BDC/REIT Activism Webinar
Theresa: Welcome to BDC/REIT Activism Webinar. I'd like to inform
everyone that this webinar is being recorded and will be available for replay
shortly after the webinar ends. This webinar will also be transcribed and that
document will be circulated within a few days. The replay and transcription will
be available under the Events tab on our website, www.cefnetwork.com. We
will be taking questions asked during this webcast, so please be sure to utilize
the Questions tab on your screen. At this time, I would like to turn it over to our
moderator and senior managing director at Alliance Advisors, Waheed Hassan.
Waheed: Thank you, Theresa. First, I want to welcome all the attendees and
panelists on behalf of Alliance Advisors. Alliance Advisors is one of the fastest
growing proxy solicitation firms with over 400 clients. We work with some of
the largest BDCs and closed-end funds. Given the rise of shareholder activism
in the BDC space, we felt that it was an opportune time to discuss why activists
are targeting BDCs and how issuers can prepare for an environment where
activism is becoming mainstream.
Let us begin with the introduction of our panelists. We are excited to have a
very experienced group with us. Tom Friedmann is a partner at Dechert. He cochairs Dechert’s global corporate finance and capital markets practice. Cynthia
Krus is a partner at Sutherland Asbill & Brennan. She advises public and
private companies and their boards on all aspects of corporate governance and
proxy fights. Phil Goldstein is a principal of Bulldog Investors. According to
Shark Repellent, Bulldog has been involved in over 177 campaigns at 144
different companies. This year, Bulldog won board representation through a
proxy contest at BDCA Ventures - a BDC company. He also serves on several
boards.
My name is Waheed Hassan and I co-head the Shareholder Activism practice at
Alliance Advisors. Prior to joining Alliance, I managed the M&A Proxy Fight
Practice at ISS, Institutional Shareholder Services. With that introduction, let's
start with the first question, and this is addressed to all the panelists. Why do we
see an increase in activism in the BDC space? Tom, let's start with you.
Tom: Sure. So I think there's a lot of different opinions on this question. I
think some of the obvious factors that get repeated frequently are that BDCs’
stock prices have been declining, or they've been low for a prolonged period.
There's also been some commentary about the fact that BDCs have relatively
high fee levels as compared to some other types of investment products in the
market. And also, recently, there have been some BDCs that have been affected
by increases in the non-accruals among investments, particularly those BDCs
that are concentrated in investments in the energy industry.
Cynthia: I would add to that that I think what you're seeing in the BDC universe
is really what's being experienced across corporate America. I think that you've
seen, for example, some of companies that you wouldn't necessarily believe
would be subject to proxy contests, such DuPont, having gone through a proxy
contest and actually effectively won that. Now there are discussions about them
merging with Dow.
So basically no one is safe. Size doesn't make you safe in this context. And in
addition, you've got a hedge fund industry that's grown substantially. There's a
universe of funds - about $130 billion - that is out there waiting to conduct
activist and proxy contest campaigns. They’ve got to put money to work just
like BDCs do. That's tripling of the assets in that market.
And effectively activism, good or bad, has shifted into the mainstream. This
hostile activity really isn't referred to in the same way it would have been
referred to back in the '80s. And so you're seeing a lot of success here with
some of these funds. Keep in mind that not necessarily every situation becomes
a contested situation. There's a lot of activity that occurs in a very informal
way. So, all of those informal campaigns have increased the number of
campaigns that are out there today, and that's what basically is happening with
BDCs. And you can actually compare it to the REIT market as well. The same
type of discount issues as well as some of the asset issues and fees are being
raised at the same time.
Waheed: Phil, what's your take on this?
Phil: Well, I think that BDCs are little different that it's…when I look at it, I
kind of think, "What's taking so long?" And I think there're two different types
of activists. There's the type that wants to manage the assets, so basically looks
at...look, I don't know if the other panelists disagree with me, but
fundamentally, the whole structure of BDC is flawed in that the fees are so high
that it's difficult to see how most shareholders are going to earn a decent return
over time. When you have 2 and 20 and regulatory costs and so forth, it seems
like it's just...there've been so many abuses issuing stock at a low NAV and
diluted secondary offering.
So there's been a wealth of abuses. And I look at it and say, "Well, it's taking so
long." But the two types or one of the type, the type where TPG and NexPoint,
would both like to manage TICC. When you combine that with terrible
performance and a big discount, you can see why that's attractive.
