Given the current economic environment, there has been increased scrutiny by public company shareholders of the managements of many underperforming companies. There are many reasons why shareholders may be dissatisfied with a public company’s performance. When shareholders believe that poor decision making, judgment or strategic vision on the part of the company’s incumbent management is to blame, they may consider an activist approach to effect change. While shareholder activism is not new, many more investors now feel that it is prudent to take a more activist approach to protect their investments.
In most instances, a shareholder’s first efforts will be to establish a constructive dialogue with management or members of the board of directors in an effort to makes its views known and encourage change. In other instances, a shareholder may have the opportunity to have its proposal put before shareholders on the Company’s own proxy statement. However, when all other options have been considered or exhausted, a shareholder may decide that it has no choice but to resort to a full proxy fight to gain representation on, or even control of, the board.
Because of the considerable costs of a proxy solicitation, in terms of resources, time and money, activist shareholders should carefully consider whether such a strategy is right for their particular situation. This article briefly discusses certain key factors to consider before deciding whether to proceed with a contested proxy solicitation.
Before determining whether to conduct a contested proxy solicitation, a shareholder must carefully consider the chances of success against the significant costs involved. While there is no “typical” proxy contest, an analysis of several important factors can provide insight into what will be required, as well as the likelihood of success. These factors typically include:
- Target company defenses. Understanding a target company’s defensive measures and a shareholder’s procedural rights is key to any solicitation. Generally, a review of the company’s articles, bylaws and other publicly filed documents allow a shareholder to determine the existence of matters such as limitations or prohibitions on the ability to call meetings, restrictions on shareholder proposals, the existence of a staggered board, the adoption of a poison pill and other limitations that may significantly increase the expense, timing and ultimately determine the success of a proxy contest. A company’s constituent documents also provide a blueprint of the procedural requirements necessary to get a shareholder’s proposals or nominations on the ballot. In addition to provisions in a company’s constituent documents, loan agreements, employment agreements and other material contracts should also be reviewed to determine whether there are change of control or similar provisions and the cost to the company in the event of success.
- Shareholder base. Ultimately, the company’s other shareholders will determine the success of a proxy solicitation. A diverse retail base may significantly increase the scope and cost of the solicitation process, while significant holdings in the hands of insiders or other hostile shareholders, even if not seemingly sufficient to block a shareholder’s agenda, may reduce the likelihood of success. The target company’s shareholder base may also work to the activist shareholder’s advantage in instances where potentially sympathetic holders, such as institutional investors, control a significant number of shares. In some instances, Federal securities laws may permit a shareholder to solicit a limited number of other shareholders without the necessity of delivering a proxy statement or conducting a full solicitation.
- Meaningful change. Poor performance is not always a sufficient basis for a change in the board or management; a successful proxy solicitation generally must identify specific and recurring faults of current management and, equally as important, give holders a reason to vote for a new agenda. While an activist shareholder need not rely on its own credentials, it must be able to present one or more qualified nominees that shareholders believe will bring meaningful change to the company.
A successful proxy contest will bring about the desired change, and even the commencement of a solicitation may significantly strengthen a shareholder’s ability to negotiate change with the company. However, where consideration of the factors discussed above suggests that it is unlikely a solicitation would be successful or, in certain cases, even possible, other strategies that may result in the desired change include:
- Nominating one or more candidates to serve as a director for election at the company’s annual shareholder meeting;1
- Making a “shareholder proposal” for inclusion on the company’s ballot at the next annual shareholder meeting, as permitted and, under certain circumstances required, under Rule 14a-8 of the SEC’s proxy rules;
- Aligning with other shareholders to form a group for Federal securities law purposes to demonstrate unified interest in causing change at the company; or
- Acquiring additional voting securities of the company to enhance both economic and voting power.
The Solicitation Process
The ultimate purpose of any proxy solicitation is to obtain the ability to vote other shareholders’ securities. However, the actual voting of these shares is the final aspect of a proxy solicitation process. The significant steps in a solicitation that must occur before the vote include:
- Notice of shareholder meeting. While activist shareholders may solicit proxies for a company’s annual meeting, many contested proxy contests culminate at a special shareholder meeting. Procedures for calling a special shareholder meeting and establishing the matters that may be brought before the meeting are typically governed by the company’s constituent documents and applicable state law.
- Proxy statement preparation. Once a shareholder meeting has been called and the proposals for that meeting established, the shareholder must prepare the proxy statement and obtain SEC approval before the actual solicitation of shareholder votes can begin.
