CSX CORPORATION, Plaintiff-Appellant-Cross-Appellee, v. THE CHILDREN‘S INVESTMENT FUND MANAGEMENT (UK) LLP, The Children‘s Investment Fund Management (Cayman) Ltd., The Children‘s Investment Master Fund, 3G Capital Partners Ltd., 3G Capital Partners, L.P., 3G Fund, L.P., Christopher Hohn, Snehal Amin, and Alexandre Behring, also known as Alexandre Behring Costa, Defendants-Third-Party-Plaintiffs-Counter-Claimants-Appellees-Cross-Appellants.
Docket Nos. 08-2899-cv (L), 08-3016-cv (XAP)
United States Court of Appeals, Second Circuit
Decided: July 18, 2011
654 F.3d 276
NEWMAN, WINTER, and CALABRESI, Circuit Judges.
Moreover, no reasonable jury could conclude that Kolesar‘s report to CFS, or the resulting requirement that Raphael be psychiatrically evaluated, was even remotely “outrageous” or “conscience-shocking.” Common negligence is categorically insufficient to shock the conscience, so the parents must raise an inference that Kolesar acted maliciously before his call to CFS can even begin to support a violation of substantive due process. Cnty. of Sacramento v. Lewis, 523 U.S. 833, 848-49, 118 S.Ct. 1708, 140 L.Ed.2d 1043 (1998) (“We have accordingly rejected the lowest common denominator of customary tort liability as any mark of sufficiently shocking conduct, and have held that the Constitution does not guarantee due care on the part of state officials; liability for negligently inflicted harm is categorically beneath the threshold of constitutional due process.“). The parents allege that Kolesar‘s report to CFS was exaggerated and misleading, but even in the light most favorable to them, nothing in the report was materially false: Raphael wrote violent journal entries, misbehaved in school, and expressed suicidal thoughts, albeit in a hypothetical, creative, imagined way. Furthermore, Kolesar‘s actions were expressly aimed at protecting Raphael, and Kolesar had a legal obligation to report suspected neglect. There is no evidence that Kolesar acted with the type of malice needed to shock the conscience.
We therefore affirm the district court‘s grant of summary judgment in favor of Kolesar and Warwick on this claim. We need not reach the question of qualified immunity.
CONCLUSION
For the reasоns stated above, the judgment of the district court is AFFIRMED.
Argued: Aug. 25, 2008.
Rory O. Millson (Francis P. Barron & David R. Marriott, on the brief), Cravath, Swaine & Moore LLP, New York, NY, for Plaintiff-Appellant-Cross-Appellee.
Richard M. Lorenzo, James G. Szymanski & M. Alexander Bowie II, Day Pitney LLP, New York, NY, for Amici Curiae Former SEC Commissioners and Officials and Professors.
Katherine Tew Darras & Rosario Chiarenza, International Swaps and Derivatives Association, Inc., New York, NY; Ira D. Hammerman & Kevin M. Carroll, Securities Industry and Financial Markets Association, Washington, D.C.; David M. Becker, Edward J. Rosen, Michael D. Dayan, Joon H. Kim & Shiwon Choe, Cleary Gottlieb Steen & Hamilton LLP, New York, NY & Washington, D.C., for Amici Curiae International Swaps and Derivatives Association, Inc., and Securities Industry and Financial Markets Association.
Roger D. Blanc, Martin Klotz & Richard D. Bernstein, Willkie Farr & Gallagher LLP, New York, NY, for Amicus Curiae Managed Funds Association.
Daniel J. Popeo & Richard A. Samp, Washington Legal Foundation, Washington, D.C., for Amici Curiae Washington Legal Foundation, National Association of Manufacturers & Business Roundtable.
JON O. NEWMAN, Circuit Judge:
This case comes to us raising issues concerning a contractual arrangement known as a “cash-settled total return equity swap agreement” although our disposition at this stage of the appeal touches only tangentially on such issues.
The Children‘s Investment Fund Management (“TCI“) and 3G Capital Partners (“3G“)1 are hedge funds that entered into cash-settled total-return equity swap agreements referencing shares of CSX Corporation (“CSX“). They later sought to elect a minority slate of candidates to CSX‘s board of directors. Alleging that TCI and 3G (“the Funds“) had failed to comply in a timely fashion with the disclosure requirements of
The District Court held that the Funds had violated
The parties have endeavored to frame issues that would require decision аs to the circumstances under which parties to cash-settled total-return equity swap agreements must comply with the disclosure provisions of
Rather than resolve such issues, as to which there is disagreement within the panel, we consider at this time only issues concerning a “group” violation of
Background
We describe here only the salient facts and District Court proceedings, leaving many details to the Discussion section.
TCI and 3G (“the Funds“) are investment funds that in 2006 came to believe that CSX, a large railroad company, had unrealized value that a change in corporate policy and perhaps management might unlock. The Funds purchased shares in CSX and entered into cash-settled total-return equity swaps referencing CSX stock. The Funds then engaged in a proxy fight with the management of CSX.
(a) Cash-settled total-return equity swaps. Total-return swaps are contracts in which parties agree to exchange sums equivalent to the income streams produced by specified assets. Total-return equity swaps involve an exchange of the income stream from: (1) a specified number of shares in a designated company‘s stock, and (2) a specified interest rate on a specified principal amount. The party that receives the stock-based return is styled the “long” party. The party that receives the interest-based return is styled the “short” party. These contracts do not transfer title to the underlying assets or require that either party actually own them. Rather, in a total-return equity swap, the long party periodically pays the short party a sum calculated by applying an agreed-upon interest rate to an agreed-upon notional amount of principal, as if the long party had borrowed that amount of money from the short party. Meanwhile, the short party periodically pays the long party a sum equivalent to the return to a shareholder in a specified company—the increased value of the shares, if any, plus income from the shares—as if the long party owned actual shares in that company.
As a result, the financial return to a long party in a total-return equity swap is roughly equivalent to the return when borrowed capital is used to purchase shares in the referenced company. Long swap positions can, therefore, be attractive to parties that seek to increase the leverage of their holdings without actually buying the shares. The short party‘s financial return, in turn, is equivalent to the return to someone who sold short and then lent out the proceeds from that sale. However, because of the inherent risks in short-
Total-return equity swaps may be “settled-in-kind” or “cash-settled.” When an equity swap that is settled-in-kind terminates, the long party receives the referenced security itself, in exchange for a payment equal to the security‘s market price at the end of the previous payment period. When a cash-settled equity swap terminates, the short party pays the long party the sum of the referenced equity security‘s appreciation in market value and other net cash flows (such as dividend payments) that have occurred since the most recent periodic payment. If this sum is negative, then the short party receives the corresponding amount from the long party. Unlike swaps settled in kind, cash-settled swaps do not give the long party a right to acquire ownership of the referenced assets from the short party. In all other respects, settled-in-kind and cash-settled equity swaps are economically equivalent.
