Friday, September 19, 2008

Argument on Reimbursements For Proxy Contests Opens the Door for Stockholder-led Bylaw Provisions

This post was provided by Marc Weingarten, a Partner at Schulte Roth & Zabel in their Business Transactions and Investment Management Groups, and a member of the firm’s Executive Committee. Marc is one of the leading lawyers representing activist investors, and has advised on many of the most significant activist campaigns in recent years, including: Jana Partners and SAC Capital with Timer Warner; Trian Group with Heinz; TCI with CSX; and Pershing Square with McDonald’s and Target Corp.

SRZ frequently issues a report on activist investing developments for their clients. The most recent issue (which also features this article) can be viewed here. Other items covered in the issue include recent developments in stockholder's rights to demand inspection of books and records along with 13D disclosure requirements for buying and selling stock.

We’re pleased to have Marc contribute to our blog and look forward to additional posts from him in the future.

The Permissible Scope of Bylaws: CA, Inc. v. AFSCME Employees Pension Plan
By Marc Weingarten and William F. Cassin

THERE ARE SURPRISINGLY few actions that stockholders, including activist stockholders, can take directly to influence corporate governance at the company they own.2 Most significantly, they lack the power to amend the company’s charter on their own initiative, as charter amendments must first be declared advisable by the board in order to be considered by the stockholders.3 Their most powerful right, of course, is to elect directors, though even this right may be substantially circumscribed through staggered-board provisions and the elimination of the right to take action by consent or to call a special meeting, as well as the application of advance notification bylaws. One of the stockholders’ few other powerful rights is to adopt or amend bylaw provisions. Section 109(a) of the Delaware General Corporation Law (the “DGCL”) in effect provides that “both the board and the stockholders, independently and concurrently, possess the power to adopt, amend and repeal the bylaws.”4 However, even this power is not absolute. It is subject to Section 141(a) of the DGCL, which provides that:

The business and affairs of every corporation organized under this chapter shall be managed by or under the direction of a board of directors, except as may be otherwise provided in this chapter or in its certificate of incorporation.

Presumably, therefore, a bylaw provision that “took management out of the board” could not be adopted by the stockholders.

On July 17, 2008, the Delaware Supreme Court issued a decision in CA, Inc. v. AFSCME Employees Pension Plan, No. 329, 2008 (Del. Supr. July 17, 2008) squarely addressing the permissible scope of a bylaw provision in view of these two statutory provisions.

The case arose in the context of an effort by CA, Inc. (“CA” or the “Company”) to exclude a stockholder proposal submitted by the AFSCME Employees Pension Plan (“AFSCME”) under Rule 14a-8 of the Securities Exchange Act of 1934 (the “Exchange Act”) for inclusion in CA’s 2008 proxy materials. The proposed bylaw amendment would require reimbursement by the corporation of reasonable expenses incurred by a stockholder in connection with the successful nomination of a candidate to the board of directors in a contested election.

The opinion, written to answer two distinct questions posed by the Securities and Exchange Commission (the “SEC”) to the Delaware Supreme Court, supported the Company’s exclusion of AFSCME’s proposed bylaw and could therefore be viewed as a defeat for both AFSCME and stockholder rights in general. However, the court’s fairly expansive holding as to the scope of permissible bylaw provisions, as well as its clear articulation of the rather narrow deficiency of the AFSCME bylaw, actually represents a significant affirmation of stockholder rights and, we believe, opens the door to creative bylaw proposals from stockholders.

Background to the Decision and the Current Law Regarding Proxy Solicitation Expense Reimbursement

As noted above, the CA, Inc. case arose out of a proposed bylaw amendment submitted by AFSCME for inclusion in CA’s 2008 proxy materials pursuant to Rule 14a-8 of the Exchange Act. This rule provides a stockholder owning a relatively small amount of a company’s securities with an opportunity to have its proposal included in a company’s proxy materials alongside those of management for presentation to a vote at the annual meeting of stockholders. The rule generally requires the company to include the proposal unless the stockholder has not complied with the rule’s procedural requirements or the proposal falls within one of 13 categories specifically enumerated in the rule.
6 If a company believes a proposal falls within one of these categories, it may inform the SEC of its desire to exclude the proposal and request a no-action letter stating that the SEC will not recommend an enforcement action against the company based on the proposed exclusion. The SEC then reviews the request and the proposal and either issues the requested no-action letter or states that it declines to do so.7 Companies receiving their requested no-action letters will typically exclude the proposal from their proxy materials, while companies failing to receive the letter will include the stockholder proposal.

