The Passive Activists

Public corporate boards used to quake at the prospect of an attack by the “activists.” These corporate “raiders” force management to abandon long-term strategy, sell off parts of their business, reduce R&D, increase prices, pump the stock value in the near term, and then cash out their investment. This would leave the loyal long-term stockholder holding the bag, which was by then pretty much empty.

Enter today the new “activist” investor. These are large, long-term holders of your equity. Think State Street and BlackRock. Think the Investor Stewardship Group, a consortium of the world’s largest investors holding perhaps 20% of the value of U.S. equities. These major investors are seeking dialogue with boards, according to a panel convened today in Newton by the New England Chapter of the National Association of Corporate Directors.

And what do these newly active investors want to discuss?

They counsel good corporate governance. They counsel focusing on long-term strategy, as they are “value” investors. They counsel listening to the old-time activists, because they might have a good idea, but not caving in immediately in order to avoid a proxy fight. They look for engaged discussions with directors, touching on such matters as the strategic use of big data, diversity, overall strategy for employee compensation, and adequacy of climate change reporting (as it bears on long-term strategy).

When the panel members from Black Rock and State Street were asked directly by the moderator, “well then, aren’t YOU the activist investors now?” there followed an awkward silence. The audience laughed. The panel declined to admit to such a role until one finally said, “well, perhaps activists with a small a.” How do BlackRock and State Street Investments like to view themselves? Not activists certainly; just “not passive.”

So the corporate landscape today contains two kinds of constituencies pressing upon boards of directors: the more now polite, but still-lurking, old-school activist directors seeking perhaps a change in the long-term strategic goals of a company; and, the major institutional equity investor seeking good governance and an articulated long-term strategic plan.

Bottom line from the institutional investors: directors should be available to speak with their major shareholders, and not just to create a relationship but, rather, to also provide substantive dialogue around matters important to long-term strategic direction.


Not Another Cyber Security Post?

Yes it is; bad news doesn’t always go away.  In this morning’s e-mail updates for us corporate lawyers, two depressing items:

First, the PCAOB (the agency overseeing the accounting for public companies) reported remarks on Friday from its deputy director for technology to the effect that companies “face hundreds, if not thousands of attempts to break into their systems on a daily basis….”  In the face of this onslaught, PCAOB is working on defining how audit teams should go about assessing the magnitude of cyber risk and defining acceptable governance policies. (Once this gets sorted out, expect the same CPA approaches to be applied to private company audits also.)

And today the SEC’s director of Corporate Finance (they pass on registration statement disclosure) announced that the staff is “looking closely” at cyber risk disclosure.  One focus is internal controls, to deal with response to a hack; are procedures in place to bring the data upstream to disclosure experts and general counsel?

On a less procedural note, the SEC speculated that companies might want to restrict trading in its shares by officers and directors when a hack is identified and material.  If a company were to take such a step, seems to me, they would have to make a public disclosure of that event, which might accelerate in some cases the reporting of data breaches; much criticism has been leveled at the dilatory pace at which some companies have announced material breaches. Such an acceleration would put great pressure on the early determination of a hack’s “materiality,” a concept in the securities laws which does have an accepted definition but in reality, much like the Supreme Court view of pornography: can’t define it but I darn well know it when I see it.

About Golden Shares

Golden Shares are equity interests with the power, within a corporate structure, to control a vote on some issue. Typically such shares are issued to creditors, who want to enforce superior rights in the event of a loan default, rather than being derailed by the equitable processes of Federal bankruptcy.  In such a case, a bankruptcy cannot be filed by a company unless the Golden Shares vote in favor.

Federal bankruptcy policy does not permit a creditor, before bankruptcy, to obtain a waiver of the company’s rights to file for bankruptcy.  If such waivers were permitted, every creditor would ask for one.  And the benefits of bankruptcy, including possible rehabilitation and fairness to creditors, would be thwarted.  Thus such agreements in all forms typically have been voided as against public policy.

But a bankruptcy court has no power to act upon any case unless, as a matter of proper corporate procedure, the bankruptcy case is duly authorized in the first instance.  If Golden Shares are properly included in the charter of a company, and thus corporate authority cannot be obtained to file the bankruptcy which thus gives the bankruptcy court any power, how can the bankruptcy court ever get so far as to over-rule the Golden Share’s power to ban bankruptcy?

