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")
The District Court held that the Funds had violated section 13(d) and granted a permanent injunction against further such violations with respect to shares of any company. See CSX Corp. v. Children's Investment Fund Management (UK) LLP, 562 F.Supp.2d 511, 552, 554-55, 573-74 (S.D.N.Y.2008) ("CSX I"). However, the Court declined to enjoin the Funds from voting their CSX shares. See id. at 568-72. CSX appealed the denial of the voting injunction; the Funds cross-appealed
The parties have endeavored to frame issues that would require decision as to the circumstances under which parties to cash-settled total-return equity swap agreements must comply with the disclosure provisions of section 13(d). Such issues would turn on the circumstances under which the long party to such swap agreements may have or be deemed to have beneficial ownership of shares purchased by the short party as a hedge.
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 section 13(d)(3) with respect to CSX shares owned outright by the Defendants (without regard to whatever beneficial ownership, if any, they might have acquired as long parties to cash-settled total-return equity swap agreements). Because we lack sufficient findings to permit appellate review of such issues, we remand for further findings.
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-equity
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 understood 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.
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.
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, Pub.L. No. 90-439, 82 Stat. 454 (1968) (codified as amended at 15 U.S.C. §§ 78m(d)-(g), 78n(d),(f) (1988)), and various rules and regulations promulgated thereunder. The Williams Act added section 13(d) to the Securities Exchange Act of 1934 to require that, among other things, various disclosures be filed with the Securities and Exchange Commission ("SEC") when a "person" has acquired "beneficial ownership" of more than 5 percent of an exchange-traded class of a company's shares. 15 U.S.C. § 78m(d)(1). Included in the statute's definition of a "person" is a "group [acting] for the purpose of acquiring, holding, or disposing of securities of an issuer." 15 U.S.C. § 78m(d)(3).
The District Court held that, for purposes of section 13(d), TCI was deemed a beneficial owner of all CSX shares held by banks as hedges against TCI's CSX-referenced swaps, and thus that TCI violated section 13(d) by failing to make timely filings once TCI's combined holdings of CSX shares and CSX-referenced swaps crossed the 5 percent ownership threshold. See CSX Corp. I, 562 F.Supp.2d at 552. In making this ruling, the District Court considered whether TCI had beneficial ownership of the hedged shares pursuant to both SEC Rule 13d-3(a), which defines a beneficial owner,
The District Court also found that TCI and 3G violated section 13(d) by failing to make timely disclosure of having formed a "group" "with respect to CSX securities... no later than February 13, 2007." Id. at 555.
The Court granted CSX a permanent injunction against TCI and 3G, prohibiting any further violations of section 13(d), whether or not involving CSX shares. Id. at 573-74. The Court concluded that it was foreclosed as a matter of law from granting an injunction prohibiting the Funds from voting the 6.4 percent of CSX shares that they had acquired after forming a group. Id. at 568-72. CSX appealed this denial of an injunction against voting the disputed shares. The Funds cross-appealed the District Court's finding that the Funds had violated section 13(d) and the grant of a permanent injunction against any future violations of section 13(d). On September 15, 2008, we entered an order affirming on CSX's appeal, but deferred until now our discussion of the reasons for that order. See CSX II, 292 Fed.Appx. at 133-34.
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 section 13(d), the beneficial owner of shares purchased by the short party as a hedge. In view of that disagreement, we conclude that it is appropriate at this time to limit our consideration to the issue of group formation, see 15 U.S.C. § 78m(d)(3), an issue as to which we seek further findings from the District Court. All members of the panel are in agreement as to this disposition.
Section 13(d) provides in pertinent part:
15 U.S.C. § 78m(d)(1), (3).
SEC Rule 13d-5(b)(1) provides that the section 13(d) disclosure requirements apply to the aggregate holdings of any "group" formed "for the purpose of acquiring, holding, voting or disposing" of equity securities of an issuer. 17 C.F.R. § 240.13d-5(b)(1). This Rule tracks Section 13(d)(3) in all respects except that the Rule adds voting as a group for the purpose of triggering the disclosure provisions. Compare id. with 15 U.S.C. § 78m(d)(3). "`[T]he touchstone of a group within the meaning of section 13(d) is that the members combined in furtherance of a common objective.'" Roth v. Jennings, 489 F.3d 499, 508 (2d Cir.2007) (quoting Wellman v. Dickinson, 682 F.2d 355, 363 (2d Cir.1982)).
