MARTY LIPTON’S WAR By focusing on quick profits, activist investors are ruining

America, claims Wachtell’s iconic cofounder. Is anybody listening?

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IN NOVEMBER 2012, THE CORPORATE LAW GURU WHO IS MOST REVERED BY MANAGERS faced off against the corporate law guru who is most feared by managers, at the Conference Board think tank in New York, in a friendly debate that was about to turn hostile. Martin Lip-ton has defended CEOs against all comers since forming Wachtell, Lipton, Rosen & Katz 50 years ago. Lucian Bebchuk, a Harvard Law School professor, champions the “activist” hedge funds that assail CEOs in an intensifying struggle for control of America’s boardrooms.

Speaking with a thick Israeli accent (“Vock-tell is wrong”), Bebchuk argued that shareholder activism helps companies in both the short and long term. Lipton, whose voice carries a trace of Jersey City (“The bawd is right”), countered that activism is awful for companies and the economy over the long run. “Nor do I accept [your] so-called statistics,” said Lipton fatefully. “Your statistics are all based on things like ‘What was the price of the stock two days later?’”

As Lipton finished the thought, Bebchuk twitched his foot. He unfolded his right leg over his left knee, and then reset his body. He licked his lips, pressed the button of an imagi-nary pen with his thumb, then lunged for a pad and started scribbling with a real one. Thus was born “The Long-Term Effects of Hedge Fund Activism,” the paper that turned a genial debate into a nasty war over the direction of corporate America. (It’s to be published in June by the Columbia Law Review.)

At 83, Lipton is a blue chip stock. He’s one of two people to make every list of the 100 Most Influential Lawyers in America since it was launched by the National Law Journal 30 years ago. (The other is Beltway legend Thomas Hale Boggs Jr., who died last September, just months after ailing Patton Boggs merged with Squire Sanders.) Wachtell Lipton remains The Am Law 100’s runaway leader in profits per partner, as it has been for 15 of the past 16 years.

Lipton is most famous as the inventor in 1982 of the “poison pill” defense to corporate takeovers, which enables a company to dilute the value of its shares when a hostile bidder draws near. He’s also heavily identified with the “staggered board,” which deters takeovers by spreading the elec-tion of a board’s directors over several years. It’s often forgotten that Lipton helped to pioneer the concept of the corporation that undergirds corporate social re-sponsibility. In his seminal 1979 work, “Takeover Bids in the Target’s Boardroom,” Lipton argued that direc-

Marty Lipton’s WarIn the battle for control of America’s boardrooms, activist investors are winning.

But not without a fight from Wachtell’s iconic co-founder.

BY MICHAEL D. GOLDHABER

For 50 years, Marty Lipton and his firm have sought to protect managers from hostile takeovers and, increasingly, activist campaigns.

P H O T O G R A P H B Y S T E V E N L A X T O N

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tors should protect the interests of not only shareholders, but all who have a stake in the company: creditors, community members and most notably employees. Lipton’s whole career (and much of Wachtell Lipton’s business model) has been or-ganized around these few ideas. His lifelong goal has been to safeguard managers against hostile takeovers and, increasingly, activist campaigns conducted in the name of shareholders.

Lucian Bebchuk, age 59, likes to attack blue chip stocks. His astonishing success has made him the only law profes-sor listed among the 100 Most Influential People in Finance by Treasury and Risk magazine. A lowly student clinic led by Bebchuk—the Shareholder’s Rights Project—has destag-gered about 100 corporate boards on the Fortune 500 and the S&P 500 stock index since 2011. As a critic of CEO com-pensation, Bebchuk paved the way for the Dodd-Frank Act rules that give shareholders more “say on pay.” Shareholder activism has drawn him into debates with Lipton in 2002, 2003, 2007, and more or less continually since 2012.

In 2012, Lipton still referred to Bebchuk with senatorial decorum, as “my friend,” and teased him about reenacting the Hamilton-Burr duel. But something soon changed. Per-

haps Lipton was disturbed by the effort to debunk his deep-est belief about the long-term effects of activism. Or perhaps what changed were the tides of fortune. For the only thing that the two can agree on is that, in Lipton’s words, the “ac-tivist hedge funds are winning the war.” And so the iconoclast is no longer amusing to the icon.

