Paulson Pushed for Family Dollar Sale as Passive Investor

By Miles Weiss

Billionaire John Paulson privately suggested on at least two occasions that Family Dollar Stores Inc. (FDO) sell itself, before his hedge-fund firm told regulators that its investment in the discount retailer was passive.
Paulson advocated for a sale in a meeting in October with Family Dollar Chairman and Chief Executive Officer Howard Levine, and then followed up with a January letter requesting that Levine “explore strategic alternatives,” according to a regulatory filing last week by the Matthews, North Carolina-based retailer. The following month, Paulson & Co. declared in a statement with the U.S. Securities and Exchange Commission that its 8.6 percent stake wasn’t held for the purpose of “changing or influencing the control” of the company.
Paulson’s lobbying efforts raise the question of
how much and how hard investors can push management -- a strategy hedge funds are increasingly pursuing -- before triggering more stringent disclosure requirements for activists that were put in place to protect companies and other stakeholders. Family Dollar is at the center of a three-way takeover battle, with Dollar Tree Inc. offering $8.5 billion for the chain and Dollar General Corp. pursuing a hostile $9.1 billion bid. Paulson, whose hedge funds invest in companies undergoing mergers, is also a passive shareholder in Dollar General.
“Telling the company what I think probably does not rise to the level” of being an active investor, said James Moloney, a securities attorney in the Orange County, California, office of Gibson, Dunn & Crutcher LLP. “If they went so far as to arm-twist, it’s possible they lost their passive status.”

Filing Requirements

Armel Leslie, a spokesman for $22.8 billion New York-based Paulson & Co., declined to comment, as did SEC spokesman Kevin Callahan and Nicholas Leasure, a spokesman for Family Dollar who works at Joele Frank, Wilkinson Brimmer Katcher.
Money managers who oversee $100 million or more in U.S. voting securities must file a Form 13F within 45 days of the end of each quarter, listing their U.S. traded equities. If an ownership stake exceeds 5 percent, they’re also required to tell regulators in separate filings if they plan to influence control of the company. Investors have 10 days to do so after reaching the 5 percent limit, though under some circumstances, the disclosure can be delayed.

1968 Act

The additional disclosure requirement was adopted by Congress in 1968 to help make shareholders and a target company’s management aware of a pending takeover attempt. Yet the SEC has never clearly defined the standards for being a passive investor, leading some shareholders to take a more aggressive stance than others in discussions with management, said Scott Kimpel, a partner in the corporate finance and merger and acquisitions group at Hunton & Williams LLP who specializes in securities compliance and transactional issues.
“This is an issue the SEC needs to focus on more, particularly as activist investing becomes more widespread,” Kimpel said in an interview.
Paulson doesn’t have a reputation for seeking to shake up management on his own, though he previously made activist filings, for instance when disclosing an 8.4 percent stake that his hedge funds acquired in Hartford Financial Services Group Inc. in 2012. The firm at the time said it had had discussions with the insurer’s board and management about spinning off units, and was planning talks with other shareholders. Paulson said in the Hartford filing that it didn’t intend “to engage in a control transaction or any contested solicitation for the election of directors.”

AngloGold Ashanti

More frequently, Paulson characterizes his investments as passive, even if he occasionally engages with management. Last year, he disclosed in a letter to clients that he was seeking ways for AngloGold Ashanti Ltd., Africa’s largest producer of the metal, to improve its valuation, adding that the company’s share price could increase if it split its business along geographic lines. Paulson reports his 6.6 percent stake in AngloGold Ashanti as passive.
Family Dollar’s board last week recommended shareholders reject the tender offer from Dollar General. The company continues to support the cash and stock offer by Dollar Tree of Chesapeake, Virginia. Family Dollar’s two largest shareholders, which together control almost 16 percent of the stock, are also backing the Dollar Tree bid, saying the lower offer has a better shot of being approved by antitrust regulators.
Paulson, whose hedge funds rank as the third-largest holder of Family Dollar stock based on his firm’s most recent 13F filing, is the biggest investor that hasn’t yet publicly taken a stance. Paulson & Co. also holds about 4 million shares of Dollar General.

