A phenomenon that has increased significantly in Germany in recent years
By Dr. Richard Mayer-Uellner, LL.M., and Dr. Martina Schmid
Earlier this year, the German-listed companies Aurelius and thyssenkrupp were attacked by short sellers. While the short attack on thyssenkrupp passed off smoothly, Aurelius suffered stock exchange losses of up to 50%. In 2016, Wirecard and Ströer were also the target of massive short attacks. In general, investor activism has increased significantly in Germany in recent years.
Shareholder activism
Unlike short sellers, who are exclusively focused on the short term, activist shareholders are a more heterogeneous group and the objectives they pursue are more varied.
Strategic activists
Investment funds and hedge funds, as well as other institutional investors, such as sovereign wealth funds, family offices and private-equity investors, frequently no longer restrict themselves to passive management of their investments. Today, such investors are trying to increase their influence on the company’s short- or long-term business strategy beyond exercising shareholders’ rights. Such operative activism may concern restructuring, the sale of parts of a company or the use of company resources to increase dividends. The form of activism where shareholders seek changes to corporate governance often aims to replace board members or put an end to the allegedly excessive remuneration of board members. For example, the long-term supervisory board chairman of Stada AG was removed from office by a resolution of the general meeting in 2016 at the initiative of an activist shareholder who held a 5% stake in the company.
Takeover arbitrage
Takeover activists often acquire a considerable minority holding in a company when a public takeover bid has been submitted or is expected. The activists’ objective is to sell their shares to the bidder at the highest possible price. The prospects for success are good if it is likely that the takeover will fail without acquiring the shares held by the activists.
Activist shareholder strategies
Initially, the activist shareholders often contact the company management, either in writing or at an informal meeting, to express their suggestions or requests. If this is not effective, they require the support of other shareholders or proxy advisors to achieve their objectives because usually they only hold a small number of shares in the target company. Seeking support for their objectives, activist shareholders often criticize the management of the company in public campaigns. In addition, they exercise shareholder rights in the context of
general meetings, in particular by requesting amendments to the agenda, countermotions or by nominating candidates for election to the supervisory board. Activist shareholders have particularly good prospects of success in companies with low shareholder representation at general meetings, which are also vulnerable to criticism (in particular in cases of poor corporate governance or weak performance of the stock price).
Short selling
Short sellers bet on a decline in the share price of a certain target company and then try to bring down the price by publishing – correct or incorrect – statements regarding the company. The company may suffer stock-exchange losses and severe reputational damage. Short sellers benefit from the current high volatility of capital markets as nervous investors are more prepared to sell their shares at lower prices. Moreover, electronic trading may accelerate price fluctuations.
What can companies do?
How can listed companies defend themselves against these kinds of attacks?
Identify weaknesses
As a precautionary measure, listed companies should diligently analyze potential weaknesses. Short sellers identify their targets by using extensive lists of criteria. The more of these criteria apply to a company, the more suitable it could be as the target of a short attack. Typical criteria are, for example, close connections between the company and major shareholders, the absence of independent supervisory board members or a business model that is complex or difficult to communicate. In this context, it is very important that the company pays close attention to investor and public relations. This includes offering comprehensive and reliable guidance on the financial figures to analysts and investors. Moreover, the company should communicate with large shareholders and opinion formers, such as banks, analysts and business or financial publications, on a regular basis, thereby offering the opportunity to voice criticism. This may increase confidence in the company and its management.
Monitor trades
The company should monitor its shareholder structure to identify changes and possible short positions. There are notification duties regarding short positions under German law. After identifying a potential target, short sellers often conduct telephone inquiries with employees of the company in order to detect irregularities. Hence, employees should be trained and instructed to refuse these calls and to notify the management of any attempts made.
Defense manual: React as quickly as possible
If the company is hit by an attack, it is particularly important to react as soon as possible. Listed companies should have a defense manual, i.e., written guidelines that outline the first steps and countermeasures to be taken after an attack. The manual describes which bodies (management board, supervisory board), departments (investor relations, legal department) and advisers (investment bank, communication consultant, legal adviser) are to be immediately informed, who the relevant contact people are, and which people form the team coordinating the defense. It contains lists of opinion formers who can be used to spread the company’s messages. The defense manual also describes precise countermeasures, e.g., taking legal steps and implementing price stabilization measures.
Legal steps
If there is reason to suspect that the short sellers have breached statutory notification requirements, the prohibitions on insider trading, disclosure of inside information and market manipulation, the German Federal Financial Supervisory Authority should be involved. It may carry out investigations, impose fines or involve the public prosecutor if there is a suspicion of criminal behavior. The company may also return the case to the public prosecutor. Moreover, the management board is obliged to assess whether damage claims can be brought against the short seller. If so, these claims must be asserted in the best interests of the company.
A market manipulation could apply if the short seller has given incorrect or misleading signals to the market or has spread information that, as he or she knows or should know, is wrong or misleading. However, legally advised short sellers usually ensure their statements cannot be qualified as misleading; they rather reinterpret or reevaluate known facts so as to cast the company in a bad light.
Restore confidence
Finally, the company should consider carrying out standard price stabilization measures, for example implementing a share repurchase program. Other possible measures include selling noncore activities or increasing the dividend. What is even more important is restoring lost confidence, which is often a cumbersome and long process. To restore confidence, the management should, particularly, seek to provide for good and transparent corporate governance – and make any improvements publicly known.
richard.mayer-uellner@cms-hs.com
