The SEC is proposing a rule change that would make it easier for tech companies to ward off activist investors. While tech executives may welcome the proposal, some investors worry that it will allow corporate mismanagement to fester. On the flip side, the change could give tech executives greater leeway to pursue so-called “moonshot” projects that have more speculative upside and often draw criticism from hard-nosed investors.
The SEC proposal would require activist investors to disclose a position of over 5% equity within five days, half the current 10-day disclosure period. The change is intended to reduce information asymmetries that can give some investors an unfair advantage. The SEC introduced the rule in February and is now observing a 60-day comment period. Democratic SEC commissioners, who currently hold a 3-1 majority, favor the proposal.
Five fewer days might not seem like such a big deal, but for activist investors, it can be the difference between profit and loss. Activist investors typically try to establish a sizable equity position before announcing to the world — and the company itself — that they intend to steer the targeted firm in a new direction.
Once an activist investor makes a public disclosure, the targeted firm’s stock price typically jumps (assuming markets agree with the activist’s thesis). For example, Twitter’s stock jumped nearly 8% after Elliott Management revealed that it had accumulated a stake with the intent of removing then-CEO Jack Dorsey.
The timing of a price jump is important because it increases the cost of purchasing more equity. Higher costs mean lower profit, and that can make activist investing less attractive in the first place.
“This is a sad day for many American businesses, which need to replace incompetent chief executives rather than entrench them,” Carl Icahn said of the rule proposal. According to Icahn, the rule change would particularly hurt investors that rely on outside funds to fuel their campaigns.
Republican SEC commissioner Hester Peirce likewise felt the new rules could harm rather than help markets. “Information asymmetries in this sense — where investors have equal access to disclosure from the issuer and insiders, but come to different conclusions about the long term prospects of a company based on their respective due diligence — are a feature, not a bug, of our capital markets,” Peirce wrote in a dissenting statement.
Some research backs up these assertions. For instance, a prominent 2014 research paper concluded that firms targeted by activist investors become better innovators in the five years following an intervention. This improvement came despite a drop in R&D expenditures at most targeted firms during that time. The researchers considered several plausible explanations, including that the firms became more focused on their core expertise, that they had better aligned incentives and that they more efficiently allocated innovative resources (e.g., patents and innovators).
Regardless of this theoretical upside, it’s safe to say no tech CEO wants to hear that an activist investor is targeting their firm. The industry is littered with instances of contentious battles between activists and executives. In 2013, for example, Icahn took an activist stake in Apple, pressuring the company to use its cash troves to pay dividends. Icahn also pressured eBay to spin PayPal off into an independent company. And before Elliot Management attempted to show Jack Dorsey the door at Twitter, ValueAct Capital helped oust Steve Ballmer from Microsoft.
These cases raise the larger question of whether activist investing needs to be so hostile in the first place. Could investors benefit from communicating with the target company earlier in the process? Would the companies even be receptive to outside guidance that isn’t backed up by the threat of a boardroom proxy battle?
“I think the [targeted] company would also say that their ability to talk to investors and to provide more context or disclosure and not have the information be one-sided or incomplete is also — from their perspective — a benefit to their shareholders,” Elizabeth Bieber, counsel and head of shareholder engagement and activism defense at Freshfields, told Protocol.
Bieber added that the existing 10-day period “does not sound like a long period of time, but is in this world.” As Bieber sees it, the 10-day period allows the activist investor to be “working in the market and the company to be in the dark until a point significantly in the future, when it is really hard to kind of catch up and to speak to their stakeholders and to sometimes correct misinformation.”
One realm in which tech companies often struggle to communicate with investors is “moonshot” investments. Any given moonshot is unlikely to pan out on its own, but the upside of even one success can theoretically be worth the effort.
Google popularized the idea of the moonshot, and Facebook has followed in its footsteps with recent metaverse activity. Moonshots often work to imbue these gigantic tech firms with an aura of innovation, but in truth, most of their revenue growth has come from either their core businesses or from more predictable growth areas, such as cloud computing. The Big Tech moonshots that have generated a lot of buzz — internet balloons and virtual reality, for instance — have struggled to move the revenue needle.
Peter Cohan, a senior lecturer of strategy at Babson College, said if major companies were more focused on financial discipline, they wouldn’t invest resources in these moonshot projects. “A lot of these companies basically entrenched the founders after the company went public and they could basically do whatever they wanted,” said Cohan. He pointed to Google as an example, claiming the company hasn’t really diversified from its core advertising business, “which is so lucrative and growing so fast that it almost doesn’t matter.” Still, Cohan said, there’s a case to be made Google would be even more profitable without the moonshot activity.
Should the SEC ruling go into effect, it would likely matter more for the next generation of tech companies rather than the current giants. Given the trillion-dollar market caps of Big Tech, investors would have a hard time accruing a position of greater than 5% equity. Will the new rules make it easier for younger tech firms to repeat the mistakes of their predecessors? Maybe. But it’s not going to be easy convincing firms of that when their predecessors are so dominant and successful. Activist investors may still have a point, but it’s so subtle — and relies on so many what-ifs — that they will have a hard time ever saying, “Told you so.”