Postedat3:29PMonJune11,2008byStikemanElliottLLP

CSXCorporationv.TCIand3GFund
CSXCorporationv.TCIand3GFund,June11,2008|08CV02764,U.S.DistrictCourt(S.D.N.Y.).
AlexColangelo
U.S.Courtdeemshedgefundbeneficialownersofsharesduetoarrangementsdesignedtoavoiddisclosureobligations.TheCourt,however,findsitselfconstrainedfrom
orderingremedysoughtbytargetcompany.
Inasomewhatemptyvictoryfortheplaintiffrailroadcompany,theU.S.DistrictCourtfortheSouthernDistrictofNewYorkfoundthatthedefendanthedgefundsemployed
surreptitiousmeanstoavoiddisclosurerequirementswhileaccumulatingsharesofCSX.Despiteitsfindings,theDistrictCourtfounditselfrestrainedbyprecedentfrom
preventingTCIand3GFundfromexercisingthevotesassociatedwiththesharestheyacquiredduringthetimetheywereoffsidedisclosureobligations.Theplaintiff,
therefore,hadtosettleforaninjunctioninhibitingthedefendantsfromanyfutureviolationsofdisclosureobligations.
Facts
Theplaintiff,CSX,operatedoneofthelargestrailroadsintheU.S.BelievingthatopportunitiesexistedtoincreasethevalueofCSX,TCIdecidedtobeginaccumulating
sharesinthecompanywiththeviewofpressingmanagementintomakingthechangesTCIconsiderednecessary.RatherthaninvestinginCSXdirectly,however,TCI
enteredintoTotalReturnSwap(TRS)agreementswithvariousfinancialinstitutions.InaTRSagreement,thefinancialinstitutionagreestopaytheinvestorcashflows
basedonanunderlyingassetinexchangefortheaccruinginterestbasedontheagreedprincipalamount.Insuchanarrangement,thefinancialinstitutionneednot
necessarilypurchasetheunderlyingasset,however,inpracticethisusuallyoccurs.
TCIbeganenteringintosuchswapagreementswithvariousfinancialinstitutionsbeginninginOctober2006.AsitaccumulatedanindirectpositioninCSX,TCIalso
begantoinvestigatealeveragedbuyoutofthecompany.CSX,however,wasnotcooperativeinthisregard.ByFebruary2007,TCIownedalmost14percentofCSXand
begancontactingotherhedgefundsitbelievedwerefavourablydisposedtoitsapproachtoCSX,withtheintentionofpromotingthepurchaseofCSXshares.Oneofthe
hedgefundswithwhichitcommunicatedwas3GFund,whichhadalreadybegunamassingsharesinCSX.TCIand3Ghadalongstandingrelationship,andoverthe
courseof2007,thetwofundsexchangedviewsandinformationregardingCSX,bothinitiatedsearchesfordirectornomineestotheboardofCSXandbothpreparedfor
proxyfights.Thedefendants,however,didnotfiledisclosureregardingtheircoordinatedeffortsuntilDecember2007.
InaccumulatingitspositionsinCSX,meanwhile,untilOctober2007,TCIdistributeditsTRSagreementsamongeightinstitutions.Thereasonforthisarrangementwas
foundbytheCourttobesoastopreventanyoneofthemfromacquiringgreaterthan5percentofCSXssharesandthushavingtodiscloseitsswapagreementswith
TCI.Duetoanimpendingproxybattle,however,TCIdecidedtoconsolidateitsswapsamongthetwoinstitutionsitbelievedwouldvoteinitsfavouratanupcoming
shareholdermeeting.Despiteattemptstonegotiatearesolution,aproxybattlecouldnotbeavoidedandCSXbroughtanactionclaimingthatTCIviolatedtheExchange
ActbyfailingtodiscloseitsbeneficialownershipofCSXstockandthatTCIand3GfurtherviolatedtheActbyfailingtomaketimelydisclosureupontheformationoftheir
group.
