Gleeson, William (General) - K&L Gates 4 Fund Organizational Documents Common Anti-Takeover...

Contents PowerPoint Presentation……………………….Tab 1

Section 13(d) of the Securities Exchange Act..Tab 2

Navigating Proxy Contests……………………..Tab 3

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William Gleeson, Corporate and Securities Partner, K&L GatesMark P. Goshko, Investment Management Partner, K&L GatesClair E. Pagnano, Investment Management Partner, K&L GatesWarren Antler, Managing Director, The Altman Group

Strategies for Closed-end Funds When Dealing with Proxy Contests and Hostile Tender Offers

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Agenda

I. Positioning Your closed-end Fund to Avoid Activist ShareholdersClair E. Pagnano, Investment Management Partner, K&L Gates

II. Navigating Proxy Contests William Gleeson, Corporate and Securities Partner, K&L Gates

III. Industry Overview Warren Antler, Managing Director, The Altman Group

IV. Question and Answer Session

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I. POSITIONING YOUR CLOSED-END FUND TO AVOID ACTIVIST SHAREHOLERS

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Activist Shareholders Overview

Over past several years activists have targeted Closed-end fundsClosed-end funds with wide trading discounts are most exposedActivist seek to arbitrage these discounts

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Fund Organizational Documents

Common Anti-Takeover ProvisionsStaggered board elections.

Removal of director only for cause by a written instrument signed by the remaining directors or by a vote of the holders of at least two-thirds of outstanding shares of the Fund.

75% shareholder vote to approve certain transactions with Principal Shareholders (any person who alone or together with its affiliates and associates, beneficially owns 5% or more of the Fund).

Supermajority provisions for open-ending the Fund (two-thirds or 75% of outstanding votes).

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Fund Organizational Documents

Require significant shareholders to disclose any derivative positions they may have against the Fund.

Review if anti-takeover provisions can be added or amended without a shareholder vote.

Consider including enhancements to anti-takeover provisions in annual proxy if shareholder vote deemed necessary.

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Trading Discounts

Critical component of an activist s strategy.

Raiders seek a profit buy the Fund on open market at significant discount and seek to force an action by the Fund that allows them to sell at a higher price.

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Trading Discounts

Create a strong record of attention to discountBoard regularly reviews and considers impact of trading discount on shareholders.

Board considers what, if any, specific actions should be taken to address trading discounts.

Prior board considerations may be used in discussions with activists and proxy materials sent to shareholders to counter claims board not activity involved.

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Trading Discounts

Actions to address discounts share repurchasesPeriodic, small tender offers typically up to 5% of outstanding shares at 95% of NAV.

At-the-market share repurchase program must be in compliance with anti-manipulation safe harbor in 1934 Act Rule 10b-18 (manner, timing, price, and volume conditions). Must be reported on N-CSR.

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Trading Discounts

Actions to address discounts focus on distributionsIncrease dividends to shareholders.

Closed-end funds are typically purchased as income vehicles. Increasing dividends may narrow trading discounts because shareholder getting increase value from investment.

Seek investing opportunities that generate more income for the Fund consider if within current investment parameters of the Fund.

Consider other changes to generate increased income.

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Trading Discounts

Actions to address discounts focus on distributionsManaged distribution plans including long-term capital gains in regular monthly or quarterly distributions pursuant to SEC exemptive order.

SEC in mid-2008 began re-issuing 19(b) exemptive orders to closed-end funds. Subject to new more onerous conditions.

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Trading Discounts

Current market conditionsPositioning the fund s investments conservatively within asset class may make fund more attractive to investors and narrow discounts.

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Evaluate and build in anti take-over provisions

Well-documented record critical to positioning the Fund against attacks from activist shareholders

Demonstrate that Board and management pro-actively involved in addressing issues and notify shareholders of such actions

Proxy voting services place significant weight on this information

Summary of Measures Funds May Consider

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II. NAVIGATING PROXY CONTESTS

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Navigating Proxy Contests

Proxy Rules: Who can say what to whom and when before furnishing a proxy statement

Fight Letters

Rule 13d-5: Groups and Wolfpacks

Advance Notice Bylaws

Preliminary Proxy Material

Proxy Contest Litigation

Settlement of Proxy Contests

Importance of Proxy Advisors

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Proxy Rules: Who can say what to whom and when before furnishing a proxy statement

Rule 14a-3(a): No solicitation shall be made unless each person solicited is concurrently, or has been, furnished with a proxy statement

Solicitation: Communication that (i) is part of a continuous plan ending in formal proxy solicitation and (ii) prepares the way for its success

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Who can say what to whom and when?

Rule 14a-12: Notwithstanding Rule 14a-3(a), a solicitation may be made before furnishing security holders with a proxy statement, provided that no proxy card before proxy statement.

If writing: conditions Two legends and filing with SEC required

If oral: no conditionsNot required to be reduced to writing, to have legends, or to be filed

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Rule 14a-12

Intent and effect: freely communicateAvailable to issuers and shareholdersPermits solicitations weeks and months before formal proxy solicitationOral: Can talk to large shareholders, make speeches, and obtain oral commitments to execute proxies

No public disclosure or SEC filings required

Written: Can send letters to shareholders and issue press releases

Must be filed with SEC

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Fight Letters

Communications in addition to the 14a-3(a) proxy statement that set forth the reasons why shareholders should give their support.

If sent before proxy statement is furnished, Rule 14a-12 governsIf sent with or after proxy statement is furnished, additional soliciting material for purpose of Rule

14a-6(b). Filing of preliminary copies not required

StrategiesFraming the debate, continuous communication, rapid response

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Rule 13d-5:

When two or more persons agree to act together for the purpose of acquiring, holding, voting or disposing of equity securities of an issuer, a group is formed and is deemed to have acquired beneficial ownership of all securities beneficially owned by its members

Rule 13d-1(a):If the group owns 5% or more and has control intent, it must file a 13D within 10 days

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Why status as a group matters:

Disclosure obligations: 13(d), the proxy rules, and advance notice bylaws

Transparency: To issuer and shareholders

Ownership triggers: Poison pills, control share, business combination, ownership limits, and Section 16

Remedies for failure to disclose: Enjoin proxy solicitation; disqualify nominees and proposals under advance notice bylaws

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Wolfpacks

loose network of like-minded hedge funds often working in tandemhunting together for the same preyA wolf pack roves from target to target trying to

force short-term gains at the expense of the long-term shareholder

13d-5 PositionMutually supportive actions in furtherance of a common goal but without an agreement

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Advance Notice Bylaws

Nomination or proposal by shareholder:Giving timely notice andMaking required disclosure

Required disclosure: (about nominee and nominating shareholder)

Agreements subject to Rule 13d-5 (a group)Derivatives, voting arrangements, and other interests and copies of documentsUpdate information until meeting date

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How is a group determination made?

Granting or receiving a revocable proxy does not form a 13d-5 groupGroup members need not be committed to acting on certain specified terms, but only to further a common objectiveCan be proved circumstantially from prior relationships, communications, and trading patterns Probably need discovery process in litigation

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How willing are courts to find that there is a group?

The most important development is [the courts] continued reluctance to find undisclosed groups

Decisions have enabled hedge funds to engage in wolf pack tactics against companies undeterred by a fear of somehow magically becoming a group merely because they hunt together and seek the same prey


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If a court finds an undisclosed group, what then?

Federal securities lawEnjoin meeting until corrective disclosure is made and absorbed; no sterilization of shares

Advance notice bylawsDisqualification of nominee or proposal

Ownership triggersPoison pill, control share, business combination, ownership limit, and Section 16

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Preliminary Proxy Material

Required if proxy statement comments upon or refers to a solicitation in opposition

Staff position: Inconsistent with Rule 14a-9 when company s initial definitive proxy statement does not disclose the existence of a solicitation in opposition when the company knows, or reasonably should know, of it

Rule 14a-6(a) requires that preliminary copies of the proxy materials be filed 10 days before furnishing

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Preliminary Proxy Materials: Helpful Hints

Getting in Line: SEC staff reviews proxies in the order that they are received Submission Codes: DEF14A (definitive proxy statement) as opposed to PREC 14A (preliminary proxy statement in connection with contested solicitations)Rule 14a-13: Inquiry of brokers and banks at least 20 business days prior to the record date of the meeting

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Basis for proxy contest litigation:

Failure to comply with the filing requirements of SEC proxy rules

Failure to comply with disclosure requirements of SEC proxy rules. Typically, framed as violation of antifraud provisions of Rule 14a-9

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Failure to comply with filing requirements

14a-12: No enforcement actions by SEC and no reported private cases

Completely ignoring the proxy rulesStudebaker Corp. v. Gittlin, the defendant shareholder completely ignored compliance with the proxy rules. The Court enjoined use of the stockholder authorizations until after compliance with the proxy rules

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How do courts approach defective disclosure claims?

participants in proxy contests . . . act . . . quickly, sometimes impulsively, often in angry response to what they consider, whether rightly or wrongly, to be low blows by the other side. Probably there will no more be a perfect . . . proxy solicitation than a perfect trial . . . .These considerations bear not only on the judgment to be applied in testing conduct and materiality, but in determining relief as well.

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The practical realities of the situation are that [Issuer] and [Activist] respectively, can and presumably will put the material facts into the hands of the [shareholders] promptly. At that point, any misleading impressions created to date should be overcome, and the fate of the mergers will be for the [shareholders] to decide. . . .

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The courts must simply be careful, when enjoining the use of proxies unlawfully solicited, to avoid disenfranchisement of the innocent security holders who gave the violator their proxies. The solution is to order a postponement of the meeting, unless it is postponed voluntarily, in order to permit resolicitation.

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Settlement of Proxy Contests

The Activist should:

Withdraw notice under advance notice bylaws

Notify SEC in writing that the proxy contest has been terminated

Withdraw demands for inspection of records

Amend Schedule 13D to indicate the proxy contest has been terminated and a settlement agreement executed

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Importance of the Proxy Advisors

Most institutions subscribe to proxy advisors and some delegate voting authorityTremendous clout, extraordinary influence, able to

sway 20% - 30% of the voteRobust association between recommendations and

contest outcomesRecommendations convey non-public information to

investors about outcome-contingent stock valuations under dissident and incumbent management. Recommendations serve to certify the quality of rival teams

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III. INDUSTRY OVERVIEW

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Current State of the Discounts

The depressed valuations have resulted in unprecedented interest in CEF s

The concept of buying at a discount has attracted institutional investors

We will see an increase in institutional buying when the new 13F s are filed

As of January 7, 2009, the average discount has improved from an average discount of -13.77 % on October 1, 2008

As of January 7, 2009, 44 CEF s trading at a discount of 20% or greater compared to 145 CEF s trading at a discount on October 1, 2008

As of January 7, 2009, 340 CEF s trading at a discount of 10% or greater compared to 474 CEF s trading at a discount on October 1, 2008

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Survey of New Institutional Investors in Closed-end Funds

The Altman Group sent out a closed-end fund survey to 480 institutional investors which show shareholdings in at least oneclosed-end fund of less than a reportable amount (less than 5% of the outstanding shares.) These holdings appear on Form 13F filings, a form used by institutions which manage at least $100 million. The target audience was primarily hedge funds and those 13F filers showing positions of less than 2% per fund. In the survey we also included institutions that have not yet invested in closed-end funds but have contacted us for information.