- Solicitation. In accordance with SEC rules, shareholders engaged in a proxy contest may publicly disclose certain information relating to their solicitation in advance of the final proxy statement. However, only after the final proxy statement has been approved by the SEC and sent to each shareholder of the company may actual proxies be solicited.
- Shareholder meeting. Following the solicitation of votes, the proxies granted by other shareholders of the company are finally cast at the shareholder meeting. While the outcome of the solicitation is typically known by the time of a meeting, official results will usually be determined by an independent examiner agreed to by the shareholder and the company.
In addition to the shareholder itself, the other players involved will include other participants in the solicitation, legal counsel (which will typically include both securities, litigation and local counsel), and a proxy solicitor. Independent proxy advisors are also likely to play a significant role in the outcome of the solicitation process. Each is discussed below.
- The participants. The SEC proxy rules identify a proxy solicitation participant as any person or group who solicits or who “directly or indirectly takes the initiative, or engages, in organizing, directing or arranging for the financing” of any person or group that solicits proxies, as well as any person nominated for election as a director. Each person named as a nominee in a proxy solicitation will also enter into an agreement with each other participant pursuant to which he or she agrees to be named as a nominee and to serve as director if elected.
- Legal counsel. Legal counsel will play a significant role in the solicitation process. Securities lawyers will have primary responsibility, together with the shareholder, for preparing the proxy statement, ensuring its compliance with SEC and company-imposed requirements and managing the SEC review and clearance process of the proxy statement. In certain instances, local counsel in the company’s home jurisdiction may also be required to advise on local law.
Thorough diligence of the target company will help to avoid procedural surprises later in the solicitation process. However, in the adversarial context of a proxy contest, it is not uncommon for the target company to object to the shareholder’s conduct of the solicitation campaign on procedural grounds. While such tactics may have a legitimate basis, they are often motivated by the desire to derail the hostile solicitation, and it is therefore important that litigation counsel be involved early on in the process to be able to respond promptly to any challenge.
- Proxy solicitor. While a proxy solicitor is retained to solicit shareholder votes, a key element of any contested proxy fight, the solicitor should be chosen based on its ability to contribute to the entire solicitation process. In addition to its capabilities in soliciting votes, a solicitor should be expected to leverage its experience to assess the target company’s shareholder base and assist in developing an efficient solicitation strategy, provide advice on the proxy statement itself and monitor the solicitation process in advance of the vote.
- Independent proxy advisors. Many institutional investors today vote in accordance with the recommendations of an independent proxy advisor, which include firms such as Glass Lewis & Co., Risk Metrics Groups (formerly Institutional Shareholder Services) and Egan-Jones. While the impact of these recommendations depends on the company’s shareholder base, in many cases they will be dispositive.
An independent advisor’s recommendations are based upon an analysis of a number of pre-determined factors established by the advisor, however, there are certain measures that the shareholder may employ to increase the chances of a favorable recommendation. These include:
- Tailored proxy materials. The proxy statement and other proxy materials should be tailored to address the advisor’s analysis process and to present key factors of that analysis in terms most favorable to the shareholder.
- Nominee qualifications. No matter how egregious the failures of incumbent directors may be, an under-qualified nominee will rarely receive a favorable recommendation from the independent advisors. The key factors that will be looked at include the extent and relevance of a nominee’s experience within the industry and prior experience on a public company board.
- Cooperation with advisor. While the independent advisors’ analysis is based primarily on public proxy materials, nominating shareholders should request, and will often be granted, an opportunity to present their position and answer any questions the advisors may have directly. Similarly, nominating shareholders should carefully review any advisor recommendations and address any inaccuracies, whether relating to the shareholder’s or the company’s materials. Advisors will often consider inaccuracies brought to their attention and may change a recommendation.
As the primary disclosure document relating to the shareholder’s solicitation, the proxy statement and any related “fight letters” must be drafted both to satisfy applicable SEC disclosure requirements as well as to present a compelling argument for change. In most proxy solicitations contests, the final proxy statement (together with the proxy voting card itself) is the only document that is sent to each shareholder of the company.