There are 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 15 U.S.C. § 78m(d)(3); 17 C.F.R. § 240.13d-5(b)(1). The District Court recognized that whether a group exists under section 13(d)(3) "turns on `whether there is sufficient direct or circumstantial evidence to support the inference of a formal or informal understanding between [members] for the purpose of acquiring, holding, or disposing of securities.'" CSX I, 562 F.Supp.2d at 552 (quoting Hallwood Realty Partners, L.P. v. Gotham Partners, L.P., 286 F.3d 613, 617 (2d Cir.2002)) (emphasis added).
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 section 13(d)(3) unless they "act as a ... group for the purpose of acquiring ... securities of an issuer." 15 U.S.C. § 78m(d)(3).
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 section 13(d) disclosure within ten days, i.e., by April 20, 2007, see 15 U.S.C. § 78m(d); 17 C.F.R. § 240.13d-1. Thus, on remand the District Court will have to make findings as to whether the Defendants formed a group for the purpose of "acquiring, holding, voting or disposing," 17 C.F.R. § 240.13d-5(b)(1), of CSX shares owned outright, and, if so, a date by which at the latest such a group was formed. Only if such a group's outright ownership of CSX shares exceeded the 5 percent threshold prior to the filing of a section 13(d) disclosure can a group violation of section 13(d) be found.
Because on remand, the District Court might find a section 13(d) group violation with respect to a group acquisition of CSX shares outright and the Defendants, on the cross-appeal, have disputed the propriety of an injunction, even on the basis of the violations as found by the District Court, we will briefly consider some of the considerations relevant to injunctive relief.
It is settled in this Circuit that an issuer has an implied right of action to seek injunctive relief for a violation of section 13(d), see GAF Corp. v. Milstein, 453 F.2d 709, 720 (2d Cir.1971), but must satisfy traditional equitable requirements for an injunction, see Rondeau v. Mosinee Paper Corp., 422 U.S. 49, 57, 95 S.Ct. 2069, 45 L.Ed.2d 12 (1975). We have recognized that a prohibition on future securities law violations has "grave consequences" because it subjects a defendant to contempt sanctions and also has "serious collateral effects." S.E.C. v. Unifund SAL, 910 F.2d 1028, 1040 (2d Cir.1990). The usual basis for prospective injunctive relief is not only irreparable harm, which is required for all
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 section 13(d), the District Court issued a broad permanent injunction against future violations, an injunction not limited to CSX shares:
The District Court predicated this broad injunction on the basis of a section 13(d) violation that took into account not only the shares of CSX that the Funds owned outright but also the much larger quantity of shares purchased as hedges by the short parties to CSX-referenced swaps. Because this opinion considers only the more limited issue of whether the Funds, as a group, committed a violation of section 13(d) with respect to shares that they owned outright, if the District Court on remand finds the existence of a group formed to acquire CSX shares outright during the relevant period, it will have to reconsider the appropriateness of an injunction, and, if one is to be issued, what should be its appropriate scope.
If a section 13(d) violation is found, limited to a group violation with respect to purchase of the shares outright (which is the only violation considered in this opinion), the threat of future violations would be less substantial than appeared to the District Court, which based its broad injunction (i.e., not limited to CSX shares) on its view that the Funds were deemed to be beneficial owners of the hedged shares purchased by the short parties to the swap agreements.
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, Pub.L. No. 94-435, 90 Stat. 1383 (1976), of its intention to acquire more than $500 million of CSX stock and that TCI "currently holds a significant economic position through common stock ownership and derivative contracts tied to the value of CSX stock." CSX I, 562 F.Supp.2d at 527 (internal quotation marks omitted). Thus, TCI's control ambitions were known to the public before it was required to file under section 13(d), at least with respect to the group's outright ownership of shares as of April 10, 2007. We recognize that a Hart-Scott-Rodino filing does not reveal all of the information required by a section 13(d) disclosure. Nevertheless, the filing has a bearing on the scope of relief warranted for the limited section 13(d) violation we have considered in this opinion.
