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

Confidence Game

I had a chance to read Christine Richard's book Confidence Game last week while on vacation.  The book details Bill Ackman/Pershing Square's short position at MBIA Inc. and the drama that unfolds over the course of a few years while Ackman speaks to anyone who will listen about the company's unstable business model. It's really very good.  If you're interested in activist investing I recommend reading this book. - Damien

In the meantime, here's an April 2010 CNBC video where Ackman and legendary short-seller Jim Chanos share their thoughts on short selling.

After the Storm: A Special Report Presentation on Shareholder Activism

This presentation was given by Damien Park from Hedge Fund Solutions at Kaplan Fox's June 3-4 conference on Recovery Risk & Returns: A Summit on Corporate Governance for Institutional Investors.

Special Report on Shareholder Activism: Presentation at Kaplan Fox Conference on "Recovery Risk & Returns"

The Future of the Board of Directors

On June 23 Marty Lipton from Wachtell, Lipton, Rosen & Katz gave a keynote speech at the Chairman & CEO Peer Forum at the New York Stock Exchange.  The title of the speech is The Future of the Board of Directors (transcript available here).

Here are a few highlights from the speech:

"In an effort to think about the board of directors of the future, we need to start with what we expect the board to do today and the rules we have set governing how directors are selected, how they function and how they relate to shareholders - not only the legal rules but also the aspirational "best practices" that we have allowed to influence corporate and director behavior.  We also need to look at how corporate management and boards are perceived by the media, the public and elected officials in the post-financial crisis era.

We expect boards to:

• 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.
• Provide business and strategic advice to management and approve the company’s long term strategy.
• Determine the company’s risk appetite (financial, safety, reputation, etc.) 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.
• Monitor the corporation’s compliance with legal and regulatory requirements 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, and sometimes even when the conflict is more imagined than real, 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.
• Determine executive compensation.
• Interface with shareholders.
• Plan for and deal with crises.
• Approve the company’s ethical standards and programs and take responsibility for “tone at the top.”
• Monitor and evaluate the board’s own performance and seek continuous improvement."

Lipton went on to provide some foresight into how boards may operate in the future: 

1. The trend to smaller boards will be reversed in order to have a sufficient number of independent directors for the audit, nominating and compensation committees and to add directors who have special expertise and are not necessarily independent.
2. A separate risk committee will likely become common at companies where risk plays a significant role.
3. Time demands of board service will result in more use of modern conferencing and communication technology; companies will have very frequent special meetings and resort widely to outside experts.
4. In a few years the seperation of the Chairman and CEO role will be more widespread.
5. The lives of CEOs and board of directors will become more challenging.

Click here to download the entire speech.