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 The U.S. Department of Justice last week alleged that the hedge fund
improperly classified two company investments as passive - and
therefore exempt from disclosure requirements - while taking an
activist role with executives. ValueAct disputes the claim.
Some communications the government cites as evidence are similar to
discussions that are increasingly common between traditional,
buy-and-hold funds and companies in their portfolios.
The case comes as active and passive investors work more together to
pressure management at underperforming companies. Activists court
passive shareholders before launching such a campaign, and passive
investors recruit activists to agitate, several activist managers
told Reuters.
Traditional funds may need to reassess their compliance with
disclosure laws, according to a memo to clients from Davis Polk, a
New York law firm with expertise in financial services.
"Such an institution will have to examine whether it can claim to
have a truly 'passive' intent," said the memo, issued in response to
the ValueAct case.
Those firms could include, for instance, T. Rowe Price Group <TROW.O>,
BlackRock Inc <BLK.N> and Vanguard Group. Spokespeople at those
companies declined to comment, and representatives of seven
additional fund firms contacted by Reuters declined to comment or
said executives were unavailable. The Justice Department also
declined to comment.
An industry trade group said the case could restrain shareholders
from addressing important issues with corporate executives and board
directors.
"The DOJ case could have a chilling effect on dialogues between
companies and their shareholders," said Amy Borrus, deputy director
at the Council of Institutional Investors, a Washington D.C.-based
nonprofit whose members include pensions, endowments and major
mutual funds.
For a graphic showing the increase in company shareholder
communication programs, see http://tmsnrt.rs/25PYHpm
Competition for better returns has led some big mutual fund firms to
take a more active role, weighing in on issues such as CEO pay and
corporate governance. Vanguard Chairman and CEO William McNabb, in a
speech last June in New York, described how the firm increasingly
addresses matters of concern with companies in its portfolio.
"We’ve become more targeted in whom we mailed letters to and more
prescriptive in our language," McNabb said.
For example, Vanguard sent out 500 letters in March 2015 to
independent chairs and lead directors outlining six principles of
corporate governance, McNabb said.
SIX WORDS
At the heart of the ValueAct case are six words in a 40-year-old law
that requires disclosure of certain investments to assist the
Department of Justice and the Federal Trade Commission in antitrust
review of mergers. The intent is to prevent investors from secretly
buying up stakes to agitate for industry consolidation.
The Hart-Scott-Rodino Act requires all buyers of voting securities
worth more than $76.3 million to notify the government, unless they
were bought "solely for the purpose of investment."
The government alleges ValueAct failed to disclose a $2.5 billion
position in two companies that planned to merge - oilfield services
peers Halliburton Co and Baker Hughes Industries Inc.
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ValueAct is fighting the case and has said that its outreach to the
companies was standard shareholder input and not active investing.
The firm declined to comment for this story.
Among the evidence asserted by the government is a December 2014
meeting with the Baker Hughes chief financial officer, where
ValueAct’s chief executive discussed gaps in the company's North
American margins and other underperforming areas. The government
also cited a ValueAct email sent to Halliburton’s CEO in July 2015
to schedule a meeting about executive compensation.
Davis Polk points out in its client memo that it’s common for
investors with stakes deemed passive to discuss those topics with
corporate management.
"It does seem to be ... a typical subject of discussion," wrote the
firm, which represents Baker Hughes in the merger.
BLURRED BOUNDARIES
John Briggs, an antitrust attorney with the law firm Axinn, Veltrop
& Harkrider LLP, called the case a one-off enforcement effort
against ValueAct that does not necessarily signal a broader
crackdown or a change in legal interpretation.
But Briggs agreed that the case highlights the blurring boundaries
between activist and traditional fund managers. A ValueAct win could
further cloud the issue, while a government victory could prompt
major investors to dial back pressure on companies.
A managing director at a large asset manager, speaking on condition
of anonymity, said that he and his colleagues routinely discuss
business improvement and executive compensation with company
executives, believing such topics do not cross legal lines. The
ValueAct case could change that interpretation, the manager said.
The lawsuit could take months or years to resolve. Any resulting
limits on fund managers could clash with a separate effort led by
the U.S. Securities and Exchange Commission in the early 1990s
encouraging more dialogue between investors and public corporations.
"The idea was that you want to free up those conversations, since
more conversations allow more accountability," said University of
Delaware finance professor Charles Elson, who follows corporate
governance. "Anything that pushes things in a different direction is
problematic."
(Additional reporting by Diane Bartz in Washington)
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