On the other hand, if a section 13(d) violation, even a limited one, is found on the basis of a group purchase of shares outright and non-disclosure when the group's holdings crossed the 5 percent
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 section 13(d) disclosure, and (b) if a group violation of section 13(d) is found, reconsider the appropriateness and scope of injunctive relief based only on the group's failure to disclose outright ownership of more than 5 percent of CSX's 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 section 13(d) disclosure obligations might have begun and the date on which they actually made those disclosures. See CSX I, 562 F.Supp.2d at 568-72. CSX argues that the Court should have enjoined the voting of those shares on three grounds: (I) courts generally have broad powers to grant injunctive relief; (ii) a "sterilization" injunction was necessary to promote the ends of the Williams Act both by leveling the playing field in the contest for corporate control in order to partially restore the integrity of the shareholder franchise and by deterring future violations of the Act's disclosure provisions; and (iii) courts have "inherent authority" to sanction litigation misconduct.
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 § 13(d) only on a showing of irreparable harm to the interests which that section seeks to protect." 638 F.2d at 380. We also said that "[t]he goal of § 13(d) is to alert the marketplace to every large, rapid aggregation or accumulation of securities... which might represent a potential shift in corporate control." Id. (internal quotation marks omitted) (second alteration in original); see also Rondeau, 422 U.S. at 58, 95 S.Ct. 2069 ("The purpose of the Williams Act is to insure that public shareholders who are confronted by a cash tender offer for their stock will not be required to respond without adequate information regarding the qualifications and intentions of the offering party."). Thus, the interests that section 13(d) protects "are fully satisfied when the shareholders receive the information required to be filed." Treadway, 638 F.2d at 380; see also United States v. O'Hagan, 521 U.S. 642, 668, 117 S.Ct. 2199, 138 L.Ed.2d 724 (1997) ("Congress designed the Williams Act to make disclosure, rather than court imposed principles of `fairness' or `artificiality,'... the preferred method of market regulation.") (internal quotation marks and citation omitted) (alteration in original). Consequently, in Treadway, we held that because shareholders had received the required information four months before the proxy contest in that case, "there was no risk of irreparable injury and no basis for injunctive relief." 638 F.2d at 380. In the present matter, the Funds' section 13(d) disclosures occurred in December 2007, approximately six months before the June 25, 2008, shareholders' meeting. Therefore, following Treadway,
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 § 14(e) violations is a meaningful goal, except possibly with respect to the most flagrant sort of violations which no reasonable person could consider lawful." Piper v. Chris-Craft Indus., Inc., 430 U.S. 1, 40 n. 26, 97 S.Ct. 926, 51 L.Ed.2d 124 (1977). Far from supporting CSX's claim, this remark mentions none of the goals of the Williams Act, concerns section 14(e) rather than section 13(d), and actually casts doubt upon the usefulness of determining remedies with an eye toward promoting compliance.
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 section 13(d) provides a general policy-based reason for prohibiting the Funds from voting the disputed shares. Refusing to "sterilize" the voted shares would, CSX argues, leave the Williams Act toothless. However, a statutory provision is not necessarily rendered toothless for lack of a particular sanction. We also note that the proposed sanction might have injured those shareholders who, fully informed, chose to vote with the insurgents.
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, 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. 503 U.S. at 72, 112 S.Ct. 1028. 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 section 13(d), an injunction prohibiting the voting of shares is inappropriate when the required disclosures were made in sufficient time for shareholders to cast informed votes. See Treadway, 638 F.2d at 380. Whether timely or not, the stated purpose of disclosure — allowing informed action by shareholders, see supra note 5 — was fulfilled.
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 Section 13(d) — no doubt true — and therefore violated Rule 13d-3. The legal conclusion, however, was also flawed, leaving unmentioned, inter alia, explicit legislation regarding swaps and Supreme Court decisions discussing statutory triggers involving "beneficial ownership" of a firm's stock. That legislation and those decisions, as they stood at the time, foreclosed the conclusion reached by the district court. Finally, the recent Dodd-Frank bill and SEC response thereto make it clear that the district court's analysis is not consistent with present law. Dodd-Frank Wall Street Reform Protection Act, Pub.L. No. 111-203, 124 Stat. 1376 (2010); Beneficial Ownership Reporting Requirements and Security Based Swaps, S.E.C. Release No. 64,087, 17 C.F.R. Part 240, 2011 WL 933460, at *2 (June 8, 2011).
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 Section 13(d). However, an agreement or understanding between the long and short parties to such a swap regarding the short party's purchasing of such shares as a hedge, the short party's selling of those shares to the long party upon the unwinding of the swap agreements, or the voting of such shares by the short parties renders the long party a
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.