Then there's the type of activism that we're seeing right now at Fifth Street,
which is where a passive investor, RiverNorth, as far as I know, which has
never engaged in activism, I know them from closed-end funds, but it seems to
be their first contest, and they look at a big fat discount in addition to the other
factors, the high fees and the terrible performance, and they just want probably
to close the discount. They don't really care. They're probably looking for some
sort of liquidity event.
So, I think Alliance is going to make a lot of money over the next couple of
years because there're going to be some successes here. And when it's going to
make the industry much more competitive, whereas before managers and
boards just thought this was just a pile of captive assets. That seems to have
changed, and I can only see it accelerating.
I just want to give one example of what I see the problem on TICC. They've
been having this litigation, and basically the manager wants to sell out the
Benefit Street partners, which apparently he's a good manager, but the former
manager or the existing manager wants to get paid. And frankly even if the
board’s sending out a letter saying, "Well, you should vote for this bill," the
new manager, which I think in my opinion, has no chance of happening. But
even if it did, if I'm on the board, I would say, "Well, why don't we just tell
Benefit Street? Why don't we just hire them and fire the existing manager and
take whatever they were going to pay the existing manager and put that into the
fund."
And then I can't really think of a good answer that a board or counsel to the
board would give that would be consistent with fiduciary duty not to pursue
that. So I think the boards are going to be very uncomfortable with credible
managers looking to replace incumbent managers who’ve performed poorly and
charging high fees if somebody offers to come in and do the job for a lower cost
and take other shareholder friendly measures.
Waheed: Thank you, Phil.
Cynthia: We can get into it, Phil. I think that, and I actually speak for Tom here.
I think that we specifically disagree with the “flawed structure”. So, I do think
that basically a lot of the structural terms, such as fees as well as issuances, are
really driven by the market itself. And to tell you the truth, I think that actually
you're somewhat proving out whether the market drives those or the statute
drives those because, for example, the fee structure under the ‘40 Act… the 2
and 20 structure is not dictated by that. And the ability to have an asset fee, an
income fee. That's something that's been driven by the market, and I think that
you've seen some people responding or management teams responding, and to
move that down. And I think that that's something that's been happening in
connection with IPOs.
And then the issue that we always hear about is the governance is that the
shareholders approve effectively any type of below NAV issuance, and that's
required by the statute. So, I do think that one of the things you need to be
careful about when you're looking at this type of a product is that there is a ‘40
Act structure here. You have to take that into account when either an activist or
a board and management team is responding to any kind of activist activities.
But I just want to go on record that I disagree and that a board is basically put
there as the gatekeeper for these funds, and the boards are the ones to look at
the adviser and the ones who are reviewing that and then having that go to
shareholders is the way that the ‘40 Act works.
Phil: Well, that has been the way it worked, if you could put the word “work” in
quotation marks, but I think what you're seeing now is, up until now, there was
never really any competition for the management contract. And once that
genie's out of the bottle now, and I personally have gotten calls from credible
managers who are looking to do the same thing. So I think that's just...look,
things can go on a long time, and everybody thinks it's working. But now it
really is market forces, and I think things have radically changed in the market
now, is starting to work.
Tom: Phil, I think that I wouldn't necessarily disagree with everything you said,
but I think that there is a point there. Two years ago, a lot of these same
managers were not considered terrible partly because loan assets generally the
pricing levels were higher. And obviously now with loan assets having traded
down in value across the board, not just with BDCs or closed-end funds, there's
obviously an arbitrage opportunity here. I don't know that that merits an across
the board condemnation of managers of BDCs, but I wouldn't disagree. There's
an opportunity here. Somebody's going to gain that increase in value if the loan
assets trade up later, and I don't blame activists and others from seeking to share
in that increase when it occurs, if it occurs.
Bust last year to 18 months ago, BDCs were trading- on average- about 5%
above NAV, just wasn't that attractive. It's not that people didn't think it could
be done, it was just not that attractive to try to take over a fund trading above
par.
Phil: I agree with you. And I didn't mean to say across the board, but I think
there's more than the....either bad or disreputable managers in the BDC space
and in, say, the closed-end fund space and maybe it’s they're just attracted by
the high fees. But you're right, of course. When they were trading at or above
NAV, maybe that wasn't as apparent, but the...
Cynthia: I have to jump in on this because you're talking about the managers.