AFSCME’s proposed bylaw, if voted on and passed by CA stockholders, would have required the Company’s board of directors to reimburse a stockholder or a stockholder group soliciting proxies in support of a short slate of director nominees (i.e., a slate of directors comprising less than a majority of the board) for its reasonable costs incurred in the solicitation, so long as at least one nominee on the short slate was successfully elected to the board. As most stockholders interested in effecting change at the board level are well aware, the almost universal rule of proxy solicitations is that expenses incurred by a corporation’s board of directors to solicit proxies for the election of the company’s nominees are paid by the corporation; such expenses are viewed much like the expenses of preparing and distributing the corporation’s annual report—as just one of the many costs associated with running a company. The practical result, however, is that a proxy solicitation conducted by an incumbent board is essentially free to the incumbent board and to the candidates nominated by the board—and remains so whether these candidates win or lose their election. In contrast, a proxy solicitation conducted by a “dissident” stockholder must be paid for by the stockholder, and, in general, the stockholder has no right to reimbursement for the cost of such solicitation, even if the stockholder’s candidate is elected.
8 And if the stockholder fails to win election for any of its candidates, there is virtually no chance of reimbursement.

The economic burden placed on stockholders undertaking a proxy solicitation operates as a significant disincentive to stockholders contemplating seeking board representation, and clearly favors incumbent boards. AFSCME’s proposed bylaw, by mandating reimbursement to successful candidates, would have mitigated the financial disincentive faced by stockholders to some extent, arguably leveling the playing field somewhat between incumbents and dissident slates.

CA’s Grounds for Exclusion and the Questions Posed to the Delaware Supreme Court

In its request for a no-action letter, CA sought to exclude the AFSCME proposal from its proxy materials on two principal grounds:
9 (i) the AFSCME proposal was not a proper subject for action by stockholders of a Delaware corporation, and (ii) AFSCME’s proposed bylaw, if adopted, would cause CA to violate Delaware law. Not surprisingly, AFSCME disagreed with CA’s view. Both AFSCME and CA’s Delaware counsel submitted opinions to the SEC supporting their respective positions, and in the face of these conflicting legal opinions, the SEC formally certified these issues to the Delaware Supreme Court for guidance.

Is the Question of Proxy-Expense Reimbursement a Proper Subject for Stockholder Action?

The Delaware Supreme Court first addressed the question of whether the AFSCME proposal was a proper subject for stockholder action. The court discussed the interplay between Sections 109(a) and 141(a), and concluded that while stockholders are entitled to adopt bylaws, their power to do so is not “coextensive” with that of the board of directors, but is limited by the board’s prerogatives under Section 141(a). In other words, there are areas of corporate power that exclusively pertain to the board, and stockholders are prohibited from infringing on board power in these areas. However, the court rejected CA’s argument that any bylaw that infringes on the power of the board of directors automatically falls outside of the scope of permissible bylaws.

The court then turned to the two central questions of the case: Where is the line between permissible stockholder action and improper intrusion on the board’s power to manage the corporation, and on which side of this line does the question of proxy solicitation expense reimbursement, as embodied by AFSCME’s proposed bylaw, fall? While it explicitly declined to provide a bright line answer to the first question, the court stated that “[i]t is well established Delaware law that a proper function of bylaws is not to mandate how the board should decide specific substantive decisions but rather to define the processes and procedures by which those decisions are made.” Having determined that the proper focus of its inquiry is whether the AFSCME bylaw was process-related, the court analyzed the proposed bylaw and concluded that while it calls for an expenditure of money, it nevertheless “has the intent and effect of regulating the process for electing directors” and, accordingly, that it is a proper subject for stockholder action.

Would the AFSCME Bylaw Proposal Cause CA to Violate Delaware Law?

The Delaware Supreme Court then turned to the second question posed to it by the SEC: whether AFSCME’s proposed bylaw, if adopted, would cause CA to violate Delaware law. The court held that it would. In reaching its conclusion, the court focused on the mandatory nature of AFSCME’s proposed bylaw, which would require reimbursement of election expenses incurred by outside stockholders in all instances of a successful election. Because it mandated reimbursement in all cases, the court reasoned, there could be situations in which compliance with AFSCME’s proposed bylaw would cause a board to breach its fiduciary duties. Reimbursement could be improper, reasoned the court, in situations where the proxy contest for which reimbursement was sought was “motivated by personal or petty concerns, or to promote interests that do not further, or are adverse to, those of the corporation.” As a result, the AFSCME-proposed bylaw would violate the well-established prohibition against contractual arrangements that preclude a board from fully discharging its fiduciary duties. For these reasons, the court held that the bylaw, if enacted by stockholders, would violate Delaware law, thereby providing the grounds on which CA could permissibly exclude it from its 2008 proxy materials.

