Csx Corp.. v. the Children's Inv. Fund Mgmt. (uk) Llp

Citation654 F.3d 276
Decision Date18 July 2011
Docket NumberDocket Nos. 08–2899–cv (L),08–3016–cv (XAP).
PartiesCSX CORPORATION, Plaintiff–Appellant–Cross–Appellee,v.The CHILDREN'S INVESTMENT FUND MANAGEMENT (UK) LLP, The Children's Investment Fund Management (Cayman) Ltd., The Children's Investment Master Fund, 3G Capital Partners Ltd., 3G Capital Partners, L.P., 3G Fund, L.P., Christopher Hohn, Snehal Amin, and Alexandre Behring, also known as Alexandre Behring Costa, Defendants–Third–Party–Plaintiffs–Counter–Claimants–Appellees–Cross–Appellants.
CourtUnited States Courts of Appeals. United States Court of Appeals (2nd Circuit)

654 F.3d 276

CSX CORPORATION, Plaintiff–Appellant–Cross–Appellee,
v.
The CHILDREN'S INVESTMENT FUND MANAGEMENT (UK) LLP, The Children's Investment Fund Management (Cayman) Ltd., The Children's Investment Master Fund, 3G Capital Partners Ltd., 3G Capital Partners, L.P., 3G Fund, L.P., Christopher Hohn, Snehal Amin, and Alexandre Behring, also known as Alexandre Behring Costa, Defendants–Third–Party–Plaintiffs–Counter–Claimants–Appellees–Cross–Appellants.

Docket Nos. 08–2899–cv (L)

08–3016–cv (XAP).

United States Court of Appeals, Second Circuit.

Argued: Aug. 25, 2008.Decided: July 18, 2011.


[654 F.3d 277]

Rory O. Millson (Francis P. Barron & David R. Marriott, on the brief), Cravath, Swaine & Moore LLP, New York, NY, for Plaintiff–Appellant–Cross–Appellee.Christopher Landau, P.C. (Patrick F. Philbin & Theodore W. Ullyot, Kirkland & Ellis LLP, Washington, D.C.; Peter D. Doyle & Andrew M. Genser, Kirkland & Ellis LLP, Howard O. Godnick & Michael E. Swartz, Schulte Roth & Zabel LLP, New York, NY, on the brief), Kirkland & Ellis LLP, Washington, D.C., for Defendants–Appellees–Cross–Appellants.

[654 F.3d 278]

Adam H. Offenhartz, Aric H. Wu & J. Ross Wallin, Gibson, Dunn & Crutcher LLP, New York, NY, for Amicus Curiae Coalition of Private Investment Companies.Richard M. Lorenzo, James G. Szymanski & M. Alexander Bowie II, Day Pitney LLP, New York, NY, for Amici Curiae Former SEC Commissioners and Officials and Professors.Katherine Tew Darras & Rosario Chiarenza, International Swaps and Derivatives Association, Inc., New York, NY; Ira D. Hammerman & Kevin M. Carroll, Securities Industry and Financial Markets Association, Washington, D.C.; David M. Becker, Edward J. Rosen, Michael D. Dayan, Joon H. Kim & Shiwon Choe, Cleary Gottlieb Steen & Hamilton LLP, New York, NY & Washington, D.C., for Amici Curiae International Swaps and Derivatives Association, Inc., and Securities Industry and Financial Markets Association.Roger D. Blanc, Martin Klotz & Richard D. Bernstein, Willkie Farr & Gallagher LLP, New York, NY, for Amicus Curiae Managed Funds Association.Daniel J. Popeo & Richard A. Samp, Washington Legal Foundation, Washington, D.C., for Amici Curiae Washington Legal Foundation, National Association of Manufacturers & Business Roundtable.Before: NEWMAN, WINTER, and CALABRESI, Circuit Judges.JON O. NEWMAN, Circuit Judge:

This case comes to us raising issues concerning a contractual arrangement known as a “cash-settled total return equity swap agreement” although our disposition at this stage of the appeal touches only tangentially on such issues.

The Children's Investment Fund Management (“TCI”) and 3G Capital Partners (“3G”) 1 are hedge funds that entered into cash-settled total-return equity swap agreements referencing shares of CSX Corporation (“CSX”). They later sought to elect a minority slate of candidates to CSX's board of directors. Alleging that TCI and 3G (“the Funds”) had failed to comply in a timely fashion with the disclosure requirements of section 13(d) of the Williams Act, 15 U.S.C. § 78m(d), CSX brought the present action. It sought injunctions barring the Funds from any future violations of section 13(d) and preventing the Funds from voting CSX shares at the 2008 CSX annual shareholders' meeting.

