September 18, 2014

KEEPING CURRENT: Poison Pills Find New Life as “Raider-Like” Activism is on the Rise

In recent years, stockholder rights plans, so-called poison pills, have been viewed as a remnant of the past as opposition from institutional shareholders and proxy advisory firms have made corporate boards reluctant to adopt or maintain them. Now with the rapid increase in “raider-like” activism, many corporate boards are again recognizing the potential usefulness of poison pills. Poison pills are certainly not a perfect antidote to a well-armed activist attempting to pressure a board to take a certain action, but a properly constructed rights plan can restore some balance and provide the board with leverage to respond and take the actions that it believes are in the best interests of all stockholders. 

Poison pills basically work as follows: If a shareholder triggers a company’s poison pill by acquiring shares in excess of the poison pill’s trigger threshold, all of the company’s other shareholders will have a right to buy additional shares at a significant discount. Since the triggering shareholder itself is not permitted to buy any of the discounted shares, the triggering shareholder’s stake will be significantly diluted when the other shareholders buy their additional discounted shares. The mere threat of this kind of dilution acts as a strong deterrent against any shareholder exceeding the trigger threshold. 

First developed to defend the “corporate bastion” against coercive, two-tiered tender offers, poison pills quickly became an essential element of the corporate governance structure of all but the very largest U.S. companies. Poison pills may no longer be fashionable among the S&P 500, but companies facing unsolicited bids are typically quick to adopt them. Now, with the rise of “raider-like” shareholder activism, poison pills have been refined and redeployed to limit an activist’s ability to easily control corporate behavior. A perfect protection they are not, but correctly drafted, poison pills do serve to provide the target company’s board of directors with the time required to fulfill their fiduciary duties and properly respond to “raider-like” activists. 

In shareholder activism situations, as in the takeover context, a poison pill can serve as a powerful deterrent. In fact, in the activism context, poison pills work the same way that they do in the traditional takeover context: their potential to dilute the triggering shareholder acts as a strong deterrent against an activist accumulating a stake in excess of the trigger threshold. With the appropriate provisions that define broadly the types of acquisitions and concerted actions that could cause the poison pill to be triggered, a poison pill can limit additional accumulations by an activist, formal 13D “group” formation by the activist with other investors, and low-ball takeover attempts by third-parties that swoop in under the cover of activist activity. Even if the poison pill is ultimately unable to entirely stop the activist, its adoption sends a strong message to the market that the board plans to stand up to the activist, evaluate strategic alternatives, and take the time to exercise its fiduciary duties to the company and its stockholders. 

If the steady increase in activist campaigns and fundraising efforts over the last five years is any indicator, activists are likely to remain a potent force in corporate America for the foreseeable future. The outcomes of activist campaigns are inherently unpredictable. Outcomes vary depending on the aggressiveness of the activist, the performance of the target, and the target’s response to the activist and other stockholders. One trend is clear: activist campaigns have become shorter. From an average of 92 days in 2010, the average length of an activist campaign dropped to 72 days in 2012 and to 43 days in 2013. Many factors could contribute to the downward trend in campaign length, but the truncated timeline means that no matter what action the board decides to take, it has to act fast. 

Instead of maintaining 10-year poison pills as was typical in the 1980s and 1990s, the standard practice now is to keep a poison pill “on the shelf” and take it out on an as-needed basis. If a company has fully briefed its board on the poison pill’s effects and prepared all the paperwork in advance, adopting a “shelf” poison pill can be a fait accompli in very little time. In order to design an effective poison pill, however, a company should customize its poison pill to send the right message. Short-term poison pills are much more flexible than “chronic” poison pills since they lend themselves to customization and therefore can be targeted to the shareholder activism situation at hand. When optimizing poison pill design to address a particular shareholder activism situation, a board should: 

Consider including a provision limiting stockholders “acting in concert.” Recent “wolf-pack” activities have demonstrated the takeover threat that shareholder collaborations can pose before activists even make a formal “agreement, arrangement, or understanding” subject to disclosure. While the standard poison pill restricts the ownership positions of shareholders who form an “agreement, arrangement, or understanding,” some companies are expanding these restrictions to shareholders “acting in concert.” If a company does include an “acting in concert” provision in its poison pill, it should take care to avoid unduly interfering with the valid exercise of shareholder rights, such as in connection with a right to call a special meeting of shareholders. 

Consider adopting a poison pill that automatically expires after one year, after which time shareholders can vote for an extension. Many companies have adopted one-year poison pills that better reflect the shorter average length of recent activist campaigns. This way, a board can adopt a poison pill (even one that is more toxic than a proxy advisor would recommend) and remove it before the next proxy season. Reserving an extension option allows the company to address unusually persistent threats. 

Consider the purpose of the poison pill when setting the trigger threshold. Generally, a 10 percent threshold restricts activists without unduly interfering with other shareholders’ investments. To allow passive investors to acquire more shares while restricting activist investors, some companies have further customized their poison pills to include a two-tiered threshold provision: a 10 percent threshold for Schedule 13D filers and a 20 percent threshold for Schedule 13G filers. 

Even if a company adopts a poison pill with a threshold at or below 10 percent, the company should be aware that the poison pill would not preclude a shareholder with a small stake from agitating for change or conducting a proxy contest. Especially with companies that allow shareholders to call special meetings or act by written consent, shareholders with relatively small stakes can successfully push for removal and replacement of directors, who can then eliminate the poison pill. Given the 10-day window for filing a Schedule 13D, a company should also be aware that an activist may have already built up a stake close to or, in some cases, even above 10 percent before the board realizes that it needs to take a poison pill off the shelf. 

Consider drafting the threshold provision to encompass ownership via swaps and other derivative instruments. To block activists from building large stakes under the radar, some companies include in their poison pills’ trigger provisions a definition of derivative instruments (e.g., “instrument[s] whose value is based on the value or price of the company’s securities”), while others achieve the same purpose by referring to the definition of “derivative security” under Rule 16 of the Securities Exchange Act of 1934. If a company adopts a poison pill that targets derivative ownership and if the poison pill’s dilutive effect operates against the swap counter-parties, the company should be aware that such a poison pill could “poison” swap counter-parties in addition to the dissident. 

Consider the possibility that a poison pill could be activated, even though it probably will not be. Given the significant and adverse consequences of triggering a poison pill, it is unlikely that an activist will go over the specified threshold. But it could happen. In 2008, however, Versata Enterprises intentionally triggered Selectica’s NOL pill. After its poison pill was triggered, Selectica had to suspend the trading of its common stock for more than four weeks in order to transfer shares to the stockholders who were unaffiliated with Versata. To avoid such market turmoil, poison pills now generally include a flexible exchange feature that allows a company to distribute rights certificates over an extended timeline, or use independently managed trusts to exercise the rights of shareholders until shares are distributed. These features give boards more time to fulfill the pill’s mandate without diminishing its immediate dilutive effect. 

These drafting considerations address some, but not all, of the issues that a board might face in a shareholder activism situation. No matter how well designed, there will be instances of shareholder activism that a poison pill cannot and should not block, such as when an activist acquires a significant stake before the company can detect a threat, or when an activist exercises her right to campaign for change through a proxy contest. Even the perfect poison pill is not an absolute antidote against “raider-like” activism, for practical, legal, and financial reasons. But at the very least, adopting a poison pill is a powerful signal to the market that a board is standing up to an activist. With constant vigilance, advance preparation, and thoughtful drafting, a board can increase poison pill potency, giving the board more power and time to consider its next steps and exercise its fiduciary duties.