(b) The transactions in the present case. The swaps purchased by the Funds were cash-settled total-return equity swaps referencing shares of CSX. The Funds were the long parties, and several banks were the short parties. Although the swap contracts did not require the short parties—the banks—actually to own any CSX shares, the Funds understоod that the banks most likely would hedge their short swap positions by purchasing CSX shares in amounts matching the number of shares referenced in the swaps, and the banks generally did so.2
The Funds’ trading in CSX shares and CSX-referenced swaps followed no consistent pattern. During some periods the Funds increased their holdings; during other periods they decreased them. Almost immediately after making its initial investment in CSX, TCI approached the company to negotiate “changes in policy and, if need be, management [that] could bring better performance and thus a higher stock price,” CSX I, 562 F.Supp.2d at 523, which would allow TCI to profit from its swap holdings. TCI later explored the possibility of a leveraged buyout (“LBO“) of CSX, and informed other hedge funds of its interest in “altering CSX‘s practices in a manner that TCI believed would cause its stock to rise.” Id. at 526. When it became clear that CSX had little interest in TCI‘s proposed policy changes or LBO proposals, TCI began preparations for a proxy contest to effectuate its desired policy and management changes at CSX.
There is no doubt that the Funds wanted to avoid disclosure under the Williams Act until a time they believed suitable. Thus, TCI took care to disperse its swaps among multiple counterparties so that no one particular counterparty would trigger disclosure under the Williams Act by purchasing as a hedge more than 5 percent of a class of CSX securities.3 TCI could not be certain how counterparties would vote their hedge shares but of course could vote
Meanwhile, the Funds engaged in various communications among themselves, with CSX‘s management, and with some of the banks. As early as November 2006, TCI had contacted CSX and two banks—one in December 2006, and the other in January 2007—about the possibility of a leveraged buyout. TCI also had communications with both Austin Friars, a hedge fund owned by Deutsche Bank, and with Deutsche Bank itself about CSX. TCI and 3G communicated between themselves at various times in 2007, but not until December 19, 2007, did they file a Schedule 13D with the SEC disclosing that they had formed a “group” by “enter[ing] into an agreement to coordinate certain of their efforts with regard [sic] (I) the purchase and sale of [various shares and instruments] and (ii) the proposal of certain actions and/or transactions to [CSX].” CSX I, 562 F.Supp.2d at 535.
On January 8, 2008, the TCI-3G group proposed a minority slate of directors for the CSX board. See id. at 536. The vote on this proposal occurred at the June 25, 2008, CSX shareholders’ meeting.
(c) The present action. On March 17, 2008, CSX brought the present action against TCI and 3G in the Southern District of New York alleging, among other things, violation of the Williams Act,
The District Court held that, for purposes of
The District Court also found that TCI and 3G violated
The Court granted CSX a permanent injunction against TCI and 3G, prohibiting any further violations of
Discussion
We leave discussion of the merits of the now-resolved CSX appeal, i.e., the issue of whether prohibiting the Funds from voting the CSX shares was an appropriate remedy for the alleged violation, to the end of this opinion, and turn to the Funds’ cross-appeal. As to that appeal, the panel is divided on numerous issues concerning whether and under what circumstances the long party to a cash-settled total return equity swap may be deemed, for purposes of
I. Statutory and Regulatory Framework
(1) Any person who, after acquiring directly or indirectly the beneficial ownership of any equity security of a class which is registered pursuant to
section 78l of this title..., is directly or indirectly the beneficial owner of more than 5 per centum of such class shall, within ten days after such acquisition, [disclose to the issuer, the SEC, and the exchanges] a statement containing such of the following information, and such additional information, as the Commission may by rules and regulations, prescribe as necessary or appropriate in the public interest or for the protection of investors.......
(3) When two or more persons act as a partnership, limited partnership, syndicate, or other group for the purpose of
acquiring, holding, or disposing of securities of an issuer, such syndicate or group shall be deemed a “person” for the purposes of this subsection.
SEC Rule 13d-5(b)(1) provides that the
II. “Group” Violation
There arе three kinds of groups that might be found in the present matter. One might consist of one or more long parties (the Funds) and one or more short counterparties that have hedged with shares (the banks). The second might consist of the Funds, i.e., TCI and 3G. The third might consist of banks that have purchased shares as a hedge. Only the possibility of a group comprising TCI and 3G is at issue on this appeal.
As we have noted, the statute and the implementing rule are both concerned with groups formed for the purpose of acquiring shares of an issuer. See
Endeavoring to meet the statutory standard, the District Court found that TCI
These findings are insufficient for proper appellate review. Although the District Court found the existence of a group “with respect to CSX securities,” the Court did not explicitly find a group formed for the purpose of acquiring CSX securities. Even if many of the parties’ “activities” were the result of group action, two or more entities do not become a group within the meaning of
Moreover, because the District Court deemed the Funds, as long parties to cash-settled total-return equity swap agreements, to have a beneficial interest in shares acquired by hedging short parties to such agreements, the Court did not distinguish in its group finding between CSX shares deemed to be beneficially owned by the Funds and those owned outright by the Funds. However, with our current consideration of a group violation confined to CSX shares owned outright by the Funds, a precise finding, adequately supported by specific evidence, of whether a group existed for purposes of acquiring CSX shares outright during the relevant period needs to be made in order to facilitate appellate review, and we will remand for that purpose. Because the combined total outright ownership of CSX shares by TCI and 3G crossed the 5 percent threshold by April 10, 2007, a TCI/3G group, if it was formed for the statutorily defined purpose, would have been required to file a
III. Appropriateness of Injunctive Relief
Because on remand, the District Court might find a
It is settled in this Circuit that an issuer has an implied right of action to seek injunctive relief for a violation of
In this case, the District Court considered both irreparable harm and the probability of future violations. See CSX I, 562 F.Supp.2d at 572-73. Having held that the Funds violated
Defendants, their officers, agents, servants, employees, attorneys, and all persons in active concert or participation with any of the foregoing who receive actual notice of this injunction... are enjoined and restrained from violating
Section 13(d) of the Securities Exchange Act of 1934, 15 U.S.C. § 78m(d) , and Regulation 13D thereunder...
The District Court predicated this broad injunction on the basis of a
If a
Another factor that would arguably weigh against a broad injunction is the disclosure that CSX made just prior to the expiration of the ten-day period following April 10, 2007, the date when the group‘s total of CSX shares owned outright crossed the 5 percent threshold. On April 18, 2007, CSX filed its Form 10-Q for the period ending March 30, 2007. The Form 10-Q reported that TCI had made a filing under the Hart-Scott-Rodino Antitrust Improvements Act,
On the other hand, if a
Under all the circumstances, we will remand to the District Court so that it may (a) determine whether the evidence permits findings as to the formation of a group, as described above, a date by which at the latest such a group was formed, and whether such a group‘s outright ownership of CSX shares crossed the 5 percent threshold prior to the filing of a
IV. Injunctive “Sterilization” of the Disputed Shares
The District Court concluded that it was foreclosed as a matter of law from enjoining the Funds’ voting of CSX shares acquired between the latest date on which their
In Treadway Companies, Inc. v. Care Corp., 638 F.2d 357 (2d Cir.1980), we held that “an injunction will issue for a violation of
CSX, however, argues that the Williams Act does not aim merely at timely dissemination of information but more broadly “seeks to provide a level playing field and to promote compliance.” Appellant‘s Brief at 48. For this proposition, CSX relies on a passing remark, in a footnote, in which the Supreme Court expressed skepticism about “whether ‘deterrence’ of
CSX also rests its “level playing field” claim on two Supreme Court cases that include “fair corporate suffrage” as among the original goals of the Securities Exchange Act of 1934: Virginia Bankshares, Inc. v. Sandberg, 501 U.S. 1083, 1103, 111 S.Ct. 2749, 115 L.Ed.2d 929 (1991), and J.I. Case Co. v. Borak, 377 U.S. 426, 431, 84 S.Ct. 1555, 12 L.Ed.2d 423 (1964). However, neither case attributed that goal to the Williams Act, and there is no reason to conclude that adequate timely disclosure of the information covered by the Williams Act would be insufficient to ensure the “fairness” of a subsequent shareholder vote.
