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Give The Hedge Fund A Board Seat, It Helps

Originally appeared at The Activist Investor.

We have long advocated for a PM to join the BoD of a portfolio company:

  1. A PM represents the first choice for many BoDs. They have the financial skills, and own a bunch of shares. They also know (or can learn) enough technical stuff to oversee executives. If you own a big slice of a portfolio company, a PM should consider seriously becoming a director there.

We’ve seen this with some frequency, too:

  1. ❖Jeff Smith served as BoD Chair at Darden, and just became a nominee at Depomed, the latter of which we highlightedearlier.

  2. ❖Just this year, Dan Plants (CEO of Voce Capital) and Jim Mitaratonda (CEO of Barington Capital) have become nominees at FBR and Chico’s FAS, respectively, not the first time either has sought or accepted a BoD seat at a portfoilo company.

  3. ❖Nelson Peltz demanded a BoD seat for himself at DuPont in 2014, which the company evidently refused, leading to the most contentious proxy contest that year.

Many other activist investor PMs do this every year. What do we make of it?

It signals that the company has become one of the most important ones in the portfolio. Joining the BoD shows company management, other shareholders, and most importantly his or her fund investors that the PM will devote scarce resources to that company.

A BoD seat represents that commitment in three ways:

Risk: a PM that joins a BoD accepts risk of litigation, and the associated cost and hassle of a lawsuit. Even with comprehensive indemnification and decent D&O insurance to cover the cost, a lawsuit brings with it endless document requests and depositions. Who really wants to turn over mobile phone records to a plaintiff attorney? And, activist situations, with troubled companies and possible M&A deals, bring with them a greater-than-average chance of lawsuits.

Trading: a director can’t easily trade shares, since he or she must do so outside of blackout periods, and must disclose promptly the size, price, and timing every trade. A PM that serves as a director thus agrees to these limits for the portfolio.

Time: the most valuable resource of all, taking hundreds of hours in year. Even the best-run companies now advise directors to budget 100 or more hours per year, for BoD and committee meetings, and preparation and follow-up. Activist situations demand even more time, with strategic reviews, CEO searches, and special committees to consider deals. Spending that time on a single portfolio company, denying time to other portfolio companies, new company research, fund raising, and fund management, means that BoD truly needs the experience and expertise of the PM.

At some portfolio companies, a PM can delegate a BoD seat to a partner, subordinate or an outsider. That company might not represent a large enough share of AUM, or its challenges might not require the PM’s time and attention.

On the other hand, the company might have become a big enough mess that the PM must join the BoD. This obviously motivated Bill Ackman to join the Valeant BoD. Doing so signals to everyone involved, especially fund investors, that turning around that situation has become his or her biggest priority.

Watch, then, when a PM decides to serve on a BoD, or even serve as a nominee for a slate. Even better, among the companies in a fund portfolio, watch which ones earn a PMs’ service as a director. If those merit his or her time, energy, and attention, they probably merit yours, too.