The oral argument on the parties’ cross-appeals in this case was heard before judges Calabresi, Newman, and Winter on August 25, 2008. We are still awaiting the Court’s decision. As I reported in my post of September 15, 2008, the panel issued a summary order on September 15 affirming Judge Kaplan’s ruling not to enjoin the voting of CSX shares by TCI and 3G. The effect of that order was to seat four of the five nominees for the CSX board put forth by TCI and 3G. The panel’s explanation of its summary order, and its ruling on Judge Kaplan’s findings of liability and his entry of a permanent injunction restraining TCI and 3G from future violations of Section 13(d) of the Exchange Act will be addressed in its forthcoming opinion that fully disposes of the parties’ appeals.
I took the occasion over this past weekend to listen to a CD of the oral argument, as presented by Chris Landau of Kirkland & Ellis for TCI and 3G and by Rory Millson of Cravath for CSX. The argument was spirited, running for about an hour. The panel was clearly well prepared and peppered counsel with questions. Indeed, the exercise reinforced the observation that an effective litigator requires a steely determination and focus, since the last thing this panel allowed counsel to do was to complete a sentence. I am sure the transcript of the oral argument reads like Joyce’s Ulysses, with the beginning of a thought appearing on one page, the middle of the thought appearing many pages later, and the conclusion of the thought appearing somewhere near the end of the transcript.
While predicting the outcome of an appeal based upon a panel’s questions is hazardous, it struck this observer that Judge Winter had difficulty with CSX’s position and will therefore vote to overturn Judge Kaplan’s decision that, by entering into cash-settled equity swaps, TCI and 3G violated Section 13(d) of the Exchange Act. Judge Calabresi, who was the most active questioner (interrupter), and Judge Newman appeared more skeptical of TCI and 3G’s position, although by several of his questions Judge Calabresi expressed concern that Judge Kaplan’s findings of fact may not have been sufficient to serve as a predicate for a finding beneficial ownership by TCI and 3G in the CSX referenced shares.
By his questioning Judge Newman focused on the realities of the relationship between TCI and the banks. He directed Landau’s attention to the passage of Judge Kaplan’s decision where the Judge quotes from the SEC’s 1977 release adopting the beneficial ownership disclosure requirements:
“It therefore is not surprising that the SEC, at the very adoption of Rule 13d-3, stated that the determination of beneficial ownership under Rule 13d-3(a) requires
‘[a]n analysis of all relevant facts and circumstances in a particular situation … in order to identify each person possessing the requisite voting power or investment power. For example, for purposes of the rule, the mere possession of the legal right to vote securities under applicable state or other law … may not be determinative of who is a beneficial owner of such securities inasmuch as another person or persons may have the power whether legal, economic, or otherwise, to direct such voting.’”
Slip Opinion at 49-50 (citing to Exchange Act Release No. 34-13291) (footnote omitted, emphasis added).
What interested Judge Newman was the reference to “otherwise” in the quoted passage and what type of “otherwise” power the SEC was referring to. Given that counterparty banks are generally indifferent to the voting of any shares they may purchase to hedge their exposure to a swap, doesn’t the long party have “otherwise” power to direct the voting of such shares? In response Landau referred to the Division of Corporation Finance’s amicus letter to Judge Kaplan of June 4, 2008, in which the Division stated clearly that “economic incentives do not constitute a sufficient basis for establishing any such [voting or investment] powers.” Judge Newman appeared to dismiss the Division’s letter as not having the authority of an SEC release, such as the one he pressed Landau on. Judge Newman even posed this hypothetical to Millson, CSX’s counsel — what if TCI had asked Deutche Bank to vote the CSX shares and Deutche Bank had said, “Sure, we’ll vote with you.” (Apparently CSX did not have the opportunity to put that question to a representative of Deutche Bank.)
Millson, repeating the stance taken in CSX’s briefs, took the position that a long party who enters into a swap referencing more than 5% of an issuer’s shares, with the intent of exercising or influencing control of the issuer, is a beneficial owner of the referenced shares. The panel appeared clearly unreceptive to adopting this position. The panel pressed Millson on Judge Kaplan’s absence of any finding that TCI and 3G “influenced” the voting by its counterparties of their CSX shares. While Judge Kaplan concluded (Slip Opinion at 61) that there is “reason to believe that TCI was in a position to influence the counterparties, especially Deutche Bank, with respect to the exercise of their voting rights,” Millson had to concede that that was not a finding of influence.
Landau pressed the panel with TCI’s argument that Rule 13d-3 cannot extend beyond Section 13(d) of the Exchange Act and that a party must have “beneficial ownership” of shares before a reporting obligation under Section 13(d) arises. Judge Newman in particular appeared to have trouble with this claim, particularly in the context of the “plan or scheme” language of Rule 13d-(b), which extends “beneficial ownership” of shares to any “trust, proxy, power of attorney, pooling arrangement or any other contract, arrangement, or device with the purpose or effect of … preventing the vesting of … beneficial ownership as part of a plan or scheme to evade the reporting requirements of Section 13(d) or 13(b) of the [Exchange] Act, …” (Emphasis added.) (The Division of Corporation Finance, in its amicus letter of June 4, 2008, stated its belief that Rule 13d‑3, “properly construed, is narrower in coverage than the statute.”) How, asked Judge Newman, can actual beneficial ownership be a predicate to a trigger for Section 13(d) reporting if the trigger includes arrangements or devices to “prevent” the vesting of beneficial ownership?
It is hard to say where this will come out. If I had to read the tea leaves, I would guess that Judge Calabresi would opt for sending the case back to Judge Kaplan for further findings, Judge Newman would affirm, and Judge Winter would reverse.
Or the panel, with judges Calabresi and Newman in the majority, could affirm Judge Kaplan’s finding of violation on grounds suggested by Professor Coffee, as discussed in my post of August 23, 2008:
“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.”
Coffee, “The Wreck of the CSX: Transparency and Derivatives,” NY Law Journal (July 17, 2008).
For my prior commentary on this case, see my posts of September 15, August 23, 13, and 1, July 30, 26, and 17, and June 24 and 23.
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