This article was first published on Insightia’s Activism module. For more information about the product, click here.
While shareholder concern over sexual misconduct has been rising for years, most demands on the issue have been by passive, ESG-focused investors. But Legion Partners’ recent campaign to oust Guess Inc. founders Paul and Maurice Marciano had all the hallmarks of a financially driven proxy contest where the investor saw an undervalued company and a possible catalyst to quickly revalue the stock.
In this case, the catalyst proposed by the activists was for shareholders to vote against the board reelection of the brothers due to long standing allegations of sexual misconduct against Paul Marciano.
And while Legion failed to remove the brothers at an April 22 shareholder meeting, largely because insiders control well over 40% of outstanding shares, the campaign and its legal ramifications should serve as a warning for boards to double down on their oversight of executive behavior.
“Since the Weinstein case broke sexual harassment has exploded as a critical risk for boards of directors and shareholders,” said Amy Borrus, executive director of the Council of Institutional Investors (CII), in an interview with Insightia. Such concerns have increased further due to current labor shortages, she added, as a company under the pall of sexual misconduct could “lose out on finding the best and the brightest when companies are competing for talent.”
She noted that the share price of Wynn Resorts has yet to recover from a sexual harassment scandal in 2019. More recently, Penn National Gaming saw its share price cut in half due in part to recurring allegations against George Portnoy, the founder of Barstool Sports, in which Penn has a controlling stake. And earlier this year, Microsoft’s buyout of Activision Blizzard was opposed by some leading shareholders due to allegations that CEO Bobby Kotick had ignored instances of sexual misconduct at the gaming company.
Speaking with Insightia, Legion’s Chris Kiper and Ted White made it clear that their investment in Guess fits the model of their other activist investments where they identify an undervalued company in a sector they like with a clear catalyst for change that would unlock shareholder value. The argument is reminiscent of Jeff Ubben’s environmental activism strategy of investing in dirty industries like oil in the belief that cleaning up the business, even marginally, would lead to higher stock returns.
As long-time investors in the apparel sector, Legion said it was impressed by Guess’ performance since Chief Executive Carlos Alberini took the helm in 2019. “He’s been leading a remarkable turnaround of the company operationally and has really done a great job in terms of improving profitability,” said Kiper, “and when you look at our model we see 100% upside from here.”
That will only happen, however, if Guess sheds the “legal, reputational, and moral risk” associated with having Paul Marciano and his brother on the board, Legion warned in its proxy statement.
That risk was highlighted in January when Guess and Paul Marciano were sued by their underwriter Beazley Insurance, which was seeking to absolve itself of any responsibility for covering claims related to Paul Marciano’s alleged “pattern” of “wrongful acts.” It was that event, according to Legion, that inspired the activist to go public with its demands.
To drive home its point, Legion made a detailed argument to show that Marciano’s behavior has a discernable impact on valuation, resulting in a “Marciano discount.”
They noted that Guess’ stock underperformed its peer group by 30% on average for almost 10 years following a 2009 lawsuit against Marciano by former model Lindsey Ring. The stock recovered after the company announced it would investigate the allegations and subsequently hired new CEO Alberini. But the stock crashed again in a flurry of new lawsuits earlier this year and lawsuits were filed in late 2021, and now trades at a 45% discount, according to Legion’s report.
“It is doing very well and yet this discount has expanded out to the biggest that it has been in recent history,” says Kiper.
Despite losing the vote, Legion says the fact that 84% of shareholders not affiliated with the Marciano’s voted against the brothers’ reelection should serve as a mandate for the rest of the board to act.
“The board seems to be content on keeping the Marciano’s involved, which is a real head scratcher given everything that’s been alleged and the risk that that the company,” said Kiper.
Following the vote, the company issued a short statement that its “board of directors takes its fiduciary duties very seriously, believes in due process, and will continue to make its decisions based on factual findings.”
Guess’ current efforts may not be enough to avoid shareholder litigation, by Legion or any other investor, according to Professor Yaron Nili at the University of Wisconsin Law School. He noted that under Delaware law, directors can be held liable for breach of the fiduciary duty of loyalty when they fail to exercise oversight of a corporation, but only when their failure is “sustained or systematic,” known as the “Caremark argument” after a precedent setting 1996 case.
He pointed to Legion’s public statement following the vote, where the activist accused the board of “tolerating the massive brand, reputation, and valuation risk” over many years and called on independent directors to do their fiduciary duty for shareholders.
“I don’t know if they’re going to bring litigation,” said Nili, “but that’s exactly the Caremark argument.”