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In the latest development in the protracted battle for control of music software company Liquid Audio Inc., the Redwood City, Calif.-based firm on Wednesday filed a suit against activist investors Musicmaker.com Inc. and Steel Partners II. Musicmaker.com’s Jim Mitarotonda and Seymour Holtzman have two nominees to the board of directors up for election at Liquid Audio’s Sept. 26 annual meeting. The activists’ plan is to initiate a change of control of the board at Liquid Audio, remove management (including Liquid Chief Executive Gerald Kearby), close down the company and distribute the company’s $82 million of cash on hand to shareholders. Meanwhile, Warren Lichtenstein, managing partner of Steel Partners II, in June offered to buy the company for $2.75 per share and has repeatedly issued comments indicating his desire for a liquidation of the firm. Liquid Audio’s suit, filed in the U.S. District Court of the Southern District of New York, said Musicmaker failed to register as an investment company and as a result, the activists should not be able to participate in a proxy fight. “Liquid Audio’s complaint alleges that [Musicmaker] has failed to register as an investment company under the Investment Company Act of 1940, and that its purchase of Liquid Audio shares and subsequent proxy contest to take control of Liquid Audio’s board of directors is therefore in violation of that Act,” said Liquid Audio in a press release Wednesday. Liquid Audio officials did not return calls seeking comment. The suit also charges that Steel Partners is conducting an illegal proxy contest by “failing to make the proper filings with the Securities and Exchange Commission.” Liquid Audio also charges Steel Partners with distributing false and misleading statements to Liquid Audio stockholders. A large shareholder who requested anonymity said Steel Partners is not conducting a proxy contest of any kind. “This sounds like just another attempt to delay a shareholder vote on Musicmaker’s nominees and for liquidation of the company,” he said. A Steel Partners official declined to comment but indicated he needed to review the suit in greater detail. Musicmaker’s Mitarotonda said his lawyers also need to examine the suit in depth before making any comments about it. Liquid Audio on June 13 agreed to a $117.8 million stock-for-stock reverse merger with Alliance Entertainment Corp., a Coral Gables, Fla.-based music distributor. Shareholders get a chance to approve or reject the merger on Sept. 26, but before that they will vote on Musicmaker.com’s board nominees. “The merger agreement will never pass since the company’s five largest shareholders who own approximately 33 percent of the outstanding shares have publicly stated their intent to vote against it,” Steel Partners said in an Aug. 12 filing with the SEC. Lichtenstein, Mitarotonda and Holtzman all have said previously that Liquid Audio’s business plan of encrypting music for electronic paid distribution is not viable and that the company should stop operating and liquidate. Mitarotonda said he doesn’t think Liquid Audio will ever be profitable and he cited the firm’s revenues of about $100,000 a quarter and its cash burn rate of about $20 million a year. Copyright �2002 TDD, LLC. All rights reserved.

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