ExchangeActandSECRules

Section13(d)(1)oftheExchangeActrequiresthatanypersonacquiringbeneficialownershipof5%ofaclassofsharesdisclose,interalia,informationregardingthe
purposeofthepurchasesandanyproposalstomakemajorchangesinthecorporatestructureofthecompany,aswellasinformationregardingthesharesownedby
associates.Thesectionwasenactedtoaddresstheincreasingfrequencywithwhichhostiletakeoverswerebeingusedtoeffectchangesincorporatecontrol.Section
13(d)(3)oftheAct,meanwhile,providesthattwoormorepersonsactingasaformalorinformalpartnershipwillbedeemedapersonforthepurposesofthefivepercent
ownershiptrigger.
Tothatend,SECRule13d3(a)providesthatforthepurposesofsection13(d)oftheAct,beneficialownerincludesthosethatdirectlyorindirectlyhaveorshare[v]oting
powerwhichincludesthepowertovote,ortodirectthevotingofthesharesand/or[i]nvestmentpowerwhichincludesthepowertodispose,ortodirectthedisposition
ofthesecurity.Further,underRule13d3(b),thosethatcreateoruseapoolingoranyotherarrangementinordertopreventthevestingofbeneficialownershipofthe
sharesortoevadethereportingrequirementsoftheActshallbedeemedtobethebeneficialownerofthesecurity.
SECRule13d3(a)Analysis
WhiletheTRSarrangementsgaveTCInodirectvotingordisposalrights,theDistrictCourtconsideredwhether,ascitedinSECv.DrexelBurnhamLambertInc.,837F.
Supp.587,607(S.D.N.Y.1993),TCIhadasignificantabilitytoaffecthowvotingpowerorinvestmentpowerwouldbeexercised.TCIarguedthattheinstitutionswith
whichitmadearrangementshadnoobligationtopurchasetheunderlyingassetandthattheycouldhavehedgedtheirshortpositionsinCSXwithotherinvestments.The
DistrictCourt,however,foundthisargumenttobeunpersuasive,findingthatforallpracticalpurposes,thefinancialinstitutionshedgedtheirpositionsinthesharessubject
totheTRSagreementsbyactuallypurchasingtheunder
lyingshares.ThisispreciselywhatTCIcontem
platedand,indeed,intended.TheDistrictCourtcitedthefactthat
TCIenteredintoTRSagreementswithnumerousinstitutionstoavoidanyoneofthemcrossingthefivepercentdisclosuretrigger,whichwouldnothavebeenanissue
hadthefinancialinstitutionsnotpurchasedtheunderlyingsecurities.Further,thebanksbehavedinthesamewayatthebackendofthetransactions,sellingthe
underlyingsharesattheterminationofaTRSagreement.Thus,theDistrictCourtfoundthat,despitenotdirectlyholdingthesharesitself,TCIsignificantlyinfluencedthe
bankspurchasesanddisposalsofCSXshares.
Withrespecttovotingpower,theDistrictCourtfoundthatwhiletherewasnoevidencethatTCIandthefinancialinstitutionswithwhichitenteredintoswapshadany
agreementwithrespecttohowthefinancialinstitutionswouldvote,TCImovedmostofitsswapstoDeutscheBankbeginninginOctober2007duetoanalignmentof
interestsbetweenitandthebank.ThesimilarinterestsofthesetwopartieswereduetothefactthatDeutscheBankalsoheldinvestmentsinCSX.Further,thepoliciesof
someofthebankswithwhichTCIhadagreementsallowedTCItopreventsharesfrombeingvoted.TheCourt,however,concededthatthesituationwithrespecttovoting
powerwasmurkierthanthatofinvestmentpower,andultimatelystoppedshortofafindingofbeneficialownershipunderRule13d3(1).WhiletheCourtmayhavebeen
leaningtowardsafindingofbeneficialownershipunderthisRule,itfoundthatitwasultimatelyunnecessarytoreachsuchaconclusiontodecidethiscaseduetoits
rulingontheviolationunderRule13d3(b),consideredbelow.
