Unpacking wolf packs.

• Author: Lu, Carmen X.W.
• Position: Activist investors working together to gain corporate board control

Wolf-pack activism has surged in the past three years. A wolf pack is composed of a group of activist investors working in unison to gain control of corporate boards. (1) These activist investors collectively buy stock in a public company and then leverage their aggregate stake to influence corporate decision making. (2) Wolf packs allow activist investors to pool their informational and financial resources, thereby greatly reducing the cost of seizing corporate control. (3) In the past two years, wolf packs have targeted companies including Sotheby's, Allergan, and DuPont. (4) The rise of wolf packs may permanently shift the balance of power between corporate boards and control-seeking shareholders. (5)

This Comment examines the law's seemingly inconsistent treatment of wolf packs, and it advances a disclosure framework that seeks to rebalance the powers of corporate boards and wolf packs. Securities law and corporate law diverge in their approach to wolf packs. On the one hand, section 13(d) of the Securities Exchange Act--designed to alert corporate boards and shareholders to takeover threats--construes wolf packs narrowly. As a result, boards and shareholders may not receive advance notice of wolf-pack activism. On the other hand, the Delaware Court of Chancery recently adopted a relatively expansive conception of wolf packs that may overly punish activist investors. I argue that requiring wolf packs to make prophylactic disclosures will strike the right balance. It will allow boards to better respond to wolf-pack activism and enable courts to better adjudicate the proportionality of such responses.

The Comment proceeds as follows: Part I discusses the history and characteristics of wolf-pack activism. Part II argues that current laws simultaneously underregulate and overregulate wolf packs to the detriment of both boards and investors. Finally, Part III explains how prophylactic disclosures can help restore the balance of power between wolf packs and corporate boards.

1. THE ORIGINS AND ANATOMY OF A WOLF PACK

   Wolf packs emerged from the recent growth in shareholder activism. (6) Activist shareholders are typically hedge funds that generate profit by implementing major changes in public companies. Such changes may involve altering a company's financing structure, investment strategy, or number of employees. (7) To effectuate change within a public company, activist investors often purchase a large stake in the public company and then lobby the company's management to implement changes that the investors believe would increase shareholder value. Activist investors may also seek to win the support of the company's other shareholders via a proxy contest to install the activist investors' choice of directors on the corporate board. (8) Fights to win over shareholders are aggressive and highly public; oftentimes, they create tremendous pressure for a company's incumbent directors to acquiesce to the activists' demands. (9)

   Activist hedge funds took off in the early 1990s after the Securities and Exchange Commission (SEC) began loosening its proxy statement rules. (10) In 1992, the SEC stopped censoring proxy statements, allowing activist shareholders to be more vocal in their criticisms of incumbent corporate boards. (11) Seven years later, the SEC adopted Rule 14a-12, which allowed activist investors to lobby other shareholders before filing a proxy statement. (12) The rule allowed activists to gauge the level of support from other shareholders and mitigate the risk of losing a costly proxy contest.

   The growth of activist hedge funds led to the emergence of wolf packs. The phenomenon first came to the attention of the courts in 2002 when a real estate company sued three investment funds for securities fraud in Hallwood Realty Partners, LP v. Gotham Partners, LP. (13) Under section 13(d)(3) of the Securities Exchange Act, groups of persons must disclose beneficial ownership of more than five percent of a company's stock. (14) The Second Circuit, however, construed section 13(d)(3) narrowly and held that the discussions between investment firms regarding their purchases did not make the firms a "group." (15) The Hallwood decision loosened regulatory oversight of wolf packs and fueled their growth. (16) In the last two years, as the markets have recovered, wolf packs have rapidly reemerged. (17)

   Economists believe that wolf packs tend to form when a single lead investor acquires a substantial stake in a target company. (18) After the lead company makes its purchase, it often encourages other activist investors to purchase stocks in the target company. (19) The activist investor makes these tips in the hopes of securing a broader coalition of votes for its proxy fight. The lead activist's large purchase may also independently spur purchases from other activist investors. (20) These investors may catch wind of upcoming activist activity and buy stocks in an attempt to profit from the lead activist's success. In short, although wolf packs may not be deemed a "group" under securities law, there is both empirical and anecdotal evidence of coordination among activist investors. (21) Studies indicate that stock prices of a target diverge from market averages in the ten to twenty days before activists publicly disclose securities purchases. (22)

   Wolf packs, however, appear to collapse as quickly as they form. The duration of an activist's participation is tied to how the activist plans to generate return. (23) In cases where a proxy fight merely seeks to replace a company's board of directors, wolf-pack participants tend to sell their shares shortly after the change is accomplished. (24) In cases where the wolf pack seeks to restructure the company, the participants may hold onto their stakes for a longer period of time while the...