`Sunlight' Bylaws May Alert Companies to Activist Moves

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By Che Odom

June 28 — As companies gird for potential proxy fights by activists, one mechanism may provide a better alert system—the corporate bylaw.

One attorney is suggesting that public corporations adopt bylaws requiring hedge fund activists and other investors to report when they acquire significant stakes in the company sooner than mandated by the federal securities laws.

Under Section 13(d) of the 1934 Securities Exchange Act, investors have a 10-day window in which to report any strategic plans—such as a takeover proposal—after they acquire more than a 5 percent beneficial ownership of a company's outstanding shares.

Miami litigator Grace Mead, a shareholder at Stearns Weaver Miller Weissler Alhadeff & Sitterson PA, told Bloomberg BNA that “sunlight bylaws” would require that hedge fund investors disclose the percentage of the fund's portfolio invested in the company, its portfolio turnover and its prior holding periods after any announcements of an ownership interest and a strategic proposal.

The bylaws also would require the activist to disclose the fund manager's compensation and investment in the fund, said Mead, who represents companies battling activists in court.

The problem is that Section 13(d) doesn't require that activists report derivative or short positions, and 10 days may allow them to gain a significantly higher ownership percentage before a company is alerted, Mead said.

Short of rule or legislative amendment, such bylaws may be the best way to give public companies better notice of looming proxy campaigns, Mead said. The information may also help other shareholders evaluate proposals coming from activists, as well as the motivation behind them, she said.

White Paper

Mead wrote a paper on her idea, “Two New Tools for Addressing Activist Hedge Funds—Sunlight Bylaws and Reciprocal Disclosures,” which was published in May in the Fordham Journal of Corporate and Financial Law.

Mead is not alone in voicing concerns about the 10-day window under the 1934 Act. In March, a group of Democratic senators introduced a bill—the Brokaw Act (S. 2720)—to amend Section 13(d).

The bill—whose chances of passage are slim—would give investors that acquire a 5 percent stake in a company's stock two business days, rather than 10, to publicly report their holdings (55 CARE, 3/22/16).

The nonprofit Government Accountability Project and other organizations called on Congress to make similar changes last year (13 CARE 794, 4/17/15).

The calls to amend Section 13(d) go back even further. In 2011, law firm Wachtell, Lipton, Rosen & Katz submitted a rulemaking petition with the Securities and Exchange Commission, asking for an earlier reporting deadline (09 CARE 324, 3/18/11). That petition is still pending.

More Activist Fights on the Way

Meanwhile, a recent Bloomberg analysis found that shareholder activists are on track to win a record 62 board seats this year, up from 58 seats in 2015 (118 CARE, 6/17/16).

Mead told Bloomberg BNA that the merger of DuPont Co. and Dow Chemical Co., disclosed in December, provided part of the catalyst for her idea.

The two chemical companies announced they would merge and then break off into three public companies through spin-offs (87 CARE, 12/14/15). The deal followed two years of pressure from activist investors, including Trian Fund Management LP, who argued that shareholders of both companies would realize greater value if they were broken up.

As she watched the deal unfold, Mead said she was struck by the information disadvantage such companies suffer. Lack of information about the activist makes dissuading stockholders from “adoption of strategic proposals that would harm long-term value” difficult, she said.

‘Uncharted Territory.'

Thomas R. Stephens, a partner at Bartlit Beck Herman Palenchar & Scott LLP, isn't convinced that changes are needed to Section 13(d). He told Bloomberg BNA that Mead's bylaw suggestion would be “uncharted territory” but may work.

“I think a narrow bylaw that includes a well thought-out justification as to how it benefits shareholders should work, provided the consequences for failure to comply are reasonable and not outsized,” he said.

While directors can amend bylaws unilaterally in most circumstances, that doesn't mean they can create whatever bylaws they wish, he said.

“Would a bylaw be enforceable if it said all shares owned by hedge funds would be automatically forfeited? I think not,” he said.

A “disclosure-based, quasi 13(d) bylaw” might be deemed reasonable by courts, but establishing a penalty for failure to comply could be a problem, Stephens said.

Mead said that such bylaws could draw the ire of institutional shareholders and proxy advisers, but should pass the scrutiny of the Delaware courts. Companies that are reluctant to adopt the provisions should ask activists to voluntarily provide the information that a bylaw would require of them, she said.

To contact the reporter on this story: Che Odom in Washington at codom@bna.com

To contact the editor responsible for this story: Yin Wilczek at ywilczek@bna.com

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