Implications of the CA Decision

From a stockholder-rights perspective, the CA decision has a number of positive implications.

The Delaware Supreme Court reaffirmed the principle that a bylaw should not mandate the board’s substantive business decisions, but rather should define the process and procedures by which these decisions are made. However, the court also held that “whether or not a bylaw is process related must necessarily be determined in light of its context and purpose.” The court found that the context of the AFSCME proposed bylaw was the process for electing directors and, accordingly, that even though the bylaw mandated reimbursement by the board with the expenditure of corporate funds, it was nevertheless a proper subject for stockholder action. Thus, a bylaw provision need not specify process exclusively; it simply must contextually relate to process. This holding opens the door to a wide array of potential bylaw provisions to be adopted at the initiative of stockholders.

While holding that the CA bylaw would have violated Delaware law, the state’s high court specified the cure for its infirmity: the inclusion of a “fiduciary out.” As indicated above, the court gave examples where the grant of reimbursement could violate fiduciary duties, such as where the dissident was motivated by personal or petty concerns, or sought to promote interests that did not further, or were adverse to, those of the corporation. While the latter seems somewhat expansive, the accompanying footnote indicates that such a circumstance may arise where a stockholder group affiliated with a competitor sought to elect candidates “committed” to using their director position to pass proprietary information to the competitor. Narrow grounds indeed, that would seem to disqualify not a single proxy contest within memory. And the court warned that, of course, “[a] decision by directors to deny reimbursement on fiduciary grounds would be judicially reviewable.” While incumbent board members might well argue against a reimbursement request submitted by a newly elected dissident board member on the grounds that the dissident’s agenda did not further the corporation’s interests, the success of such an argument seems highly unlikely in view of the majority stockholder approval implicit in the election of the dissident to the board.

The aspect of the court’s holding that defines the permissible scope of a bylaw may also be used by activist stockholders as a sword as well as a shield. It is not beyond boards to adopt bylaws seeking to restrict stockholder rights or powers, and the language of this decision should provide courts with the necessary ammunition to invalidate such provisions, even though board-approved.

The court noted in this decision that it has, in the past, upheld a bylaw requiring that board decisions be unanimous in order to be effective. A bylaw of this nature would be extremely powerful to an activist when coupled with the election of a minority slate, or even one director. The court also noted that it has, in the past, upheld the power of stockholders to abolish board-created committees. This raises some interesting questions. Could stockholders mandate the creation of a board committee? Possibly more significantly, could they identify which members of the board were to sit on the newly created committee?

The court declined to adopt a bright-line test dividing bylaws into those that stockholders may unilaterally adopt and those that they may not. This lack of predictability will, unfortunately, mean more litigation, with boards again utilizing the corporate treasury to fight dissidents who must finance their cause out of their own pockets. This very lack of predictability, however, also opens the door to stockholders willing to craft, with a view to the court’s guidance, bylaw proposals that will withstand challenge. More case law undoubtedly will be forthcoming. ■



1. Marc Weingarten heads the business transactions group at Schulte Roth & Zabel LLP. His practice focuses on mergers and acquisitions, leveraged buyouts, activist investing and investment partnerships. He can be reached at 212.756.2280 or William F. Cassin, a senior associate in the business transactions group, contributed to the preparation of this article.

2. This article presumes the application of Delaware corporate law.

3. DGCL § 242(b).

4. CA, Inc. v. AFSCME Employees Pension Plan, No. 329, 2008 (Del. Supr. July 17, 2008).

5. As discussed below, while the expenses incurred by incumbent directors are usually paid by the company, outside stockholders must bear their own expenses, which can be considerable, in connection with nominating directors.

6. The categories include, among others, (i) if the proposal is not a proper subject for stockholder action under the laws of the jurisdiction in which the company is incorporated; (ii) if the proposal would cause the company to violate any state, federal or foreign law to which it is subject; (iii) if the proposal relates to a personal grievance against the company; and (iv) if the proposal deals with a matter relating to the company’s ordinary business operations.

7. During the 2006–07 proxy season, the SEC responded to approximately 360 Rule 14a-8 no-action requests, according to the SEC.

8. While a newly elected member or members of a board are free to request reimbursement for the expenses incurred by the stockholder responsible for his or her election, under the law of most jurisdictions, including Delaware, the majority is equally free to reject the request. If a stockholder successfully nominates and elects a majority of the board of directors, the stockholder may be able to recoup its expenses, assuming such reimbursement is approved by the new majority of the board, but reimbursement may also be subject to approval by stockholders.

