Public companies would be well advised, on a lovely, clear day (in the Delaware sense), to update their advance notice bylaws. In the normal course these bylaws receive little attention, but in the event of an activist campaign they are critical to the board’s ability to discharge its fiduciary duties.  The board will have a positive duty to inform itself, among other things, of the activist’s plans and proposals, the degree of the activist’s financial alignment with long-only stockholders, and the qualifications and independence of the activist’s nominees.  This information will inform any settlement discussions, support a recommendation for or against the activist’s nominee and allow the board to ensure that stockholders receive accurate and timely disclosure regarding the nomination.

In light of recent Delaware cases regarding the enforceability of advance notice bylaws, and in order to elicit information necessary to board and stockholder decision-making, Milbank has prepared a model advance notice bylaw, focusing in particular on the degree of alignment between the activist and the other stockholders of the corporation.  The link to this bylaw can be found here (the “Alignment ANB”).

Key features of the Alignment ANB include the following:

Clarity. The Alignment ANB is drafted in a clear and direct manner, without setting up potential foot faults and boobytraps for activists seeking to nominate directors. The information sought, while comprehensive, is only what is necessary to provide boards and stockholders with a proper foundation for their decision-making.  The bylaw heeds the Delaware Supreme Court warning in Kellner v. AIM Immunotech, Inc. that “[a]n unintelligible bylaw is invalid under ‘any circumstances’”[1]

No Daisy-Chains or Acting In Concert Expanders. Delaware courts have been critical of bylaws that expand the disclosure requirements to persons and entities that may have little to do with the nominations being made. Typically, advance notice bylaws will seek disclosure with respect to any person deemed to be “acting in concert” with the nominating stockholder – a definition that in some circumstances can be difficult to pin down and often leaves a significant amount of discretion to the board in determining when a person is “acting in concert” with the nominating stockholder. The Alignment ANB by contrast provides a well-defined scope of inquiry, limiting itself to disclosure with respect to “Proposing Persons,” defined as the nominating stockholder and persons that have directly (or, to the knowledge of the nominating stockholder after due inquiry, indirectly) entered into a contract, arrangement, understanding or relationship with the nominating stockholder related to the nomination. Note that the due inquiry requirement will not create a new burden on the activist, as it mirrors the inquiry the activist will make to determine group status. Moreover, this approach eliminates the uncertainty and burden created for the activist by use of an “acting in concert” approach.

Additionally, the Alignment ANB requires disclosure of certain material contacts with other stockholders (or potential investors in the corporation) from the date 3 months prior to the date of the Proposing Stockholder Notice (together with disclosure of any material expressions of support received as a result of such contacts). This requirement may give some comfort to those who have embraced the “acting in concert” approach as a means to capture activists who “cheat” by taking an overly narrow view of “group” formation in evaluating their Rule 13D and Section 16 obligations.  While this provision may yield relevant information in this regard, the point is not to test for Rule 13D compliance – the application of Rule 13D is easily avoided and, in the end, Rule 13D does not seek to regulate proxy contest disclosure. The bylaw instead seeks to ensure compliance with Rule 14a-12, which is a proxy rule seeking to put all stockholders on an equal informational footing.

Rule 14a-12 requires disclosure of solicitations made prior to distribution of the proxy statement. While a number of activists seem to have a fairly disciplined approach to Rule 14a-12, a review of filing practices shows that some activists either ignore Rule 14a-12 or perhaps have an inappropriately narrow definition of what constitutes a solicitation. Requiring disclosure of early contacts with other stockholders and of material expressions of support received – regardless of whether the activist considers such contacts to constitute solicitation – should answer questions around whether those early contacts were indeed solicitations made in violation of Rule 14a-12. It will also provide stockholders with useful information regarding the scope and type of the support (if any) enlisted by the activist before its campaign became public knowledge and regarding the content of any early pitch made privately by the activist.

