Until last year, having management and dissident nominees listed on the same proxy card was largely a pipe dream. Now, it has become a tactical battlefield and Starboard Value’s CEO Jeff Smith is taking a stand to fix an element he says is ripe for misuse.
Smith gave a presentation at Schulte Roth & Zabel’s annual shareholder activism conference earlier this month arguing that universal ballot contests involving a short slate could be manipulated to guarantee a win for management nominees, contrary to what shareholders had intended. As companies get more creative in their use of the universal ballot (also known as universal proxy), that could lead to problems as big as last year’s too-close-to-call contest between Trian Partners and Procter & Gamble, which sparked an inquiry into U.S. proxy plumbing.
“The current universal ballot proposed by some companies and attorneys will create issues where a majority of shareholders vote for change but change does not happen,” Smith told me. “That would be wrong.”
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To understand the issue, say an activist nominates five candidates against a board comprised of eight seats (these slides, courtesy of Starboard, will help). In a traditional proxy contest using two cards, votes will be weighted to the dissidents if shareholders feel strongly about the need for change but the three management nominees running unopposed would almost certainly be elected. A proxy contest using a universal ballot might mean investors are a bit pickier, with the result that fewer of the dissident nominees are elected – hence why companies have been keener to use a universal ballot in situations like SandRidge Energy, which faced having its entire board replaced.
A universal ballot, however, could also lead to freakish results. In a fight involving a short slate against a full one, there are enough possible outcomes for every single candidate to receive over 50% of the shares. The side running the full slate – let's assume it's the company – could promote different candidates to different shareholders and split the vote, romping to victory.
(Again, check the slides for the math– and remind yourself that this isn't a trick.)
Smith is at pains to point out that this isn't a case of sour grapes. His firm has yet to be undermined in a campaign, having settled with Mellanox Technologies in June after the Israeli company adopted the universal ballot. Instead, he says it's important to fix the issue before it disenfranchises shareholders and has made a suggestion to that effect.
Starboard’s solution would be to divide the universal ballot into two sections – one featuring an equal number of candidates for contested seats, and the other containing the uncontested nominees. That would make the proxy fight a simple first-past-the-post race, with shareholders entitled to express their disapproval of uncontested directors by withholding votes as they are entitled to do in any uncontested election.
"This is a fairly simple, fair, and obvious solution," Smith wrote in an email. "It is unclear to us why issuers, activists, or shareholders should have an issue with this proposal."
One objection might be that it would limit the degree of choice afforded by the universal ballot - perhaps its chief appeal – although it would still be more flexible than the current, two-card arrangement. A more pressing issue is that there is little in the proxy rules to force companies to adopt this approach and apparently no appetite to revisit the issue at the Securities and Exchange Commission, which apparently did not anticipate the issue when it proposed a new rule back in 2016.
The collapse of that rulemaking seems to have sparked a run of experiments with private ordering for the universal ballot, although the link is likely coincidental. In an Olshan Frome Wolosky memo last year, Andrew Freedman noted that companies were starting to demand activist nominees consent to being named on management’s questionnaire. At Rent-A-Center, Engaged Capital sued and the company backed down, while at Buffalo Wild Wings, the company co-opted a dissident nominee. Freedman’s conclusion: “overzealous defense advisors are beginning to seize on this seemingly inadvertent drafting error in an attempt to get a leg up on the dissident.”
Nonetheless, adoption of the universal proxy is still a rare event, mostly dictated by tactics. As far as I can tell, at Campbell Soup neither side has requested a universal ballot, perhaps in part because the company is seen as having a strong advantage over dissident Third Point Partners.
“It’s a great concept but if it’s not implemented the right way, it could cause more harm than good,” Schulte Roth & Zabel’s Ele Klein, who interviewed Smith at the firm’s conference, told me. “In theory, both sides should be fine with the universal proxy. The question is, can we be in favor of it?”
This week I was at the Council of Institutional Investors’ (CII) Fall 2018 conference, where most of the open sessions were spent discussing environmental, social, and governance (ESG) issues. BlackRock’s Barbara Novick, in the week the firm launched more ESG products, pointedly told the assembled crowd that she thought it should be renamed GES, since good practice on the other two issues tend to flow from good governance. Elsewhere, ESG research was touted for myriad qualities –risk management, revealing the quality of the management, and even alpha generation. CII’s big campaign this year is to pressure stock exchanges to change their listing standards so as not to admit companies without a sunset provision that will eliminate their dual-class share structures within seven years. A previous effort by the industry body to address the matter with index providers faltered when index fund houses said they wanted regulators, not index providers, to address the issue.
For more on ESG, look out for the next issue of Activist Insight Monthly when it is released in early November.
Quote of the week comes from PPG Industries, the latest target of Trian Partners and a surprise candidate for a management change. The activist generally prefers to work with management but made its first public demand at the company calling for the return of former CEO Chuck Bunch – a former Heinz board colleague of Nelson Peltz. PPG hopes to brush the issue aside, issuing a statement yesterday to the effect that:
“Shortly after Trian Partners disclosed its investment in PPG, two of PPG’s independent directors traveled to meet with Trian to listen to their perspectives on PPG. During the meeting, PPG established a framework for a constructive and private dialogue, with which Trian agreed, and that framework was discussed in detail with the PPG board of directors. We have a long history of listening to our shareholders and we hope that Trian is willing to accept our offer for a continuing, constructive private dialogue.”