Southwest Airlines (LUV.US) may be close to a settlement with activist investor Elliott, sources say

After four months of public battle with activist investor Elliott Investment Management, Southwest Airlines (LUV.US) may finally be ready to call a truce. Sources revealed last Saturday that the two sides have been discussing a possible settlement to avoid a proxy fight over control of the airline's board. Some sources said Elliott proposed a framework that would give it proxy rights without control of the airline's board. The sources added that negotiations were moving toward a solution as of Saturday, but were not finalized and could fall through.

Southwest Airlines' stock has fallen about 40% in the past three years, and its market value has dropped to about $18 billion. Although the airline's stock has risen about 20% in the past year, it still trails the performance of its peers.

Elliott disclosed in June that it had a stake of about $2 billion in Southwest Airlines. After years of underperformance, Elliott called for a shake-up of the company's strategy and leadership, and targeted Southwest Airlines' chairman Gary Kelly and CEO Bob Jordan. Elliott said the airline's leadership refused to upgrade its operations, hurting shareholders and leaving the airline unable to withstand competitive challenges.

Southwest Airlines announced in September that Kelly and six board members would step down. At the same time, the airline showed support for Jordan. The airline also announced major policy changes as part of its plan to revitalize its business and fend off Elliott. For example, Southwest Airlines will begin selling assigned seats later this year and will introduce a premium fare option that offers extra legroom. However, the airline will retain its policy of allowing two free checked bags.

Elliott has nominated eight directors to Southwest Airlines' board and called for a special shareholder meeting on December 10. The airline responded that its board has made every effort to reach a constructive solution with Elliott, including a framework for appointing up to three of Elliott's nominees. The airline also said Elliott's request for a special shareholder meeting was "unnecessary and inappropriate."

Southwest Airlines also announced a $2.5 billion stock buyback plan last month. Other measures include adopting what is known as a "poison pill" strategy to protect itself from Elliott's attack. The airline will also create a new finance committee to oversee future financial, operational and business plans and strategies.