Activist Investing Today: S&P's Karageorge on Detecting Activist Campaigns Pre-Disclosure

This is Ron Oral, host of the Activist Investing Today podcast, and today I'm super excited to have on the program, John Cara George, Executive Director at S&P Global. John heads up S&P's Activist Defense Surveillance Group, a sister company to the deal, which is also owned by S&P, and we can't wait to hear some tidbits about how John and his team identify activist accumulations before they are publicly disclosed. John brings a whopping 33 years of experience in tracking activist campaigns, having identified hundreds of initiations by activist investors, and I'm really excited about this. So thank you, John, for taking the time. Thanks, Ron. It's great to be here. Okay. So my understanding is that your surveillance group can identify accumulations by activists before they are picked up by the usual public disclosures. So these are the 13 F filings, the 13 D filings when an activist crosses 5% that's the 13 D, the 13 F, four times a year. These are filings that I follow closely, and increasingly activists have been using derivatives to get around these filings, and we see these kind of large derivatives accumulations by activists that don't require public reporting at all. So tell us a little about it, John. The due advice companies, also in your advice, do work for companies, mostly or do work with advisors as well, and also if you could talk a little about whether your team focuses mostly on the US derevizations or you work in the UK and elsewhere as well. All right. So a lot of great questions there. Let me unparse, if you will, a little bit. So as far as with the regions we cover, so the US we've been offering activist surveillance for a number of years, kind of have revamped our offering with some proprietary data sets that are unique to S&P. We rolled out a new product several years ago, and this year we were happy to announce that we launched a European Stocks Arales product where we were able to actually enter some new markets. So we're currently working with companies in France and Germany in the UK, hopefully later this year, rolling out a product in Japan, which as you know, Ron has been a hotbed for activism. So we work in all regions and adding countries all the time. We can dive a little deeper if you want and as to disclosure laws and how it's different than the US, but at a very high level, yes, we do offer products in the US, Europe, Canada, I should have mentioned as well. As far as picking up accumulation, so if we're doing our jobs properly, hopefully we're picking up accumulations from activists, be it through equity or be it through derivatives, hopefully we're picking that up before 13F, or 13D announcements. And obviously, hopefully before any kind of new story comes out. Also we've seen, and I'm sure you're well aware that a lot of activist campaigns are more behind the scenes. So inter-quarter where an activist will reach out to an issuer long before anything is filed or seen either through the news or what have you. So if we're doing our jobs properly, we're giving that company or that issuer advance warning. So typically, elegant, if they're working in taking a large stake in a large cap or mega cap name, elegant will take weeks. If not months, they kind of build out their positions, but some of the newer players or smaller players like an ironic, can quickly build a position in a stock and a mid cap stock or even a smaller large cap stock depending on the free flow. You know, often build that position in a week to two weeks or three weeks. So we're trying to give our issuers, our clients as much warning before they receive that phone call from the activists. And the LA is the 800 pound gorilla of the activist world and there, as far as I could tell, the largest employer of derivatives accumulating a stealthy way at companies before they publicly launch their campaigns or engage with the company privately. And so I guess one thing I often see is that these activists are striking these derivatives agreements with banks. And then the banks buy shares as a hedge on those derivatives contracts, often called swaps or total return swaps, CRSs. And so I guess maybe you could talk a little about that, John. And I'm wondering if the banks that activists use as counter parties to their derivatives agreements, did they change or did the activists always trying to find a new bank to do their derivatives contracts with in an effort to try to remain more non-amists? And are you able to keep track with these kind of shifting counter parties if that's what's happening? It's a great question. A question we had asked not only by our issuers, by the banks and lawyers that we also work with as well on these type of situations. But I would say that there's a couple of different things going on. Typically, we see, for the most part, derivatives and swaps being built by foreign banks and brokers. And that's twofold. There's tax implications that's involved with building out these swaps that it's more favorable for foreign banks and brokers to build out these positions. But moreover, what we see is that, especially on the sell side, if the company has a relationship with the bank or broker and they're following them on the sell side and they're a US bank or broker and it's a US stock and it's a bulge bracket firm. Typically, we won't see those type of situations develop as far as the derivative or a swap being put on. Typically, we'll see his foreign banks and brokers, right? So where there are less common names that will be following a US stock on the sell side. And the reason behind that and the rationale behind that is because at the end of the day, the sell side wants to have a relationship with the issuer. They don't want the issuer to be breathing down their neck and saying, "Hey, I see that you put on this huge broker