CSX also argues that the importance of deterring violations of
The inappropriateness of share sterilization in such circumstances leaves open the question of what remedies might be appropriate when disclosure that is timely with respect to a proxy contest is not made, and we do not reach that issue here.
CSX quotes Franklin v. Gwinnett County Public Schools, 503 U.S. 60, 72, 112 S.Ct. 1028, 117 L.Ed.2d 208 (1992), to the effect that once a federal right of action exists there is a “traditional presumption” that courts can use “all available remedies” unless Congress clearly has provided otherwise. In a similar vein, CSX argues that because the District Court found that officials of both Funds testified falsely, see CSX I, 562 F.Supp.2d at 573, the Court was permitted to issue an injunction to “sterilize” the Funds’ disputed shares as a way of sanctioning abuses of the judicial process. However, neither the presumption about the general availability of remedies nor the responsibility of federal courts to protect the integrity of their proceedings, see, e.g., In re Martin-Trigona, 737 F.2d 1254, 1261 (2d Cir.1984), supersedes Treadway‘s holding: in the case of
Conclusion
The District Court‘s denial of an injunction against the voting of shares is again
WINTER, Circuit Judge, concurring:
I concur in the judgment remanding for further findings.
The district court‘s finding of a February 2007 group formation that required disclosure under Rule 13d-5(b)(1) cannot be upheld for various reasons discussed infra. Particularly, it was based in part on a flawed analysis of the economic and legal role of cash-settled total-return equity swap agreements.
The court viewed the economic role of such swaps as an underhanded means of acquiring or facilitating access to CSX stock that could be used to gain control through a proxy fight or otherwise. In my view, without an agreement between the long and short parties permitting the long party ultimately to acquire the hedge stock or to control the short party‘s voting of it, such swaps are not a means of indirectly facilitating a control transaction. Rather, they allow parties such as the Funds to profit from efforts to cause firms to institute new business policies increasing the value of a firm. If management changes the policies and the firm‘s value increases, the Funds’ swap agreements will earn them a profit for their efforts. If management does not alter the policies, however, and a proxy fight or other control transaction becomes necessary, the swaps are of little value to parties such as the Funds. Absent an agreement such as that described above, such parties must then, as happened here, unwind the swaps and buy stock at the open market price, thus paying the costs of both the swaps and the stock.
The district court‘s legal analysis concluded that the one role of such swaps was to avoid the disclosure requirements of
I
In my view, cash-settled total-return equity swaps do not, without more, render the long party a “beneficial owner” of such shares with a potential disclosure obligation under
My discussion of the basis of this conclusion will begin with an examination of aspects of the underlying statutory scheme and resultant caselaw not discussed by the district court. It will then turn to the application of relevant rules promulgated by the SEC.
a) The Statutory Scheme
Examination of the statutory scheme is particularly important in this matter, for two reasons. First, critical language used in
To reiterate,
Some measure of certainty should be accorded to persons subject to
In the present case, much certainty can be provided simply by following the language of
The term “beneficial owner[s]... of any equity security” was not drawn from thin air in 1968. Id. It was already a familiar term from its use in Section 16, which was part of the original 1934 Act. Section 16 requires the reporting of purchases and sales, and disgorgement of profits from certain of those sales, by a defined group of insiders: directors, officers, and, importantly for my purposes, “beneficial own-
The purpose of Section 16 is generally said to be to reveal transactions by insiders, so defined, and to prevent short-swing profit making based on non-public, material information, i.e., insider trading. See, e.g., Foremost-McKesson, Inc. v. Provident Sec. Co., 423 U.S. 232, 243, 96 S.Ct. 508, 46 L.Ed.2d 464 (1976) (describing the purpose of Section 16(b)); H.R. Rep. 73-1383, at 13, 24 (1934) (stating that Section 16(a) was motivated by a belief that “the most potent weapon against the abuse of inside information is full and prompt publicity” and by a desire “to give investors an idea of the purchases and sales by insiders which may in turn indicate their private opinion as to prospects of the company“).
Section 16 relies as fundamentally on the concept of beneficial ownership as does
However, in 1991, the SEC harmonized Section 16‘s interpretation of beneficial ownership of 10 percent with the corresponding provisions (but for a 5 percent requirement) of
Even without Rule 16a-1(a)(1), the pertinent language of the two sections is identical, and harmonization of interpretation is normally necessary. See, e.g., Gustafson v. Alloyd Co., Inc., 513 U.S. 561, 570, 115 S.Ct. 1061, 131 L.Ed.2d 1 (1995) (“The 1933 [Securities] Act, like every Act of Congress, should not be read as a series of
The caselaw under Section 16 is particularly informative with regard to whether
For another and very pertinent example, Section 16 has been held to allow a 13.2 percent shareholder to avoid disgorgement of profits made on a sale of 9.96 percent of the shares made within six months of their purchase by strategic timing of the sales. Reliance Elec., 404 U.S. at 419-20, 92 S.Ct. 596. The shareholder first sold enough shares to reduce its holdings to 9.96 percent, just below the 10 percent threshold, and then sold the rest of its shares shortly thereafter. Id. at 420, 92 S.Ct. 596. The shareholder avoided disgorgement of the profits on the second sale even though the two sales “were effected pursuant to a single predetermined plan of disposition with the overall intent and purpose of avoiding Section 16(b) liability.”4
In so holding the Supreme Court stated:
The history and purpose of § 16(b) have been exhaustively reviewed by federal courts on several occasions since its enactment in 1934. Those courts have rec-
ognized that the only method Congress deemed effective to curb the evils of insider trading was a flat rule taking the profits out of a class of transactions in which the possibility of abuse was believed to be intolerably great. As one court observed: In order to achieve its goals, Congress chose a relatively arbitrary rule capable of easy administration. The objective standard of Section 16(b) imposes strict liability upon substantially all transactions occurring within the statutory time period, regardless of the intent of the insider or the existence of actual speculation. This approach maximized the ability of the rule to eradicate speculative abuses by reducing difficulties in proof. Such arbitrary and sweeping coverage was deemed necessary to insure the optimum prophylactic effect. Thus Congress did not reach every transaction in which an investor actually relies on inside information. A person avoids liability if he does not meet the statutory definition of an “insider,” or if he sells more than six months after purchase. Liability cannot be imposed simply because the investor structured his transaction with the intent of avoiding liability under § 16(b). The question is, rather, whether the method used to “avoid” liability is one permitted by the statute.