9. As noted above, both of the grounds cited by CA are among those listed in Rule 14a-8 as permissible grounds for excluding a stockholder proposal.

Thursday, September 11, 2008

Activist Investor Ironfire Capital's Investment Thesis for GEOY

This post is provided by Eric Jackson who manages an activist hedge fund called Ironfire Capital. In addition to his activist efforts at GEOY, Eric has publicly pressed for change at Yahoo! earlier this year and at Motorola last year. This is an article originally written for and is also posted on his blog Breakout Performance.

We look forward to additional contributions from Eric on a regular basis.

My first Activist Investor column for in March featured GeoEye (GEOY), a satellite company in which I had just started an activist campaign.

This investment is down more than 20% since the start of the year (despite a 50% run-up since mid-July); however, the company's management has been receptive to recent behind-the-scenes activist efforts. GeoEye looks ready to make significant gains in the remainder of this year and into next year after the launch next Thursday of its newest satellite (GeoEye-1).

GeoEye leads the market, in terms of revenue, in operating satellites that capture geospatial images used by government and businesses. Its images are used by such customers as Google Earth, the U.S. Department of Ho
meland Security as well as agriculture companies, city developers and planners, real estate developers, video-game makers and companies that develop location-based applications. GeoEye offers a whole set of tools and services for customers to package its images (including historical images from its library) and help them analyze and dissect the information.

What first attracted me to small-cap GeoEye was its low valuation. It had a trailing price-to-earnings ratio of 12 in February, despite projections of growing earnings by 20% each year for the next five years. Unfortunately, that figure kept dropping until it was below 6 in early July.

Up until the last couple of quarters, when the company started losing some orders to competitor DigitalGlobe, which currently operates the newest satellite in the sky, GeoEye was generating $200 million in revenue with operating margins in excess of 45%. If you assume a rapid return to these numbers (and likely higher) once GeoEye-1 launches next week, this company's shares can be bought for just above 4 times next year's earnings.

The company's stock price has slumped in the past six months for several reasons. Its planned launch of the GeoEye-1 satellite had been delayed several times and investors have worried it would be delayed again. The successful launch of the satellite is a gate for future earnings potential. Until the launch happens, however, customers will go to GeoEye's competitor, which currently has the best satellite in the sky.

Other uncertainty has weighed on the stock price. GeoEye announced earlier this year that it would need to restate a small part of its previous year's earnings based on advice of its accountants to ensure they had properly accounted for previous net operating loss carry-forwards.

One of GeoEye's greatest problems has been poor communication. Management has done a lousy job outlining its competitive advantages to investors. This poor communication only exacerbated investors' concerns about the GeoEye-1 launch delay and the earnings' restatement.

It got so bad that one analyst, during the first-quarter earnings call, excoriated GeoEye's CEO
and CFO for their poor job of communicating. He directly blamed this failure for the company's low P/E ratio.

Positive Signs

But some things have gone on behind the scenes in the past six months that should please investors. First, GeoEye's No. 1 competitor, DigitalGlobe, filed to go public. This meant it had to open its books to the public in an S-1 filing with the Securities and Exchange Commission, a disclosure that revealed it was smaller than GeoEye. DigitalGlobe's decision to go public also allowed Matthew O'Connell and Henry Dubois, GeoEye's CEO and CFO respectively, to speak more freely about their business without fear of giving their private competitor an unfair advantage.

The second thing that has happened is that O'Connell and Dubois have listened to the criticism of shareholders and learned from it. The recent second-quarter earnings call was much improved over previous ones. On the most recent call, held earlier this month, they laid out all the details of the Sept. 4 satellite launch and cleared up what they had recently concluded about their recent restatement in a way that comforted investors. The stock has held its recent gains, instead of dropping precipitously as it did after the first-quarter call.

GeoEye has also been responsive to private criticisms I've directed to management, so I would like to give them public credit for this.

When I launched my activist campaign against GeoEye in the spring, I outlined in a letter to GeoEye's chairman and CEO three important but fixable problems I urged them to correct:

1) raising the company's price-earnings ratio through better investor relations and better communication in general,

2) clearing up the earnings delay immediately, and

3) ensuring management and the board had enough "skin in the game" and adding new board members to strengthen the overall team.

I have spoken to Matt O'Connell and Henry Dubois several times since I sent my first letter. In my view, communication with investors is much improved when it comes to discussing what the company is doing to achieve its immediate-term goal of a successful satellite launch, frequent pitching of the strong GeoEye story through investor meetings. Speeches at investment banking conferences have clearly laid out why GeoEye is significantly ahead of DigitalGlobe and why the market for geospatial images is expected to explode in the years ahead.

