Latest Shareholder Activism Developments in Canada and the U.S.: 13D Monitor’s 10 Questions with Jennifer Longhurst
McCarthy Tétrault partner Jennifer Longhurst recently spoke to 13D Monitor on the latest developments in shareholder activism in Canada and the U.S. As a member of the firm’s Mergers & Acquisitions and Critical Situations & Shareholder Activism groups, Jennifer provides integrated, judgment-based advice to assist capital markets clients in a broad range of activism-related situations, to maximize value and drive successful outcomes, including in corporate governance issues and disputes, activism, unsolicited M&A proposals, activist campaign strategies, securities law compliance issues, insider trading and reporting and securities regulatory proceedings and investigations.
Having acted on all sides, across multiple industries and jurisdictions, Jennifer is able to offer clients strategic advice informed by a 360-degree view of activism. Working collaboratively with other members of the firm, and leveraging the firm’s deep industry expertise and truly national platform, Jennifer guides clients through the storm of complexity that activist situations present and helps craft value-maximizing outcomes responsive to each client’s unique objectives.
In the following excerpt from “10 Questions with Jennifer Longhurst” in the July edition of 13D Monitor’s “The Activist Report,” Jennifer offered in-depth insights on key trends that could affect your business, including early warning beneficial ownership reporting and universal proxies, the differences between activism in Canada and the United States, what activism might look like 10 years from now, and the future of ESG in the space.
If you subscribe to 13D Monitor, you can read the full article here. Please reach out to Jennifer or any other member of our Critical Situations & Shareholder Activism team if you have any questions or need assistance.
13DM: As someone who advises boards and management, have you seen the receptiveness to activists change in the C-suite and the boardroom as activism has evolved and become more widely accepted? Is there a difference between the US and Canada in that respect?
Jennifer: We have witnessed an evolution in activism over the past 15 years. Ten years ago, when Pershing Square successfully replaced a portion of the board at CP Rail, the “clubby” nature of Canadian boards was common and, frankly, accepted. Most boards saw themselves as being immune from challenge. Since then, activism has become mainstream, with a much larger range of market participants employing activist strategies. As a result, boards in Canada, like elsewhere, are more aware of their potential vulnerability and many have become more proactive in trying to anticipate and pre-empt issues. However, despite the many activist campaigns waged since then, many boards still underestimate their susceptibility to challenge and some have a tendency to become dug in. That continues to be one area where we as advisors can help our clients adopt a more objective, non-emotional and holistic approach to assessing and responding to these situations.
13DM: If you were to give directors one piece of advice, what would it be?
Jennifer: Simply put, “listen and engage”. That’s not to say that issuers facing an activist situation should give in to every demand; but in the early stages most boards will benefit from taking the time to engage with their investors, and listening to what is being said (and not being said). In my experience, most activists are sophisticated, innovative, well-researched, well-advised, and highly prepared, typically giving them an advantage. Added to this, we’ve witnessed a greater propensity for historically passive investors to align themselves with engaged investors, both behind the scenes and publicly. And with the rise of stakeholder capitalism and focus on corporate purpose, retail investors, lobbyists and interest groups, regulators, the media and other capital markets players are playing an increasingly important role in determining the outcome of campaigns, making it more important than ever for boards to try to understand the perspectives of their key stakeholders and resist the temptation to be dismissive.
13DM: The universal ballot will go into effect in the United States this summer. In Canada, contested proxy situations have been resolved with a universal ballot for many years. Tell us about the advantages and disadvantages we will see with a universal ballot.
Jennifer: The changes under Rule 14a-19 represent a significant departure from past US practice, with some believing the new requirements will enhance activists’ leverage and increase proxy threats. This is in contrast to Canadian proxy solicitation rules that have long permitted (but do not mandate) the use of universal ballots. The main benefit to the universal ballot is affording shareholders the ability to vote for a mixed slate of nominees proposed by an issuer and a dissident, enhancing shareholder choice by allowing investors to pick and choose what they believe to be the best slate of directors. In that respect, universal proxies are a shareholder-friendly tool that enhance shareholder democracy. In Canada, there remain several strategic and governance considerations that come into play when deciding whether or not to use a universal ballot. On the one hand, using a universal ballot can increase the chances that shareholders will use that card, giving greater visibility into voting. However, this advantage is eroded where both the issuer and investor use a universal proxy. Universal cards can also work against a dissident, by increasing the chances that shareholders may cast their vote for some of management’s nominees rather than the activist’s entire proposed slate, particularly where the activist is seeking a majority or full slate.