Id. at 422, 92 S.Ct. 596 (internal quotation marks and citations omitted). Given the Supreme Court‘s direction to harmonize the interpretation of multiple statutory uses of identical language and SEC Rule 16a-1, the well-established approach of Section 16 governs the interpretation of “beneficial ownership of any equity security” in
A large measure of certainty is provided by this test‘s mechanical attributes, but, as Reliance Electric noted with regard to Section 16, at a cost. Reliance Electric, 404 U.S. at 422, 92 S.Ct. 596. Application of the language of
There is also an inevitable underbreadth, see id. not requiring disclosure of conduct that constitutes significant steps in an attempt to gain control but does not fall within the pertinent language. Without triggering any disclosure requirement, a potential acquirer can, for example, amass 4.9 percent of the target company‘s shares. The potential acquirer may further make inquiry of some large shareholders with an eye to learning how many shares might be available for private purchases in the future and what price ranges are likely, so long as there is no implicit or explicit agreement to buy. Pantry Pride, Inc. v. Rooney, 598 F.Supp. 891, 900 (S.D.N.Y.1984) (“Section 13(d) allows individuals broad freedom to discuss the possibilities of future agreements without filing under securities laws.“). Such inquiries may cause—and be expected to cause—these other shareholders to keep or acquire more shares than they otherwise would, in anticipation of the potential acquirer deciding to make an acquisition.
The same potential acquirer may line up financing in anticipation of a large purchase of the target company‘s shares in a short period of time. The potential acquirer can then form a group with other likeminded investors and coordinate future plans to buy the target company‘s stock, again so long as the 5 percent ownership threshold is not yet reached. The group may then cross the threshold and acquire an unlimited amount of the company‘s securities over a ten-day period before being
The district court also did not consider the fact that Congress has been well aware of legal issues involving swaps for years and has repeatedly passed legislation regarding them, all of which is specifically relevant to the issues in this case and generally relevant to the propriety of, or need for, courts’ adopting legal rules that Congress and the SEC have avoided. For example, as part of the 2000 amendments discussed infra, Congress exempted security-based swap agreements from the 1934 Act‘s definition of a security. See infra note 6;
However, neither exemption from, nor inclusion in, the definition of security affects the outcome here because
My point, nevertheless, is that Congress was well aware of the issues arising from security-based swaps. In fact, security-based swap agreements are a metaphoric Alsace-Lorraine in the conflicting claims of jurisdiction by the SEC and the Commodity Futures Trading Commission (“CFTC“) over securities futures products. See Peter J. Romeo & Alan L. Dye, Section 16 Treatise and Reporting Guide § 1.02[5], at 48-49 (Michael Gettelman ed., 3d ed. 2008).
The 2000 legislation, in effect at the time of the district court‘s opinion and the hearing of this appeal, included a moderately lengthy and detailed amendment to the 1934 Act broadly limiting the SEC‘s regulatory authority over security based swap agreements. See
In 2010, the Dodd-Frank bill not only included security-based swaps in the definition of security but also amended the definition of beneficial owner contained in Section 13 of the SEA. The provision now states:
(o) BENEFICIAL OWNERSHIP. — For purposes of this section and section 16, a person shall be deemed to acquire beneficial ownership of an equity security based on the purchase or sale of a security-based swap, only to the extent that the Commission, by rule, determines after consultation with the prudential regulators and the Secretary of the Treasury, that the purchase or sale of the security-based swap, or class of security-based swap, provides incidents of ownership comparable to direct ownership of the equity security, and that it is necessary to achieve the purposes of this section that the purchase or sale of the security-based swaps, or class of security-based swap, be deemed the acquisition of beneficial ownership of the equity security.
Two matters of significance must be noted. First, if
b) Beneficial Ownership
I turn now to the issue of whether the Funds, as long parties to the cash-settled total-return equity swaps, are beneficial owners of referenced shares bought by short parties to hedge short positions in those swaps. The district court held that if a long party to such a swap would expect that the short party would hedge its position by purchasing shares, then the long party was a beneficial owner of those shares because it “had the power to influence” the purchase. CSX Corp., 562 F.Supp.2d at 546. The district court further found that the “only practical alternative” for the short parties to hedge was to purchase CSX shares. Id.
The fact that the purchasing of CSX shares was the “only practical alternative” for short parties to hedge, as found by the district court, is not a circumstance that differentiates the swaps here from cash-settled total-return equity swaps generally. Other hedging methods for short parties exist, but these methods are exceptional. Henry T.C. Hu & Bernard Black, The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership, 79 S. Cal. L.Rev. 811, 816, 837 (2006). Moreover, they also appear to involve derivatives, e.g., swaps, stock options, or stock futures, that may result in the purchasing of referenced shares as a hedge by other parties further down in the chain of transactions. Id. The existence of other hedging methods does not affect the analysis, therefore, because the arguments proffered by CSX and the district court are as applicable to these hedge shares as they are to a first short pаrty‘s purchase of hedge shares.
In any event, a short party‘s purchasing of shares is the most practical and common method of hedging, and long parties will expect that it will be used, if not by the immediate short party, then by another down the line. As a result, the district court‘s ruling renders the long party to virtually all cash-settled total-return equity swaps a “beneficial owner” of such swaps. Thus, my discussion of the legal meaning of “beneficial owner” will assume that long parties expect short parties to hedge by buying shares.
There appears to be no generally accepted or universal definition of the term “beneficial owner.” Like the term “fiduciary,” it is very context-dependent, suggesting no more perhaps than that a power—e.g., to vote shares or an asset be used for the benefit of the “beneficial owner.” SEC v. Chenery Corp., 318 U.S. 80, 85-86, 63 S.Ct. 454, 87 L.Ed. 626 (1943) (“But to say that a man is a fiduciary only begins analysis; it gives direction to further inquiry. To whom is he a fiduciary? What obligations does he owe as a fiduciary? In what respect has he failed to discharge these obli-
In the present context, there are two SEC rules that apply: Rules 13d-3(a) and 13d-3(b). See
1) Rule 13d-3(a)
SEC
For the purposes of sections 13(d) and 13(g) of the [1934] Act a beneficial owner of a security includes any person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise has or shares:
(1) Voting power which includes the power to vote, or to direct the voting of, such security; and/or,
(2) Investment power which includes the power to dispose, or to direct the disposition of, such security.
To reiterate, the swap agreements in the instant case do not obligate short parties to purchase shares as a hedge, to sell such shares either at a particular time or to the long party, or to vote those shares as the long party desires. The issue here is whether, under
A) Investment Power
CSX argues that it was “inevitable” that TCI‘s swap counterparties would buy CSX shares to hedge their short swap positions and then would sell those shares when TCI closed out its swaps. Brief of Cross-Appellee at 42. TCI had, CSX concludes, “the economic ability to cause its short counterparties to buy and sell the CSX shares” and therefore had “investment power” over those shares. Id.
It would be quite anomalous to hold that a swap-holder who makes such a remark is a beneficial owner of the hedge shares while an identical swap-holder who makes no such statement is not such an owner. Such a rule would, moreover, potentially cause repetitive litigation by creating triable issues based on oral statements in every Section 13(d) case involving swaps. Cf. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 743, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975) (expressing concern that “holder” claims would “throw open to the trier of fact many rather hazy issues of historical fact the proof of which depended almost entirely on oral testimony“). Finally, as discussed infra, TCI‘s swaps would allow it to profit if it caused a change in CSX‘s business plan that increased the value of the company without a control struggle. The remarks in question may well have been an exaggerated description of that potential benefit.
