Corporate Governance

Beneficial Ownership, Equity Swaps, and Proxy Contests: CSX v. The Children's Investment Fund (The Next Steps) (Part 9)

By J. Robert Brown

We are addressing the ongoing litigation between CSX, the railroad company, and a number of hedge funds, including The Children's Investment Fund and 3G Capital Partners. The case revolves around the obligation of the Funds to disclose certain equity swaps involving shares of CSX.  The Funds have launched a proxy contest, with the annual meeting scheduled for June 25.  The district court issued an opinion in the case on June 9.  The opinion is posted on the DU Corporate Governance web site.  

What is the next step?  Plaintiff, CSX, won in the sense that the trial judge agreed that the hedge funds violated Section 13(d).  At the same time, the company lost because the trial judge did nothing more than enjoin defendants from future violations.  The shares were not sterilized or the transactions unwound.  Defendants can still vote the shares despite the legal violations. 

The violation of Section 13(d) provided the defendants with a number of advantages.  Whether because of beneficial ownership of the hedged shares or because of the earlier group formation, the hedge funds were able to increase their position without the glare of publicity.  The whole Schedule 13D regime was built around the notion that the gradual acquisition of control would be reported to the public.  Once a 5% or more position is revealed, shareholders must "promptly" disclose any material change in the percentage, with a 1% change presumptively material.  See Rule 13d-2(a), 17 CFR 13d-2(a).  Moreover, promptly means quick.  See In re Cooper Laboratories, Inc., Exchange Act Release No. 22171 (admin proc June 26, 1985)(time period for prompt disclosure depended in part in market's sensitivity to the information; in that case, promptly meant within 48 hours).  

In other words, the company and investors would have been alerted much sooner about the position of the hedge funds and any changes in the position. The information probably would have affected the share prices (causing an increase), making additional acquisitions more difficult (at least more expensive).  But based upon the remedy awarded by the court, the defendants incurred no adverse consequence as a result of the undisclosed positions.  (The court did assess costs against the defendants). 

The case is going up on appeal.  On Thursday, CSX filed a notice of appeal.  The next day, the hedge funds did the same.  CSX is seeking review of the denial of injunctive relief, particularly the failure to enjoin the voting of the shares acquired between the time the group was formed and the date of the trial.  The trial judge has denied an injunction pending appeal.  Of course, the shareholder meeting is June 25, an improbably short time for the Second Circuit to do much (except possibly issue an injunction pending appeal).  Once the meeting takes place, the issues may become moot, at least if the hedge fund directors are not elected. 

As for the upcoming proxy contest (for a minority of directors), Risk Metrics has a good piece on the subject.  Among other things, the post notes that two "transportation-affiliated unions, the Brotherhood of Locomotive Engineers and Trainmen (BLET) and the Brotherhood of Railroad Signalmen (BRS), have come out against the dissident slate."

 Numerous documents filed in the case, including the complaint, various motions and legal memorandum, and an assortment of amicus briefs (including one from the Division of Corporation Finance at the SEC) and legal opinions, can be found at the DU Corporate Governance web site.

Full post as published by The Race to the Bottom on June 17, 2008 (boomark / email).