Banc of California (BANC) in Irvine is using an unusual strategy to handle an activist shareholder by filing a lawsuit against the investor.
The $4 billion-asset company filed a lawsuit in the U.S. District Court for the Central District of California against Basswood Capital Management, claiming the New York hedge fund violated a late 2012 confidentiality and nondisclosure agreement.
The agreement was tied to a potential private placement between Basswood and Banc of California. Basswood skipped the private placement and began buying shares on the open market, allegedly breaching the contract.
Banc of Califonia wants the court to order Basswood to divest the stock and to pay damages.
Banks rarely sue investors, but banking lawyers say the lawsuit shows the lack of options banks face as they deal with activist shareholders.
"As long as the shareholder is not committing a crime or breaking the rules, there are not a lot of weapons for banks," says Frank Bonaventure, a partner at Ober Kaler.
"Getting into litigation as a plaintiff is tricky for banks," Bonaventure adds. "You really have to run a risk analysis. The best way to deal with an activist is to do the best you can do. Good performance takes the wind out of their sails."
Banc of California, in a colorfully worded complaint, claims that Basswood aggressively built a large stake while in possession of nonpublic information.
"The ink was hardly dry on the parties' contract when Basswood's affiliates while Basswood was in possession of BANC's material nonpublic information began to surreptitiously accumulate a substantial stake in BANC through open-market purchases that went unreported for months," the lawsuit claims. "While subject to the contractual standstill and in possession of material nonpublic information becoming the Company's single largest shareholder."
Basswood's stake in Banc of California peaked at 7.37%, though it has since declined to 3.54%.
It is important to note that the root of the lawsuit is about the way that Basswood obtained its stake, and not its activism, lawyers says. Banc of California will need to focus on its claims that the hedge fund breached a contractual arrangement.
"Based on a quick look, this really is about a breach of contract," Bonaventure says. "It is just coincidentally involves an activist."
Banc of California's complaint also alleges that Basswood has formed a coalition with other shareholders, including well-known activist firm PL Capital, but has filed forms with the Securities and Exchange Commission that are associated with passive investors.
PL Capital and Basswood have frequently invested in the same companies. Earlier this month Richard Lashley, one of PL Capital's principals, sent a lengthy letter to Steven Sugarman, Banc of California's president and chief executive, depicting a contentious exchange between the men during a recent investor day in New York.
Lashley claimed in his letter that Sugarman was "flustered and frustrated" by questions and "belittled" him in response. "You and I did not get off to a good start," Lashley added. "Let's work to have a more productive dialogue going forward."
PL Capital is now Banc of California's biggest shareholder, with a 7.1% stake.
Sugarman and Basswood did not return calls seeking comment. Lashley said in an interview that his firm and Basswood are not familiar. "The allegation that we are acting in concert is laughable and not worthy of rebuttal," he said.
Banc of California and the activists have also traded barbs over the pricing of the bank's recent $110 million capital raise. Banc of California raised the money last month to support its purchase of Popular's (BPOP) southern California branch network.
Priced at $9.78 a share, the capital raise was completed at a 17% discount to Banc of California's stock price when the offering was announced. Lashley referenced the pricing and size of the raise in his letter to Sugarman as "disappointing and unexpected."
Banc of California, in its lawsuit, pointed the blame squarely on Basswood, saying the investor's activism prompted Endicott Management, one of the banking company's biggest shareholders, to skip out on the offering.
"Basswood's deliberate interference with the company's capital-raising activities impacted execution," the lawsuit claims.
Contentious relationships between Sugarman and activist shareholders fail to surprise several industry observers. Sugarman, a lawyer and founder of an investment firm, led Banc of California's 2010 recapitalization, when it was known as as First PacTrust. From there, he went from sitting on the company's board to becoming co-CEO. (He became the company's only CEO when Greg Mitchell left in September 2012.)
Sugarman leads a non-traditional management team that is passionate about the company, though he can be defensive when dealing with critics, industry observers say.
Still, the company likely finds itself the target of activists because of its performance. Though it has completed several acquisitions under Sugarman's direction, it is profitability is bumpy. The company has lost money in three of its last six quarters.
"Investors are questioning whether management can execute and achieve peer profitability," says Brett Rabatin, an analyst at Sterne Agee.
"It is perceived as a 'show-me' stock and, given the numbers in the last year and the fact that they keep coming back to the markets, tell us that, generally speaking, the sentiment is low on the name," Rabatin adds.