End of week thoughts on a variety of issues impacting investor relations, the markets and the investment community, from Chris Taylor, EVP, Global Research, Thought Leadership & Partnerships
Fixing Disclosure by Activists
Ownership disclosure by activist investors continues to be in the spotlight of regulators following an announcement earlier this week by the Justice Department that it was filing a lawsuit against ValueAct Capital Management, claiming that it did not properly disclose significant stakes it acquired in Baker Hughes and Halliburton in late 2014 as proscribed under The Hart-Scott-Rodino (HSR) Act. Now Congress has jumped into the fray, as two Senators got on their populist soapboxes (Public Enemy #1 being activists) to announce legislation that would, amongst other things, shorten the window that an investor has to file a Schedule 13D from 10 days to two days once it breaches 5% of shares outstanding.
It is unlikely that substantial changes to Section 13(d) will happen any time soon and it’s doubtful that Congress will continue to aggressively hunt the activist bogeyman once the election cycle has passed. How Justice and ValueAct proceed in their HSR case is certainly important, but it is beside the point that we want to make.
The vast majority of legal discussions regarding ownership disclosure by activists continue to focus on significant stakes that cross the 5% threshold or on the antitrust filing requirements via HSR. What’s always left out is the gaping hole in Rule 13(f), which enables activists and other investors to acquire indirect stakes in companies via security-based swaps (and other derivatives) without disclosing them in their quarterly Form 13F. There has been legal chatter that goes back several years about how to treat these swaps and if they represent beneficial ownership and we’ve written on the use of swaps in the past.
For now, security-based swaps are not defined as 13F eligible securities and continue to operate under the radar until Form 13D takes over and the ownership disclosure is made. It’s important to note that listed, exchange-trade options are 13F eligible securities and investors are required to report these positions each quarter.
In reality, several quarters can pass without any public notification that an activist is building a stake in a target. Activists will use swaps positions, along with their reputation, as leverage to initiate the engagement process with the management and boards of companies. The opaqueness of these swap arrangements and the fact that these positions are not publicly disclosed (until they are >5%) make it difficult for a company to understand the true size of the activist’s economic exposure. Given that the swap positions give activists the access to management that typically is only afforded to a known, material shareholder, shouldn’t companies expect and demand better and more comprehensive disclosure?
Over the past several years the National Investor Relations Institute (NIRI) along with several supporters, including the NYSE and the Society of Corporate Secretaries and Governance Professionals, have pushed for the post-quarter reporting period for 13Fs be shortened from 45 days to two days and the reporting period for 13Ds be shortened from 10 days to two days following the move above 5%. Given the rise in activism and the expanding use of swaps and other derivatives by this group, expanding the list of 13F-eligible securities to make sure these instruments are included should be at the top of the list of any recommended changes to investment adviser disclosure rules.
Has Activism Come to Japan?
Headline news was made in Japan today with the resignation of the Chairman and CEO of Seven & i Holdings, parent of 7-Eleven. The boardroom battle, which culminated in the resignation of the Chairman and CEO seems to be as much the result of internecine strife as it is the workings of an activist, in this case Dan Loeb’s Third Point, who extolled the virtues of the winner in the Seven & i’s boardroom battle and put forth his strategic recommendations for the company in a late 2015 investor letter.
Seven & i is not the first “activist” investment that Loeb has made in Japan, as he also made headlines with investments in Fanuc (a famous company in Japan know for amazing manufacturing robots and a head office at the base of Mount Fuji) and Sony (a company that needs no introduction). While Loeb pushed for action at Fanuc and Sony, his approach to date has been markedly different than the flame-throwing he is apt to do in the US. By taking a low-key and outwardly respectful approach in his dealings with companies, Loeb is making sure he doesn’t stoke the nationalistic, protectionist reaction that the populace and government in Japan can have to foreign investors. Additionally, Loeb may understand that effecting significant change at a Japanese company through an activist-styled investment is not as practical as it is in the US and his goals in Japan may be more incremental.
Regardless, it’s premature to expect that activist investing will take hold in Japan. In the late 1990’s and early 2000’s a relatively small NY-based hedge fund, Steel Partners, made a lot of noise in Japan, as it eyed the country’s cash-rich balance sheets as easy targets for activism. While Steel Partners had its moments, unseating the Board of Aderans for instance, its failures to impact Japan Inc. were far more numerous. Even in the case of Aderans, Steel Partners was victorious primarily through its own large stake (close to 30%) and the more than 9% holding by a sympathetic western investor, Dodge & Cox. Activism is expensive and time consuming and Steel Partners, an investor name that was once feared in many Japanese boardrooms, has not been heard from in close to a decade.
Loeb’s Third Point is certainly a different, more sophisticated investor than Steel Partners ever was, but it’s still too early to make the proclamation that activist investing has arrived in Japan. The success of activist investing is not only the result of the activist investor, but the support that activist agendas receive from the long-term institutional investors of their targets. Only with that broad-based support, whether explicitly through shareholder votes or via back-channel communication to the Board, can activism succeed on a consistent basis. The firewall for Japanese companies against foreign activism is the support they receive from the local Japanese institutional investment firms and trust banks. Without support from the large base of local investors, activism in Japan will continue to have some modest success from time to time, but a trend it is not.