Winning Without A Fight: Steps For Activist Shareholders To Change Management

Friday, June 1, 2007 - 01:00


On March 29th, 2007, three hedge funds and a mutual fund, each a significant stockholder of Take-Two Interactive Software, Inc., attended the annual stockholders meeting of Take-Two and effected a change in control of the board of directors. Long before the March 29th meeting, ZelnickMedia Corporation had approached the four stockholders individually to interest them in a slate of insurgent directors proposed by ZelnickMedia and a plan that ZelnickMedia representatives play a major management role if the insurgent directors were elected. Before any decision had been reached by the four stockholders to go forward, Take-Two announced that it had scheduled its first annual stockholders meeting in approximately 22 months. At the meeting held March 29th, 2007, and without having engaged in a proxy contest, that group of four stockholders elected their slate of insurgent directors instead of existing management's proposed slate without a proxy contest. This article sets forth some of the legal issues the group of stockholders faced and is a template for shareholder replacement of management of underperforming companies.

Characteristics Of The Target Company

The methods used by the group in the Take-Two matter require the target company to have the following four characteristics: (1) concentration of ownership so that the needed votes can be garnered staying within the ten-person limitation set by the proxy rules, (2) dissatisfied stockholders motivated toward change, (3) no poison pill or shareholder rights plan triggered by the formation of a "group", and (4) by-laws with no impediments to stockholders taking action by consent or at the annual meeting.

The Written Consent Route

The Proxy Rules

The SEC's proxy rules, contained in Regulation 14A, require that stockholders receive a proxy statement before their votes are solicited, absent an exemption. One exemption is Rule 14a-2(b)(2), which permits persons other than target company management to solicit ten or fewer persons without delivering a proxy statement.

Section 13(d)

Section 13(d) and the rules promulgated thereunder require persons to file a Schedule 13D if they own more than five percent of the outstanding stock of a public company and intend to influence control or management of the target company. Persons which are either institutional investors which do not have an intention to influence the target company's control or management or passive investors can file a shortened form Schedule 13G in lieu of the more detailed Schedule 13D. Once a qualified institutional investor seeks to influence control or management, or once a passive investor ceases to be passive, then that investor must convert from a Schedule 13G to a Schedule 13D.

Converting from a Schedule 13G to a Schedule 13D has two consequences. First, the reporting person must file a Schedule 13D, requiring far more extensive disclosure about the stockholder and its directors and officers. Second, upon converting from a Schedule 13G to Schedule 13D, Rule 13d-1(e)(2) prohibits the reporting person, during the ten-day period following the filing of the Schedule 13D, from voting its shares or acquiring any additional shares of the target company. This ten-day freeze is important to the timing of director removal.

Stockholders which agree to act in concert for the purpose of acquiring, selling, voting or holding the target company's voting securities will form a "group" at that time. If that group owns more than 5% of the target company's stock, that group is a Section 13(d) reporting person and must file a Schedule 13D. Precisely when the group agrees to act in concert is intensely factual. It is wise to have a defining moment, or a "hook," that signifies the formation of the group at a given time, rather than arbitrarily designating a given time.

The Schedule 13D that is filed could, but it should not be, construed as a proxy solicitation. To reduce the chances the Schedule 13D (or the consents, as discussed below) would constitute a solicitation, each should contain a legend noting that it is not a solicitation of any action and no stockholders outside of those within the proxy rules ten-person limitation are requested to join.

Form 3

Under Section 16(a), each group member which becomes a more than ten percent beneficial owner must file a Form 3. Rule 16a-1(a)(1) provides that solely for the purpose of determining whether a person is a more than ten percent beneficial owner under Section 16(a), "beneficial owner" means any person deemed a beneficial owner pursuant to Section 13(d). Because each group member is deemed to beneficially own all the shares of the other group members under Rule 13d-3, and assuming the group in the aggregate owns more than ten percent of the stock, each group member which was not already a more than ten percent holder before the formation of the group would have to file a Form 3. Any change in any group member's ownership of target shares thereafter will require a Form 4 filing.

Investors Agreement

When the group determines it wants to act in concert, the group members should enter into an Investors Agreement. The Investors Agreement should contain the following principal terms: (1) a representation as to how many shares each group member has a right to vote; (2) a covenant that each group member will not sell, transfer, or otherwise dispose of its shares or encumber in any way its right to vote its shares; (3) an agreement as to how shares will be voted; (4) an agreement as to how expenses (including legal counsel) should be allocated; (5) an agreement on future cooperation, including supplying information for the Schedule 13D and any amendments thereto; (6) an agreement to take all actions necessary to vote shares, at a meeting or by written consent; (7) a representation that the information supplied in the Schedule 13D or other documents by each group member is accurate, and indemnification with respect thereto; (8) a termination provision which allows a reasonable amount of time for the group to tender its written consents to the target company's secretary and to otherwise see the proposed actions to completion; and (9) an agreement that public announcements by the parties should be prohibited without mutual consent.

