Safety in numbers? Forget about it. Howard Godnick and William Gussman Jr. of the New York-based law firm Schulte Roth & Zabel have some advice: When it comes to activist hedge funds, flying solo is the way to go. In the ongoing battle between activist hedge funds and the companies they appear to be menacing for change, say the lawyers in a firm report, “one of the most powerful – and easy to use – weapons” at the targets’ disposals is section 13(d) of the Securities Exchange Act of 1934. That provision can turn hedge funds into violators if they fail to disclose that the activist was acting as part of a “group” of investors as it relates to investing in company stock. Section 13(d) requires an investor (or group of investors) to file Schedule 13D within10 days of acquiring “beneficial ownership” or more than 5% of class of voting securities. Hedge funds, say the lawyers, may unwittingly be creating such a group. Godnick and Gussman note that the so-called “wolf pack” effect occurs when a hedge fund acquires considerable stock, and then existing HF investors in that company increase the number of their own shares. G&G say that while section 13(d) violators can’t be sued for monetary damages, they could find themselves in a public relations nightmare. Targeted companies could use the violation by “forming a perceived basis for fraud claims...constituting a perceived basis upon which to grant a preliminary injunction against a proxy contest or other actions instigated by activist investors...[and] providing a powerful public relations too for entrenched management against the activist investor” by asserting the activism violated securities laws.
Activist hedge funds could avoid the “group trap,” say the lawyers, by taking a variety of steps.

• Educate top HF management about 13(d) and target companies’ “eagerness” to catch hedge funds in even the slightest slip-up.

• Avoid written agreements with other investors regarding purchase, sale or voting of stocks.

• Avoid the use of terms such as “activist,” “group” and “agreement” in written communications regarding goals common to investors for which management “could be cited as the ‘smoke’ evidencing the fire of an agreement.”

• Always hire separate and independent lawyers when engaging in similar but separate investment strategies.

• Most important, “be vigilant about timely closure and meticulous about the accuracy of their public filings, ensuring strict compliance with federal securities laws.”