The Williams Act: A Truly “Modern” Assessment

Posted by Scott Hirst, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on Saturday October 22, 2011 at 9:49 am
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Editor’s Note: The following post comes to us from Andrew E. Nagel, Andrew N. Vollmer, and Paul R.Q. Wolfson, partners at Wilmer Cutler Pickering Hale and Dorr LLP, and is based on a paper by the authors, available here. Related work by the Program on Corporate Governance on the SEC consideration of possible changes to rule 13(d) includes The Law and Economics of Blockholder Disclosure by Bebchuk and Jackson.

Recently, a debate has emerged about the merits of certain proposed piecemeal reforms to the Williams Act’s 13(d) disclosure regime. The aim of our paper, The Williams Act: A Truly “Modern” Assessment, is to examine the implications of these proposals and to suggest that, before making any changes to the regime, the Commission should undertake a comprehensive review of the role of the Williams Act in today’s market and decide what best serves overall shareholder interests. The paper was prepared on behalf of certain members of the Managed Funds Association and was sent in advance of various meetings with the Staff of the Securities and Exchange Commission and with certain SEC Commissioners. The participants at those meetings included Pershing Square Capital and JANA Partners, as well as BlackRock, California State Teachers’ Retirement System, Florida State Board of Administration, The New York State Common Retirement Fund, Ontario Teachers’ Pension Plan Board, TIAA-CREFF, T. Rowe Price, and pension fund representatives of Change to Win and the United Food and Commercial Workers Union.

The Williams Act: An Historical Perspective

Enacted in 1968, the Williams Act was a response to a wave of hostile coercive takeover attempts, primarily cash tender offers. At the time the Williams Act was passed, the vast majority of shares were owned by individual shareholders, a fragmented and ill-informed group unprepared to exert their rights as shareholders. Cash tender offers posed the real risk of destroying value by forcing shareholders to tender their shares on a compressed timetable.

The Williams Act was designed to protect these investors, who faced serious dilemmas when “corporate raiders” launched attempts to take over companies in which they owned stock. It was intended to fill gaps in federal and state corporate law, as Federal securities laws already included disclosure requirements for proxy fights and share-for-share exchanges, while no laws applied to cash tender offers.

At the same time, Congress recognized that takeovers of underperforming companies could benefit shareholders and the economy as a whole, and also recognized that unduly impeding the acquisition of large block holdings comes at a significant cost to efficiency and the markets. Congress, therefore, sought to balance the interests of managers, potential acquirers, and shareholders.

Evolution of Corporate Governance

Since the 1960s, the corporate governance landscape has evolved dramatically in three key ways which suggest that it may be time for a comprehensive review of the provisions of the Williams Act and the protections it affords.

First, the enactment of new federal and state corporate antitakeover laws and implementation of corporate defense mechanisms have effectively closed the legal gaps that existed and put an end to the coercive tender offers that the Williams Act sought to address. It is difficult today to find a publicly held company that is not shielded by a poison pill or antitakeover statute, or both, such that incumbent management now has the upper hand in corporate governance contests.

Second, the composition of shareholders of public companies has changed significantly. In the 1960s, individual shareholders, who were widely dispersed and did not have the resources or the incentives to stay well-informed, held more than 80% of shares in U.S. corporations. Today, they account for only one-third of equity holdings. Most shares are owned by institutional investors who do have the resources and incentives to be engaged, hold larger concentrated blocks of stock, vote their interests more actively, and are far better informed. Because institutional investors are active participants in shareholder democracy it is nearly impossible today for a minority shareholder to individually dictate the outcome of a proxy contest or otherwise take control of a company through accumulations of a 10% (or even higher) position.

The third important development has been the emergence, over the last two decades, of a new breed of investors – active shareholders – who pursue investment strategies entirely different from the corporate raiders of the past. These engaged investors do not seek to acquire control of companies, but instead seek to bring about operational, strategic, governance, capital allocation or other changes in order to create value for both passive and active shareholders. In the process they undertake the transaction costs, reputational risks, and legal and economic liabilities necessary to effect corporate change. Engaged investors, therefore, provide a market-driven mechanism for positive change.

The Current Debate

Recently, outside law firms that typically represent U.S. public company incumbent boards and management have called for piecemeal changes to the Williams Act’s Section 13(d) disclosure regime that would place greater burdens on and reduce the economic incentives for active shareholder engagement across all U.S. corporations. The proposals include (1) shortening the current ten-day reporting period for disclosure of greater than 5% ownership positions and (2) expanding historic concepts of “beneficial ownership” to include synthetic or cash-settled derivatives to widen the scope of positions counted towards the threshold for disclosure. In addition, the Securities and Exchange Commission staff recently indicated that the Commission may consider rule changes in this area.

Our paper argues that the calls for narrowly targeted changes to the Williams Act from pro-management commentators rely on several faulty premises: First, that the ten-day filing period is a reflection of the technology of the 1960s rather than an attempt by Congress to achieve the appropriate balance among the relevant interests affected by takeover attempts. Second, that short-term selling shareholders who dispose of their shares in the period before a large-block investor discloses its purchases are harmed in some fashion, when, in fact, such investing actually brings substantial benefits to these short-term selling shareholders. Third, that the current 13(d) regime permits concentrated, engaged shareholders to obtain “control” of U.S. public companies prior to disclosure of their ownership interests, when it is now nearly impossible to acquire “control” of a company through 10% (or even greater) positions, because shareholder bases are no longer largely comprised of dispersed and ill-informed individual shareholders. Furthermore, the reforms suggested by pro-management forces undermine the market-based incentives for active shareholder engagement, and thus, these proposals would chill the market for engaged investing, making it less likely that such activity occurs at all. Without that activity, no one would obtain the benefits of the value creation that currently results from engaged investing, and corporate democracy would be weakened by narrowing in many cases the choices available to shareholders.

Our paper strongly urges that the Commission should review the history and policy underlying the Williams Act’s disclosure regime before adopting piecemeal changes that only benefit one side of the debate. The fundamental question in any proposed modernization of the Williams Act should be: Would changes benefit or harm shareholders? Moreover, our paper suggests that expanding the disclosure requirements of the Williams Act would not only fail to add anything to investor protection, but it would actually hurt investors and the economy as a whole, and that a comprehensive policy review would support changes to the Section 13(d) regime that encourage greater active shareholder involvement, including, among other things, an upward revision of the 5% disclosure threshold which currently relies on outdated notions regarding corporate control.

Despite its origins as a response to hostile takeovers, the current Williams Act disclosure regime sets the current balance between providing incentives for engaged investors to make investments and allowing passive, long-term shareholders to benefit from those investments. Whatever the Commission does, we believe any changes must be supported by clear evidence and driven by sound policy decisions, and that any changes should be preceded by an open and informed reassessment of all aspects of the Williams Act and the modern corporate landscape in which both shareholders and management participate.

The full paper is available here.

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