Icahn, Peltz

Family Dollar has been a magnet for activist investors, including Carl Icahn and Nelson Peltz. Peltz disclosed in July 2010 that his Trian Fund Management LP had taken a 6.6 percent stake in Family Dollar and had met with Levine to discuss improving shareholder returns. The following year, Peltz made a $7.6 billion offer to acquire Family Dollar, a bid that the company later rejected.
In June of this year, Icahn said he had purchased a 9.4 percent stake in Family Dollar and would seek talks with management. Later in the month, Icahn wrote a letter to Levine urging that the company be put up for sale and threatening to remove the board if Family Dollar didn’t cooperate.
Both Peltz and Icahn told regulators that their positions were activist, triggering the more stringent disclosure requirements.
Paulson initially disclosed his Family Dollar stake in May 2013 in a Form 13F, the filing in which money managers report all their holdings after the end of each quarter. By June 30, his firm held about 6.5 percent of Family Dollar’s outstanding common stock, which grew to 9.9 percent as of Sept. 30.

Meeting Levine

The following month, Paulson met Levine to push for a sale of the company, according to the filing Family Dollar made last week with the SEC. Levine had met with two Dollar General executives, CEO Rick Dreiling and Director Michael Calbert, a few days earlier to explore the potential for a merger.
During that meeting, Dreiling and Calbert “conveyed that they were keenly interested in a combination of the two companies,” according to a filing by Dollar General last week. The filings don’t show whether Paulson knew about the meeting.
Paulson sent a follow-up letter to Levine in January “in which he again advocated for Family Dollar to explore strategic alternatives and sell itself,” Family Dollar said in its disclosure. Paulson’s firm owned 8.6 percent of Family Dollar as of Dec. 31.

‘Ordinary Business’

Paulson didn’t disclose whether his investment was active or passive until Feb. 14, when Paulson & Co. submitted a Schedule 13G saying the hedge-fund firm considered the stake to be passive. The firm used standard language stating that Paulson & Co. bought the stake “in the ordinary course of business” and that the shares are “not held for the purpose of or with the effect of changing or influencing the control of” Family Dollar.
Paulson could wait that long because registered investment advisers who don’t plan to engage in activism can delay filing a 13G until 45 days after end of the calendar year in which they crossed the 5 percent mark. Should an investor change their mind during that period and pursue an activist strategy, they can make the appropriate filing then without regulatory sanctions.
Activist investors are subject to extensive disclosure requirements, including details on the identity of the investors, the price and date of their recent transactions in company stock, the source and amount of money spent to buy the stake, any recent steps or future plans to influence management or seek control, contractual arrangements, and the use of derivatives. Passive investors simply report the number and percentage of shares held.

‘Non-Passive’

“Most people want to stay there if at all possible, and that is why they will refrain from engaging in what some might call non-passive activity,” Moloney said. Paulson, for instance, would have had to disclose his meetings and letter with Levine if he classified himself as an active investor in Family Dollar upon reaching the 5 percent level.
Investors in the ordinary course of business can talk to management or the board of a company and express their views without falling into the active category, said Eleazer Klein, an attorney at Schulte Roth & Zabel, a New York-based law firm that works with hedge funds. Telling directors that you will seek their ouster should they fail to follow your suggestions is a different matter, Klein said.

Expressing Opinions

“There is no reason shareholders can’t express their opinion of what the company should be doing and still be passive investors,” Klein said in a telephone interview. “The question is whether you are pushing the line or crossing it.”
Perry Corp., the $10.9 billion hedge-fund firm founded by Richard Perry, in July 2009 settled a dispute with the SEC over its acquisition of a 9.9 percent stake in Mylan Inc. in 2004. Perry initially classified its stake as passive and changed it into an activist stake the following year. The SEC alleged that Perry bought the stock in order to vote in favor of a merger that would have given it a profit on an arbitrage position in Mylan, and thus could not claim that the shares were bought “in the ordinary course of business,” one of the requirements for filing on Schedule 13G.
“When institutional investors, such as Perry, acquire ownership of securities for the purpose of influencing the direction of management of an issuer,” the SEC said in its order, “the acquisition is not made and the shares are not held in the ordinary course of business.”
Without admitting or denying the SEC allegations, Perry agreed to pay a $150,000 penalty to settle the matter, the SEC said. The agreement brought “to a satisfactory conclusion any concerns that were raised,” the firm said at the time.
“There is ambiguity” in the language of the law, said Henry Hu, a law professor at the University of Texas who formerly served as the first director of the SEC’s division of economic and risk analysis. “There are a whole bunch of reasons you would prefer going to the more bare-bones disclosure” for passive investments.