On its most recent call, GeoEye specifically mentioned how it's spending much more time talking to investors and telling its story. GeoEye is now covered by four analysts (all with buy ratings) compared to the one analyst it had last quarter. GeoEye has spelled out how its newest satellite will be the industry-leader for the next two years until DigitalGlobe launches its next satellite.

Also, last week, they hired their first chief technology officer, whose job it will be to better communicate the technical advantages of GeoEye's images and how they will play a part in the burgeoning location-based services market. This last point is still what has been missing in the recent GeoEye presentations and speeches.

The earnings restatement has now occurred, and it did not prove significant. Past years' lost earnings should be equaled out by a tax credit awarded later this quarter. There has been no cash impact on the company and the company still has a strong balance sheet to see it through the successful launch of GeoEye-1.

In terms of management and the board improving its makeup, there is still some work to do. O'Connell, Dubois and some others on the management team purchased some stock earlier this spring. I had encouraged them to do so as a sign of confidence in the company. Unfortunately, they only bought about $18,000 each. In my opinion, that's not enough -- especially given the generous executive pay they receive.

The CEO, O'Connell, deserves a pass on this issue, as he came from Wall Street to run GeoEye a number of years ago and had to make a big personal investment in the company. I know he understands the concept of "skin in the game." I wish he would encourage other officers and directors to follow his lead. Management needs to realize that stock options given to them as part of their compensation is "found money," compared to open market stock purchases.

On the issue of improving the board, there are already a number of strong individuals on this board, many with a government background (which makes sense as the government is GeoEye's largest customer and a co-investor in the new satellite). This board still could use some people with more of a commercial background, as that's a growing customer area for GeoEye.

However, when I spoke to O'Connell, I made it clear that I was much more interested in seeing the company tell its story effectively, clearing up any restatement uncertainty and encouraging insiders to buy some more stock than discussing the board composition issue. I believe they've prioritized the criticisms appropriately.

The bottom line is that GeoEye has listened to its critics and taken action to address many of the criticisms. Management needs to go further in some areas, but they deserve credit for what they've done to date. As an investor, I feel much more confident in this company's prospects based on my interactions with management and seeing them make some progress against these weak points.

GeoEye's biggest weak point remains communicating its powerful story to investors. It can't rely on its CTO to explain its competitive advantages to Wall Street. This is the job of the CEO and CFO, and they've only improved from a "C-" to a "C+" on their communication skills in the last three months.

All eyes are now on the Sept. 4 launch of GeoEye-1. The company needs to continue to actively communicate with investors on the day of and the day following the launch. The launch team has a 98% success rate over the last 150 launches. After launch, the company will perform tests to ensure everything is working correctly, and its largest customer, the National Geospatial-Intelligence Agency, will sign off that everything looks good at the end of October. That sign-off will allow the agency to agree to a new service-level agreement with GeoEye to buy images in the quarter ahead. Other customers will likely follow.

The launch should therefore have a large catalyst effect on the stock price. A more reasonable valuation for the stock would be 12 times next year's earnings, or triple its current price. It might take a few quarters to get there, but patience and activism are likely to be rewarded.

Tuesday, September 9, 2008

20 Activist Hedge Funds Managing $40 Billion+ Will Gather in Phoenix to Compare Notes

Many of the world’s most aggressive hedge funds, along with their strategic advisers, are convening in Phoenix, AZ later this month to discuss investment ideas and exchange best practices in shareholder activism.

Phil Goldstein (See Phil's recent profile in Fortune Magazine) and I are co-chairing The Second Annual Hedge Fund Activism & Shareholder Value Summit September 22-23 at the Biltmore in Phoenix, Arizona.

Panel discussions will be led by some of the best known activists who together manage more than $40 billion in assets and have instigated high profile fights at several companies this year, including: Dillard’s Department Stores, CSX Corp, Brinks Co, CNet Networks, Ikon Office Solutions, Yahoo!, Motorola, and Phoenix Companies, to name a few…

Some of the notable speakers include fund managers from Barington Capital, Bulldog Investors, Dalton Investments, Ironfire Capital, Jana Partners, Lawndale Capital, Locksmith Capital, Newcastle Management, Oliver Press, RLR Capital, Sandell Asset Management, Shamrock Activist Value Fund, Steel Partners, The Children’s Investment Fund (TCI) and Western Investments.

Top advisers to the activists (and a few advisers to companies) include (my firm) Hedge Fund Solutions, Joele Frank, and Sard Verbinnen (Strategy Consultants and Public Relations Specialists); DF King, Georgeson, Innisfree, MacKenzie Partners, and The Altman Group (Proxy Solicitors); Olshan Grundman, Schulte Roth, Lowenstein Sandler, Kirkland & Ellis, Skadden Arps and Wachtell Lipton (Legal Counsel); RiskMetrics/ISS, Glass Lewis, and Proxy Governance (Proxy Advisors); and more.

