SEC staff advises court on views of beneficial ownership for 13D

By Cydney Posner

An article from the NYT today is reporting on the outcome (for now anyway) of CSX Corp v. The Children's Inv. Fund Mgmt, LLP. The article reports that, yesterday, the court found that the funds "used the swaps in a way that consciously allowed them to build a position while delaying such disclosure to the broader stock market. The swaps hung 'like the sword of Damocles over the neck of CSX.' Viewing those swaps as anything but regular shares owned outright, 'failed to take account of the practical realities of the world,' and would 'be open to the gravest abuse.' " Nevertheless, the court allowed the hedge funds to vote their shares, notwithstanding their failure to provide adequate timely disclosure under Section 13(d). According to the article, the court indicated that it would have enjoined the vote had it not felt bound by precedent. However, the court did bar the funds from future violations of the securities laws, but said no new disclosures were required because all relevant facts were now public: "Any penalties for defendants’ violations must come by way of the Securities and Exchange Commission or the Department of Justice…." The SEC staff's view was that equity swaps did not confer beneficial ownership of shares held by the swap counterparties merely because of economic incentives (i.e., that the counterparties would risk losing business from the hedge funds) to vote as the funds would prefer, in the absence of an actual arrangement or understanding. The article reports that Prof. Joseph Grundfest and others argued that a victory by the hedge funds "would render compliance" with the disclosure requirements "essentially voluntary." The article reports that the court found "persuasive reasons" for its view that the funds did have beneficial ownership of the shares owned by the counterparties, but rested its decision primarily on Rule 13d-3(b), which provides that anyone who enters into "an arrangement that prevents the vesting of beneficial ownership as part of a plan or scheme to avoid" disclosing a position, is deemed to be a beneficial owner. Of course, the SEC staff's position was that acquiring equity swaps with the motive of avoiding reporting and disclosure generally is not a violation of Section 13(d) unless the steps create a false appearance. The court also found that the funds had formed a 13(d) "group" well before they acknowledged doing so. According to the article, the court said their "protestations to the contrary" were largely based on their claim that they started every meeting by saying there was not a group. Interestingly, the article reports that the court viewed its decision as largely agreeing with the SEC staff position, which is a bit surprising given that the staff supported the position of the hedge funds in this case.