The briefs are well done, CSX's by Cravath and TCI/3G's by Kirkland & Ellis and Schulte Roth. CSX's is the more colorful, running with Judge Kaplan's many findings of TCI's principal's--Christopher Hohn and Snehal Amin--lack of credibility. In CSX's brief, they come off as foul conspirators, misleading the market, the court, and even Congress. The defendants, assert CSX, engaged in a "clandestine" "scheme" to take control of CSX in violation of securities laws; repeatedly undertook to "conceal" knowledge of their swaps referencing CSX common from the market; "selectively" disclosed information to CSX so as to exert pressure on CSX; testified repeatedly before the Court below and Congress "falsely" (some five pages are devoted to detailing this "false" testimony); "stuffed the ballot box" in the June 25 shareholders' election for directors; and "manipulated" the playing field. Just the type of stuff one expects from plaintiff's lawyers.
The apparent purpose behind this heated advocacy is to convince the Second Circuit to do equity and burn these guys, by issuing the injunction Judge Kaplan stated he was willing to issue but felt constrained by the Second Circuit's decision in Treadway Companies v. Care Corporation, 638 F.2d 357 (1980) not to issue, namely, enjoin TCI/3G from voting the shares they acquired during the period between when Judge Kaplan found they formed a Section 13(d) group (February 12, 2007) and when they filed a 13D (December 19, 2007). In this effort, CSX emphasizes the broad powers of federal courts to redress violations of the securities laws, the wilfulness of the defendants' Section 13(d) violations, and their tilting the playing field so as to preclude a fair election for the CSX directors on June 25. CSX even relies, as one ground for its injunctive request, upon the defendants' false testimony in the trial court. This is rough stuff. And to think that Hohn and Amin (and Behring--3G's managing director) probably think of themselves as the good guys in this fight.
One can understand the effort--the insurgents announced right after the meeting that they believed four of their five nominees were elected to the CSX board. At the conclusion of the meeting, CSX took the highly unusual step of postponing announcement of the results until July 25, but on July 16 announced preliminarily that four of the insurgents' nominess, including Hohn and Behring, were elected. The results are of course subject to the outcome of CSX's appeal. So the outcome of the election will be determined by the Second Circuit (did something like this ever happen before?).
To this oberver the Second Circuit would have to move away from Treadway (and its parent, Rondeau v. Mosinee Paper Corp., 422 U.S. 49 (1975)) to grant the relief sought by CSX. The trick in Section 13 litigation is to maintain a level playing field, to coin a phrase, between management and insurgents. Treadway teaches that the interests sought to be protected by Section 13(d) are fully protected "when the shareholders receive the information required to be filed." That happened here--TCI/3G filed their 13D in December 2007 and distributed a proxy statement to CSX's shareholders in advance of the June 25th shareholders' meeting. Judge Kaplan rejected all of CSX's claims that the 13D and proxy statement contained material misstatements and omissions. So unless the Second Circuit panel gets inflamed by the defendants' allegedly "egregious" conduct, I would think CSX has an uphill battle in convincing the Second Circuit to issue an injunction dis-enfranchising TCI/3G and "kicking" the insurgents' nominees off the CSX board.
The problem I have with much of the supposed harm to the CSX shareholders alleged by CSX is this: the shareholders who may have been harmed by TCI's and 3G's tardy 13D filing sold their shares. They're no longer shareholders. Their redress against TCI and 3G would be to assert that had TCI and 3G disclosed their CSX positions earlier they might have received a higher price for their shares. But presumably they would have been sellers nevertheless: if a shareholder sells at $10 she undoubtedly is a seller at $12. And if this is true, how does enjoining TCI and 3G from voting the shares they acquired from such shareholders redress the harm from tardy disclosure to such shareholders?
While CSX's opening brief is the more colorful and hard-hitting of the two opening briefs, I find the defendants' persuasive. It has the more difficult task--convincing the Second Circuit to reverse Judge Kaplan's findings of liability. I posted blogs on Judge Kaplan's decision on June 23 and 24, and as I said in my June 24 post: " . . . once the beneficial ownership bell is rung on equity SWAPs it will not be unrung." Picking up on this theme, the defendants refer to Judge Kaplan's decision as having "triggered an earthquake in federal securities law and practice" by calling into question the widespread use of cash-settled equity swaps.
