order to right the ship. A successful withhold campaign is likely to have affects as serious as a formal proxy contest or other shareholder action, but requires much less to be successful.

There are different ways that a corporation or a board of directors can prepare in order to optimize its response to these types of special situations. Many still choose to be more passive, which tends to involve relying on reactive proxy solicitation (essentially going to battle and fighting back), or building consensus by objectively considering the campaign’s ideas in an attempt to make the situation more cooperative.

Others may take more proactive approaches, such as regularly evaluating business lines and market regions, monitoring the company’s ownership, understanding the activists, evaluating risk factors, or even having engagement plans in place that are tailored to the shareholder base and concurrent issues that the company faces. It is becoming more common for a board of directors to increase engagement and accountability to the shareholders in an attempt to better prevent withhold campaigns.

It will be important for all stakeholders to track how this trend influences the market, and the impact it may have on how businesses prepare for shareholder activism.

The author would like to thank Daniel Lupinacci, summer law student, for his assistance in preparing this post.

“The Great White Short?” Canada Is the World’s #3 Destination for Activist Short Selling

Recently, Activist Insight released a report on activist short selling. Activist short selling is when investors publicly bet on a stock going down in value. Among other interesting trends, the report shows that Canada ranks number 3 in the world for activist short campaigns. The data suggest that Canadian companies should be on high alert about the possibility of an activist short play.

The global number of activist short campaigns is trending downward

2015 represented a high water mark for activist short selling, with 274 campaigns globally. Since 2015, numbers have trended downward, with 263 campaigns in 2016, 186 in 2017, and 40 in Q1 2018.

The reasons for this downward trend may have to do with more careful selection of targets. We have seen a similar phenomenon on the long side. The overall number of public proxy fights is generally trending downward. However, we see activists in the Canadian market being more picky about targets on the long side, and increasingly achieving settlements based on realistic potential outcomes in a proxy fight.

Nonetheless, Canada remains a hotspot for activist short campaigns

Canada saw 9 public short campaigns in 2017, placing it behind only China (12) and the United States (138). For funds in the US looking for new targets, Canada is a particularly attractive environment. Canada is geographically close and culturally familiar. It is also relatively easier for activist short sellers to take a large short position opposite a Canadian issuer, given the smaller average market caps of Canadian companies.

Activist short sellers are doing well particularly when they target smaller companies

For campaigns against companies with market capitalizations less than USD $50 million, the average one-year campaign return in 2017 was 57.8%. For companies with market capitalizations between $50 million and $250 million, that number was 34.4%. Strikingly, for companies larger than this, one-year returns on short campaigns were negative. For instance, for campaigns against companies with market caps over $10 billion, the average one-year return was -19.1%.

Because many activist short campaigns tend to be loud and splashy, and target high-profile companies, smaller issuers may not think of themselves as potential targets. This belief can be dangerous. The greater success of short sellers against smaller targets will likely encourage them to focus on smaller targets—which Canadian companies are more likely to be by US standards.

Advice for issuers

Even one tweet from an activist short seller can quickly and significantly depress the value of a company’s shares. Regardless of their performance, Canadian issuers should be prepared for the possibility of an activist short attack, and game out possible responses long before one occurs.

The authors would like to thank Bikaramjit Sandhu, summer law student, for his assistance in preparing this post.

Tracking the Rise of Shareholder Activism in Asia

Shareholder activism has steadily been on the rise in Asia in the past seven years, but is it here to stay?

According to a recent report published by J.P. Morgan in May 2018, the numbers seem to support this proposition. As outlined in the report, only 10 shareholder activist campaigns took place in Asia in 2011 — that number ballooned to 106 in 2017.

Shareholders of Asian firms have historically been reluctant to engage in public activism. There are likely many reasons for this, including, according to Chelsea Naso of Law360, the prevalence of control block shareholders in the Asian corporate landscape, which makes activist campaigns more difficult.