Both literally and in the context of the term “beneficial ownership” and Section 13(d)‘s concerns over control, this argument gives too much breadth to the term “direct the disposition of.” To “direct” something, or to “influence” it, even indirectly, one generally must have some measure of active control, and, in the context of Section 13(d) and swaps, that control must be exercisable in the interests of the long party. See Filing and Disclosure Requirements Relating to Beneficial Ownership, Securities Act Release No. 5925, Exchange Act Release No. 14,692, Investment Company Act Release No. 10,213, 43 Fed.Reg. 18,484, 18,489 (Apr. 28, 1978) (Section 13(d) disclosure is required from any person who has the “ability to change or influence control“); Interpretive Release on Rules Applicable to Insider Reporting and Trading, Exchange Act Release No. 18,114, 46 Fed.Reg. 48,147 n. 17 (Oct. 1, 1981) (beneficial ownership under Section 13(d) “emphasizes the ability to control or influence the voting or disposition of the securities“).
“Influence” must also be interpreted in the context of Section 13(d)‘s concern over control transactions. No one would dream that the author of a weekly column providing stock tips that reliably cause investors to buy and sell the stocks mentioned was the beneficial owner of the shares bought and sold even though the column “influence[d],” not to say caused, the purchases and sales.9 A relationship that leaves
Rather, without an agreement or understanding with regard to hedging or unwinding, cash-settled total-return equity swaps leave the short counterparty free to act solely in its self-interest. Absent an agreement or informal understanding committing the banks to buy shares to hedge their CSX-referenced swaps or to sell those shares to the long party when the swaps terminated, the Funds possessed only the power to predict with some confidence the purchase of those shares as a hedge, not the power to direct such a purchase, much less to direct those shares’ disposition. The long counterparties’ act of entering into a swap, therefore, falls well short of “directing” the short counterparties to purchase the stock.
Long counterparties may well expect short counterparties to hedge their swap positions by buying the shares involved in an amount roughly equal to those specified in the swap. However, as noted supra, alternative hedging methods exist and are sometimes used. See, e.g., Caiola v. Citibank, N.A., 295 F.3d 312, 315-18 (2d Cir. 2002); Hu & Black, 79 S. Cal. L.Rev. at 816, 837. As noted, see Note 9, supra, these alternative methods may lead to a third party, whose identity is unknown to the long-party, buying hedge shares. Had the banks chosen, fоr whatever reason, not to hedge their short swap positions with a purchase of shares, not to sell all their hedge shares once the swaps had terminated, to alter their hedging methods and sell the hedge shares before the swaps were unwound, or to sell those shares to a competing would-be acquirer of CSX, the Funds would have lacked any means, legal or moral, to compel the banks to alter that choice or even to inform the Funds of their actions. See Hu & Black, 79 S. Cal. L.Rev. at 839. Thus, the sort of power that CSX attributes to the Funds does not fit within the language “to direct the disposition” of the CSX shares.
CSX recognizes the need to establish a nexus between influencing a sale of the short party‘s hedge shares upon unwinding and the long party‘s control ambitions by arguing that, in the inducing of those sales, the Funds exercised investment power by “materially facilitat[ing] [the Funds‘] rapid and low-cost acquisition of a physical position upon the termination of the swaps.” Brief of Cross-Appellee at 43. Whether or not the alleged “material facilitation” would run afoul of the Reliance Electric test, see supra, or would provide a sufficient nexus to the term “investment power” to constitute “beneficial ownership,”
Cash-settled equity swaps allow the short party to retain its hedge shares or dispose of them at the highest price available. Thus, the long party‘s choices for acquiring actual shares in the referenced company are either to go into the open
Buying or selling by the short party may affect the availability and price of shares, but hardly constitutes the claimed “material facilitation.”10 If the market for the shares is liquid, as will often be the case, then rapid acquisition of those shares would be possible regardless of the sale of shares used to hedge swap positions. Thus, such a sale would have little practical effect on the long party‘s ability to acquire shares. If the market is highly illiquid, then potential short parties would find it very costly to acquire the shares and thus either would not acquire shares to hedge their short swаp positions or, more likely, would refuse to enter into such swap agreements.11
If the market‘s illiquidity is more moderate, then closing out swap agreements may provide a degree of confidence that a block of shares will go on the market. However, purchasing this confidence will be very expensive, because keeping individual short parties under Section 13(d)‘s 5 percent threshold may require using several short counterparties, who will be competing with each other for limited available shares and will pass the resulting increased hedging costs on to the prospec-
Moreover, cash-settled total-return equity swaps will not lower a long party‘s costs of acquisition. The basis for CSX‘s claim that these swaps allow long parties to acquire shares at a low price is unclear. It may be based on the belief that unwinding the swaps will momentarily increase the market supply of shares and thus lower those shares’ market price. However, if the swap unwinding is likely to lower the prices of the referenced shares, then the short party, who, as a seller, will suffer from that downward slippage in prices, will insist on passing those foreseeable extra hedging costs along to the long party in the form of higher “interest” payments, leaving long parties on the average in much the same (or worse) economic position as if they had simply bought the shares directly, without a detour through a cash-settled equity swap position. In other words, cash-settled total-return equity swaps, without more, are not a substitute for the ownership of shares by parties seeking to control a corporation. Control still requires the purchase of shares on the open market, as happened in the instant case, or from the short party at the open market price, thus causing the party seeking control to bear thе costs of both the swaps and the shares.
In the absence of some other agreement governing the disposition of shares purchased to hedge a swap position, merely having a long position in a cash-settled total-return equity swap does not constitute having the power, directly or indirectly, to direct the disposition of shares that a counterparty purchases to hedge its swap positions, and thus does not constitute having “investment power” for purposes of
B) Voting Power
The district court found no evidence of explicit agreements between TCI and the banks committing the banks to vote their shares in a specified way. CSX Corp., 562 F.Supp.2d at 543. Nevertheless, CSX argues that TCI‘s ability to select counterparties gave it “voting power,”
In fact, TCI eventually consolidated its swap holdings in Citibank and Deutsche Bank. TCI “hope[d] that Deutsche Bank would vote in [TCI‘s] favor” because a hedge fund internal to Deutsche Bank, Austin Friars, also had investments in CSX. Brief of Cross-Appellee at 45-56. CSX argues further that when TCI chose its other swap counterparties, it selected banks that it knew were “sympathetic to [its] voting objectives.” Id. at 46 n. 26. CSX concedes that some of these counterparties had policies that prohibited them from voting their shares but argues that the effective removal of these counterparties’ shares from the voting pool left TCI in a better position than if the votes of those shares had been left to chance. I disagree on both counts.
