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When a New Jersey-based company called Arbinet-thexchange Inc. faced an investor’s bid to replace two board members last year, one thing was guaranteed: plenty of work for lawyers. Attorney Joe Johnson, chairman of Boston-based Goodwin Procter’s mergers & acquisitions and corporate governance practices, advised the company on the mechanics of the so-called proxy fight, including Securities and Exchange Commission procedures and state corporate law matters. As it turns out, the investor won a seat for himself, but lost his bid for a second. The company, which operates an electronic exchange for communications companies, has since announced a special committee of independent directors to review strategic options, including the investor’s proposals. And Goodwin Procter has been the ongoing outside counsel since the election. For many corporate lawyers, this transaction feels increasingly familiar. Activist and dissident shareholders, particularly hedge funds, are boosting corporate legal work as boards of directors cope with demands from sophisticated investors and proxy contests when those investors seek a board seat. The activists want changes to increase shareholder returns, including using extra cash to pay a dividend or buy back stock from shareholders or selling a division. As lawyers help companies grapple with an increase in activism, they also expect proposed SEC and New York Stock Exchange (NYSE) rule changes for proxy contests to heighten activist investors’ leverage by easing the board election hurdles currently faced by outsiders. Shareholder proposals on board-governance matters � such as requiring majority voting to elect directors or an independent board chairman � have climbed markedly over the past five years from 58 proposals in 2002 to 166 in 2006, according to research by New York-based Georgeson Inc., which runs proxy contests for management and activist groups. The board-related proposals jumped amidst modest increases in overall governance proposals to 385 in 2006, up from 375 in 2005 and down from 2003′s spike to 427, which was driven by that year’s flurry of executive-compensation proposals. Contested shareholder proposals are also on the upswing, climbing to 31 in 2006 from 23 in 2005 and 28 in 2004, compared with 40 in the recent peak year of 2001. Hedge funds behind activism Many hedge funds are flush with cash and casting about for new investment opportunities, flooding into the equity markets. They’re buying stock and pondering what companies can best do with the piles of cash on their balance sheets and whether the company is maximizing its profitability potential, said Robert Profusek, a New York-based Jones Day partner. Activism “really took off in 2005 and 2006″ as hedge funds decided to play a more dynamic role in their equity investments, said Mark Gerstein, a lawyer in the Chicago office of Latham & Watkins lawyer. “They concluded they had to become catalysts to drive value from their equity portfolio and not simply wait for management and extraneous events to improve that value,” Gerstein said. Hedge funds’ mobilization has translated to more work for lawyers. Gerstein advised Chicago-based fitness center chain Bally Total Fitness Holding Corp. when two groups of hedge fund investors sought to replace three directors and the CEO, who ultimately left under pressure. Proxy disputes typically spawn work for several practice groups and even outside firms with expertise in the corporate law of the state where the company is incorporated. For help with the proxy fight and with Bally’s Delaware state court and federal court litigation over the insurgents’ proposals and director contest, Gerstein called in a Latham senior corporate partner in New York and litigation and securities colleagues in Washington. Since state laws regulate director election issues, and Bally is incorporated under Delaware law, Latham & Watkins also brought in Delaware-based Richards, Layton & Finger. Hedge funds believe that they have investment philosophy and expertise to drive performance at undervalued companies, even when those companies’ performance is generally strong, said Akin Gump’s Patrick Dooley. Dooley represented oil company Houston Exploration Co. in Houston when insurgent group JANA Partners LLC of San Francisco pushed the company to agree to an acquisition. Last month, Houston Exploration announced that Forest Oil Corp. of Denver would acquire it. “Once one of these funds surfaces with a credible plan or theory of enhancing value, all of a sudden a significant number of shareholders [will often be] pressing the company to do something,” Dooley said. When one hedge fund zeros in on a perceived opportunity, other hedge funds frequently pile on, Dooley said. Multiple hedge funds investing in the same company and in some cases, competing for control, is also driving the increase in shareholder activism, said Profusek. Hedge fund Steel Partners LLP of New York recommended that Jones Day client GenCorp. Inc., which makes missile propulsion technologies, add noted Delaware corporate law expert and Richards Layton lawyer R. Franklin Balotti to the board in 2005. Then in 2006, hedge fund Pirate Capital LLC of Norwalk, Conn., launched a successful proxy fight to replace Balotti and two other directors to advance its own agenda for maximizing the company’s value. Jones Day advised the Rancho Cordova, Calif.-based GenCorp. when Pirate sued it during the proxy fight, and strategic direction since the board change. “If there’s an insurgent agitating for change . . . you’ve got a guy in the boardroom saying your plan is no good,” Profusek said. “Every decision that’s made is like a tooth extraction. Lawyers would end up getting involved in all kinds of stuff.” Behind the scenes Lawyers are also behind the scenes when activists make moves. Dooley worked with GWA Investments LLC of Pasadena, California during its successful bid for three seats on the board of Fremont, Calif.