Examination of the statutory scheme is particularly important in this matter, for two reasons. First, critical language used in Section 13(d) is used elsewhere in the 1934 Act, and some harmonization of interpretation is desirable, if not necessary. Second, in 2000 and 2010, Congress amended the 1934 Act with particular reference to security-based swaps in ways relevant to this case.
To reiterate, Section 13(d) requires disclosure of a variety of information
Some measure of certainty should be accorded to persons subject to Section 13(d)'s disclosure requirements. Investors benefit little from case by case, prolonged, expensive and repetitive litigation that weighs amorphous standards and circumstantial evidence regarding state of mind with disparate outcomes, particularly when the underlying information quickly loses its relevance because of ever-changing commercial environments. Even where a disclosure requirement seems less than fully comprehensive, knowledge of what need be disclosed and what need not at least leaves the market with some certainty as to the unknown.
In the present case, much certainty can be provided simply by following the language of Section 13(d). The language does not impose a general disclosure requirement that is triggered by an intent to obtain control or an equity position of influence within a particular company. Nor does it purport to require, as suggested by the district court, disclosure of all steps that might be part of a control transaction in the eyes of a court.
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 owner[s]
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 Section 13(d). Subsequent to court decisions that both rejected the SEC's views and read Section 16 in a mechanical way, see Reliance Elec. Co. v. Emerson Elec. Co., 404 U.S. 418, 92 S.Ct. 596, 30 L.Ed.2d 575 (1972), the SEC, in promulgating Rules 13d-3(a) and (b) stated that Section 13(d) and Section 16 had different purposes and the new rules were "not intended to affect interpretations of Section 16." Adoption of Beneficial Ownership Disclosure Requirements, Securities Act Release No. 5808, Exchange Act Release No. 13,291, 42 Fed.Reg. 12,342, 12,342-43 (Mar. 3, 1977).
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 Section 13(d). See Ownership Reports and Trading by Officers, Directors and Principal Security Holders, Exchange Act Release No. 28,869, Investment Company Act Release No. 17,991, 56 Fed.Reg. 7242, 7244-45 (Feb. 21, 1991). By SEC rule, a "beneficial owner" under Section 16 was defined as "any person who is deemed a beneficial owner pursuant to section 13(d) of the [1934] Act."
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 Section 13(d) is to be interpreted as giving decisive weight to a would-be acquirer's intentions toward a target, as the district court did, or whether a more mechanical, conduct-based interpretation is appropriate. Although modern financial transactions have generated some close cases — e.g., Kern County Land Co. v. Occidental Petroleum Co., 411 U.S. 582, 93 S.Ct. 1736, 36 L.Ed.2d 503 (1973) — the application of Section 16 is largely mechanical, that is, independent of the purposes or state of mind of parties to a transaction. See, e.g., Magma Power Co. v. Dow Chem. Co., 136 F.3d 316, 320-21 (2d Cir.1998) ("Section 16(b) operates mechanically, and makes no moral distinctions, penalizing technical violators of pure heart, and bypassing corrupt insiders who skirt the letter of the prohibition. Such is the price of easy administration.") (internal quotation marks omitted). For example, disgorgement has not been required for a stock purchase and sale made by a board member on the same day the member resigned, when the resignation became effective before the execution of the transactions. Lewis v. Bradley, 599 F.Supp. 327, 330 (S.D.N.Y.1984) ("Bradley's resignation was the first order of business; next, was the sale and delivery of the shares; and finally, the exercise of his option rights. That the sequence of events may have been deliberately designed is of no consequence."); see also B.T. Babbitt, Inc. v. Lachner, 332 F.2d 255, 258 (2d Cir.1964) ("Since the interval between the purchase and the sale exceeded six months — if only by one day — any profit which Lachner may have made on the transaction is not recoverable under § 16(b).").
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."
In so holding the Supreme Court stated:
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 Section 13(d). 15 U.S.C. § 78m(d)(1).
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. 404 U.S. at 422, 92 S.Ct. 596. Application of the language of Section 13(d) leads to an inevitable overbreadth — requiring disclosure where no control or influence is intended by a holder of 5 percent of shares.
