The proxy process represents the principal means by which shareholders become informed of and participate in the business to be undertaken at a public company’s annual meeting. Traditionally, so-called activist shareholders have been prevented from including their own nominations for open director seats in the annual proxy materials mailed to shareholders. As we have previously explained, the Dodd-Frank Act has changed the balance of power between shareholders and company management by providing a process in which shareholders can require the inclusion of their nominations to the board of directors in proxy statements in the form of new Rule 14a-11 pursuant to the Securities Exchange Act of 1934.
By means of a letter to the board of directors and an amended Schedule 13D filing on September 8, 2010, Discovery Equity Partners, LP, a shareholder in Tier Technologies, Inc., announced its plans to take advantage of the new 14a-11 proxy access rules and submit its nominations for up to two directors to the shareholders in the proxy statement for the company’s 2011 annual meeting. Discovery Equity Partners, LP and its sole general partner, Discovery Group (together, “Discovery”) own a combined 13.5% of the company’s outstanding common stock.
As described by RiskMetrics Group, Discovery has a history of board activism at Tier Technologies, and was involved in a proxy war in 2009. Most recently, in January 2010 Discovery notified Tier Technologies that it intended to nominate three candidates for director. Discovery subsequently reached an agreement with the company that resulted in the reduction of the company’s board to seven directors, separated the roles of chairman and CEO, and reimbursed Discovery for costs incurred in the 2009 proxy war. For its part, Discovery agreed to support management and refrain from nominating director candidates at the 2010 meeting.
Pursuant to the new Rule 14a-11, the formal shareholder proxy access process will begin with the filing by Discovery of a Schedule 14N with the SEC. The 14N can only be filed within a uniform 30-day window beginning 150 calendar days prior to the date the company mailed its proxy materials for the previous year’s annual meeting and ending 120 calendar days prior to the mailing date of the prior year’s proxy materials. Note that although a Schedule 14N notice of intent to require the inclusion of shareholder nominees in company proxy materials is subject to the 30 day window, Schedule 14N may be filed at any time for other purposes, such as to engage in communications with other shareholders for the purpose of forming a nominating group under new Rule 14a-2(b)(7).
Tier Technologies held its 2010 annual meeting on April 8, and mailed proxy materials on March 18, meaning that Discovery would not be eligible to file a Schedule 14N until October 18, 2010, and the 30 day window would expire on November 17, 2010. However, Rule 14a-11 only becomes effective 60 days after publication in the federal register. Although publication in the Federal Register is expected very soon, Rule 14a-11 will be unavailable to Discovery for the 2011 annual meeting if the new rule is not published by September 19.
The filing of the letter with an amended 13D brings several questions to the forefront. One of the admitted purposes of adopting the uniform 30-day window for Schedule 14N filings, as disclosed at pages 177-178 of the SEC’s adopting release was to “reduce disruptions that might occur when a company receives shareholder nominations for director.” Is Discovery making an end-run around that restricted filing window by disclosing its intention to use Rule 14a-11 now? Probably not. If the new rules were effective at this time, Discovery could file a Schedule 14N announcing its intent to form a nominating group at any time under Rule 14a-2(b)(7).
Discovery is limiting its legal options by use of this tactic. By announcing an intent to use Rule 14a-11, it can no longer hold its securities with the purpose, or with the effect, of changing control of the registrant or to gain more board seats than are available under Rule 14a-11. So the days of its proxy wars with Tier are over. Tier may have a formidable challenge on its hands, as Discovery is a sophisticated investor and will likely campaign for its nominees effectively and to the maximum extent allowed by law.
Discovery’s tactic is not without legal risk. By drawing attention to itself in this manner, other shareholders may contact Discovery and engage in various communications. If not carefully circumscribed, those communications could be unlawful solicitations in violation of the proxy rules.
Nonetheless, we expect other activist investors will copy Discovery’s tactic. Note that any person can file a Schedule 13D even if they do not own five percent of the outstanding stock, so such filings could proliferate.
We also expect other boilerplate surrounding Rule 14a-11 to appear frequently in Schedule 13D’s. For instance, almost anyone filing a Schedule 13D reserves the right to engage in a broad range of transactions. That reservation of rights will probably grow to include the right to make nominations under Rule 14a-11 and join Rule 14a-11 groups.
Check dodd-frank.com frequently for updates on the Dodd-Frank Act.