This year, the practice of activist hedge funds engaged in proxy contests offering special compensation schemes to their dissident director nominees has increased and become even more egregious. While the terms of these schemes vary, the general thrust is that, if elected, the dissident directors would receive large payments, in some cases in the millions of dollars, if the activist’s desired goals are met within the specified near-term deadlines.

These special compensation arrangements pose a number of threats, including:

…continue reading: Bylaw Protection against Dissident Director Conflict/Enrichment Schemes

This paper suggests that the essence of these funds and their regulation lies not just in the nature of their investments, as is widely supposed, but also—and more importantly—in the nature of their organization.

Specifically, every enterprise that we commonly think of as an investment fund adopts a pattern of organization that I am calling the “separation of investments and management.” These enterprises place their securities, currency and other investment assets and liabilities into one entity (a “fund”) with one set of owners, and their managers, workers, office space and other operational assets and liabilities into a different entity (a “management company” or “adviser”) with a different set of owners. Investment enterprises also radically limit fund investors’ control. A typical hedge fund, for example, cannot fire and replace its management company or its employees—not even by unanimous vote of the fund’s board and equity holders.

I explain this pattern of organization and explore its costs and benefits. I argue, paradoxically, that the separation of investments and management benefits fund investors by limiting their control over managers and their exposure to managers’ profits and liabilities.

…continue reading: The Separation of Investments and Management

In a new study, The Myth that Insulating Boards Serves Long-Term Value (forthcoming, Columbia Law Review, October 2013), I comprehensively analyze – and  debunk – the view that insulating corporate boards serves long-term value.

Advocates of board insulation claim that shareholder interventions, and the fear of such interventions, lead companies to take myopic actions that are costly in the long term – and that insulating boards from such pressure therefore serves the long-term interests of companies and their shareholders. This claim is regularly invoked to support limits on the rights and involvement of shareholders and has had considerable influence. I show, however, that this claim has a shaky conceptual foundation and is not supported by the data.

In contrast to what insulation advocates commonly assume, short investment horizons and imperfect market pricing do not imply that board insulation will be value-increasing in the long term. I show that, even assuming such short horizons and imperfect pricing, shareholder activism, and the fear of shareholder intervention, will produce not only long-term costs but also some significant countervailing long-term benefits.

Furthermore, there is a good basis for concluding that, on balance, the negative long-term costs of board insulation exceeds its long-term benefits. To begin, the behavior of informed market participants reflects their beliefs that shareholder activism, and the arrangements facilitating it, are overall beneficial for the long-term interest of companies and their shareholders. Moreover, a review of the available empirical evidence provides no support for the claim that board insulation is overall beneficial in the long term; to the contrary, the body of evidence favors the view that shareholder engagement, and arrangements that facilitate it, serve the long-term interests of companies and their shareholders.

I conclude that, going forward, policy makers and institutional investors should reject arguments for board insulation in the name of long-term value.

Here is a more detailed account of the analysis in the article:

…continue reading: The Myth that Insulating Boards Serves Long-Term Value

This blog has repeatedly reported on the use of empty voting strategies at the Canadian telecommunications provider Telus Corporation. (see, e.g., here and here). Empty voting – that is, the strategic separation of economic risk from voting rights – has been considered by courts, regulators and academics over the past years in various forms. The latest account is the case of Canadian telecommunications company Telus, which became the target of US hedge fund Mason Capital. After a lengthy battle in various courtrooms, the dust has settled around this conflict. The Telus saga sheds new light on how empty voting structures are used by businesses in practice and supports calls for regulatory activity. In my recent paper, Empty Voting Revisited: The Telus Saga, I analyze the various instances of this important legal battle and develop regulatory implications.

…continue reading: Empty Voting Revisited: The Telus Saga

Concerns about the internal governance of hedge funds have dramatically increased in recent years. During the financial crisis of 2008, investors became frustrated when numerous hedge fund managers suddenly prevented them from withdrawing their capital yet nonetheless continued to charge them fees. Since the financial crisis, concerns about hedge fund governance have focused on transparency, operational practices, and the growing view that fund directors do not effectively monitor fund managers.

In my paper, Hedge Fund Governance, which was recently made publicly available on SSRN, I provide the first comprehensive scholarly analysis of hedge fund governance. In doing so, my paper makes several contributions. First, it contributes to the literature on corporate governance by conceptualizing the unique way in which hedge funds are governed and situating their style of governance within established paradigms. I argue that hedge fund governance is a type of responsive managerialism.

…continue reading: Hedge Fund Governance

In what can only be considered a form of extortion, activist hedge funds are preying on American corporations to create short-term increases in the market price of their stock at the expense of long-term value. Prominent academics are serving the narrow interests of activist hedge funds by arguing that the activists perform an important service by uncovering “under-valued” or “under-managed” corporations and marshaling the voting power of institutional investors to force sale, liquidation or restructuring transactions to gain a pop in the price of their stock. The activist hedge fund leads the attack, and most institutional investors make little or no effort to determine long-term value (and how much of it is being destroyed). Nor do the activist hedge funds and institutional investors (much less, their academic cheerleaders) make any effort to take into account the consequences to employees and communities of the corporations that are attacked. Nor do they pay any attention to the impact of the short-termism that their raids impose and enforce on all corporations, and the concomitant adverse impact on capital investment, research and development, innovation and the economy and society as a whole.