With a revolving cast of big-name partners, Lipton has churned out ever more frequent and vicious memos. He called Bebchuk’s paper “extreme and eccentric”; “tendentious and misleading”; and “not a work of serious scholarship.” He gleefully noted that a sitting SEC commissioner called an-other paper by Bebchuk so “shoddy” as to constitute securities fraud. (Thirty-four professors rallied in Bebchuk’s defense and jumped on the commissioner for abusing his power.) Bebchuk and Lipton lobbed posts back and forth on the Harvard corpo-rate governance blog with “na-na-na-na-na” titles. “Don’t Run Away From the Evidence” led to “Still No Valid Evidence,” which led to “Still Running Away From the Evidence.”

When Lipton was recently asked what he’d say to Bebchuk over a cup of coffee, he could no longer contemplate the idea: “I am afraid that professor Bebchuk is so invested in, and ob-sessed with, his mistaken views as to business and the econo-my that any conversation about governance and activism over a cup of coffee, or other venue, would be a waste of time.”

Lipton blames “short-termist” hedge funds for America’s economic stagnation and inequality since the financial crisis. He even touts a study blaming them for the financial crisis. His memos on activism are themselves obsessive, overgener-alized, and over-the-top. They also may be right.

IT HAS BECOME A COMMON MEME THAT WE LIVE IN THE “age of the activist investor.” Estimated assets under activ-ist management in 2014 ranged from $120 billion to more than $200 billion. On the low end, that’s up 269 percent since 2009, or 4,344 percent since 2001, according to the Alterna-tive Investment Management Association, a trade group.

Activists attract funds because they win. Nearly three-quar-ters of activist demands were at least partially satisfied in 2014, according to the data collector Activist Insight. Ernst & Young says that half of S&P 500 companies engaged with activists in 2013. But even that understates their impact, because the way to pre-empt an attack is to adopt their mindset. Boston Con-sulting Group advises companies to “be your own activist.”

Wachtell is rare among top law firms in categorically refus-ing to advise activist hedge funds. It helped 20 companies to quell activism in 2014, and Wachtell dealmakers spend an in-creasing amount of time playing firefighter. Lipton put the por-tion of his time devoted to manning the fire hose at 25 to 30 percent. Daniel Neff, one of the co-chairmen of the firm, esti-mates that activism consumes about 20 percent of his own time; he had answered an alarm from a Fortune 200 CEO just before we spoke. Lipton urges directors to go through a “fire drill” at least once a year, practicing how they would respond to an ac-tivist demand. Sometimes the fire drill takes the form of play acting. Who gets to play billionaire activist investor Carl Icahn, they wouldn’t say.

The Wachtell lawyers didn’t see the comic potential be-cause they take activism so seriously, and so personally. When asked if the tone of their memos was perhaps a touch Sca-lia-esque, Steven Rosenblum, the mild-mannered corporate co-chairman, replies that activists are far more shrill. “They are flat-out uncivil, rude, loud and obnoxious,” he says. “They are incredibly unpleasant and total bullies. People should not conduct themselves that way.” Sabastian Niles, a young coun-sel whom Lipton jokingly calls the firm’s activist defense de-partment, says that over the past three months, three separate activists had said to three CEO clients of Wachtell: “I will destroy you” if they didn’t do XYZ.

Lipton rose to prominence in the 1980s defending against corporate raiders like Icahn, when they needed to win an outright majority of the board to gain corporate control. For Lipton, the only difference between corporate raiding and modern activism is that the Icahns of the world figured out how to get their way with only 2 percent of the share register. To seize effective control of the board, activists harness the voting power of the largest investors. Their secret is that gi-ant stock funds outsource their votes to proxy advisory firms, which routinely side with activists. And thanks in no small part to Bebchuk, there are few staggered boards left to retard shifts in voting power.

The activist trend has snowballed in recent years for two reasons, according to James Woolery, who recently left as chairman-elect of Cadwalader, Wickersham & Taft to form a hedge fund, Hudson Executive Capital, that aims to work with both boards and activists. First, share owner-ship has consolidated among a handful of giant asset man-agers, so the top few shareholders can swing control of the board. Second, the gi-ant asset managers are rapidly losing market share to low-fee Ex-change Traded Funds (ETFs). That makes the institutional in-vestors desperate to show high immediate returns. So instead of activists going hat in hand to the institutions, the institu-tions now approach the activists with “requests for activ-ism.” This practice is so common that there is even a name for them in the industry: RFAs.

