Source: https://www.yalelawjournal.org/comment/unpacking-wolf-packs
Timestamp: 2019-04-20 06:12:52+00:00

Document:
This Comment examines the law’s seemingly inconsistent treatment of wolf packs, and it advances a disclosure framework that seeks to rebalance the powers of corporate boards and wolf packs. Securities law and corporate law diverge in their approach to wolf packs. On the one hand, section 13(d) of the Securities Exchange Act—designed to alert corporate boards and shareholders to takeover threats—construes wolf packs narrowly. As a result, boards and shareholders may not receive advance notice of wolf-pack activism. On the other hand, the Delaware Court of Chancery recently adopted a relatively expansive conception of wolf packs that may overly punish activist investors. I argue that requiring wolf packs to make prophylactic disclosures will strike the right balance. It will allow boards to better respond to wolf-pack activism and enable courts to better adjudicate the proportionality of such responses.
The Comment proceeds as follows: Part I discusses the history and characteristics of wolf-pack activism. Part II argues that current laws simultaneously underregulate and overregulate wolf packs to the detriment of both boards and investors. Finally, Part III explains how prophylactic disclosures can help restore the balance of power between wolf packs and corporate boards.
Activist hedge funds took off in the early 1990s after the Securities and Exchange Commission (SEC) began loosening its proxy statement rules.10 In 1992, the SEC stopped censoring proxy statements, allowing activist shareholders to be more vocal in their criticisms of incumbent corporate boards.11 Seven years later, the SEC adopted Rule 14a-12, which allowed activist investors to lobby other shareholders before filing a proxy statement.12 The rule allowed activists to gauge the level of support from other shareholders and mitigate the risk of losing a costly proxy contest.
A fundamental goal of both securities and corporate law is the protection of shareholder interests.28 An important component of this goal is preserving the balance of power between control-seeking shareholders and corporate boards.29 The two parties serve as a check on each other: control-seeking shareholders help monitor corporate boards while corporate boards owe fiduciary duties to prevent control-seeking investors from exploiting their holdings to the disadvantage of minority shareholders.30 Securities law seeks to balance the competing interests of control-seeking shareholders and boards through disclosure rules.31 Meanwhile, corporate law seeks to achieve the same end through ex post review of board decisions.32 In the case of wolf packs, however, neither securities law nor corporate law appears to adequately balance the power of boards and control-seeking activist investors.
Second, wolf packs can partially evade section 13(d) when only the lead activist shareholder discloses its ownership stake. Such a move can lead corporate boards to underestimate the activist threat. For example, in the fight over control of Barnes and Noble, the lead activist investor held an 18.7% stake in the company.40 However, the actual wolf pack controlled a 36.14% stake.41 The wolf pack’s sizeable stake meant that the activist investors only needed 13.87% of the shareholder votes to establish the majority required to oust the incumbent board.
Third, the ten-day disclosure window under section 13(d) critically undermines the value of any potential disclosures from wolf-pack members. Activist investors typically engage in a buying frenzy during this ten-day period42 in order to maximize their profits from future increases in share price. A wolf pack’s aggregate shareholdings thus concentrate potential gains among a small handful of activist investors.
Corporate boards traditionally adopt poison pills in response to control-seeking shareholders.44 The poison pill is a share dilution device invented in the 1980s that makes it very costly to acquire control of the target company.45 The Delaware Chancery Court’s recent decision upholding Sotheby’s poison pill, Third Point LLC v. Ruprecht,46 appears to have adopted a broad stance against collaboration among activist investors.
Third Point is no outlier. In Yucaipa American Alliance Fund II, LP v. Riggio,51 a case decided in 2010, then-Vice Chancellor Strine suggested that a poison pill that capped activist share ownership at twenty percent was justified to prevent two activist investors from forming “a de facto control bloc . . . through conscious parallelism.”52 In short, corporate law has seemingly adopted a much broader view of wolf packs than securities law.