Financial Alignment Disclosure. The Alignment ANB requires the nominating stockholder to be very clear about the net financial position the activist and other participants in the solicitation have taken in the corporation.  Derivatives are an ever more important component of many activists’ holdings. While activists are typically required to disclose the derivatives they hold, in practice this disclosure tends to be very high level, without an explanation of the overall net effect of the derivatives.  For example, activists often are not required to disclose voting rights associated with derivative positions and are very seldom required to disclose the cumulative financial strategy behind derivative purchases -e.g., whether the derivatives, taken as whole, are designed to protect against losses, to profit from losses, to supercharge stock price gains, to limit reporting requirements, to decrease costs that would arise from owning stock outright or to otherwise transfer the economic consequences of ownership. The Alignment ANB requires disclosure both of the strategy behind the derivatives purchases and of the economic terms associated with that strategy. Disclosure of basic economic terms, such as when the derivatives expire, terminate or are subject to renewal or repricing will allow stockholders to understand if there are important constraints on the time horizon for the activist to achieve a change in market price. Revealing basic economic terms of the derivatives will allow stockholders to understand how much capital the activist has put at risk, and how that risk compares to risks taken by long-only holders over different time horizons. Given the prominence of derivatives in strategies employed by a number of important activists, without having clear answers to these questions it will be impossible for the board and stockholders to judge the financial alignment of the activist with long-term stockholders.

Voting Borrowed Shares. While lending shares of the corporation to cover short sales may provide income for large fund complexes, it is unlikely that these fund complexes (or other long-term holders) wish to promote empty voting in a contested corporate election.  Permitting the voting of borrowed shares by an activist – amplifying the activist’s voting power when there is no meaningful economic stake in the shares being voted – misaligns voting power with the economic consequences of the vote and does not promote good long-term decision making. The Alignment ANB accordingly requires the nominating stockholder and allied participants in the solicitation to waive their right to vote shares in excess of their collective net long position – in other words, to waive the right to vote shares that were borrowed or otherwise subject to an offsetting sale or delivery obligation.

Alignment of Plans and Proposals. The most important piece of information needed for boards making recommendations and for stockholders casting their votes is a clear statement of precisely what change the activist is seeking to implement.  Schedule 14A does not require this information – perhaps relying on the fact that activists will need to convincingly set out their plans and proposals in order to attract the votes needed to elect their nominees. Yet, in the absence of a detailed disclosure requirement, it can sometimes be hard to reconcile the demands made by an activist in the run-up to a proxy fight with the statement of the activist’s objectives in its proxy statement.

For example, an activist’s proxy statement may say that it wants to replace the CEO. The background section of the corporation’s proxy statement records that the activist in its early interactions with the board proposed a spin-off, which the CEO resisted. Stockholders will want to know whether the activist intends to replace the CEO because he or she is a bad operator or whether the activist intends to replace the CEO because it wants to effect a spin-off. In such a situation, the economic interests of the activist in promoting a spin-off will be material to stockholders, regardless of whether Schedule 14A expressly requires this level of disclosure and regardless of whether the activist would choose to designate this interest a “plan or proposal” in its Schedule 13D disclosure (if applicable).

In the Schedule13D context, defining just when a thought experiment becomes a “plan or proposal” has led to a practice of over-inclusive disclosure that tells stockholders nothing about an activist’s plans by telling stockholders that everything is possible.  Proxy disclosure, which provides the basis for stockholders’ voting decisions, should be more rigorous.  Activists should be transparent about exactly how they intend to steer the corporation. Stockholders deserve to know what material analyses the activist has performed in making its investment – whether those analyses focus on investment returns from certain transactions (like spin-offs, recapitalizations, asset sales, etc.) or on fixing operational issues such as, e.g., supply chain management. These analyses will provide information about whether the activist already has a strong point of view on the best outcome of a strategic alternatives review, or material economic reasons to press for one outcome over another. While the analyses may not have resulted in a concrete “plan or proposal,” they can reveal the direction the activist will want to move, and perhaps of what motivated the activist’s initial investment.  This in turn will give stockholders a clearer view as to their alignment with the incentives of the activist, who will have an important voice in the management of the corporation if its campaign is successful. In order to generate better disclosure on this critical item, the Alignment ANB explicitly requires disclosure of the activist platform, and a summary of material economic analyses performed.

