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For CFOs, it's a critical question that doesn't always have an easy answer.
Kate O'Sullivan, CFO Magazine
October 1, 2007
When asked who owns his company's stock, CFO David Bronson laughs. "I wish I knew," he says. Despite an active investor-relations program at the company, medical-supply distributor PSS/World Medical, plenty of shares change hands without Bronson ever knowing who is buying or selling. "I don't understand why investors get to know what we're doing but we don't get to know what they're doing," he says. "How does that promote an efficient market?"
Many companies find themselves in the same maddening position. After years of increasing demands for more transparency about corporate results and practices — most of which have been met — there remains a fundamental disconnect in shareholder relations: many investors are simply anonymous. "We have to disclose everything there is to disclose," says Brooke Wagner, vice president of corporate communications at Indevus Pharmaceuticals. "Yet we're not allowed to know who owns us."
While investment managers with more than $100 million in assets must report their holdings after the end of a quarter, that information is stale and frequently irrelevant by the time companies ever see it, thanks to the speed of the markets. There is also little oversight of the process, which means investors often neglect to file in a timely manner, particularly if they don't want to be identified. Other investors deliberately structure their funds to avoid triggering reporting requirements, maintaining just under the minimum number of assets or establishing multiple small funds to avoid reporting.
This creates a host of problems for finance executives and investor-relations teams, who are eager to communicate with — or at the very least identify — their shareholders. While most of the respondents to a new survey of finance executives and IR officers (IROs) conducted jointly by CFO magazine and the National Investor Relations Institute (NIRI) said they were at least "familiar" with their shareholder base, it's clear that familiarity is not enough. Instead, CFOs and IROs insist that specific knowledge of their shareholders would allow them to understand investors' goals, to better explain movements in their stock price, and to determine which of the many investors who contact their companies warrant the CFO's or CEO's valuable time. Perhaps most important, that knowledge can help them avoid being blindsided by one of the growing ranks of activist investors.
Cat and Mouse
But actually identifying stockholders is like "grasping for straws in the wind," says IR consultant Trudy Self. Part of the problem is that the rules to ensure transparency are woefully out of date. The Securities and Exchange Commission first drafted Section 13F, which requires investors with more than $100 million in assets under management to disclose their positions within 45 days of the end of each quarter, in 1975. That was long before the proliferation of hedge funds, electronic markets, and algorithmic trading.
Today, by the time a quarter closes, "an investor can build a position and liquidate it, build it and liquidate it, and you'd never know they were there," says Robert Weiner, vice president of investor relations at PSS. And that's particularly true in active segments like biotech. "We review the 13F ownership updates from Nasdaq each quarter as they go through," says Eileen McIntyre, senior director of corporate communications at Cubist Pharmaceuticals. But by that point, she says, "it's possible that the holdings of some hedge funds have already been sold."
Aside from the generous filing deadline, there is precious little enforcement of the rules. "There is no penalty if funds don't file within 45 days," says Maureen Wolff-Reid, president of investor-relations consultancy Sharon Merrill Associates and former NIRI chairperson. One IR officer who used to work for an institutional investor says that when he first joined the buy-side firm, he discovered four years' worth of unfiled 13F reports in the back office. And if they choose to file, "what will they report?" asks Wolff-Reid. "Will it be their current position, or their position as of an earlier date?"
Complicating matters are the deliberate efforts of some investors to remain anonymous. "There are certainly funds out there that don't want you to know," says Andrew Kramer, director of investor relations at Interactive Data, a financial-market-data provider. "They can go to great lengths to make sure you don't know." For example, a fund could buy shares on July 1, which they don't have to report until October. But if they sell by September 30, they don't have to report the position at all. Other investors hover just below the 5 percent ownership threshold that would require them to file a different disclosure form, Form 13D, with the SEC.
Such actions are not simply ploys to infuriate finance and IR executives, although they often produce that result. Many investors keep their positions quiet to evade copycats who could pile into or out of a stock and affect the price. Large, well-known investors like Warren Buffett's Berkshire Hathaway can even petition the SEC to keep their holdings out of the public eye. While these investors may still file a 13F, the SEC may agree not to publish the information it contains in an effort to avoid an impact on the stock in question.