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 like-minded 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; Commodity Futures Modernization Act of 2000, Pub.L. No. 106-554, app. E, sec. 301 & 303, § 206B (amendment to the Gramm-Leach-Bliley Act, Pub.L. No. 106-102 (1999)), & § 3A (amendment to the 1934 Act), 114 Stat. 2763, 2763A-449 to -453 (codified at 15 U.S.C. §§ 78c-1, 78c note). In 2010, as part of the Dodd-Frank bill, Congress included security-based swaps in the 1934 Act's definition of a
However, neither exemption from, nor inclusion in, the definition of security affects the outcome here because Section 13(d) applies to securities issued by a target firm and the swap instruments in question were not issued by CSX. Nor do the legislative definitions explicitly resolve the issue of whether the long party to a cash-settled total-return equity-based swap agreement is the "beneficial owner" of referenced securities purchased as a hedge by the short party. I turn to that issue infra.
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 Commodity Futures Modernization Act of 2000 §§ 301 & 303. In particular, that amendment prohibited the SEC from "promulgating, interpreting, or enforcing rules; [] or issuing orders of general applicability" 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 [cash-settled total-return equity swap.]"
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:
Dodd-Frank Wall Street Reform Protection Act § 766(e). However, the SEC has not exercised its new authority to promulgate rules that specifically reference swaps. Rather, it has repromulgated Rule 13(d)-3 on the ground that "[a]bsent rulemaking under Section 13(o), [the amendment to Section 13(o)] may be interpreted to render the beneficial ownership determinations made under Rule 13d-3 inapplicable to a person who purchases or sells a
Two matters of significance must be noted. First, if Rule 13d-3 did not apply to such swaps before the amendment, the district court was wrong in its legal analysis. Second, the repromulgated Rule makes no mention of security-based swaps and in the words of the amendment to Section 13(o) regulates them "only to the extent" that it applies as written.
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 party'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 obligations?
In the present context, there are two SEC rules that apply: Rules 13d-3(a) and 13d-3(b). See 17 C.F.R. §§ 240.13d-3(a), -3(b). These Rules were in effect at the time of the district court's decision and, as discussed supra, were repromulgated in 2011 pursuant to the Dodd-Frank amendment to Section 13.
1) Rule 13d-3(a)
17 C.F.R. § 240.13d-3(a).
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 Rule 13d-3(a), such swaps accord the long party investment or voting power over the hedge shares when the short party purchases referenced shares as a hedge.
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.
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.
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, for 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. 17 C.F.R. § 240.13d-3(a)(2).
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," 17 C.F.R. § 240.13d-3(a)(2), the "material facilitation" claimed here substantially overstates the effect of acquiring long positions in cash-settled equity swaps.
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."
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 prospective long party. Moreover, if the long party's purpose is to ensure the availability of shares when making its acquisition move, the ultimate effect of these swap stratagems may be only to reduce market illiquidity for a competing acquirer — perhaps an acquirer that is in league with the firm's management or even management itself — who, having avoided the costs of the swaps, will be better positioned to make its own bid.
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
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 Rule 13d-3(a). 17 C.F.R. § 240.13d-3 (a)(2).
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," 17 C.F.R. § 240.13d-3(a)(1), over the counterparties' hedge shares.
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 Rule 13d-3(a)(1). To hold otherwise would distort both the term "beneficial owner" and the word "power." A short party's self-interest is not an obligation to vote as the long party would desire. Nor is it a right in the long party to compel the short party to vote in a particular way.
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 17 C.F.R. § 240.13d-3(a)(1). Indeed, the facts indicate the opposite: when TCI realized that it needed to exercise control and decided to wage a proxy battle, it started unwinding its swaps and buying shares in order to vote the shares as it pleased, indicating that the Funds' swap positions did not give the power, directly or indirectly, to "direct the voting" of the counterparties' CSX shares. Id.
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.
While Rule 13d-3(a) sets forth the criteria for beneficial ownership of a security, Rule 13d-3(b) sets forth criteria for being "deemed" such a beneficial owner:
17 C.F.R. § 240.13d-3(b).
Rule 13d-3(b) is one of a large number of historical and contemporary rules and regulations, or preliminary notes to them, that seek to prohibit "plan[s] or scheme[s] to evade" statutory provisions or SEC rules and regulations.
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," 17 C.F.R. § 240.13d-3(b), TCI of beneficial ownership of the CSX shares that TCI's counterparties purchased. Therefore, the issue under Rule 13d-3(b) is whether those swap arrangements had the purpose or effect of "preventing the vesting," id., of beneficial ownership in the short parties' hedge shares.