That a short party‘s self-interest predisposes it to vote in favor of positions taken by a prospective long counterparty is insufficient, on its own, to show a transfer of voting power to the long counterparty for purposes of Section 13(d) and
Purchases by a short party with a policy against voting shares held solely as a hedge will not increase the voting power of a long party‘s shares. Abstaining can have influence only with regard to shares that, if not purchased by a short party as a hedge, would have been voted against the wishes of the long party. Because the hypothetical voting intentions of persons from whom the abstaining short parties purchased their shares on the open market are unknown, this asserted influence over
The facts that the Funds “hoped” that Deutsche Bank would vote in the desired way, or that the Funds entered into cash-settled equity swap agreements with counterparties believed to be inclined to vote as the Funds desired, do not constitute the requisite power to direct the counterparties’ vote. See
Finally, I note that my conclusion parallels Congress‘s earlier decision to exclude security-based swaps in determining whether a party is a 10 percent beneficial owner, for purposes of Section 16, triggering its reporting and disgorgement provisions, while requiring 10 percent owners to report security-based swap holdings and to disgorge short-swing profits in trading them. See supra note 7.
2) Rule 13d-3(b)
While
Any person who, directly or indirectly, creates or uses a trust, proxy, power of attorney, pooling arrangement or any other contract, arrangement, or device with the purpose of [sic] effect of divesting such person of beneficial ownership of a security or preventing the vesting of such beneficial ownership as part of a plan or scheme to evade the reporting requirements of section 13(d) or (g) of the [1934] Act shall be deemed for purposes of such sections to be the beneficial owner of such security.
Evasion provisions are catch-all methods of closing unforeseen “loopholes” that seek to use form to evade substance or to comply with technicalities while violating the “spirit” or intent of regulatory provisions. As such, there are two important points to be made about them. First, evasion provisions do not expand the permissibly regulable area. Second, they are not subject to the canon of construction that a statutory or regulatory provision must be read to have effect and is not superfluous. New York State Restaurant Ass‘n v. New York City Bd. of Health, 556 F.3d 114, 130 n. 17 (2d Cir.2009) (quoting APWU v. Potter, 343 F.3d 619, 626 (2d Cir.2003)) (“A basic tenet of statutory construction, equally applicable to regulatory construction, is that a text should be construed so that effect is given to all its provisions, so that no part will be inoperative or superfluous, void or insignificant, and so that one section will not destroy another unless the provision is the result of obvious mistake or error.“) Evasion provisions may be superfluous in actual practice because there are no loopholes.
There is no contention that the Funds’ cash-settled total-return equity swap arrangements had the purpose or effect of “divesting,”
At one end of a spectrum of relevant conduct raising Section 13(d) issues, a party, or parties to a group, may decide to take steps toward the acquisition of a company. As noted above, they may plan to buy a significant block of shares well in excess of 5 percent. They may buy 4.9 percent of the company‘s shares but stop there solely to avoid disclosure. They may arrange financing14 and make preliminary
At the other end of the spectrum, a party or group contemplating acquisition of a company may provide funds to another party or parties to buy shares with the understanding that the buyer(s) will retain them in the buyer‘s name, to be conveyed to the would-be acquirer when so directed and without the nominal buyer(s) bearing any risk. Whether or not various aspects of such a transaction would be legally enforceable, such a sham would trigger the disclosure requirements of Section 13(d) if the shares held by the parties in the aggregate exceeded 5 percent. In this example, the understanding between the parties places the ostensible seller comfortably within the meaning of the term “beneficial owner,” because the buyer has obligated itself to retain the shares in order to reconvey them to the seller. (The underlying contract would also make the party behind the scheme part of a “group” with the buyer, as discussed infra.) In my view, the Funds’ cash-settled equity swap agreements with the banks fall closer to the first hypothetical on the spectrum for purposes of Section 13(d).
Again, for the Funds to be “deemed” a beneficial owner under
The district court found “overwhelming” evidence that the Funds entered into the swap agreements “at least in major part, for the purpose of preventing the vesting of beneficial ownership of CSX shares in TCI and as part of a plan or scheme to evade the reporting requirements of Section 13(d)....” CSX Corp., 562 F.Supp.2d at 548-49. The district court rested this conclusion upon the following evidence: (i) TCI‘s chief financial officer once said that a reason to use swaps is that they provide “the ability to purchase without disclosure“; (ii) TCI emails had discussed the need to limit the size of swap agreements with individual counterparties in order to avoid those counterparties’ having to disclose their holdings of shares purchased for hedging purposes;15 (iii) TCI acquired only 4.5 percent of CSX‘s shares—below Section 13(d)‘s 5 percent reporting threshold—until TCI was ready to disclose its position; and (iv) TCI admitted that one of its motivations for avoiding disclosure by its swap counterparties was a concern that disclosure would drive up the market price of CSX shares and thus increase TCI‘s
Conduct violating
This view of “evasion” under
The district court‘s rationale depended so heavily on the Funds’ intent to avoid disclosure that it found it unnecessary to decide whether cash-settled total-return equity swaps constituted the equivalence of beneficial ownership of shares absent a desire not to disclose. CSX Corp., 562 F.Supp.2d at 545-48. (The district court strongly implied that it did.) It simply held that such swaps prevented the vesting of beneficial ownership—a characteristic common to all non-purchasing acts—and was intended to avoid disclosure—an ever-present state of mind. Id. at 551-52. The intent to avoid disclosure cannot constitute a violation of the statute when the underlying transaction does not provide the party with the substantial equivalence of the rights of ownership relevant to control. That is clearly the meaning of Reliance Electric.
I am aware of no SEC guidance establishing the meaning of “evade” in
Similar analyses can also be seen in more recent Commission statements. For example, in a 1995 release concerning Regulation S, the Commission stated that the pertinent evasion provision would preclude an exemption under Regulation S where factors indicated that “the economic or investment risk never shifted to the offshore purchaser, and that the securities—as a matter of substance as opposed to form—never left the United States....” Problematic Practices Under Regulation S, Securities Act Release No. 7190, 60 Fed.Reg. 35,663, 35,664 (Jul. 10, 1995). In a 2002 adjudication, the Commission stated that “Regulation S shelters only bona fide overseas transactions; it is not a haven for any foreign stock distribution that is part of a plan to evade the registration provisions of the Securities Act.” In re Weeks, Initial Decision Release No. 199, 2002 WL 169185, at *34 (Feb. 4, 2002) (emphasis in original), aff‘d, In re Hesterman, Securities Act Release No. 8139, Exchange Act Release No. 46,703, 2002 WL 31374801 (Oct. 22, 2002). Similarly, in addressing the applicability of the evasion provision under
In sum, as pertinent to the instant matter, evasion provisions may apply where a transaction, while in technical compliance with a rule, still evades its underlying policies. For example, the SEC staff has stated that “it does not seem to us to be necessarily sinister to [avail oneself] of a valid registration exemption so long as the public policy ... as expressed in the Act is not frustrated.” Hamelly Indus., SEC No-Action Letter, 1976 WL 10536, at *3 (Nov. 29, 1976).
Evasion provisions must be read in light of the underlying statutory or regulatory provision. As explained above, there are many perfectly legal methods of intentionally avoiding disclosure under Section 13(d). Section 13(d) is designed to compel disclosure of holdings involving 5 percent beneficial ownership interests. It does not require disclosure of control ambitions absent such holdings. In that light, “evasion” suggests a transaction with the ownership characteristics and benefits intended to be regulated, or steps to create a false appearance of the transaction or the persons entering into it,16 to avoid compliance with the regulation‘s reporting requirements. See Letter from Brian V. Breheny, Deputy Dir., SEC Div. of Corp. Fin., as Amicus Curiae to Hon. Lewis A. Kaplan, U.S. Dist. Court for the S. Dist. of N.Y. (June 4, 2008), CSX Corp. v. The Children‘s Inv. Fund Mgmt, L.L.P., et al., Doc. No. 08-cv-2764, at 3.