…continue reading: Important Questions about Activist Hedge Funds

The activist-hedge-fund attack on Apple—in which one of the most successful, long-term-visionary companies of all time is being told by a money manager that Apple is doing things all wrong and should focus on short-term return of cash—is a clarion call for effective action to deal with the misuse of shareholder power. Institutional investors on average own more than 70% of the shares of the major public companies. Their voting power is being harnessed by a gaggle of activist hedge funds who troll through SEC filings looking for opportunities to demand a change in a company’s strategy or portfolio that will create a short-term profit without regard to the impact on the company’s long-term prospects. These self-seeking activists are aided and abetted by Harvard Law School Professor Lucian Bebchuk who leads a cohort of academics who have embraced the concept of “shareholder democracy” and close their eyes to the real-world effect of shareholder power, harnessed to activists seeking a quick profit, on a targeted company and the company’s employees and other stakeholders. They ignore the fact that it is the stakeholders and investors with a long-term perspective who are the true beneficiaries of most of the funds managed by institutional investors. Although essentially ignored by Professor Bebchuk, there is growing recognition of the fiduciary duties of institutional investors not to seek short-term profits at the expense of the pensioners and employees who are the beneficiaries of the pension and welfare plans and the owners of shares in the managed funds. In a series of brilliant speeches and articles, the problem of short-termism has been laid bare by Chancellor Leo E. Strine, Jr. of the Delaware Court of Chancery, e.g., One Fundamental Corporate Governance Question We Face: Can Corporations Be Managed for the Long Term Unless Their Powerful Electorates Also Act and Think Long Term?, and is the subject of a continuing Aspen Institute program, Overcoming Short-Termism.

…continue reading: Bite the Apple; Poison the Apple; Paralyze the Company; Wreck the Economy

Hedge funds first began engaging in the assertive form of shareholder activism for which they are renowned in the United States, and the United States is where hedge fund activism has become most firmly entrenched as part of the corporate governance landscape. Nevertheless, hedge fund activism is a global phenomenon, with companies in numerous countries being targeted. The United Kingdom, Japan and Canada are the three countries other than the U.S. where hedge fund activism has been most prevalent. The efforts of hedge fund activists in Britain and Japan have begun to capture the attention of academics (e.g. Iris Chiu, The Foundations and Anatomy of Shareholder Activism (2010) and John Buchanan, Dominic Chai and Simon Deakin, Hedge Fund Activism in Japan: The Limits of Shareholder Primacy (2012)). In the case of Canada, however, little has been said about hedge fund activism in the academic literature. Correspondingly in “Hedge Fund Activism Canadian Style,” recently published on SSRN, I describe the emergence of hedge fund activism in Canada, identify the legal and economic variables that account for its rise to prominence and offer predictions on whether the trend will be sustained.

…continue reading: Hedge Fund Activism Canadian Style

I plan to speak about the Enforcement Division’s and in particular the Asset Management Unit’s priorities in the hedge fund space. I’ll discuss the importance of specialization and expertise to this effort; the risks for investors; how these risks are informed by the hedge fund operating model; and how a hedge fund manager’s business may be at odds with the manager’s fiduciary duty to the fund. I’ll also discuss the types of misconduct we’ve seen crossing our desks in the Asset Management Unit, and I’ll conclude with certain best practices to avoid the specter of an enforcement referral or inquiry.

…continue reading: Enforcement Priorities in the Alternative Space

Schulte Roth & Zabel is pleased to present Distressed Investing M&A, published in association with mergermarket and Debtwire. Based on a series of interviews with investment bankers, private equity practitioners and hedge fund investors in the US, this report examines the market for distressed assets at home and abroad.

Economic uncertainty brought on by the looming US “fiscal cliff” have placed companies in difficult situations where many are forced to sell assets and restructure operations and debt in order to avoid a court mandated sale further down the line. The value gained and time saved by selling assets prior to in-court restructuring and liquidation is signaled by the respondents’ shift toward dealmaking early and out-of-court.

Outside of the US, the eurozone crisis and macroeconomic concerns in the emerging markets are having a similar effect. While some are waiting for a solution to the sovereign debt crisis, distressed investors are geared to take advantage of attractively-priced assets within the region. Hyperinflation remains a concern for the markets in Latin America and India, while economic growth has slowed in Brazil and China. Both are likely to create distressed opportunities over the next 12 months.

Respondents cite the energy sector as likely to be the most active for distressed M&A in the next year. Low natural gas prices in the US are hitting the bottom line and companies are feeling the strain. Additionally, inflation concerns in Asia may expose manufacturing companies, who respondents describe as “losing the battle” against prices.

In addition to the above findings, this report provides insight into pricing, litigation, club deals, and various other issues concerning the distressed M&A community. We hope you find this study informative and useful, and as always we welcome your feedback.

…continue reading: 2012 Distressed Investing M&A Report