The recent Federal District court case of In re Franchise Services permitted enforcement of Golden Share power, based on the following distinction: if the holder of Golden Shares got the shares for little or nominal consideration, then they really are not true corporate shares with enough economic interest within the debtor company to be given the vote, but rather they are just a gimmick to try to end-run public policy.  But in this case, the lender was a bona fide hard money equity investor, and as such could legally bargain for a control over bankruptcy to protect its investment.  The lender here only became a creditor after it was a material investor.  The Golden Shares were not a gimmick, but negotiated corporate rights afforded to a bona fide equity holder, and thus those shares could be properly voted as part of requisite corporate action and thus could be used to bar bankruptcy.

The case is on appeal to the Fifth Circuit, and there are prior cases on either side of this issue, so stay tuned.  And even if the decision in this case is upheld (that is, the Golden Shares of real equity investors can be sued to block company bankruptcy filing), there remain the following issues: Golden Shares obtained only to veto bankruptcy still will be ignored; it is not clear what metric should be used to measure the adequacy of the size of the equity interest needed to uphold the Golden Shares power; it is not clear as to the rights of an equity holder + lender if both the equity interest and the loan are made at the same time that the Golden Shares are issued (a not unusual business structure.)


At the end of last week, the Delaware Chancery Court refused to permit CBS independent directors to obtain a restraining order that would have prevented controlling shareholder Shari Redstone from interfering with the plan that the directors had devised to prevent Redstone from forcing a merger of CBS and Viacom.  The directors wanted to amend the CBS By-Laws to permit them to issue more stock and thus dilute Redstone’s vote so as to prevent the merger.

While the facts are complex and while there is no precedent for what the independent directors were attempting to do, the interesting part (at this stage) is that the Court held that, even though it was indeed possible that Redstone was breaching her fiduciary duty, Redstone and her allies had the right to protect their majority controlling interest from attack.  The court system would give relief after the fact if it were found there was a breach of fiduciary duty if a merger were to occur.

In Delaware mergers where controlling persons in effect self-deal, there are numerous ways to prevent abuse of power, including getting an independent director vote, setting up independent director committees, getting independent shareholder votes, and obtaining comfort from third party experts.  The courts are full of cases filed after the fact alleging that the minority was abused by majority control of a merger or acquisition. But here relief was sought before the fact, and even though there was an independent board committee that dis-recommended the merger, the Chancery weighed the equities and opted to protect the majority in exercising its control; there would be time later to do justice if required.

This is likely to be fast-moving, in that if a merger occurs it will be hard to unwind or calculate injury if the entities actually begin to operate as a single enterprise.   Stay tuned.

The Culture of Fine Wines?

95 Points James Suckling: A wine with beautiful strawberry and chocolate with hints of pie crust. It’s full-bodied with super integrated tannins and a long, long finish. Needs at least four to five years to really come together but so wonderful. Not the amazing 2009 but clearly outstanding.

 94 Points Wine Spectator: This delivers a slightly chewy-edged feel, with charcoal and roasted alder hints holding sway over the core of steeped damson plum, black currant and anise notes. Shows grip through the finish, but stays long, featuring a lovely backdrop of tar and warm stone.

 Winemaker Notes: The Chateau XXXXXXXXX is a dark color with a fine crimson tint. The wine offers notes of ripe fruit, mocha and vanilla along with powerful yet harmonious and smooth tannins.

 The above was received from a good friend and fine wine merchant, describing a wine on offer which I will not name as that is not the point.   The point is this:  as I understand it, this fine wine (at a mere $125 per bottle) tastes like charcoal, roasted alder, steeped damson plums, black currant, anise, tar, warm stone, strawberry, chocolate, pie crust, ripe fruit, mocha and vanilla.  What with its dark color, smooth tannins, grip, strength, chewy edge, length of finish, well – I for one cannot wait to taste it in at least four or five years when it is ready to drink.  I do hope to live that long, and I hope you the reader live that long also, because I am counting on YOU to buy a bottle of this stuff and lay it away in my wine cellar and drink it with me some day.  Because I ain’t paying $125 for a bottle of anything other than the Elixir of Youth….

 Final query: if this wine is at least four or five years from coming together (and given the description of flavors I can see that the wine needs mucho coming together), how do they know it is so great today?  I think I have a lot to learn, but I will learn about wine while laughing all the way.


CEO Pay Ratio Disclosure– Dumb and Dumber

I have posted before about how dumb it is to care about the ratio of a CEO’s pay to the median pay of all public company employees.  Even dumb ideas also generate unintended consequences, and now it is open season on the unexpected.

