Southern District of New York Attacks Stealth Proxy Contest Tactics
As previously reported in the February 2008 edition of Corporate Quick Hit, activist investors have been taking advantage of an apparent loophole in the Securities and Exchange Commission's Section 13D reporting requirements in order to set the stage for proxy contests without tipping off the targets or the market. Under these reporting requirements, investors who "beneficially own" more than five percent of the equity securities of a public company must disclose their holdings in public filings, in order to facilitate transparency in the markets. Beneficial ownership in this context means having the power to control the vote or the disposition of such securities.
In a recent case before the United States District Court for the Southern District of New York, the court considered whether a hedge fund violated Section 13D by failing to disclose beneficial ownership of shares of CSX Corporation ("CSX") referenced in cash-settled, total return equity swaps. The hedge fund entered into these swaps with eight counterparties, which in the aggregate afforded the hedge fund with economic upside on a position equivalent to more than 14% of CSX's shares (with a notional value in excess of $2.5 billion).
The court, in a fact-specific opinion, relying on the "anti-evasion" provision of Rule 13d-3(b) under the Securities Exchange Act, as amended, held that the hedge fund was "deemed" to be the beneficial owner of the CSX shares covered by the total return equity swaps—even though the hedge fund had no legal right to vote or dispose of such shares. Under Rule 13d-3(b), any person who uses a contract, arrangement or device with the purpose of preventing the vesting of beneficial ownership as part of a plan or scheme to evade the disclosure required by outright ownership is deemed to be the beneficial owner of the shares. The court found "overwhelming" evidence to support a finding that the hedge fund had engaged in the swap transactions primarily for that purpose.
The court, however, stopped short of enjoining the voting of the CSX shares covered by the total return equity swaps. In refusing to enjoin the voting of such shares, the court stated that it was constrained by binding precedent. The court further stated that were it not so constrained, it would have issued the injunction.
CSX Corp. v. Children's Investment Fund Mgmt. (UK) LLP, No. 08 Civ. 02764, 2008 U.S. Dist. LEXIS 46039 (S.D.N.Y. Jun. 11, 2008)
No Ruling Means No Change for Fantasy Baseball Leagues
On June 2, 2008, the United States Supreme Court denied Major League Baseball Advanced Media's ("MLBAM") petition for a writ of certiorari in a suit filed by MLBAM against C.B.C. Distribution and Marketing, Inc. ("CBC"), a fantasy sports game operator. The decision effectively affirms the lower court's ruling that CBC's First Amendment rights to use baseball players' names and statistical information supersedes the players' intellectual property rights.
The Eighth Circuit balanced the players' intellectual property rights with CBC's First Amendment rights and found that "the recitation and discussion of factual data concerning the athletic performance of players on Major League Baseball's website command a substantial public interest and, therefore, is a form of expression due substantial constitutional protection." The Supreme Court's decision not to review the Eighth Circuit's ruling enables CBC and other fantasy operators to use players' names and statistics without obtaining a license from the property owner, in this case MLBAM and the Major League Baseball Players Association ("MLBPA").
This case facilitates fantasy providers' operations by removing the need for these operators to obtain and pay for a license to use players' names and statistics. The number of fantasy providers will likely increase and the top-tier providers will need to differentiate themselves and offer a superior product to compete with the likely influx of new fantasy game operators. Ironically, this may provide an opportunity for property owners (like MLBAM and the NFL) to offer a more comprehensive and appealing rights package (including video and other copyrighted material) to game operators that want to distinguish themselves from the pack. A fantasy website that enables fantasy game players to see video clips of their players hitting a home run could provide the consumer with a richer experience than the website that merely posts the home run as a statistic.
For a more detailed discussion of the implications of this case, click here.
C.B.C. Distribution and Marketing, Inc. v. Major League Baseball Advanced Media, L.P, 505 F.3d 818 (8th Cir. 2007)
Delaware Court Denies Advancement of Litigation Expenses to Former Director
Under the Delaware General Corporate Law, Delaware corporations may advance expenses incurred by a director in defending a legal action, suit or proceeding. Such advances may be made pursuant to whatever terms and conditions the corporation sets forth in its governing documents. A recent Delaware Court of Chancery decision held that provisions in a corporation's bylaws allowing for the advancement of legal expenses to directors could be amended to terminate a former director's rights to advancement without such director's consent. The amendment, passed several months after the director's resignation, removed the word "former" from its definition of the directors entitled to such advancement.
In arguing that his rights to advancement under the corporation's bylaws should be protected, the former director claimed that his right to advancement of legal expenses was a vested contract right that the corporation could not terminate unilaterally. In finding for the corporation, the court held that the former director's right to advancement vested only at the time litigation commenced, that is, after the amendments to the bylaws had been passed. Consequently, the former director was denied advancement of litigation expenses.
