Renowned New York corporate lawyer Martin Lipton was in Toronto on October 8 preaching the evils of shareholder activism to anyone listening at the OSC Dialogue, an annual event hosted by the Ontario Securities Commission at which market participants are brought together on issues and trends facing the capital markets.

Mr. Lipton’s message is stark and unsettling: shareholder activists, and activist hedge funds in particular (so he claims) [1], contribute to a malaise of “short-termism” that has infected corporate North America by, among other things, pressuring management of corporations to shift management strategy away from long-term value creation, the “core engine for economic growth, national competitiveness, real innovation and sustained employment,” [2] and towards short-term measures designed to create immediate increases in stock prices.  If he’s right, this is a problem of crisis proportions, posing nothing less than a threat to the national, and arguably global, economy as a whole.

The trouble, or at least part of the trouble, is that it is not at all obvious that he’s right.  Notwithstanding Mr. Lipton’s claim that “there is quality empirical evidence that short-termism and activism have an adverse impact on the long-term prospects of companies generally”[3] the matter is far from being free of controversy.  Among others, Professor Lucian Bebchuk of Harvard Law School, a leading scholar in the field and a long-time intellectual adversary of Mr. Lipton’s, disputes the claim, arguing that it is not supported by the data. [4]

I have no intention of trying to settle the debate here, in part because I’m not sure that it can be settled.  As Mr. Lipton himself has observed in responding to Professor Bebchuk’s position (though seemingly without recognizing the implications of his observation for his own position):[5]

[n]o empirical study…is capable of measuring the damage done to…companies and the…economy by the short-term focus that dominates both investment strategy and business-management strategy today. There is no way to study the parallel universe that would exist, and the value that could be created for shareholders and other constituents, if these pressures and constraints were lifted and companies and their boards and managements were free to invest for the long term.

The difficulty identified here by Mr. Lipton is commonly understood to be a more general difficulty with proving counter-factuals: how can one ever reliably measure what would have happened in the real world if certain real-world conditions did not hold?  What, indeed, would the world look like if activist investors and the alleged pressures towards “short-termism” they place upon company management simply did not exist?  I think Mr. Lipton is right to observe the difficulty in attempting to answer this question empirically [6].  I only wonder how he can have appropriate confidence, in light of his observation, that he is sounding the alarm on a real crisis.

Regardless, my principal concern with Mr. Lipton’s message has nothing at all to do with whether it’s correct.  Let’s assume for the moment, even though the evidence so far appears to be mixed at best and even though Mr. Lipton himself seems to doubt the very possibility of definitive evidence, that there is after all a crisis to be alarmed about, that shareholder activism does indeed effectively destroy long-term value to the detriment of companies, their stakeholders and the economy as a whole.  My concern is that this crisis, even if it exists, is not one to which the OSC should be responding — certainly not, at any rate, in the manner in which Mr. Lipton would like the OSC to respond.

Make no mistake: Mr. Lipton’s proposed response to this supposed crisis is to scale back the power of investors. Specifically, he seeks legislative and regulatory change, including in the manner in which regulators interpret existing legislation, which would “rein in the power of hedge funds and short-term shareholders” [7] and “provide appropriate protections to companies, as opposed to focusing only on new rights for shareholders who already have significant leverage to pressure companies.” [8]  The idea, of course, is that if shareholders have relatively less power to alter a company’s board composition and strategic direction, management will feel less pressure to adjust management strategy towards value-destroying short-term goals.

There is obvious tension between Mr. Lipton’s call for shareholder disempowerment and one of the fundamental purposes served by securities legislation in Canada: investor protection.  Indeed it is difficult to imagine how the OSC could use its rule-making authority, or the power of its commissioners to interpret securities legislation, in a manner that would curtail shareholder power while purporting to keep faith with this fundamental purpose, unless it is prepared to take the paternalistic (not to say “offensive”) position that shareholders somehow need to be protected from themselves.  Is there really any hope for the notion that the OSC could ever justify regulating or interpreting away rights and other protections afforded shareholders by the proxy voting regime on the basis that investor protection demands preserving for shareholders long-term value that, left to their own devices, they would otherwise destroy?

Of course, Mr. Lipton’s point is precisely that regulators should not be so concerned with investor protection.  What is needed, according to Mr. Lipton, is more concern and protection for the companies that are targeted (and even those that aren’t targeted) by activist attacks, more concern for economic growth, national competitiveness, sustained employment and the threats they face from activist investors who have been armed to the teeth by corporate and securities laws that make it all too easy to impose their short-term agendas on target companies.