The goal of the survey was to gauge the composition of institutional shareholder base in closed-end funds and how that may have changed following recent market turmoil.

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There were 76 respondents to the following questions, and their answers are summarized on the following slides:

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Managed Payout Policies

In August 2008 CEF s started to receive exemptive relief from section 19B from the SEC in order to implement managed payout programs

Investors looking at the ARP s crisis, the state of the stock market the cutting of dividends of CEF s and the Wall Street scandals, investors are more concerned about safety than yield

As of Jan 7, 2009 you have 76% of CEF s with managed distribution programs trading at a discount of 10% or greater compared to 78%of CEF s trading at a discount of 10% or greater on October 1, 2008

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Review Of Key Topics Of 2008

18 CEF s either terminated or merged in 2008, 1 CEF converted to an ETF2 CEF s reached settlements with dissidents to conduct tender offers4 shareholder proposals failed, 3 of the proposals were submitted by Dr. Baer3 lifeboat provision shareholder votes to convert to an open-end fund were defeated26 CEF s conducted tender offers, 1 was a third party tender and 5 were in-kind tendersWe had the first in-kind tender of a domestic CEF Tri-ContinentalThere were 8 proxy fights, 5 of the fights were won by the fund, 1 fight resulted in neither the dissidents or incumbents received enough votes to be elected, 2 fights the dissidents did not vote their shares therefore the funds were unable to obtain quorum

*Note to obtain the complete historical record of 2008 contact

Cecilia Gondor at Thomas J Herzfeld Advisors at 305 271 -1900.

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City of London Investment Group Barry Olliff

COL has had 1 proxy fight in the past 10 years, in 2004 COL nominated directors at the Korea Fund annual meeting Will vote to without directors vote at Country funds annual meetingsWill support the dissidents and will vote for lifeboat provisionsLong Term Buyer of Country FundsCurrently COL holds significant positions in 16 Country funds

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Bulldog Investor Phil Goldstein

Every position held by Bulldog can result in a shareholder proposal or a proxy fight

Currently Goldstein holds significant positions in 9 funds

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Western Investment Art Lipson

Every position has the potential to wind up as a proxy fight

Western will hold leveraged derivative positions

Western is interested in short term profits

Currently Western holds significant positions in 5 funds

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Proxy Contests 2008

ASA LTD vs LAXEY PARTNERS

COHEN & STEERS REIT & UTILITY INCOME FUND vs WESTERN INVESTMENT COHEN & STEERS SELECT UTILITY FUND

Incumbent directors were re-elected

DWS GLOBAL COMMODITIES STOCK FUND vs WESTERN INVESTMENT

None of the nominees received sufficient number of votes to be elected

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Proxy Contests 2008 (continued)

FRANKLIN UNIVERSAL TRUST vs. BULLDOG INVESTORSIncumbent directors were re-electedShareholders voted against a plan to merge into an open-end Franklin fund

INSURED MUNICIPAL INCOME FUND vs. BULLDOG INVESTORSA quorum could not be reached because Bulldog group did not vote its sharesBulldog followed with a suit representing over 25% of the shares outstanding on the grounds that the stock holders were so divided that directors of the fund could not be elected

JOHN HANCOCK TAX-ADV DIV INCOME FUND vs. WESTERN INVESTMENTS

Incumbent directors were re-elected

MFS INTERMEDIATE INCOME TRUST vs. KARPUS INVESTMENT MANAGEMENT

Karpus did not vote its shares, therefore the fund was not able to achieve a quorum

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Shareholder Proposals 2008

FORT DEARBORN INCOME SECURITIESShareholder Ralph Bradshaw submitted a shareholder proposal to terminate the advisory agreementProposal did not pass

WESTERN ASSET CLAYMORE INFLATION LINKED OPP & INC. FUNDShareholder Walter Baer submitted a proposal to merge into a Western open-end fundProposal did not pass

MFS CALIFORNIA INSURED MUNICIPAL FUNDShareholder Walter Baer submitted a proposal to merge into an open-end fundProposal did not pass

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Shareholder Proposals 2008 (continued)

TEMPLETON DRAGON FUNDShareholder Morris Scheffler submitted a proposal to convert to an open-end fundProposal did not pass

FRANKLIN UNIVERSAL TRUSTShareholder Walter Baer submitted a proposal to merge the fund into an open-end fundProposal did not pass

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Activist Did Not Proceed With Proxy Contests

AMERICAN SELECT PORTFOLIOAMERICAN STRATEGIC INCOME PORTFOLIOAMERICAN STRATEGIC INCOME PORTFOLIO IIAMERICAN STRATEGIC INCOME PORTFOLIO III

vs.Ralph Bradshaw Chairman of Cornerstone Funds

Bradshaw owned 301 shares of each fundIncumbent directors were re-elected

RIVUS BOND FUND vs. RALPH BRADSHAWBradshaw owned 601 shares of the fundIncumbent trustees re-elected

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Shareholder Proposal 2009

BOULDER GROWTH & INCOME FUNDFund received 2 separate shareholder proposals form Ralph Bradshaw and Ron Olin

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Funds With Dissident Actions In 2009

INVESTMENT GRADE MUNICIPAL INCOME FUNDWestern Investment filed an opposition proxy for the Jan 15, 2009 meetingelect 2 directors entitled to vote solely on ARPselect 4 common directorsreject proposed new investment adv contractapprove Karpus shareholder proposal to terminate inv adv contractapprove Walter Baer shareholder proposal recommending that the board be prohibited from retaining UBS Global AM as investment managerfor fund

WESTERN ASSET VARIABLE RATE STRATEGIC FUNDWalter Baer shareholder proposal to open-end or liquidateOpportunity Partners shareholder proposal to conduct a self tender for all outstanding shares at NAV. If more than 50% tender, tender should be cancelled and the fund liquidated or merged into an open-end fund

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Funds With Dissident Actions In 2009

FIRST TRUST/ABERDEEN EMERGING OPPORTUNITY

Bulldog Investors submitted a shareholder proposal to be included in 2009 proxy statement Propose that the board authorize the fund to conduct a self tender for all the outstanding shares at NAV if more than 50% of shareholders submit shares for a tender, the tender be cancelled and the fund liquidated or open-ended

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Change Of Control Votes

Since the change in NYSE Rule 452 dissidents have used their voting power to block change of control votes on investment contracts

Because of lack of funds available to dissidents caused by the current market conditions they have passed on change of control votes on several major fund groups

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Question & Answer Session

SECTION 13(d) OF THE SECURITIES EXCHANGE ACT

TABLE OF CONTENTS

Page

[1] Section 13(d): Purpose....................................................................................................... 1

[2] Securities Subject to Section 13(d) ..................................................................................... 1

[3] Forms 13D and 13G............................................................................................................ 1 [a] Rule 13d-1(a) and Schedule 13D............................................................................ 1 [b] Rule 13d-1(b): Schedule 13G for institutional investors. ...................................... 1 [c] Rule 13d-1(c) Schedule 13G for passive investors................................................. 2

[4] Amendments to Schedules 13D and 13G ........................................................................... 2

[5] Switching from Schedule 13D to Schedule 13G ................................................................ 2

[6] Beneficial Ownership.......................................................................................................... 2

[7] Beneficial Ownership Through Total Return Swaps .......................................................... 3

[8] Control Intent ...................................................................................................................... 4

[9] Groups................................................................................................................................. 5

[10] 13(d) Litigation ................................................................................................................... 7 [a] Private Right of Action. .......................................................................................... 7 [b] Damage claims........................................................................................................ 7 [c] Injunctive relief. ...................................................................................................... 8 [d] Injunctive actions seeking compliance with the filing requirements or

amended disclosure................................................................................................. 8 [e] Short-circuiting injunctive actions seeking compliance with the filing

requirements or amended disclosure....................................................................... 8 [f] Sterilization as a Remedy...................................................................................... 10

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[1] Section 13(d): Purpose

Section 13(d) of the Securities Exchange Act (“Exchange Act”) and the 13d-series of rules promulgated there under, require persons who have acquired substantial interests in the equity securities of certain public companies to file a statement with the SEC that alerts shareholders of a large accumulation of stock by a party that might potentially affect the company’s control.

[2] Securities Subject to Section 13(d)

Section 13(d) is applicable only to equity securities and it applies to the following classes of equity securities, among others:

• Equity securities registered pursuant to Section 12(b) of the Exchange Act (exchange listed securities);

• Equity securities registered pursuant to Section12(g) of the Exchange Act (a class is required to be registered under Section 12(g) if the class is held by at least 500 record holders and the issuer has $10 million in assets; voluntary registration is possible where the requirements are not met; exchange listed securities are exempt for Section 12(g)); and

• Equity securities issued by a closed-end investment company registered under the Investment Company Act of 1940.

[3] Forms 13D and 13G

[a] Rule 13d-1(a) and Schedule 13D

Rule 13d-1(a) applies to a person who, as a result of acquisitions of securities, “directly or indirectly is the beneficial owner of more than 5 per centum of a class of equity securities.” The rule requires that person to file a Schedule 13D with the SEC within 10 calendar days after the acquisition.

[b] Rule 13d-1(b): Schedule 13G for institutional investors.

Rule 13d-1(b) provides that certain institutional investors may file a short-form statement on Schedule G rather than file a statement on Schedule 13D. Such institutional investors include brokers and investment advisors who acquired such securities:

• In the ordinary course of his business; and

• Not with the purpose or with the effect of changing or influencing the control of the issuer, nor in connection with or as a participant in any transaction having such purpose or effect.

The institutional investors must file Schedule 13G within 45 days after the end of the calendar year.

[c] Rule 13d-1(c) Schedule 13G for passive investors.

Rule 13d-1(c) provides that a person other than an institutional investor listed in Rule 13d-1(b) may file a Schedule G rather than Schedule 13D if

• He beneficially owns less than 20% of the class; and

• He has not acquired the securities with the purpose nor with the effect of changing or influencing the control of the issuer, nor in connection with or as a participant in any transaction having such purpose or effect.

Schedule 13G must be filed with the SEC within 10 calendar days after the acquisition.

[4] Amendments to Schedules 13D and 13G

Rule 13d-2 requires that if any material change occurs in the facts set forth in the Schedule 13D or 13G, an amendment must be filed. An amendment to the 13D must be filed promptly. If the 13G filer owns less than 10%, an amendment to the 13G must be filed within 45 days after the end of the calendar year. If the institutional investor 13G filer acquires more than 10%, an amendment must be filed within 10 after the end of the month in which the 10% threshold is exceeded and additional acquisitions of 10% take place. If the passive investor 13G filer acquires more than 10%, an amendment must be filed within 10 after the end of the month in which the 10% threshold is exceeded and additional acquisitions of 10% take place.

[5] Switching from Schedule 13D to Schedule 13G

Rule 13d-1(e) provides that if a 13G filer changes its control intent, it must begin to file on Schedule 13D. The change in the reporting form is required if it acquires additional securities after having changed its control intent or “holds” the securities at a time that it has a control intent; that is, with the “the purpose nor with the effect of changing or influencing the control of the issuer.” For passive investors, the change is required if the passive investor’s beneficial ownership exceeds 20%.

