In late September 2011, funds controlled by Pershing Square Capital Management, Inc. (Pershing Capital) began acquiring common shares of Canadian Pacific Railway Limited (CP Rail) at prices approximating the 2-year low in CP Rail's trading price. By October 18, 2011, Pershing Capital had acquired over 5% of the outstanding CP Rail shares, prompting an obligation to file a Schedule 13D report with the Securities Exchange Commission. By the time that report was filed on October 28, 2011, Pershing Capital's interest exceeded 10%, resulting in an obligation to file an early warning report with the Canadian Securities regulators, which ultimately was filed five days later. Pershing Capital disclosed in those reports its belief that CP Rail's shares were undervalued and that it was engaging in discussions with management, the board and other shareholders regarding CP Rail. Subsequent negotiations between CP Rail's board and Pershing Capital broke down and by early January 2012 the two sides were entrenched in their positions and the public was aware that a proxy battle was imminent.
Pershing Capital sent a requisition for a shareholder meeting to CP Rail on January 23, 2012 but when CP Rail later that same day announced that its annual meeting would be held on May 17, 2012, Pershing Capital withdrew its requisition.
Pershing Capital filed a dissident information circular on January 24, 2012 and began holding public investor meetings to build support. CP Rail filed its proxy circular on March 22, 2012 and began holding its own public investor meetings.
Support for Pershing Capital's proposal grew over the months, including support from proxy advisory firms Institutional Shareholder Services (ISS) and Glass, Lewis & Co (Glass Lewis), and established Canadian institutional investors, such as the Canada Pension Plan Investment Board and the Ontario Teachers' Pension Plan Board. Prior to the shareholder meeting, it became clear that Pershing Capital's nominees would be elected. Prior to the shareholder meeting, and to avoid further embarrassment, CP Rail's CEO left the company and he and five other directors decided not to stand for re-election. Immediately following the meeting, the board consisted of seven Pershing Capital nominees and nine continuing directors; a continuing director was appointed as acting Chair and a Pershing Capital nominee was appointed as interim CEO.
The story did not end with the annual meeting. On June 4, Paul G. Haggis, a Pershing Capital nominee, was appointed Chairman of the board. Subsequently, two non-Peshing Capital nominees resigned from the board - David Raisbeck on June 11, 2012 and Rick George on June 26, 2012. On June 29, 2012, Hunter Harrison was appointed as CEO and as a director. As a result, within 1½ months following the shareholder meeting, Pershing Capital nominees constituted a majority of the board, holding eight of the fifteen positions, with Pershing Capital nominees serving as CP Rail's Chair and its CEO.
Key Lessons Learned
- No Public Company Is Immune From Shareholder Activism – Pershing Capital took on one of Canada's biggest, widely-held, blue chip companies, with a well-respected board of directors and deep connections in corporate Canada. And they won.
- Relative Performance Matters, Not Absolute Performance – CP Rail has been consistently profitable, notwithstanding the economic downturn. Dividend rates on its shares have increased steadily. However, CP Rail's performance over time consistently lagged its peers. For example, the five-year shareholder return in the Globe & Mail's board games analysis in each of the last six years for CP Rail has consistently underperformed the five year shareholder return reported for CN Rail. It was CP Rail's historic relative underperformance and the absence of any change in the trend to relative underperformance which appears to have motivated shareholders to support change at the board level.
- Corporate Governance Best Practices Are Necessary But Not Sufficient – CP Rail has generally been ranked within the top 20 companies included in the Globe & Mail's annual board games analysis and tied for fourth in 2011 and tied for sixth in 2010. In the Canadian Coalition for Good Governance's annual Governance Gavel Awards CP Rail received an honourable mention in 2005 for excellence in the disclosure of director information and in 2009 won the award for Best Disclosure of Board Governance Practices & Director Qualifications. However, external recognition of CP Rail's corporate governance practices was not enough to dissuade CP Rail shareholders from voting for change to address CP Rail's historic relative underperformance.
- Canadian Institutional Shareholders Will Support Change To Improve Returns – Generally, Canadian pension funds prefer to make their views known or instigate change through dialogue rather than costly, public proxy battles or litigation. However, the CP Rail battle shows that in the current low-yield environment, institutional shareholders are willing to support change if someone else spearheads a proxy battle and provides a compelling argument for change.
- Proxy Advisory Firms Do Have Influence – The debate continues on the prominence and perceived power of firms which provide proxy voting advice, such as ISS and Glass Lewis, and is the subject of a recent consultation paper issued by the Canadian Securities Administrators (CSA Consultation Paper 25-401 "Potential Regulation of Proxy Advisory Firms"). (See our Osler Update.) But there is no question that Pershing Capital's strategy was influenced by the need to court and win the support of proxy advisory firms. Pershing Capital deliberately chose to nominate less than a majority of the board, thereby avoiding detailed review of its plans for CP Rail, questions about the loss of continuity on the board, and concerns about triggering of a change in control under CP Rail's contracts and agreements. Pershing Capital's disclosure emphasized ISS' key performance metric, total shareholder return and performance relative to peers. And Pershing Capital ensured that the recommendations of both proxy advisors were widely distributed.
- Boards Need to Engage More With Shareholders – Effective shareholder engagement can help build resiliency to withstand criticism by activist shareholders or to defuse matters before parties become entrenched in their positions. There were warning signs that CP Rail was a potential target for activism – its relative stock underperformance was easy to assess, none of the businesses spun-out from CP Rail in 2001 were ultimately able to succeed on their own and of those spun-out businesses, Fairmont Hotels & Resorts Inc. had even been targeted by an activist shareholder. Despite these warning signs, there are reports that the CP Rail board did not do enough to seek and respond to input from its shareholders on company performance. Through engagement, other Canadian boards, such as Maple Leaf Foods Inc. and Cott Corporation, have been able to establish a working relationship with an activist shareholder on the board. But clearly there was a breakdown in constructive engagement between Pershing Capital and the CP Rail board. And Pershing Capital, by issuing a proxy circular even before a record date for determining shareholders entitled to vote at the meeting had been set, and well before CP Rail distributed its proxy circular, was able to take the lead in communications with CP Rail's shareholders.
Andrew J. MacDougall is a partner and practices corporate and securities law, with a particular focus on mergers and acquisitions and corporate governance.
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