Delaware Consent Issues

Delaware law controls the validity of the written consent. A stockholder must hold its shares in certificate form (rather than book entry form) on the date that stockholder executes a written consent for that stockholder's consent to be effective.

Under Section 228(c) of the Delaware General Corporation Law, stockholders have 60 days from the first day a consent is filed to complete the consent process. The group could file consents for less than all the requisite shares on day one and try to induce other stockholders (within the proxy rules 10-person limitation) during the ensuing 59 days to file consents.

Rule 14f-1

Rule 14f-1 provides that if persons are to elect a majority of the directors other than at a stockholders meeting, the issuer must distribute a mini-proxy statement (a Schedule 14f-1) ten days prior to the new majority directors taking office. The rule does not prohibit electing directors in two steps ( e.g., the group members could sign a consent placing one nominee on the board and, after the Rule 14f-1 ten-day period, replace the remainder of the incumbent directors). It is the target company's obligation to file with the SEC and distribute to its stockholders the Schedule 14f-1.

The Consents Themselves

Two consents probably are needed. The first consent should modify the most recent publicly filed version of the by-laws to ensure that the incumbents have not changed and cannot change the by-laws, until the election, and with the consent, of at least one of the insurgent directors.

The second consent is more substantive. It provides for: (1) the removal of incumbent directors, if so desired; (2) the addition of at least one insurgent director, mindful of a change that would implicate Rule 14f-1; (3) fixing the new number of directors; (4) the removal of all remaining unwanted incumbent directors, with the effective date of the removal approximately 13 days after the date the Section 13(d) 10-day freeze expires (to allow for the filing and mailing of the Schedule 14f-1 plus the required ten days); (5) the addition of the remainder of the insurgent slate, effective at the same time the incumbent directors are removed (13 days); (6) recommendation to the directors that the target company reimburse the group's out-of-pocket expenses; (7) attachment of the proposed Schedule 14f-1 (which should not be filed as an exhibit to the Schedule 13D until the second consents are delivered); and (9) the target company should correct any Schedule 14f-1 defects and promptly file and mail it.

Each consent should contain the same legend discussed above.

The Annual Meeting Route

As an alternative to the consent route described above, the group members can attend in person or by proxy the annual stockholders meeting called by the target company and vote for the insurgent slate.

Many of the same issues apply equally to voting at an annual meeting. The issues surrounding the proxy rules, Section 13(d), the necessity for filing a Schedule 13D and Form 3 are equally applicable to a written consent and to voting at an annual meeting. However, Rule 14f-1 does not apply to voting at an annual meeting since that rule addresses changes of directors other than at annual meetings.

Voting Issues

A number of issues surround a vote at a meeting. As discussed above, when converting from a Schedule 13G to a Schedule 13D, a rule promulgated under Section 13(d) mandates a 10-day freeze on voting and acquiring additional stock. Ideally, the prospective group members may wish to wait until the record date is announced, form the group, convert from a Schedule 13G to a Schedule 13D, and have the 10-day freeze run after the record date.

As to the form of ballot that should be employed by the group to vote for its insurgent slate, it is wise to take the ballot distributed by the target company at the annual meeting, scratch out the names of the incumbent directors, and replace them by handwriting the names of the insurgent directors. This method minimizes the possibility that the target company will object to the form of ballot. It also helps insulate the group from a proxy solicitation claim.

Agreement with the Target Company

It is highly advantageous for the group to enter into an agreement with the target company governing the rules of the annual meeting. Depending upon the reaction of existing management and the relative strength of the group, such an agreement may or may not be achievable.

Back-Up Consents

The ability to vote at the stockholders meeting is determined by the number of votes that can be cast on the record date of the annual meeting. The number of votes that can be given by consent is determined on the date the consent is delivered. Therefore, if the members of the group are unable to vote at the meeting enough of the shares owned by them on the record date to carry the vote at the meeting, a back-up consent may be desirable.

Target Company Defenses

The target company may try to erect defenses once it learns from a Schedule 13D filing that the group is going to try to replace management. Under Delaware case law, once the incumbent directors learn of the plans of the group, actions they take are highly suspect and are likely to be struck down by a Delaware court as devices of entrenchment. The target company also could commence litigation based on Delaware or federal securities law claims. Because the insurgent group in this template, such as in the Take-Two matter, represents a majority of the stockholders of the target company, management should not be favored to prevail in such litigations.


Today hedge funds and mutual funds often own very large blocks of stock of their portfolio companies. Where collectively a group of funds own a majority (or close to a majority) of a company's outstanding shares, those funds need not sit idly and watch as management steers the company in a manner the group believes not to be in the best interests of the company's stockholders - and changing the company's course need not include a proxy fight. A well-coordinated effort by a stockholder group following this template can put stockholders back in control to determine the direction of their company.

Adam J. Kansler is a Partner in the corporate law practice group, and Leila Zahedani is a law clerk, all in Proskauer's New York office.

Please email the authors at or with questions about this article.