Latest Round of CSX v. The Children’s Investment Fund: No Agreement on Whether Equity Swaps Confer Beneficial Ownership

July 28, 2011

In CSX Corp. v. The Children’s Inv. Fund Mgmt (UK) LLP (July 18, 2011), the 2nd Circuit U.S. Court of Appeals reaffirmed that, for violations of Section 13(d) of the Securities Exchange Act of 1934, the injunctive remedy of vote sterilization is not available where timely and curative disclosure has been made. The Court did not decide the more important question of whether cash-settled total return equity swap agreements confer beneficial ownership for purposes of Section 13(d). The Court was divided on this issue, which signals that the SEC will face added pressure to promulgate rules in this area.


CSX is the latest opinion in a three-year saga relating to the 2008 CSX annual meeting proxy contest by the Children’s Investment Fund Management (UK) LLP, 3G Capital Partners Ltd. and various of their affiliated hedge funds (the “Funds”). The principal issue underlying most aspects of the case is whether the Funds acquired beneficial ownership of CSX shares by entering into cash-settled total return equity swap agreements. Generally, the equity swap agreements conferred the benefit of any increases, and detriment of any declines, in the value of CSX shares to the Funds in exchange for interest payments by the Funds to the swap counterparties.1 By entering into these swaps, the Funds effectively had economic ownership of the shares, without any outright ownership. Instead, the swap counterparties typically purchased CSX shares to hedge their swap exposure.

For purposes of their Section 13(d) obligations, the Funds took the position that the equity swaps did not confer any beneficial ownership of the CSX shares, which allowed them to delay their initial Schedule 13D filing. A District Court held that the Funds had violated Section 13(d) and granted a permanent injunction against any further violations, although the District Court's holding was fact-specific and it did not hold that equity swaps would always confer beneficial ownership of the corresponding shares. The District Court declined to enjoin the Funds from voting their CSX shares, which decision was affirmed by the Appeals Court. The Funds appealed the District Court’s permanent injunction.

Court’s Analysis

The Appeals Court specifically declined to address the important issue of whether the cash-settled total return equity swap agreements conferred beneficial ownership on the Funds.2 In doing so, the Appeals Court noted there was disagreement within the three-judge panel. Judge Winter issued a detailed concurrence explaining his position that, in and of themselves, these equity swap agreements did not confer beneficial ownership because the agreements did not give the Funds the ability to direct voting or disposition of shares purchased by the swap counterparties and the agreements were not a prohibited scheme to evade the Section 13(d) disclosure requirements.

The Appeals Court did reaffirm that the Funds’ Schedule 13D, which disclosed the outright ownership of CSX shares as well as shares subject to equity swaps almost six months before the annual meeting, was sufficient for the CSX shareholders to cast informed votes, and that the remedy of sterilization of the voting of the CSX shares was not available in this situation. The Court noted that the interests that Section 13(d) protects “are fully satisfied when the shareholders receive the information required to be filed.”3


CSX is more notable for illustrating the continued amorphous definition of beneficial ownership under Section 13(d), and in particular disagreement as to the treatment of equity swaps agreements and other derivatives, than for its actual holding. As the complexity of financial derivatives grows, there will be an increase in the decoupling of Section 13(d) beneficial ownership (which is based strictly on voting and dispositive power) and economic ownership. In light of the lack of clarity in this area, and absent further SEC rulemaking expanding the beneficial ownership definition to include equity swap agreements as authorized under the Dodd-Frank Wall Street Reform Protection Act, companies cannot rely on incorporating the Section 13(d) definition of beneficial ownership as a rough proxy for economic ownership. Accordingly, companies should review their poison pills and other corporate documents, agreements and plans (including advance notice provisions of their bylaws), which often use Section 13(d) beneficial ownership concepts, to see whether they should be clarified or expanded to include swaps, derivatives and other similar forms of economic ownership.

For additional information concerning this alert, please contact your regular Bingham corporate contact or the following lawyers:

David K. Robbins

Stephen D. Alexander

Michael P. O’Brien

Janice A. Liu

1 At the termination of the equity swap, the Funds would be entitled to payment equal to the appreciation of the market value of the shares and any dividend payments on the shares or, if the CSX shares had declined in value, the Funds would be obligated to pay the swap counterparties an amount equal to the decline in market value in addition to interest payments.

2 The Court remanded the case back to the District Court (1) to decide when the Funds had formed a group for purposes of Section 13(d) based only on the shares owned outright by the Funds (i.e., excluding the swaps) and (2) to reconsider the appropriateness of the District Court’s permanent injunction of violations of Section 13(d) based on the failure to disclose the outright ownership of CSX shares.

3 Treadway Companies, Inc. v. Care Corp., 638 F.2d 357, 380 (2d. Cir. 1980).

This article was originally published by Bingham McCutchen LLP.