Extreme Value Hedging: How Activist Hedge Fund Managers Are Taking on the World

Chapter 4

How Activists Use Litigation to Pursue Their Agenda

In 2002, faced with an impending proxy contest, California software producer, Liquid Audio, decided it would expand its board from five to seven seats. The intended effect: dilute or reduce the impact of two activists that each wanted a seat on the board. If successful, the insurgent shareholders would only gain two seats on a board of seven members, instead of being two directors on a board of five. Dissidents James Mitarotonda and Seymour Holtzman realized that they would need to step things up a level if they wanted their proxy contest to effect the changes they wanted to see take place.¹

In fact, the activists wanted to see the company cancel a proposed merger that they didn't like and instead liquidate itself and distribute proceeds to shareholders. Liquid Audio was a cash-rich, yet profitless company that manufactured software enabling consumers to download and purchase music from the Internet in a proprietary digital format. Mitarotonda and Holtzman were sure that Liquid Audio's business plan was destined to fail, given all the unlicensed downloading people at the time were doing using Napster and all the other free file-sharing programs available on the Internet.

That's when they decided to employ another strategy often utilized by activists to achieve their goals: the lawsuit.

They filed a complaint with the Delaware Chancery Court, arguing that the company was violating its fiduciary duty to shareholders by ...