Rule 13d-3(b) must be read in the context of both Section 13(d), which provides the underlying authority for the Rule's promulgation, and of Section 16, as discussed at length supra. As that discussion indicated, a person or group triggers obligations under Sections 13 and 16 by conduct.
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 financing
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 Rule 13d-3(b) there must be evidence both that their purpose in entering the CSX-referenced swap agreements was to "prevent" the vesting of beneficial ownership and that the intended prevention was part of a plan or scheme to "evade," 17 C.F.R. § 240.13d-3(b), the Section 13(d) disclosure requirements.
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;
Conduct violating Rule 13d-3(b) must also include a plan or scheme to "evade" the Section 13(d) reporting requirements. 17 C.F.R. § 240.13d-3(b). The district court concluded that TCI's purchases were part of such a plan or scheme to evade. CSX Corp., 562 F.Supp.2d at 549. It stated that "no one suggests that TCI did nothing more than enter into an equity swap," and that "[a]t a minimum, it entered into the [cash-settled total-return equity swap agreements] rather than buying stock for the purpose, perhaps among others, of avoiding the disclosure requirements of Section 13(d) by preventing the vesting of beneficial ownership in TCI." Id. at 550 (internal quotation marks omitted).
This view of "evasion" under Rule 13d-3(b) is extraordinarily expansive. To be sure, TCI wanted to avoid disclosure and constrained its trading activities accordingly. In fact, the intent to avoid disclosure under Section 13(d) is ubiquitous. Quite apart from wanting to conceal acquisition tactics, a desire to avoid the expense of disclosure is inevitable. But "preventing" the vesting of beneficial ownership in shares must mean more than what the district court described. At a minimum, the transaction must include a component that provides a substantial equivalence of the rights of ownership relevant to control, or include steps that stop short of, or conceal, the vesting of ownership, while nevertheless ensuring that such ownership will vest at the signal of the would-be owner. Conduct lacking such a component or steps does not violate the statute even when fully intended to avoid disclosure. Reliance Elec., 404 U.S. at 422, 92 S.Ct. 596 ("Liability cannot be imposed simply because the investor structured his transaction with the intent of avoiding liability under § 16(b).").
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 everpresent 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 Rule 13-3(b), nor has our caselaw addressed the issue. In applying evasion provisions, the Commission appears to borrow doctrine from the tax evasion context, in particular, the business purpose and substance over form doctrines. See generally Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266, 79 L.Ed. 596 (1935) (holding that when the form of a transaction does not comport with its substance, the substance of the transaction controls for tax liability purposes). For example, in what is perhaps its earliest interpretive guidance, the Commission suggested that a transaction would be interpreted as an attempt to evade registration requirements under the Act if it was not deemed "bona fide," even if it "might comply with the literal conditions of [the Act]." Letters of General Counsel Discussing Application of Section 3(a)(9), Securities Act Release No. 646, 1936 WL
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 Rule 144A, the Commission stated that the provision applies when "the substance of a transaction is contrary to the Rule even though the transaction is structured so as to comply with the Rule's technical requirements, such as when the transaction is a sham designed to create the illusion that it should be exempt." Letter from Jacob H. Stillman, Solicitor, Office of the Gen. Counsel of the SEC, to Hon. Karon O. Bowdre, U.S. Dist. Court for the N. Dist. of Ala. (Nov. 28, 2006), In re Healthsouth Sec. Litig., No. CV-03-BE-1500-S (N.D.Ala.), at 8.
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,
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), 15 U.S.C. § 78m(d), is not present in
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 Rule 13d-3. For the reasons stated, this hardly justifies a court treating cash-settled total-return swaps as an evasion of Section 13(d).
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.
Rule 13d-5(b)(1) provides that the Section 13(d) disclosure requirements apply to the aggregate holdings of any "group" formed "for the purpose of acquiring, holding, voting or disposing" of those securities. 17 C.F.R. § 240.13d-5(b)(1).
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.
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, Rule 13d-5(b)(1) applies only to groups formed "for the purpose of acquiring, holding, voting or disposing" of "securities" of the target firm. The Rule does not encompass all "concerted action" with an aim to change a target firm's policies even while retaining an option to wage a proxy fight or engage in some other control transaction at a later time. Indeed, the Rule does not encompass "concerted action" with a change of control aim that does not involve one or more of the specified acts.