In light of this holding, it is advisable for directors of Delaware corporations to seek expense advancement and indemnification rights through individually negotiated contracts with the corporation. Unlike corporate bylaws, such contracts may not be amended without the consent of the contracting parties.
Schoon v. Troy Corp., No. 2362-VCL, 2008 Del. Ch. LEXIS 36 (Del. Ch. Mar. 28, 2008)
Delaware Court Refuses to Enjoin Merger Vote Based on Financial Advisor Proxy Disclosure
The Delaware Court of Chancery recently refused to enjoin a merger vote based on a claim of insufficient disclosure in the merger proxy. The claimants argued that certain financial data considered by the target's financial advisor and discussed with the target's board of directors should have been disclosed in the merger proxy. The financial data at issue included forecasts as to the target's future financial performance, synergy analyses based on publicly available information from other merger transactions, and preliminary discounted cash flow analyses. After determining that neither the financial advisor nor the board of directors deemed the undisclosed financial data reliable or actually relied upon such data in reaching their valuation opinions, the court concluded that there was no showing that such information was material and that disclosure of such unreliable information "could well mislead shareholders rather than inform them." The court went on to state that "the fact that something is included in materials that are presented to a board of directors does not, ipso facto, make that something material."
In re BEA Systems, Inc. Shareholders Litigation, C.A. No. 3298-VCL (Del Ch. Mar. 26, 2008)
Companies Should Resolve Ambiguities in Advance Notice Terms in Their Bylaws
A recent Delaware Chancery Court decision, subsequently affirmed by the Delaware Supreme Court, allowed a stockholder to nominate a slate of new directors despite the stockholder's failure to satisfy the requirements of a bylaws advance notice provision. The advance notice provision reads, in pertinent part, as follows: "Any stockholder of the Corporation that has been the beneficial owner of at least $1,000 of securities entitled to vote at an annual meeting for at least one year may seek to transact other corporate business at the annual meeting. . . ." As of the date of the annual meeting, the stockholder did not meet that requirement. Nonetheless, the court found in favor of the stockholder by interpreting the advanced notice provision as applying only to proposals intended to be included in the company's proxy materials pursuant to Rule 14a-8 of the Securities Exchange Act of 1934, as amended.
Shortly after its above decision, the Delaware Chancery Court ruled in favor of a stockholder of a different company that sought to nominate director candidates from the floor of the annual meeting, despite the company's advance notice of business bylaws provision. The company had included the election of directors as an agenda item in its notice of annual meeting. The court ruled that, in light of that notice, no advance notice was required for stockholder nominations of directors. In this regard, the court found that the company, by noticing the election of directors as an item of business, had brought the business of considering director candidates—both the board nominees and the stockholder's slate of directors—before the annual meeting.
The above cases serve as a continued reminder that Delaware courts view advance notice provisions in bylaws skeptically and will interpret vague language contained in such provisions narrowly in favor of stockholders.
JANA Master Fund, Ltd. v. CNET Networks, Inc., 2008 WL 660556 (Del. Ch. Mar. 13, 2008), aff'd 2008 WL 2031337 (Del. S. Ct. May 13, 2008)
Levitt Corp. v. Office Depot, Inc., No. 3622-VCN (Del. Ch. Apr. 14, 2008)
Senate Bill Seeks to Require Disclosure of Beneficial Ownership of Newly-Formed Corporations and LLCs
Citing a need to help law enforcement prevent the misuse of private companies for money laundering, tax evasion or other misconduct, Senators Obama (D-Ill.), Levin (D-Mich.) and Coleman (R-Minn.), all members of the U.S. Senate Permanent Subcommittee on Investigations, recently introduced a bill to the United States Senate entitled the "Incorporation Transparency and Law Enforcement Assistance Act (the "Act")." If enacted, the Act would require every state to obtain an annual listing of the beneficial owners of each corporation or limited liability company formed under its laws. If any beneficial owner is not a United States citizen, the Act would further require corporations and limited liability companies to provide a certification from an in-state formation agent that such agent has verified the identity of such beneficial owners. Civil and criminal penalties would be established for persons who knowingly provide false beneficial ownership information or intentionally fail to provide required beneficial ownership information to a state. In addition, the Act would require formation agents in each state to establish anti-money laundering programs to ensure that they are not forming business entities for criminal or otherwise suspect persons.
The Act would exempt public companies and their subsidiaries from the aforementioned requirements, as such companies are already overseen and regulated by the Securities and Exchange Commission. If enacted, states will have until October 2011 to require beneficial ownership information of all other newly formed entities.
The bill has been referred to, and is awaiting approval from, the Senate Committee on Homeland Security & Governmental Affairs.
Senate Bill 2956 (2008)
For more information on these issues or other corporate matters, please contact:
Copyright © 2008 Herrick, Feinstein LLP. Corporate Quick Hit is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.