The District Court held that the Funds had violated section 13(d) and granted a permanent injunction against further such violations with respect to shares of any company. See CSX Corp. v. Children's Investment Fund Management (UK) LLP, 562 F.Supp.2d 511, 552, 554–55, 573–74 (S.D.N.Y.2008) (“ CSX I ”). However, the Court declined to enjoin the Funds from voting their CSX shares. See id. at 568–72. CSX appealed the denial of the voting injunction; the Funds cross-appealed

[654 F.3d 279]

the granting of the permanent injunction. On September 15, 2008, we affirmed the District Court's denial of the voting injunction. CSX Corp. v. Children's Investment Fund Management (UK) LLP, 292 Fed.Appx. 133, 133–34 (2d Cir.2008) (“ CSX II ”). In this opinion, we consider some of the issues raised by the Funds' cross-appeal and explain the reasons for our earlier order in CSX's appeal.

The parties have endeavored to frame issues that would require decision as to the circumstances under which parties to cash-settled total-return equity swap agreements must comply with the disclosure provisions of section 13(d). Such issues would turn on the circumstances under which the long party to such swap agreements may have or be deemed to have beneficial ownership of shares purchased by the short party as a hedge.

Rather than resolve such issues, as to which there is disagreement within the panel, we consider at this time only issues concerning a “group” violation of section 13(d)(3) with respect to CSX shares owned outright by the Defendants (without regard to whatever beneficial ownership, if any, they might have acquired as long parties to cash-settled total-return equity swap agreements). Because we lack sufficient findings to permit appellate review of such issues, we remand for further findings.

Background

We describe here only the salient facts and District Court proceedings, leaving many details to the Discussion section.

TCI and 3G (“the Funds”) are investment funds that in 2006 came to believe that CSX, a large railroad company, had unrealized value that a change in corporate policy and perhaps management might unlock. The Funds purchased shares in CSX and entered into cash-settled total-return equity swaps referencing CSX stock. The Funds then engaged in a proxy fight with the management of CSX.

(a) Cash-settled total-return equity swaps. Total-return swaps are contracts in which parties agree to exchange sums equivalent to the income streams produced by specified assets. Total-return equity swaps involve an exchange of the income stream from: (1) a specified number of shares in a designated company's stock, and (2) a specified interest rate on a specified principal amount. The party that receives the stock-based return is styled the “long” party. The party that receives the interest-based return is styled the “short” party. These contracts do not transfer title to the underlying assets or require that either party actually own them. Rather, in a total-return equity swap, the long party periodically pays the short party a sum calculated by applying an agreed-upon interest rate to an agreed-upon notional amount of principal, as if the long party had borrowed that amount of money from the short party. Meanwhile, the short party periodically pays the long party a sum equivalent to the return to a shareholder in a specified company—the increased value of the shares, if any, plus income from the shares—as if the long party owned actual shares in that company.

As a result, the financial return to a long party in a total-return equity swap is roughly equivalent to the return when borrowed capital is used to purchase shares in the referenced company. Long swap positions can, therefore, be attractive to parties that seek to increase the leverage of their holdings without actually buying the shares. The short party's financial return, in turn, is equivalent to the return to someone who sold short and then lent out the proceeds from that sale. However, because of the inherent risks in short-

[654 F.3d 280]

equity positions—share value can be more volatile than interest rates—persons holding short positions in total-return equity swaps will usually choose to purchase equivalent numbers of shares to hedge their short exposure.

Total-return equity swaps may be “settled-in-kind” or “cash-settled.” When an equity swap that is settled-in-kind terminates, the long party receives the referenced security itself, in exchange for a payment equal to the security's market price at the end of the previous payment period. When a cash-settled equity swap terminates, the short party pays the long party the sum of the referenced equity security's appreciation in market value and other net cash flows (such as dividend payments) that have occurred since the most recent periodic payment. If this sum is negative, then the short party receives the corresponding amount from the long party. Unlike swaps settled in kind, cash-settled swaps do not give the long party a right to acquire ownership of the referenced assets from the short party. In all other respects, settled-in-kind and cash-settled equity swaps are economically equivalent.

(b) The transactions in the present case. The swaps purchased by the Funds were cash-settled total-return equity swaps referencing shares of CSX. The Funds were the long parties, and several banks were the short parties. Although the swap contracts did not require the short parties—the banks—actually to own any CSX shares, the Funds understood that the banks most likely would hedge their short swap positions by purchasing CSX shares in amounts matching the number of shares referenced in the swaps, and the banks generally did so.2

The Funds' trading in CSX shares and CSX-referenced swaps followed no consistent pattern. During some periods the Funds increased their holdings; during other periods they decreased them. Almost immediately after making its initial investment in CSX, TCI approached the company to negotiate “changes in policy and, if need be, management [that] could bring better performance and thus a higher stock price,” CSX I, 562 F.Supp.2d at 523, which would allow TCI to profit from its swap holdings. TCI later explored the possibility of a leveraged buyout (“LBO”) of CSX, and informed other hedge funds of its interest in “altering CSX's practices in a manner that TCI believed would cause its stock to rise.” Id. at 526. When it became clear that CSX had little interest in TCI's proposed policy changes or LBO proposals, TCI began preparations for a proxy contest to effectuate its desired policy and management changes at CSX.

There is no doubt that the Funds wanted to avoid disclosure under the Williams Act...

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