[6] Beneficial Ownership

Rule 13d-3 defines “beneficial ownership.” The filing requirement of Rule 13d-1(a) is triggered by the beneficial ownership of 5% of a class of equity securities. Under Rule 13d-3(a), beneficial ownership is based on

• Voting power which includes the power to vote, or to direct the voting of, such security; and/or

• Investment power which includes the power to dispose, or to direct the disposition of, such security.

Beneficial ownership for Section 13(d) is not based on having a pecuniary interest in the securities.

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An investment adviser with discretionary authority to vote or to dispose of the securities, but without any economic interest in the securities, is the beneficial owner of the securities. A client of such adviser who enjoys the economic benefits of ownership but has neither the right to vote or to dispose of the securities is not the beneficial owner. If an adviser has voting power and the client has the power to direct the sale of the securities, both the adviser and the client are beneficial owners.

Rule 13d-3(a) provides that a person who shares voting or investment power is a beneficial owner. Thus, if an adviser and the client must agree on a sale, both the adviser and the client are beneficial owners.

Rule 13d-3(a) provides that the right to vote or dispose can be based on “contract, arrangement, understanding, relationship, or otherwise” and can be direct or indirect.

Rule 13d-3(b) provides that a person is deemed to be a beneficial owner of securities if that person has the right to acquire beneficial ownership of such security within 60 days. The rule includes the right to acquire:

• Through the exercise of any option, warrant or right;

• Through the conversion of a security;

• Pursuant to the power to revoke a trust, discretionary account, or similar arrangement; or

• Pursuant to the automatic termination of a trust, discretionary account or similar arrangement.

[7] Beneficial Ownership Through Total Return Swaps

Rule 13d-3(b) provides that

Any person who, creates or uses a contract, arrangement, or device (including a trust, proxy, power of attorney, pooling arrangement) with the purpose of effect of divesting such person of beneficial ownership of a security or preventing the vesting of such beneficial ownership as part of a plan or scheme to evade the reporting requirements shall be deemed for purposes of such sections to be the beneficial owner of such security.

In CSX Corporation v. The Children's Investment Fund (UK) LLP, 562 F. Supp. 2d 511 (S.D.N.Y., 2008), affirmed without opinion by CSX Corp. v. Children's Inv. Fund Mgmt. LLP, 2008 U.S. App. LEXIS 19788 (2d Cir. 2008), the court, relying on Rule 13d-2(b), held that a hedge fund was the beneficial owner of the amount of shares referenced by Total Return Swaps (“TRS”). A total return swap is an instrument whereby two counterparties agree to exchange the cash flows on two financial instruments over a specified period of time. In the CSX case, the counterparties on each TRS agreed to pay the hedge fund an amount equal to the distributions or dividends paid on, and any increase in the market value of, a specified number of CSX common stock over a specified time period. (Such a party is referred to as the “short party.”) The hedge fund agreed to pay the counterparty interest at the negotiated rate on the “notional amount” (i.e.,

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the value of the specified number of CSX shares at the time the parties entered into the TRS transaction) plus an amount equal to any decrease in the market value of such shares over the relevant period. (This party is sometimes referred to as the “long party.”) As a result of the TRS transaction, neither party actually owns any of the shares referenced and thus neither has power to vote or dispose of the shares. However, typically, the short party hedges its position by acquiring the referenced shares.

The count found strong evidence that the hedge fund, in this case the “long party,” created and used the TRSs, at least in major part, for the purpose of preventing the vesting of beneficial ownership of CSX shares in the hedge fund and as part of a plan or scheme to evade the reporting requirements of Section 13(d). The court held that the hedge funds were beneficial owners of the amount of shares referenced by TRSs.

Rule 13d-3(b) applies where one enters into a transaction with the intent to create the false appearance that there is no large accumulation of securities that might have a potential for shifting corporate control by evading the disclosure requirements of Section 13(d) or (g) through preventing the vesting of beneficial ownership in the actor.

The Court held that the hedge fund violated Section 13(d) by failing to file a Schedule 13D within 10 days of entering into TRSs referencing more than 5 percent of the CSX shares then outstanding. The SEC staff filed a letter with the court indicating that it did not believe that the TRS gave the long party beneficial ownership.

[8] Control Intent

Whether a person has control intent is relevant to Sections 13d-1(e) and 13d-3(b), which refer to

the purpose [or] with the effect of changing or influencing the control of the issuer, [or being] a participant in any transaction having such purpose or effect

Generally speaking, a person who does not have control intent is referred to as a passive investor.

Control is not defined for purposes of Section 13(d) and the rules thereunder. However, courts may look to Rule 12b-2 under the Exchange Act for guidance. That rule defines “control” to mean the “possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.”

In many situations, it is easy to identify a person with control intent, especially where the shareholder seeks board representation. In Chromalloy Am. Corp. v. Sun Chem. Corp., 611 F.2d 240, 246 (8th Cir. 1979), the court found an intent to control where the defendant planned to acquire twenty percent of the issuer’s stock, attempted to gain representation on the issuer’s board of directors, and intended “to review continually its position” with respect to the issuer. Id. at 246. The court therefore concluded that the defendant was required to disclose its control purpose on Schedule 13D, even though the purpose had “not taken shape as a fixed plan.” Id. at 247.

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Similarly, in Standard Financial, Inc. v. LaSalle/Kross Partners, L.P., 1997 U.S. Dist. LEXIS 1916 (N.D. Il. 1997), the court decided that the defendants should have disclosed in their Schedule 13D that they had a control purpose, rather than a mere investment purpose. The court relied principally on the following evidence in finding a control purpose: “(1) defendants’ expressed intent to gain two seats on the board of directors and (2) defendant’s expert’s opinion that defendants could enhance their returns by influencing management.” 1997 U.S. Dist. LEXIS at 1920.

In the absence of an attempt to procure board representation, it may be difficult to determine whether a person has control intent. The Chromalloy court expressed the test for control intent as follows:

[a] desire to influence substantially the policies, management and actions of [an issuer] amounts to a purpose to control [the issuer]

But this test may be too broad and could interfere with normal discussions with significant investors, especially institutional investors. In Transcon Lines v. A.G. Becker Inc., 470 F. Supp. 356 (S.D.N.Y.1979), the court held that “making suggestions and attempting to influence management to adopt policies that will improve [the company’s] performance” without an intent to seek board representation did not constitute a control purpose.

It is not clear at what point discussions can be viewed as evidencing a control purpose. The court in Egghead.com, Inc. v. Brookhaven Capital Mgmt., Inc. 194 F. Supp. 232 (S.D.N.Y.2002) found a control intent on part because the defendants “met with [the CEO] multiple times and had ‘intense’ discussions with him about disposition of assets, acquisition plans, financial plans, strategic plans, and day-to-day activities, including the use of cash proceeds from the divestiture of a division of Egghead and strategies for raising the stock price.” The exact significance of the “intense” discussions in establishing control intent can not be determined because the defendants also requested board seats.

In Groskaufmanis & Garner, Monitoring the Dance: An Assessment of the SEC’s Regulation 13D-G Amendments, 6 Corp. Governance Adviser, July-Aug. 1998, at 16, it was noted that suggesting a divisional spin-off is “passive.” But if the spin-off is presented “as a demand by a substantial shareholder with the implicit (or explicit) threat to rally other shareholders on the same issue,” it would evidence a control purpose.

[9] Groups

Rule 13d-5(b)(1) provides that

When two or more persons agree to act together for the purpose of acquiring, holding, voting or disposing of equity securities of an issuer, the group formed thereby shall be deemed to have acquired beneficial ownership, for purposes of Sections 13(d) and(g) of the Act, as of the date of such agreement, of all equity securities of that issuer beneficially owned by any such persons.

The rule requires an agreement to act together. “[I]f the parties have not agreed to act, then a group does not exist.” Jacobs v. Pabst Brewing, 549 F. Supp. 1050, at 1066 (D. Del. 1982). (In

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Jacobs, allegations that an investment adviser agreed with his clients to act as a voting block sufficiently alleged the existence of a group so that a motion to dismiss was denied.)

The requirement that the group “agree to act together for the purpose of acquiring, holding, voting or disposing” of the issuer’s securities “does not proscribe informal discussion among existing shareholders concerning the performance of current management.” Bath Indus. Inc. v. Blot, 427 F.2d 97, 110 (7th Cir. 1970).

In order to find the existence of a group, a court need not find a formal or written agreement. Indeed, courts have noted that where persons seek to avoid disclosure, execution of a formal agreement by a group to acquire additional shares in support of its objectives is unlikely. Id. at 110. Similarly, the court in SEC v. Savoy Indus. Inc., 587 F.2d 1149, 1164-65 (D.C. Cir. 1978), said:

the agreement need not be written . . . . Any arrangements may be formal or informal . . . . However, it is equally clear that whatever meeting of the minds, understanding, or arrangement that may exist need not be written. It is possible, indeed commonplace, for two or more to take concerted action informally.

A review of cases in which management has alleged that certain shareholders constituted a group for purposes of Rule 13d-5 suggests three general conclusions:

• As a general matter, courts agree on the types of factors that are relevant to determining the existence of a group based on circumstantial evidence. The most important factors include prior relationships, communications, and trading patterns.

• Courts apparently place different weight and give different significance to these factors and how they do so is not necessarily predictable .

For example, in meVC Draper Fisher Jurvetson Fund I, Inc. v. Millennium Partners, L.P., 260 F. Supp. 2d 616 (S.D.N.Y. 2003), the company argued that the trading patterns of the alleged group members indicated the existence of a group. The company claimed that the alleged group members engaged in coordinated trading, such trading being “tag team” trading (or trading at separate times) in order not to cause the price to rise an undue amount. The court found it significant that the alleged group members sometimes purchased at the same time; that is, they acted in a manner inconsistent with the supposed agreement to trade at separate times. In part because of such trading, the court refused to find that a group existed.

On the other hand, in CSX, the company alleged the existence of a group in part on the basis of trading patterns. Defendant shareholders responded that during period, the alleged group members sold shares “asymmetrically,” with one alleged group member reducing its exposure by 40% and the other “by a smaller percentage.” Defendants claimed that the lack of coordination was inconsistent with the existence of a group. The court rejected the argument.

. . . even assuming, for the sake of argument, that [the parties’] sales were, in whole or in part, not within the mutual contemplation of the defendants,

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that would not necessarily foreclose a finding that they acted as a group. Co-conspirators and members of cartels act on their own from time to time.

The court found that a group existed.

• Finally, as a general matter, courts appear reluctant to find the existence of a group based on circumstantial evidence. Courts do find groups to exist, as in the CSX case. But a more common attitude of courts is captured in the following excerpt from a law review article.

From a tactical point of view, the most important development is [the courts’] reluctance to find groups lurking amidst shareholders who merely talk to one another and have frank exchanges of views about their investee companies . . . . “Congress” said the court, did not intend for Section 13(d) to serve merely as an eleventh-hour bludgeon for management embroiled in proxy contests. Decisions such as these have enabled hedge funds to engage in “wolf pack’ tactics against companies undeterred by a fear of somehow magically becoming a group merely because they hunt together and seek the same prey.

