US companies devise tactics to limit activists’ advances

By Stephen Foley. This article originally appeared on the Financial Times website, on September 19th, 2014

US companies are devising new tactics to limit the advance of activist investors, as hedge funds wage an increasing number of campaigns to unseat entire corporate boards.

The number of occasions on which activists have put forward a full slate of new board members has more than doubled in the past two years, reflecting the growing confidence and financial firepower of this sector of the hedge fund industry.

In response, companies are appealing directly to shareholders to cap activists’ influence to a minority of board seats, in what corporate governance lawyers describe as a “cat and mouse game” between the two sides.

Darden Restaurants, which owns the US chain Olive Garden, is the latest in a string of companies to concede a minority of seats to an activist and argue that handing full control of the board to a hedge fund would hurt shareholders’ interests.

“Companies are using a new tactic in the face of the risk of majority-slate contests,” said David Rosewater, partner at Schulte Roth & Zabel, which advises activists.

“It is a cat-and-mouse game. When they gift seats to the activist, it gives companies an argument that it doesn’t represent the same kind of mandate for change.”

Darden has put up only eight nominees for 12 board seats at next month’s annual meeting, leaving four free for nominees from Starboard Value, the activist fund run by Jeff Smith, which is running 12 candidates.

Darden is locked in a battle with Starboard over how it is running Olive Garden and other chains. Darden warned last week of “the risks and destabilisation that would result from full board turnover and giving control to a single shareholder’s nominees”.

Assailed by activists, many companies are entering settlement talks and agreeing to give them board seats, as Hertz did last week with corporate raider Carl Icahn.

Darden’s plan to leave seats vacant even though a settlement cannot be reached comes on the heels of similar concessions at Cliffs Natural Resources, an iron ore miner, and Bob Evans Farms, a restaurant chain. In both cases, activists were attempting to take a majority of board seats.

In the US, where shareholders are handed two competing voting cards and allowed to vote on only one, the aim is to encourage them to use the management ballot, even if they would like activists to receive some board representation. That maximises the chances of management keeping control.

At Bob Evans Farms, the manoeuvre kept Sandell Asset Management to a minority of the seats, but at Cliffs, Casablanca Capital did win control and replaced the chief executive.

According to global data from research group Activist Insight, there have been 21 contests in the past two years in which activist hedge funds have proposed nominees to completely replace a corporate board. All but two are US companies. That compares with eight contests globally in the two years before that.

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