Developments in Takeover Defenses

As discussed in our recent Webcast on Developments in Takeover Defenses, Latham & Watkins LLP has prepared a new model of advance notice bylaw provisions that have been updated and modernized, not only to address the issues raised in the recent decisions in JANA Master Fund, Ltd. v. CNET Networks, Inc. and Levitt Corp. v. Office Depot, but also to address significant related problems posed by activist investors’ frequent use of undisclosed derivative securities and/or “wolf pack” tactics as weapons in threatened or actual proxy contests. We have also included provisions that establish more robust and protective procedures for shareholders to call special meetings or act by written consent. The text of our model advance notice bylaw provisions is now available on our Web site here.

The evolving forms of equity ownership in U.S. publicly traded companies, the recent Delaware decisions refusing to apply ambiguously drafted advance notice bylaws and recent strategies deployed by activist and other “event driven” investors, have caused many U.S. publicly traded companies to reexamine their advance notice bylaw provisions to, among other things, assess whether the required procedures and disclosures adequately address the interests of the corporation and its shareholders. In particular:

• The attributes of equity ownership in U.S. publicly traded companies has expanded dramatically due to the proliferation of derivative, swap and other transactions now available in the marketplace. For example, “total return equity swaps” allow an investor to create the economic equivalent of ownership of common stock without ever acquiring ownership of the security itself. Historically, investors have taken the position that these economic relationships do not confer beneficial ownership of the underlying equity under the federal securities laws and, for that reason, are not required to be disclosed. Conversely, investors also now have the ability to use derivatives to establish record ownership and thus the right to vote the shares without any exposure to economic ownership. This can be achieved, for example, by purchasing shares and simultaneously entering into offsetting put and call options or more simply by “borrowing” shares just prior to the record date for a shareholders’ meeting and returning the borrowed shares shortly thereafter, a strategy often called “record date capture.”

• Activist and other “event driven” investors also frequently execute their strategies in loose but effective coordination with other like-minded activists, without disclosure of their coordinated activities or any material relationships or other interests they hold. Most activist investors take the position that, because these coordinated activities are not conducted pursuant to an actual agreement (written or oral), they are not required to be disclosed under the federal securities laws.

• When deployed, these strategies permit investors to manipulate their economic interests and voting rights, as well as the nature and timing of disclosure, in a manner that may deprive the corporation and, more importantly, the shareholders of the ability to make informed voting and other decisions. For example, the corporation and its shareholders have an interest in knowing, in the context of a proposal for an extraordinary transaction, that the proponent of the proposal holds 15% record ownership but has reduced its economic ownership to 5% using derivative instruments, such that the proponent’s voting interest far exceeds its economic interest.

• Existing Delaware corporate law and federal securities laws recognize the interest of the corporation and its shareholders in having access to information that would be material to shareholder voting decisions. If a shareholder has made a proposal or nomination at an annual meeting, or is soliciting shareholders to call a special meeting or act by written consent, we believe information about the proponent’s economic, voting and other interests is material.

• Although the interest of the corporation and its shareholders in transparency is significant in these circumstances, existing federal securities laws have not been updated to address the changing aspects of equity ownership created by the proliferation of derivative instruments or the coordinated activities of activist and other “event driven” investors. Arguments have been made that disclosure may be required in certain circumstances under the federal securities laws, but the applicability of existing disclosure requirements is too often highly fact specific and, thus, far from clear. For example, the court in CSX Corp. v. The Children’s Investment Fund Management (UK) LLP, et al., held that “total return equity swaps” entered into by two activist investors constituted “beneficial ownership” requiring disclosure under the federal securities laws, after finding that the activist investors were engaged in a scheme to evade applicable disclosure requirements. Whether or not this holding is upheld on appeal, it is intensely fact specific. The same is true of the court’s second holding in CSX Corp. that the two defendant hedge funds had formed a group for purposes of the disclosure requirements of the federal securities laws. Moreover, it is now clear that the available remedies for such violations of the federal securities laws are extremely limited, and of dubious efficacy.

• There is uncertainty regarding what disclosures, if any, are required under the federal securities laws. There is also value in creating a regime under which the corporation and its shareholders have access to information that is material to voting and other decisions in the context of shareholder proposals and/or board nominations at an annual or special meeting or through a written consent solicitation. For this reason, we believe the board of directors of a Delaware corporation should be able to adopt reasonable bylaw provisions to elicit disclosure of information considered by the board to be relevant to shareholder decision-making, so long as the bylaw provisions are not intended to and do not unduly burden shareholder voting rights.

• Our model advance notice bylaw provisions clarify and strengthen the conventional advance notice bylaw, thereby bolstering their effect as tools to establish an orderly and efficient process for shareholders’ seeking to take action or nominate directors, as well as to elicit information relevant to the corporation’s and other shareholders’ evaluation of the proposed action or nominations. The new disclosure provision and related additions to traditional advance notice bylaws, we believe, are not unreasonable or unduly burdensome nor do they otherwise to restrict, in an inequitable manner, the ability of shareholders to make proposals, nominate directors, call special meetings or act by written consent.