Bernard Sharfman, in his new article on SSRN, The Tension Between hedge Fund Activism and Corporate Law, argues that hedge fund activism for control of a publicly traded corporation is a positive corrective measure in corporate governance.  After asserting that hedge fund activism should be permitted, Sharfman, argues, controversially, that courts should depart from traditional deference to a corporate board's decision making authority under the business judgment rule.  Alternatively, Sharfman urges courts to adopt a heightened standard of scrutiny when reviewing defensive board actions against hedge funds.

[Hedge Fund Activism] has a role to play as a corrective mechanism in corporate governance and it is up to the courts to find a way to make sure it continues to have a significant impact despite the courts’ inclination to yield to Board authority. In practice, this means that when the plaintiff is an activist hedge fund and the standard of review is the Unocal test because issues of control are present, a less permissive approach needs to be applied, requiring the courts to exercise restraint in interpreting the actions of activist hedge funds as an attempt to gain control. 

If there are no issues of control, then Board independence and reasonable investigation still needs to be the focus. That is, before the business judgment rule can be applied, the courts need to utilize an enhanced level of scrutiny in determining whether the Board is truly independent of executive management or any other insider such as a fellow Board member. As previously discussed, Board independence is critical to maximizing the value of HFA. Moreover, reasonable investigation of the activist hedge fund’s recommendations should be required to justify Board action taken to mute the fund’s influence. Like the Unocal test, the burden of proof for establishing independence and reasonable investigation needs to be put on the Board. In sum, what is required in the court’s review of Board actions to mute the influence of an activist hedge fund is something similar to the first prong of the Unocal test except independence and reasonable investigation is now focused on the Board’s evaluation of the fund’s recommendations, not the threat to corporate policy and effectiveness.

Sharfman uses Third Point LLC v. Ruprecht, the 2014 Delaware case invovling Sotheby's poison pill, to illustrate how the traditional (deference) standard of review leads to boards being able to defeat hedge fund activists.

An interesting comment published in the Yale Law Journal by Yale Law Student Carmen X.W. Lu, Unpacking Wolf Packs, offers an alternative view of the Third Point case emphasizing the coalition of hedge funds acting in that case and the court's skepticism of wolf pack activist investors. 

-Anne Tucker