SEC Is Probing Companies Getting Devoured by ‘Wolf Pack Activism’

NEW YORK (The Deal) -- The Securities and Exchange Commission's enforcement unit is looking into whether several activist funds teamed up at target companies without disclosing their alliances.

The unit is working quietly, sending several private inquiries for information to the insurgent funds, according to people familiar with the matter.

But don't expect a major crackdown any time soon.

The SEC's efforts were reported by The Wall Street Journal this month.

The paper noted that scrutiny of activists, though rare for the SEC, was part of a broader focus on trading disclosures.

And while the inquiry is potentially explosive, observers say that they would be surprised if the SEC's actions result in a major enforcement initiative. In addition, corporate lawsuits seeking to identify illegal collaboration haven't amounted to much over the years.

At issue are Schedule 13D filings made to the SEC. Activist fund managers and other investors are required to publicly report their stakes within 10 days of owning 5% or more of a public company when they have plans to communicate some sort of strategic options for the business, which they must explain in the report.

Any two activist fund managers who jointly agree to buy, sell or vote securities and communicate their intentions for the company are required to jointly file a 13D if they together own more than a 5% stake. Companies targeted by insurgents lately have stepped up pressure on the SEC to identify whether activists are working as a group but not disclosing their ties.

The breadth of the inadequate disclosure problem is unclear.

However, a recent study by The Analysis Group titled "Wolf Pack Activism" suggests that a number of insurgents wait to file a 13D to allow other investors to accumulate large positions in the same targeted company before disclosing their stake.

The study found 10 instances between 2010 and 2014 where activists crossing the 5% ownership threshold waited at least eight days to file their 13D and that in those instances there was an "abnormal trading volume" of more than 10% of the target's shares outstanding.

It also found similar abnormal trading volume at a few examples where the activist disclosed its stake earlier.

The study noted that these activists only reported owning between 5% and 5.9% stakes when they filed, suggesting that the primary insurgent may be tipping off other activist-type funds that it planned to report their investment shortly.

Secondary activists are eager to accumulate shares in anticipation of the primary insurgent's filing because the public disclosure typically represents the formal launch of an insurgency, and it usually causes a substantial spike in share prices. For example, ConAgra Foods (CAG) shares shot up to about $42.67 from $39.11 after JANA Partners filed its 13D at the packaged-foods company on June 18, and it continues to trade at an elevated price.


A review of past 13D group actions involving the SEC is a short list that includes only two orders in the past 15 years, none of which involved activist fund managers.

An SEC spokeswoman declined to comment.

One well-known Washington lawyer who advises companies targeted by activist investors acknowledges that there is no evidence of the SEC probe being a major initiative.

"If you think about all the other things on their enforcement plate, including worrying about fraud and abuse and crimes against the individual investing public, that they would make 13D a priority given their limited budget, is unlikely," he said.

The courts have also provided little help to corporate targets. In fact, companies have found that lawsuits -- filed to convince activists to give up rather than pay legal bills -- have backfired by enraging institutional investors.

"[Institutions] would say, 'This is how the company is dealing with complaints about underperformance from a fellow shareholder? A lawsuit?'" said Marc Weingarten, partner at Schulte Roth & Zabel.

"Today the activists often have deeper resources than the companies they're criticizing, so the expense strategy doesn't work," he said. "The lawsuits went away."

In addition, the lawsuits are mainly toothless, in that courts aren't authorized to award monetary damages when it comes to 13D collaboration allegations.

"In all 50 states you can scream until the cows come home, but there are no monetary damages awarded in 13D cases," the corporate lawyer said.

The most extensive 13D lawsuit in recent years was a complex piece of federal litigation in New York that involved a blockbuster proxy battle between activist investor The Children's Investment Fund and railroad operator CSX (CSX).

The railroad alleged that The Children's Investment Fund was actually acting as a group with another fund, 3G Capital Partners, much earlier than they acknowledged in a 13D filing.

A judge in 2008 ruled that The Children's Investment Fund and 3G Capital Partners violated 13D rules but didn't bar them from voting their shares. Instead, the court required the two funds to correct their 13D filing, which they already had done, and enjoined them from future violations.

A Second Circuit appeals court later that year refused to overturn the ruling that allowed the two funds to vote their shares.

And in a 2011 opinion, the Second Circuit confirmed that remedies for a 13D violation were limited, holding that greater evidence was required to show that they were acting in concert for the purpose of acquiring shares. It remanded the case back to a lower court for further findings about whether a group had actually been formed, but CSX then dropped the case.

"As CSX shows, it is very difficult to get any real value from bringing a 13D case," said Eleazer Klein, partner at Schulte Roth & Zabel.



A major initiative to clamp down on Schedule 13D compliance would likely need Congress to revisit the almost 50-year-old 13D statute.

Companies are limited in their ability to seek redress for 13D violations because they can't pursue monetary damages under 13D, and effective injunctive relief is limited, all of which frustrates private enforcement efforts, said Keith E. Gottfried, partner at Morgan Lewis & Bockius.

A move by Congress to authorize federal courts to award monetary damages and broad injunctive relief when it comes to 13D violations would "drive a much stricter level of compliance with the rules," he said.

Andrew M. Freedman, a partner in Olshan Frome Wolosky's shareholder activism practice, said that he thinks that the SEC's inquiries will produce little.

He said that in his experience companies send letters to the SEC as a delaying tactic to make contests more expensive.

"[SEC inquiries] will put funds and institutions on alert in terms of how they conduct their discussions," Freedman said. "But I don't see this leading to a wide-scale agenda at the SEC to prosecute undisclosed group activity."

Freedman added that the well-known established activists -- JANA Partners, Starboard Value, Trian, Value Act and others -- are too careful and well-advised to have these missteps.

"It may be that the SEC could take some actions with relatively unsophisticated new wannabe activist investors," he said.

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