Hedge funds as activist shareholders

Transcription

1 Hedge funds as activist shareholders by Hansjürg Appenzeller and David Oser, Homburger AG Shareholder activism by hedge funds is controversial. A recent study (entitled Hedge Fund Activism, Corporate Governance and Firm Performance by Randall Thomas, Alon Brav, Wei Jiang and Frank Partnoy) suggests that the mere announcement of hedge fund activism tends to add 5% to 7% to the target's share price and to outperform the market. This is in part because other activist shareholders pile in when a campaign has been mounting by one of their kind (the wolf pack approach). Even though conclusions about the long-term impact of hedge fund activists are far from being universal, there is, according to said study, no empirical evidence for the assertion that hedge fund activism destroys value or is short term in focus. Hedge funds are believed to play an increasing role in the investment and shareholder activist community for some time to come. Estimates suggest that approximately 5% of the over 10,000 hedge funds worldwide (with assets exceeding US$1.5 trillion) pursue activist strategies. Emergence of hedge fund activism Shareholder activism said to help overcome the classic agency problem of publicly held companies covers a broad spectrum of activities and takes a variety of forms. It ranges from private discussions or public pressure on targets to change the business strategy, to force a sale, to alter the capital structure (e.g., share buybacks or extraordinary dividends, sale or spin-off of non strategic business, etc) or to change the leadership, to proxy contests, and to litigation against present or former management or board members. In fact, the threat of litigation is sometimes an essential part of the activist strategy. The activism is supposed to enhance the value for shareholders. Hedge funds target undervalued companies. They slowly start acquiring shares of the company in the Hansjürg Appenzeller David Oser Hansjürg Appenzeller, Partner tel: +41 (43) hansjuerg.appenzeller@homburger.ch David Oser, Associate tel: +41 (43) david.oser@homburger.ch

2 market. Once they have a substantial stake in the firm they start demanding changes in the company policies or strategies from the management. Sometimes, arm twisting methodologies may also be employed in order to get the company at the table or to accept the changes being suggested. The increased shareholder activism in Switzerland is visible in two trends: First, hostile takeovers which made high profile entries in the Swiss market for corporate control in 2005 are definitely here to stay. Various high profile takeover battles were fought since then. Second, corporate litigation has become more common, either because involuntary targets tried to keep away hostile bidders or because minority shareholders have started to exercise their rights in takeover offers and statutory mergers. Legal framework Disclosure obligations If a hedge fund (directly, indirectly or in concert with a third party) acquires or sells securities in a Swiss company listed on a Swiss exchange and as a result reaches, exceeds or falls below certain thresholds of voting rights, these holdings must be notified to the target, the relevant exchange and the market. The thresholds are 5%, 10%, 20%, one-third, one-half and two-thirds (in addition, probably as of December 12, 2007, 3%, 15%, 25%). Apart from all classes of shares of the target carrying voting rights, whether listed or not, other securities and transactions are to be included for determining the size of the shareholdings: Derivatives: The acquisition or sale of conversion and share acquisition rights (e.g., call options) and or the granting (writing) of share sale rights (e.g., put options) have to be reported. It does not matter whether the derivative is settled in cash or physically settled. It should be noted that the calculation of positions involving derivatives can be tricky and may require a detailed analysis. Execution of acquisition and sale rights: A new obligation to notify arises if the shareholding reaches, exceeds or falls below a threshold percentage in the event of their exercise or non-exercise as well as the execution or non-execution of such rights. There may be even a reporting obligation if options expire. Conversion rights: The exercise of conversion rights or rights to acquire shares are considered to be share acquisitions. Share lending/repo transactions: If the share lender no longer owns the securities and has no entitlement to vote, while the share borrower acquires voting rights but no economic ownership, such share lending will result in a disclosure obligation (see also REPO transactions, provided that the acquirer of the securities can exercise voting rights). Other separation of economic ownership from voting power: There are other ways to decouple votes from economic ownership. However, hedge funds cannot have undisclosed economic ownership if they have shed the formal voting rights to another market participant. In general, the shareholdings or economic interests in shares or other securities are aggregated in the following instances: Acting in concert, organised groups: If investors coordinate their conduct by contract or by any other organised proceeding, they are held to be acting in concert or as an organised group. Investment funds: With regard to domestic and foreign investment funds, the investment manager must notify globally the holdings of all shareholdings of the funds under its management. Information about the identity of investors is not required. The intentional failure to observe any substantial shareholder reporting requirements constitutes a criminal offence under Swiss law. The maximum penalty amounts to the double of the purchase price or the sales proceeds. The fine is calculated on the basis of the difference between the equity interest newly held by the person subject to a reporting obligation and the last threshold reported by such person.

