June 22, 2015 Bruce Goldfarb quoted in The Deal on Tempur Sealy proxy contest

How Tempur Sealy changed the insurgency game

by Ronald Orol  |  Published June 22, 2015 at 8:43 AM 

Last month, an activist fund drove out two buyout shop directors and the CEO of mattress company Tempur Sealy International Inc. (TPX) in a wildly successful insurgency campaign.However, unlike most activist proxy contests, H Partners Management LLC wasn’t pushing a dissident slate of director candidates.  Instead the fund, which is based in New York, employed a so-called “just vote no” campaign seeking to have shareholders vote against incumbent director candidates even though they are running unopposed. The approach, also known as a withhold vote campaign, is less intrusive that a traditional proxy contest because the activist isn’t seeking to bring on its own slate of directors. Nevertheless, it seeks to embarrass a company and its directors enough that it will make major changes.And embarrass Tempur Sealy is exactly what H Partners did. Opposition to each of the three targeted incumbent directors ranged from nearly 80% to roughly 90%. Tempur Sealy struck a rare post-fight settlement three days after the battle concluded — the CEO and two targeted directors stepped down and the mattress company agreed to reimburse H Partners for its campaign costs of up to $1.2 million.

However, the most significant outcome of the campaign was the Securities and Exchange Commission’s approval of H Partners’ strategy. H Partners, advised by Olshan Frome Wolosky LLP, persuaded the agency to approve a proxy card for the  withhold vote campaign that was mailed separately from the management proxy card. Typically the SEC allows for a dissident proxy card only in traditional proxy contests pitting dissident director candidates against incumbent board members.

The SEC’s approval of H Partners’ proxy card has some proxy solicitors and activist hedge fund managers predicting more insurgent funds will be encouraged to employ withhold vote campaigns in the future. According to FactSet, there were five activist hedge fund ‘just vote no’ withhold campaigns that concluded in 2015, up from two in 2014 and two in 2013.

Getting a green light from the SEC was critical for H Partners because the dissidents were entitled to obtain preliminary voting tallies from Broadridge Financial Solutions Inc. (BR) during the days and weeks leading up to the election. Broadridge is a company that has a near monopoly on distributing proxy materials, including preliminary vote tallies. Broadridge did not return calls.

However, starting in 2013, the intermediary firm stopped providing the preliminary voting tallies for those kinds of campaigns to dissident investors but continued to provide them confidentially to targeted corporations.

Bruce Goldfarb, CEO of Okapi Partners in New York, said he believes both activist hedge funds and public pension funds will accept the costs of filing proxy material for their uncontested insurgencies in the right circumstances because they understand that obtaining preliminary vote tallies are critical to a successful campaign. “They may not use it every time. They will assess the cost and effectiveness of it but they will use it,” he said.

Insurgents argue that the preliminary vote data is invaluable because it can help them identify whether they should allocate more time and money on their efforts or whether they should shift focus.

A top activist investor said SEC approval of H Partners proxy card was a big deal. “Getting the preliminary vote data in a just vote no campaign is important,” he said. “Vote no campaigns are the ultimate reflexive campaigns. Being able to tell investors that haven’t made up their minds yet that withhold votes are coming in is vital. These types of things snowball.”

Still, it is unclear how frequently the approach will be employed. A person familiar with the SEC noted that the agency has to look at the particulars of each situation before deciding whether to approve proxy cards. However, activist attorneys, proxy solicitors and others are calling the Tempur Sealy proxy precedent-setting — suggesting that the SEC will approval similar requests in the future.

Backers are encouraging insurgent funds and public pension funds to use the cards, arguing that in addition to being less intrusive, “just vote no” campaigns can be an effective alternative to a traditional proxy contest in situations where dissidents have missed the deadline to nominate directors — typically two to three months before the annual meeting.

