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U.S. Appeals Court Upholds CSX Corp. Decision

The Guardian: Company-Side Shareholder Activism Alert

Affirms Lower Court’s Decision Not to Enjoin Hedge Fund from Voting Its Shares of CSX Stock at Annual Meeting

On September 15, 2008, the U.S. Court of Appeals for the Second Circuit affirmed the ruling of the District Court for the Southern District of New York in CSX Corporation v. The Children’s Investment Fund Management (UK) LLP, et al.1 which refused to enjoin the hedge fund The Children’s Investment Fund (TCI) from voting its shares at CSX’s 2008 Annual Meeting of Shareholders. The Second Circuit’s ruling came in the form of a “Summary Order” and indicated that it was only addressing at this time the issue of whether TCI should have been enjoined from voting its shares. The Second Circuit has indicated that an opinion will follow.

In this case, CSX Corp., one of the nation’s largest railroad and transportation companies, was pitted against two investment firms, TCI and 3G Fund L.P. (3G). Among the questions that faced the district court was a question of first impression with respect to whether the defendants, as the holders of cash-settled equity total return swap positions, are, pursuant to Rule 13d-3(a) of the Securities Exchange Act of 1934 (Exchange Act), the beneficial owners of the referenced stock held by the short counterparties and, accordingly, required to report such beneficial ownership on a Schedule 13D disclosure statement. While the district court indicated that it was somewhat persuaded that the answer should be “yes,” ultimately, the district court was able to avoid directly addressing that question.2 Subscribing to the tenet that courts should decide no more than what is essential to resolve their cases, the District Court declined to rule on the legal question of whether the holder of a cash-settled equity total return swap is the beneficial owner under Rule 13d-3(a) of the Exchange Act. Rather, the district court held that the defendants should be deemed the beneficial owners of the referenced shares because they had used the equity swap transactions as “part of a plan or scheme” to prevent the vesting of beneficial ownership and to avoid the disclosure that would have been required had they bought shares of CSX’s common stock outright.3

The district court also held that the defendants had formed a “group” within the meaning of Section 13(d) months before they had filed their Schedule 13D disclosure statement.4 Notwithstanding that the district court held that the defendants had violated Section 13(d), the district court declined to award CSX all the injunctive relief it had sought. While the district court did enjoin the defendants from further Section 13(d) violations, it did not grant CSX’s request to “sterilize” the CSX shares held by the defendants that had been acquired during a period of noncompliance, thereby preventing the defendants from voting their CSX shares at CSX’s 2008 annual meeting of shareholders. The district court concluded that it was foreclosed as a matter of law from granting such injunctive relief, but that, if it could, it would have exercised its discretion to do so.5

While much of the CSX Corp. decision focused on the issue of beneficial ownership under Rule 13d-3, the district court’s decision was also noteworthy for its discussion of the limited nature of the remedies currently available to an issuer for violations of Section 13(d). The Second Circuit has long held that while an issuer does not have a private cause of action for monetary damages for violations of Section 13(d), an issuer does have a private cause of action and standing to sue for injunctive relief for such violations.6 Accordingly, it is not a surprise that CSX, in its complaint against TCI, did not seek monetary damages for violations of Section 13(d), only various forms of injunctive relief.7

Among the injunctive relief sought by CSX from the district court was an order to prevent TCI from voting at the 2008 annual meeting of CSX shareholders the CSX shares that it had acquired during the time that it was not in compliance with Section 13(d). CSX had argued that its shareholders would be harmed irreparably without such relief and that “sterilization” of the stock was required to “avoid permitting defendants to retain the fruits of their violations and to deter future violations.”8 However, while holding that TCI had violated Section 13(d),9 the district court concluded that it was foreclosed as a matter of law from enjoining TCI from voting its CSX shares acquired during a time when it was not in compliance with Section 13(d). The district court noted its frustration with its limited ability to order injunctive relief for violations of Section 13(d) and indicated that if it were free to so enjoin TCI from voting its CSX shares, it would have exercised its discretion to do so.10 With respect to any penalties for defendants’ violations of Section 13(d), the district court indicated that such relief must come by way of appropriate action by the SEC or the Department of Justice.11