-based semiconductor company Exar Corp. in late 2005. Dooley helped the hedge fund approach the company quietly with an offer to place two of its own directors on the board. When negotiations fell apart, he led GWA through the proxy contest and helped the new board members advance GWA’s strategic agenda. “If you win, in the process of integrating new board members and seeking to make changes insurgents believe are appropriate, there’s a lot of advisory work and technical legal work,” Dooley said. Investor groups are also scrutinizing companies’ merger plans. A Caremark Rx Inc. shareholder group asked the Delaware Chancery Court to force the pharmacy company to disclose more information about its planned merger with CVS Corp. of Woonsocket, R.I. Following the court’s ruling this month, the Nashville, Tenn.-based Caremark, which is also fielding an unsolicited bid from pharmacy company Express Scripts Inc of Maryland Heights, Md., released more information and postponed the merger vote until March. “We are pleased that the Court has recognized the need for Caremark to make complete and accurate information available to its shareholders,” said an investor group attorney Stuart Grant of Delaware-based Grant & Eisenhofer. In a different type of activist uprising, a shareholder group pushed for the reinstatement of former president and CEO John Nano and the replacement of the entire board, when the stock of Fairfield, Conn.-based technology licensing company Competitive Technologies Inc. dropped last year. The company’s former law firm, Seyfarth Shaw, declined to talk about this month’s board turnover, but recently deposed board member Maria Maccecchini said the company and board “relied enormously on counsel.” Maccecchini, a Philadelphia-based scientist and “angel investor,”-an individual who funds early -stage companies typically in exchange for an equity stake-said the board was “taken aback” by all the rules and regulations associated with a proxy fight. “The lawyers became very important, because none of us knew what we were supposed to do,” Maccecchini said. The Competitive Technologies shareholder group had the unusual goal of reinstating a former CEO, but the common catalyst of shareholder unhappiness is the same as in other proxy fights, said Nano’s lawyer Richard Cutler of the Cutler Law Group in Augusta Georgia. “There’s a lot of angry shareholders and lots of ways to get a remedy,” Cutler said. On the horizon Activist stand to gain even more power if proposed SEC and NYSE rule changes come into play. As of July 1, the SEC will allow companies and other parties including shareholder groups to distribute proxy materials over the Internet to shareholders who request an online option. The SEC’s goal is to give companies, and shareholders mounting their own proxy campaigns, a less expensive alternative than using the mail to collect shareholder votes. The SEC is reviewing a rule that allows companies to exclude certain shareholder proposals from company-issued proxy materials in light of a 2d U.S. Circuit Court of Appeals decision last year. That decision said the agency was wrong to recommend that AIG would not face enforcement action if it excluded an investor’s proposal, said SEC spokesman John Nester. American Federation of State, County and Municipal Employees, Employees Pension Plan v. American International Group, Inc., 462 F.3d 121 (2d Cir.). “The chairman has said he wants the commission to adopt one clear rule for all companies and all investors that clearly articulates shareholder access to the ballot box,” Nester said. The agency’s comprehensive examination of its rules surrounding shareholder access to the proxy process includes a review of other countries’ practices. “We’re looking into what other countries do, recognizing that there may or may not be parallels that guide our decision-making,” Nester said. NYSE is mulling a recommendation to eliminate broker discretionary voting starting in January 2008. The idea, which was birthed by a group it appointed by NYSE to examine the proxy voting process, is to curtail broker voting on proxy proposals when the broker holding the stock has not been able to obtain instructions from shareholders. The current rule allows brokers to vote on a range of routine matters if they don’t received shareholder instructions 10 days before the shareholder meeting. “Today the election of directors is simply too important to ever be considered routine, even where the election is uncontested,” said NYSE president & co-chief operating officer Catherine R. Kinney in a statement. “Shareholder voting on the election of directors is a critical component of good corporate governance.” At the behest of activists, more and more companies are also changing their bylaws or adopting policies providing for a majority vote for the election of directors, rather than a plurality vote, said Louis Goodman, a Boston partner at New York-based Skadden, Arps, Slate, Meagher & Flom. Goodman, mostly represents the targets of activist investors, including Newton, Mass.-based mutual fund RMR Hospitality & Real Estate Fund, which is embroiled in a proxy contest. Corporate changes calling for a majority vote for director elections would magnify the effect of the NYSE proposal. “If the NYSE rule goes into effect, it’s going to become harder to get that majority vote if more of the shares held at brokerage houses aren’t counted,” Goodman said. “It gives more leverage to the activists. It’s going to be easier for an activist to keep a sitting director from being elected.”

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