Part of what we are talking about, I was disagreeing that BDC are flawed
structures, just to be clear, not necessarily on the other statements that Phil is
making. But the point is that the market, it forces I think our working here, and
one of the things that when you're looking at an activist or campaign
circumstance, I don't know that necessarily all those could be considered
successful. So, you're involved in two BDCs that I think are actually, from a
market standpoint, trading at the lowest level for their pricing, First Hand
[Techonolgy Value Fund, Inc.] and the MVC [Capital, Inc.]. And I think that
those were both campaigns that you had launched, so it's not a panacea.
Phil: First of all, I was not involved at MVC. I am on the board but I was never
involved in any activism with MVC. BDCV is in a liquidation mode, and also I
would distinguish that those are equity-oriented BDCs.
Look, there are problems, which are the minority there. There problems with all
BDCs but because of the opacity of the assets, but I think this is call...my
understanding is it pretty much confined to the income-oriented BDCs, and the
pricing problems. There's a lawsuit. I'm not going to opine on the merits, but
again on Fifth Street, where the allegation is that the manager was refusing to
take write-downs because the manager wanted to issue an IPO of the
management company and was artificially inflating to keep the fees up
and...there is a lot of concerns about that. But anyway, the bottom line is the
activism is going to probably continue, and we can disagree as to whether
BDCs are a flawed structure. I just think when you have expense ratios in the 45% rate, it sort of...
Cynthia: Yeah, I think we can all agree that activism is effectively here to stay.
I think with proxy access, which I think is one of the reasons that all of this is
moving into the mainstream, that there's definitely going to be more activities
and boards and management teams need to be more informed as well as the
activism because not every activist I think is the same. They may look like the
same playbook, but I think that just like you have to distinguish between
companies, you have to distinguish between activists.
Phil: I agree with that.
Waheed: Maybe we can spend some time trying to understand what made you
transition from a mutual fund activist to a BDC activist, and how do you
identify the target?
Phil: Well, I wouldn't say we transitioned. We just happened to see an
opportunity where, in the case of BDCV, it was a small enough fund for us to
handle, small enough BDC. And also the management agreement was
transferred to an affiliate of RCS Capital who, if you haven't been following the
news, has had more than its share of problems. So once that came out, we just
saw no future for that fund that was trading at a 25% discount from NAV. And
it was a pretty easy proxy fight to win. That said...
Cynthia: I'll like to get our moderator to weigh in on this because actually, I
think that ISS supported the current management, [of BDCV], and I think it was
as a result of the plan that has been laid out by the management team and that I
don't think that they felt it was laid out in the public documents by you, Phil, or
your group. So, I don't know whether, do you want to talk about that and how
ISS plays into this?
Phil: I don't think ISS has much effect on BDC votes. If you want to start
talking about ISS, there are times when we agree with them, and there are times
when we don't. And in this case, I don't think they got it. I think that there was
no future for this fund, but, look, ISS, like everybody else, is entitled to its
opinion. But the problem with...the reason why ISS is really not much of a
factor is because there’s very little institutional ownership of BDCs and the
institutions that own now are much more likely to just vote their own interests
and ignore what ISS says. And so I don't think they're much of a factor like they
would be in an operating company like a DuPont.
Waheed: With respect to ISS, the key thing that people have to be mindful of is
that ISS only influences a certain portion of the ownership. With BDCs and
closed-end funds, a lot of these are primarily owned by retail investors who
don't tend to follow ISS For BDCs and closed-end funds that do have some
institutional ownership, you can influence ISS to recommend for you. But,
again, it’s an advisory vote only. The key is whole engagement strategy that
companies must emply, like how do you reach out to retail investors, who tend
to be management-biased to begin with, that matters most.
Tom: If I may add one other thing, and this goes to this structure point that
Cynthia raised. I think that one thing that makes certain BDCs attractive [to
activists] is because of the quirks of the ‘40 Act. Management can get into a
situation where it's difficult to move, to improve their own performance. They
can't raise capital. They can't incur additional debt. And there's only so much
you can do in terms of shifting assets around to different names. And I think
that obviously, it's just like closed-end funds, so I think you get into a situation
where you're dead in the water and it obviously makes it attractive if someone
is trying to just aggregate assets.
Waheed: So moving on, this is for Tom and Cynthia, how are you advising your
clients to deal with this activism trend?
Cynthia: Well, I'll go, and Tom, please stop me if you want as I walk through
some of this. I think one of the most important issues is the composition of your
board, and I think actually Phil would agree with me on this. The people you
put on your board, their background, their experience, their understanding of
the business, is incredibly important. And I would suggest to people that they
look at their current boards and see if they've got everything, every type of
experience they need filled out. And if they don't, they might want to review
that. Either add people or consider what else to do, but I really believe that that
is one of the primary areas because unlike years, or maybe five years ago, so
you would not see board members being as active in this type of area. You
would more than likely not have them out talking about your company. You
would mostly have left that to management. I believe that's really shifted, and I
do believe that's going to continue to shift, especially since they have such an
important role in these 40 Act entities, where you have to have at least a
majority of independents that that lead director or chairman really takes on an
incredibly important role, especially in this type of an area.
