U.S. lawsuit against activist ValueAct puts mutual funds on alert

NEW YORK/BOSTON (Reuters) - The U.S. government’s lawsuit against ValueAct Capital targets one activist investor but could call into question routine practices across the $16 trillion mutual fund industry, according to attorneys and industry representatives.

The U.S. Department of Justice last week alleged that the hedge fund improperly classified two company investments as passive - and therefore exempt from disclosure requirements - while taking an activist role with executives. ValueAct disputes the claim.

Some communications the government cites as evidence are similar to discussions that are increasingly common between traditional, buy-and-hold funds and companies in their portfolios.

The case comes as active and passive investors work more together to pressure management at underperforming companies. Activists court passive shareholders before launching such a campaign, and passive investors recruit activists to agitate, several activist managers told Reuters.

Traditional funds may need to reassess their compliance with disclosure laws, according to a memo to clients from Davis Polk, a New York law firm with expertise in financial services.

“Such an institution will have to examine whether it can claim to have a truly ‘passive’ intent,” said the memo, issued in response to the ValueAct case.

Those firms could include, for instance, T. Rowe Price Group TROW.O, BlackRock Inc BLK.N and Vanguard Group. Spokespeople at those companies declined to comment, and representatives of seven additional fund firms contacted by Reuters declined to comment or said executives were unavailable. The Justice Department also declined to comment.

An industry trade group said the case could restrain shareholders from addressing important issues with corporate executives and board directors.

“The DOJ case could have a chilling effect on dialogues between companies and their shareholders,” said Amy Borrus, deputy director at the Council of Institutional Investors, a Washington D.C.-based nonprofit whose members include pensions, endowments and major mutual funds.

Graphic on shareholder outreach initiatives.

For a graphic showing the increase in company shareholder communication programs, see

Competition for better returns has led some big mutual fund firms to take a more active role, weighing in on issues such as CEO pay and corporate governance. Vanguard Chairman and CEO William McNabb, in a speech last June in New York, described how the firm increasingly addresses matters of concern with companies in its portfolio.

“We’ve become more targeted in whom we mailed letters to and more prescriptive in our language,” McNabb said.

For example, Vanguard sent out 500 letters in March 2015 to independent chairs and lead directors outlining six principles of corporate governance, McNabb said.


At the heart of the ValueAct case are six words in a 40-year-old law that requires disclosure of certain investments to assist the Department of Justice and the Federal Trade Commission in antitrust review of mergers. The intent is to prevent investors from secretly buying up stakes to agitate for industry consolidation.

The Hart-Scott-Rodino Act requires all buyers of voting securities worth more than $76.3 million to notify the government, unless they were bought “solely for the purpose of investment.”

The government alleges ValueAct failed to disclose a $2.5 billion position in two companies that planned to merge - oilfield services peers Halliburton Co HAL.N and Baker Hughes Industries Inc. BHI.N

ValueAct is fighting the case and has said that its outreach to the companies was standard shareholder input and not active investing. The firm declined to comment for this story.

Among the evidence asserted by the government is a December 2014 meeting with the Baker Hughes chief financial officer, where ValueAct’s chief executive discussed gaps in the company’s North American margins and other underperforming areas. The government also cited a ValueAct email sent to Halliburton’s CEO in July 2015 to schedule a meeting about executive compensation.

Davis Polk points out in its client memo that it’s common for investors with stakes deemed passive to discuss those topics with corporate management.

“It does seem to be ... a typical subject of discussion,” wrote the firm, which represents Baker Hughes in the merger.


John Briggs, an antitrust attorney with the law firm Axinn, Veltrop & Harkrider LLP, called the case a one-off enforcement effort against ValueAct that does not necessarily signal a broader crackdown or a change in legal interpretation.

But Briggs agreed that the case highlights the blurring boundaries between activist and traditional fund managers. A ValueAct win could further cloud the issue, while a government victory could prompt major investors to dial back pressure on companies.

A managing director at a large asset manager, speaking on condition of anonymity, said that he and his colleagues routinely discuss business improvement and executive compensation with company executives, believing such topics do not cross legal lines. The ValueAct case could change that interpretation, the manager said.

The lawsuit could take months or years to resolve. Any resulting limits on fund managers could clash with a separate effort led by the U.S. Securities and Exchange Commission in the early 1990s encouraging more dialogue between investors and public corporations.

“The idea was that you want to free up those conversations, since more conversations allow more accountability,” said University of Delaware finance professor Charles Elson, who follows corporate governance. “Anything that pushes things in a different direction is problematic.”

Additional reporting by Diane Bartz in Washington