WHETHER ALL THIS IS FOR GOOD OR EVIL, OR BOTH,

depends on which narrative you accept. According to the hedge fund narrative, activists champion little-guy share-holders against fat-cat CEOs of lousy companies, who feed at the corporate trough with their cronies. “Wachtell has a great business defending corporate America and particu-larly Lipton himself,” says Marc Weingarten of Schulte Roth & Zabel, the dominant firm for activists along with Olshan Frome Wolosky. “It gives no credit to what activists are clear-ly doing, which is making managers more focused on maxi-mizing shareholder value than on self-aggrandizement and lining their own pockets.”

According to the corporate narrative, activists are billionaire hedgies who are out to make a quick buck, while driving great companies and the economy into a ditch. Studies find that ac-tivists typically hold a stock for only nine months before bailing out. In that short time, they will aim at all costs to hack employ-ment, R&D and capital expenditures; overload the company with debt; return money to shareholders through dividends and

buybacks; and, as the ultimate goal, goose the stock through M&A activity. “At bottom, every activist campaign is one or two steps to sell the company,” says Wachtell’s Neff.

There’s truth to both perspectives, as shown by the two 2014 activist deals profiled elsewhere in this issue. Both in-volved takeovers —for while Neff may overstate matters, Ac-tivist Insight confirms that 49 percent of last year’s activist campaigns made public demands related to M&A outcomes. In the CommonWealth REIT deal [see “A Battle Over REIT Goes to the Mat,” page 57], the Icahn protégé Keith Meister

appears to have created real value for shareholders by throw-ing out the father-and-son directors to whom the CEO had given exclusive power to manage the REIT’s real estate, and who were botching the job.

In the case of Allergan [see “An Ugly Battle Over Botox,” page 52], the activist standard-bearer William Ackman made a failed $53 billion run at the admired maker of Botox. Aller-gan typically devoted 17 percent of sales to R&D. It cut that back to 13 percent during the takeover battle, and the white knight buyer cut it to 7 percent of combined sales. Ackman’s bidder historically held R&D at 3 percent.

“Ackman said this is the most accretive deal he’d ever seen,” notes Wachtell’s Neff, who advised Allergan. “Why?

Because they would slash R&D. They took out the best performer in its sec-tor. Allergan didn’t need fixing.” For Neff, Aller-gan is a cautionary tale of killing innovation. And while Botox isn’t exactly a life-saving drug, it is innovative. The author of “A Culture of Narcis-

sism” might have noted that America is now too superficial to invest deeply in cosmetic surgery.

Despite Allergan, the hedge fund account of shareholder activism prevails in the press and the legal academy. As Law-rence Fink, CEO of the giant money manager Blackrock Inc., noted last year in an interview critical of hedge funds: “The narrative today is so loud now on the activist side.”

Some are searching for a middle ground. Writing in the Harvard Business Review, Harvard professor Guhan Sub-ramanian laments a debate characterized by “shrill voices, a

Campaigns by Harvard professor Lucian Bebchuk, Lipton’s nemesis, have made it easier for activists to oust boards.

Lipton and Bebchuk have lobbed “na-na-na-na-na” blog posts.

“Don’t Run Away From the Evidence” led to “Still No Valid Evidence,”

which led to “Still Running Away From the Evidence.”

A record number of activists and target companies

Source: Activist Insight

76

136

89

155 150

263

160

291

203

344 ● Companies subject

to activist demands

● Public activists

2010 2011 2012 2013 2014

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lem. “We are having an epidemic right now of activism directed at getting management to choke off investment,” he says. “It seems un-likely to me that there has been a major increase in managerial abuse the last few years. It seems unlikely to me that American business has been chronically over-investing the last few decades. That makes me think there is likely too much aggressive activism,” sometimes at the expense of employees.