The overwhelming evidence is that TCI, while understanding that a hostile proxy fight might ultimately be necessary, first sought to change CSX's policies without a control change and to profit through swaps. In fact, TCI was negotiating with CSX management at the end of March, and the strongest evidence relied upon by the district court in support of the TCI-3G group finding was the "parallel proxy fight preparations," which occurred in "late September-October 2007." CSX Corp., 562 F.Supp.2d at 553-54. The finding of a group formation in February 2007 is, therefore, flawed.
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.
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.
CSX Corp. v. Children's Investment Fund Management (UK) LLP, 562 F.Supp.2d 511, 518 (S.D.N.Y.2008) ("CSX I").
17 C.F.R. § 240.13d-3(a).
17 C.F.R. 240.13d-3(b).
134 Cong. Rec. S8224-01 (June 20, 1988) (statement of Sen. Proxmire) (paragraph break omitted).
Senator Paul Sarbanes, a co-sponsor of Proxmire's bill, echoed this concern:
Id. (statement of Sen. Sarbanes).
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.
15 U.S.C. § 78c-1 (as codified).
The Funds argue that Section 3A(b)(2), 15 U.S.C. § 78c-1(b)(2), prohibits the SEC from treating long parties as "beneficial owners" of shares purchased as hedges by short parties. Given the 2010 amendments discussed in the next paragraph of the text, it is a moot question whether the SEC Rules discussed infra would be beyond its powers if deemed at the time of the district court opinion to render long parties beneficial owners of shares purchased as a hedge by short parties.
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.
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. ¶¶ 59, 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. ¶ 52. 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." 17 C.F.R. §§ 230.501-.508 n. 6. A nearly identical evasion provision appears in each of current Rule 144, 17 C.F.R. § 230.144 n. 2 (exempting registration for sales of restricted or control securities), Rule 144A, 17 C.F.R. § 230.144A n. 3 (exempting registration for sales to Qualified Institutional Buyers), Rule 147, 17 C.F.R. § 230.147 n. 3 (exempting registration for intra-state issuances), Regulation S, 17 C.F.R. §§ 230.901-.904 n. 2 (exempting registration for offers and sales outside the United States), and Rule 701, 17 C.F.R. § 230.701 n. 5 (exempting from registration sales of securities pursuant to employment compensation plans).
Rule 10b5-1(c) provides an affirmative defense to insider trading charges for trades made pursuant to written plans for the sale of securities by corporate insiders who may have material nonpublic information. 17 C.F.R. § 240.10b5-1(c)(1)(i). However, the affirmative defense is available only when the plan to purchase or sell securities was "given or entered into in good faith and not as part of a plan or scheme to evade prohibitions of this section." 17 C.F.R. § 240.10b5-1(c)(1)(ii). Other rules with evasion provisions include Rule 10b-18, 17 C.F.R. § 240.10b-18 n. 1 (exempting certain issuer repurchases from market manipulation rules), Rule 167, 17 C.F.R. § 230.167 note (exempting certain communications in connection with asset backed securities from dissemination restrictions under Sections 5(c) and 2(a)(10)), and Rule 168, 17 C.F.R. § 230.168 n. 1 (exempting forward looking and factual business information from the dissemination restrictions under Sections 5(c) and 2(a)(10) of the Act).
15 U.S.C. § 78c note; see also Giovanni P. Prezioso, Broker-Dealer Regulation: The Commodity Futures Modernization Act of 2000 (American Law Institute — American Bar Association Continuing Legal Education, cosponsored by the Federal Bar Association, January 10-11, 2002). As I noted supra, the economic position of a party to a cash-settled equity swap is identical to the economic position of a party to an equity swap that is settled in kind. The latter, however, gives the long swap party an additional right, not shared by the rest of the market, to acquire directly from the short party the shares referenced by the equity swap. Such extra agreements concerning purchases and sales clearly bring in-kind-settled equity swap agreements under the Section 206A exclusion from Section 3A's prohibition on SEC regulation. Likewise, an agreement between the long and short swap parties about the voting of hedge shares is not itself properly characterized as a swap agreement, as Section 206A defines that term, and therefore Section 3A places no obstacle in the way of finding that such a voting agreement can create a "group" for purposes of Section 13(d).
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.
