The Gary Cooper Of Governance

No board is too tough for activist investor Andrew Shapiro

When Sheldon Razin, chief executive and founder of health-care software maker Quality Systems Inc., left the company on Apr. 5, most people thought it was just another case of a CEO resigning under pressure. Governance watchers, however, knew that Razin's resignation--and the reconstitution of Quality Systems' board--resonated far beyond that, thanks to a small investor named Andrew E. Shapiro. Lacking the institutional might of the major pension funds--but full of vim and vigor--Shapiro got Quality Systems to put into its bylaws one of the strongest corporate governance planks ever seen. Moreover, he did it with no more than a 10% stake in the company, bought through his investment fund, Lawndale Capital Management.

Today, Shapiro's work at Quality Systems and his continuing role as a small-cap activist investor are being held up as a model by which to push for good governance, in large and small companies alike. "[Shapiro] has very cleverly identified a niche," says Charles M. Elson, a board expert and professor at Stetson University College of Law in St. Petersburg, Fla. "The real significance is seeing the movement filter from large companies to smaller ones."

"GADFLY." Shapiro, 39, a former distressed-securities specialist with the Belzberg family in the late 1980s, founded San Francisco-based Lawndale in 1993 as a small-cap value investment firm with less than $200,000. It now has $25 million under management--a relative pittance, but enough to make noise in smaller companies. Shapiro seeks out undervalued companies where a $5 million or $10 million stake has impact, but he differs from other value investors by placing a huge emphasis on corporate governance. A key part of his investment strategy is to analyze the board and make sure that it's chock-full of active, independent outsiders who will challenge the CEO if need be. "The bottom line," he says, "is that good governance enhances operating performance."

Despite being referred to as "pushy" and "grating" by some board experts and others who feel spammed by his constant e-mail updates, Shapiro gets results: Lawndale's portfolios are up an annualized 18% since its inception in 1993. He is usually invested in no more than 5 to 10 companies at a time. Once he takes a stake, companies can expect to hear from him immediately, with plenty of friendly suggestions on how to unlock hidden value. "A call from Andy today would cause people to not enjoy their lunch," laughs Richard H. Koppes, former deputy executive director of the California Public Employees' Retirement System (CalPERS) and a Lawndale investor. "He's a great gadfly."

Shapiro usually starts off with some thoughts for the board or the CEO. Go along, and all will go smoothly. Resist--and you could be out of a job. Shapiro's first public push took place in '94, at MDT Corp., an underperforming maker of medical and dental sterilization equipment. Shapiro took a 3% stake worth $3 million and asked the company to cut costs and to improve marketing. When he got little response from the board, Shapiro led a "Vote No" campaign against the nominated slate of directors that gained 32% of the votes. It was the second-highest such vote ever recorded at the time; it resulted in MDT adding more independent directors. But Shapiro wasn't done. In 1996, he raised a stink when the company was sold to Sweden's Getinge Industrier without, in his view, a proper auction. Boosting his stake to some 9.3%, he managed to up the purchase price by 22%, clearing over $1 million in the process.

Shapiro continued his persistent approach at Quality Systems, where in early 1995 Lawndale took a 5% stake in the then-$12 million company. Shapiro was attracted to the low stock price and significant cash hoard, which was being actively invested in foreign currencies. First, Shapiro suggested that the company focus on building sales rather than on cash management. Razin agreed, and an acquisition helped move the stock from 2 to 32 in 1995. Then, Shapiro set his sights on the insider-heavy board, which included Razin's wife, a close friend, and a major customer. Razin rebuffed him, and Shapiro decided to take his gains and move on.

BIG GUNS. But that wasn't the end of the story. By 1996, Quality Systems was in deep trouble again, with the stock down to 7 after an acquisition led to higher costs and fewer revenues than expected. Shapiro bought back in and asked for board changes. Again, he got nowhere. This time, he brought out the big guns: In February, 1999, Shapiro filed a five-point shareholder proposal that would have required the company not only to agree to groundbreaking corporate governance rules, but to put them directly into its bylaws--making the changes permanent unless repealed by stockholders or a two-thirds majority of the directors. That's different from most shareholder proposals, which are usually agreed to on a one-time basis.

Included in the proposal was a new slate of directors, held to standards of independence far higher than in most companies, and a proviso that no board vote could occur without at least half of the directors present being independent. Quality Systems asked the Securities & Exchange Commission to bar the proposal, but it refused, surprising many who felt a multipronged proposal would never fly. In August, the company capitulated rather than face a full-scale proxy fight. The board was reconfigured, and Razin agreed to give up his CEO role. Razin did not respond to repeated requests for comment. Quality Systems' stock rose to 18 3/4 in February before falling to about 9 in the recent market turbulence.

Now, Quality Systems' bylaws are fast becoming a template for other investors looking to create change. Early this year, Palo Alto Investors, a $200 million hedge fund, used a proposal modeled on Shapiro's to get the board to make changes at Embrex Inc., a Durham (N.C.) biotech company. And Koppes thinks the SEC-approved plank should be used in large companies as well. "I think [governance activists elsewhere] ought to use his proposal," he says.

Meanwhile, Shapiro is pushing for board changes at hihe Wistar Institute in Philadelphia for study. Now those same cells are the source of brain cells being transplanted into stroke patients in the hopes that some brain function will be restored.

The tale begins in the late 1970s, when Peter W. Andrews, an Oxford-educated scientist, was at Philadelphia's Wistar Institute studying certain cancers known as teratocarcinomas: tumors consisting of embryonic-like cancer cells found in the reproductive system. These cells either continue to grow uncontrollably into those companies become more affordable. "These were small, emerging, growth companies that have come public earlier than most, and thus the governance processes have not matured," he says. Elson agrees. "These companies are sorely in need of change," he says, "and Shapiro is a pit bull." Bad boards, beware.

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