LIPTON SPEAKS OF THE LIFETIME CONTRACT BETWEEN A

company and its employees, and Neff says that philosophy carries over to law firm management. Wachtell Lipton re-sisted pressure from some partners during the financial crisis of 2008 and 2009, and refused to lay off a single summer as-sociate or staffer. “We would not put a family’s breadwinner out on the street and change his and his family’s life so the partners can make a couple more dollars,” says Neff. “That attitude comes down from the white-haired gentleman.”

Some critics find it a bit rich when Lipton echoes liberal think tanks on distributional inequality. They note that Lip-ton never met an executive pay plan he couldn’t defend, in-cluding the $210 million that The Home Depot Inc. awarded in 2006 to CEO Robert Nardelli despite its flagging share price. Lipton’s consistent loyalties lie not with stakeholders, they suggest, but management.

“Has there ever been an issue where Marty Lipton sided with shareholders against management?” asks Yale Law School’s Jonathan Macey. “I believe the answer to that question is no.”

Macey goes further, and queries whether Lipton’s loyalty to CEOs should disqualify his law firm from acting for di-rectors. “Suppose I’m a director of a public company, and we are faced with activist investors. Suppose the CEO says, let’s

hire Wachtell. If I really thought that law firm took Marty Lipton’s radical view”—and Macey takes pains to say that al-though it is possible, he does not really think the firm would do that—“then I think it would be a violation of the fiduciary duty of loyalty to hire that firm. Because Marty Lipton is not interested in protecting shareholders; he’s interested in pro-tecting management.”

Lipton replies that while his memos speak only for the lawyers who sign them, they are absolutely consonant with fiduciary duties. All Wachtell lawyers advise directors to con-sult with activists, Lipton said, and sometimes advise them to change business strategy. “I’ve had clients with mediocre management,” added Neff, “and I said to the activist: ‘OK, you’re right, how do we fix things?’”

So would Lipton concede that in a bad company, activists

can be good for the economy? “No!” he shoots back. “They’ll push to fire more people and cut more R&D and go too far. They’ll want two times too much. It’s terribly macroeconom-ically harmful.”

Though his memos chronicle every shot fired across the activists’ bow, Lipton knows he’s still losing. The only recent development that truly comforts him is the letter sent to CEOs a year ago by Blackrock’s Larry Fink. “It concerns us,” Fink wrote, “that, in the wake of the financial crisis, many companies have shied away from investing in the future

growth of their companies. Too many companies have cut capital expenditure and increased debt to boost dividends and increase share buybacks.” As Fink later put it more succinctly, activists “destroy jobs.”

Fink’s opinion matters more than most, because he speaks for $4 trillion in assets.

Lipton will never win his war until institutional shareholders vote against

activists more. He is the first to say so, and others agree. Chief Justice Strine of Delaware urges institutional shareholders to tailor their voting policies to their investors’ investment ho-rizons—and to recognize the unique long-term outlook of people relying on index funds for college or retirement.

That change in mentality could be promoted through sys-temic reform. Summers says that policy changes to give long-term shareholders more voting power or managers more tools to fend off activists deserve serious consideration. But change could also be achieved through the exercise of old-fashioned good judgment. “Companies and pension funds are getting smarter,” says Millstein. “If the real investors think the activists are wrong, then they don’t have to go along.”

Email: mgoldhaber@alm.com.

seemingly unbridgeable divide between shareholder activists and managers, rampant conflicts of interest, and previously staked out positions that crowd out thoughtful discussion.”

The outspoken Chief Justice Leo Strine Jr. of the Delaware Supreme Court [“Tell Us What You Really Feel, Leo,” March 2012] relates a story that lies somewhere in between the two poles. In Strine’s telling, the little-guy investor needs to be protected from the self-dealing of both company managers and activist money managers.

“The media and academia are captive to intellectual lazi-ness,” Strine says. “It’s easier to write a story about the bad, bad managers against the innocent shareholders, as if it’s still 1935. It’s much harder to write about the current com-plexities of a system of monied interests (money manager

stockholders) ver-sus other monied interests (corporate managers), and how the poor incentives of that system often give the shaft to or-dinary Americans, both as investors who have to invest through money manager intermediaries to save for retire-ment and college for their kids, and as workers who need em-ployment from corporations to feed their families.”

