VI. Conclusion.

AuthorBriggs, Thomas W.
PositionCorporate Governance and the New Hedge Fund Activism: An Empirical Analysis

At the end, we are inevitably left with a fundamental question: what is the meaning of hedge fund activism? This Article has conducted a legal, empirical, and theoretical study in an effort to develop an answer.

This Article has shown that the SEC opened the door to hedge fund activism when it got out of the proxy material pre-screening and censorship business in 1992 and when it adopted the Regulation MA-related "free communication" Rule 14a-12 in 1999. The recent rise in hedge fund assets, the increasing difficulties fund managers have had in finding ready-made investment opportunities for so much money, and the changes in investor and corporate attitudes following the scandals that led to the passage of the Sarbanes-Oxley Act in 2002 have all combined to allow hedge funds to walk through this open door.

This Article's empirical survey of hedge fund activism during 2005 and the 2006 proxy season is notable both for what it found and for what it did not find. In raw numbers, 52 hedge fund activism situations during this period hardly make hedge funds a direct and present threat to corporate America. But the indirect effects appear to be much greater. Armed with Rule 14a-12 and evidently undeterred by the threat of becoming a "group" under the Schedule 13D rules, hedge funds with significant shareholdings have been able to use wolf-pack tactics against companies to achieve at least some of their aims. The ovine willingness of institutional investors to follow the pro-shareholder, pro-activist recommendations of ISS and its competitors have helped make these tactics still more effective.

Despite claims that hedge funds are frequently dangerously conflicted, the survey did not find much in the way of a "dark side" to hedge fund activism. With only one notable exception (Perry at Mylan Labs), adverse positions and other conflicts appear to have been fully disclosed in the few instances where they have appeared. Shareholders would seem to have been really put off by the disclosed conflicts only once (Verizon-MCI-Deephaven). Nevertheless, based on the survey, it seems that the proxy and Schedule 13D rules require clarification so that their line-item disclosure requirements directly pick up these potential conflicts.

In any event, what hedge funds actually do does not fit neatly into the "nexus of contracts" and other theories of how shareholders and corporate managements relate to each other. At least one thing is clear. This Article would not exist if hedge funds were the powerless, atomized shareholders of the latter-day Berle and Means theorists or if they were deterred by the well-documented obstacles to a greater shareholder role in corporate governance.

Hedge fund activists paradoxically practice "shareholder primacy" but cannot believe in it as a theory lest it empower the large and frequently conflicted institutional investors such as public pension and union funds sufficiently to allow them to take a competing seat at the corporate governance table. There is also a second paradox. Hedge fund activists must believe in director primacy as an academic theory because it most accurately describes the current state of the real world and because it helps justify keeping these kinds of other institutions as far away from the corporate governance banquet table as possible. But of course as shareholder activists, they do not for a minute believe in "director primacy" as a practical matter. Perhaps the best way of thinking about how hedge fund activists fit into corporate governance today is raw balance-of-power politics with proxy fights taking the place of warfare. Or to phrase it another way, hedge fund activists appear to have finally effected what John Pound perhaps prematurely predicted over a decade ago: the rise of the political model of corporate governance.

Hedge fund activists apparently continue to believe that direct board representation helps them to achieve greater control over their investments and, presumably, greater profits. On the other side, corporate managements seem to believe that this kind of effective "control" is not at all an unalloyed good.

It is too early to say whether hedge fund activism is profitable for the funds, value-maximizing for other public shareholders, or good for corporate governance in the United States generally. As for the first point, the results so far appear somewhat mixed. (275) As for the second, the survey uncovered substantial shareholder skepticism in just one instance. (276) And as for the third, only time will tell. (277) This Article's data are too limited for a definitive answer. But this much seems certain: hedge fund activists do sometimes come up with "eminently sensible ideas," (278) and the pressure they bring is forcing managements far beyond those of the few specific companies directly affected to come up with their own good ideas or, in Martin Lipton's words, to "[r]eview basic strategy ... in light of possible arguments for spinoffs, share buybacks, special dividends, sale of the company or other structural changes." (279)

Hedge fund activists are not "normal" institutional investors. They threaten and even actually launch proxy fights for corporate control. They attack in wolf packs. If this causes managements to reexamine their businesses and "review basic strategy" accordingly, corporate governance has unquestionably been improved.

(1.) See, e.g., K.A.D. Camara, Classifying Institutional Investors, 30 J. CORP. L. 219, 222 & n.11 (2005) (commenting that "[i]nstitutional investors were last a hot topic in the late 1980s and early 1990[s]" and providing a brief literature summary). The author's views on early 1990s shareholder activism are set forth in Thomas W. Briggs, Shareholder Activism and Insurgency Under the New Proxy Rules, 50 BUS. LAW. 99 (1994).

