By H. Rodgin Cohen
Banking organizations of all shapes and sizes are increasingly encountering challenges from shareholder activists seeking to force a sale of the bank or other fundamental change in strategy, operations or senior management. In order to force the target company to accede to these demands, the activist shareholder will frequently demand board seats, and, if denied, run a so-called “short slate” proxy contest seeking minority representation on the board.
The number of activist challenges against all companies, bank and nonbank, has soared in recent years, and these activists, predominantly hedge funds, have a demonstrated record of success.
Although there is some correlation between positive financial and market performance on the one hand, and reduced vulnerability to an activist challenge on the other, the scale of this correlation does not reach the equivalence of insulation. If an activist initiates a public campaign, there can be a significant change in the target’s shareholder base from long-term holders to event-driven investors in a very short period of time. While the percentage of banks that are likely to be confronted with an activist challenge is small, it is little comfort to be a statistical anomaly if your bank is forced into a sale by hedge fund activists.
In dealing with the threat of hedge fund activism, a bank’s key to success is as much dependent upon what it does before the challenge as afterwards. If the first time the bank begins to deal seriously with an activist challenge is when the activist publicly announces its challenge, then the bank will be operating at a serious disadvantage. If the activist has center stage with the bank’s stockholders and the relevant media for weeks while the bank is planning its strategy, many minds will be largely made up before the bank is even heard.
Accordingly, here are 10 actions that banking organizations should consider taking in advance of any activist challenge:
1. The first, and most important, is to assure that the board is united with respect to the most likely activist demands: a sale of the company and seats on the board. If an activist has support on the board, the bank’s ability to resist the activist is sharply degraded.
Obviously, no final board response is possible unless and until there is an actual and specific activist proposal. Nonetheless, there should ideally be a uniform sense of the board that an activist effort to force the sale of the bank is not in the best interests of the bank and its stockholders. This pre-challenge analysis should not be misinterpreted as suggesting that any specific transaction should automatically be rejected as contrary to the best interests of the bank, its stockholders and its other constituencies, but only that the activist playbook of putting a “for sale” sign on the bank is not likely to be the best strategy. If the bank decides to sell, it should be at the time and place and methodology of the board’s own choosing on behalf of all shareholders, and not the decision of a single shareholder acting in its own best interest.
There should also ideally be a uniform sense of the board that the addition of activist nominees to the board could prove counterproductive if the nominees have an agenda to promote or expect to be treated as some sort of “super director.” Collaboration should not preclude disagreement, but a continuously contentious board is likely to prove an ineffective board. Similarly, the board should also have a uniform understanding of the dynamics of an activist challenge for board seats. Such a challenge will be disruptive and costly—but it lasts only a few months. Confrontational activist representatives in the boardroom can be disruptive for years.
2. A second pre-challenge step is the preparation of a “reply deck.” An activist frequently prepares a slide deck in support of its sell-the-company thesis, and this is circulated to investors and the media. We recommend the advance preparation of a deck that can be used to counter an activist’s platform of a sale. It can also be used to help educate the board and to explain the bank’s overall strategy to investors before an activist challenge is mounted.
3. The bank’s discussions with investors, analysts and the media should focus on the bank’s long-term value as an independent organization, as well as recent financial performance. In the current activist environment, it is more important than ever to ensure that your largest shareholders understand the bank’s overall strategy, and that the bank in turn understands any concerns these shareholders may have.
4. We recommend forming an activist challenge working group, which should comprise bank executives and can be supplemented by external advisers. This group would meet periodically, review recent developments and plan for an activist challenge. It would then be in a position to respond promptly if an actual activist challenge were mounted.
5. Maintain a list of constituents to approach promptly if an activist attack is launched. This would include leading shareholders, employees, media, regulators and any relevant elected officials.
6. Review your charter, bylaws and policies with respect to director qualifications, the window period for director nominations and shareholder proposals and shareholder meeting mechanisms. There are likely to be certain requirements, particularly relating to transparency, which could help ensure that the board and shareholders act on an informed basis in the event of an activist challenge.
7. Implement a stock watch program to monitor any unusual stock accumulations. You should understand, however, that an activist can accumulate a relatively large position, including by use of derivatives, without prompt disclosure.
8. Carefully consider regulatory defenses such as whether an activist’s approach might involve a change of control requiring review or approval under relevant banking statutes. In particular, for state banks we would recommend a review of your state banking laws and regulations to determine whether the state banking authorities are empowered to require an application before some person, or group of persons, could exercise a controlling influence over the bank.
One model would be state insurance laws, which have broad definitions of “controlling influence” and “acting in concert.” We see no logical basis for requiring hedge funds to obtain regulatory approval before acquiring a controlling influence over insurers, but not imposing a similar requirement to acquire a controlling influence over banks. One other regulatory issue to be considered is the director interlock prohibitions in Section 8 of the Clayton Act and the Federal Reserve’s Regulation L, particularly as they could apply to a hedge fund director. This could disqualify certain hedge fund director nominees.
9. Consider in advance whether there are political considerations. If an activist surfaces with a demand for a sale, you may want to call promptly on federal, state or local officials to seek their support. The argument to elected officials would relate to the adverse impact of a forced sale on employees and the local economy generally.
10. Finally, you should recognize that there are differences among activists. There is a spectrum as to their tactics, capabilities and reasonableness, and, if you have the luxury of time, your planning should take these differences into account.
One bonus recommendation: If you receive an activist challenge and you decide to fight, then you should fight to win and deploy all necessary resources. A half-hearted effort virtually ensures that you will lose because the activist will make a full-scale effort. This is, after all, about the future of your bank.
H. Rodgin Cohen, a preeminent figure in corporate law, is senior chairman at Sullivan and Cromwell LLP.
