DealLawyers.com Blog

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