CSX v. TCI; CSX's Reply Brief

CSX reported on July 31, 2008 the results of the contested election for directors held at its 2008 annual meeting of stockholders. As the TCI/3G group announced shortly after the meeting, four of its nominees (Hohn, Behring, Lamphere and O’Toole) received a sufficient number of votes to oust four of the incumbent directors. However, with respect to Messrs. Hohn and O’Toole, the vote is sufficiently close so that if the Second Circuit “sterilizes” the group’s 6.4% of the outstanding shares (approximately 26 million shares) acquired in violation of Section 13(d) of the Exchange Act, as found by Judge Kaplan below, then these two candidates will not be seated on CSX’s board.

So CSX’s appeal of Judge Kaplan’s refusal to sterilize the “tainted” shares has meaning, and may explain the ferocity of CSX’s reply brief filed with the Second Circuit on July 30. While CSX developed the theme of “tilting the playing field” in its opening brief on appeal (see my blog of July 17), it hammers on this theme in its reply brief, setting the stage with its very first utterance: “Defendants set out to steal an election by violating the law.” Hohn and his cohorts “in order to steal the election, illegally evaded the rules that the Williams Act established to maintain a fair playing field.” Reply Brief at 4. The Court, urges CSX, should do equity to deal with “these new violators with new methods” -- specifically, declare null and void the TCI’s and 3G’s group’s voting of the “illegally-obtained” shares at CSX’s 2008 annual meeting of stockholders.

The rhetoric flies, with a plethora of literary citations. In its 10-page preliminary statement, CSX cites such legal luminaries as Justices Cardozo (Meinhard v. Salmon) and Holmes (The Common Law and The Path of the Law), as well as Charles Dickens (Oliver Twist), Thomas Hobbes (De Cive and Leviathan), John Milton (Areopagitica), and George Orwell (1984). This is stimulating stuff!

The foundation of CSX’s “tilting the playing field” argument is the following conjecture by Judge Kaplan, in his decision of June 11, 2008:

“Those current shareholders who have held shares throughout the period [the period to the record date for the annual meeting, including the period during which Judge Kaplan found TCI and 3G to have violated Section 13(d) of the Exchange Act], however, may be in a different position [than those shareholders who purchased CSX shares after the defendants filed their Schedule 13D]. Defendants’ actions may have contributed to creating a corporate electorate that is materially different today than it was before defendants made those purchases. Those who are content with present management and unconvinced by defendants’ blandishments may be in a weaker position than they might have occupied had defendants made full and timely disclosure. That all of the facts now have been disclosed does not alter this prospect. So the question is whether if foreclosing defendants from voting the shares they acquired during their violations would avert irreparable injury that otherwise would occur."

Trial Court Decision at 105-106 (footnote omitted) (emphasis added).

Constrained by the Second Circuit’s decision in Treadway Cos., Inc. v. Care Corp., 638 F.2d 357 (2d Cir. 1980), Judge Kaplan concluded that this possibly “weakened electorate” surmise is not sufficient to establish irreparable harm, and therefore serve as a predicate for the issuance of a “sterilization” injunction:

“It necessarily follows [from Treadway and the absence of any other case in which irreparable harm was found because a defendant had obtained a degree of effective control of the issuer before complying with Section 13(d)] that the alteration of the corporate electorate arguably affected by defendants’ actions, which did no more than increase its likelihood of prevailing in the current contest, cannot be regarded as irreparable injury that properly may be remedied by preventing the voting of the stock acquired while defendants were in violation of Section 13(d).”

Trial Court Decision at 109 (footnote omitted).

So CSX urges the Second Circuit to “level the playing field” and prevent the “stealing” of the 2008 election by the TCI/3G group by nullifying the group’s voting of the tainted 26 million shares:

“While tilting the playing field may be profitable for defendants and defendants’ friends (at the expense of the marketplace generally), it is exactly what the Williams Act sought to prevent.”

Reply Brief at 22.

But how would earlier disclosure by TCI and 3G in accordance with Judge Kaplan’s and CSX’s reading of Section 13(d) and Rule 13d-3 have leveled the playing field? Presumably the “weakening” of the electorate referred to by Judge Kaplan is the fact that stockholders supporting management at the 2008 annual meeting were fewer in number than they otherwise would have been had TCI and 3G timely filed a Schedule 13D. Judge Kaplan concluded, and CSX repeatedly emphasizes (by the use of its “TCI’s friends and family” rhetoric), that TCI and 3G undoubtedly tipped fellow hedge funds to get in on the action and buy CSX shares. Let’s assume TCI had filed a Schedule 13D back in December of 2006, when the referenced shares underlying its swaps exceeded 5%. How would TCI’s and 3G’s fellow hedge fund managers, and like-minded opportunistic investors, have reacted to the filing? By not buying CSX shares? If the result of an earlier filing would have been more opportunistic purchases of CSX shares, on the assumption that TCI was making a move on CSX, would not the playing field have been even more tilted in favor of the insurgents?

Proxy contests are not democratic elections. People don’t buy shares because they think the target’s management are good guys. They buy shares to make money. So I have problems working through CSX’s plea to the Second Circuit that it neutralize the TCI/3G’s group’s tainted shares in order to “level the playing field.”

(For my earlier posts on this case, see my entries of August 1, July 30, 26, 17, and June 24 and 23.)