Delaware judge rejects early unmasking of activist fund investors in proxy bylaw fight

The seal of the Court of Chancery for the State of Delaware is seen on a wall in the Sussex County Court of Chancery in Georgetown, Delaware
The seal of the Court of Chancery for the State of Delaware is seen on a wall in the Sussex County Court of Chancery in Georgetown, Delaware, U.S., June 9, 2021. REUTERS/Andrew Kelly

(Reuters) - In a big win for activist investors, hedge fund Politan Capital Management LP has shut down an attempt by medical device maker Masimo Corp to use the litigation discovery process to unmask Politan’s investors.

Vice Chancellor Nathan Cook of Delaware Chancery Court ruled from the bench on Tuesday that Masimo cannot compel Politan to reveal its backers as the company and the hedge fund fight over the validity of Masimo’s controversial bylaw amendment.

That information, Cook said, is not relevant under Delaware precedent from 1987’s Atlantic Research Corporation v. Clabir Corporation, to the board’s decision to adopt the controversial new bylaw, which requires investment funds that have nominated a candidate for Masimo’s board to tell Masimo shareholders about their own financial backers in advance of proxy voting for directors.

The key question, the judge said, is whether Masimo’s board acted reasonably when they decided to adopt the advance notice requirement. Because board members did not know the identity of Politan’s investors when they made the decision, Cook said, Masimo does not need the information to defend the bylaw amendment.

Cook also said that allowing Masimo to unmask Politan’s backers in discovery – even under a protective order – would effectively give Masimo the very information that Politan has sued to block the company from demanding. Cook said he would not order the hedge fund to reveal confidential secrets that “three months from now, I may well conclude Masimo is not entitled to after trial.”

It’s important to remember that Cook’s ruling this week does not resolve the merits of the closely watched fight over Masimo’s bylaw amendment. But Politan had argued that the mere prospect of being forced to reveal investors in the discovery process – even under a protective order – might chill activist funds from conducting proxy campaigns.

Cook’s decision, in other words, eliminates the possibility that Politan would abandon its challenge to Masimo’s advance notice requirement to protect the confidentiality of its investors.

Politan, which is represented by Schulte Roth & Zabel and Cadwalader, Wickersham & Taft, declined to provide a statement about this week’s decision, which also denied Masimo's demand for information about Politan's internal workings and communications with investors.

Masimo counsel Michael Carlinsky of Quinn Emanuel Urquhart & Sullivan emphasized in an email statement that the ruling did not address the underlying validity of the bylaw.

“We are confident in Masimo’s position that the bylaw amendments bring about much needed transparency and will continue to vigorously defend those amendments,” Carlinsky said. Masimo is also being advised by Paul Hastings and by former Delaware Vice Chancellor Joseph Slights of Wilson Sonsini Goodrich & Rosati.

Masimo adopted the bylaw amendment, as I told you earlier this month, in September, after Politan founder Quentin Koffey revealed the hedge fund’s 8.4% stake in the company and indicated that he wanted two seats on the Masimo board.

Politan sued Masimo and its board members in October to invalidate the new bylaw. The hedge fund contends that the provision is a naked attempt to ward off activist investors by requiring funds to reveal proprietary information that, in some instances, is contractually confidential. Politan asserts that Masimo's bylaw interferes with shareholders’ voting rights and improperly entrenches the company’s current leadership.

Masimo responded with a countersuit accusing Politan of making false representations about its investment in the company and asking Chancery Court to bless the advance notice bylaw. Masimo insists that the new rule promotes crucial transparency about board candidates, after the U.S. Securities and Exchange Commission changed proxy voting regulations to require that companies present shareholders with all director candidates on a single voting card.

In discovery, Masimo demanded that Politan identify its investors. When Politan refused to comply, the company moved to compel disclosure, arguing that the information would prove Masimo directors were right to doubt Politan's repeated assertions that its investors are passive and free of conflicts.

But Cook said in Tuesday’s ruling that the board cannot justify its decision-making with after-the-fact information. “What defendants might theoretically discover about Politan now by turning over the proverbial rocks is, at least based on the arguments and record presently before me, irrelevant,” the judge said.

Cook also quashed Masimo’s separate subpoena for information from the investment fund EnTrust Global Partners LLC. The Wall Street Journal reported last August that EnTrust was backing Politan’s campaign for Masimo board seats, but the Delaware judge said additional information about EnTrust’s role was not relevant to the question of whether the board acted reasonably in adopting the advance notice bylaw.

Masimo counsel Carlinsky noted in his emailed statement that Politan made a notable concession during the dispute over Masimo’s discovery demands. The hedge fund, Carlinsky said, agreed that it would not contest the “objective correctness” of the Masimo board’s perceptions at the time it adopted the bylaw amendment.

Politan will therefore have to argue at trial that even if the Masimo board rightly doubted the hedge fund’s intentions, its decision to adopt the advance notice requirement was unreasonable and disproportionate.

It’s still not clear, and likely won’t be until trial, what standard Cook will use to evaluate the board’s decision. His options range from deference to directors under the business judgment rule – although that’s unlikely in a case involving shareholder voting rights – to the extremely stringent test from 1988’s Blasius Industries, Inc. v. Atlas Corporation, which demands that directors offer a compelling justification for interfering with shareholder votes. Between those extremes is the standard established by the Delaware Supreme Court in 1985’s Unocal Corporation v. Mesa Petroleum Co., which allows corporate directors to take reasonable actions against takeover threats.

Trial is scheduled to begin on March 7.

Read more:

Corporate tactic to unmask activist hedge fund investors faces key Delaware hearing

Law firm Sidley warns clients about rules that may hinder activists

Koffey's Politan takes 9% stake in Masimo, to push for change

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Alison Frankel has covered high-stakes commercial litigation as a columnist for Reuters since 2011. A Dartmouth college graduate, she has worked as a journalist in New York covering the legal industry and the law for more than three decades. Before joining Reuters, she was a writer and editor at The American Lawyer. Frankel is the author of Double Eagle: The Epic Story of the World’s Most Valuable Coin.