The Spotlight on Boards

Marty Lipton, co-founder of the corporate law firm Wachtell, Lipton, Rosen & Katz, published a memo on September 9, 2010 outlining public company board of directors’ roles and responsibilities. Below is a summarized version of this memo:

The Spotlight on Boards

• Current focus on the performance of corporate boards prompts revisiting what is expected from the board of directors of a major public company – not just the legal rules, but also the aspirational “best practices” that have come to have almost as much influence on board and company behavior.
• Choose the CEO, monitor his or her performance and have a detailed succession plan in case the CEO becomes unavailable or fails to meet performance expectations.
• Plan for and deal with crises, specially crises like HP where the tenure of the CEO is in question, BP where there has been a major disaster or J&J and Toyota where hard-earned reputation is threatened by product failure. 
• Determine executive compensation, achieving the delicate balance of enabling the company to recruit, retain and incentivize the most talented executives, while avoiding media and populist criticism for “excessive” compensation
• Interview and nominate director candidates, monitor and evaluate the board’s own performance and seek continuous improvement in board performance.
• Provide business and strategic advice to management and approve the company’s budgets and long-term strategy
• Determine the company’s risk appetite (financial, safety, reputation, etc.), set state-of-the-art standards for managing risk and monitor the management of those risks. 
• Monitor the performance of the corporation and evaluate it against the economy as a whole and the performance of peer companies.
• Set state-of-the-art standards for compliance with legal and regulatory requirements, monitor compliance and respond appropriately to “red flags.”
• Take center stage whenever there is a proposed transaction that creates a seeming conflict between the best interests of stockholders and those of management, including takeovers.
• Set the standards of social responsibility of the company, including human rights, and monitor performance and compliance with those standards.
• Oversee government and community relations.
• Pay close attention to investor relations and interface with shareholders in appropriate situations.
• Adopt corporate governance guidelines and committee charters.

To meet these expectations, it will be necessary for major companies to have a sufficient number of directors to staff the requisite standing and special committees; to have directors who have knowledge of, and experience with, the company’s businesses, even though meeting this requirement may result in boards with a greater percentage of directors who are not “independent”; to have directors who are able to devote sufficient time to board and committee meetings, and the preparation for them; to provide regular tutorials by internal and external experts as part of expanded director education; and to maintain a true collegial relationship among and between the company’s senior executives and the members of the board.

- Martin Lipton


Posted by David Schatz

Research Report on Shareholder Activism Makes SSRN’s Top Ten List

A paper written by Damien J. Park (Managing Partner, Hedge Fund Solutions) and Matteo Tonello (Director, Corporate Governance The Conference Board)  titled, “The Role of the Board in Turbulent Times: Avoiding Shareholder Activism”,  has recently been ranked in Social Science Research Network’s (SSRN) Top Ten download list for the topic “CGN: Boards & Directors”.

The paper provides coverage on the future, causes, and nature of shareholder activism and offers possible strategies that companies can employ to avoid it. Social Science Research Network is an online organization that acts as a clearinghouse for all scholarly research concerning business-related news and more. World-renowned financial economist, Michael Jensen, founded the organization in 1994. He is arguably best known for developing Jensen’s alpha, but has also been active in issues concerning corporate governance. His organization is a powerful resource. We encourage you to visit its site.

To download a copy of “The Role of the Board in Turbulent Times: Avoiding Shareholder Activism”, click here.

How to calculate Jensen's Alpha
Portfolio Return − [Risk Free Rate + Portfolio Beta * (Market Return − Risk Free Rate)] 

BTW- congratulations to Matteo Tonello for being named to the Directorship 100 list of most influential people in corporate governance.

Posted by David Schatz

Retail & Restaurant Companies Targeted by Activist Investors

Below is a summary list of activist targets in retail and restaurant companies (updated September 2010).  This information was extracted from Hedge Fund Solutions' quarterly analysis of activist investments - a subscription service with limited circulation to no more than 50 clients in 2010.

Contact us to request a complimentary copy of the complete quarterly activist analysis, examining over 1000 companies.  In the meantime, feel free to subscribe to our FREE weekly activist reports which are distributed every Monday afternoon.

Retail and Restaurant Activist Targets Sept 2010

Posted by David Schatz, Damien Park and Jon Heller

GuruFocus Podcast Interview with Jon Heller

Jon Heller, CFA

Geoff Gannon, who now hosts the Investor Questions Podcast for GuruFocus.com, recently interviewed Jon Heller, a Partner with Hedge Fund Solutions and co-author of the firm's activist investment research products.  Jon is also the guy behind the Cheap Stocks blog.