Briggs, Corporate Governance and the New Hedge Fund Activism: An Empirical Analysis, 32 Journal of Corporation Law, 681 at 690, Summer, 2007.

An example of the general attitude can be found in meVC Draper Fisher Jurvetson Fund I, Inc., supra. Millenco commenced a proxy contest relating to the election of directors. In connection therewith Millenco nominated directors, one of whom was George Karpus, the owner and principal of Karpus Management. The company claimed that Millenco’s nomination of Karpus and Karpus’ acceptance of such nomination supported the seemingly common-sense conclusion that Millenco and Karpus management “agreed to pool their votes in the upcoming director elections” and hence were a 13(d) group. Nevertheless, the court refused to find that a group existed.

[10] 13(d) Litigation

[a] Private Right of Action.

The issuer has a private right of action for violations of Section 13(d) and the rules thereunder.

[b] Damage claims.

Section 13(d) does not provide any damages remedy to an issuer that was allegedly injured by the failure of a shareholder to comply with Section 13(d)’s disclosure requirements. Hallwood Realty Partners, L.P. v. Gotham Partners, L.P., 286 F.3d 613 at 620 (2d Cir. 2002).

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[c] Injunctive relief.

[T]he object of § 13(d) [is] increasing honest disclosure for the benefit of investors . . . issuers have a private cause of action and standing to sue for injunctive relief because, inter alia, such relief increases the accurate information available to investors.

Hallwood at 621.

[d] Injunctive actions seeking compliance with the filing requirements or amended disclosure.

When a violation of Section 13(d) has been established, courts have the power to order compliance with the filing requirements or corrective disclosure. If the defendant shareholders are engaged in a proxy contest or a tender offer, the courts have the power to enjoin the holding of the shareholder meeting or the consummation of the tender offer until corrective disclosure is made. In Bath Indus., supra, the court enjoined the defendants from

proceeding with their plan (including, but not limited to removing the chief executive officer of [plaintiff] Bath and calling for a special shareholders’ meeting) until they have complied with Section 13(d) of the 1934 [Securities Exchange] Act. The injunction is to remain in effect until it is determined that defendants have filed legally sufficient statements pursuant to Section 13(d).

[e] Short-circuiting injunctive actions seeking compliance with the filing requirements or amended disclosure.

In injunctive actions involving alleged failures to disclose the shareholders’ control intentions relating to the company and/or the existence of a group of which the defendants are members, the company typically seeks to conduct discovery about the defendants. Defendants resist because discovery is expensive and distracting and could reveal information damaging to the shareholder/defendants. Defendants are often able to moot the lawsuits by preemptively filing or amending their Schedule 13D (or in the context of a proxy contest, the proxy materials) to disclose the substance of the issuer’s allegations. The shareholders acknowledge that the matters cited in the issuer’s allegations are disputed, but do not admit that the allegations are correct. There are cases that hold that such disclosure will defeat the company’s demand for an injunction and it will terminate discovery by the company.

In Bally Total Fitness Holding Corp. v. Liberation Investments, L.P., 2005 U.S. Dist. LEXIS 34897(D. Del. 2005), the company and some shareholders were locked in a proxy contest. The company sued, alleging that the shareholders’ disclosure in the Schedule 13D and in its proxy statement was defective. The company asked for an injunction against further and the company’s complaint for injunction set forth the reasons why the disclosure was allegedly defective. The shareholders responded by issuing a new proxy statement that “set forth, verbatim, all of the allegations of insufficient disclosures that Plaintiff had listed. Defendants also included their responses to Plaintiff’s allegations.” In light of the shareholders’ disclosures, the court denied the company’s request for an injunction and terminated discovery.

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To obtain a preliminary injunction based on a violation of a disclosure provision of the Securities Exchange Act of 1934, a plaintiff must make a showing of irreparable harm . . . . However, if a defendant cures the alleged defects in disclosure, a showing of irreparable harm is precluded . . . . In the context of a motion for preliminary injunction, where there is a good faith dispute as to facts or an alleged legal violation, disclosure of the dispute is sufficient to cure the alleged defects.

Here, the parties have a good faith dispute with regard to Plaintiff’s allegations, and Defendants’ revised statement fully discloses all matters that Plaintiff indicated it would pursue at the preliminary injunction hearing. Thus, the Court concludes that Plaintiff cannot make a showing of irreparable harm and the preliminary injunction proceeding is, therefore, moot. Accordingly, the Court will grant Defendants’ Motion To Dismiss The Preliminary Injunction Proceeding. Because there will be no preliminary injunction proceeding, Plaintiff’s Motion For Expedited Discovery is also moot and will be denied.

At 3-4.

Other courts have held that the mere disclosure of the existence of a dispute is insufficient and that shareholders are entitled to a statement of the actual facts. In Warner Communications, Inc. v. Murdoch, 581 F. Supp. 1482 (D. Del. 1984), the court found that merely disclosing the existence of a dispute was insufficient. The court said that allowing the shareholders to substitute disclosure of allegations for disclosure of facts would

significantly circumvent the disclosure goals of § 13(d). Material facts might often be concealed and omitted from initial 13D Statements, to be cured only by subsequent disclosure of adverse claims which allege the omissions but which are disputed by the disclosing party. As a result, the true facts would often remain obscured and hidden from investors.

581 F. Supp. at 1501.

The court refused to dismiss an injunctive action.

The net effect of the Amendment is to inform investors of the possibility of the group’s existence, rather than the fact of the group’s existence. If a §13(d)(3) group does exist, this fact must be disclosed, not the possibility of the fact. Whether such a group exists is a factual issue that cannot be determined on the present motions to dismiss . . . .

Nevertheless, at this point in the proceedings, the Court is unable to determine whether [shareholders] genuinely and in good faith dispute [the Company’s] allegations that the companies are operating in violation of the Investment Company Act of 1940.

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[f] Sterilization as a Remedy.

Sterilization is the name given to a remedy that would deny a shareholder who violated Section 13(d) the right to vote the shares. Such a remedy could be very advantageous to a company in a proxy contest. Requests for such a remedy are routinely denied on the basis that such a remedy would be inconsistent with the purposes of the statute. In the CSX case, the court said:

[The leading Supreme Court case] does not foreclose the possibility [of] relief such as sterilization for Section 13(d) violations, but it does make clear that a prerequisite to such relief is a showing of irreparable harm. Moreover, the determinative question is whether, absent an injunction, there would be irreparable harm to the interests which Section 13(d) seeks to protect -- viz. “alert[ing] investors to potential changes in corporate control.” In consequence, private plaintiffs usually are unable to establish an irreparable harm once the relevant information has been made available to the public. Second Circuit cases go so far as to suggest, in dicta, that irreparable harm can not be established once corrective disclosure is made.

Indeed, in General Aircraft Corporation v. Lampert, 556 F.2d 90(1st Cir. 1977), the court denied to order sterilization. The rationale was that although the defendants violated the disclosure requirements of Section 13(d), the acquisition of the shares was legal.

Appellants’ stock was acquired legally more than a year prior to the filing of the present action. Investors are entitled to the legitimate fruits of their investment . . . . In the circumstances disclosed by this record, sterilization of appellants’ legally acquired shares would be punishment, not deterrence, since it would deprive appellants of previously acquired voting rights without sound reason.

Courts have indicated that there are two situations in which they might order sterilization, but such remain only possibilities.

In CSX, the court indicated that if, as a result of their violations, the defendants were able to obtain “a degree of effective control,” sterilization might be appropriate. But under prior case law in that circuit, the minimum percentage for “a degree of effective control” was at least 31%, a standard that was not met in that case. Moreover, the court noted that “plaintiffs have cited no case, in or out of our Circuit, in which irreparable harm was found because a defendant had obtained a degree of effective control.” As a result, the court held that

the alteration of the corporate electorate arguably effected by defendants’ actions, which did no more than increase its likelihood of prevailing in the current contest, cannot be regarded as irreparable injury that properly may be remedied by preventing the voting of the stock acquired while defendants were in violation of Section 13(d).

In General, the court held that it might be appropriate to sterilize shares acquired just before a proxy contest.

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While it may be appropriate for the courts to enjoin the voting of shares rapidly acquired just before a contest for control following a Section 13(d) violation . . . absent a clear showing of irreparable injury, disenfranchisement should not extend to prior holdings legally acquired.

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NAVIGATING PROXY CONTESTS

TABLE OF CONTENTS

Page

[1] PROXY CONTESTS: DEFINITION................................................................................ 1

[2] APPLICATION OF THE SEC PROXY RULES TO PROXY CONTESTS..................... 1

[3] PROXY CONTEST ISSUES.............................................................................................. 1

[4] COMMUNICATIONS CONSTITUTING “SOLICITATIONS” FOR PURPOSES OF THE PROXY RULES.............................................................................. 2 [a] The term “solicitation.”........................................................................................... 2 [b] Determining which communications are solicitations............................................ 2

i. Routine corporate disclosures ..................................................................... 2 ii. Other communications by the Issuer........................................................... 2 iii. Communications by Activists ..................................................................... 3

[c] Indirect communications......................................................................................... 4

[5] PRELIMINARY PROXY MATERIALS........................................................................... 4 [a] Rule 14a-6............................................................................................................... 4 [b] Proxy statement delivery requirements................................................................... 4 [c] Preliminary Proxy Materials. .................................................................................. 5

i. Rule 14a-6(a) .............................................................................................. 5 ii. SEC review of preliminary proxy materials ............................................... 5 iii. Preliminary materials to be filed by Activists............................................. 6 iv. Preliminary materials to be filed by issuers................................................ 6

[d] E-Proxy rules. ......................................................................................................... 7

[6] COMMUNICATIONS OUTSIDE OF A 14a-3(a) PROXY STATEMENT ..................... 7 [a] Issuer and Activists: Communications after the 14a-3(a) proxy

statement has been delivered. ................................................................................. 7 [b] Issuer: Before the 14a-3(a) proxy statement has been furnished........................... 8

i. Rule 14a-12................................................................................................. 8 ii. Rule 14a-2(b)(6).......................................................................................... 9

[c] Activists: Before the 14a-3(a) proxy statement has been furnished. ..................... 9 i. Rule 14a-12................................................................................................. 9 ii. Rule 14a-2(b)(2).......................................................................................... 9 iii. Rule 14a-2(b)(6)........................................................................................ 11

[7] SOLICITATIONS BY PERSONS WHO WILL NOT SEEK PROXY POWER ............ 11 [a] Rules available to persons not seeking proxy power. ........................................... 11 [b] Election not to seek proxy power.......................................................................... 11 [c] Rule 14a-1(l). ........................................................................................................ 12 [d] Rule 14a-2(1). ....................................................................................................... 12

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[e] Rule 14a-2(b)(6).................................................................................................... 14

[8] REMEDIES FOR VIOLATION OF RULES 14a-3 AND 14a-6 ..................................... 14

[9] REMEDIES FOR FRAUD IN PROXY SOLICITATIONS ............................................ 15 [a] Rule 14a-9............................................................................................................. 15 [b] Standards for determining whether to issue an injunction.................................... 16

[10] SETTLEMENT OF PROXY CONTESTS....................................................................... 17 [a] SEC rules relating to settlement............................................................................ 17 [b] Voting of proxies after a settlement...................................................................... 18 [c] Actions by the Activist to settle a proxy contest................................................... 18 [d] Terms of a settlement agreement. ......................................................................... 19

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[1] PROXY CONTESTS: DEFINITION

A proxy contest involves solicitations of proxies, consents or authorizations by any person or group of persons for the purpose of opposing a solicitation by any other person or group of persons with respect to the election or removal of directors or one or more proposals subject to a shareholder vote or consent.