Finally, representatives from major institutional investors like CalSTERS, T. Rowe Price, Angeles Investment Advisors, Delaware Public Employees Retirement System and Denver Employees Retirement Plan - who combined control hundreds of billions in pension fund assets, will talk about how they manage activist investments.

This is guaranteed to be an epic affair with plenty of thought provoking discussions around what successful activist investors are doing and how they are doing it -- including a no-press-allowed case study of CSX led by the dissident investor TCI and their legal counsel Marc Weingarten from Schulte Roth.

For additional information visit the event’s website.

Posted By Damien Park, CEO Hedge Fund Solutions.

Monday, September 8, 2008

Activist Hedge Fund Pershing Square Sends Letter to US Treasury Secretary Paulson

Pershing Square Capital Management Releases Letter to US Treasury Department Regarding Fannie Mae and Freddie Mac Restructuring

Dear Secretary Paulson:

We understand that a Treasury plan for Fannie/Freddie (the GSEs) may be announced this weekend. We thought you might find useful some further thoughts on potential GSE solutions.

As you are likely aware, we had previously distributed a proposed restructuring plan for the GSEs. In that plan, under a prepackaged conservatorship, equity interests would be extinguished, subordinated debt would be exchanged for warrants, and senior debt would be exchanged for new senior debt and common equity in the newly recapitalized entities. The government would write a put to the new common equity holders which would expire in three years.

It appears, however, that the GSEs may need help more quickly, and conservatorship may not be triggered until the GSEs are formally determined to be undercapitalized. As such, in the event the government needs to inject capital immediately, we suggest you consider the following transaction (the Transaction).

In order to minimize risk to tax payers while being equitable to other constituents, we suggest that the Treasury consider purchasing senior subordinate debt in the two companies in an amount sufficient to address their capital needs in the short to intermediate term. This senior sub debt would be junior in right of payment to the outstanding senior unsecured debt and senior to the outstanding sub debt, preferred stock, and common equity. We refer to the outstanding sub debt, preferred and common stock as the Subordinate Securities.

The issuance of senior sub debt is permitted under the GSE legislation and under the existing terms of the outstanding debt and equity securities of the two entities (please see the attached memo for further details). As a condition of Treasurys purchase of senior sub debt, the GSEs would defer the interest payments on the outstanding sub debt (which can be deferred for as much as five years), and the dividend payments on preferred and common stock. All of the Subordinate Securities would continue to remain outstanding according to their existing terms.

The new senior sub debt should have a market-based coupon and Treasury should receive low-strike price warrants (penny warrants) for a substantial portion, i.e., 49% of the two companies. The coupon and warrant structure should be as close to fair-market-value terms as possible. The ultimate determination of fairness would be the willingness of non-government investors to purchase the Transaction securities on the same basis as Treasury. As part of the Transaction, the GSEs would deleverage their capital structures by paying down senior debt from the free cash flow generated by their core businesses further improving the position of the new senior sub debt.

The benefits of the Transaction are as follows:

  • The Transaction can be accomplished under the existing terms of the outstanding GSE securities without any required consent other than from the GSEs.
  • The new security would be senior in right of payment to the existing sub debt and preferred stock minimizing the risk to tax payers while providing substantial support to the outstanding senior debt that has been deemed implicitly guaranteed by the government.
  • The new debt interest payments would be tax deductible, reducing the after-tax cost of capital to the GSEs, particularly when compared with preferred stock.
  • In the event the outlook and performance of the GSEs and their assets were to improve dramatically, the senior sub debt could be redeemed, distributions to the Subordinate Securities could resume, and their values would increase accordingly.
  • In the event that the GSEs fundamentals continued to deteriorate and they became undercapitalized, the GSEs could be placed in conservatorship. In conservatorship, their balance sheets could be restructured along the lines of our original plan or another plan with the Treasurys senior sub debt treated preferentially to the Subordinate Securities, again minimizing risk to the tax payer.
  • The Transaction would be fundamentally fair to all constituents and would respect the existing terms and corporate hierarchy of all outstanding GSE securities.
  • The Transaction would minimize moral hazard issues for sub debt, preferred, and common stock investors.

Most importantly, we believe there are serious negative implications for other large financial institutions in the event the Treasury were to bail out Subordinate Security holders. The Treasury and OFHEO have done substantial research on the benefits to capital market discipline from large financial institutions issuance of subordinate debt, and the destructiveness of the government implicitly or explicitly guaranteeing such obligations.

