CSX v. TCI; TCI's Influence Over the Voting of CSX Shares Held By Counterparties Citibank and Deutsche Bank: Not

By its order of July 31, 2008, the Second Circuit requested from the parties information about the stockholder vote for directors held at the June 25, 2008 annual meeting, including the extent, if any, that invalidating the votes of the 6.4% of CSX’s shares found by Judge Kaplan to have been acquired by TCI/3G after they should have filed a Schedule 13D until they in fact did so would affect the outcome of the vote.

The parties responded to the order by their submissions of August 20, 2008. We learn from TCI/3G that Deutsche Bank, one of TCI’s/3G’s primary counterparties, did not vote the CSX shares it had acquired as a hedge to its exposure to the group’s CSX cash-settled swaps with Deutsche Bank. Apparently, neither did Citibank, the group’s other primary counterparty. So what kind of “evaders” are TCI and 3G anyway? Lambasted by CSX and Judge Kaplan for exercising “influence” over their swap counterparties’ voting of CSX’s shares in the proxy contest with CSX, the group’s influence did not extend to persuading Deutsche Bank and Citibank to vote their CSX shares in the election!

Judge Kaplan did not find that TCI/3G exercised voting power over their counterparties’ CSX shares within the meaning of Rule 13d-3(a). Nevertheless, his findings on the group’s “influence” over Deutsche Bank were one of the foundations of his conclusion that the group violated the “anti-evasion” “plan or scheme” provision of Rule 13d-3 (paragraph (b)) and this finding has been cited by, among others, Professor Coffee in his July 17, 2008 commentary on the case in the New York Law Journal as the ground on which the Second Circuit could sensibly affirm Judge Kaplan’s finding of Section 13(d) liability:

“The ‘voting power’ prong [of Rule 13d-3(a)] has, however, greater promise. Most swaps dealers do not vote the shares they buy to hedge their position for a variety of reasons: because they have no economic motive to vote, because they fear losing Schedule 13G eligibility, or because it is more profitable to lend their shares to short sellers. Those that do vote often divide their votes, voting both ways according to some formula or according to the recommendations of a proxy advisory firm. Thus, the repeated act of recalling shares just prior to the record date and relending the shares immediately afterward does distinguish Deutsche Bank in this case from the vast majority of swaps dealers. A narrower decision, written on this rationale, could find a violation [of Schedule 13(d)] without generally deeming the ‘long’ side of an equity swap to be the beneficial owner of the referenced shares held by the dealer.”

Of course, having the power to vote the shares held by another does not mean that the shares will actually be voted by the agent. If I hold CSX shares in street name, I clearly have the power to vote the shares, even if my broker doesn’t do so. But where the power is not the result of a customary principal/agent relationship, and must be established by an “arrangement, understanding, [or] relationship” (Rule 13d-3(a)), then the circumstantial evidence establishing an “implicit” agreement becomes important. And if the party “implicitly” agreeing to do something in fact doesn’t do it, doesn’t that go to the existence (or non-existence) of the agreement?

So for this observer, the fact that neither Citibank nor Deutsche Bank voted the CSX shares they acquired to hedge their swaps with TCI takes the steam out of Judge Kaplan’s decision. Of course, there is another explanation entirely consistent with a finding that, at the time the swaps were entered into, there was an implicit agreement on voting: the filing by CSX of this lawsuit (filed some three months before the annual meeting), which just very well may have convinced Deutsche Bank and Citibank not to vote their CSX shares.

Who knows, CSX might even have intended that result with the filing of its lawsuit.