In this article, the term “Issuer” refers to the company whose shareholder meeting is the subject of a proxy contest and the term “Activist” refers to shareholders opposing management or the board of directors. Shareholders who submit a proposal for inclusion on the company’s proxy statement pursuant to SEC Rule 14a-8 are not required to, and typically do not, engage in solicitation activities and thus do not file proxy materials. Thus, such shareholders are not considered Activists for purposes of this discussion.

[2] APPLICATION OF THE SEC PROXY RULES TO PROXY CONTESTS

The proxy rules apply to every solicitation of a proxy with respect to securities registered under the Exchange Act pursuant to Section 12(b) (securities registered on an exchange) or Section 12(g) (generally speaking, an issuer must register if its has more than $10 million in assets with a class of securities held by more than 500 record holders).

The proxy rules do not apply to issuers that file reports pursuant to Section 15(d) of the Exchange Act. An issuer has a duty to file reports under Section 15(d) if it has had a registration statement relating to the sale of securities declared effective under the Securities Act, but does not have securities registered under Sections 12(b) or 12(g).

Rule 3a12-3 under the Exchange Act exempts foreign private issuers (defined in Rule 3b-4) from compliance with the proxy rules.

[3] PROXY CONTEST ISSUES

The most important securities law issues involved in proxy contests are:

• Under what circumstances will a particular communication constitute a solicitation for purposes of the proxy rules

• Rules governing the filing of preliminary proxy materials

• Rules governing communications outside of the 14a-3(a) proxy statement

• Solicitations by persons who will not seek proxy power

• Remedies for violation of Rules 14a-3 and 14a-6

• Remedies for fraud in proxy solicitations

• Settlement of proxy contests

[4] COMMUNICATIONS CONSTITUTING “SOLICITATIONS” FOR PURPOSES OF THE PROXY RULES

[a] The term “solicitation.”

The term “solicitation” is defined in section (1) of Rule 14a-1(l) to mean, subject to certain exceptions, the following:

• Any request for a proxy whether or not accompanied by or included in a form of proxy;

• Any request to execute or not to execute, or to revoke, a proxy; or

• The furnishing of a form of proxy or other communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.

There is no interpretive issues with the first two tests in the rule and the first part of the third (“furnishing a form of proxy”). There are, however, interpretative problems with the latter part of the third test: “communication to security holders under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy.”

[b] Determining which communications are solicitations.

In deciding whether a communication is reasonably calculated to result in the procurement, withholding or revocation of a proxy, a frequent issue is whether the communication implements a plan that ultimately involves asking shareholders to sign a proxy card. If the communication implements such a plan, it is likely to be deemed a solicitation; if not, it will not be deemed a solicitation. The application of this principle is illustrated by the following.

i. Routine corporate disclosures. Routine dissemination of reports and disclosures of developments in accordance with established practice are not subject to the proxy rules. Thus, the routine distribution of annual and quarterly reports as well as “other communications containing information and comment concerning the business of the character normally sent to security holders by corporate management during the course of a fiscal year” are not subject to the proxy rules. Sec. Ex. Act Rel. 5276 (1956). It is assumed that such disclosures are for purposes other than influencing a proxy solicitation, although in fact such disclosures may have such an effect. However, if such a report “includes a discussion of, or an attack upon, an opposition group or solicitation” it would be subject to the proxy rules. Id.

ii. Other communications by the Issuer. In Kass v. Arden-Mayfair, Inc., 431 F. Supp. 1037 (C.D. Cal. 1977), a letter that was sent to shareholders by a newly elected Chairman to “introduce” himself to the shareholders and to present some recent steps taken by the company and that was sent more than a month before shareholders initiated a proxy contest was not deemed to be a solicitation. The court said that the “record does not indicate that the defendants sent the subject letter as part of a continuing plan to solicit proxies. Rather, this letter appears to have been sent pursuant to management’s policy to stay in touch with the shareholders.”

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iii. Communications by Activists. In Chris-Craft Indus., Inc. v. Indep. Stockholders Comm., 354 F. Supp. 895 (D. Del. 1973), the court indicated that communications by Activists made long before that actual solicitations by them of proxy cards can constitute solicitations if those communications are part of a plan to wage a proxy contest:

It is not necessary that a communication expressly asks for a proxy to constitute a solicitation. Solicitations subject to the proxy rules also include communications “which are (1) part of a continuous plan ending in solicitation and (2) which prepare the way for its success . . .”.

The court in Shamrock Holdings, Inc. v. Polaroid Corp., 709 F. Supp. 1311 (D. Del. 1989) reached essentially the same result as the Chris-Craft court, indicating that the determination of whether a communication is a solicitation depends on “the purpose of the communication and the totality of circumstances in which it was made.” The importance of “plan” and “purpose” can be illustrated by Calumet Indus., Inc. v. MacClure, 464 F. Supp. 19 (N.D. Ill. 1978) and Chris Craft. In Calumet, members of a Stockholders Committee had been contacting shareholders to determine whether they would support a proxy contest against management. Certainly, if there had been a “plan” that involved asking shareholders to sign a proxy card at some future time, the contacts would have been solicitations. But the court held that such communications were merely “organizational communications which went on among members of the Committee and its supporters” and did not constitute a proxy solicitation. The court’s rationale was that as of the date the communications were made, a firm decision had not been made to launch a proxy contest and there were obstacles outside of the control of the Committee members that would have to be overcome before a decision to engage in a proxy contest could be launched.

. . . the evidence indicates that the defendants did not even agree to wage a proxy solicitation prior to being assured that the Bray Group would support them. It was evident to all involved that no challenge would succeed without the support of this large block of votes, and the activities of [Committee members] indicate that any discussions carried on prior to obtaining that support were preliminary in nature and did not amount to an agreement within the meaning of Section 13(d).

In Chris-Craft, a small group of shareholders were dissatisfied with management. Then one Kelly, not a member of the group, proposed to acquire the company, a move that the group supported. Members of the group prepared and sent a form letter to large shareholders, which was to be signed by the shareholders and sent to Kelly by large shareholders “indicating their support for his acquisition proposals, with which he would then confront management.” At the same time “there were also discussions [within the group] concerning the possibility of a proxy fight . . . in the event Kelly’s proposals to management were still rejected.” The company rejected Kelly’s proposals and a proxy contest was launched by the shareholder group. The issue in the case was whether the form letter sent to shareholders constituted a solicitation for purposes of the proxy rules. Management argued that the letters were

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solicitations, claiming that the letters would have the effect that the proxy rules intended to regulate; that is, they were communications “intended to prepare the way for the success of a proxy contest in the event that management refused to surrender control of the company via Kelly’s proposals.” The shareholders contended that the letters should be judged on their primary purpose which was “to be shown to management as a sign of stockholder dissatisfaction and as support for Kelly’s merger proposals.” The court found that the letters were not a solicitation because it was “not convinced that the letters were obtained with the intention of aiding an eventual proxy solicitation.” In support of this finding, the court found, similar to the finding in Calumet, that at the time the letters were sent to shareholders, a firm decision had not been made to launch a proxy contest and thus, at the time, there was no plan for a proxy contest.

During the meeting in Chicago in August, 1970, the idea of a proxy fight was discussed. [A member of the group] informed the others attending that there was not sufficient financial strength in that group to wage a proxy battle. This position was accepted.

[c] Indirect communications.

The court in Long Island Lighting Co. v. Barbash, 779 F.2d 793 (2d Cir. 1985) noted that communications that are not directly addressed to shareholders can still be solicitations.

Deciding whether a communication is a proxy solicitation does not depend upon whether it is “targeted directly” at shareholders. See Rule 14a-6(g), 17 C.F.R. § 240.14a-6(g) (requiring that solicitations in the form of “speeches, press releases, and television scripts” be filed with the SEC).

Similarly, Trans World Corp. v. Odyssey Partners, 561 F. Supp. 1315, 1320 (S.D.N.Y. 1983), holds that

A section 14(a) claim may be stated where a person solicits shareholders by making an effort to influence shareholder opinion by communicating certain information to the financial press and the greater financial community.

[5] PRELIMINARY PROXY MATERIALS

[a] Rule 14a-6.

In a proxy contest, the Issuer and the Activists are required to file a proxy statement pursuant to Rule 14a-6 that complies with and contains all of the information required by Schedule 14A. However, Activists are not required to file a proxy statement if they are relying on the exemption from the filing requirements set forth in Rule 14a-2(b)(vi), which is discussed below.

[b] Proxy statement delivery requirements.

Rule 14a-3(a) provides that no solicitation subject to the SEC’s proxy rules shall be made unless each person solicited is concurrently furnished, or has previously been furnished, with a preliminary or definitive proxy statement containing the information specified in Schedule 14A.

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Schedule 14A lists the “information required in proxy statement,” such as information about the compensation of officers and directors.

Although Rule 14a-3(a) allows solicitations to be made on the basis of preliminary proxy material, in practice, preliminary proxy material is not used for solicitations. If preliminary material is required, it must be filed with the SEC and there is a risk that changes to the proxy materials may be required as a result of comments from the SEC staff. If changes are made, resolicitation may be required. Thus, solicitations are made on the basis of definitive material.

[c] Preliminary Proxy Materials.

i. Rule 14a-6(a). Rule 14a-6(a) requires that preliminary copies of the proxy statement and form of proxy be filed with the SEC at least 10 calendar days prior to the date that definitive copies of such material are first sent or given to security holders. Unless required to do so, persons soliciting proxies do not file preliminary proxy materials and the SEC staff would not review and comment on preliminary proxy material unless it is required to be filed.

ii. SEC review of preliminary proxy materials. In a proxy contest, preliminary proxy materials are reviewed by the Office of Mergers & Acquisitions in the Division of Corporation Finance. The ten-day period before definitive proxy materials can be mailed provides the SEC staff with time to review the proxy materials and to make comments that typically suggest changes in the proxy materials. Typically, the filing party responds to the comments and often makes the suggested changes. It is generally believed to be risky to ignore or to reject SEC staff comments and persons who do risk the initiation of a SEC enforcement action. The filing of revised preliminary material does not recommence the ten day time period unless the revised material contains material revisions or material new proposal(s) that constitute a fundamental change in the proxy material. The whole process can sometimes exceed ten days.

In a proxy contest, the SEC staff reviews materials in the order in which they are filed. If the Issuer files on day one and the Activist files on day two and the staff takes seven days to review the Issuer’s proxy material, the staff will not begin to review the Activist’s proxy materials until it has completed the review of the Issuer’s materials.

