© 2019 Morgan, Lewis & Bockius LLP

SHAREHOLDER ACTIVISM PREPAREDNESS: WHAT BOARDS OF DIRECTORS NEED TO KNOW TO AVOID BEING AN EASY TARGET FOR AN ACTIVIST INVESTOR

Keith E. Gottfried

NACD Capital Area Chapter Program

February 13, 2019

Important Information

This presentation is intended to provide a general introductory overview of the issues discussed and is not intended to provide a complete analysis of such issues.

This presentation is for educational and informational purposes only and is not intended, and should not be construed as, legal advice. Readers should not act upon the information contained in it without professional counsel. Nor is this presentation intended to establish an attorney-client relationship.

This presentation may be considered attorney advertising in some jurisdictions. The hiring of an attorney is an important decision that should not be based solely upon advertisements. Prior results do not guarantee similar outcomes.

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Biography of Presenter

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Keith E. GottfriedWashington, D.C.T 202.739.5947F 202.739.3001

New York, NYT 212.309.6261F 212.309.6001

Keith E. Gottfried is a partner in the New York, NY and Washington, DCoffices of Morgan, Lewis & Bockius LLP where he leads the firm’s top-ranked shareholder activism defense practice.

Keith counsels public companies, based in the United States and abroad, ina wide array of industries with respect to preparing for and/or responding tohigh-profile proxy contests, special meeting demands, consent solicitations,withhold and vote-no campaigns, shareholder proposals and other activistshareholder campaigns as well as contests for corporate control andnegotiated and contested M&A situations. Keith also advises publiccompanies and their boards of directors on strategies for making a companyless vulnerable to activist shareholders, shareholder engagement, investorcommunications, corporate governance issues, board compositionenhancement and other board advisory matters.

Frequently quoted by the national business media on issues relating toshareholder activism, Keith publishes and presents regularly on shareholderactivism related topics. Keith is listed in the 2018 edition of Chambers USA:America’s Leading Lawyers for Business, which ranks him as a leadingcorporate / M&A lawyer. In 2018, Keith was named by the NationalAssociation of Corporate Directors (NACD) to its list of Directorship 100honorees, which recognizes the most influential people in the boardroomcommunity, including directors, corporate governance experts, regulators,and advisors.

Biography

Key Topics Covered

● Recent shareholder activism trends.

● What is driving shareholder activism.

● The activist investor’s agenda - what an activist investor looks for in its targets and the goals of an activist’s engagement with a company.

● The activist investor’s playbook – the phases of an activist’s engagement with a company.

● Types of activism campaigns.

● Early warning signs of an activist investor.

● What makes a company vulnerable to an activist investor.

● Steps companies can take to be less vulnerable to an activist investor.

● Planning for how a company would engage with an activist investor.

● What to do now.

● Concluding thoughts.

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Recent Shareholder Activism Trends –Activist Campaigns Worldwide

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607 641

773

886 853

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Activist Campaigns Worldwide (2013 – 2018)

# activistcampaigns

Source: Activist Insight

Recent Shareholder Activism Trends –Activist Campaigns in the U.S.

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327375

427

486 470420

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Activist Campaigns in the U.S. (2013 – 2018)

# activistcampaigns

Source: Activist Insight

Recent Shareholder Activism Trends –Activist Campaigns by Region

7Source: Activist Insight

420

470

486

427

375

327

68

56

66

70

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120

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97

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36

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0 100 200 300 400 500 600 700 800 900 1000

2018YTD

2017

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2015

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Activist Campaigns by Location of Company Headquarters

US Canada Europe (excl. U.K.) U.K. Asia Australia Other

Recent Shareholder Activism Trends –Activist Campaigns in Asia

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Company HQ 2013 2014 2015 2016 20172018 YTD

China 4 5 9 11 11 13

Hong Kong 8 11 16 16 14 9

India 2 1 3 9 6 4

Israel 2 7 4 8 8 5

Japan 13 14 21 21 33 43

Kazakhstan 0 0 0 1 0 0

Korea, Republic of 0 1 4 4 2 9

Malaysia 1 3 8 7 6 4

Singapore 7 5 9 13 12 9

Taiwan 0 1 0 1 0 3

United Arab Emirates 0 0 1 0 1 0

Asia Total 37 48 75 91 93 99

Source: Activist Insight

Recent Shareholder Activism Trends –Proxy Fight Trends

Source: SharkRepellent FactSet

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75

4256

100109

126134

10093

7790 93

105 109

79

107

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Proxy Fights Trend Analysis (2003 – Present)

# Fights

Majority of Proxy Contests Don’t Go the Distance

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• Fewer proxy contests “go the distance” all the way to a contested meeting.

