NEGATIVE ACTIVISM.

• Author: Bliss, Barbara A.

ABSTRACT

Shareholder activism has become one of the most important and widely studied topics in law and finance. To date, popular and academic accounts have focused on what we call "positive activism, " where activists seek to profit from positive changes in the share prices of targeted firms. In this Article, we undertake the first comprehensive study of positive activism's mirror image, which we term "negative activism. " Whereas positive activists focus on increasing share prices, negative activists take short positions to profit from decreasing share prices.

We develop a descriptive typology of three categories of negative activism and use a private database of activist activity and other hand-collected information to provide empirical evidence about the frequency and manner with which each category occurs. First, informational negative activism seeks to uncover and then communicate the truth about companies whose shares the activists believe are overvalued. We show that the announcement of this kind of activism is associated with a statistically significant abnormal decline in share prices. Second, operational negative activism involves dismantling or disabling sources of value at companies. We document a range of actual and potential instances of operational negative activism and associated abnormal share price declines. Third, unintentionally negative activists are failed positive activists: their announcements of ownership stakes in companies they target are met with immediate negative abnormal returns.

Using this typology and the related evidence, we explore the policy and regulatory implications for each category of negative activism. We show a range of areas where policy and regulatory goals either conflict with or seemingly ignore the effects from negative activism. We also offer several ways that existing regulatory approaches could be improved to account for negative activism. In general, we advocate less regulation, and even subsidization, of informational negative activism; tighter regulation of operational negative activism; and a more nuanced approach to unintentional negative activism.

TABLE OF CONTENTS INTRODUCTION I. POSITIVE ACTIVISM II. NEGATIVE ACTIVISM A. Three Categories of Negative Activism B. Empirical Evidence of Negative Activism 1. Informational Negative Activism 2. Operational Negative Activism 3. Unintentional Negative Activism III. REGULATING NEGATIVE ACTIVISM A. Current Regulation of Positive Activism B. Current Regulation of Negative Activism C. Rationalizing Negative Versus Positive Activism Regulation 1. Informational Negative Activism 2. Operational Negative Activism 3. Unintentional Negative Activism CONCLUSION INTRODUCTION

On the morning of December 17, 2019, Muddy Waters, an investment fund, released a statement that it had bet against shares of NMC Health, a United Arab Emirates-based healthcare company, based on "serious doubts about the company's financial statements, including its asset values, cash balance, reported profits, and reported debt levels." (1) NMC Health's share price fell by more than one-fourth that morning. (2)

On June 17, 2018, Elon Musk announced that a Tesla employee had sabotaged the car company's operations, changing its computer code, and exporting sensitive data to third parties. Musk wrote: "We need to figure out if he was acting alone or with others at Tesla and if he was working with any outside organizations." (3)

On April 11, 2017, three roadside bombs exploded while the German soccer team Borussia Dortmund drove by on its way to a tournament quarterfinal match. The bombs sent metal pins through the bus, injuring one of the players, but miraculously sparing the others. Unlike most sports teams, Borussia Dortmund had publicly traded shares. (4)

On July 15, 2016, the Federal Trade Commission (FTC) announced a settlement in which Herbalife, the nutritional supplement company, agreed to pay $200 million in consumer relief, hire an external monitor, and substantially change some of its business practices. (5) FTC officials previously had been pressured by various parties, including members of Congress, to find that Herbalife misled investors by failing to disclose that most of its sales were generated from recruiting new distributors, not from selling to customers. (6)

On February 10, 2015, an inter partes review was filed with the U.S. Patent Trial and Appeal Board, challenging a patent held by Acorda Therapeutics, Inc., a pharmaceutical company whose shares were traded on NASDAQ. (7) The media reported the news of the filing the same day. (8)

On May 15, 2014, Jim Chanos, the head of Kynikos Associates, appeared on CNBC and criticized Keurig Green Mountain and SodaStream, two manufacturers of single-serve beverages. Chanos expressed skepticism about efforts by both companies to expand into single-serve cold products. (9)