If the transaction under scrutiny does not have substantially the characteristics or expected benefits that are intended to be regulated, then an evasion provision simply does not apply. Evasion of Section 13(d),
It is also critical to note that the swaps here were not sham transactions creating a false appearance while lacking economic substance. Long counterparties to such swaps have legitimate economic purposes. As the district court found with regard to TCI, the swaps would enable TCI to reap a leverage-amplified profit if CSX‘s management, faced with the Funds’ potential challenge, instituted new policies that increased the value of the company. CSX Corp., 562 F.Supp.2d at 522, 527. If that occurred, a successful insurgent proxy fight or other control transaction would have been precluded, but TCI would share in the increased value resulting from its efforts. Similarly, if competing bidders appeared with a higher price for the company, TCI would share in the increased share price.
Finally, my view does no substantial damage to underlying statutory policies; indeed, it effectuates them. As noted, swaps are not instruments that have escaped Congress‘s attention and are a poor candidate for being labeled an unforseen device used to evade congressional purpose.
To the contrary, at the time of the district court‘s decision, the 2000 Act not only exempted security-based swaps from the securities laws definition of a regulable “security” but also “prohibited” the SEC from regulating security-based swaps in the extraordinarily broad language quoted supra. See supra note 6. Congress‘s then perception of a lack of an equivalence between cash-settled total-return swaps and ownership of the underlying securities was further demonstrated by Section 16‘s exclusion of such swaps from the calculation of the 10 percent disgorgement trigger but inclusion in the calculation of profits from short-swing trades. That scheme recognizes that ownership rights do not attach to swaps and therefore such swaps cannot afford access to inside information. See supra note 7. Given that by statute swaps could not then be counted in calculating Section 16‘s disgorgement trigger for the long party, it was a bold step indeed for the district court to hold that shares purchased and owned by the short party as a hedge were to be counted as owned by the long party because swaps “evade” the statutory purpose.
The situation is not much different today. While the SEC now has authority to regulate security-based swaps, it has simply repromulgated
c) “Group” Formation
I turn now to the issue of group formation, which governs the determination of which of the many participants in the events described above may be subject to Section 13(d)‘s disclosure requirements.
Many of the concerns about the use of swaps to avoid Section 13(d)‘s disclosure
With respect to whether there was such an agreement or understanding between the Funds, the district court found that TCI and 3G formed a group with respect to CSX securities no later than February 13, 2007. CSX Corp., 562 F.Supp.2d at 555.18
As noted by my colleagues, the district court enumerated the circumstances, “including the existing relationship, the admitted exchanges of views and information regarding CSX, 3G‘s striking patterns of share purchases immediately following meetings with [TCI officials], and the parallel proxy fight preparations” that persuaded it to find that TCI and 3G had formed a group by February 13, 2007. Id. at 553-55.
The district court‘s finding as to the formation of a group between TCI and 3G in February 2007 cannot be upheld without adopting the district court‘s legal conclusions regarding swaps. It was necessarily based in part on the premise that TCI‘s purchase of swaps rendered TCI a beneficial owner of shares bought by the short parties as a hedge. It was that premise that led the court to conclude that TCI‘s goal in February 2007 was at that time to seek control of CSX through the use of swaps. Indeed, on February 13, 2007, TCI and 3G did not own in the aggregate 5% of CSX‘s actual shares.
The district court‘s finding of a group also suffers from a second error. That finding was that “the parties activities from at least as early as February 13, 2007, were products of concerted action.” Id. However,
The overwhelming evidence is that TCI, while understanding that a hostile proxy
There are only two pieces of evidence supporting the February 2007 finding. One is the fact of the relationship between TCI and 3G—a 3G affiliate was an investor in TCI. The other is that, on two occasions, 3G purchased shares after conversations with TCI. These are the only concrete acts relied upon by the district court that might reflect a February 2007 agreement requiring aggregation of TCI/3G shareholdings.
As to the ongoing relationship between TCI and 3G, it surely demonstrates an opportunity to form a “group,” but it also provides an explanation for frequent conversations that do not involve CSX. With regard to 3G‘s purchases of stock, there is no claim that TCI increased its shareholdings at the same time, that is, no evidence of “concerted action” in buying actual shares. In fact, there is no evidence whatsoever that 3G‘s and TCI‘s purchases of CSX stock were coordinated in February 2007. Indeed, the district court found that, at this time, TCI was informing other funds of TCI‘s interest in altering CSX‘s business plans in the hope of “steer[ing] CSX shares into the hands of like-minded associates.” CSX Corp., 562 F.Supp.2d at 553. There is no evidence that 3G‘s purchases at this time were more than the result of this sharing of information, which
The finding of a “group” owning 5% of CSX shares in February 2007 is clearly erroneous, and I concur in order to seek clarification on a remand.
CONCLUSION
I therefore concur in the result. I add a final word, a relief to any reader who got this far. The issue here is not fact specific. Total-return cash-settled swap agreements can be expected to cause some party to purchase the referenced shares as a hedge. No one questions that any understanding between long and short parties regarding the purchase, sale, retention, or voting of shares renders them a group—including the long party—deemed to be the beneficial owner of the referenced shares purchased as a hedge and any other shares held by the group. Whether, absent any such understanding, total-return cash-settled swaps render a long party the beneficial owner of referenced shares bought as a hedge by the immediate short party or some other party down the line is a question of law not fact. At the time of the district court opinion, the SEC had no authority to regulate such “understanding“-free swaps. It has such authority now, but it has simply repromulgated the earlier regulations. These regulations, and the SEC‘s repromulgation of them, offer no reasons for treating such swaps as rendering long parties subject to Sections 13 and 16 based on shares purchased by another party as a hedge. Absent some reasoned direction from the SEC, there is neither need nor reason for a court to do so.
UNITED STATES of America, Appellee,
v.
Matthew MARINO, Defendant-Appellant.
Docket No. 09-1965-cr.
United States Court of Appeals, Second Circuit.
Argued: May 10, 2010.
Decided: Aug. 18, 2011.
Notes
Defendants [are] The Children‘s Investment Fund Management (UK) LLP...[,] The Children‘s Investment Fund Management (Cayman) LTD[,].... [and] The Children‘s Investment Master Fund.... These entities are run by defendant Christopher Hohn.... Defendant Snehal Amin is a partner of [The Children‘s Investment Fund Management (UK) LLP]. These five defendants are referred to collectively as TCI.
Defendants [are] 3G Fund L.P....[,] 3G Capital Partners L.P..... [and] 3G Capital Partners Ltd..... They are run by defendant Alexandre Behring.... These four defendants are referred to collectively as 3G.
