I read with interest the six recommendations that attorneys Joseph E. Gilligan and Brian C. O’Fahey gave to “every public company” in a recent Wall Street Biobeat (Staying Ahead of Activist Shareholders, GEN, April 1, 2009.) I appreciate free legal advice as much as anyone, particularly when it is offered to those with whom I transact business; but as an investor and board member in some of these same companies, I would like to offer a different point of view.

To paraphrase Gilligan and O’Fahey’s recommended strategies for maintaining company control:

1. Form a rapid action team of management and board members to prepare for activist activity (presumably triaging their time away from actually running the business).

2. Keep a close eye on who is buying the company’s stock and discourage anyone from making the share price go up.

3. Strive for unity on the board (in order to…what? Avoid the appearance of openness to suggestions from the company ownership?).

4. Create legal and administrative impediments to attempts by shareholders to influence the strategy of the company—that they ostensibly own.

5. Limit the freedom of assembly of stockholders—no special meetings allowed.

6. Maintain adequate insurance coverage for board members to minimize the risk that they will be intimidated by the threat of legal action against them. (This actually seems pretty sensible.)

An implicit seventh recommendation is to use the investors’ own money to pay the consultants, public relations firms, and attorneys’ fees to implement strategies 1 through 6.

Now, I may be old-fashioned, but I stubbornly cling to the notion that the goals of corporate officers, boards of directors, and shareholders need not be mutually exclusive, and that a coordinated response to disruptions in a business plan is both possible and improves the likelihood of the company navigating that disruption. Further, the preemptive antagonisms implicit in Gilligan and O’Fahey’s recommendations make unified effort more difficult and lead to unnecessary squandering of the company’s resources.

Business plan disruptions are of particular concern in cash-burning development-stage industries like biotechnology that rely on serial fundraising. Despite significant progress in scientific, clinical, and regulatory areas, market valuations can fall significantly due to doubts about the sustainability of the underlying financing model. Affected companies need a disciplined realignment of priorities, spending cuts, asset sales, and the need to rethink acquisition proposals at valuations that previously would have been considered too low.

Thankfully, most management teams and boards of directors are fully capable of making these difficult but necessary decisions and implementing changed strategies. But, what is one to make of the company that, rather than presenting a clear and logical strategy for dealing with a more difficult environment, responds by dedicating valuable officer and director time and cash reserves to the formation of anti-activist SWAT teams, the implementation of bylaw changes, and the accrual of extra consultant and legal fees?

Or how about the adequately funded but pipeline-challenged company that experiences a clinical or regulatory failure, leaving the company with little or no operations, but with a bank account significantly greater than its market capitalization? In other words, one could theoretically buy the whole company, liquidate it, and keep a hefty profit from the company’s own cash.

Understandably, the officers who run these companies want to use the cash to formulate a new business plan and keep their companies and their jobs alive, while investors may prefer to liquidate the company and use the cash for a different purpose. This type of investor activism is no more than two parties with legitimate claims on a common asset disagreeing as to that asset’s proper disposition, and I dare say that the owners of the asset (i.e., the shareholders of the company) deserve a seat at this particular negotiating table without having to fight through a series of procedural impediments.

Opponents of shareholder actions will claim that these activists’ motives are somehow impure; activist investors are not widows and orphans using the proceeds to buy food and keep their homes. No, these are vultures who swoop in and load up on the cheap stock, intending to liquidate the company and use the cash for something else (maybe to give to widows and orphans?). So what? Is this type of investor any less entitled to choose how to use the proceeds from a business transaction?

But, what if the net result is that the activist who had no prior relation to the company now demands control over it after buying a significant stake at a huge discount? Again, so what? The new investor bought stock in the open market. If the existing officers and board of the company, with far more knowledge of the company prospects than any open-market purchaser, collectively thought that the market price was a gross undervaluation, they themselves were in a position to purchase the stock, preserve their jobs, and insure the company’s future. Is the management team that fails to act on the low valuation of their company justified in denying a voice to those investors who were bold enough to act?

So, are these defenses really necessary? Do we need to assume that the interests of management and ownership have to be at odds? And are pre-emptive anti-investor actions on the part of the officers and the board more or less likely to lead to effective communication, and the smooth navigation through a transition in strategy?

Returning to Gilligan and O’Fahey, I offer to them and to officers and directors an alternative set of recommendations:

1. Disband the anti-activist rapid action team, and let management and the board get back to the work of running the company.

2. Meet with and listen to your shareholders and let them understand your strategy.

3. Encourage dissenting views within the board.

4. Give any 10% owner the right to call a special meeting or to nominate a board slate; if the meeting has no merit no one will come, if the slate is unqualified no one will vote for it.

5. Most importantly, buy some stock. Nothing gives you more credibility with your investors than being one of them.


David Sable, M.D. ([email protected]), is the portfolio manager of the Special Situations Life Sciences Fund.

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