It is important to apply the correct codes when filing the preliminary material on EDGAR. If the proxy materials are marked with the code “DEF14A” (definitive proxy statement) as opposed to PERK 14A (preliminary proxy statement in connection with contested solicitations), the ten day period will not begin to run until the materials are refiled. If the proxy materials are marked with the code “PRE 14A” (preliminary proxy statement not related to a contested matter or merger/acquisition) as opposed to PREC 14A (preliminary proxy statement in connection with contested solicitations), it may not get to the Office of Mergers & Acquisitions in order to start the review process. If the Issuer fails to comply with the requirements of Rule 14a-13, the SEC staff may delay clearly the proxy statement and the Issuer may be required to comply before it can solicit. Rule 14a-13 under the 1934 Act deals with the requirement that the registrant inquire of record holders the number of copies of proxy solicitation material necessary to

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supply such material to beneficial holders. The rule requires that the inquiry be made at least 20 business days prior to the record date of the security holder meeting, with certain exceptions, including at such later time as the rules of a securities exchange permit for good cause shown.

iii. Preliminary materials to be filed by Activists. Activists who solicit proxies (except those who solicit pursuant to Rule 14a-2(b)(6) which provides an exemption from compliance with Rule 14a-6), must always file preliminary proxy material in connection with a proxy statement. Note that shareholders who submit a proposal for inclusion on the company’s proxy statement pursuant to SEC Rule 14a-8 are not required to, and typically do not, engage in solicitation activities and thus do not file proxy materials. Thus, such shareholders are not considered Activists for purposes of this discussion.

Note that, generally speaking, a recommendation by an Activist that shareholders use Issuer’s proxy card to vote “against” or “withhold” Issuer’s nominees or an Issuer proposal (often referred to as a “just say no” campaign) would not require the filing of a proxy statement (whether preliminary or definitive). The recommendation would be exempt from the filing requirements under Rule 14a-2(b)(1), which is discussed below. However, there is case law that holds that if an Activist supplies the shareholders with a form of Issuer’s proxy card so that the shareholder can mark the card “against” or “withhold” and return the card to the Issuer, the exemption of Rule 14a-2(b)(1) is not available. Of course, if the Activist supplies shareholders with its own form of proxy card appointing the Activist or its designees as the proxy to vote the shares, it must comply with the proxy rules.

iv. Preliminary materials to be filed by issuers. Issuers are not required to file preliminary proxy material if the only matters to be acted on are

• The election of directors;

• The approval of accountants;

• A shareholder proposal included pursuant to Rule 14a-8; or

• The approval or amendment of certain employee benefit plans.

However, an Issuer must file preliminary material if it knows or has reason to believe that there will be a proxy contest; that is, if it knows or has reason to believe that Activists will solicit proxies. Rule 14a-6(a) requires that an Issuer file preliminary material if the Issuer’s proxy materials “comment upon or refer to” a solicitation in opposition in connection with the meeting in its proxy material. The SEC staff takes the position that if the Issuer knows or has reason to believe that Activists will solicit proxies in a proxy contest (i) in connection with the election of directors, (ii) against a company proposal (such as a merger or sale of Issuer), or (iii) for a proposal to be made by the Activists, the antifraud provisions of Rule 14a-9 require that the Issuer refer to such solicitation in the company’s proxy materials.

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The staff’s position is that if Issuer knows that an Activist will wage a proxy contest, it must, under antifraud provisions of Rule 14a-9, mention that fact in the proxy materials.

The staff believes that it is inconsistent with this provision of Rule 14a-9 when the initial definitive proxy statement does not disclose the existence of a solicitation in opposition when the registrant knows, or reasonably should know, of a solicitation in opposition. The staff believes the existence of alternative nominees is material to security holders’ voting decisions. Further, it is not appropriate for the registrant to omit this information from its initial proxy statement and wait to address the solicitation in opposition at a later time in the solicitation. It is also inappropriate to merely disclose the existence of the solicitation in opposition in a press release issued at the same time the registrant mails to shareholders the definitive proxy statement that omits the information.

In practice, if an Activist has given Issuer notice that it intends to make nominations or submit a proposal (other than a 14a-8 proposal) at the shareholder meeting, Issuer is deemed to “know” that there will be a proxy contest and must file preliminary material. Such notice would be supplied to Issuer if the Activist gives notice pursuant to an advance notice bylaw.

[d] E-Proxy rules.

Beginning January 1, 2009, all public companies must comply with the E-Proxy rules in Rule 14a-16. The E-Proxy rules require that Issuers conducting proxy solicitations post materials on the Internet and can choose among the delivery options for proxy materials available under the E-Proxy rules: the “notice and access option,” the “full set delivery option,” or a hybrid of these options.

[6] COMMUNICATIONS OUTSIDE OF A 14a-3(a) PROXY STATEMENT

[a] Issuer and Activists: Communications after the 14a-3(a) proxy statement has been delivered.

After a party (Issuer or Activist) has furnished a shareholder with a proxy statement pursuant to Rule 14a-3(a) or contemporaneous with such furnishing, that party can furnish additional soliciting materials to shareholders without filing preliminary copies with the SEC and without a delay for SEC staff review. Rule 14a-6(b) requires that “all other soliciting materials, in the same form as the materials sent to security holders, must be filed with the Commission no later than the date they are first sent or given to security holders.”

Rule 14a-3(f) provides that the delivery requirement of Rule 14a-3(a) (no solicitations unless the person solicited has been furnished with a proxy statement) does not apply to speeches in public forums, press releases, published or broadcast opinions, statements, or advertisements appearing in a broadcast media, newspaper, magazine or other bona fide publication disseminated on a regular basis, provided that (1) no form of proxy, consent or authorization or means to execute the same is provided to a security holder in connection with the communication; and (2) at the time the communication is made, a definitive proxy statement is on file with the Commission

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pursuant to Rule 14a-6(b). The rule has largely been superseded by other rules, particularly Rule 14a-12. In any case, it is of limited utility. It is useful only during the short period after SEC clearance of the proxy statement was obtained and before distribution of the definitive proxy statement.

[b] Issuer: Before the 14a-3(a) proxy statement has been furnished.

Before the Issuer furnishes the 14a-3(a) proxy statement, it may make solicitations without violating Rule 14a-3(a) (which requires that no solicitation be made before furnishing the shareholder with a proxy statement) in reliance on Rules 14a-12 and/or 14a-2(b)(6).

i. Rule 14a-12. Rule 14a-12 permits both written and oral communications before the filing of a proxy statement so long as all written communications related to the solicitation are filed on the date of first use.

Oral communications do not need to be reduced to writing and filed. Presumably, this covers speeches in public forums, which would otherwise be prohibited by Rule 14a-3(f). The conditions to reliance on the Rule 14a-12 exemption are:

• No form of proxy is furnished until a proxy statement is delivered;

• An obligation to disclose participant information in all written communications;

• A requirement to include on all written communications a prominent legend advising security holders to read the proxy statement; and

• A requirement to file all written communications no later than the first date of use.

Written communications need not be filed in preliminary form and are not subject to SEC staff review before they are may be disseminated.

The SEC release in 1999 adopting liberalizing changes to Rule 14a-12 indicated that management can communicate freely (subject to the requirement to file written materials) with shareholders about

• Significant corporate events requiring a shareholder vote, including a proposed merger or acquisition, or an employee benefit plan required to be approved by shareholders under listing rules; and

• Significant corporate governance matters requiring a shareholder vote, including the election of directors and, in particular, a contested election of directors.

The Issuer may orally discuss with shareholders any issues relating to a proxy contest and can obtain non-binding promises to support the management slate of directors or management. But it can not provide a form of proxy to, or obtain an executed form of proxy from, shareholders until after a proxy statement has been provided to the shareholders.

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Until 1999, Rule 14a-12 was limited to communications in connection with business combinations. That year, the rule was expanded to include communications relating to any matter subject to a proxy solicitation. The rationale for expanding the scope of the rule was that “many recent developments in technology that have enabled companies to communicate more frequently with security holders at a significantly reduced cost . . . . In light of the rapid pace of change in the securities markets and developments in technology, we believe the time has come to update the proxy rules to permit security holder communications to flow more freely and to facilitate a more informed security holder base.”

ii. Rule 14a-2(b)(6). Rule 14a-2(b)(6) allows Issuers (and shareholders) to make communications that would be deemed solicitations on electronic shareholder forums prior to compliance with Rules 14a-3 or 14a-6. See discussion below.

[c] Activists: Before the 14a-3(a) proxy statement has been furnished.

Before an Activist files or furnishes the 14a-3(a) proxy statement, it may make solicitations without violating Rule 14a-3(a) (which requires that no solicitation be made before furnishing the shareholder with a proxy statement) pursuant to

• Rule 14a-12;

• Rule 14a-2(b)(2); and

• Rule 14a-2(b)(6).

i. Rule 14a-12. An Activist can make use of Rule 14a-12 in the same manner as the issuer.

Rule 14a-12 assumes that an Activist has an intention of soliciting proxies pursuant to Rules 14a-3 and 14a-6. The rule requires that written communications must advise shareholders where they can get a proxy statement and a definitive proxy statement must be sent to shareholders before or at the time of furnishing a form of proxy.

However, an Activist relying on the rule may at any time abandon its intention to make a proxy solicitation and “as a result, parties relying on the rule are not obligated to furnish a written proxy statement if the solicitation is discontinued for any reason.” Sec. Ex. Act Rel. 42055. That release recommended, but did not require, that “if a solicitation is discontinued, we believe it would be appropriate for the soliciting persons to inform previously solicited security holders that the solicitation is over and provide a brief explanation of why it is being canceled.”

ii. Rule 14a-2(b)(2). Rule 14a-2(b)(2) exempts any solicitation made otherwise than on behalf of the Issuer where the total number of persons solicited is not more than ten. The rule is useful for:

• An Activist making solicitation of a small number of shareholders who own enough shares to be successful in the proxy contest so that it will be unnecessary to make a non-

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exempt solicitation. The rule allows the person to make a solicitation without compliance with Rules 14a-3(a) and Rule 14a-6;

• An Activist who has not decided whether to make a 14a-3(a) solicitation and desires to “test the waters” with a few shareholders. An Activist relying on Rule 14a-2(b)(2) is not precluded from making a solicitation subject to Rules 14a-3(a) and Rule 14a-6; or

• An Activist who desires that preliminary activities be conducted in secrecy. An Activist intending to make a solicitation subject to Rule 14a-3(a) could rely on Rule 14a-12 and not be subject to the limitation of ten persons in Rule 14a-2(b)(2). But Rule 14a-12 requires that written communications be filed with the SEC, so that if the Activist prefers secrecy and will make solicitations in writing, it may be better to start with Rule 14a-2(b)(2) and switch to Rule 14a-12 or commence compliance with Rule 14a-3(a). If the Activist will not make written solicitations, it can rely on Rule 14a-12 and maintain secrecy.