Two reasons why shareholder activism is on the rise in Asia

  1. An increase in Asian governmental reforms that are encouraging shareholders to take a more activist approach
  2. An influx of global institutional investors into Asia who have shown a willingness to support shareholder activism

Asian Governmental Reforms

Governments in a few prominent Asian jurisdictions have taken steps to reform regulations and protect the interests of minority shareholders. Hong Kong Exchanges and Clearing Limited finalized new rules seeking to “restrict abusive practices and protect the interest of minority shareholders.” Likewise, South Korea’s Financial Services Commission has announced plans that aim to encourage minority shareholder participation. Finally, in Japan, Prime Minister Shinzō Abe has publically advocated for corporate governance reform, which could be a boon for prospective activist activity.

The actions of regulators and government officials throughout Asia have contributed towards a changing corporate cultural landscape where activists feel more empowered to challenge the status quo of governance structures.

Attracting Global Attention

As shareholder activism demonstrates that it may improve companies’ stock performance, global institutional and activist investors have been increasingly willing to launch and/or support activist campaigns.

Examples of prominent investors engaging in Asian activist campaigns include Elliot Management’s involvement in Korea and Third Point’s activity in Japan. Furthermore, foreign funds now make up approximately 21% of investors in India, compared to 13% in 2008.

While significant obstacles still exist, including cultural factors and development of the legal framework, shareholder activism is beginning to look like it may have some staying power in certain Asian jurisdictions.  The recent rise is evident in the numbers: Asian activist activity now makes up 31% of all activist campaigns outside of the U.S., a dramatic  increase compared to 2011, when it comprised only of 12%.

If these trends persist, expect those numbers to continue to rise.

The author would like to thank Josh Hoffman, summer student, for his assistance in preparing this legal update.


Changes coming to Canadian Business Corporations Act (CBCA)

Bill C-25 received Royal Assent on May 1, 2018. The bill will amend the CBCA by: reforming certain aspects of director elections; creating requirements for public companies to disclose officer and director diversity representation; and introducing the new Notice-and-Access Regime.

While some of the CBCA amendments have come into force, many of the amendments – including those described below – will come into force on a future date. As well, certain amendments must await changes to relevant regulations. The Federal Government has published the proposed regulatory amendments and is currently accepting comments from the public. It is projected that it will take 18-24 months to develop the new regulations. In M&A deals where the target is incorporated under the CBCA, the acquirer should be aware of the implications that Bill C-25 will have on federally incorporated companies.

Changes to Director Election Process:

  • For public companies, the new CBCA rules will allow newly elected directors to hold office only until the next annual meeting. Prior to the amendments, directors could hold office for three years.
  • The voting procedure will change for certain corporations (public corporations based on the proposed regulations). There will be a separate vote for each candidate nominated for a director position, instead of a single slate vote being held for all nominated candidates.
  • The proxy form in the regulations will be amended to allow shareholders to cast votes either “for” or “against” a nominee. The current form only allows a vote “for” or a “withholding” of a vote when during majority voting.
  • When there is only one nominee per board position for a public company, the nominee will only be elected if they win the majority of votes being cast for or against them. These changes are meant to provide shareholders with greater influence in board elections. Under the current rules, a plurality system is used for uncontested elections for public companies, where shareholders can only vote “for” or “withhold” votes. The plurality voting method allows a nominee to win a board seat even if they only receive one vote for their election, with all other shareholders withholding their votes. While the TSX tried to solve this issue by requiring directors who receive a majority of withheld votes to tender their resignation, the board can reject the resignation and allow the elected director to continue to sit on the board. The new CBCA rules would apply to all public companies, not just those traded on the TSX, and they would prevent a director who fails to gain a majority of votes from serving on a board, subject to limited exceptions. Furthermore, only in particular circumstances will a single nominee be able to be appointed as a director after failing receive a majority of the votes in an election. Under the proposed regulations these circumstances include: the need to fulfill either the Canadian residency requirement or the requirement that two of the directors are not employees or officers of the company.