SECRule13d3(b)Analysis
Asdiscussedabove,Rule13d3(b)providesthatpoolingarrangementsforthepurposeoreffectofavoidingreportingrequirementsdeembeneficialownershiponthe
creatorofthearrangement.Onthispoint,theDistrictCourtfoundthatTCIsarrangementscreatedthefalseappearancethatnoaccumulationwastakingplace.Thus,the
CourtfoundthatTCIcreatedandusedtheTRSswiththepurposeandeffectofpreventingthevestingofbeneficialownershipinthecompanyaspartofaschemeto
avoiditsdisclosurerequirements.Assuch,TCIwasdeemedtobeabeneficialownerofthesharesheldbythefinancialinstitutionswithwhichitenteredintoswap
agreements.
Section13(d)andGroupFormation
Withrespecttotheformationofthegroup,whichrequireddisclosureundersection13(d)oftheAct,TheDistrictCourtfurtherfoundthatTCIand3GGroupformeda
groupforthepurposesofthelegislation,nolaterthanFebruary13,2007,thedateofaparticularemailandsubsequentdiscussionbetweenthedefendantsregarding
activityinCSXstock.ThecircumstancesofthecasepersuadedtheCourtthatthedefendantsactivitiesfromatleastasearlyasthisdatewereproductsofconcerted
actionnotwithstandingthedefendantsdenials.
Disposition
WhiletheCourtfoundthatthedefendantsviolatedsection13(d)oftheExchangeActinfailingtofiletimelydisclosurewithrespecttobeneficialownershipandgroup
formation,theCourtdidnotfindthattheeventualdisclosurefiledbythedefendantswasfalseormisleadingastoamaterialfact.

Further,despitethefindingsonthedisclosureviolations,theDistrictCourtfounditselfboundbyprecedentinassessingrelief.WhileCSXpleadedforinjunctiverelief
prohibitingthedefendantsfromvotinganyofthesharestheyowned,theDistrictCourtfoundtheargumenttosweeptoobroadly,andlimiteditsconsiderationonlytothose
sharesacquiredduringthetimethedefendantswereoffsidetheirreportingrequirements.Evenwithinthismorelimitedfocus,theDistrictCourtfounditselfboundbythe
decisionofTreadwayCos.,638F.2d(D.D.C.,1978),ontheprincipleofirreparableharm.Inthatcase,theacquisitionofa31percentblockofshares,whereinsomeofthe
purchaseswerecompletedduringaperiodofnoncompliance,wasfoundtobeinsufficienttothreatenirreparableinjuryontheremainingshareholdersbecausecontrol
hadnotpassed.
TheDistrictCourtwasobviouslydispleasedwiththelimitationsplacedonitbythisprecedent,findingthat[i]tisquestionablewhetherabrightlinerulethatappearsto
foreclosetheexistenceofadegreeofeffectivecontrolintheabsenceofastockholdinglargerthan31percentisconsistentwithcommercialrealitiesandthatcourts
haverecognizedthatminorityshareholdingorboardrepresentationmayconferadegreeofcontrol,atleastinsomecircumstances.Astheproportionofsharesheldin
thiscasebythedefendantsfellbeloweventhelevelfoundinTreadway,theCourtfounditselfbound,andCSXcitednocaseinwhichirreparableharmwasfound
becauseadefendanthadobtainedadegreeofeffectivecontrol.TheCourtwasclear,however,thathaditnotbeensolimited,itwouldhaveexerciseditsdiscretionto
grantaninjunctionagainstTCIfromvotingthesharesitacquiredduringdisclosurenoncompliance.TheDistrictCourt,however,didfindtheprobabilityoffutureviolation
tobesubstantialandassuchenjoinedthedefendantsfromfutureviolations.
OnSeptember15,2008,theU.S.CourtofAppealsfortheSecondCircuitupheldtheDistrictCourtdecisiondecliningtoenjointhedefendantsfromvotingtheirsharesofCSX.TheSecondCircuit
alsostatedthatanopinionwouldfollow.

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