While securities law underregulates wolf packs, corporate law may well do the opposite. First, using “conscious parallelism” to identify wolf packs may overestimate the actual strength of activist alliances. Wolf-pack activists have different agendas and some may exit before a proxy contest.53 In Third Point, Trian sold its stake in Sotheby’s a month after the company implemented its poison pill.54 Meanwhile, Marcato, unlike Third Point, was more interested in getting Sotheby’s to return its cash reserves to investors than in implementing management changes. After the Sotheby’s board negotiated an end to Third Point’s agitation earlier this year, Marcato was left to lobby against the board alone.55 The Sotheby’s saga suggests that, in some instances, wolf packs can be relatively loose coalitions with different investment agendas and timelines.
Finally, the Delaware courts’ use of “conscious parallelism” to uphold a poison pill may encourage corporate boards to adopt more expansive poison pills. Currently, most poison pills use the securities law definition of “group” to define wolf packs.58 However, corporate boards may be inclined to adopt the broader Delaware definition as an additional means of deterrence. While these pills would likely be contested in court, the fact-intensive review required to determine the validity of such pills may place undue time and cost burdens on activist investors.
The law’s treatment of wolf packs faces timing and identification problems. Securities law allows wolf packs to slip under its disclosure rules. Corporate law, meanwhile, may cast an overbroad net on wolf packs.
Preemptive disclosures may provide a means of resolving both the timing and identification problems surrounding wolf packs. This Part recommends a preemptive disclosure framework that requires three amendments to Rule 13d under the Securities Exchange Act: (1) shortening the current ten-day grace period for making a Schedule 13D filing disclosing when an investor or group acquires a five percent or greater stake in a public company, (2) broadening the definition of “group” under Rule 13d-5 in order to require all activist investors to name the other investors to whom they have disclosed their intention to engage in a proxy fight once they collectively acquire a five percent or greater stake in a public company, and (3) imposing penalties for activists who fail to fully disclose the identities of wolf-pack members.
The framework’s first requirement provides earlier notification of potential changes to a targeted company. The requirement also limits activist investors’ ability to use the current ten-day reporting period to amass a de facto controlling stake. While this requirement affects all shareholder activists, its impact would be most acutely felt by wolf packs that benefit from the coordination opportunities provided by the ten-day buffer and reap the greatest profits from a successful activist campaign. As such, this requirement would not only better alert boards to possible wolf-pack activity, but also level the playing field for activists who are not part of the wolf pack.
The second requirement for prophylactic disclosure from activist investors addresses the fact that wolf packs are most likely to form when a lead activist investor tips off other activists about an upcoming proxy fight.59 This requirement is designed to identify wolf-pack members without having to resort to circumstantial evidence or proxy measures such as “conscious parallelism.” Rather than trying to establish a bright-line test for what constitutes a wolf pack and risk substantive evasion, the SEC and the courts ought to shift the task to activists who, as insiders, are most apt to know their membership. Since activists may seek to conceal the identity of the wolf pack by either overdisclosing or underdisclosing the names of participants, I recommend, as a third requirement, introducing penalties to deter such behavior. For example, funds that have received solicitations but fail to disclose their membership in a wolf pack should be penalized. Membership in a wolf pack could be identified ex post by establishing a rebuttable presumption that major purchasers of target company stock in the days immediately leading up to a Schedule 13D filing are members of the wolf pack. Penalties for investors that fail to disclose their membership in a wolf pack could include requirements to disgorge profits or dispose of stock holdings.
While this proposal is novel, it is well situated within the bounds of both securities and corporate law. Under the Dodd-Frank Wall Street Reform and Consumer Protection Act, Congress expressly provided that the SEC could shorten reporting windows.60 Additionally, Schedule 13D, which shareholders are required to file when they exceed a five percent ownership threshold, asks shareholders to declare the purpose of their purchases and “contracts, arrangements, understandings or relationships . . . with respect to any securities of the issuer.”61 Moreover, the Second Circuit has explicitly held that “the purpose of section 13(d) is to alert the marketplace to every large, rapid aggregation or accumulation of securities, regardless of technique employed, which might represent a potential shift in corporate control.”62 Additionally, corporate law requires that corporate boards only deploy poison pills that are proportional to the threat posed.63 The disclosure framework would not only help corporate boards better determine what constitutes a proportional response to a wolf pack, but would also make boards more accountable for disproportionate responses.