Sophisticated investors also don't want to tip their hands to competitors. Short-term holders in particular rely on any slight information edge to make quick gains and jealously guard their strategies. IR executives relate stories of attending meetings with hedge-fund investors in which the sell-siders who arranged the meeting were asked to leave the room so they wouldn't hear the hedge fund's questions and glean some insight into the fund's plans. "[Investors] don't want to share information and they don't want to be shadowed," says Joshua Young, director of investor relations at Millipore, a manufacturer of products used in biotech production and research.
Despite the obstacles, public-company finance executives — nearly 50 percent of whom say they spend more time on IR activities than they did two years ago — are united in their desire to better understand their shareholder base. "It's important to get to know your investors, particularly if they've assumed large positions. You want to understand their reasons for investing, because your preference is to develop long-term relationships," says George Scanlon, finance chief at home builder Levitt.
Many CFOs, resigned to the gaps in their shareholder knowledge, simply do as much as they can with the information they have. Scanlon, for example, spends a couple of days each month meeting personally with investors. Given the company's position in the struggling residential real estate market, he says, "it's important to maintain visibility with shareholders and help them understand how the company is dealing with market conditions." One-on-ones with potential investors also help ensure that investors know the company well before they take a large position in the stock.
Jeff Babka, CFO of telecom-services firm NeuStar, takes a similar, hands-on approach to investor identification, speaking to some investors more than once a week. In his company's highly technical sector, he says, "we need to make sure they understand the business." And Babka attributes some of the positive momentum NeuStar's stock typically sees after earnings calls to that education process.
Still, like many CFOs, Babka says he has good information (based on investors' quarterly public filings) about the company's top 10 or 20 shareholders, but admits that within any given quarter, "you can't get a whole lot of information about what's going on."
Last year at clothing manufacturer VF Corp., CFO Robert Shearer took matters into his own hands. By canvassing its shareholders, VF was able to identify 50 percent of its base as part of a major project designed to help understand what was driving total shareholder return, a metric the company emphasizes both internally and externally. Shearer and his team talked with investors, former investors, and noninvestors who had shown interest in the company.
"Until you understand who your investors are and why they're making decisions, it's very hard to know what they're looking for from you," says Shearer. The conversations ultimately helped the company decide to make a significant increase in its dividend.
The Elusive 25 Percent
Such outreach efforts produce only a partial picture of stock ownership, however. To get a more complete understanding, CFOs can track SEC filings or rely on information from the stock exchanges to identify shareholders, especially large institutions that willingly identify themselves. In addition, lists of so-called non-objecting beneficial owners (NOBOs) — those shareholders who have indicated their names may be revealed to the company — are available from data clearinghouse Automatic Data Processing. Still, says Millipore's Young, "75 percent accuracy is the best you're going to do, given the hedge-fund activity and short-term money."
For a company like VF, with a stock price north of $80, a 2.5 percent short interest, and little concern about activist attacks, a limited view is sufficient. But for more-vulnerable companies, the elusive — and possibly threatening — 25 percent who remain unknown can create a lot of anxiety. Getting a handle on them requires a little more finesse.
That's where stock-surveillance services come in. Offered by such firms as Thomson Financial, Ilios Partners, and Capital Bridge, these services track trade settlements and attempt to back into the share-ownership information by tracing which custodial banks tend to settle trades for which investors. Because much of the information surveillance firms attempt to gather is closely guarded, however, what they do piece together is a picture that is widely acknowledged to be more art than science. Moreover, the price of such services — up to $60,000 annually — can be prohibitive for smaller companies.
Still, more than 50 percent of public-company respondents to the CFO/NIRI survey subscribe to such services, despite the fact that just 29 percent of IR executives are very confident in the data's accuracy. Most likely, the other 50 percent conduct detective work on their own through regular communication with the investors they do know. These include hedge funds — which many finance and IR executives hasten to point out are often extremely knowledgeable about the company, the industry, and other investors in the sector — sell-side analysts, and other investors. As one IR consultant points out, often a holder won't reveal his own position but might drop hints about who else is buying or selling.