Tom: I think that's right. One other area that we tend to focus on, and I'm sure
you do as well, Cynthia, is pushing boards, and particularly independent
directors, to take ownership of the annual renewal process on the advisory
contract. That's an area where there's a huge range of practice in the market
frankly, and I suspect that goes well into open-ended funds and closed-end
funds as well as BDCs. But independent directors can insist on certain
information being provided. Sometimes they do. Sometimes they do not.
I think that it's important in the selection of your peer group when you're
comparing performance that you try to get an objective data set and not just a
cherry-picked group. I wouldn't say any of the clients I work with have cherrypicked, but I think it's certain open to being done because you can pick your
sample as management. I think it's incumbent on the independent directors to
kick the tires on that and press and make sure they know what the market rates
are and the structures of fees so that they're not an outlier. And I think that can
go far to eliminating someone's argument in an activist situation that there's
some different fee structure that they can bring to bear that's going to result in
enhanced performance for shareholders.
Cynthia: I couldn't agree more. That 15(c) process, which is what we're talking
about for boards, where they have to annually approve the fee structure, that
you really do have to take into account what's happening today when you're
going through that review, and I would think the boards would want some
information about that and what's been transpiring so they have to be very
informed.
And that leads on to my second point, which would be, performance. One way
to inoculate yourself is performance and not only the management team, but the
board has to be addressing that constantly. You used to look at some of these
issues at a quarterly or even on an annual basis. Honestly, a lot of the strategic
issues that boards are looking at really need to be done as often as they're
getting together. And they need to make sure that they're educated.
Phil: Can I add just my two cents on that? I think that I don't disagree about the
importance of the board, but in addition to having good paper credentials, I
think it would...and I don't really know how this works, but I think it would be
helpful if the board has significant skin in the game. Meaning, every director
should have a significant investment in that BDC. That's not a guarantee that
the BDC is going to perform well, but it certainly aligns the interests of the
board with the shareholders. I don't know how that actually...what the actual
facts are, but that something's I would look for. And if I was an activist running
against an incumbent board and they had no stake in the BDC, it's certainly an
area of weakness.
Waheed: Phil, to your point, when I was at ISS the issue would have often
come up - that the incumbent directors don’t have skin in the game. And in our
conversation with the incumbent directors, one issue that they raised - was that
skin in the game is a subjective term for somebody whose net worth is half a
million or a million dollars, for them investing $100,000 is the skin in the game.
Whereas if you talk about a large institution investor or hedge fund, for them
skin in the game means millions of dollars. So, it becomes very difficult for
institutional investors, the proxy advisory firms, and people who are not part of
the process to determine whether someone has vested interest in the company as
a director or not.
Phil: Well, that's true, but I think if you're making, let's say, I don't know what a
typical director makes, but let's say he's making $60,000 a year. I think putting
a third of that into buying shares in the market is not unreasonable.
Cynthia: What I will say about this is, unlike most of the issues that come up,
there's not a ‘40 Act restriction on boards owning shares in a BDC. So, I'll go
into my next point, which is really knowing your shareholder base. And that
doesn't mean getting to know them when basically you've got somebody who's
come in and wants to put a slate of new directors up. You need to be aware of
it. And actually BDCs probably have more information than they're thinking
about because they've done some of these other votes that might require you to
go deep into the base of the shareholders.
So, it's one, knowing who they are today, and as you build them, as you're
doing additional offerings, who's coming into your stock. Understand who they
are, how they act, and monitoring and working with the advisory firms on
tracking that information. So, you really do need to understand that and
promote who you want in the stock. And I would say when and if Phil comes
into your stock, you should be aware of it.
And if he writes you a letter and asks you questions or makes suggestions, that's
something that both the management team and the board need to take very
seriously. And not necessarily that you're going to agree with him on everything
that he's suggesting but those types of things, that is...those are strategic issues
that need to be vetted throughout the firm, and there needs to be that type of
significant engagement with the shareholder base. And that's the world we live
in right now, and I think it's only going to get more significant on those types of
encounters.