It’s also anticipated that there will still be ways to ‘game’ the use of universal proxies. While the new rules require issuers and dissidents alike to use universal proxies when soliciting in contested director elections, prescribe presentation, formatting and disclosure requirements, and are aimed at providing greater transparency about nominees through the nomination notice and filing deadlines, there are areas where the rules are silent. For example, the rules do not require the use of identical cards – only that they adhere to the prescribed rules. Issuers and dissidents will still be able to provide distinct voting recommendations, present their respective slates of nominees before or after the other’s, and may use different colors for their cards. And of course, each party can and will use their proxy statements and other public communications to enhance their leverage.
Importantly, given dissidents’ obligations under Rule 14a-19 still require compliance with issuers’ advance notice requirements, I also expect many US issuers will continue the trend of tightening up their advance notice requirements, making nominations more onerous. We’ve seen this trend recently, with issuers lengthening their nomination deadlines and expanding the informational requirements in their bylaws. We’ve also seen some US Delaware court decisions – such as in Rosenbaum v. CytoDyn and Strategic Investment Opportunities v. Lee Enterprises – uphold issuers’ rejection of activists’ nominations due to failure to adhere to timeliness and/or form and informational requirements, which may embolden other issuers to take similar steps.
It will also be interesting to see how universal ballots may impact “vote no” campaigns. Vote no campaigns can produce very powerful outcomes and have a lower barrier to entry than proxy contests. With the changes to the “bona fide nominee” rule, dissidents may opt to use universal cards to enhance their ability to solicit proxies in such campaigns. This may in turn increase their leverage, especially with the uptick in majority voting in the US.
13DM: There are several other laws and regulations that make activism easier in Canada. Tell us about some of those. Which of them would you like to see adopted in the US?
Jennifer: Many have suggested that Canada is an activist-friendly jurisdiction. On balance, I don’t entirely agree with that sentiment, however, there are some tools in Canada that engaged shareholders can leverage. Some notable examples include Canada’s requisition right, oppression remedy, the “15-shareholder or less” and “public broadcast” proxy solicitation exemptions, and the wide-spread adoption of majority voting.
In Canada, shareholders holding 5% or more of an issuer’s voting shares can requisition directors to call a meeting for any proper business purpose, including to elect directors. While this statutory right can be a powerful tool for activists, it’s not bullet-proof. Courts have tacked on additional requirements and require a strict level of technical compliance by activists seeking to use this strategy. Moreover, this right only requires directors to “call” the meeting within 21 days of receiving a valid requisition, and courts have given directors a lot of latitude within their “business judgment” as to when the meeting must actually be held, which often results in meetings occurring several months after the requisition has been made.
Another powerful right of shareholders in Canada is the statutory “oppression remedy”. This is a broad statutory remedy, which provides a means of redress to minority shareholders (and certain other complainants) for various issuer or board actions or omissions that are oppressive or unfairly prejudicial, or that unfairly disregards shareholders’ interests. This tool (or the threat of it) can help limit defensive strategies that might otherwise be employed by issuers faced with activism. If a claim is successful, courts enjoy broad power to make any order they think fit, including to restrain the conduct, to appoint or replace directors or even to vary or set aside a transaction.
There are also two unique exemptions from Canadian proxy solicitation requirements – which require issuers and dissidents to prepare and send a proxy circular in order to “solicit” proxies (which captures a wide range of actions and communications) – available only to investors. First, shareholders are permitted to solicit proxies from up to 15 shareholders without having to send a dissident proxy circular, which can be an effective and low-cost way for activists to build support, especially at issuers with more concentrated ownership. There is also a “public broadcast” exception available only to dissidents, which similarly can facilitate the solicitation of proxies without sending a proxy circular; in the context of a contested director election, the dissident need only provide certain prescribed disclosure and publicly file what is commonly called a “skinny” or “pre-emptive” circular. This technique, employed by Pershing Square in the CP Rail contest, can afford dissidents a lot of flexibility to engage in public solicitation campaigns, sometimes long before the issuer is able to respond.
One final established feature in Canada is “majority voting”. The Toronto Stock Exchange requires all TSX-listed issuers that are not majority-controlled to have a majority voting policy, requiring that shareholders be permitted to vote in respect of each director nominee and that each director must receive more “for” than “withheld” votes in order to be elected, failing which the director must tender their resignation and the board must accept the resignation, absent exceptional circumstances. Effective August 31, 2022, directors of all reporting issuers incorporated under Canada’s federal corporate statute will become subject to mandatory majority voting standards, which are similar to the TSX rules, but go further. For those companies, which comprise a large proportion of Canada’s public issuers, their shareholders will be able to vote “for” or “against” individual director nominees and if a nominee receives less than 50% of the “for” votes, they will not be elected as a matter of law, and boards will generally not have discretion to keep them on the board. While majority voting under both rules only applies in uncontested director elections, it does play a pivotal role in “vote no” campaigns or where investors wish to remove one or more directors without running a contest. I expect shareholders will increasingly leverage these requirements to target and remove directors perceived as being ineffective stewards of the various ESG issues under focus.
