Sunlight Bylaws Can and Should Expose Short-Term Hedge Fund Activists

Abstract

Publicly-traded companies have the power to pass sunlight bylaws to address hedge fund activism. Sunlight bylaws would require activist hedge funds to publicly disclose any strategic proposals and their financial interests in companies earlier and at thresholds lower than current securities laws. Sunlight bylaws would also require disclosure of additional information, including: (1) the percentage of the fund’s portfolio invested in the company; (2) the fund manager’s compensation; (3) the fund manager’s investment in the fund; (4) the fund’s portfolio turnover; and (5) the fund’s prior holding periods after any announcements of an ownership interest and a strategic proposal. Academic proponents of hedge fund activism defend activism based on the theory that activist hedge fund managers are systematically better agents for long-term stockholders than the incumbent board and executive management. These proponents argue that fund managers have large stakes in their funds, the funds’ profitability is highly contingent on the financial performance of its investments, and the funds hold relatively few concentrated investments. Sunlight bylaws would target factual information essential to that claim and require its disclosure in succinct, summary form. Sunlight bylaws would also state that if a stockholder violates them, that stockholder cannot nominate a candidate for a seat on the board or propose any issue for the next stockholders’ vote. But institutional investors and proxy advisory firms support hedge fund activism in the abstract, and a board that passed a sunlight bylaw might precipitate litigation or a proxy fight. Public companies should therefore, on a case-by-case basis, request the same or similar information when an activist that has held shares for a brief period of time makes a strategic proposal. Public companies should negotiate confidential treatment of any disclosures for a period of time so that the activist can reap the full benefit of the short-term increase in share price after the disclosure of its investment and strategic proposal some academics and institutional investors think necessary to incent activism. But public companies should also make very clear that they reserve the right to publish any questions that the activist refuses to answer or for which it insists on confidential treatment. And the other stockholders, who likely invest over longer timeframes, should carefully consider any information that the activist discloses — or, equally importantly — refuses to disclose.