Waheed: That's a good point. One challenge that we have seen among our
clients who have a large retail ownership is when you have significant portion
of OBO shareholders, objecting beneficial owners, it's difficult to reach out to
them and to know who they are. So, again, it goes back to composition of the
shareholder base. If you have institutional investors, it's easier to engage with
them and to know who they are and to track them. But if you have a large
portion of objecting beneficial owners, there's very limited visibility that
management and the board have on who these people are.
And some of our clients have used various engagement strategies to gather a
database of who these investors are. So if they are in a contested situation, they
can reach out to them and say hey, we need to talk. But again, that information
tends to change as shares trade over time. Some issuers use market surveillance
services, to track on a regular basis the changes in shareholder base. But you're
absolutely right, it is important to keep in touch with the shareholders and not
reach out to them only when you need them.
Cynthia: Well, I want to say, just having a shareholder day, you know what I
mean? Or brown bag lunches or something. You're talking about retail
shareholders. They want to understand the BDC, where maybe the fund is a
very top level but the underlying portfolio companies -- giving them more
information on what type of investment you have in your portfolio, which is all
public, could be very, very helpful for a shareholder to understand, potentially
using your annual meeting for some of that.
It really is something that is going to have to be done. You're paying them
dividends, hopefully - fairly regularly, and to the extent that you can use that
vehicle in any way to keep assessing them. [is useful]. I'll mention one thing
that I heard in connection with MCG, that was a merger transaction, but there
was the activist, I'll call him an activist, Phil Falcone came in, and ultimately
MCG or PennantPark prevailed to close that transaction. I do believe that some
of that was the outreach to the shareholders. Meaning, that I know that the
company basically was on the phone talking to people from the beginning of
the day, to then end of the day, and you could have hundreds of calls
throughout that whole process, and I believe it was really that...not only the
letters and the information provided, but it was actually that work on the phone,
which is a lot of drudgery to get that all accomplished and takes away the
resources operating the business. But sometimes that, at some level, it's going
to become a cost to the business to basically make sure you know who your
shareholders are.
Phil: I would just add that it's fine to know the shareholders, but it's very
difficult when you have such a dispersed shareholder base. My impression is
that I suspect that a lot of shareholders of BDCs have no idea what it is they
own, they are sold, “You get a high income and don't worry about where it
comes from. Don't worry about leverage.” They don't even know what it is they
own. But that said, I don't think it would hurt to have, and some BDCs do it
maybe more than some, should have earnings calls every quarter or every six
months.
Tom: Yeah, I think they do. Phil. I think that your point is correct, though I
think for most of these retail investors, even if an announced earnings call and
they have it every quarter, I think retail typically doesn't participate. I do think
this is an issue that's hard to get around for a lot of retail investors, who are, as
you say, sold on the product because it generates regular high current income,
and most of these BDCs continue to distribute that income, you don't have most
of the retail investors marching in the streets. I think certainly if they start
seeing real erosion in NAV and their statements that might move them to
support activists. But I think for a lot of these, they're fairly passive and they're
not really reacting other than if their dividend is cut.
Phil: I agree with that.
Cynthia: But you want them to be active enough to respond as you need them
or to weigh in on who they want the manager to be. One thing that operating
companies have started doing is having a separate call from the earnings call
discussing some of these, what I would consider governance-based issues, and
maybe that's something that might be adopted by some of the BDCs because I
don't think you can just throw in the towel and say you can't get to them
because then…
Tom: No, I agree. I agree. I just...
Cynthia: ...otherwise you'll have funds that are zombie funds.
Tom: I think that's right. I think it also matters a little bit which group
approaches you. If an activist group approaches you, if it's someone that has a
track record in the industry and obviously understands the asset classes that
BDCs invest in, and I think that's one sort of an issue for a board to deal with. If
it's someone who really has no track record, I think that’s very different
consideration for the board because there's no assurance you're going to trade
out for something better. You may just trade out.
Phil: That's true.
Waheed: Let's get on the NAV issue and the factors affecting the NAV
discount. A lot of boards that I talked to have difficulty in trying to figure out a
game plan that would permanently reduce the NAV discount. So if NAV
discount is the core area of contention in BDCs, how are boards thinking about
it? Is that the only thing you [Phil] look at?
Phil: What's the question? Is that the only thing you look at?
Waheed: Yeah, is NAV discount the only metric that you look at in order to
decide which fund to go after?