This Comment argues that current securities law and corporate law are inconsistent and ineffective in their treatment of wolf packs. Securities law adopts an excessively narrow view of wolf packs, allowing them to slip past its disclosure rules. Corporate law, on the other hand, has construed wolf packs far more broadly and risks overpunishing investors. I argue that a prophylactic disclosure framework will correct the gaps in the current law and restore the proper power balance among corporate boards and control-seeking shareholders.
See Briggs, supra note 6, at 686-94.
286 F.3d 613 (2d Cir. 2002); see Briggs, supra note 6, at 691.
15 U.S.C. § 78m(d) (2012).
Hallwood, 286 F.3d at 617-18.
See Briggs, supra note 6, at 691; Coffee & Palia, supra note 2, at 35.
Lipton, supra note 1, at 1.
Coffee & Palia, supra note 2, at 23-33.
See sources cited supra note 21.
Coffee & Palia, supra note 2, at 36.
See Briggs, supra note 6, at 708.
Allen et al., supra note 28, at 612, 621.
Choi & Pritchard, supra note 28, at 2.
See Coffee & Palia, supra note 2, at 28.
Yucaipa Am. All. Fund II, L.P. v. Riggio, 1 A.3d 310, 324 (Del. Ch. 2010).
See Emmerich et al., supra note 34, at 150-53.
See Allen et al., supra note 28, at 522-32.
No. 9469-VCP, 2014 WL 1922029 (Del. Ch. May 2, 2014).
1 A.3d 310 (Del. Ch. 2010).
See Brav et al., supra note 18, at 4-8; Coffee & Palia, supra note 2, at 36.
Pulliam et al., supra note 21.
See Brav et al., supra note 18, at 24-26; Coffee & Palia, supra note 2, at 23-33.
17 C.F.R. § 240.13d-101 (2015).
GAF Corp. v. Milstein, 453 F.2d 709, 717 (2d Cir. 1971).
Allen et al., supra note 28, at 522-31.
See John C. Coffee, Jr. & Darius Palia, The Wolf at the Door: The Impact of Hedge Fund Activism on Corporate Governance 28-39 (Columbia Law & Econ., Working Paper No. 521, 2015), http://ssrn.com/abstract=2656325 [http://perma.cc/F3YZ-M2MA].
Robert Cyran & Richard Beales, Ackman and Valeant Drum Up Stealth Activism, N.Y. Times: DealBook (Apr. 22, 2014, 8:16 AM), http://dealbook.nytimes.com/2014/04/22/ackman-and-valeant-drum-up-stealth-activism [http://perma.cc/SPN3-Z69J]; Steven Davidoff Solomon, In DuPont Fight, Activist Investor Picks a Strong Target, N.Y. Times: DealBook (Jan. 27, 2015, 6:58 PM), http://dealbook.nytimes.com/2015/01/27/in-dupont-fight-activist-investor-picks-a-strong-target [http://perma.cc/ED8Z-7FLA].
See David Benoit & Kirsten Grind, Activist Investors’ Secret Ally: Big Mutual Funds, Wall St. J. (Aug. 9, 2015, 10:38 PM), http://www.wsj.com/articles/activist-investors-secret-ally-big-mutual-funds-1439173910 [http://perma.cc/5HW3-PE4N]; Coffee & Palia, supra note 2, at 100.
Thomas W. Briggs, Corporate Governance and the New Hedge Fund Activism: An Empirical Analysis, 32 J. Corp. L. 681, 686-94 (2007).
See Bill George & Jay W. Lorsch, How To Outsmart Activist Investors, Harv. Bus. Rev., May 2014, at 88, 90.
See Alon Brav et al., Wolf Pack Activism 3-4 (Robert H. Smith Sch., Research Paper No. RHS 2529230, 2015), http://ssrn.com/abstract=2529230 [http://perma.cc/K358-W8JR]; Coffee & Palia, supra note 2, at 23-33.