You can listen to the interview here.

A Breakdown of Proxy Access

On August 25, 2010, the Securities and Exchange Commission voted 3-2 along party lines to allow proxy access. The new rule is historically significant since the SEC has considered investors’ right to proxy access for over three decades. While ultimately this reform was a victory for shareholder activists, it certainly does not offer a golden ticket for a successful dissident proxy campaign.

The new rule will allow shareholders to nominate directors on corporate proxy materials alongside management’s nominees. With the goal being to encourage long-term investment, the SEC will grant proxy access only to a shareholder – or multiple shareholders – who have owned 3% or more of a given company’s shares continuously for at least the past three years (note: companies under $75M in market cap are exempt for three years). Interestingly, “[s]hareholders will not be eligible to use the rule if they are holding the securities for the purpose of changing control of the company”. Additionally, shareholders eligible to use this new rule may nominate no more than one nominee, or what is 25% of the number of a company’s directors – which ever is greater. Submission of nominees must be prior to 120 days before the anniversary date of last year’s mailing of the company’s proxy statement. Other stipulations include the following: eligible investors will be entitled to include a 500 word supporting statement for their nominee(s), companies may seek a "no action letter" to permit the company to exclude the nominee(s); priority is given to the largest shareholder (or shareholder group) in the instance of multiple shareholders proposing more than 25% of the board; nominees must satisfy the eligibility requirements of federal and state laws, as well as objective independence standards of the national security exchange/association rules applicable to the company; investors cannot borrow shares to meet the 3% threshold, however, investors who lend shares may count it toward the threshold so long as they recall the stock before the election.

In defending itself against a possible lawsuit by the nation’s largest business lobby, The Chamber of Commerce, SEC Chairman Mary L. Schapiro argued that the Dodd-Frank Wall Street Reform and Consumer Protection Act granted the SEC the authority to address the issue of proxy access.

Andrew Shapiro of Lawndale Capital Management, an activist hedge fund investor who invests primarily in micro cap companies, complained that the new rule doesn’t go far enough. He argues that small company boards should not be exempted from the rule since their shareholders, “having already lost corporate governance protections from various other small company exemptions… are most in need of proxy access to offset the more prevalent dysfunction found in small company board’s governance”. Conversely, The Chamber of Commerce and other corporate representatives have complained that labor unions and pension funds would use proxy access to force their will on companies, thus damaging companies’ ability to realize otherwise sound business objectives. The Chamber of Commerce has argued that proxy access grants “special interests the ability to hold the board hostage on narrow issues at the expense of other shareholders” and “[s]pecial-interest politics have no place in the boardroom”. They have pledged to fight the rule tooth-and-nail.

However, without a Court injunction, proxy access will effect companies mailing proxy materials to shareholders as early as March 2011.  The implications are far reaching for both investors who want to use access and corporations who find themselves on the receiving end. This means that companies, Wachtell, Lipton, Rosen & Katz recommend, place a “heightened emphasis on investor relations and [have] more strategic and tactical thought being devoted to corporate governance issues”. Corporate boards will need to hold management to greater accountability than ever before, and focus more on issues like community and labor relations, social responsibility, executive compensation, ethical standards, etc. – which have been the subject of much criticism by labor unions and pension funds. On the other side, shareholders will need to seek “long-term value [in] their investment [in order] to manage the proxy access regime responsibly”.


Posted by David Schatz

CEO Succession Planning & Shareholder Activism

Executive transitions at Hewlett-Packard, Sara Lee, GM and BP provided a topical backdrop for our presentation last week to the Southwestern Regional Conference of the National Investor Relations Institute.

The main sideshow was H-P’s handling of its decision to replace Mark Hurd including sending an under-prepared Marc Andreesson to front its public face, demonstrating its not just the decisions that you make but how you message them that is so important; the company saw $13.7B of shareholder value evaporate in a week.

The presentation centered on CEO succession and shareholder activism, coming soon after the SEC’s policy reversal on the issue and our subsequent Conference Board paper that analyzed the implications thereof.