See: Report to Congress The Feasibility and Desirability of Mandatory Subordinated Debt, Board of Governors of the Federal Reserve System and United States Department of the Treasury (December 2000), available at:

Subordinated Debt Issuance by Fannie Mae and Freddie Mac, Valerie L. Smith, Office of Federal Housing Enterprise Oversight, OFHEO WORKING PAPERS, Working Paper 07 3 (June 2007), available at;

Signals from the Markets for Fannie Mae and Freddie Mac Subordinated Debt, Robert N. Collender, Samantha Roberts, Valerie L. Smith, Office of Federal Housing Enterprise Oversight, OFHEO WORKING PAPERS, Working Paper 07 4 (June 2007), available at: abs=1000264;

(Due to its length, this URL may need to be copied/pasted into your Internet browser's address field. Remove the extra space if one exists.)

Subordinated Debt and Bank Capital Reform, Douglas D. Evanoff, Federal Reserve Bank of Chicago, Larry D. Wall, Federal Reserve Bank of Atlanta, FRB Atlanta Working Paper No. 2000-24 (November 2000), available at

To the extent the Treasury were to bail out the GSEs subordinate debt which was: (1) never implicitly guaranteed by the government, (2) always rated below Triple A by the rating agencies, and (3) held by investors who knowingly took on the risk of loss in exchange for a substantial credit spread above the GSEs senior debt it would endanger the systemic benefits from subordinate debt issuance for every highly leveraged banking institution in the world and the capital markets at large.

Furthermore, we do not believe that the Treasury can purchase GSE sub debt, preferred stock or common stock without incurring an immediate loss to tax payers because of the enormous amount of existing debt senior to these instruments. At a market coupon or dividend yield (to the extent that one were to exist), any debt issued pari passu to the existing sub debt, or preferred stock issued pari passu or even senior to the existing preferred stock would require a yield that would be uneconomic for the GSEs. No third-party investor would purchase these securities regardless of their terms in light of their junior position in the GSEs capital structure.

Please note that Pershing Square and affiliates own CDS on the subordinate debt of the GSEs. We also note that nearly all participants in the capital market debate on the GSEs are either long or short the outstanding GSE securities.

We are contemporaneously releasing this letter to the public in the interest of market transparency.


William A. Ackman


Pershing Square Capital Management, L.P.
William A. Ackman, 212-813-3700

Saturday, September 6, 2008

This blog was contributed by Christopher Faille, a reporter (formerly with Thomson Reuter’s HedgeWorld) and an expert on activist investing. Chris also maintains an interesting blog about the struggle for control of corporations

Today’s entry for our blog reviews a new book titled, Encyclopedia of Alternative Investments, ed. Greg N. Gregoriou, CRC Press, Boca Raton , Fla. , 2008, 541 pp, $199.95 (cloth).

We look forward to receiving regular updates from Chris on what he sees happening with activist investing around the world.

The 545 entries in this single volume reference work will answer that many questions about hedge funds, funds of funds, managed futures, commodities markets, and venture capital.

Some of the entries are quite brief. The term “oversold,” for example, gets a straightforward definition in 65 words.

Other entries are elaborate, mini-articles, such as the 400 words, two charts, and concise bibliography accorded to “implied volatility.” Such entries go far beyond what one finds in the standard online glossaries devoted to the jargon of investments, traditional or alternative.

Readers of this blog inclined to browse might open first to the entry on “activists.” They’ll find that it breaks no new ground – but of course it isn’t the function of an encyclopedia to break new ground. That entry, by Dieter G. Kaiser, defines the term then summarizes recent research concluding that activist investors' demands are met (board representation secured, share repurchase programs initiated, etc.) more than 60% of the time. It is also generally to the benefit of shareholders when they are.

Mr. Kaiser notes, too, a study in the German markets that concluded that the beneficial “long-term wealth effects created by private equity investors are significantly higher than those of hedge fund activists.”

There are 16 members of the editorial board, each of them quite distinguished – among them Josh Lerner of Harvard University and François-Serge Lhabitant of the University of Lausanne, Switzerland. There are more than a hundred contributors. But the captain of this ship is Greg Gregoriou, professor of finance, State University of New York, Plattsburgh .

Reviewed by Christopher Faille

Over 50 Activist Investments During August

Below is a summary list of investments made by shareholder activists during the month of August. This information was extracted from Hedge Fund Solutions' Catalyst Equity Research Report(TM) - a free in-depth weekly research report on activist investments.