• The majority of proxy contests don’t go the distance; they either get “settled” or are withdrawn.

• Not all proxy contests settle:

– 33 went to a vote in 2018: M20, D11, S2

– 30 went to a vote in 2017: M16, D13, S1

– 38 went to a vote in 2016: M28, D9, S1

– 31 went to a vote in 2015: M16, D14, S1

– 32 went to a vote in 2014: M12, D18, S2

– 30 went to a vote in 2013: M12, D17, S1

• 2016 was a year when more proxy contests “went the distance” than at any time in the past 8 years (compare to 51 in 2009).

• Proxy contests that “go the distance” are often at small-caps.

*Source: SharkRepellent FactSet

What is Driving Shareholder Activism?

• Substantial inflows of capital to activists.

• Relatively low interest rates make activism attractive for investors seeking yield.

• Acceptance by institutional investors of activism as an investment strategy.

• Desire of new activists to prove themselves to investors and attract more AUM.

• Conducive regulatory environment.

• Access to inexpensive debt to fund value enhancement initiatives such as special cash dividends and stock buybacks.

• Strong M&A market that encourages activists looking to push companies to sell.

• Encouraged by activists’ successes, more investors adopt an activist strategy.

• Institutional investors more willing to support activists.

• Increased willingness by companies and boards to engage with activists.

• Willingness of companies to settle with activists and avoid a proxy contest.

• Many companies continue to be “sitting ducks” and reluctant to assess their structural and other vulnerabilities with any kind of urgency.

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The Activist Investor’s Agenda

• Opportunity to generate an outsized return.

• Perception that the company is undervalued by the markets relative to its intrinsic value.

• Perception that there is a “lever” that the activist can access whether through constructive engagement with the company’s management / board or through a contested solicitation, which will unlock shareholder value.

• Perception that the company is in a vulnerable position due to past mis-steps that have damaged the credibility of the current board / management team.

• Perception that the activist’s ideas will find a supportive audience.

• Perception that other shareholders will support the activist.

• Activist agenda is often M&A related, e.g., calling for a review of strategic alternatives, focused on operational changes, focused on capital allocation/balance sheet improvements, and/or focused on corporate governance changes (but typically only as means to end of unlocking shareholder value).

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The Activist Investor’s Playbook

Phase 1 – Identify Target

• Determine that the company is undervalued by the markets relative to its intrinsic value.

• Determine that there is a “lever” that the activist can access whether through constructive engagement with the company’s management / board or through a contested solicitation, which will unlock shareholder value.

Phase 2 – Accumulate Stake in the Company

• Acquire shares, in stealth mode if possible, including through cash-settled equity swaps and other derivatives.

Phase 3 – Engage with the Company

• Request meetings with management and/or independent directors.

Phase 4 – Apply Pressure

• Escalate engagement with the company and level of criticism of the company.

Phase 5 – Seek Influence or Control

• Request changes to strategic direction of the company (such as initiating a process to sell the company), board representation and/or other governance changes at the company.

• Wage proxy contest, special meeting demand, or consent solicitation to effect changes to Company’s board composition and/or seek other governance changes at the company and/or wage withhold / vote-no campaigns to place pressure on directors to resign.

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Types of Activism Campaigns

• Annual meeting proxy contest for board representation

– Minority slates

– Control slates

• Special meeting proxy contest to remove and replace directors

– May not be permitted by governing documents or may require shareholder(s) to meet an ownership threshold

– May require two solicitations – one to call the meeting and one for the business to be voted on at the meeting

• Consent solicitations to remove and replace directors

– May not be permitted by governing documents

– Generally, cannot be restricted or prohibited in the bylaws

– May require a higher vote threshold for shareholder approval

• Vote no or withhold campaigns

– Majority voting makes these campaigns more potent and enables activists to cause a director not to receive a majority of the votes cast and then force the director’s resignation

• Rule 14a-8 shareholder proposals

– Not a typical tool of the “economic” activist

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Early Warning Signs of an Activist Investor

• Unusual upticks in the trading volume of the company’s stock.

• Accumulations by activists or other investors known to follow activists.

• Form 13F filings.

• Schedule 13G / 13D filings.

• HSR filings.

• Letter from a shareholder calling for changes to board composition or strategy.

• Contact from an activist seeking a meeting with management or board.

• Activists requesting meetings at investor conferences.

• Activists attending earnings calls.

• Unusual questions raised during earnings calls.

• Unusual calls to the investor relations team.

• Media inquiries.

• Market rumors.

• Reports that other shareholders have been contacted by an activist.

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What Makes A Company Vulnerable To An Activist Investor?

• Poor stock price performance.