A little history. After the 2008 meltdown, Congress tried to earn some public brownie points by shaming CEOs, whose salaries were either blamed for the recession or were held up as an object for further outrage, by requiring this disclosure.  They needed someone to enforce it and chose the SEC, which after all was already in the business of demanding disclosures by public companies.  Of course, the SEC mandate is to protect the securities market and the people who invest in it; nothing to do with shaming CEOs or setting implicit social policy.

So the SEC took years to finally propose a rule that the SEC itself had not asked for and did not want.  About 8 years after the legislation was passed, this proxy season is the first time we get to see the ratio of CEO pay.  It is unclear to me that investors actually care, and they should not.

Overly simple example to make my point: assume that there is a public company with two employees.  Joe is the office gofer and makes $20,000 a year. Jane invented the app that earns the company $200,000,000,000 a year.  Jane is paid a thousand times multiple, higher than all but one multiple heretofore reported in the press: $200,000,000.  Leaving over $199 Billion on the table for the lucky shareholders.  I just love my stock position in Jane’s company.  As for my reaction to the ratio?  For my money (and it IS my money), give her more.  The securities markets and I the investor are safe and sound.  Jane is not shamed; she is underpaid.

Who IS upset by the high ratios?  Well, the press for one, it is headline news, see for example today’s issue of Boston Business Journal.

The compensation consulting firms.  What an opportunity to develop new metrics and sell more advice.

Employees, but not about the ratio.  They know they don’t earn like the CEO and shouldn’t.  No, they are interested in the median number, which is just incidental to the intent of the SEC rule.  Everyone earning less than the median feels underpaid; or so suggests the Boston Business Journal.

And now a member of the Massachusetts State Senate is proposing a tax law that will increase taxes on companies with a ratio exceeding 100.  Not only unintended, but would discourage public companies from locating here in Massachusetts.  And if one wants progressive income taxation, that should be imposed systematically, not in a way that punishes statistics based on happenstance or perhaps even efficient management.

Ironically, the only dog in this fight which is getting its intended result may be — the US Congress.  They wanted to shame CEOs, and they may get their way. (Here’s a random thought: the Congress that mandated this rule in 2010 is NOT of the same make-up as today’s Congress– one might speculated that today’s Congress does not want to shame these CEOs.)  Meanwhile, CEOs are looking at the ratios and, if they are ONLY paid 100 times the median, they may be planning to ask for a raise!

Just sayin’….

Recruiting Non-Profit Directors

When adding non-profit directors, the key attributes are finding people who have a passion for the mission, who work well with others in groups, who feel empowered to ask questions and not just go with the flow, who can assist in providing funding either personally or from others, and who are significantly diverse.

An expert panel convened in Boston today by the New England Chapter of the National Association of Corporate Directors noted that robust statistical evidence, in both the for-profit and not-for-profit sectors, supports the proposition that diverse boards perform better; diversity is not just a moral issue, it is an element of good governance.

What is diversity?  It includes but is by no means limited to racial, ethnic and gender diversity.  It is an inclusiveness of generational diversity and of representatives of the cohorts which a non-profit entity may serve or with which it interfaces. It includes differences in thought and experience and, sometimes, geography.

What about the pressure to place large donors on boards?  It is appropriate if they are otherwise engaged and provided they do not confuse the board function of supervision with attempting to run the organization itself, or with believing they are entitled to great influence based on their personal financial contribution.  The panel noted that raising funds on the part of board members who cannot afford to make a fixed contribution is a teachable skill that also cements younger supporters into  future leadership.

Onboarding diverse board members is a critical task; one panelist stated that his large non-profit provides in effect a director’s boot camp for new and often diverse board members, and provides an assigned mentor for the first year of service.

Money and Old Age: Installment Four


The fourth panel on May 3 discussed aging and wealth from the standpoint of the “financial solutions provider” (the investment product provider). Representatives of Allianz, PIMCO, Empower Retirement and Eaton Vance suggested the following:


A hot topic in investment today is how a company stacks up on the ESG analysis: is the company Environmentally responsible, are its business practices Sustainable, how transparent and ethical is its Governance? While 70% of European investment is driven by ESG to some degree, the U.S. experience is far lower. But ESG will become more important in the U.S. First, there is a positive correlation between higher market value as a percentage of book value where companies have high ESG scores, so these companies are better investments. Second, millennials are more and more demanding ESG compliance.


