I have often wondered—perhaps you have as well—how "innovative" the practice of law really is. Certainly you’ve heard the view that a profession built on precedent is inherently allergic to innovation, but I believe there are tremendous benefits, reputational, professional, and otherwise, in being a lawyer who can actually come up with a novel argument or approach. So my radar, at scan not stun, is always on the lookout for legal practice innovations.
What do I mean by "innovation" in this context?
My favorite example, being a corporate/securities guy, is the poison pill, invented by Marty Lipton at Wachtell in 1982. No one had ever seen anything like it, and, when it was validated by the Delaware Supreme Court in 1985, it changed the rules of the takeover game. And to this day, Wachtell is benefiting from the halo effect of that innovation.
Several weeks ago I heard about a group of disaffected and activist institutional shareholders that took on the management of Take-Two Interactive Software, videogame company and maker of the marquee title, "Grand Theft Auto," at the company’s annual meeting recently. Not only did the activists succeed in replacing the entire Board of Directors with their own slate, but they did so without a proxy solicitation or proxy fight, then and there at the annual meeting.
I wanted to hear more about how they pulled off this unorthodox move, so I arranged to sit down with Adam Kansler, a Proskauer partner who represented ZelnickMedia, the leader of the consortium of institutional shareholders. Here’s what I learned.
Proskauer’s client, ZelnickMedia, led by its founder Strauss Zelnick, thought Take Two was a company that was fundamentally sound although it had been doing certain things badly—such as permitting a stock options backdating controversy to escalate into a criminal indictment of its CEO (something of a feat in itself), and being threatened with de-listing by NASDAQ for not having held an annual meeting, or filed a 10-K or 10-Q, for 22 months. (When I heard this and expostulated to Adam that "I didn’t think you could do that," his comprehensive and understated reply was: "You can’t.")
Let me first set the stage. After that, I commend to you Adam’s summary of the preparations for the annual meeting, and how the team navigated the myriad of complex, intersecting issues of federal securities law, Delaware corporate law, and the bylaws of Take Two itself, that made this unprecedented board "takeover" possible.
Four institutional shareholders owned a combined 46.1% of Take Two, and while they all were sorely disappointed in incumbent management and thought it had to go, some were more active and others more passive in promoting that objective. The initial spark for the no-proxy-contest approach came from the client, who essentially asked Proskauer, "Can’t we just call these four or five people up and change control?"
Adam points out that they were not wrong: As a general matter, Delaware corporate law lets the majority control. But Delaware corporate law also runs smack into federal securities law (or vice versa, if you prefer), as neither corpus was designed to follow the other.
Multiple paths were carefully considered, but it was an action by Take-Two – calling a stockholders’ meeting – that ultimately set the stage for investors to show up at that meeting, nominate a new slate of directors from the floor, and proceed to vote them in on the spot. A few key circumstances came together to enable this:
Ownership in Take Two was highly concentrated, enabling a small handful of actively-minded investors, notably less than ten as provided in an exemption from the proxy solicitation rules, to effectively act to force a change. Also, Strauss Zelnick had put together a strong management team, with a reputation for running things well. This meant that should the activists succeed in taking over the Board, it would not be a hollow victory: They could actually make a positive difference.
But a somewhat subtler aspect was as important: There has been a change in the way institutional investors behave. In the past, institutional investors were essentially mutual funds and pension funds, and their universal attitude was one of passivity, in the sense that dissatisfaction with a portfolio company did not imply they’d try to change the company; it meant they’d sell. But within the past five years, this has changed, as money has piled into hedge funds, and they have become more strategically driven. They are no longer just arbitrageurs, but money managers willing to be active.
Although none of the participants was interested in doing anything truly “hostile” or "destructive," as Adam put it, they did look to some extent at hostile takeovers as a model for what they planned to do and for being prepared for potential reactions by Take-Two. "And was there resistance from incumbent management?," I ask. "Well, with nearly a majority of shareholders on our side, the incumbents probably found it hard to comfortably say no."
Although the notion of replacing the entire Board of a public company without a proxy fight seems innovative enough to me, Adam is a bit more modest: "This was not really the invention of something completely new, like the poison pill, but more the discovery of and careful navigation down a path previously undiscovered." As they say, we report, you judge.
I commend to you the admirably readable summary of the legal issues involved provided by Adam and his team [here’s the *pdf describing more of the legal machinery].
All I’ll add, to goad your professional interest, is to ask if you know the answer to this question: If you are the record owner of stock held at a broker-dealer (non-certificated, that is), which has been leant out in the ordinary course by the broker-dealer to a short seller or other third party, you still have the right to vote those shares, don’t you?
But I also think this unorthodox transaction opens a very nice, broader question: What does the massive liquidity and increasing activism of private equity imply for the landscape of public companies in the United States? After all, as Adam points out, we’re no longer in plain vanilla mutual fund land, where the solution to problem management is simply to sell.
Two competitive pressures at once are converging on private equity and public companies: It’s less and less attractive to be public, and at the same time the easy, out-size returns for private equity are harder and harder to grasp against the heightened competition for deals and pressure to pay up to the present discounted value of the foreseeable future gains.
The convergence of these trends may be more public companies willing to more or less supinely acquiesce to private equity’s mandates for change, particularly as percentage ownership stakes in the hands of private equity grow. After all, if 46% of your shareholders are agitating for replacing management, doesn’t it become awkward to defend your incumbency for the sake of incumbency? "Passive" private equity will be less competitive in the marketplace, and "to the ramparts" public company defenses may no longer be seen as worth the candle.
If I’m 10% right, look to see more innovative transactions such as that pulled off by Adam Kansler and his team at Proskauer.
And, if your firm doesn’t have a private equity practice yet, I hope you have some chips on other squares on the green felt in the center of the table.
