September 10, 2012

Forest Laboratories Proxy Fight Vindicates Strong Defense

Here’s a Wachtell Lipton memo I received while I was out on vacation:

On Wednesday, Forest Laboratories’ shareholders reelected nine out of ten incumbent director nominees, while rejecting three out of dissident Carl Icahn’s slate of four directors, despite ISS’s recommendation in favor of two of Icahn’s nominees. These results, along with the recent victory by AOL against Starboard (see our memo, AOL Shareholders Reject ISS Supported Activist Hedge Fund), represent an important reminder that companies under attack by dissidents have a chance to defend themselves with a well-crafted message that articulates a strategy for long-term success, notwithstanding strong activist pressure with backing from ISS.

This week’s contest was round two between Forest and Carl Icahn, who owns nearly 10% of the pharmaceutical company. In 2011, Icahn sought to place four directors on Forest’s board, but was rebuffed by shareholders, who elected all ten of the Company’s nominees instead. Icahn promoted a short slate again this year, attacking the Company for what he perceived to be failures in governance practices and performance. In response, the Company made a compelling case for its business strategy and recent governance reforms. In addition, the Company pointed out that two of Icahn’s nominees suffered from potential conflicts: in one case, an unusual contractual arrangement based upon Icahn’s profits, which incentivized the nominee to “swing for the fences” during a 30 month period; and in the second case, a contingent value right related to one of Forest’s products, which could lead that nominee to favor just a single product. Notably, Glass Lewis supported Forest’s slate and explicitly noted these potential conflicts. And while ISS decided to recommend two (but not four) of Icahn’s nominees, it did not support either of the two candidates with potential conflicts, both of whom were defeated. Moreover, Forest argued that a third Icahn nominee, who is an Icahn senior executive, could not be expected to represent the interests of all shareholders and that he was “overboarded.” He too was defeated, despite an ISS recommendation in favor. Forest also resisted Icahn’s broad books and records request under Delaware ยง 220, substantial parts of which were refused in court.

The results at the Forest meeting hold important lessons. First, in many cases a company can overcome even a contrary ISS recommendation with a resolute defense of its governance story and long-term plans. The best defense will be made directly to its shareholders with the participation of independent directors and will be most likely to succeed when there has been an ongoing dialogue on key issues long before any activists surface. Second, companies may resist overly broad fishing expeditions into corporate records, even if it means going through litigation. Finally, the identity and incentives of the dissident slate does matter. In the case of Forest, the Company was able to argue that two of the four nominees had potential conflicts, and that a third was overly close to Icahn and served on too many other boards. In the end, the only dissident nominee elected by shareholders was an independent outsider without prior ties to Icahn.