3 Mandatory offer obligations If a hedge fund acquires shares, directly or indirectly, taking its holding (or its holding combined with any concert party) to one-third or more of the voting rights of the target (whether or not such voting rights may be exercised), it will have to make a mandatory offer for all listed equity securities of the target (subject to an opting out or opting up as set out in the target's articles of incorporation). The obligation to make a mandatory offer is only triggered if a share purchase is completed. Insider and market abuse restrictions Under certain circumstances, an activist hedge fund is barred from dealing in the target's shares if such share dealings constitute a violation of the applicable provisions on insider trading dealing and of market abuse rules. As a general rule, stake building does not qualify as breach of insider dealing nor price manipulation rules. Legal tools to influence strategy and management The following summary of minority shareholders' rights is not exhaustive but focuses on rights which entail a certain nuisance potential. Rights of shareholders outside shareholders' meetings One or more shareholders representing together at least 10 % of the share capital or representing shares of a par value of SFr1m (subject to lower thresholds as set out in a target's Homburger AG Weinbergstrasse CH Zürich P.O. Box 338 CH Zürich Phone Fax lawyers@ homburger.ch Since its establishment in 1957, Homburger has advised and represented Swiss and international corporate enterprises and individual entrepreneurs on key aspects of business law. We offer our clients expert legal advice, support them in business negotiations, represent them in court, and protect their interests in civil and administrative proceedings. We are commited to finding and implementing solutions to the complex legal issues facing corporations and entrepreneurs. Homburger has six practice groups integrating the skills and experience of lawyers focusing on specific areas. The main practice areas are corporate and commercial law, mergers, acquisitions and corporate restructuring, securities and corporate finance, private equity, banking, litigation and arbitration, insolvency law, intellectual property, copyright, competition and media law, telecommunications and IT-law, tax law, business succession planning, wills and foundations.

4 articles of incorporation) in the target may request the calling of a shareholders' meeting and may request items to be included in the agenda, respectively. Further, prior to the shareholders' meeting, an activist shareholder may submit explanations to its own motions and to motions of the board of directors (e.g., explanation why chairman and CEO functions should be separated). Rights of shareholders at shareholders' meetings During the meeting of shareholders, every shareholder has the right to vote, the right to speak, the right to submit motions (with regard to agenda items) and the right to raise objection against unauthorised attendance in the meeting of shareholders. At the shareholders' meeting, any shareholder has a right to make motions within the scope of agenda items. As a rule, resolutions may not be passed on agenda items which have not been duly announced in the invitation to the shareholders meeting. For instance, if new board members are put up for election, the agenda item for this election is often listed as item Elections to the Board of Directors. It has not been ruled yet by courts whether the chairperson may refuse to hold a vote on a motion of a shareholder to remove any or all of the current members of the board of directors under the agenda item Elections to the Board of Directors. Information rights of all shareholders All shareholders have the right to request information from the board of directors, subject to business secrets or other legitimate interests of the company. If the information is being refused without reason, a court may order the company to provide information to shareholders. Every shareholder may request the meeting of shareholders that certain facts be subject to a special audit if this is necessary for exercising shareholders rights and if the right to information has previously been exercised, but not been satisfied. If the meeting of shareholders does not approve the motion to appoint a special auditor, shareholders who represent together at least 10% of the share capital or shares with a par value of SFr2m may request the judge to appoint a special auditor. Right to request dissolution Shareholders representing together at least 10% of the share capital may request to dissolve the company if they submit valid reasons. Blocking power Shareholders representing more than 33 1 / 3 % of the voting rights represented in the meeting of shareholders have the power to block certain important decisions (e.g., capital transactions, mergers, spin-offs, etc). Nuisance power Activist hedge funds often get involved in various legal disputes. While these disputes are usually an adjunct to an overall activist strategy, litigation is sometimes an essential and effective part of the activism. In our experience, the main purpose of intervention is to delay the transaction process to the fullest extent possible and by that to improve negotiation power. The following legal challenges are conceivable for activist hedge funds: Challenging shareholders resolutions which allegedly violate the law or the articles of incorporation. Freezing entries in the commercial registers: Register freezes can be obtained against the registration of certain resolutions of the shareholders meeting which become legally effective only upon registration with the commercial register (e.g., amendments to the articles of incorporation, alteration of the capital structure, merger and spin-off transactions). They are efficient and effective means to intervene in, and delay, corporate actions (e.g., completion of capital increases or of mergers, etc). Blocking merger or spin-off transactions: The Swiss Merger Act provides for three court actions in merger and spin-off situations besides the freezing of the registration in the commercial register as described above and prohibition actions by employees: appraisal action (focus on consideration, no impact on legal

5 effectiveness), challenge action (if Swiss Merger Act is violated) and responsibility action (against responsible persons involved). Blocking takeover offers: request the Federal Banking Commission to reject any (positive) recommendation of the Takeover Board and to issue provisional measures suspending the offer; appeal to the Swiss Federal Supreme Court against such decisions; civil law actions requesting the suspension of the offerors voting rights and/or claiming damages; upon settlement of the offer, the shareholder may exercise its rights as a minority shareholder (see above). Potential liability of the members of the Board and of the Executive Management in the exercise of their day-to-day duties: The members of the executive management are personally liable not only to the company, but also to each shareholder (and, in bankruptcy, to the creditors) for any damage caused by intentional or negligent violation of their duties. The same rules apply, by and large, to the members of the board of directors. Shareholders and creditors who suffer a direct loss may sue in their personal capacity for monetary compensation (direct action). Further, if the company suffered a loss due to the violation of corporate duties, the company, each shareholder and (in bankruptcy) the creditors are entitled to claim monetary compensation for payment to the company (a type of derivative action). Contact us: Homburger AG Weinbergstrasse 56 58, P.O.Box 358, CH-8035 Zurich, Switzerland tel: +41 (43) fax: +41 (43) web: info@homburger.ch

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