Judge Kaplan invited the SEC to address two issues before him, and the SEC's Division of Corporation Finance did so by its letter of June 4, 2008. In this letter, the Division states its disagreement with CSX's postion that economic incentives for counterparties can alone establish "beneficial ownership" of the referenced shares in the long party. It states its position that a standard cash-settled equity swap, standing alone, is not sufficient to create beneficial ownership of the referenced shares in the long party. It appears that Judge Kaplan was influenced by this postion and the pleas of several amici to punt on deciding whether the TCI/3G CSX SWAPs conferred beneficial ownership on TCI/3G under Rule 13d-3(a) (the basic statement of beneficial ownership for Section 13(d) purposes) and to focus on Rule 13d-3(b) instead, the "anti-evasion" prong of the beneficial ownership rule (to use the term for paragraph (b) of Professor Grundfest et al.--see my post of June 24). By relying on the anti-evasion prong of Rule 13d-3, the Judge undoubtedly intended to narrow his ruling to deflect the cries of the chicken-littles.
But from a doctrinal standpoint, the Judge would have been better off doing what he wanted to do, namely, hold that cash-settled equity swaps, at least of the size of those before him, necessarily confer beneficial ownership of the referenced securities on the long party, and openly disagreeing with the SEC's view as stated in its June 4, 2008 letter to the court. That position would have squared with the reality of a cash-settled equity swaps as seen by the Judge and would have comported with his guide to the interpretation of securities law:
"The securities markets operate in the real world, not in a law school contracts classroom. Any determination of beneficial ownership that filed to take account of the practical realities of that world would be open to the gravest abuse." (Opinion at 62.)
In its opening brief before the Second Circuit, TCI/3G attack Judge Kaplan's finding that they violated the anti-evasion prong of Rule 13d-3, arguing that (i) the Judge ignored the views of the SEC's Division of Corporation Finance of Rule 13d-3, and (ii) the Judge interpretated the Rule such that he extended its scope beyond Section 13(d) of the Exchange Act, the Rule's parent.
Section 13d-3(a), the basic definition of beneficial ownership, is broadly drafted, including within the scope of beneficial ownership of a security, direct or indirect ownerhip of the security, whether "through any contract, arrangement, understanding, relationship, or otherwise . . ." This definition, though, is tied to "voting power" or "investment power," that is the power to dispose or direct the disposition of a security.
The anti-evasion prong of Rule 13d-3, paragraph (b), includes within beneficial ownership any agreement or "device" "with the purpose or effect" of divesting a person of beneficial ownership or preventing the vesting of such ownership "as part of a plan or scheme to evade the reporting requirements of Section 13(d) or 13(g) of the [Exchange] Act . . ."
While the Division's June 4 letter to Judge Kaplan has some ambiguity, the Division is clear that a standard cash-settled equity swap does not confer voting or investment power upon the long party and thus does not confer beneficial ownership of the referenced securities upon the long party. The Division also states that "taking steps with the motive of avoiding reporting and disclosure generally is not a violation of Section 13(d) unless the steps create a false appearance."
TCI/3G rely heavily upon the Division's interpretation, and the deference that should be shown to an administrative agency when interpretating its own rules, in arguing that Judge Kaplan found beneficial ownerhship of the CSX referenced shares in TCI when, under Rule 13d-3, there should be none. So the SEC letter is likely to play a large role in the Second Circuit's decision. My reading of it is that it is more supportive of TCI's/3G's position than it is of CSX's position.
Notwithstanding the breadth of Rule 13d-3(a), Judge Kaplan concluded that the concept of beneficial ownership must be extended by Rule 13d-3(b); otherwise, what would be the point of paragraph (b)? TCI/3G concede the rule of statutory construction that words should be read so as not to render them superfluous, but argue, creatively in my opinion, that the anti-evasion prong of Rule 13d-3 should be construed as a "belt and suspenders" approach to the definition of beneficial ownerhship: paragraph (b) simply states the obvious--that sham transactions meant to disguise beneficial ownership will not be recognized as doing so. The argument has some appeal, but whether it flies before the Second Circuit is anyone's guess.
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