Second Circuit Decision Sends CSX and Hedge Fund Suitors TCI and 3G Back to District Court to Examine When Funds Formed a “Group” to Acquire CSX Stock, Leaving Unresolved the Issue of Beneficial Ownership of Shares Referenced in Cash-Settled Total-Return Equity Swaps

In 2006, hedge funds sponsored by The Children’s Investment Fund Management and 3G Capital Management (respectively, TCI and 3G, or the Funds) believed shares of railroad giant CSX Corporation (CSX) were undervalued and sought to “unlock” that value by influencing CSX management.  The Funds acquired positions in CSX both directly and through cash-settled total-return equity swaps that referenced CSX stock.  See “IRS Directive and HIRE Act Undermine Tax Benefits of Total Return Equity Swaps for Offshore Hedge Funds,” Hedge Fund Law Report, Vol. 3, No. 12 (Mar. 25, 2010).  Unable to persuade CSX management to change its policies, in January 2008, the Funds commenced a proxy fight.  In response, CSX sued the Funds for violating the disclosure requirements of Section 13(d) of the Securities and Exchange Act of 1934.  CSX argued that the Funds were the beneficial owners of the CSX shares that the Funds' counterparties had acquired to hedge the swap contracts and that the Funds had been operating as an undisclosed “group.”  The District Court agreed and enjoined the Funds against future violations of Section 13(d) but refused to prohibit the Funds from voting their shares at the CSX meeting.  See “District Court Holds that Long Party to Total Return Equity Swap May be Deemed to have Beneficial Ownership of Hedge Shares Held by Swap Counterparty,” Hedge Fund Law Report, Vol. 1, No. 14 (Jun. 19, 2008).  Each of the parties appealed different parts of the District Court’s decision, and on July 18, 2011 – almost three years after the appeal was argued – the Second Circuit issued its long-awaited decision in the matter.  This article summarizes the Second Circuit’s decision.  For a summary of the original complaint in this matter, see “CSX Sues Hedge Funds TCI and 3G for Violating Federal Securities Laws,” Hedge Fund Law Report, Vol. 1, No. 4 (Mar. 24, 2008).

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