position for this activist investor and they're worried about getting in a sticky situation between the issuer and the sell side." So if you can find a broker that doesn't have a relationship already on the sell side, it's a lot cleaner for the activists, obviously, and not having to worry about a potential, not necessarily conflict, but a sticky situation between the sell side and the issuer. Yeah, that's really interesting. So I'm not going to ask you the names of the banks that you follow. I have in my mind a good, pretty good idea. What are the big international, the non-US banks that are doing this? But are there certain banks who are like, "Oh, that bank accumulates a large share position." We kind of note historically that this particular activist has worked with that bank. So that's kind of a red flag saying, "This activist could be accumulating a derivatives position. Is that some fairer?" Yeah, certainly. We have our scary list, if you will, right? So will we see either accumulations happening in real time with those foreign brokers or we're seeing those 13Fs come across with foreign brokers? It certainly raises an eyebrow. We have our activist surveillance model where we've literally tracked hundreds and hundreds of activist campaigns. So we know what an Elliott campaign looks like. We know what a starboard, what a person campaign looks like. We've databaseed all of that. So we have a very good understanding of how they accumulate, be it through common stock or be it through swaps. Not to say that it's always going to look the same, but certainly what does stand out is an anomaly, right? So where it's a traditional fidelity or T-R-O price or Vanguard or some kind of ETF looks one way and when an activist is building a stock, it looks completely different. So without going into a whole bunch of detail, there are signs and there are tells of an activist build vis-a-vis a traditional or a vanilla institutional build. And another thing that I feel like I've seen these activists do when they do these derivatives contracts with banks, brokers, is that well, I mean, there's one example that goes in mind with this Norwegian cruise lines. It appears to me that Elliott accumulated the River position with multiple banks because we saw multiple warned banks disclose large new positions in Norwegian cruise lines. So is that something you're seeing activists do also? And is that something you're able to track that the activists go to multiple banks to do derivatives contracts? And they're trying to be more evasive, but you can still track that. So I was saying for the most part, for 90% of the activists out there at that dabble in the derivatives and swapspace, they're going to use multiple banks to perform those swaps and derivatives. So it's not just one. Obviously there's risk associated. So it makes sense for them to parse out to multiple banks and brokers. And I'm sure multiple banks and brokers don't want to accrue all that risk on their book either. So we often see with most campaigns, public or non-public, that is definitely dispersed. There's a couple exceptions here and there, but for the most part, yeah, it's going to be multiple meaning five, six, seven different banks. Okay. So we talk a little bit about surveillance and being able to identify. activists before they publicly disclose their positions. And that's really interesting stuff. So I also wanted to talk a little bit about the kind of leverage that activists have when they buy these big derivatives positions because it's something that's kind of always bothered me for a long time because they don't have the shares and without the common equity shares, they don't have a boat without a boat, they don't have the stick, right? They can't launch the proxy fight to get their distant directors elected. But yet still, we see time and time again, companies settling with activists that have huge derivatives positions, but no common shares. And for the example that I actually mentioned a minute ago, which was Eliot added more than 10% economic stake. That's what they like called economic position. I guess economic can include both swaps and common shared, but in this case, it swaps 10% economic stake in Norwegian cruise lines. And then the Norwegian struck a settlement that five outside directives the board. And Eliot never owned any shares. So talk a little about that is they do the exact same as have a lot of leverage on companies if they buy huge derivatives positions. Sure. So obviously, I don't have to tell you, you can see over the last year or two years, especially with the universal proxy card. There's been a record number of settlements. We've seen very little, I can probably count on a hand or two over the last year. How many have actually gone to a proxy fight at least in the States. But I think it has the same effect. You know, when you see a story come out and you'll see that Eliot or whomever has 10% economic interest, it's obviously, as you said, it's a huge tell that some portion thereof is being held in swaps and derivatives. So at the end of the day, it has the same effect. It's a big number. And at the end of the day, if Eliot or another activist investor wanted to convert those swaps into commatures, they certainly can. So at the end of the day, it definitely gets the company's attention, which is their modus operandi by announcing either this huge percent or this huge dollar amount. You often see if it's not a percent, you'll see that they own a billion dollars worth of stock or a hundred million dollars worth of stock. But at the end of the day, it has the same effect. It's that large number that looms and makes for a sexy new story to come out. And it certainly causes someone at the issue where the C-suite to have to engage, even though it's like you said, some portion thereof in derivatives. Yeah, no, I think that's exactly the point of