13DM: Despite having many shareholder-friendly laws, it does not seem that the Canadian shareholder base is as activist friendly as in the US. Is that true? Are there other customs, laws or regulations in Canada that favor companies?
Jennifer: Some of the seemingly activist-friendly legal tools in Canada – like the 5% requisition right – are not as clear-cut as they seem, which can work in issuers’ favour. There are other features of the Canadian market, which can make it appear as though Canadian shareholders are not as activist friendly or tip the balance of power in favour of issuers.
Canadian issuers tend to be smaller, less liquid and have higher concentrations of ownership, relative to their US counterparts. These factors, combined with Canada’s smaller investor community, can create challenges for activists in two ways. First, they can make it more difficult for investors to discretely accumulate the toehold stake needed to justify a potentially long and expensive proxy campaign – doing so requires time and well-planned logistics. Depending on the size of the stake sought, this can become more difficult due to the immediate disclosure obligation and trading moratorium triggered (subject to certain exceptions for “eligible institutional investors”) under Canada’s “early warning reporting” (EWR) regime (similar to the US 13D/13G regime) once an activist acquires 10% ownership of an issuer’s shares.
Second, while institutional investors, pension funds and other major investors in Canada are today more receptive to activists than in the early years of activism, there are legal constraints that can impede securing their support. Our insider trading and tipping rules often make investors wearing of engaging in discussions with activists, especially in the early stages of a campaign, to avoid being tainted with material undisclosed information that would compromise their freedom to trade. Layered onto this are concerns about being characterized as a “joint actor” with an activist, for fear that any perceived agreement or understanding with respect to voting or share acquisitions would require their ownership to be aggregated for purposes of determining whether the 10% EWR disclosure or the 20% ownership threshold under Canada’s mandatory takeover bid regime have been triggered.
I also believe there remains a culture in Canada that can result in greater hostility by issuers and their boards and shareholders to perceived “outsiders”. This is exacerbated when US- or foreign-based activists seek to import tactics or rhetoric that may have worked well elsewhere, but have not been tailored to the Canadian context. This makes it even more crucial that investors and issuers involve seasoned advisors to help navigate some of these “softer” issues that can dramatically impact campaign outcomes.
13DM: There has been a lot of discussion about the intersection of ESG and shareholder activism. How has that impacted your advice to clients?
Jennifer: Several factors have accelerated the focus on a wide range of ESG issues, making them more prevalent themes in activism. COVID exposed many issuers’ lack of resiliency in these areas. Added to this, the explosion of regulatory initiatives and litigation focused on climate-related reporting and the Net Zero transition, the rise in stakeholder capitalism, and focus on “corporate purpose”, are all contributing to a rise in ESG activism. Our firm recently published an article on climate-related activism – An inconvenient truth about climate-related shareholder activism. As discussed in our article, I anticipate that climate, along with certain other priority ESG issues – including those relating to human capital and redefining the workplace, human rights, supply chain resiliency, cyber security and diversity – will become dominant themes in upcoming activist campaigns, especially with the expanding pool of would be activists.
For my issuer clients, this means assessing their strengths and weakness across a much broader range of considerations. Beyond traditional governance practices, it requires looking at the diversity of their leadership and broader workforce, including from a racial and ethnic diversity perspective. It requires analyzing the competencies of boards and senior management, to ensure that the leadership team has the right mix of skills to enable them to tackle complex and ever-changing ESG priorities, including climate, cyber security/AI, human capital and executive compensation. It also means that as these issues evolve and activists continue to innovate and adapt by leveraging technology and new outlets to reach wider and more varied audiences, issuers too need to become savvier with how they use new technologies to communicate their strategies and plans. And lastly, it means bringing a laser-focus on issuers’ disclosure relating to these issues – what have they said about where they are in their ESG journey and where are they going, and whether they are following through on those plans.
On the investor side, these themes are taking on greater importance in campaigns and it’s accepted that many ESG initiatives can enhance to long-term value. However, one of the key differentiators between campaigns that have been successful versus those that have not, is an investor’s ability to clearly articulate the link between the “E” and “S” and short, medium and long-term value creation. Simply ‘tacking on’ ESG issues in the hopes that doing so will increase the chances a campaign resonates with the issuer’s institutional investors and other stakeholders is unlikely to be successful if the correlation between value and values cannot be communicated.