See Lucian A. Bebchuk et al., The Long-Term Effects of Hedge Fund Activism, 115 Colum. L. Rev. 1085, 1122 (2015); Alon Brav et al., Hedge Fund Activism, Corporate Governance, and Firm Performance, 63 J. Fin. 1729, 1756 (2008); Susan Pulliam et al., Activist Investors Often Leak Their Plans to a Favored Few: Strategically Placed Tips Help Build Alliances for Campaigns at Target Companies, Wall St. J. (Mar. 26, 2014, 10:37 PM), http://www.wsj.com/articles/SB10001424052702304888404579381250791474792 [http://perma.cc/33N2-UR53].
See Coffee & Palia, supra note 2, at 36; Charles Nathan, Observations on Short-Termism and Long-Termism, Harv. L. Sch. F. on Corp. Governance & Fin. Reg. (Oct. 12, 2015), http://corpgov.law.harvard.edu/2015/10/12/observations-on-short-termism-and-long-termism [http://perma.cc/YU8S-6PVG].
Brav et al., supra note 21, at 1769; Alon Brav et al., Hedge Fund Activism: A Review, 4 Found. & Trends Fin. 185, 205 (2010); Coffee & Palia, supra note 2, at 36.
See William T. Allen et al., Commentaries and Cases on the Law of Business Organizations 269-70 (4th ed. 2012); Stephen J. Choi & A.C. Pritchard, Securities Regulation: Cases and Analysis 1-2 (4th ed. 2015).
See Lucian A. Bebchuk & Robert J. Jackson, Jr., The Law and Economics of Blockholder Disclosure, 2 Harv. Bus. L. Rev. 39, 45 (2012); Briggs, supra note 6, at 718.
See Adam O. Emmerich et al., Fair Markets and Fair Disclosure: Some Thoughts on the Economics of Blockholder Disclosure, and the Use and Abuse of Shareholder Power, 3 Harv. Bus. L. Rev. 135, 144 & n.30 (2013).
654 F.3d 276, 284 (2d Cir. 2011) (holding that “a precise finding, adequately supported by specific evidence, of whether a group existed for purposes of acquiring CSX shares outright during the relevant period needs to be made”).
Whether shareholder activism generates long-term value for shareholders is subject to intense debate. Compare Bebchuk et al., supra note 21 (arguing that shareholder activism does not have a detrimental effect on long-term interests of companies), with Martin Lipton, Empiricism and Experience; Activism and Short-Termism; the Real World of Business, Harv. L. Sch. F. on Corp. Governance & Fin. Reg. (Oct. 28, 2013), http://corpgov.law.harvard.edu/2013/10/28/empiricism-and-experience-activism-and-short-termism-the-real-world-of-business [http://perma.cc/Z3HA-2WYC] (arguing that activism has led to serious adverse effects on companies).
See Margaret Collins, Peltz’s Trian Sold State Street Shares in Third Quarter, Bloomberg Bus. (Nov. 15, 2013, 12:00 AM), http://www.bloomberg.com/news/articles/2013-11-14/peltz-s-trian-sold-sotheby-s-state-street-stakes-last-quarter [http://perma.cc/TJ9S-N3NK].
David Benoit, Marcato Urges Sotheby’s To Buy Back Stock, Wall St. J. (Feb. 20, 2015, 1:19 PM), http://www.wsj.com/articles/marcato-urges-sothebys-to-buy-back-stock-1424456393 [http://perma.cc/U4UF-M2BJ].
See Leonard Chazen & Jack S. Bodner, Conscious Parallelism May Justify a Wolf Pack Pill, Law360 (May 27, 2014, 9:45 PM), http://www.law360.com/articles/540818/conscious-parallelism-may-justify-a-wolf-pack-pill [http://perma.cc/349E-GBKP].
See Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 929R, 124 Stat. 1376, 1866 (2010) (modifying section 13(d)(1) of the Securities Exchange Act of 1934 to require disclosure “within ten days after such acquisition . . . or within such shorter time as the Commission may establish by rule”).
* Yale Law School, J.D. expected 2016. I am especially grateful to Jonathan Macey, John Morley, and Vishal Chanani for their valuable feedback and advice, and to Roberta Romano for inspiring this project. I would also like to thank Jeff Chen, Dahlia Mignouna, Michael Clemente, and the editors of the Yale Law Journal for their insightful suggestions and careful editing.

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