Maybe.  But if that’s what’s needed (again, the evidence is far from conclusive), it’s something that the OSC and the other Canadian securities regulators are very poorly positioned to provide.  Economic growth, national competitiveness and sustained employment are doubtless laudable goals.  But they are not the goals that the OSC is charged with pursuing, so unless they can somehow be shoe-horned into the seemingly much narrower objective of fostering “fair and efficient capital markets and confidence in the capital markets” it is unclear how the OSC could ever sacrifice its mandate of investor protection in pursuit of such goals.

All to say that Mr. Lipton is barking up the wrong tree.  This comes as no surprise once we recognize that his proposed solution to the supposed crisis of shareholder activism and “short-termism” is legislative reform.  If it’s new law he’s after, he really should be taking his cause to the provincial and national legislatures.  Beyond the fact that the legislatures are competent, in a way that the Canadian securities regulators are not, to legislate in furtherance of broad policy objectives such as economic growth, national competitiveness and sustained employment, they are also better positioned to tailor an appropriate legislative response to the supposed crisis identified by Mr. Lipton.

Mr. Lipton simply assumes, for example, that the appropriate response to the supposed tendency of company management to shift management strategy away from long-term value creation in response to the pressures towards “short-termism” created by activist investors is to legislate away the pressure, as it were, by making it more difficult for investors to initiate and conduct proxy battles and replace company management.  It’s entirely conceivable, however, that a more effective response would be to enact express legislative provisions requiring the officers and directors of corporations to manage the affairs of the corporation with a view to the creation of long-term value and prohibiting short-term measures directed primarily at securing near-term increases in stock price.  If the goal is long-term value creation, after all, it seems more likely to be attained by laws that drive at that goal directly than by laws that take the circuitous route of eliminating short-term pressures.  In any event, the provincial and national legislatures would be better positioned than securities regulators to make that determination and, more importantly, to implement the appropriate legislative solution if it in fact requires articulation of the duties of company management (a matter in respect of which the securities regulators are not competent to legislate).

In the end, my biggest problem with the concerns raised by Mr. Lipton is not that he raises them on the strength of inconclusive evidence.  My biggest problem is with the forum in which they are being raised.  The concerns he raises may well be important.  They may even constitute a crisis, though I personally want to see a great deal more evidence before reaching that conclusion. Either way, Mr. Lipton’s concerns are simply none of the OSC’s concern.

[1] Fasken Martineau DuMoulin’s 2013 Canadian Proxy Contest Study, co-authored by Aaron Atkinson, Brad Freelan and me, suggests that activist hedge funds comprise only a minority of the dissidents who initiate and conduct formal proxy contests in Canada. In the circumstances, some work would need to be done by Mr. Lipton to, first, establish that activist hedge funds have investment strategies that differ from that of the typical Canadian investor in being more focused on short-term value (among other things, it is not even clear that activist hedge funds have a shorter average holding period than the typical investor) and, second, explain why company management would be more responsive to pressures created by hedge funds as opposed to by other shareholder activists who have longer-term investment strategies and significantly outnumber activist hedge funds, before the problem he identifies can properly be laid at the feet of activist hedge funds.

[2] Martin Lipton, Current Thoughts About Activism, in The Harvard Law School Forum on Corporate Governance and Financial Regulation, August 8, 2013.

[3] Activist investors destroying companies, costing jobs, top corporate lawyer says, in The Globe & Mail (online edition), October 8, 2013.

[4] Lucian A. Bebchuk, Alon Brav, and Wei Jiang, The Long-Term Effects of Hedge Fund Activism, working draft, July 2013.  See also, Lucian A. Bebchuk, The Myth that Insulating Boards Serves Long-Term Value, Columbia Law Review, Fall 2013, Vol. 113, October 2013.  But see Martin Lipton, The Bebchuk Syllogism, in The Harvard Law School Forum on Corporate Governance and Financial Regulation, August 26, 2013.

[5]  Martin Lipton, The Bebchuk Syllogism, in The Harvard Law School Forum on Corporate Governance and Financial Regulation, August 26, 2013.

[6] My partner Richard Steinberg posits that it may be possible to circumvent the difficulty Mr. Lipton observes with studying “parallel universes” empirically by analyzing short-term and long-term shareholder returns in jurisdictions that are “activist friendly” in comparison to shareholder returns in “activists unfriendly” jurisdictions.

[7] Q&A With Martin Lipton and Richard Ferlauto: Short-termism, in The Conference Board Governance Centre Blog, December 9, 2009.

[8] Martin Lipton, Current Thoughts About Activism, in The Harvard Law School Forum on Corporate Governance and Financial Regulation, August 8, 2013.