While the proxy statement and any related fight letters must present the argument for change, they must also satisfy the SEC’s disclosure requirements, both in order to clear the SEC comment process and to protect participants from potential liability. In particular, a proxy statement, and any other solicitation materials used by solicitation participants, are subject to the SEC’s standard anti-fraud provisions that prohibit false or misleading statements or the omission of material information. A violation of these provisions may result in the SEC requiring a shareholder to amend its proxy materials, prohibit the use of the proxy statement altogether or invalidate any votes received based on alleged false or misleading information or, in extreme cases, the institution of an enforcement action.
In addition to the shareholder’s reason for wanting change, each proxy statement must include, among other things, detailed information about each solicitation participant including:
- all relevant experience of each nominee for at least the past five years;
- any related party transactions or relationships between any participant and the target company;
- any criminal conviction of a participant during the past ten years;
- the amount of each class of securities (and any derivatives of such securities) of the target company each participant owns and all transactions in such securities over the past two years; and
- the participant’s total estimated costs of the solicitation, information about who will be responsible for such costs and whether the participant will seek to recover costs from the company.
The SEC will typically provide written or verbal comments to the preliminary proxy statement within 10 days of filing. Before the actual solicitation of proxies from other shareholders can commence, any SEC comments must be addressed and the final proxy statement, together with the form of written proxy, must be distributed to the shareholder base. While the SEC will not assess the substance of a shareholder’s argument for change, typical SEC comments ask participants to include required information that the SEC does not believe was adequately provided in accordance with SEC forms and rules or to delete or modify unauthorized information such as forecasts or insufficiently substantiated assertions. In addition, the SEC may address any concerns with the proxy statement that the opposing side may identify and raise with the SEC.
The actual cost of mounting a proxy contest will depend on a number of factors and the principal costs will typically include legal fees and expenses, the fees and expenses of the solicitor, and printing and mailing costs. While not dependent on the shareholder base, legal fees will also vary widely depending on, among other factors, the proposals included in the proxy, the extent of SEC comments to the proxy statement, the jurisdiction and applicable law governing the solicitation and the defense mounted by the company, including whether the company raises legal challenges to the solicitation based on alleged failures to meet certain procedural requirements. Such challenges, which are a common defensive tactic of a target company, can result in protracted litigation even before the actual solicitation begins and can significantly increase the total cost of the campaign. Solicitation, printing and mailing fees and costs are dependent on the company’s shareholder base. It is not unusual for aggregate costs to exceed $1 million.
While a shareholder must be prepared to bear all of these costs, both Delaware and New York law permit a shareholder to seek reimbursement of its expenses, subject to shareholder approval, which not surprisingly will typically depend on the ultimate success of the solicitation. Under both Delaware and New York law, the company’s incumbent management is entitled to reimbursement of reasonable expenses incurred in connection with the defense of a contested proxy contest.
In the adversarial environment of a contested proxy contest, every filing made during the period leading up to and in the course of the solicitation is likely to be subject to heightened scrutiny, both by the SEC, the target company and other investors. To the extent not already reporting on a Schedule 13D, shareholders will generally be required to switch to a Schedule 13D as soon as they form the requisite intent to bring about the intended change, and may be prohibited from buying or voting any of the target company’s shares from the time they have changed their intentions (from being “passive” to “active”) until 10 days after the Schedule 13D has been filed with the SEC.
It must also be kept in mind that any participant in the solicitation process that owns any of the company’s shares, regardless of number, will be deemed to be part of a group for Section 13 purposes and subject to Section 13 filing obligations. In addition, because any member of a group for Section 13 purposes is deemed to be the beneficial owner of all voting securities held by that group, each participant must be aware of the possibility of being subject to Section 16 of the 1934 Act, including the short swing profit rules, especially those applicable to ten percent shareholders, as a result of participating in a proxy solicitation.
The conduct of a contested proxy solicitation is a significant undertaking that should be carefully considered before investing the significant time and resources likely to be required. While there is no way to assure the outcome of any solicitation, careful consideration and planning with experienced persons can significantly increase the likelihood of success.
If you have any questions with respect to the foregoing, please contact one of the attorneys listed below.
1 On May 20, 2009, the SEC announced its intent to propose amendments to the proxy rules that would, among other things, permit shareholders owning a minimum number of shares to include one or more director nominees in the company’s own proxy materials. These amendments, if implemented, would track recent changes to the Delaware General Corporations Law that will become effective on August 1, 2009, that permit (but do not require) bylaws of Delaware companies to include provisions requiring the company to (i) include shareholder director nominations in the company’s proxy materials or (ii) reimburse shareholders for expenses incurred in connection with a contested proxy solicitation relating to the election of directors.