Phil: No. When I'm looking at it as an activist, it’s the same as with any
company, there're three fundamental...issues. First of all, you want to be able to
buy something that you feel the intrinsic value is significantly greater than. So,
obviously the discount has to be there. Otherwise it's pointless to...there's no
money to be made. But the second thing is what is the shareholder base and
how likely are you to win? And then lastly is the performance itself. If a BDC
has had good performance and yet the NAV itself has done okay but the
discount is widened, I think that's something that a manager could say, "Look,
we performed pretty well, but if there's been write-downs and the NAV has
fallen and the discount is widened out, that's going to make them...it's going to
put a pretty good bull's eye on their back, so.
But certainly, without the discount, there's not going to be any activism because
there's no money to be made. Unless it comes from the managerial activist. But
even then I doubt that they would want to get involved unless the fund is
trading at a discount because they're going to have a very tough time winning a
proxy fight.
Cynthia: I would just say that the companies, and I think you just heard it from
Phil, who are out there actively in campaigns, -- you’ve got to look at your
vulnerabilities. The board has to look at..., the board and the management teams
need to look at the market, and they obviously need to try and make sure that
the market knows what their plan is, whether it's repurchasing stock or altering
fees in some way. Those are all things that the board needs to take into account.
And you would rather have your board do it than necessarily have somebody
externally do that for you. So that's what we would suggest make the board take
that very seriously. I would want to move an engagement plan. So we've been
talking about what happens in a market that might make an issuer potentially a
target of a campaign of an activist, but what can you do in advance of that
happening?
Cynthia: And the real points are the things we've already talked about, but also
you really need to educate your board about what this process is all about, what
type of activities they’ll see, what kind of statements will be used, the language
that might be used. Reputation is a real issue here, I think for some boards. And
just because you don't like somebody or don't care for their arguments doesn't
mean that you can just ignore them. You need to make sure you've got the right
individuals helping you out. Meaning, whether they're bankers or lawyers or
solicitors, make sure you’ve got the people who are educated, been through this
process, and the board understands this.
You don't want to be talking about the type of issues that might come up,
whether you’re talking about a classified board or advanced notice provisions
or pieces of litigation for the first time ever when you're basically having to
decide whether you're going to basically fight somebody or agree to add
somebody to the board. Because one of the things that's been happening outside
of the BDC space specifically is that there's a lot of campaigns that aren't going
to a contest where an additional board member is added and then it's not clear
whether that's going to be successful or not.
And then when you get to an actual contest…. contests are increasing, but the
management teams, because so few of them are going actually to full-blown
contests, are actually sometimes winning. So you can't assume that you're not
going to win. At the outset you have to be committed with your story, your
message. It has to be one voice. You have to explain it to everybody in
whatever terms that they can understand it. You really have to have that
engagement plan in place and have your internal and external teams ready to
go. Again, I'll say that this world is not going to...we're not going to put this
genie back in the bottle.
Phil: I agree with Cynthia about that. I also agree with her about engaging with
the activist. To me that's a no-brainer because there's no downside. It always
pays to talk because you may be able to reach settlement the resolution, and if
you can't, well, it didn't lose anything except a little bit of time. And it also
may, I think it helps to just have that conversation because you're dealing with a
human being. And ultimately you may settle in a few. If you don't really know
who you're talking to, it's very difficult to have an understanding of what they're
willing to do.
Waheed: So moving on, Tom and Cynthia, you've been involved in a number of
proxy fights. So what are the key winning strategies for issuers? How do they
win a proxy fight?
Tom: I think Cynthia just hit them both. We can reiterate. I think having a team
assembled that understands how to deal with these issues, particularly advisors,
financial and legal, I think are crucial. I think having some notion of what the
market is, so that you have a sense of whether to push back or to accommodate.
And then reaching out to shareholders early and often is probably the crucial
thing if you end up in this battle because it does come down to, as Cynthia
mentioned earlier, phone calls and more phone calls and trying to articulate an
argument as to why the incumbent management should stay in place.
Cynthia: The question that I think the management board and everybody should
think about is…what is winning to me? Because I will say that having been
through several of these and actually several of them in the past year, this is a
battle field. And I'm not sure that everybody's prepared on a day-to-day basis to
deal with the onslaught of publicity and the messaging and the press releases,
the websites.
And those are the types of things that you're going to be talking to that your
board's going to want to weigh in on, so the time and effort and unfortunately,
potentially distraction if you're not careful from your business. You really have
to decide on how you're going to go about this. And if, for example, if you're
going to fight, are you going to go to the ends of the Earth, to basically get
involved in litigation? Remember, when you're before a court, both voices in
that court, regardless of who owns what or who has contract, has the same level
of authority to be there or standing, to be there better stated.