Discussion of “target date” funds, that aim for liquidity at a set date (e.g. when a person is to retire or a child starts college). These funds generally change portfolio mix away from possibly volatile equities as the target date approaches. Consistent with all other panels, there was agreement that investors need to stay in equities for the long haul. Target date funds are “outmoded.”


People with advisors are 33% more successful than those without (source or detail not explained). Younger investors can invest without great customization of advice until they reach their fifties. At that point, peoples’ life situation, style, goals etc. become individualized and at that point they need individual advice.

And again echoing a prior panel, this group discussed who bears the economic risk of providing economic guarantees for a life-time annuity? How does the insurer hedge the risk? Hedging mechanisms (not identified) are costly. But there is need that some part of retirement funds be like a salary, a defined lifetime periodic payment (annuity).


Discussion of resistance of some advisees to paying management fee. Per the panel: “cost is not expense.” It is a mistake for investors to look for “no fee” programs. The issue is the net result. It is true that pressure on fees will continue, but without “workplace savings” there is great need for advisors.



Money and Old Age: Third Installment


 The third May 3 panel discussed wealth and aging from the vantage point of leading financial advisors. Four successful on-the-ground advisors offered the following perceptions of the advisory business, prodded by observations from Professor Joe Coughlin, director of the MIT Age-Lab.


Investors must stay in equities longer or forever. A suggested mix for aging investors: 70% equity.


Advisors to date have sold investment advice. In the future they must offer broader services, about life. Advisors generally work with educated and financially more secure people, and since the greatest indicators of long life are money and education, planners must be very focused on the end game. It was even suggested that what advisors are now paid for, portfolios, should be given for free, and what advisors now are being pressed to provide for free should be what is compensated. Here are examples of services which advisors might need to master: housing in old age, transportation cost and availability, updating homes so people may stay in them as they age, concierge medicine, health insurance, fighting boredom and staying independent longer.


The statistic of loss of advisor business on the death of parents was stunning. It was suggested that the next generation changes financial advisors 98% of the time. The solution, says highly successful financial advisor Susan Kaplan of Newton, MA, is for the advisor to meet with, and include in all family meetings, the next generation, to create a direct bond. Furthermore, Kaplan suggests thinking of the advisor as providing, psychologically, a virtual family office.


How do advisors deliver more service than today, at economic scale? Technology, and staffing a team with varied skill-sets.


What will happen with fees, given the new concierge model of the RIA? Why base fees on AUM? No clear prediction of future fee models emerged from the discussion.


Money and Old Age: Second Installment


The second panel on wealth and aging discussed financing retirement through the lens of the asset management firm, with participants from the highest executive levels of Putnam, MFS, BOA, Columbia Threadneedle and BlackRock. Major take-aways:


Placing retirement costs on employees through 401k plans has not been successful. We lost old-style pension plans. We need new solutions, perhaps annuities purchased over time by “forced savings.” The average 401k on retirement contains only $91,000. But attractively priced products are not now available.


Discussion of who incurs the “risk” of “age liability.” With lengthening lives, not many financial product companies are anxious to incur that risk.


Given longevity, we must keep equity in portfolios all our lives (a theme in all panels). Also, we may consider using Health Savings Accounts as part of retirement planning (not explained.)


There is a need for easy-to-understand retirement products. People now insist on understanding. Millennials are risk-adverse (perhaps due to the experience of their parents and the 2008 recession).


Women continue to outlive men. Women will own a majority of retirement assets. Women now are 57% of the U.S. workforce. Women retire two years earlier than men, are underpaid, take more time off due to family roles, start investing later than men, want to be “scholars” understanding everything before they act when they should be investing ASAP. Earnings in society also are not growing robustly. Women thus need to be thought about in detail in terms of advisory services, as they tend to be less prepared to retire.


In investing, traditional company value could be seen on a balance sheet. Today, value is in technology, which gets quickly written off. How do you judge a company in terms of investment? Tech investment is attractive to millennials. Part of the answer: look at cash-flow.


Discussion of effect on the market by discontinuation of the government’s program of quantitative easing. How will retail investors react to a major increase in the supply of bonds in the marketplace?


You must invest with a long view, a 20-year window. One recommendation: U.S. equities, which show the ability to promote the “most profound value growth,” to which ultimately should be added Chinese equities when the market becomes less opaque.


Current investors need to be better prepared for the future by advisors. Markets are always subject to drops. It has been a decade since “we have been discussing loss and volatility.”