For purposes of counting to ten for purposes of Rule 14a-2(b)(2):

• The number is based on the number of persons solicited rather than the number who actually give proxies Crouch v. Prior, 905 F. Supp. 248, 257 (D.V.I. 1995);

• Where “one person who controls several blocks of stock in different capacities is solicited, the interests that he represents should be counted as one for the purposes of the ‘ten persons’ provision of the rule.” Water & Wall Assocs. v. Wygod, 1973 U.S. Dist. LEXIS 13966 at 20 (D.N.J. 1973)16 at 20. Thus, solicitation of a person who holds shares (i) directly, (ii) as trustee for another and the trust gives the trustee voting rights, and/or (iii) as investment advisor to several funds and the advisor is given power to vote is deemed to be the solicitation of one person for purposes of counting to ten;

• If more than one person has the power to vote, the persons are counted separately. “To correctly count the number of persons solicited, the person soliciting the shares must determine how many voting entities or persons actually hold the voting rights for the shares being solicited.” Crouch v. Prior, supra;

• Spouses who hold securities separately are counted separately. Crouch v. Prior, supra;

• The SEC’s Division of Corporation Finance Compliance and Disclosure Interpretations provide that a 13D filing may be viewed as a solicitation of all shareholders and would make reliance on the exemption in Rule 14a-2(b)(2) unavailable:

an insurgent intending to engage or engaging in a solicitation of no more than 10 persons under Rule14a-2(b)(2) should remain mindful that its filing and dissemination of a Schedule 13D – depending on the content of this document and other relevant facts and circumstances – may be deemed to constitute a more widespread ‘general’ solicitation that may preclude reliance upon Rule 14a-2(b)(2).

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iii. Rule 14a-2(b)(6). Rule 14a-2(b)(6) allows a person to make communications that would be solicitations on an electronic shareholder forum (often referred to as a message board) provided that

• The solicitation is made more than 60 days prior to the date announced by the Issuer for its next annual or special meeting of shareholders. If the Issuer announces the date of its next annual or special meeting of shareholders less than 60 days before the meeting date, then the solicitation may not be made more than two days following the date of the registrant’s announcement of the meeting date;

• The person does not seek either on its own or another’s behalf, the power to act as proxy for a shareholder; and

• The person does not furnish or otherwise request, or act on behalf of a person who furnishes or requests, a form of revocation, abstention, consent, or authorization.

Participation in an electronic shareholder forum does not eliminate a person’s eligibility to solicit proxies after the date that Rule 14a-2(b)(6) is no longer available, or is no longer being relied upon.

[7] SOLICITATIONS BY PERSONS WHO WILL NOT SEEK PROXY POWER

[a] Rules available to persons not seeking proxy power.

The definition of “solicitation” is broad enough to include communications by persons who make recommendations to shareholders as to how to vote, but do not seek to have themselves or their designees act as proxies (that is, they do not ask for proxy cards naming themselves or their nominees as proxies for the shareholder). Put differently, they are not Issuers or, as defined in this article, Activists.

There are three exemptions from compliance with the proxy rules for such persons:

• Rule 14a-1(l);

• Rule 14a-2(b)(1); and

• Rule 14a-2(b)(6).

Rules 14a-1(l) and 14a-2(b)(1), are not available to the Issuer and are not available to Activists who engage in a proxy contest.

[b] Election not to seek proxy power.

Rules 14a-1(l) and 14a-2(b)(1) specifically provide that the exemptions made available by those rules are not available if the person making such solicitations has or will solicit or engage in a proxy solicitation subject to Rules 14a-3 and 14a-6 or make a solicitation subject to Rule 14a-12. Rules 14a-1(l) provides that it is available only to a person “who does not otherwise engage in a proxy solicitation.” 14a-2(b)(1) provides it is available to a person who “does not, seek, directly

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or indirectly, either on its own or another’s behalf, the power to act as proxy for a security holder.” Thus, if a person makes a solicitation in reliance on Rules 14a-1(l) or Rule 14a-2(b)(1), that person can not use the exempt solicitation to “test the waters” for a later proxy solicitation in compliance with the proxy rules.

[c] Rule 14a-1(l).

Subsection (2)(iv)(A) of Rule 14a-1 excludes from the definition of solicitation “a communication by a security holder who does not otherwise engage in a proxy solicitation stating how the security holder intends to vote and the reasons therefore, provided that the communication is made by means of speeches in public forums, press releases, published or broadcast opinions, statements, or advertisements appearing in a broadcast media, or newspaper, magazine or other bona fide publication disseminated on a regular basis.”

Subsection (2)(iv)(A)’s exclusion of communications from the definition of “solicitation” (and thus the exemption of such communications from the proxy rules)

• Is available to shareholders;

• Is not available to Issuer;

• Is not available to persons who are not shareholders, such as proxy advisory firms, which rely on Rule 14a-2(b)(1);

• Is not available for oral or written communications sent or given directly to any individual shareholder;

• Is not available to a shareholder who has relied on Rule 14a-12 for communications prior to furnishing shareholders with a 14a-3(a) proxy statement;

• Precludes a shareholder from relying on the exclusion from later soliciting proxies by means of a 14a-3(a) proxy statement; and

• Is available to shareholders who are not eligible for the exemption in Rule 14a-2(b)(1)(i)-(x).

[d] Rule 14a-2(1).

Rule 14a-2(b)(1) exempts from Rules 14a-3 and 14a-6 (except subsection (g) of Rule 14a-6) any solicitation by or on behalf of any person who does not, at any time during such solicitation, seek directly or indirectly, either on its own or another’s behalf, the power to act as proxy for a security holder and does not furnish or otherwise request, or act on behalf of a person who furnishes or requests, a form of revocation, abstention, consent or authorization. Case law holds that a person relying on Rule 14a-2(b)(1) may not provide shareholders with a copy Issuer’s proxy card (or a broker-dealer instruction form relating to Issuer’s proxy card) for the purpose of changing a previously given vote or instruction.

Rule 14a-2(b)(1) is not available to Issuer.

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Rule 14a-2(b)(1) is broader than Rule 14a-2(b)(1) in that

• It is available to persons who are not shareholders. Rule 14a-2(b)(1) permits any person, including proxy solicitation firms, to make recommendations to shareholders as to how to vote; and

• It permits solicitations directly to individual shareholders.

However, Rule 14a-2(b)(1) has important limitations. It is not available to:

• Any nominee for whose election as a director proxies are solicited;

• Any person soliciting in opposition to a merger or other extraordinary transaction approved by the board of directors if that person is proposing or intends to propose an alternative transaction to which such person or one of its affiliates is a party. Thus, it is available to shareholders who oppose a merger if they do not intend to propose an alternative transaction;

• Any person who is required to report beneficial ownership of the Issuer’s equity securities on a Schedule 13D, unless such person has filed a Schedule 13D and has not disclosed pursuant to Item 4 thereto an intent, or reserved the right, to engage in a control transaction, or any contested solicitation for the election of directors. Thus, if a 13D filer has expressed any “control” intentions or even reserved a right to have any “control” intentions, it may not rely on Rule 14a-2(b)(1);

• Any person who, because of a substantial interest in the subject matter of the solicitation, is likely to receive a benefit from a successful solicitation that would not be shared pro rata by all other holders of the same class of securities, other than a benefit arising from the person’s employment with the registrant. If (a) X proposes to acquire Y, (b) Y rejects the offer, (c) Z, a shareholder of Y, commences a proxy contest to replace Y’s board after which it will accept X’s offer, X cannot rely on Rule 14a-2(b)(1); and

• Any person acting on behalf of any of the foregoing.

A person who relies on Rule 14a-2(b)(1) in making a written solicitation and at the commencement of that solicitation owns beneficial securities of the class which is the subject of the solicitation with a market value of over $5 million, must file a Notice of Exempt Solicitation pursuant to Rule 14a-103 to which all written soliciting materials are attached. No filing need be made with respect to oral solicitations (other than with respect to scripts used in connection with such oral solicitations), speeches delivered in a public forum, press releases, published or broadcast opinions, statements, and advertisements appearing in a broadcast media, or a newspaper, magazine or other bona fide publication disseminated on a regular basis. Persons not eligible to rely on Rule 14a-2(b)(1) may be able to rely on Rule 14a-1(l)(2)(iv)(A). That rule excludes from the definition of “solicit” and “solicitation” any communication by a security holder who does not otherwise engage in a proxy solicitation (other than a solicitation exempt under Rule 14a-2) stating how the security holder intends to vote and the reasons therefore. It is, however, limited to communications made by means of speeches in public

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forums, press releases, published or broadcast opinions, statements, or advertisements appearing in a broadcast media, or newspaper, magazine or other bona fide publication disseminated on a regular basis.

[e] Rule 14a-2(b)(6).

The exemption in Rule 14a-2(b)(6)is available to persons who will not seek proxy power. See discussion of the rule above.

[8] REMEDIES FOR VIOLATION OF RULES 14a-3 AND 14a-6

Rules 14a-3 and 14a-6 can be violated by simple non-compliance or late compliance with the rules, by misplaced reliance on exemptions such as Rules 14a-2(b)(1), 14a-2(b)(2) or 14a-2(b)(6), or by a failure to comply with the requirements of Rule 14a-12. In appropriate circumstances, a court can issue an injunction. The scope of an injunction can range from an injunction against further violations to an injunction against use of proxies obtained in violation of the proxy rules to an injunction to stop action approved as a result of illegal proxies (such as enjoining consummation of a merger) to an injunction requiring that the consummated action (such as a merger) approved as a result of violation of the proxy rules be unwound.

The U.S. Supreme Court in Mills v. Elec. Auto-Lite Co., 396 U.S. 375, 386, 90 S. Ct. 616, 24 L. Ed. 2d 593 (1970) rev’d and remanded, 552 F.2d 1239 (7th Cir. 1977), a proxy rules case, set forth general guidelines for the issuance of injunctions in proxy cases:

in selecting a remedy, the lower courts should exercise “‘the sound discretion which guides the determinations of courts of equity,’” keeping in mind the role of equity as ‘the instrument for nice adjustment and reconciliation between the public interest and private needs as well as between competing private claims.’”Commentators have indicated that there has been no case where an injunction has been issued to unwind a consummated merger. Loss, Seligman, and Parades, Securities Regulation (online version), Chapter 10 at fn. 531 (“Loss”).

Commentators have indicated that there has been no case where an injunction has been issued to unwind a consummated merger. Loss, Seligman, and Parades, Securities Regulation (online version), Chapter 10 at fn. 531 (“Loss”).

However, in Morris v. Bush, Fed. Sec. L. Rep. (CCH) ¶90,430 (N.D. Tex. 1999), the court found violations of the proxy rules that were primarily violations of Rules 14a-3 and 14a-6 (there were also fraud violations); and issued a preliminary injunction (1) voiding the purported election of directors of [the Activists] . . . and re-installing plaintiffs [the incumbents] as directors . . . and (2) sterilizing the voting rights of the individual defendants or other persons acting in concert with them unless and until all disclosures required by law are made . . . .”

Loss suggests that in an action seeking an injunction before the shareholder vote takes place, an injunction requiring resolicitation is likely to be the appropriate remedy.

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The courts must simply be careful, when enjoining the use of proxies unlawfully solicited, to avoid disenfranchisement of the innocent security holders who gave the violator their proxies. The solution is to order a postponement of the meeting, unless it is postponed voluntarily, in order to permit resolicitation.

Chapter 10, at 544.

