Sotheby’s shareholders defend activist investors in suit vs board

By Alison Frankel
April 2, 2014

The heat surrounding so-called activist investors — hedge funds that buy up big chunks of a company’s stock, then leverage their position to mount proxy campaigns or otherwise force boards to change the way the company is managed — could hardly be more intense than it is now. Well, okay, maybe there would be even more controversy if Michael Lewis wrote a book about a genius upstart who defied accepted deal conventions and revolutionized corporate takeover battles. But putting aside the Wall Street tizzy inspired by this week’s publication of Lewis’s new book about high-frequency trading, the deal world’s favorite topic remains activist investors like Carl Icahn, Paul Singer, William Ackman and Dan Loeb.

Just in the last two weeks, Chief Justice Leo Strine of the Delaware Supreme Court published his extraordinary essay on shareholder activism at the Columbia Law Review, the Wall Street Journal did a fabulous story on hedge funds tipping each other off about their targets, and Martin Lipton of Wachtell, Lipton, Rosen & Katz — whose avowed disdain for short-term investors has recently manifested in litigation with Icahn — revealed at the Tulane M&A fest that there are actually a couple of activist funds he respects. (He said he wouldn’t go so far as to say he “likes” them, though.)

A new shareholder derivative complaint against the board of the auction house Sotheby’s is the latest contribution to the furor over activist investors. Two of the most successful shareholder firms in the game, Bernstein Litowitz Berger & Grossmann and Grant & Eisenhofer, filed the class action Tuesday night in Delaware Chancery Court on behalf of St. Louis’s employee pension fund. The suit squarely aligns shareholders with activist investor Loeb and his Third Point hedge fund, which owns nearly 10 percent of Sotheby’s stock and has launched a proxy contest for three board seats at the auction house.

Like Loeb, who brought his own suit against Sotheby’s board last week, shareholders want to invalidate the company’s poison pill, which was apparently enacted in response to Loeb’s stock acquisition and triggers when an activist investor crosses a 10 percent ownership threshold. (One of the purported problems with the pill: It permits passive investors to own up to 20 percent before the pill kicks in so it overtly discriminates against investors like Loeb.)

Shareholders have added an argument that Sotheby’s board members violated their duties when they renewed a debt agreement in which a change of board control triggers default. According to the complaint, that proxy put, as such provisions are known, serves only to scare shareholders from tendering their votes to an activist like Loeb, for fear that he’ll eventually acquire enough board seats to set off the default provision. (Notably, Loeb’s suit focuses only on the poison pill, not the proxy put.)

What’s most intriguing about the new shareholder complaint against Sotheby’s, though, is its sermonizing in defense of activist investors. As Dealbook pointed out earlier this month, big money managers such as BlackRock and T. Rowe Price are increasingly likely (somewhat to their own surprise) to side with the Icahns of the world against corporate boards. But it’s still exceedingly unusual for a public pension fund to join an activist investor in pre-deal litigation. Funds and their lawyers are vastly more likely to sue after an activist investor has put a target into play and forced a deal. Post-deal litigation, in fact, frequently puts pension funds at odds with activist investors. Speaking broadly, the funds (and their lawyers) place themselves in the way of activists who want transactions to close so they can take home their profits.

In the Sotheby’s case, however, Bernstein Litowitz and Grant & Eisenhofer go out of their way to voice solidarity with Loeb — and with activist investors in general. “While not every activist pursues the smartest or most value-maximizing proxy campaigns, there remain a far greater number of lackadaisical, disinterested and sometimes even downright disloyal boards of directors who truly warrant becoming the subject of a full-blown stockholder rebellion,” the complaint said. “In other words, even though passive investors, by definition, are not running the proxy fight, they and the companies in which they invest significantly benefit if the applicable rules make it feasible for activists to invest the time and resources needed to lead a thoughtful and value-creating proxy contest.”

Sure, the complaint said, pronouncements by activist investors prompt “grunts and moans (from) corporate advisers longing for the days of absentee stockholders and unfettered board power.” But proxy contests remain anomalies, the complaint said, and they’re the most efficient way for passive shareholders like the St. Louis fund to send a message to underperforming boards “without having to incur the cost and burden of leading the charge when exercising the power of the franchise becomes necessary.” In short, the complaint makes the point that sometimes the interests of an activist investor looking for short-term returns dovetail with those of long-term pension fund shareholders.

That’s not a popular argument in the debate about activist investors. Strine’s Columbia essay, like much of the writing and speaking about activist hedge funds, posits a distinct split between them and institutional investors who want corporate boards to be free to build long-term value for the enterprise. It’s easy to demonize the activists, after all, by portraying them as selfish billionaires whose actions undermine the retirement savings of middle-class, money-market fund investors.

The new Sotheby’s brief is the newest proof that the activist investor phenomenon is (like most things) complicated. Come to think of it, that might just make it a good topic for Michael Lewis.

The Sotheby’s board is represented by none other than Wachtell Lipton. Wachtell partner William Savitt declined to comment.

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