While hedge funds may employ them, it is unclear whether activist institutional investors will use the new mechanism. Philip Larrieu, an investment officer at the California State Teachers’ Retirement System, said he isn’t sure public pension funds would follow the H Partners approach and seek to set up a proxy card for future withhold vote campaigns. He added that setting up such a variation on a traditional proxy contest would change a public pension fund’s status and add significant costs over the current so-called “exempt solicitation” approach institutional investors have employed for just vote no campaigns, other insurgencies and their precatory proposals. “More costs may be fine for H Partners, which has a larger stake,” Larrieu said. “But for a fund like ours, I’m not sure it would help us.”

Andrew Freedman, partner at Olshan Frome Wolosky LLP, acknowledges that a fund seeking to set up a proxy card for a withhold vote campaign will incur substantially more costs than if they employ a traditional exempt solicitation approach. However, he argues that having a proxy card for a withhold vote campaign is critical for assertive shareholders that are seeking board and management changes because it allows the dissident to have the same information executives have about the votes coming in during the two to three weeks leading up to the meeting.

“It is important to know what the preliminary voting results are at various periods of the campaign so that the activist fund can conduct or strategize its campaign accordingly,” he said. “It is too much of a disadvantage for a dissident to run a full-fledged campaign without knowing what percentage of the vote is coming in as withholds or for management.”

Freedman compares the situation to an NBA finals game. “Imagine if the [Cleveland] Cavaliers didn’t know what the score was heading into the fourth quarter or last two minutes of an NBA Finals game,” he said. “Their style of play and game plan is informed by the scoreboard.”

Freedman suggested that a traditional exempt solicitation is the least expensive approach but not that effective as a force for change. “An exempt solicitation is a more half-hearted, less convincing approach that may work when you are not seeking big changes but want to send a message that you don’t agree with the executive pay for example,” he said.

He added that the costs are not prohibitively expensive. While a traditional exempt solicitation campaign – including legal costs — can be conducted for between $75,000 and $200,000, a full-blown effort with a proxy card solicitation and Broadridge mailings can cost between $200,000 and $1 million.

Larrieu said CalSTRS and other public pension funds agree that companies have an unfair advantage because they receive the preliminary vote tallies when it comes to withhold vote campaigns and any other precatory proposal under consideration at an annual meeting. However, he’s taking a different tack-if the investor protagonist isn’t getting the information neither should the targeted company. “It should be a level playing field,” he said.

Broadridge currently provides companies with a tally, including a breakdown of for and against votes, 10 to 15 days prior to the annual meeting and each day afterwards until the meeting. The requirement was set up so that companies would identify if they are on the road to getting enough votes to achieve quorum, the minimum votes needed for the meeting to be valid. However, Larrieu and other institutions are urging the SEC to require that Broadridge should only provide an aggregate total tally of shares voted for each director and ballot item, without the for and against breakdown.

Broadridge, the Council of Institutional Investors and the Society of Corporate Secretaries and Governance Professionals, had until recently been working on setting up a three party system that would have companies provide the information voluntarily to shareholder proponents. However, those talks broke down in April, according to the CII.

Larrieu expressed disappointment with the breakdown of talks, adding that companies have voluntarily agreed in the past to provide preliminary vote tallies to some shareholder proponents.

He acknowledged that companies may be more likely to reach a three-party agreement with a long-term institutional investors than with a more combative activist hedge fund. It also may be harder to reach an agreement, he added, when a proponent has a more aggressive withhold campaign at a targeted company as opposed to a less controversial precatory shareholder proposal.

Nevertheless, proxy cards for just vote no campaigns could be a useful activist approach for future campaigns. If the SEC OKs more of these kinds of proxy cards they are more likely to be employed by an activist hedge fund manager willing to expend significant resources to effect change than by a public pension fund. However, Goldfarb said that public pension funds will find ways to use it as well. CalSTRS, he noted, was involved in some high-profile activist campaigns, such as its recent partnership with activist Legion Partners to target Perry Ellis International Inc. (PERY).

“I’m sure in the right circumstance, a public pension fund like CalSTRS would consider employing it as well,” he said.

Read more: How Tempur Sealy changed the insurgency game – The Deal Pipeline