‘Dead Hand’ Slows Activist Meister $2.9 Billion REIT Buyout Bid

All company founders will fight to keep their jobs, maybe none more so than Barry Portnoy and his son Adam.

The Portnoys are chairman and president of CommonWealth REIT, a Newton, Massachusetts, trust founded in 1986 that owned $7.2 billion of office and industrial properties as of March 31. Their legal and corporate governance tactics have so far thwarted a three-month-old attempt by Keith Meister’s Corvex Management LP and Jeff Blau’s Related Fund Management LLC to either buy the trust for $2.9 billion or evict its board. The activist investors argue the stock is depressed by excessive fees paid to an outside management company owned by the Portnoys and poor corporate governance.

CommonWealth has so many takeover barriers that Institutional Shareholder Services, a shareholder rights group in Rockville, Maryland, gave it the firm’s lowest score in an April report -- a 10 -- for protecting investors from risk.

“That’s about as bad as you can get,” said Patrick McGurn, special counsel to ISS. Except for dual classes of voting shares, CommonWealth boasts every takeover defense a company can employ, from a poison pill to the obscure “Dead Hand” to mandatory arbitration of shareholder conflicts, McGurn said.

CommonWealth, which has properties in cities including Chicago, Denver and Philadelphia, declined to comment on the ISS corporate governance score, said spokeswoman Carlynn Finn. Most investor complaints about corporate governance are about the company’s outside management firm, not its takeover defenses, Adam Portnoy, 42, said in a phone interview in late April. He said the fees are not unreasonable.

Stock Drop

The outcome of the CommonWealth battle could be determined by an arbitration panel that will decide whether to allow a shareholder vote to remove board members. The fight shows that even while securities laws, courts and activists are eroding takeover defenses, some boards still protect management at the risk of alienating investors, said Charles Elson, director for the John L. Weinberg Center for Corporate Governance at the University of Delaware.

“A lot of companies have defenses but the fewer you have the more you curry favor with investors,” Elson said.

Shareholder Rally

Shareholders have rallied to the activist investors, who said they were prepared to buy the company for $27 a share in late February and later reduced the offer to $24.50 a share. The stock, then at $15.85, jumped nearly 50 percent. Meister and Blau argued that the company’s real estate assets place its share value around $40.

Meister, 40, is a protege of Carl Icahn who in November helped get ConAgra Foods Inc. to buy Ralcorp Holdings Inc. for more than $6.6 billion including debt. Blau, 45, is chief executive officer of Related Cos., a real estate developer that also runs an investment firm.

Stiff takeover defenses awaited the investors. CommonWealth’s poison pill limits investors to holding no more than 10 percent of shares, which caused the activists to cap their stake at 9.8 percent. They now own 9.2 percent. The Dead Hand provides that only board members who approved the poison pill can revoke it.

CommonWealth also has a staggered five-member board, so that different directors, also known as trustees, are up for re-election every year. That requires hostile bidders to seek a two-thirds vote to oust all the directors at once in what’s known as a consent solicitation. Adam and Barry Portnoy are two of the board’s five trustees.

New Barriers

When Meister’s group announced its bid on Feb. 26, it said it would push for a consent solicitation vote unless CommonWealth agreed to its terms.

A few days later, on March 1, CommonWealth erected new barriers. The board adopted a rule requiring that shareholders own 3 percent of the stock for three years before they could initiate a vote to replace directors. That was up from a threshold of $2,000 in stock and just one-year ownership. And it said that its bylaws require that any disputes be settled by arbitration, not in court.

CommonWealth’s position was upheld on May 8 by a judge in Maryland, where it is incorporated, after Meister sued. The judge ruled the company had the authority to adopt mandatory arbitration, and sent the matter to a three-member panel.

The ruling is “treating a public company like a small private partnership,” said Elson. “To deny shareholders the right to the courtroom is a problem.”


CommonWealth’s incorporation in Maryland helped its cause as the state has a reputation as friendlier to management than shareholders, said John Coffee, a professor at Columbia University Law School. Delaware, where about 60 percent of Fortune 500 companies are incorporated, wouldn’t be likely to uphold mandatory arbitration or Dead Hand provisions, he said in a phone interview.

The activist groups intend to continue their bid to replace the board and are “confident” arbitrators will allow a shareholder vote, said Joanna Rose, a spokeswoman for Related. They are collecting votes while awaiting the panel’s decision.

Meanwhile, after the Meister bid the Portnoys also tried to clarify Maryland law to make it tougher to remove board members, according to a company statement April 15. They lobbied legislators to require that shareholders prove cause to oust a director. While lawmakers didn’t act on the measure, the company said it is interpreting Maryland law to require that directors can only be removed for cause.

Morea Vote

CommonWealth’s efforts to protects its directors surfaced again this week when the firm ignored a May 14 shareholder vote not to re-elect director Joseph Morea, who was backed by less than 50 percent of the shares. A day after the annual meeting CommonWealth asked Morea to fill the vacancy created by his own resignation, which he accepted.

Reinstating directors after they lose an election is fairly common, Elson said. It’s also “insulting to investors,” he said. “If you don’t respect shareholder wishes, what’s the point of having a vote?”

In a statement, CommonWealth said that Morea’s failed re-election bid reflected shareholder unhappiness over the board’s opposition to the takeover bid, not Morea’s performance.

While the Portnoys battle to keep their jobs, CommonWealth shareholders have taken a hit. From its peak of $32.80 in April 2010 the stock had fallen by half before the takeover was announced. Management cut the dividend to 25 cents a share in 2012, where it remains, compared with 84 cents a share in November 2008.

Taxable Earnings

REITs, whose primary income streams are from real estate, are required by the U.S. Internal Revenue Service to distribute at least 90 percent of their taxable earnings to shareholders as dividends. In exchange they pay little or no income tax.

Meister has focused his attack on the Portnoy-owned REIT Management and Research LLC, which manages CommonWealth’s properties. As CommonWealth buys more buildings, RMR’s fees, based on the amount of assets, rise even if the properties perform poorly, the activists said in statements. CommonWealth fees to RMR increased to $69.8 million in 2012 from $62.2 million in 2010 even while the stock was falling, according to company filings.

Most REITs manage their properties internally, said Stifel & Co. analyst John Guinee.

Adam Portnoy said using RMR to manage property lowers costs because four other REITs also employ the firm to manage property, achieving benefits of scale.

“If we had internal management, costs would be higher,” he said in the April interview.

While Portnoy said he’s “not proud” of the declining stock price, he said the company is operating “in the toughest sector there is,” suburban commercial real estate.

‘Troublesome History’

The trust has suggested that Meister and Blau would not be good choices to run the firm. In a slide presentation made for investors, CommonWealth said they both have a “troublesome history” of managing real estate investments. Blau was CEO of American Mortgage Acceptance Co., a mortgage REIT that filed for bankruptcy in 2010.

Related and Corvex have said that 20-year real estate veteran Jim Lozier, co-founder and former CEO of Archon Group LP, a subsidiary of Goldman Sachs Group Inc., would run CommonWealth if the Portnoys are ousted.

Perry Corp., which owns 5.5 percent of the stock, and Luxor Capital, which has 4.7 percent of the shares, according to data compiled by Bloomberg, both said they support Corvex and Related.

So does retiree Dean Norman, who bought almost 3,000 shares of CommonWealth REIT back in 2005. In an angry letter to CommonWealth’s board, Norman, 67, said his original investment of $33,812 has plummeted by 52 percent.

“They don’t care about the shareholders,” Norman said in a telephone interview. “I’d like to see them run the company for us and not for RMR. I don’t need to take any more hits on this.”

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