Whether a court will order resolicitation is in the court’s discretion, is dependent on the facts and circumstances, and is not necessarily predictable. In Studebaker Corp. v. Gittlin, 360 F.2d 692 (2d Cir. 1966), the defendant shareholder completely ignored compliance with the proxy rules. The District Court enjoined use of the stockholder authorizations obtained by the defendant in violation of the proxy rules “save after compliance with the Proxy Rules of the Securities and Exchange Commission issued under § 14(a) of the Securities Exchange Act.”

The Second Circuit upheld the issuance of the injunction while recognizing that time is very important in proxy statements and the injunction could “inconvenience” the shareholder.

. . . the only consequence of an injunction is that the defendant must effect a compliance with the statute which he ought to have done before. To be sure, time is of the essence in proxy contests – at least the participants generally think it to be. But the district court could properly have considered that the public interest in enforcing the Proxy Rules outweighed any inconvenience to Gittlin in having to start again.

On the other hand, the court in Bertoglio v. Texas Intern. Co., 472 F. Supp. 1017 (D. Del. 1979), took almost the opposite approach. The court found probable violations of the proxy rules but denied a preliminary injunction, saying that the plaintiff must await a hearing on a permanent injunction after the shareholder vote. The rationale was that the harm to the issuer as a result of the proxy rule violations was outweighed by the costs and dislocations of a resolicitation.

the assertions of irreparable injury advanced by Texas International as insufficient to warrant the grant of preliminary injunctive relief, particularly when compared to the expense and dislocation involved in ordering an immediate resolicitation of proxies and rescheduling of the meeting, and when viewed in light of the possibility that TI’s claims may be mooted at the May 31st meeting if none of the Ling-Bertoglio candidates is elected to the Board.

At 18.

[9] REMEDIES FOR FRAUD IN PROXY SOLICITATIONS

[a] Rule 14a-9.

Rule 14a-9 prohibits oral and written misstatements or omissions in connection with any solicitation or communication in connection with a proxy contest.

No solicitation subject to this regulation shall be made by means of any proxy statement, form of proxy, notice of meeting, or other communication, written or

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oral, containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading or necessary to correct any statement in any earlier communication with respect to the solicitation of a proxy for the same meeting or subject matter which has become false or misleading.

Allegations of violations of Rule 14a-9 are the most frequent subject of proxy contest litigation.

[b] Standards for determining whether to issue an injunction.

In determining whether an injunction is appropriate, courts must initially determine whether the statement or omission is false and misleading and if so, whether it is material. Even if the misstatement or omission is material, the plaintiff, who complains of injury from the misstatement or omission and asks for an injunction, must prove, especially in connection with a request for a preliminary injunction, that the balance of hardships is in the plaintiff’s favor.

In the context of a proxy contest, courts appear generally willing to allow the parties considerable freedom to make their cases to shareholders and generally unwilling to intervene without a high level of certainty that the proxy rule violations have caused prejudice. Below are three cases with consistent conceptual approaches, but, presumably because of different fact patterns, different results. In Kass v. Arden-Mayfair, Inc., 431 F. Supp. 1037 (C.D. Cal. 1977), the court noted that the absence of candor and some “puffing” in the proxy materials would not necessarily render a solicitation invalid. In effect, to some degree, a lack of candor and “puffing” is allowable. In addition, the court also noted that a plaintiff would be required to make a “persuasive showing of materiality” to obtain an injunction. In denying a preliminary injunction, the court said:

In light of the fact that proxy contests are adversary proceedings, it is inevitable that each side will find some fault with what is said about itself by the opponents. The absence of complete candor and the presence of some “puffing” will not necessarily render a proxy contest invalid . . . . However, the permissible latitude is limited, since a non-disclosed fact or a “puffed-up” accusation may constitute the presentation of an untrue statement . . . . However, absent a persuasive showing of materiality by the plaintiffs at trial, this court will be inclined to find a lack of materiality in these and other complaints the plaintiffs have made concerning the defendants’ discussion of the Louart nominees.

In Kennecott Copper Corporation v. Curtiss-Wright Corporation, 584 F.2d 1195 (2d Cir. 1978), the court noted the same concerns as the Kass court but did order a preliminary injunction, although the reason was truly odd. Apparently, the lower court’s apparently misplaced criticism of one of the parties became known to shareholders and was determinative of the election.

There is no requirement that a material fact be expressed in certain words or in a certain form of language. . . . Fair accuracy, not perfection, is the appropriate standard. Rare indeed is the proxy statement whose language could not be improved upon by a judicial craftsman sitting in the serenity of his chambers . . . .

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This is particularly so where the statement is prepared in the “hurly-burly” of a contested election. . . . Not every corporate counsel is a Benjamin Cardozo . . . and nit-picking should not become the name of the game. . . .

There is a strong likelihood, however, that the election results were influenced by the criticism of Curtiss-Wright contained in the district court’s election-eve decision. Equity demands, therefore, that the proceedings of the 1978 annual meeting be voided in whole or in part so as to permit a new election of directors.In Capital Realty Investors Tax Exempt Fund Ltd. P’ship v. Dominium Tax Exempt Fund L.L.P., 944 F. Supp. 250 (S.D.N.Y. 1996), the court noted the “stresses” under which documents used in a proxy contest are drafted and said that probably there is no perfect proxy solicitation. More importantly, these factors bear not only on materiality but the proper relief to be ordered.

In Capital Realty Investors Tax Exempt Fund Ltd. P'ship v. Dominium Tax Exempt Fund L.L.P., 944 F. Supp. 250 (S.D.N.Y. 1996), the court noted the “stresses” under which documents used in a proxy contest are drafted and said that probably there is no perfect proxy solicitation. More importantly, these factors bear not only on materiality but the proper relief to be ordered.

Moreover, as Judge Friendly so aptly wrote, participants in proxy contests and tender offers “act, not ‘in the peace of quiet chamber,’ . . . but under the stresses of the market place.” . . . “They act,” he went on, “quickly, sometimes impulsively, often in angry response to what they consider, whether rightly or wrongly, to be low blows by the other side. Probably there will no more be a perfect tender offer [or proxy solicitation] than a perfect trial.” . . . These considerations bear not only on the judgment to be applied in testing conduct and materiality, but in determining relief as well.

In this case, the court noted that there was ample time before the meeting for the parties to set the record straight by new solicitations and refused to issue an injunction, allowing the parties to go at it so that the shareholders could decide.

Assuming that the proxy statement goes out soon, the threat of irreparable injury to plaintiffs is at most de minimis, and the balance of the equities, to the extent it is relevant here, does not tip decidedly in favor of the plaintiffs. The practical realities of the situation are that [Issuer] and [Activist] respectively, can and presumably will put the material facts into the hands of the [shareholders] promptly. At that point, any misleading impressions created to date should be overcome, and the fate of the mergers will be for the [shareholders] to decide. . . . The issuance of an injunction at this moment therefore would serve no useful purpose.

[10] SETTLEMENT OF PROXY CONTESTS

[a] SEC rules relating to settlement.

Rule 14a-4(e) requires that if a person solicits proxies, that person, subject to reasonable specified conditions, must vote them and vote them in accordance with the instructions given.

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The proxy statement or form of proxy shall provide, subject to reasonable specified conditions, that the shares represented by the proxy will be voted and that where the person solicited specifies by means of a ballot provided pursuant to paragraph (b) of this section a choice with respect to any matter to be acted upon, the shares will be voted in accordance with the specifications so made.

This rule does not prohibit a person soliciting proxies from settling a proxy contest. The only provisions specifically relating to settlement of a proxy contest are Items 3(b)(6) of Schedule 14A and Items 4(d) of Forms 10-K and 10-Q, which require disclosure of the terms and the anticipated cost.

A description of the terms of any settlement agreement by the registrant and any participant . . . terminating any solicitation subject to [Rule 14a-12(c), which applies to proxy contests involving the election or removal of directors], including the cost or anticipated cost to the registrant.

In adopting the disclosure requirements, the SEC indicated that after the settlement, the settling parties would not be required to file new proxy statements relating to the settlement. In particular, if the settlement involved the Issuer agreeing to accept the Activist’s nominees, the Issuer would not be required to file a new proxy statement relating to the Activist’s nominees. The adopting release indicated that the settlement should be disclosed in the Issuer’s proxy statement for the next annual meeting of shareholders unless if has previously been disclosed in documents which have been filed with the Commission and disseminated to shareholders. However, if, in connection with the meeting in question, the Issuer were required to file an amended proxy statement for other reasons, it would be required to disclose the settlement. The settlement would also have to be disclosed in the 10-K or 10-Q as appropriate.

[b] Voting of proxies after a settlement.

If a proxy contest is settled,

• Neither the Issuer nor the Activist can use the proxies to vote for the other party’s nominees whom they did not nominate but who will be elected pursuant to the terms of the settlement. Note that Rule 14a-4(d) allows for Activists to nominate a short slate and to vote for Issuer’s certain of Issuer’s nominees to fill out the slate.

• The Activist cannot use the proxies it has obtained to vote for a proposal submitted to shareholders by the Issuer if the Activist’s proxies instruct it to vote against.

[c] Actions by the Activist to settle a proxy contest.

In connection with any settlement, the Issuer should require the Activist to do the following:

• Withdraw the notice provided pursuant to the Issuer’s advance notice bylaws concerning the Activist’s intent to nominate directors or propose other business;

• Provide written notification to the SEC that the proxy contest has been terminated;

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• Withdraw the Activist’s demands for inspection of shareholder records and, in particular, updates of shareholder records; and

• If the Activist has filed a Schedule 13D, file an amendment to indicate the proxy contest has been terminate and a settlement agreement executed.

[d] Terms of a settlement agreement.

Any settlement agreement terminating a proxy contest would deal with some or all of the following issues:

• Board representation: Either the Activist’s nominees or independent directors, either replacing current directors or through an increase in the size of the board;

• Voting agreement: The Activist to vote its shares in support of the Issuer’s slate at the meeting that is subject to the proxy contest and perhaps future meetings;

• Termination of the proxy contest;

• Standstill agreement: The Activist agrees not to initiate, support, or participate in a proxy contest and certain other activist-type activity for a period of time;

• The procedure for making public announcements regarding the settlement, including the content of a joint press release;

• Reimbursement of expenses: Payment of all or some of the Activist’s expenses in connection with the proxy contest;

• Implementation of Activist’s platform: A commitment by the Issuer to implement one or more elements of the Activist’s platform, whether economic (such as pursuing a sale) or involving corporate governance;

• Mutual releases and covenants not to litigate.

Board representation raises a number of issues, which may include the following:

• Will the Activist’s nominees replace existing directors or will the size of the board be increased?

• Will the Activist’s nominees join the board immediately or wait until the next annual meeting?

• Should the Activist’s nominees be independent for purposes of listing requirements?

• For what period of time will the Issuer support the election of the Activist’s nominees?

• Is the Activist’s continued representation on the board conditioned on continuing to hold a specified percentage or amount of the shares?

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• Does the Activist have the right to designate replacement directors?

• Will the Activist’s nominees be guaranteed committee positions and on which committees?

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Gleeson, William (General) - K&L Gates 4 Fund Organizational Documents Common Anti-Takeover...

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Transcript of Gleeson, William (General) - K&L Gates 4 Fund Organizational Documents Common Anti-Takeover...