II. The legal foundations of hedge fund activism today.

• Author: Briggs, Thomas W.
• Position: Corporate Governance and the New Hedge Fund Activism: An Empirical Analysis

To begin with, there is no legal or even generally accepted definition of a "hedge fund." According to the Securities and Exchange Commission (SEC), a hedge fund is any privately offered "entity that holds a pool of securities" or other assets and that is not a registered mutual fund. (20) Perhaps many people simply think of hedge funds as secretive, aggressive, anything-goes investors. (21) For purposes of this Article, the term includes plain vanilla hedge funds as well as other "fellow traveling" funds with a similarly aggressive activist investment style. But for any investor, SEC and related rules form a veritable slalom course that must be run in any proxy fight or other shareholder activism effort. These rules have essentially been reworked twice in recent years, first in 1992 with the avowed purpose of making traditional large-institution activism easier, (22) and then again near the turn of the millennium to streamline merger and acquisition transactions. (23) As the following pages will describe, however, the surprising consequences of these changes for hedge fund activism have only recently become fully apparent. Two of the changes, the termination of SEC proxy censorship and the free-communication rule adopted in 1999, have essentially revolutionized proxy fights and made hedge fund activism as we know it today possible.

1. The SEC Rules and the 1992 Reforms

   Absent an available exemption, any shareholder "solicitation" automatically invokes the full panoply of the SEC's proxy rules. (24) These rules define a "solicitation" as any communication to shareholders "under circumstances reasonably calculated to result in the procurement, withholding or revocation of a proxy." (25) This is a facts-and-circumstances test. Even the SEC has acknowledged that what constitutes a solicitation is therefore "not always clear," and that "almost any statement of views" could expose a shareholder to litigation risk. (26) Cautious lawyers consequently advise their clients accordingly.

   Complying with the rules means filing a proxy statement and card in preliminary form with the SEC for review by the staff. (27) Once all comments are cleared, the shareholder is free to mail its materials to all or as many other shareholders as it wishes. (28) Identifying these other shareholders and coping with the truly Byzantine complexity of actually reaching them through brokerage firm and other Wall Street back offices (29) then necessitates hiring a financial printer and a professional proxy solicitation firm, which only adds to the legal expenses already incurred. (30) But from here things get easier. After distributing the proxy statement, nothing else that an insurgent sends out has to be pre-cleared with the SEC, as had been the case before the 1992 reforms. (31) According to the adopting release, the SEC got itself out of the proxy censorship business because it believed that contestants "should be free to reply to [an opponent's] statement in a timely and cost-effective manner, challenging the basis for the claims and countering with their own views on the subject matter through the dissemination of additional soliciting material." (32) This change has proved to be revolutionary. Restrained only by the general proxy antifraud rule, (33) a hedge fund activist is now free to disseminate to the world near telephone books full of essentially unverifiable presentation slides.

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