Such efforts may require money or time, but the price of not knowing may be even higher, particularly for companies concerned about a possible activist investor. "Accuracy is so much more important in a defensive situation," says Paul Schulman, executive managing director of The Altman Group, a proxy solicitation firm that also helps companies monitor hedge-fund ownership. "CFOs may think they have an idea of who owns their stock, but when it comes to real-time knowledge, they really don't."
When hedge funds start accumulating a position, for example, other hedge funds take notice, as rumors spread within the highly connected, gossip-fueled industry. They then buy the stock while other, more-long-term investors may start selling. As a result, executives who thought they had a good handle on their shareholder base — at least as of the end of the previous quarter — wind up surprised. "The news is always less good than the company expects," says Ken Altman, founder of The Altman Group, referring to the analyses of a company's shareholder base that his company conducts. "Shares move very, very quickly from being promanagement to neutral to being hostile," he says.
Even an activist with a small stake can shake things up. Richard Breeden, the former SEC chairman and founder of hedge fund Breeden Partners, held less than 2 percent of the shares of H&R Block when he proposed an alternate slate of directors at the struggling tax preparer. But other, larger holders threw their votes behind Breeden, and suddenly he and his supporters controlled 13 percent of the company, landing him a seat on the board.
Ultimately, if someone's objective is to establish an activist stake, "it's easy to do," says Gary Lutin, a former investment banker who now runs shareholder forums at his firm, Lutin & Co. "And there isn't much of anything you can do to find out about it." Investors have to notify the SEC only after accumulating more than a 5 percent stake of a company's voting shares. In fact, 47 percent of respondents to a recent NIRI survey acknowledged that they had had an activist shareholder at some point. A quarter of them first learned of the activist's presence through a 13D filing. Many more, of course, learned by direct contact from the investor.
How much impact investor secrecy has on the efficiency of the market is unclear. Gregory Miller, an associate professor at Harvard Business School who studies financial communication, says he doesn't know of any existing research on the topic. But he can understand the frustration of executives who are trying to identify their constituencies. "As a manager, it's very hard to do business not knowing who's on the other side of the deal," he says. "It would keep me up at night if I were a CFO."
The frustration, in fact, is palpable. "The time frame for funds' filing deadlines should be moved up and they should be enforced," says PSS's Bronson. "If the idea is to have a transparent marketplace, I don't know why that wouldn't be a part of it."
One possible solution would be to accelerate the 13F filings to a monthly schedule. But such a change is unlikely to happen soon, in part due to the size and heft of the financial-services-industry lobby. In addition, the SEC doesn't seem to be in any hurry to address investors' filing requirements. Indeed, John Nester, spokesman for the agency, says the topic is "a nonissue" at the moment.
Of course, barring better disclosure by investors, CFOs can always use their powers of deduction to figure out who owns their stock. As one hedge-fund manager recently told Indevus Pharmaceuticals's Wagner, "You'll know I've sold when I stop calling you."
Kate O'Sullivan is a senior writer at CFO.
The Best Offense
What happens if through stock surveillance or conversations with investors a CFO does learn that his company is about to become an activist target?
A company that is preparing to defend itself against possible attack might initiate a stock buyback or look at disposition of an underperforming asset earlier than intended, says Ken Altman, founder of The Altman Group, a proxy solicitation firm that also helps companies monitor hedge fund ownership. "If they're aware that pressure is building, they can do things so that it looks like they're the ones taking the proactive steps, as opposed to acquiescing to an activist hedge fund," he says.
Above all, finance executives should take an honest look at their companies. "The way to deal with [a lack of knowledge about investors] is not to fret about who is holding your stock but to make sure you are in a position to deal with it by taking care of the business," says Gary Lutin, who runs shareholder forums at his firm, Lutin & Co. "Activists pick vulnerable targets. Nobody goes after the fastest, strongest buffalo." — K.O'S.