How to Keep Shareholders in Check

Company executives in several countries have recently recorded a series of victories over so-called shareholder activism, i.e., the collective efforts of small or minority shareholders to influence management, notes The Economist, observing that these events could turn into a trend.

Last month, for example, a court in Massachusetts ruled that one such shareholder activist, Bob Monks, cannot file a class action lawsuit on behalf of shareholders against the company Stone&Webster and its former auditor PricewaterhouseCoopers, finding that Monks is a shareholder activist and as such is not sufficiently ‘typical’.
‘I explained to everyone that there is no shareholder democracy in America and that to change that, lawsuits need to be filed, and now I have discovered that I cannot even do that,’ said the activist, who has been campaigning (so far unsuccessfully) for 16 years to be elected to the board of the retail company Sears, Roebuck. He had even taken out a full-page ad in the Wall Street Journal stating that the existing board of the company is ‘an asset that does not generate income.’

Later, he attempted to achieve this through the courts, but after the aforementioned ruling, he says he feels ‘completely powerless’.
In the ongoing struggle between shareholders and management, the disqualification of Bob Monks is just one of the victories recently recorded by top executives, not only in America. In early October, the European Commission abandoned its long-standing effort to introduce the principle of ‘one share, one vote’ into European legislation. This would have strengthened the legal protection of minority shareholders, which is notoriously weak in some parts of the EU. The main opponents of this principle were lobbyists for large shareholders, such as the Swedish business dynasty Wallenberg, which uses special shares to maintain control over companies.

A recent decision by the Japanese Supreme Court also dealt a strong blow to the young movement of shareholder activism in Japan. Foreign investors, mainly from the U.S., are pressuring companies to return some of the unusually large payouts. A notable example is Steel Partners, a New York hedge fund that has purchased stakes in about 30 Japanese companies for around three billion dollars since 2000, including some of the most popular Japanese brands like Sapporo beer or the food company Bull-Dog. One minister even accused these investors of ‘greenmail’, which is market jargon for extortion. To counter such shareholders, Japanese companies have resorted to the so-called poison pill, a tactic that reduces the value of shares of an unwanted buyer. More than 300 companies have done something similar just this year.

In August, the Supreme Court ruled that Bull-Dog’s poison pill is legal, and Steel Partners is a ‘malicious buyer’. Although most shareholders generally approve of this tactic, its goal is to reject the principle that all shareholders are treated equally. It would be premature to claim that this series of defeats for shareholder activists is turning into a trend, as the balance of power between management and shareholders varies significantly from the U.S. to Japan to different parts of the EU. However, this could change if several upcoming battles end in victories for management. For example, in Germany, a law is expected to be passed that would allow the mutual cooperation of minority shareholders to be considered ‘concerted action’, so they could be required to make a takeover bid for a company if they collectively hold more than 30 percent of the shares.

According to one amendment from the fund community, this would conflict with the United Nations principles on responsible investment and would make ‘the actions of activist investors nearly impossible in Germany’. Such a law would be the ultimate consequence of the notorious ‘locust invasion’ on the management of Deutsche Börse, the operator of the Frankfurt Stock Exchange, led by Chris Hohn from The Children’s Investment Fund with the support of a group of other hedge funds.
In the U.S., the battle is being fought on several fronts. The Supreme Court heard arguments on October 9 in the case of Stoneridge Investment Partners v. Scientific Atlanta, which is considered key on both sides of the debate. It concerns transactions between telecom equipment sellers, including Motorola on one side, and a company that improperly managed their accounting. The contentious issue is: if these companies knew about it, does that make them liable for fraud?

Some prominent lawyers – including a former chairman of the Securities and Exchange Commission, the U.S. stock market regulator – fear that if the court rules that a third party is liable, it will open the floodgates for many lawsuits, arguing that this would significantly reduce the competitiveness of American companies. On the other hand, the aforementioned Bob Monks believes that this case is a test that will show whether U.S. authorities can prevent the issuance of securities based on false data. The SEC is also at the center of the battle regarding procedures for changing companies’ internal rules on the election of board members.

In early October, consultations were completed on two proposed rules: one that would allow companies to disregard provisions of their bylaws that were voted on by proxy, i.e., by shareholders who do not attend annual meetings, and another that would require companies to adopt those decisions anyway. Institutional investors protest that the second rule does not go far enough, while their opponents argue that any expansion of shareholder rights should be rejected to actually save shareholders from themselves. Excess shareholder democracy inevitably leads, critics of shareholder activism say, to a lack of value for shareholders.  (Davorka Zmijarević)