CSX Corp. v. Children‘s Investment Fund Management (UK) LLP, 562 F.Supp.2d 511, 518 (S.D.N.Y.2008) (”CSX I“). Information that must be disclosed underFor purposes of
sections 13(d) and13(g) of the Act a beneficial owner of a security includes any person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise has or shares:
- Voting power which includes the power to vote, or to direct the voting of, such security; and/or,
- Investment power which includes the power to dispose, or to direct the disposition of, such security.
Any person who, directly or indirectly, creates or uses a trust, proxy, power of attorney, pooling arrangement or any other contract, arrangement, or device with the purpose of [sic] effect of divesting such person of beneficial ownership of a security or preventing the vesting of such beneficial ownership as part of a plan or scheme to evade the reporting requirements of section 13(d) or (g) of the Act shall be deemed for purposes of such sections to be the beneficial owner of such security.
134 Cong. Rec. S8224-01 (June 20, 1988) (statement of Sen. Proxmire) (paragraph break omitted).During the ensuing 10 days, the company‘s shareholders are kept in the dark. The general investor knows nothing about this acquisition. Meanwhile, in that 10-day period, the acquirer knows, the arbitragers know, the people who are working with him know about the deal. They are the insiders. They can move swiftly; they can move invisibly. They may acquire working control of the corporation without the knowledge of the overwhelming majority of shareholders or the management. Icahn grabbed 20 percent of TWA before the 10-day window closed.
Senator Paul Sarbanes, a co-sponsor of Proxmire‘s bill, echoed this concern:
Id. (statement of Sen. Sarbanes).Under current law, any person who acquires more than 5 percent of a company‘s stock need not file a disclosure statement of having done that until 10 days after the acquisition that exceeds the 5-percent threshold. This has permitted stock acquisitions much greater than 5 percent during the 10-day window period before any disclosure is required.... As a result, by the time the first disclosure is made, a person may have accumulated a very significant interest in excess of 5 percent in the company.
In fact, in some instances, they may even have secured a controlling interest in the company, particularly if you define “controlling” as being a much smaller figure than a majority interest, since a person holding a very large interest, with everyone else holding a very small interest, is perceived as controlling, even though they are short of majority control.
Senator Paul Simon unsuccessfully introduced a bill that would have been even more restrictive than Proxmire‘s, proposing that disclosure be required after only two days, and lowering the ownership threshold from 5 percent to 2 percent. See Richard Greenfield, Merger Mania: Don‘t Blame “Raiders” for Systemwide Abuses, Legal Times, Apr. 4, 1988, at 16.
§ 78c-1. Swap Agreements
(a) Non-security-based swap agreement
The definition of “security” in
section 78c(a)(10) of this title does not include any non-security-based swap agreement (as defined insection 206C of the Gramm-Leach-Bliley Act ).(b) Security-based swap agreements
(1) The definition of “security” in
section 78c(a)(10) of this title does not include any security-based swap agreement (as defined insection 206B of the Gramm-Leach-Bliley Act ).(2) The Commission is prohibited from registering, or requiring, recommending, or suggesting, the registration under this chapter of any security-based swap agreement (as defined in
section 206B of the Gramm-Leach-Bliley Act ). If the Commission becomes aware that a registrant has filed a registration application with respect to such a swap agreement, the Commission shall promptly so notify the registrant. Any such registration with respect to such a swap agreement shall be void and of no force or effect.(3) Except as provided in
section 78p(a) of this title with respect to reporting requirements, the Commission is prohibited from—
- promulgating, interpreting, or enforcing rules; or
- issuing orders of general applicability; under this chapter in a manner that imposes or specifies reporting or recordkeeping requirements, procedures, or standards as prophylactic measures against fraud, manipulation, or insider trading with respect to any security-based swap agreement (as defined in
section 206B of the Gramm-Leach-Bliley Act ).(4) References in this chapter to the “purchase” or “sale” of a security-based swap agreement (as defined in
section 206B of the Gramm-Leach-Bliley Act ) shall be deemed to mean the execution, termination (prior to its scheduled maturity date), assignment, exchange, or similar transfer or conveyance of, or extinguishing of rights or obligations under, a security-based swap agreement, as the context may require.
Consider, for example, the swap transactions at issue in the 2006 failed buyout offer of Sears Canada by Sears Holding. See In re Sears Canada Inc., et al., 2006 CarswellOnt 6994 (Ont.Secs. Comm. Aug. 8, 2006), aff‘d In re Sears Canada, et al., 2006 CarswellOnt 6272 (Ont.Div. Ct. Oct. 11, 2006). Prior to the buyout announcement, hedge fund Pershing Square, L.P. (“Pershing“) held an equity position of 5.3 million shares in Sears Canada. Id. ¶ 22. To avoid unfavorable tax consequences relating to a dividend payment by Sears Canada, Pershing, still prior to the buyout announcement, converted its Sears Canada holdings to a derivative position by selling all its shares in connection with entering cash-settled equity swap agreements with SunTrust Capital Markets, Inc. (“SunTrust“). Id. ¶ 22. To hedge its swap agreement with Pershing, SunTrust entered its own swap arrangements with Bank of Nova Scotia (“BNS“) and Scotia Capital Markets Group, a BNS subsidiary. Id. ¶¶ 20, 103, 159. In the process, SunTrust arranged the sale of Pershing‘s Sears Canada shares to BNS. Id. ¶¶ 20, 103. For its part, BNS hedged its swap position with SunTrust by purchasing shares of Sears Canada stock and entering additional offsetting swap agreements. Id. ¶¶ 159, 221. At the time it entered into its swap agreement with SunTrust, Pershing had no knowledge of which party ultimately purchased its Sears Canada shares, nor did BNS, the purchaser of Pershing‘s Sears Canada shares, know who had sold them. Id. ¶¶ 159, 103. Ultimately, BNS‘s interest in its Sears Canada shares was in direct opposition to the interests of Pershing, as evidenced by BNS voting its shares in favor of the buyout offer while Pershing opposed the offer as inadequate. Id. ¶ 152. Nevertheless, one can argue that Pershing, by entering its swap agreement with SunTrust, “influence[d]” the purchase of Sears Canada shares by BNS.
Evasion provisions remain prevalent in the SEC‘s current rules and regulations. Regulation D, which, among other things, replaced Rules 146, 240 and 242, see Revision of Certain Exemptions from Registration, Securities Act Release No. 6389, 47 Fed.Reg. 11,251-01 (Mar. 16, 1982), includes an evasion provision stating that “regulation D is not available to any issuer for any transaction or chain of transactions that, although in technical compliance with these rules, is part of a plan or scheme to evade the registration provisions of the Act.”
(1) any put, call, straddle, option, or privilege on any security, certificate of deposit, or group or index of securities, including any interest therein or based on the value thereof;...(3) any agreement, contract, or transaction providing for the purchase or sale of one or more securities on a fixed basis;
(4) any agreement, contract, or transaction providing for the purchase or sale of one or more securities on a contingent basis, unless such agreement, contract, or transaction predicates such purchase or sale on the occurrence of a bona fide contingency that might reasonably be expected to affect or be affected by the creditworthiness of a party other than a party to the agreement, contract, or transaction ....
However, with this one exception, there is no evidence that the Funds had any understanding with any of the banks regarding the purchase of CSX shares, the sale of such shares to the Funds when the swaps were unwound, or the voting of such shares.