Following the issuance of the district court’s opinion, both CSX and TCI filed appeals with the Second Circuit. CSX, in its appeal, asked the Second Circuit to opine as to whether federal courts can enforce Section 13(d) by entering a sterilization order that would prevent shareholders from voting shares of the issuer that they had acquired during the time that they were not in compliance with Section 13(d). TCI and 3G, in their appeal, asked the Second Circuit to review the district court’s holdings that TCI should be deemed the beneficial owner of CSX shares referenced by its cash-settled total return equity swaps, and that TCI and 3G had formed a disclosure-triggering “group” for purposes of Section 13(d) no later than February 13, 2007. The defendants also sought to have the Second Circuit overturn the permanent injunction issued by the district court that prohibits the defendants from violating the disclosure requirements of the Exchange Act with respect to any future transaction. CSX had also unsuccessfully sought to have the Second Circuit issue an injunction to hold the votes on the CSX shares held by TCI and 3G in escrow, pending the outcome of the appeal.

On June 25, CSX held its 2008 annual meeting of shareholders and then adjourned the meeting to allow time for the independent inspector of election to tabulate the voting results. Three weeks after votes had been cast at the annual meeting, CSX announced that, based on the preliminary draft report of the independent inspector of election, four of TCI’s five nominees were elected by the shareholders to CSX’s 12-person Board of Directors. On July 25, CSX announced that it had asked two of TCI’s nominees to join its board but that it would await the final certification of the annual meeting’s vote results and its appeal to the Second Circuit before seating any more of TCI’s nominees. In light of the Second Circuit’s decision to affirm the lower court’s ruling not to enjoin TCI from voting its shares at CSX’s 2008 annual meeting of shareholders, on September 24, CSX reconvened its 2008 annual meeting, accepted the final report of the independent inspector of elections, and seated the final two members of TCI’s slate of nominees elected at that meeting.

Conclusion

Unfortunately for issuers, Section 13(d) does not provide any express right for issuers—or even the shareholders that Section 13(d) was enacted to protect—to bring a private cause of action seeking monetary damages or injunctive relief to redress violations of Section 13(d). While issuers have, on numerous occasions, sought to have federal courts infer that a private cause of action to seek such remedies exists for violations of Section 13(d), these efforts, at least with respect to the right to seek monetary damages, have generally not been successful. While the federal courts have been somewhat more receptive to inferring the right of issuers to seek injunctive relief for violations of Section 13(d), assuming that the issuer can demonstrate that it would be harmed irreparably in the absence of such relief, the Second Circuit’s order upholding the district court’s opinion that it was foreclosed as a matter of law from enjoining defendants from voting their CSX shares obtained during a period of noncompliance with Section 13(d), reminds us once again how limited such injunctive relief is. In the absence of any regulatory changes, we should expect that such injunctive relief will continue to remain so limited for the near future.


  1. See CSX Corporation v. The Children’s Investment Fund Management (UK) LLP, et al., No. 08 Civ 2764 (LAK) (S.D.N.Y. June 11, 2008).
  2. CSX Corp. at 2.
  3. Rule 13d-3(b) under the Exchange Act provides in substance that one who creates an arrangement that prevents the vesting of beneficial ownership as part of a plan or scheme to avoid the disclosure that would have been required if the actor had bought the stock outright is deemed to be a beneficial owner of those shares.
  4. See CSX Corporation v. The Children’s Investment Fund Management (UK) LLP, et al., No. 08 Civ 2764 (LAK) (S.D.N.Y. June 11, 2008), at 2.
  5. CSX Corp. at 115.
  6. See GAF Corp. v. Milstein, 453 F.2d 709 (2d Cir. 1971), cert. denied 406 U.S. 910 (1972).
  7. See Complaint of CSX Corp. in CSX Corp. v. The Children’s Investment Fund Management (UK) LLP, et al., No. 08-Civ. 2764 (S.D.N.Y. filed March 17, 2008), at 29–30.
  8. CSX Corp. at 105.
  9. CSX Corp. at 115.
  10. CSX Corp. at 115.
  11. CSX Corp. at 3.