The CSX Saga

I would be lying if I said I didn’t greatly enjoy the daytime dramas unfolding between CSX Corp. and the Children’s Investment Fund of Britain (not to mention 3G Capital Partners of Brazil, which has been slightly less in the spotlight in this guerrilla-like battle). I loved the bit with the clown Lou Dobbs, furiously flashing his American flag lapel jewelry, full of grave indignation over the “new threat to national sovereignty and security” (ahem, that would be anyone messing with railroad companies like CSX) and CSX bawling to the SEC (which, by most accounts, seems to have ignored it) and I especially loved TCI and 3G’s squirrelly gathering of CSX shares (which, according to a federal judge yesterday, totally violated securities laws). So, does that mean the funds will be kicked out of voting with their misbegotten shares? Ah, therein lies the rub.

A federal judge ruled Wednesday that two hedge funds seeking to win a proxy fight at the CSX Corporation had violated securities laws by not disclosing their positions and intentions many months before they did.

But Judge Lewis A. Kaplan of Federal District Court in Manhattan nonetheless ruled that there was nothing effective that he could do. He refused to bar the hedge funds from voting their shares, as CSX had requested, at the annual meeting on June 25.

“Some people deliberately go close to the line dividing legal from illegal if they see a sufficient opportunity for profit in doing so,” Judge Kaplan wrote in his 115-page decision.

“A few cross that line and, if caught, seek to justify their actions on the basis of formalistic legal arguments even when it is apparent that they have defeated the purpose of the law. This is such a case.”

The two hedge funds — the Children’s Investment Fund of Britain and 3G Capital Partners, a Brazilian fund — are backing a dissident slate of five directors at the CSX meeting. The funds own 8.7 percent of the company’s shares, and have positions in equity swaps — a form of derivative contract — that amount to another 12.3 percent of the shares.

Judge Kaplan all but invited CSX to appeal his decision to the United States Court of Appeals for the Second Circuit. The judge said he believed that he could not stop the funds from voting their shares, largely because of a Second Circuit precedent. If he could have done so, the judge said, he would have issued such an injunction.

The judge 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 ruling said.

That put the ball squarely in the S.E.C.’s court. Evidence in the case showed that CSX had been trying for months, without success, to persuade the commission to act. The only public role of the S.E.C. so far came when a staff member, responding to a request from the court, sent a legal interpretation that largely agreed with the position of the hedge funds.

The case drew attention far beyond the ranks of those who care whether the hedge funds can win the fight and gain board representation. While that would not give the funds control, it would give them a place inside the company to push for management changes.

The fight pitted the two best-known legal scholars in the area — professors who have written major papers jointly — against each other. A former member of the S.E.C., Joseph Grundfest, who is now a law professor at Stanford, argued that a victory by the hedge funds “would render compliance” with the disclosure requirements “essentially voluntary.” More to come, I'm sure.

long CSX calls