• Poor operating and financial performance, particularly compared to peer companies.

• Poor total shareholder return (TSR) (particularly compared to peer companies).

• Higher G&A expenditures than peers.

• Capital structure.

• Low leverage compared to peers and significant potential for the company to increase its leverage and fund a special dividend or stock buyback.

• Cash on balance sheet viewed as in excess of the company’s needs

• Lack of trading liquidity resulting in less than efficient markets valuing the stock.

• Leadership issues.

• Strategy execution.

• Failure to publicly articulate a credible strategy for enhancing shareholder value.

• Perceived inability to create shareholder value without meaningful change.

• Potential opportunities for an activist to “unlock” shareholder value (e.g., unrelated businesses, stranded assets, sale of the company, etc.).

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What Makes A Company Vulnerable To An Activist Investor?

• Lack of confidence by investors in board/management to create shareholder value.

• Board composition, tenure, governance, experience, and leadership issues.

• Subpar corporate governance practices.

• History of negative recommendations from proxy advisory firms.

• Related party transactions.

• Minimum insider ownership.

• Executive compensation not aligned with performance.

• Failure to sufficiently engage with shareholders.

• Lack of attention to issues of concern to shareholders.

• Lack of attention to issues that are easy building blocks for an activist’s messaging platform.

• Ability of an activist investor to acquire a significant stake.

• Ability of activist to attract other investors supportive of its concerns.

• Bylaws not recently updated and/or which lack robust advance notice provisions.

• Lack of preparedness for an activist investor.

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Steps Companies Can Take To Be Less Vulnerable To An Activist Investor

• Improve financial performance and stock price.

• Know all the obvious paths to “unlocking” shareholder value and be prepared to explain why any of those paths should not be pursued.

• Refresh the company’s strategic plan to enhance shareholder value and seek to incorporate input from shareholders.

• Prepare an internal “white paper” on the company, incorporating multiple perspectives.

• Refine investor presentation and other strategic communications to hone key messages on value enhancement initiatives and long-term growth plans.

• Increase the company’s visibility on “wall street” and in financial community.

• Review shareholder profile on a regular basis.

• Plan investor outreach to enhance investor relations, assess investor sentiment, gather intelligence and market strategy for value enhancement.

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Steps Companies Can Take To Be Less Vulnerable To An Activist Investor

• Conduct a comprehensive assessment of vulnerabilities, including structural ones.

• Review bylaws and consider amending bylaws on a “clear day”.

• Consider developing a shelf shareholder rights plan.

• Enhance processes to receive early warning of an activist targeting the company.

• Become familiar with advisors experienced in shareholder activism defense and assemble an activism response team in waiting.

• Assess any proxy advisory firm issues that can be proactively addressed.

• Assess any corporate governance issues that can be proactively addressed.

• Determine whether there are any obvious gaps in relevant experiences and competencies on the Board and assess whether there are board composition issues that can be proactively addressed.

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Planning For How The Company Would Engage With An Activist Investor• Identify which members of the board/management should be on the “front lines”

in engaging with the activist.

• Identify who should be the “first responders.”

• Plan how the company would respond to an activist’s meeting request.

• Plan which company representatives should meet with the activist.

• Plan an approach to the meeting with the activist that indicates a commitment to constructive engagement.

• Consider what the company’s public response, if any, would be to an activist publicly disclosing a stake in the company.

• Consider what the company’s public response, if any, would be to an activist publicly disclosing it has submitted a notice of nomination to the company.

• Consider how the company would respond to the receipt of a “white paper” from an activist, both one privately-shared and one publicly-disclosed.

• Conduct scenario planning exercises with the board and outside advisers (legal, investment bankers, proxy solicitors, PR/IR) to prepare for activist engagement.

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What To Do Now

● Assess (in an attorney-client privileged setting) in a comprehensive manner the extent to which the company may be vulnerable to an activist investor, including reviewing the company’s bylaws and other governing documents.

● Understand why an activist may seek to target the company and, to the extent possible, identify activists that would be likely to have an interest in the company.

● Know all the obvious paths to “unlocking” shareholder value and be prepared to explain why any of those paths should not be pursued.

● Enhance processes to receive early warning of an activist targeting the company.

● Develop and maintain an “intelligence network” of analysts, print and online media, institutional investors, portfolio and governance managers at institutional investors, investment bankers, proxy solicitors, and legal advisors to stay abreast of developments that may make the company vulnerable or likely to be targeted.

● Continuously revise the company’s shareholder engagement strategy.

● Assemble an activism response team in waiting.

● Continuously develop a pool of potential board candidates, particularly candidates who can be suggested as candidates in connection with a settlement.

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