Diversity Disclosure Requirements:

The CBCA amendments will require public companies to provide information relating to diversity policies at every annual meeting. The information to be disclosed is the same information required under Items 10 to 15 of Form 58-101F1 (Disclosure of Corporate Governance Practices) under provincial securities rules. The difference is that the disclosure requirements will apply to the broader “members of designated groups”, which includes women, Aboriginal peoples, persons with disabilities and visible minorities. Companies that fail to adopt written policies regarding representation of members of designated groups on their boards will be required to explain to shareholders why they chose not to adopt such policies. Advocates of this change to the CBCA hope that this will increase diversity on boards of public companies. However, securities rules that required such disclosure for representation of women on boards failed to produce significant gains in gender diversity on boards in the last few years. It remains to be seen whether the CBCA changes will be more successful in creating diversity on boards of public companies.

The new Notice-and-Access Regime:

The amendments to the CBCA and the proposed regulations will allow public companies to rely more heavily on electronic means for communicating proxy-related materials to its shareholders. Shareholders will be able to access proxy materials over the internet. The Federal Government has communicated that, “until the required regulations are developed, Corporations Canada is of the view that the notice-and-access regime provides shareholders with sufficient disclosure to support applications for exemptions” from having to circulate paper copies of proxy materials and annual financial statements to shareholders.

The author would like to thank Arron Chahal, summer student, for his assistance in preparing this legal update.

The Gender Question: BC Securities Commission asks for comment on disclosure requirements with respect to board gender diversity

In late 2014, the Canadian Securities Administrators (CSA) published “comply or explain” rules regarding female representation in director and executive officer positions. The requirements were codified in National Instrument 58-101 (the Disclosure Requirements) and created a positive duty for issuers in participating jurisdictions to disclose the details of female representation, including issuers’ targets, policies, and mechanisms to address female representation in director and executive officer roles. Where issuers do not adopt such mechanisms or consider female representation, they are required to explain their reasons for not doing so. The Disclosure Requirements were adopted in all CSA jurisdictions except for BC and Prince Edward Island on December 31, 2014 (with the exception of Alberta, which did not adopt until December 31, 2016) (the Participating Jurisdictions).

Following the adoption of the Disclosure Requirements, the CSA conducted a review of the progress of female representation for women on boards and in executive officer positions. We reported on this review (CSA Staff Notice 58-309) in late 2017.

In January 2018, we posted that we expected further discussions surrounding board gender diversity in the lead up to the 2018 proxy season, with leading proxy advisory firms such as the Institutional Shareholder Services and Glass Lewis & Co. LCC adding a voting policy with respect to board gender diversity to their 2018 proxy voting guidelines for Canada.

As 2018 progresses, it is clear that discussions about gender diversity remain an ongoing area of focus for regulators. On February 26, 2018, the British Columbia Securities Commission (BCSC) published a notice and request for comments seeking input on the gender diversity Disclosure Requirements in NI 58-101 (the Consultation). Although BC has not adopted the Disclosure Requirements, BC-based TSX-listed and other non-venture issuers must comply with the Disclosure Requirements regardless, as they report in at least one of the Participating Jurisdictions.

The Consultation, which is running in tandem with consultations on the same issue by the Participating Jurisdictions, is meant to assist the BCSC in understanding the views of BC market participants as well as the benefits and challenges of diversity-related requirements. Comments are meant to discuss the Disclosure Requirements generally, and whether Canadian securities regulators should consider any further regulatory measures or actions in this area.

The Consultation is asking for some more specific inputs as well, such as:

  • the experience so far in providing information mandated by the disclosure requirements;
  • whether the disclosure requirements provide investors with the necessary information to inform their investment and voting decisions and how that information is incorporated;
  • whether corporate governance guidelines regarding gender diversity-related governance policies should be implemented and if existing guidelines are sufficient; and
  • whether issuers should be required to disclose if they have policies relating to diversity other than gender.

Based on the specific questions asked by the BCSC, it is clear that the Commission to be turning its mind to how the disclosure process can be improved and whether the tools already in existence, such as governance policies and prescribed format, are satisfactory.

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