13DM: In the Exxon campaign, it seems like the burden flipped from the activist to the company. Is this an outlier or do you expect to see the burden of persuasion switch to the board in activist ESG campaigns?
Jennifer: I’m not sure the burden shifted in a way that was unique to that campaign. When you dissect it, the Engine No.1 campaign at ExxonMobil is a terrific example of what makes an activist successful. First, the climate concern was not the sole aspect of that campaign – while prominent, there was also focus on traditional governance, operational and financial non-performance issues. The campaign was thoughtfully waged and offered bespoke solutions, which enabled Engine No.1 to secure the support of Exxon’s top shareholders; it did not purport to impose a one-size-fits-all solution on the company, something we’ve seen in some other recent ESG-themed campaigns that have proved less successful.
In any campaign, engaged investors that put forward well thought-out, tailored and clearly-communicated theses, and which effectively connect the dots between the initiatives proposed and value generation, will typically succeed in shifting a greater burden on the issuer to defend their resistance to those plans. In my view, that’s not unique to ESG-themed campaigns.
13DM: The SEC has proposed several new rule amendments, including a) reducing the time investors have to file a 13D from 10 days to five, b) shortening the time investors have to file Schedule 13D amendments to one business day; and c) redefining the definition of beneficial ownership to include certain derivatives, such as cash settled swaps. What is your view of these proposals?
Jennifer: These proposals have generated a great deal of attention, and debate. First, the accelerated 13D filing deadline may render it more difficult and expensive for activists to accumulate sufficient stock to justify the resources, time and efforts necessary to pursue proxy campaigns. Perhaps more concerning, however, is the broadening of the concept of “beneficial ownership”, given uncertainty surrounding how it will be applied and the risk it might dampen important but otherwise benign discussions among investors.
The other controversial area of the proposed rule changes is the expansion of “deemed” beneficial ownership to include derivative securities, which would treat holders of cash-settled derivatives as the beneficial owner of the shares if the holder would be a Schedule 13D filer, even absent a right to direct the voting or acquisition or disposition of the underlying shares. While I appreciate the desire for issuers and some other market participants to have more transparency concerning investors’ economic exposure, the inclusion of non-equity derivatives seems at odds with the concept of what we’ve historically understood “beneficial ownership” to be. We faced a similar debate back in 2013 when our securities regulators had proposed several changes to our corresponding EWR regime, which included a proposal to incorporate equity equivalent derivatives for purposes of calculating the disclosure threshold. As a result of several comments submitted in response to that proposal, ultimately our securities regulators opted to not include cash-settled derivatives for those purposes, a decision I supported. More recently, there has been renewed focus in Canada about the extent to which, if at all, non-equity derivatives should be considered for purposes of our EWR disclosure triggers and in the context of takeover bids or other efforts aimed at influencing change at issuers. In both cases, I think it important that full cost-benefit analyses are undertaken to ensure that the benefits of any rule changes outweigh the potential costs, and don’t have a dampening effect on otherwise legitimate activist strategies and trading activities.
13DM: What does shareholder activism look like in Canada 10 years from now? How do you expect it to evolve?
Jennifer: I expect ESG themes will become more prevalent in activist campaigns, especially where issuers are lagging their peers operationally or financially, but that won’t be unique to Canada. In the near term, more companies will face scrutiny for lack of diversity or the requisite ESG skills among their leadership, inadequate human capital and human resources practices, outsized executive compensation, or insufficient attention to managing cyber security risks. I also anticipate that with the continued focus in both Canada and the US on dual class share structures and some of the longer-term governance and accountability challenges they can present, those issuers will face greater pressure to implement sunsets or other governance protections to prevent perpetual founder (or inter-generational) control.
Institutional investors and retail investors are likely to play an increasingly prominent and influential role in activism, making it even more important for engaged investors to build alliances. Doing so will also become more complex, as many institutional investors become less reliant on proxy advisory firm recommendations and vote according to their own voting policies, and as voting control devolves from some asset managers to their ultimate asset owners. Leveraging new technologies and the seemingly endless communications outlets available, will also become more central to campaign success or failure. Lastly, I expect corporate and securities regulators (and courts) will become more involved in activist campaigns, as they are increasingly drawn into dispute and increase their focus on the processes, strategies and disclosures of the parties in activist situations. What does all of this mean? For all of us in the activism space, having carefully-crafted and multi-faceted plans and strategies in place will become more, not less, critical in all aspects of shareholder activism.