At the beginning of the COVID outbreak in the US, The Williams Companies adopted an unusually protective poison pill to thwart any activist campaigns that might arise in the then existing market conditions. Vice Chancellor McCormick struck down the pill in a decision published February 26. The Vice Chancellor’s decision is important in at least two regards.

  • First, it seems to have significantly narrowed the idea of what constitutes a “threat” from an activist that can justify the adoption of a pill. 
  • Second, it seems to have emphatically laid to rest the idea that the shareholding threshold to trigger a pill (whether it be 5% or 20%) can include shares held not only by a person or 13-d group, but also shares held by any person “acting in concert” with such person or group.

The Threats

For a pill (or other defensive device) to be upheld, the board must have reasonable grounds to believe a threat to corporate policy and effectiveness exists, and the defense must be proportionate to the identified threat. In this case, the board identified three threats: 

  1. The generalized threat of shareholder activism in a time of low stock prices and market uncertainty.
  2. The threat that activists would pursue short-term agendas or distract management from the task of guiding the company through the challenges presented by the pandemic.
  3. The threat that activists or others would “stealthily and rapidly” acquire more than 5% of the shares of Williams.

Activism Generally

The Vice Chancellor dismissed the first threat almost out of hand, finding that “activism is a broad concept, referring to a range of stockholder activities designed to change or influence a corporation’s direction. ” Activism’s purposes can include anything from implementing ESG goals to seeking management change or a sale of the company. Accordingly, “categorically concluding that all stockholder efforts to change or influence corporate direction” would constitute a threat justifying defensive action would be tantamount to granting a license to interfere with the stockholder franchise. The court viewed activism as being “intertwined with the stockholder franchise,” reasoning that activists’ main coercive tool is a proxy fight. Perhaps as a result of this emphasis on the stockholder franchise, the court seems to view pills put in place to defend against activism differently than traditional pills put in place to defend against hostile offers.

In looking at precedent, the court found four cases where Delaware jurists upheld defensive actions in the face of the stockholder activism – as opposed to defenses erected against hostile tender offers. It found that those cases all involved a “specific takeover attempt,” even when not involving a traditional tender offer. In short, the court read the precedent in favor of implementing defenses against activism to be quite limited, and, rather than leave open the circumstances in which that defenses against activism could be justified, concluded that, even if read broadly, the cases would only support defensive actions against activism “in response to a concrete action by a stockholder activist” (emphasis added).

Short-termism

The second threat is a more particularized version of the first – being focused on two potential negative consequences of activism: (i) short termism, where an activist “seeks short-term profit without the regard to the impact on the company’s long-term prospects”, and (ii) the distraction to management created by an activist campaign. Here, the Vice Chancellor seems to be making new law, noting that “[n]o case has evaluated under Unocal whether these types of particularized activist concerns constitute cognizable threats.”

The court does not seem overly convinced that short-termism is a problem that can serve as the basis for a legal remedy, seeing short-termism concerns as perhaps another manifestation of the idea that “shareholders will cast votes in a mistaken assessment of their own best interests” –  and therefore that the board needs the ability to interfere with the shareholder franchise. This is an idea that the court finds to be anathema to Delaware doctrine, stating that “short-termism and distraction concerns boil down to the sort of we-know-better justification that Delaware law eschews in the voting context.” Of course, the court in Air Products v Airgas did uphold precisely that sort of “we-know-better justification” when the board in that case refused to dismantle its defenses in the face of very significant shareholder support for a hostile bid – but perhaps because Airgas involved at hostile takeover attempt, rather than activism, the  court did not seem to view the Airgas precedent as relevant.

Moreover, it seems a mistake to accept the “central criticism” of short-termism that “shareholders who vote in favor of short-termism . . . are hurting themselves as much as they are hurting their fellow shareholders.” In fact, most activists, if nothing else,  are excellent traders, and are interested in making the price of their target’s stock move up in the short term, when they will then trade out. They are not buy-and-hold investors saving for retirement, and are thoroughly indifferent as to whether the stock price movement comes at a cost to the long-term value of the company. To make law based on the assumption that all shareholders are aligned in creating long-term value is to overlay the most extreme and unrealistic version of the efficient market hypothesis onto a conflicting reality, and is a particularly confounding approach coming on the heels of the Gamestop madness, which would have tested Milton Friedman’s faith in the rationality of the market in valuing a company’s prospects. 

The court does not go so far as to rule that short-termism and distraction could not be a cognizable threat – which is a good thing, given that there is more than ample justification found in the academic literature (as well as real life) to provide a board with “reasonable grounds” for believing that short-termism is a threat to corporate policy. Ruling that short-termism could never be considered a threat would eliminate the ability of the board to exercise its judgment on a matter where the court notes “reasonable minds” can differ. 

Instead, the court ruled that short-termism and management distraction in this case could not be deemed a cognizable threat because the threat was “hypothetical”, rather than a “specific, immediate activist play seeking short-term profits or threatening disruption.” This is likely to be the most controversial aspect of the decision.

