Michael Levin’s The Activist Investor newsletter recently flagged an academic paper by Ben Bates of Harvard Law School on advance notice bylaws, “Rewriting the Rules for Corporate Elections.” The paper analyzes advance notice bylaws from 2004 to 2023 using a dataset of 14,000+ bylaws from 3,800+ public companies. Wow! The findings prove something we already knew — that advance notice bylaws have become longer and more complex while drafting variability has increased — but the methods employed to prove this and the paper’s insights on market-wide and firm-specific events that prompted changes in advance notice bylaws over the years are worth spending time on.

The paper used absolute length (word count) and individual components (disclosures required of activists) to assess complexity. The paper identified the following categories of individual components:

Agreements, arrangements, and understandings – between an activist and related parties, such as director nominees or other investors
Affiliates – of the activist
Associates – of the activist
Acting in concert – any other parties with which the activist might collaborate
Competitors – any investment or interest in competitors of the company
Derivatives – investment in derivative securities of the company, and possibly of competitors
Family members – extend various disclosure obligations to family members of the activist and its BoD nominees, and possibly affiliates or associates
Known supporters – of the activist, such as other shareholders
Performance fees – for the activist, say based on company performance or the outcome of the activist project
Questionnaire – whether the company requires director nominees to complete one of these
SEC Reg S-K Item 404 disclosures
SEC Schedule 13D disclosures

The paper says there were two big waves of amendments to advance notice bylaws. The first coincided with the 2008 financial crisis and an increase in campaigns by hedge funds against the firms included in the data set. The second, unsurprisingly, followed the universal proxy card rules. In the last few years, most bylaw amendments both accounted for the use of UPC and added additional substantive disclosure requirements.

The paper claims that variability in advance notice bylaws is the biggest issue — in terms of cost to shareholders — and points to features of Delaware law that may promote this variation. These include the relative lack of power of shareholders in amending corporate bylaws, Delaware courts’ willingness to blue pencil bylaw provisions and the very high standard Delaware courts apply for facial invalidity. It suggests three potential reforms to promote “standardization”:

– Amend the DGCL to require a shareholder vote on all amendments of bylaw provisions that govern board elections or nomination procedures

– Delaware courts could use their equitable powers to start requiring companies to give shareholders some time to cure disclosure deficiencies, particularly for deficiencies in responding to ambiguous and contestable ANB provisions

– Courts could lower the standard for finding ANBs to be facially invalid

– Meredith Ervine 

This recent insight from ICR focuses on the hidden costs of short attacks for companies and posits that, despite the often larger risks posed by short attacks, both reputationally and financially, companies are usually less prepared for a short attack than a proxy contest. Here are some factors they highlight on the relative risk posed to companies:

– Short activism, or short attacks, are far more frequent than proxy contests. In 2023, there were 110 different short attacks and only 27 proxy contests globally (excluding closed-end fund activism), according to ISS Compass. The lower number of proxy contests is largely a reflection of companies and activist shareholders’ ability to arrive at a settlement agreement in advance of a vote.

– While companies and activists may battle in a proxy contest, they fundamentally have the exact same goal – to improve stock performance. … Companies targeted by short attacks are often outperforming their peers and they most certainly do not share the same goal, as short sellers profit only when the stock declines in value.

– The market reaction to a traditional activist campaign announcement can be negligible or, in some cases, be very positive. … In 2023, the average one-day market reaction to a short attack was -7.1%, according to Factset Market Data.

– Traditional shareholder activism is easier to predict and therefore easier to prepare for.

Despite that unpredictability, the article says the themes of short attacks almost always fall into three buckets:

Valuation. Example: Company is overvalued based on aggressive company projections or unsupported investor hype/optimism.

Financial. Example: Unorthodox or fraudulent accounting often associated with recognition of revenue. Conflicts of interest with partners/management/board.

Product. Example: Ineffective or harmful product/service, the product/service does not work as described or is potentially dangerous to the end user.

It goes on to make the “ounce of prevention” argument, and advocates for the following proactive measures, some of which are just good IR and financial reporting practices:

– Scenario plan for potential weaknesses or attack points. Where are you vulnerable?
– Do not issue aggressive guidance that might encourage investors and analysts to overvalue your company.
– Adopt conservative accounting practices and be cautious in using non-standard accounting measures which are often “red flags” for short sellers.
– Ensure disclosure controls are effective such that public filings contain all material information, including negative sensitive issues.
– Report bad news and unexpected results or developments as promptly and thoroughly as possible.
– Prepare a “Break the Glass” Communications Plan that includes: the short attack response team; draft press releases for multiple scenarios; and draft communications for employees, customers, suppliers, etc.
– Regularly monitor short interest as a percentage of float. A spike in short interest often precedes an attack.

– Meredith Ervine 

In mid-September, the SEC announced settled charges against Deere & Co. for allegedly violating the books, records & internal controls provisions of the FCPA. Deere consented to SEC’s cease and desist order and agreed to pay disgorgement and prejudgment interest totaling approximately $5.4 million and a civil penalty of $4.5 million. The charges are relevant to readers of this blog since the violative conduct was carried out by employees and senior personnel at a newly-acquired subsidiary in the few years following its acquisition. The SEC’s press release says:

“After acquiring Wirtgen Thailand in 2017, Deere failed to timely integrate it into its existing compliance and controls environment, resulting in these bribery schemes going unchecked for several years,” said Charles E. Cain, Chief of the SEC Enforcement Division’s FCPA Unit. “This action is a reminder for corporations to promptly ensure newly acquired subsidiaries have all the necessary internal accounting control processes in place.”

This Freshfields blog focuses on takeaways for acquirers:

The Order does not allege that any personnel at the parent company were complicit in or aware of the improper payments. … The Order notes that Deere itself had already adopted relevant policies and procedures, including policies on entertainment of government officials and policies on factory visits by non-U.S. government officials. …The fact that a penalty was assessed against Deere at all, however, underscores the continuing need for FCPA compliance after a transaction closes and while the new asset is being integrated.

This case highlights the long-term value proposition for an acquiring company to conduct risk-based FCPA and anti-corruption due diligence on potential new business acquisitions, reinforced by appropriate post-acquisition integration into the acquirer’s existing compliance and internal controls environment.  With focus before and after, acquirers have a better chance to identify and address any potential legacy issues and mitigate the risk that the acquired entity’s misconduct (if any) continues undetected post-acquisition, as it appears was the case for Deere and Wirtgen Thailand.

Over on the Radical Compliance blog, Matt Kelly gives more of the details for those interested, calling this “one of the more colorful FCPA cases we’ve seen in a while.” In the end, Matt also touts pre-acquisition due diligence on the target’s potential bribery risk and compliance program together with post-acquisition integration and reminds readers, “even expenditures that might be immaterial in financial reporting can still bring material FCPA risks.”

When I read this enforcement action, I immediately thought of the fairly recently announced “Mergers & Acquisitions Safe Harbor Policy” intended to incentivize voluntary self-disclosure of wrongdoing uncovered during the M&A process. But that is a DOJ program, and this involved civil enforcement by the SEC. In his blog, Matt pointed out that the SEC order identifies the remediation steps Deer undertook, including firing responsible employees, improving internal audit and compliance programs, and cooperating with the SEC’s investigation, although the order makes no mention of voluntary self-disclosure.

– Meredith Ervine