In the session, we emphasized the following points:

• Many companies and boards do a poor job of CEO succession planning
• A changing governance climate is placing responsibility firmly in the boardroom; CEO succession is now recognized as a major policy and risk issue
• Poor CEO transition management is a big deal and a major business discontinuity
• Drawing  a correlation between external CEO hiring and unpalatable levels of executive compensation, large investor groups are starting to challenge corporations to reveal details of their internal succession practices
• Companies will soon see activist investors leverage CEO succession-related governance deficiencies to advance their change agenda

We urged Investor Relations executives to avoid shareholder angst by helping their companies get ahead of the issue, including:

• Knowing (and influencing) what the Board’s role in CEO succession planning should be
• Understanding why shareholders  care about CEO succession planning
• Providing high level disclosure of CEO succession planning process to reassure shareholders of the Board’s oversight
• Knowing that there is no other job like the CEO … and that internal development is a multi-year process – absent such internal process external hiring (and higher costs) become inevitable

 A copy of the presentation follows.

NIRI Southwest CEO Succession and Shareholder Activism

Posted by Edward Ferris, Partner Hedge Fund Solutions

The Battle Over Barnes & Noble Continues

Hedge Fund Solutions has been following the ongoing activist situation at Barnes & Noble, Inc. ("BKS") since early 2009 when billionaire Ron Burkle – who runs the investment firm Yucaipa – first disclosed an 8.3% ownership position at an average cost of $14.68 per share.  Since then, Burkle has increased his ownership to just under 20%. Deep value investor Aletheia Research & Management - which has previously stated its support of Burkle's activist campaign - has since accumulated a little more than 16%.
[Click here to review Aletheia's investment positions as of June 30, 2010]

In response, BKS installed a shareholder rights plan that would go into effect when an individual shareholder accumulates more than 20% of the Company's outstanding stock or when multiple shareholders, "who combined own over 20%, enter into an 'agreement, arrangement or understanding… for the purpose of acquiring, holding, voting… or disposing of any voting securities of the Company.'"  However, under the terms of the poison pill, the 20% trigger would not apply to the Riggio family, which owns a substantial equity and management stake in the Company.

"We believe having over 37% of the Company shares in the hands of the Riggio family and other insiders, coupled with the 20% ownership limitation enforced on other shareholders under the poison pill, has a coercive effect on the Company’s other shareholders and gives the Riggio family a preclusive advantage in any proxy contest", argued Burkle in a January 28 letter to the board of BKS.  "[T]he Board is sending a message to the other shareholders and the investing community that Barnes & Noble is a company controlled and operated for the benefit of selected insiders."

After the BKS board rejected Burkle’s request to raise the poison pill's threshold to 37% - equivalent to the Riggio family's ownership - Burkle filed a lawsuit against BKS in the Delaware Chancery Court on May 5. His complaint: the member of BKS' board breached their fiduciary duties of loyalty, care and good faith by adopting and maintaining a discriminatory poison pill without any legitimate corporate purpose.

On August 3, in a move that suggested BKS' belief that the Delaware Chancery Court would rule in favor of Burkle, BKS issued a press release stating its interest in "a possible sale of the company, in order to increase stockholder value". In addition, the Company began settlement discussions with Burkle, reportedly agreeing to offer him three board seats on a nine person board. However, settlement discussions broke down just before the Chancery Court's ruling, presumably because Burkle was unwilling to agree to a two-year standstill, which would restrict him from seeking additional board representation next year.

Then, what appeared to be a nearing end to the two parties' disparity, proved false, morphing into an inevitable proxy fight.

On August 11, Vice Chancellor Strine dismissed Yucaipa's complaints, arguing that BKS' poison pill was a proportionate defense against Yucaipa's growing stake in the Company and did not preclude Yucaipa's ability to run a successful proxy campaign. (Strine's Decision can be found at the end of this article.) BKS announced the following day that settlement discussions between the two parties had ended.

Following the ruling, on August 18, in a preliminary proxy statement, Yucaipa announced their intention to nominate three individuals to the BKS board of directors at the next annual shareholder meeting and to get the board to raise the poison pill trigger to 30%. Yucaipa's other plans have included BKS buying out at least part of its competitor, Borders Group, Inc., and to get BKS to enter into a partnership with a technology company - particularly, Hewlett-Packard Co. - in order to enhance BKS' product offerings and better compete against Amazon.com. Riggio is not enthusiastic about any of these proposals. 

Posted by David Schatz
Strine Decision in Burkle's Lawsuit Against Barnes & Noble