So, you really want to make sure you've got this, an informed understanding.
And I think that may very well be why some of the people are necessarily going
to a full-blown contest. But again, I would just say that this is something that
you need to be thinking about when you're talking to people about your annual
meeting. Are you worried about your election of your directors? This is an allyear round issue now. It is not something that you can wait for because the
activists, good, bad, or ugly, are coming in, and they may be very well demand
something at a special meeting or, again, they don't even have to necessarily be
launching a contest. They can write a letter and put it on the web, attach it to a
13D and throw a company into a lot of issues, and so there's a lot of different
ways for this to be drawn out.
Actually, I read something that was surprising to me - that actually the activists,
over 60% of them that are involved own less than 1% of the companies they're
involved in. That's the universe of all companies, not just BDCs, but I thought
that that was extremely interesting.
And your board has got to be ready to basically withstand the statements that
are going to be made about them, whether it's through the press releases or
websites or whatnot. But not only the people who are involved. There's
analysts. There's the market. There's newspapers. They're going to all.
Everybody loves drama. And that's going to be something that's going to… be a
challenge. Not many directors want to be necessarily reading about themselves
on the front of the Wall Street Journal. So, it's really something that you have to
really spend time and think through how the company's going to respond.
Phil: Let me throw out a thought. You're always assuming that there's going to
be...that the board and management are aligned and that the activist comes
along and now you have to dig in and would decide whether you want to dig in
or settle. I don't know of one example, and this I think is very telling, where the
board was proactive and said, "You know what? This manager has done a
terrible job. We're going to get rid of him. We're going to bring in somebody
much better at a lower fee. We're going to take shareholder-friendly actions
trading in a big discount."
You can point to the ‘40 Act and securities laws and stable as about fiduciary
duty all you want, but the reality is that the boards have pretty much been
rubber stamps for the manager. That's the reality.
Tom: There are examples where people have terminated operating agreement. It
may not have been as in light as an activist battle, but there are certainly
instances where boards have terminated operating agreements or management
agreements for external advisors.
Phil: Pretty rare. Pretty rare.
Tom: Well, maybe, but the point is, the statement that boards...I think for every
board that does it, there are probably many that think through the idea in
connection with their annual renewal, and some of them go forward and some
of them decide not to. But I think there is this sense that boards are rubber
stamps. I don't think that's accurate, at least based on my experience. And
Cynthia, I'd be interested in your experience.
Cynthia: Yeah.
Tom: That's not what it feels like when the advisor is trying to get its fees reapproved. That is not the feeling in the room. So, I'm sure that from your
perspective that's the case, but I haven't had that experience.
Cynthia: I couldn't agree more, and I actually think...in the market now, there
are people who are looking at their fees and reassessing. And I don't think
necessarily that the outcome is indicative of the fact of what kind of discussions
went on or what was prevented. And I would say actually in connection with
the IPOs in the last couple of years for BDCs, just as an example. A number of
these companies waived their fees in the first year or so, first six months they
ranked up. They're the ones who came up with the total returns and the high
water marks. That's one of the reasons that they're being thrown out. And some
of these older contracts didn't have some of that because the market wasn't
necessarily demanding them.
So I do think that those discussions go on. At least that's my experience and
itmay not be as evident publicly, but I think that there's actually a couple of
companies who've already responded to some of this.
Phil: By the way, to throw in a commercial for MVC, just about a week ago, we
did announce a reduction in the fee that was pushed by the board. So it does
happen, and but not often enough.
Waheed: And I just want to add a point on engagement strategy. In our
experience both at ISS and outside, companies and boards need to have two
distinct messaging strategies, and they need to simplify it. The biggest
challenge that companies and boards have is that they feel everyone
understands the business as well as they do. And when they go out and explain
the strategy to retail investors, a lot of them don't have a clue of how these
businesses work, the underpinnings of debt strategy or equity strategy and
whatever the management is trying to accomplish.
So, I think for success, companies need to have two distinct messaging
strategies, simplify them, -- one for institutional investors, one for retail
investors. And just like Cynthia and Tom said, stay in touch with the
shareholders and explain to them what they're trying to do, what is the plan to
create the shareholder value over the long run. And as long as the message is
simple and easy to understand, you convince people to support the management
and the board.