Year after year, shareholder activism dominates both media headlines (10) and legal scholarship. (11) Hundreds of times per year, a hedge fund activist announces that it has acquired a significant stake in a company and then demands reform. (12) The targeted company's stock price typically increases during the time surrounding the announcement, and often a vicious battle ensues. (13) Shareholder activists say they are trying to improve companies and increase share prices by persuading management to improve operations, or sell off underperforming units, or reveal new information to the public. We refer to this well-known kind of shareholder activism as positive activism, because its goal is to make money through interventions that positively affect share prices.

Although positive activism has received extensive attention, it is not the only form of activism. The six examples cited above also involve activists who are attempting to influence companies. However, in these examples, the activists are trying to destroy their targets, often in unorthodox or undesirable ways. We label activism that seeks to make money through interventions that a decrease company's stock price as negative activism.

In this Article, we identify and systematically address, for the first time in the literature, the concept of negative activism, which is in many ways the mirror image of positive activism. In negative activism, the activist typically sells short (14) a company's shares instead of buying them. A negative activist thereby seeks to profit from, and has incentives to cause, a decline in share prices--the opposite of a positive activist, who profits when share prices rise. (15)

The above six examples illustrate what we mean by negative activism. Muddy Waters, the firm that disclosed skepticism about NMC Health, is run by Carson Block, a leading short seller. (16) Elon Musk asserted that the Tesla employee-saboteur might have been involved with short sellers. (17) The perpetrator of the soccer team bombing was a German citizen who had borrowed money to bet $45,000 against the soccer team's shares on the day of the attack, seeking potential profits of up to $600,000. (18) The campaign against Herbalife was orchestrated by Pershing Square Capital Management, a hedge fund with a $1 billion short position in the company. (19) The Acorda Therapeutics inter partes patent challenge was filed by the Coalition for Affordable Drugs, a group of hedge funds managed by Kyle Bass, who had taken a short position in the company. (20) Jim Chanos had sold short shares of Keurig Green Mountain and SodaStream before he disclosed those positions. (21)

As we show, negative activism is important and surprisingly common, with hundreds of examples in recent years. Some instances involve large public companies, such as Herbalife, that are embroiled in controversy. (22) Other examples involve claims of corporate mismanagement or misleading disclosures, (23) in many ways providing a quasi-regulatory function traditionally served by shareholder class actions, the SEC, and other bodies. (24) Some negative activism is by firms that hold long positions in some companies, but short positions in others. Yet the literature on shareholder activism currently focuses on positive activism and ignores negative activism, even though negative activism is a significant portion of activist activity. (25)

Moreover, negative activism presents crucial policy challenges. As the word "activism" implies, negative activists do not sit back and wait passively for stock prices to decline so that their short positions will gain value. Instead, many actively attempt to induce a decrease in share prices. In a market economy that typically prioritizes value creation, rather than value destruction, negative activism may strike many as troubling or manipulative.

In this Article, we have two primary goals. First, we set forth an analytic framework for assessing different types of negative activism. Like positive activism, negative activism exhibits a range of characteristics, and it is important not to paint all of negative activism with a single broad brush. A saboteur at Tesla or a roadside bomber are different from an anti-corporate campaigner or a patent challenger or a skeptic about a company's profitability. We present a rabric for distinguishing among these, and other, examples.

Second, and relatedly, we address potential policy responses to negative activism. We argue that responses should be tailored to the characteristics of the different types of negative activism. The introductory six examples of negative activism do not all deserve the same regulatory response. We show several ways that our analysis of negative activism can be applied to improve business and financial regulation. In the process, we show how scholars and policymakers might adopt and apply our framework to business and financial regulation of various types.

This Article proceeds in three parts. Part I provides background on positive activism. We describe the conditions that have led to activist investing's...