| Insight for investors

Looting of assets and attempt to kill: Investors who track 13D filings have every right to remain silent

by | Aug 21, 2019

Even though shareholder activism is a fertile hunting ground for finding ideas, there are some situations when it is better to avoid getting involved too early.

One such situation is an “ugly fight” – I’ll explain this with a couple of examples.

1. Sorrento Therapeutics: “Looting of assets” and “Little more than theft”

In May 2016, Wildcat sent a letter to the board of Sorrento Therapeutics highlighting critical “red flags”.

Wildcat argued that the company had been acquiring and/or transferring assets to newly-created wholly-owned subsidiaries and then issuing significant amounts of those subsidiaries’ shares back to the company’s executive officers and directors through significant grants of options, and warrants for Class B super-voting stock, all exercisable for a nominal consideration, thereby engineering a personal benefit for these officers and directors at the direct expense of the company and its shareholders.

Wildcat called this series of transactions, “little more than a looting of company assets” and “little more than theft”.

Wildcat filed a lawsuit against the insiders, and the company entered into a settlement agreement with Wildcat. Pursuant to the agreement, the company agreed to terminate all options and warrants currently outstanding in company subsidiaries that had been granted to Dr. Ji [CEO] and any other directors.

Key takeaways

First things first – Wildcat’s activism is deeply appreciated in this case. It took ten long months for the company to settle with Wildcat. Most importantly, Wildcat’s involvement resulted in the termination of “problematic” options and warrants to insiders.

At the same time, from an investing standpoint, when a shareholder refers to an insider’s transaction as “looting of assets” and “little more than theft”, it is better to stay away from the situation until the “core problem” is solved.

2. Natural Gas: The arguments from both sides are horrible to read

Natural Gas is a Cleveland-based natural gas distributor.

The company terminated Richard M. Osborne as CEO and appointed his son as his successor. Subsequently, in 2014, Richard Osborne argued that he was illegally terminated and launched a proxy campaign.

Arguments by Richard Osborne

Richard Osborne (Former CEO), sent a letter to shareholders that contained inflammatory statements about company executives and board members.

Some of his arguments:

  • According to the captain, Greg Osborne, CEO: The company needs to do more to protect dedicated employees from sexual and other forms of exploitation.
  • The head of the audit committee was imprisoned for attempting to kill his live-in friend.
  • Kevin Degenstein (COO) had previously been fired because of his accounting practices.
  • How many board chairmen of publicly traded companies frequent strip bars, let alone debase themselves in such a crude way?
  • Here is the link to the SEC filing.

 Argument by the company

The company fought back, saying Richard Osborne illegally stole customers from its Ohio utilities.

Some of the company’s arguments:

  • After Richard Osborne was ousted, he started a competing utility business. In a press release, the company accused Osborne of severing gas lines of one of the company’s employee. It notes: “Ohio Rural and Richard Osborne severed gas lines owned by our Ohio utility, terminating service to approximately 50 independently owned businesses we serve, and replaced our meters with their own”.
  • The company wrote, “In September 2014, employees of Cobra Pipeline Co., another Ohio pipeline company owned by Richard Osborne, tampered with one of our regulator stations by inserting a solid metal plate in the pipeline, cutting off the flow of gas to some of our customers. We immediately called the police and lodged a complaint with the PUCO, who issued a cease and desist order against Cobra on the same day.”

Generally, if you read arguments from both sides (incumbent and activist), you would side with either one or the other. But in this case, you would be scratching your head if you were asked to pick a side.

It is better to avoid this sort of situation.

Key learnings:

  • Not all activist filings are investible.
  • Not all fights are equal – fighting against a “way the company should move forward” is different from fighting against the “moral character” or “questionable ethical practices” of the insiders.
  • Always read the arguments – if the activist’s arguments raise red flags, wait until the problems are solved.

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