the there's this kind of implicit understanding that Eliot, if it wanted to, could convert that swaps position into shares. But they rarely do that. I mean, I can only think of one example at Southwest Air, where I guess the company pushed back and then Eliot started cashing out their derivatives position and accumulating more and more common shares than the company settled with them, if I remember correctly. But I guess there's this implicit idea understanding that the activists hate the word "convert." The fence advisors always use the word "convert." They can convert the derivatives. I think the activists say that we would settle our derivatives position in cash and then we would use new cash to buy a large share position. And there's not a lot of relationship between the settling the unwinding the derivatives position in cash and this new position. But I could totally see the defensive virus point of view, where they say that, yes, they're converting the derivatives position. So, I guess that's part of the leverage that they could actually liquidate their derives position by shares. But for whatever it is, it's a huge thing and something that more and more activists I'm noticing are doing. They're buying these large derives position. So the one thing I'll just add to that is I think the reason we're seeing it happening more and more is that the end of the day, the activists themselves don't have to commit a lot of capital in order to build out these positions. So they could be running multiple campaigns, if you will, without having to commit all of that capital. And you surpe all of their dry potter to run multiple campaigns at a time. So it's definitely a leverage thing that they use. And certainly we've seen derivatives play a huge part in that. Yeah, so I guess it's stupid to buy derivatives than buy common shares, right? So that's another reason why they like it. And so it's kind of costly to convert it, despite they don't like that term into common shares with the vote. Okay, so the SEC issued this guidance recently that is raising eyebrows, activist defense advisors, you know, the lawyers that represent companies talking about activists, and the lawyers that represent activists are at odds over the interpretation of this guidance. But it basically asks whether investors are buying total returns, swaps, TRSs, with the intent of indirectly acquiring voting power or a future right to acquire the reference equity securities and should be required to file a 13D disclosure of the position, activist file 13Ds. Currently when they buy more than 5% of common shares in the company and they have to disclose, you know, their interest in the company and what kind of changes they want, it's kind of an activist filing. And so this is the what we were talking before, they seem flustered idea that they could convert the derivatives into shares. So anyways, defense advisors say that this guidance that the SEC issued could discourage activists from accumulating more than 4.9% in swaps to stay below this 5% threshold. And they feel that the guidance suggests that if you buy more than 5% swaps, you may have to file 13D. The activist advisors, disagree on the interpretation of the guidance guidance is kind of complicated and little opaque as far as I'm concerned. But the activist advisors think that as long as the activists don't have some sort of agreement with the counterparty that the counterparty would both their corresponding common share position in favor of the activist's dissident slate or there's agreement that the common shares owned by the counterparty bank goes to the activists when the activists unwinds their gris position. As long as there's on these kind of sketchy agreements and they just kind of unwind their derivatives in cash, then they're free to buy as many derivatives as they want. And that's basically what they've been doing. They don't do those other type things when they unwind it's in cash. So anyways, putting that aside, if the activist suddenly felt compelled to not buy more than 4.9% in swaps, would that be a problem for the activist? Currently, we see like Elliot say, oh, we're the second largest investor in this company. So I go look it up and that means they own 11% and of course there's no 13th, no 13F so they must be all under derivatives. But if they were for some reason, felt discouraged from buying more than 4.9%, would that be a problem for the activist? I don't think so because it's the end of the day. I think I alluded to earlier in our conversation that I don't think an Elliot or any activist for that matter needs 11% to really start a campaign or work behind the scenes. I should say to get the company's attention, right? I think even I mentioned Ironic maybe it was Snap, but I'm thinking about that they came out and they said they had a 2% position. But I think even with 2 or 3 or 4% position or even a 4.9% position, the activists can still contact the company and say we're a large shareholder and any stock and start that negotiation if you will. Like I said, I don't think you need to be over that 5% in order to affect change out of company if you're an activist. Okay. All right. That's great, John. Thank you so much. I mean, I just have to be clear, I'm not saying that this that activists are suddenly going to start reading this guidance and making that determination. I asked the SEC several times to clarify their guidance and they did not respond to me. So I think they purposely are trying to scare the activists. So I don't know they'll do that, but it isn't an interesting point of view. I appreciate that. You've been listed in the activist investment today podcast and we've been speaking to John Kerr-George, Executive Director at S&P Global and head of the S&P's activist defense surveillance group. Thanks, John, for taking the time. Thank you. I really enjoyed it, Ron. Thanks so much.