Securities Law, Wall Street

Finance And Law: Activist Investing Creates New Challenges in Securities Law

In complex situations involving disclosure decisions and legal strategy as much as investment savvy, attorneys can play a key role.

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chart graph investment rate of return ROI stock bondEver since the legislation of the 1930s and 1940s created the SEC and defined the expectations of legal and illegal investment behavior, investors have been looking for grey areas. In all areas of the investing world, from hedge funds to private placements, the industry has shifted over time, with regulators eventually adapting by adopting new rules. The activist investing phenomenon is the latest twist in this ongoing story, and it is an area that securities lawyers and compliance specialists need to be cognizant of.

To understand the current drama unfolding between regulators and investors, and how it impacts attorneys working in the securities field, a little history is in order. Put simply, activist investors are investors who buy large stakes in publicly traded firms and then attempt to induce the company to take some specific action – spin off a division, sell itself, restructure the company, etc. Activist investing, like other areas of the investment markets, goes through waves of boom and bust. In the 1980s, activist investors like Carl Icahn and T. Boone Pickens became famous as corporate raiders. By the early 1990s, activist investors were less often discussed in the financial media, and the space stayed quiet through the turn of the millennium.

In the last decade, though, activist investing has seen a resurgence, with folks like Bill Ackman and Daniel Loeb taking major public positions. The new trend in activist investing essentially goes something like this: (1) take a position in a company, (2) talk up that position – either short or long, and (3) wait for the markets to respond.

These types of investments create a number of fundamental dilemmas that attorneys, regulators, and investors need to understand going forward. First, taking a position and then mounting a public campaign around that position necessarily creates relevant inside information. If company XYZ is going to become the target of a costly critical campaign against management by fund ABC, it is highly likely that XYZ’s management team will be distracted and unable to fully focus on running the firm. That by itself will likely cause the company to be at a competitive disadvantage. How should disclosure around these types of campaigns be handled? Can funds that intend to initiate such campaigns relate their plans to other funds in an effort to build a network of investors? These are key questions that are at issue in several campaigns taking place right now or that have taken place in recent months.

Similarly, how do activist investors deal with disclosure of their positions? The Justice Department recently sued a fund called ValueAct over its investments in the oil services firms Halliburton and Baker Hughes. The issue in question for the suit centered on whether investors who intend to buy minority stakes in companies must seek antitrust clearance. Seeking that clearance would require that the fund publicly disclose its purchases. The Justice Department accused ValueAct of trying to sway the management of both BHI and HAL and benefit by exerting influence over the merger. (The suit settled in July.)

The Hart-Scott-Rodino Act (HSR) requires acquirers of stock worth more than $76.3 million to publicly alert regulators. Purchases of less than 10 percent of a company’s shares that are made “solely for the purpose of investment” are exempt from the filing requirement. But investors can only rely on that exemption if they are passive, or have “no intention of participating in the formulation, determination or direction of the basic business decisions.”

Clearly activist investors may or may not meet these requirements depending on the specific strategies they adopt. In these complex situations, which involve disclosure decisions and legal strategy as much as investment savvy, attorneys can play a key role for funds, firms, and regulators.

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Michael McDonald is an assistant professor of finance at Fairfield University in Connecticut. He holds a PhD in finance. Michael consults extensively with organizations ranging from Fortune 500 companies to start-up businesses on financial matters through Morning Investments Consulting. Michael has served as an expert witness in legal disputes, and is an arbitrator with the Financial Industry National Regulatory Authority (FINRA). Michael can be reached at M.McDonald@MorningInvestmentsCT.com.

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