To receive the FREE report delivered via email weekly, subscribe at

For additional information on any specific transaction below, contact Damien Park at 215.325.0514 or

Ticker Company Activist Investor

ALDN Aladdin Knowledge Systems Vector Capital
AMLN Amylin Pharmaceuticals Eastbourne Capital Management
ATSG Air Transport Services Group Perella Weinberg Partners
BCSB BCSB Bancorp Finacial Edge Fund
BRNC Bronco Drilling Wexford Capital
CAPE Cape Fear Bank Corp Maurice Koury
CLF Cleveland -Cliffs Harbinger Capital
COHR Coherent Inc Oliver Press Partners
CPHL CastlePoint Holdings Omega Advisors
CVC Cablevision Systems Corp Harbinger Capital
CVG Convergys Corp Jana Partners
EPIC Epicor Software Corp Elliott Associaes
EXAS Exact Sciences Corp Intrinsic Value Asset Management
FCL Foundation Coal Holdings Owl Creek
FMLPE.OB Feldman Mall Properties Mackensie Patterson Fuller
GCS DWS Global Commodities Stock Fund Western Investments
GET Gaylord Entertainment Co Gamco Investors
HRC Hill-Rom Holdings Breeden Capital
HUN Huntsman Corp DE Shaw
IKN Ikon Office Solutions Steel Partners
INCB Indiana Community Bancorp Financial Edge Fund
ISH International Shipholding Corp Liberty Shipping Group
JRC Journal Register Co Third River Capital Management
LDG Longs Drug Stores Corp Pershing Square Capital
MIM MI Developments Greenlight Capital
NDN 99 Cents Only Stores Akre Capital Management
NYT New York Times Harbinger Capital
OEH Orient Express Hotels DE Shaw
ORNG Orange 21 Costa Brava
PCOP Pharmacopeia, Inc Josiah Austin
PNNW Pennichick Corp Gamco Investors
PRXI Premier Exhibitions, Inc Sellers Capital
RFMI RF Monolithics Doucet Asset Management
RSG Republic Services inc Cascade Investment
RUSS.PK Whitney Information Network Kingstown Capital
SECX.PK SED International Holdings Hummingbird Management
SFLY Shutterfly Inc Discovery Capital
SLTC Selectica Inc Steel Partners
SPA Sparton Lawndale Capital
TAC Transalta Corp The Childrens Investments Fund
TECUA Tecumseh Products Herrick Foundation
TGT Target Corp Pershing Square Capital
TIER Tier Technologies Discovery Equity Partners
TMWD Tumbleweed Communications Corp Empire Capital
TY Tri-Continental Corp Western Investments
UAHC United American Healthcare Corp Lloyd Miller
VNBC Vineyard National Bancorp Jon Salmanson
WBSN Websense Inc Shamrock Activist Value Fund
XJT ExpressJet holdings Hayman Advisors
XOHO.OB XO Holdings Amalgamated Gadget
ZILG Zilog Riley Investment Management
Zinc Horsehead Holding Corp Cobalt Capital Management

Tuesday, September 2, 2008

Activist’s Efforts Fail at French Bank Natixis; Could set off a wave of activism at European Banks.

The following blog was written by Marko Grassmann, an analyst with a large asset management firm based in Munich, Germany. Marko has been closely monitoring activism in Europe for the past few years and will be a regular contributor to our blog with posts on what is happening with shareholder activism within the EU. If you’d like to contact Marko, his email address is

David Einhorn, famous for short selling Lehman Bros. shares earlier this year, sent a letter to French bank Natixis on August 19 opposing the Company’s proposed €3.7bn rights issue. Click here to view the letter.

Instead of diluting the share base by around 50%, Einhorn’s New York hedge fund, Greenlight Capital Inc. came up with an alternative proposition: Redeem the 20% cross-share holdings in each of its parent companies - Banques Populaires and Caisses d'Epargne. Shortly after the release of the letter, a second hedge fund, Royal Capital Management, who manages approximately $2bn in assets, endorsed Greenlight’s plan.

The share issue was unveiled after the bank suffered a €1.5 billion loss in the second quarter, mainly related to write-downs on structured products like CDOs, and needed additional capital to meet regulatory requirements. A research analyst from Oddo Securities in Paris said, “[Greenlight’s] proposal is worth considering, but probably comes too late.” The analyst was proven correct a couple of days later.

On Friday, 28.08 the Natixis’ shareholders approved the share offering with an acceptance of nearly 90%. Banques Populaires and Caisses d'Epargne who each own 35% of Natixis’ shares secured the outcome of the vote in advance.

Even though the efforts of Einhorn and Royal Capital were deemed a failure, circular shareholdings have been criticized before and could prove to be the entrée needed for a wave of activism in European banks and other EU companies to come.