Cynthia: I'll give a tip just for BDCs messaging, - one of the reasons people can
look at them and get a little more detail. If you had a bank that was listing out
every one of its loans like the BDCs do, there's actually a lot more information
in there. It may not necessarily translate to how it's valued, but I do think that
there's some in there and that companies, the BDC management teams and the
advisors can help get a little more meat understanding that for a retail investor
because I do think that getting down to what BDCs do -- make investments in
middle market and small companies is something that somebody can
understand, a screen door company or something like that. They may not
necessarily look at all the multiples and how they’re putting their finances in
place and what their ratios are, but they can understand that somebody's
providing a product.
So I think that messaging approach really is something that we all have to
concentrate on and try and do better for this universe.
Waheed: In the interest of time, we can move on to concluding remarks. What
do we expect for next year and key takeaways for investors, boards and
management?
Cynthia: I think I’ve already said it, is that I think we're going to see more
activism, whether you're talking about activism from a standpoint of replacing
the directors or challenging the advisory fees. I think that it's going to continue
on or affect the sales process. All of those are pieces of this, and I think we're
going to see more and more of it, not only in the BDC space but throughout
corporate America.
And I think as proxy access comes in, I think it's going to become even
more...companies are going to be even more embroiled in that.
Phil: Yeah, I would...
Tom: I would echo that. Go ahead, Phil.
Phil: I don't like to make predictions, and I think of the answer to that question
will depend on how the current campaigns, especially the one at Fifth Street and
the one at TICC play out. But I'll go out on a limb and say I don't see anything
that's going to stop this train or a lot of people getting on it if there is some
success.
Tom: Yeah, I would add two things. One, I do think that you'll see probably
some additional boards. I think in addition to MVC, Medley reduced fees last
week, you may see more of that. You may see introductions and break point
fees, which is something people have talked about a great deal, but you have
not seen much of it in the BDC space. So I think you will see more of that
action without necessarily the pressure of an activist other than an inchoate
pressure that's out there in the market now.
Cynthia: I'll chime in because I think we have another minute or more is that
there's an interesting process going on right now with American Capital. They
for I think over a year or so have been talking about a spin off. And there was
an investor who came in, and Eliot Management I believe it is, came in and
basically challenged the spin-off and what was happening there. And almost -from an outsider looking at it in almost overnight, they decided to basically go
out and conduct a process. They hired actually two investment bankers and
conducted a process and increased the size of their repurchase program.
It'll be interesting to see whether we even have much activism going on in that
circumstance when you have such quick action by that particular board. Now,
again, this is an outsider looking in, all of this could have been going on for
quite a while and I wouldn’t know.
Waheed: Thank you. We have a question from the attendee. How do RIC limits
on BDC ownership impact activism?
Cynthia: I think you're talking about the investment companyrules. There's
certain limits on 3% issue. Basically the purpose of the statute is to not allow
pyramiding of fees. And so if you're a fund, another individual fund can't own
any more than 3%. An individual, just to be clear, can own whatever they want.
So this is only applicable to pools of capital and where you're worried about
pyramiding fees.
But you can actually have somebody like a Fidelity or Wellington or something
like that have multiple funds within that structure owning over 3%. So it
depends on those facts and circumstances. I think that there's been some use of
that tool in connection with trying to challenge the ability of some investors or
activists to basically come together as a group. I think that's something you
have to look at and take into account and analyze.
However, I think there have been some cases that have basically sided with the
fact that really that that provision doesn't necessarily help you in the long run
because you can have several funds. You can have several individuals. You can
have SMAs and that type of thing involved. It's not necessarily just because
somebody is working or is a part of a solicitation that those should all be
aggregated, is what I'm trying to get to.
So I think it's something that you definitely to take into account, and you might
use it in connection with a campaign, but I'm not sure that it's a be-and-end-all.
Phil: I don't think it's a much of a factor because I don't think the fundregistered investment companies are activists anyways, so I don't think it's
much of a factor.
Cynthia: But I do think if you have groups, and I think this is one of the things
that the SEC looks at every once in a while. So if you have a group that's acting
together, they should be disclosing it. So that is a better way to think of it.
Tom: I guess one other thing in the ‘40 Act is probably obvious, but I'll just
mention that just the fact that to approve an advisory contract, you need a board
vote and a shareholder vote, so the board remains important almost regardless
of how the transaction evolves. You can never go straight to the shareholders
without the board assisting.
Waheed: Okay. Thank you. With that, we conclude the webinar. Thank you
everyone. We thank all the panelists for their valuable insight, especially Tom,
Cynthia, and Phil - thank you for your time. A transcript and recording of this
webinar will be made available in a couple of days. Thank you all the attendees.