At 88, Ira Millstein of Weil, Gotshal & Manges is perhaps the only corporate law guru to outrank Strine and Lipton. (“If I don’t have a long-term perspective at my age, when am I ever going to have one?” he jokes.) “As far as Marty’s concerned, I disagree because he’s damning the whole move-ment,” says Millstein. “I know activist hedge funds that are in the business of promoting long-term growth. I know other activists who are only interested in jerking the stock a little bit. I think there are plenty of both.”

WHAT BEBCHUK DOES IN “THE LONG-TERM EFFECTS OF

Hedge Fund Activism” is to see which narrative dominates if you ignore the anecdotes and study the data. Working with University of Chicago-trained financial economists Alon Brav and Wei Jiang, he tracked the performance of every activist-targeted company over the long term. Not over two days, but over five years. Bebchuk writes drily, “When avail-able, economists commonly prefer objective empirical evi-dence over unverifiable reports of affected individuals.”

The finding that made Lipton go ballistic is put simply by University of Chicago professor Steven Kaplan: “When you get these activists involved, the stock price goes up and stays up, and if anything, the operating metrics improve. Done. End of story.”

To its critics, Bebchuk’s paper is far from the end of the sto-ry. Scholars ranging from Columbia Law School’s John Coffee Jr. to Yvan Allaire of the Institute for Governance of Private and Public Organizations find the data ambiguous and meth-odologically flawed. Both attribute any gains by shareholders to a combination of fleeting takeover premiums and wealth transfers from employees (as the result of layoffs or wage cuts) or bondholders (as the result of downgrades or bankruptcies). In other words, Ackman and some shareholders are getting

rich on the back of workers and pensioners.“I don’t agree with Bebchuk, because you can’t

prove a case with a number,” says Millstein. “I’m not saying he’s twisting the numbers, but he’s com-ing up with the conclusions he believes in the first place.” Says Lynn Stout of Cornell Law School: “He’s trying to prove his own theories.”

In Stout’s view, Bebchuk is looking at the wrong thing. “He should be looking at what activists do to the economy as a whole,” she says. “If Bebchuk went to a fishing village, he would find that people catch more fish with dynamite than nets, and he

would conclude that everyone should fish with dynamite.” That doesn’t mean the dy-namite is good for the pond. For instance, Beb-chuk’s study says noth-ing about the fate of the many activist targets that disappeared from the sample. By Bebchuk’s own numbers, activist intervention increased the chance of corporate

death over the study period from 42 to 49 percent. “To me, that says we’re dynamiting a lot of fish here,” says Stout.

Bebchuk’s supporters say it takes a model to beat a mod-el. So why doesn’t Wachtell fund counterresearch? “If we wanted to phony up a model, we could do the same thing he does,” retorts Lipton. He thinks the evidence, “empirical, ex-periential, and overwhelming,” is already on his side.

Roughly 95 percent of S&P 500 profits last year were funneled back to shareholders through buybacks or divi-dends, according to a Bloomberg projection. A study by J.W. Mason of the Roosevelt Institute found that only 10 percent of profits plus borrowings were being reinvested in public companies today—compared with 40 percent in the 1960s and 1970s. Perhaps not surprisingly, the Center for American Progress cites a recent study showing investment by private companies to be more than double today’s rate for public ones. Chicago economists say that shareholders are allocating all that capital efficiently. Others, like Pavlos Masouros of Leiden University, think the shortfall in invest-ment is retarding GDP growth, and amplifying inequality.

Former Treasury Secretary Lawrence Summers is per-suaded that hedge fund activism is a macroeconomic prob-

“We are having an epidemic right now of activism directed

at getting management to choke off investment,”

says former Treasury Secretary Lawrence Summers.

FirmAdvised

a companyAdvised

an activist Total

Wachtell 20 0 20

Wilson Sonsini 11 3 14

Skadden 11 2 13

Latham 10 0 10

Top firms that defended companies in 2014 …

… and those that represented activists

FirmAdvised

a companyAdvised

an activist Total

Olshan 1 52 53

Schulte Roth 2 35 37

Paul Weiss 0 7 7

Akin Gump 0 6 6

Source: Wall Street Journal FactSet Activism Scorecard

Marc Weingarten of Schulte Roth, which advises activists, says they have made managers less focused on “self-aggrandizement.”