(2.) See, e.g., Bernard S. Black, Shareholder Passivity Reexamined, 89 MICH. L. REV. 520 (1990) (arguing that better institutional monitoring would likely happen if legal restrictions on shareholders were loosened). By the late 1990s, however, Professor Black had acknowledged that his hopes for the role that institutional monitoring could play in corporate governance were all but dashed. See Bernard S. Black, Shareholder Activism and Corporate Governance in the United States, in 3 THE NEW PALGRAVE DICTIONARY OF ECONOMICS AND THE LAW 459 (Peter Newman ed., 1998) (acknowledging that low institutional activism efforts produce commensurately low results).

(3.) See Mara Der Hovanesian, Attack of the Hungry Hedge Funds, BUS. WK., Feb. 20, 2006, at 72; Allan Murray, Hedge Funds Are the New Sheriffs of the Boardroom, WALL ST. J., Dec. 14, 2005, at A2; Emily Thornton, The New Raiders, BUS. WK., Feb. 28, 2005, at 32; see also Andrew Ross Sorkin, To Battle, Armed with Shares, N.Y. TIMES, Jan. 4, 2006, at C1 ("[T]oday corporate boards are adjusting to a new reality: the activist investor, armed with a handful of shares and a megaphone, is changing corporate America and the deal-making landscape.").

(4.) Compare Justin Hibbard, Take Your Best Shot, Punk, BUS. WK., Nov. 7, 2005, at 118 (quoting a hedge fund manager as saying, "We're putting together a war machine ... [and] no company will be safe"), with Memorandum from Martin Lipton et al., Partner, Wachtell, Lipton, Rosen & Katz, to Clients: Be Prepared for Attacks by Hedge Funds (Dec. 21, 2005), available at http://www.realcorporatelawyer.com/pdfs/wlrk122205-02.pdf ("Expose the attackers for what they are, self-seeking, short-term speculators looking for a quick profit at the expense of the company and its long-term value."); see also Bryan Armstrong, Partner, Ashton Partners, The New Crisis: Shareholder Activism (2005), available at http://www.ashtonpartners.com/pdf/The%20New%20Crisis%20-%20Shareholder %20Activism.pdf (giving advice on how to deal with the "crisis" of shareholder activism); David A. Katz & Laura A. McIntosh, Advice on Coping with Hedge Fund Activism, N.Y.L.J., May 25, 2006, at 5 (providing advice on how to cope with hedge fund activism).

(5.) See Battling for Corporate America, ECONOMIST, Mar. 11, 2006, at 69 (asking, "Who will come out on top in the renewed struggle between shareholders and managers?").

(6.) See, e.g., Erin E. Arvedlund, Easing the Sting, BARRON'S, Jan. 30, 2006, at 46 (citing Burton Malkiel as noting that hedge fund performance appears to have entered "an era of single-digit returns"); Susan Pulliam & Martin Peers, Once a Lone Wolf, Icahn Goes the Hedge-Fund Route, WALL ST. J., Aug. 12, 2005, at A1 ("The quick profits that hedge funds seek are harder to come by now, partly because they've exploded in number, resulting in far more savvy investors on the prowl and thus fewer undiscovered values."); Henry Sender, Hedge Funds: The New Corporate Activists, WALL ST. J., May 13, 2005, at C1 (noting that traditional passive strategies no longer work so "instead of just taking bets on the outcome of others' moves, [hedge funds] themselves are becoming the catalyst for change in the corporate world"); Thorns in the Foliage, ECONOMIST, Apr. 1, 2006, at 61 (noting that "these days it is becoming harder for hedge-fund managers to make money").

(7.) See Lauren Etter, Volatile Markets Bring Hedge Funds Under Fire, WALL ST. J., July 1, 2006, at A9; Lauren Etter, Why Corporate Boardrooms Are in Turmoil, WALL ST. J., Sept. 16, 2006, at A7 (noting that total hedge fund industry assets have reached $1.2 trillion); Growing Pains, ECONOMIST, Mar. 4, 2006, at 63.

(8.) See Steve Fishman, Get Richest Quickest, N.Y. MAG., Nov. 22, 2004, at 28 (article subtitled "In the precarious hedge-fund bubble, it's either clean up--or flame out"). Hedge fund fees vary considerably, but often consist of a management fee of up to 2% per year plus a performance fee of 20% or more of profits; mutual fund fees are often 1% with no performance fee. See id.; see also Jenny Anderson, For Hedge Funds, Life Just Got a Bit More Complicated, N.Y. TIMES...

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