First, this ruling takes discretion away from the board to reasonably determine that short-activism is a threat unless there is a “specific, immediate activist play”.  For example, “investment limiting” campaigns are a favorite tactic of many hedge funds, which often find ways to extract cash from companies by cutting R&D and other long-term investments [1]. If a board reasonably felt itself vulnerable to such a campaign, believing, based on advice from its banker, that it fit the profile of a company likely to be targeted for this sort of activism, and further believing that such a campaign, if successful, would require the company to reduce its long-term capital investment in a manner that would seriously damage the long-term prospects of the company, should that company be prohibited from taking ANY defensive action because there is no specific, immediate campaign being launched? Remember, this finding by the court means that short-termism if it is not specific and immediate,– no matter how likely –is not a threat, and therefore NO defensive action, regardless of how proportionate it may be, would be permitted – undercutting the idea that the court will provide a “situationally specific” evaluation of any defense challenged in Delaware.

Second, the court does nothing to distinguish its decision from that in Moran v Household International, where the court famously upheld a pill “in reaction to what [the board] perceived to be the threat in the market place of two-tiered tender offers.” The board in Moran was not facing a “specific, immediate” takeover offer. It is unclear why the court believed it necessary to categorically eliminate the ability of the board to judge for itself the immediacy of any threat.

Rapid Accumulations

Finally, the court finds that whether the third threat can serve as the basis for a defensive response is also something that “reasonable minds could dispute.”  The Williams’ pill, preventing an activist from rapidly accumulating over 5% of Williams’ stock without any notice to the market, significantly lowers the threshold for triggering the pill from the more typical 15-20% found in traditional pills. This is presumably because the purpose is different than that of a traditional pill – rather than protecting against unwanted takeovers, this pill protects against activists building a significant stake before the market learns of their plans. The court spends some time reviewing the different academic proposals for “gap-filling pills” intended to remedy flaws in the Williams Act notification scheme, showing perhaps some sympathy for the idea of a private ordering fix for the deficiencies in the current notification regime.  Unlike the threat of short-termism, the court does not require that, for this threat to be cognizable, it must be manifested in a “specific, immediate” campaign.  Rather it finds that even if a rapid stock accumulation were a cognizable threat, the pill as drafted is a disproportionate response.

And it is somewhat hard to argue with that particular conclusion. The court spends a few sentences noting that the 5% trigger for the pill is truly exceptional and rather draconian for a non-NOL pill, and spends the balance of its opinion laying to rest the idea that the “acting in concert” provision, as drafted, could ever be workable or justified. This pill, in addition to having a 5% trigger, would have aggregated all derivative securities held by the activist (well beyond the types of derivative securities included for 13-d reporting purposes), would have aggregated all of the securities held by other shareholders “acting in concert” with the activist, even if there were no “agreement or understanding” sufficient to form a group under Rule 13-d, and had a “daisy chain” provision, meaning that not only were the securities held by someone acting in concert with the activist aggregated, but also any securities held by someone who was acting in concert with someone who was acting in concert with the activist, and so on. Besides chilling anodyne communications among stockholders, these definitions cut so broadly that it would be difficult to understand their scope, leaving the board with broad discretion to sort out just whose shares would be subject to the pill. As one participant in the trial put it, this pill “was a bridge too far.”

Overall, this case will further discourage the idea of the “activist pill”. There has always been a question as to whether a poison pill is well-tailored to defend against activism. Activists do not need to accumulate any particular percentage of shares in order to influence corporate policy – less than a quarter of activism campaigns ever proceed to a proxy fight – and many proxy fights are settled – so the franchise, even if implicated, is rarely exercised. Activists’ accumulation strategies are, in general, not intended to secure a voting position so much as to simply to buy enough shares, or economic interests in shares, to be able to profit from the anticipated price rise. Stopping or slowing an accumulation campaign at 5%, if that were ever allowed, could yield some benefit to companies subject to an activist attack by potentially reducing the size of the stake an activist can build on the cheap before giving notice to the market[2], reducing its incentives to even begin a campaign. However, without a low threshold and an “acting in concert” provision, a pill would be unlikely to put a dent in the momentum that an activist builds with other stakeholders even before making its stake public, or give the company much more time to prepare a response. And if a company has to wait until it knows of a specific campaign before putting a pill in place, it will be too late – the activist will have announced its stake. The court’s willingness to consider the types of “gap-filling” pills suggested by academics may have signaled an openness to an approach that effectively requires pauses in the accumulation strategy, but, particularly after this ruling, it will be hard to design a pill that is effective in slowing activists.

Footnotes

[1] Both sides in the activism debate agree that these “investment limiting” campaigns are prevalent, and Professors Coffee and Palia (in an article cited by the court) note that hedge fund activism is associated with “(1) increased leverage, (2) increased shareholder payout, (3) reduced long-term investment in research and development.”This sort of campaign is a particular threat to companies like Williams with a long-term capital investment horizon. John C. Coffee and Darius Palia, The Wolf at the Door: The Impact of Hedge Fund Activism on Corporate Governance, 41 Journal of Corporate Law 545, 550 (2016)

[2] While this may reduce the incentive of an activist to bring a campaign, if the activist is truly motivated by increasing the intrinsic value of the company, rather than simply by taking advantage of market lows, the lost incentive should not be of a great magnitude.