Over the last decade, company boards have had to endure some of the most challenging moments, in the form of attacks by various hedge funds instigated by activist investors like Carl Icahn, Bill Ackman, Dan Loeb, and Nelson Peltz. Some of the companies have ended up losing out, while others have jsut managed to survive the storm.

War With Activist Hedge Funds: Do Companies Stand a Chance?

Some of the most notable companies to have experienced activist investor attacks include Proctor & Gamble Co. (NYSE:PG), McDonald’s Corporation (NYSE:MCD), Illinois Tool Works Inc. (NYSE:ITW), DuPont Fabros Technology Inc. (NYSE:DFT), Motorola Solutions Inc. (NYSE:MSI), Target Corp. (NYSE:TGT), Pepsico Inc. (NYSE:PEP), H.J. Heinz Company (NYSE:HNZ), Kraft Foods Inc. (NASDAQ:KFT), and The Home Depot, Inc. (NYSE:HD), notes the report by Martin Lipton.

Activist hedge funds, have on so many occasions emerged successful, in their pursuit to take over the control of companies. According to Martin Lipton, in his article, published at the Harvard Law School Forum on Corporate Governance and Financial Regulation, activists hedge funds have been receiving a lot of backing from the institutional investors and ISS, mainly due to the fact that a majority of them have interest in the hedge funds.

Additionally, the Securities Exchange Commission (“SEC”), has no particular provision barring activist investors from secretly acquring more than 5% shareholding in a company, before disclosure of their stakes. Furthermore, activist hedge funds have bee able to successfully utilize fully, various loopholes that allow them to gain control of company boards. Lipton has listed them as follows:

(a) Proposing a proxy resolution for creation of a special committee of independent directors to undertake a strategic review for the purpose of “maximizing shareholder value”.

(b) Conducting a proxy fight to get board representation (note solicitation for a short slate is very often supported by ISS and when it is, is usually successful).

(c) Orchestrating a withhold the vote campaign.

(d) Convincing institutional investors to support the activist’s program.

(e) Using stock loans, options, derivatives and other devices to increase voting power beyond the activist’s economic equity investment.

(f) Using sophisticated public relations campaigns to advance the activist’s arguments.

The last point has been well utilized by Carl Icahn, as we featured recently in one of our articles, when he disclosed a few companies that he holds certain opinions against them, including Chesapeake Energy Corporation (NYSE:CHK), Navistar, and Forest Labs. Since then, Chesapeake Energy Corporation (NYSE:CHK) has gone ahead with plans to overhaul its board, and had it replaced with new members, including the Chairman.

We also at some point this year featured the case of activist investor, Douglas Schaller, when he successfully orchestrated a change in the board of the Bank of Floyd, in a scenario that fitted well within the Bank Holding Company Act (BHCA) rules.

According to Lipton, the above cases, along with other possible scenarios, considering the loopholes listed above, can be prevented or overcome if the following measures are implemented.

The companies must first and foremost accept that activist investors are there to stay, and they wont be going anywhere any time soon. Therefore, companies must prepare in advance, like Navistar International Corp (NYSE:NAV) disclosed a couple of months ago, and protectiveness is the best term here, and this would involve:

  • Creating a team to deal with Hedge Fund Activism: the writer recommends a small group of two to five officials, plus a lawyer, investment banker, proxy soliciting firm, and a public relations firm. A closer look at these will tell you that a majority represent the loopholes that have been exploited by activist hedge funds so often. Additionally, the company must maintain a continuous update of the company’s board of directors, while keeping an eye on featured activist hedge funds.
  • Monitoring Shareholder Relations: this is yet another tool that activist investors use so often, and Lipton recommends a review of all matters touching on shareholders, including dividend policy and analyst presentations among others. Additionally, pro-activeness is once again emphasized, as is maintaining a close contact with major institutional investors, and monitoring ISS, CII, and TIAA-CREF corporate governance policies. Furthermore, is is important to keep track of hedge fund and institutional investor holdings in the company.
  • Ultimately, a successful fight cannot be won without preparing yourself for the worst. It is advisable that the board is prepared for activist battle in advance, through various presentations and encouragement to maintain a unified board consensus.
  • The other important aspect is to monitor trading, by keeping a close eye on Form 13-F filings, as well as Form 13-D, which we featured in our article yesterday detailing Icahn’s views on Oshkosh Corporation (NYSE:OSK) and JLG separation.

The rest of the details of the report on fighting a war against activist hedge funds is available here.

Nonetheless, as featured in or earlier articles, this war is getting tougher and tougher for the companies. The push for declassified boards makes it pretty easy to overhaul the whole board in one Annual General Meeting (AGM). Companies will have to be aware of their shareholders’ perceptions, and try to play along, making sure that their needs are met. As we have seen, shareholders are a major target by activist hedge funds in pursuit of plans to change boards.

Additionally, we also recently featured two cases where shareholders are likely to have an opportunity to finally decide who stays on the board, and who earns what. U.K and Switzerland are pushing for a binding shareholder vote on various critical issues.

Whether the companies have a chance to ever fend off activist hedge fund influence in the affairs of the business, that remains to be seen. However, if Lipton’s measures were to prove effective, then it could form a major breakthrough in the company vs activist hedge funds, boardroom battles.