Independence of Nominees.  In some cases, activists will nominate their own employees as directors, in a clear bid to drive their platform (which platform, as noted above, should be made transparent to voting stockholders). In other situations, activists will nominate “independent” directors, with the apparent intention of bringing independent expertise to the problems faced by the corporation.  At times, however, the term “independent” is applied rather liberally, making it less clear whether the nominee was put forth in order to drive the activist’s platform, or to serve as an independent technocrat. The Alignment ANB seeks to make the connections between nominees and the activist clearer, requiring disclosure of whether the nominee and activist have had discussions to align on a shared agenda for the corporation (and if so, the result of such discussions), on financial, social and family ties, and finally, on whether the nominee is expected to share confidential board information with the activist going forward. The degree of independence of any given nominee will matter acutely to voting stockholders, particularly if they are not fully on board with the activist’s platform or if their financial interests do not clearly align with the activist’s.

Consequences. The Delaware Supreme Court in the Kellner case held that although the challenged bylaws were unenforceable, the activist plaintiffs would be denied relief as a result of the plaintiffs’ own “deceptive conduct”.  Indeed, it is hard to fathom why an activist’s nominees would not be promptly disqualified in a proxy contest marred by the activist’s deceptive conduct.  Yet, as has been recent pointed out in a posting from practitioners at Sidley Austin, “Lying in Corporate Elections”[2] the remedies available to corporations are so weak and/or difficult to obtain as to be virtually useless. The authors note that the SEC Division of Corporate Finance has been increasingly reluctant to provide significant comments in proxy fights, and the SEC Division of Enforcement has not instituted proceedings prior to a stockholder meeting in recent years – meaning that appeals to the agency charged with monitoring compliance with the Federal disclosure rules will likely be fruitless. Moreover, seeking a preliminary injunction in a Federal court has equally unappealing prospects – litigation is expensive and insurers do not generally pay for litigation costs incurred when the corporation is the plaintiff, stockholders reflexively look on with disfavor when a fellow stockholder is sued by the corporation, and the usual hurdles to obtaining a preliminary injunction remain (showing irreparable harm, proving probability of success on the merits based on a limited record, demonstrating that the balance of equities favors the corporation, etc.).

Yet there is no coherent justification for permitting an activist’s nominees to stand for a vote if the activist has violated fundamental proxy rules designed to protect the integrity of the vote.  In particular, material violations of Rule 14-9 (designed to eliminate false or misleading statements in the context of a proxy fight) and Rule 14a-12 (designed to put all stockholders on an equal informational footing) should disqualify the activist’s nominees. The Alignment ANB requires the board to act to disqualify the activist’s nominees in these circumstances.  Boards will of course wish to be somewhat circumspect in fulfilling this obligation, and will want to have clear evidence of a meaningful violation of these federal rules before disqualifying nominees,  but the board would ill-serve the stockholders by moving forward with a vote that has been tainted by false or misleading statements, or where the activist has relied on a strategy of selective dissemination of information to gain support for its platform.

In short, the Alignment ANB, without placing unfair burdens on the activist, will allow boards and stockholders to better judge their alignment with the activist’s financial incentives and stated platform, and to judge whether the nominees, if elected, will be likely to act independently or as agents of the activist. The bylaw also provides an effective remedy in the unfortunate event that the activist has materially violated Federal law in the course of its solicitation.

[1] Kellner v. AIM Immunotech Inc., -A.3d- 2024 WL 3370273 at 42 (Del. July 11, 2024).

[2] Kai H.E. Liekefett and Derek Zara, Lying in Corporate Elections, Harvard Law School Forum on Corporate Governance, September 13, 2024.