CSX Corp. v. Children's Investment Fund Management (UK) LLP

08-2899-cv
CSX Corp. v. The Children’s Inv. Fund Mgmt.

UNITED STATES COURT OF APPEALS

FOR THE SECOND CIRCUIT

August Term, 2008

(Argued: August 25, 2008 Decided: July 18, 2011)

Docket Nos. 08-2899-cv (L), 08-3016-cv (XAP)

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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.
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Before: NEWMAN, WINTER, and CALABRESI, Circuit Judges.
Appeal and cross-appeal from the June 11, 2008, judgment of the

United States District Court for the Southern District of New York
(Lewis A. Kaplan, District Judge), finding the Defendants in violation

of section 13(d) of the Williams Act, 15 U.S.C. § 78m(d), and

permanently enjoining them from future violations. See CSX Corp. v.

Children’s Investment Fund Management (UK) LLP, 562 F. Supp. 2d 511

(S.D.N.Y. 2008). The District Court deemed the Defendants to be the

beneficial owners of shares of CSX Corp. purchased by short parties to

cash-settled total-return equity swap agreements entered into by the

Defendants as long parties. The District Court also found that the

Defendants formed a “group” within the meaning of section 13(d)(3).
See 15 U.S.C. § 78m(d)(3). At this stage of the appeal, we consider

only whether a section 13(d) violation occurred with respect to CSX

shares owned outright by the Defendants acting as a group . Because

the District Court did not make findings sufficient to permit

appellate review of a group violation of section 13(d) with respect to

outright ownership of CSX shares, we remand for further consideration.

An earlier order affirmed the denial of an injunction against the

voting of shares acquired by the Defendants while they were not in

compliance with section 13(d). We explain that ruling on the ground

that injunctive “sterilization” of shares is not available when

shareholders had adequate time to consider the belated Williams Act

disclosures before the relevant shareholders’ vote.

Affirmed in part, vacated in part, and remanded in part. Judge

Winter concurs in the judgment with a separate opinion.

RORY O. MILLSON (Francis P. Barron &
David R. Marriott, on the brief),
Cravath, Swaine & Moore LLP, New York,
New York, for Plaintiff-Appellant-Cross-
Appellee.

CHRISTOPHER LANDAU, P.C. (Patrick F.
Philbin & Theodore W. Ullyot, Kirkland &
Ellis LLP, Washington, D.C.; Peter D.
Doyle & Andrew M. Genser, Kirkland &
Ellis LLP, New York, New York; Howard O.
Godnick & Michael E. Swartz, Schulte Roth
& Zabel LLP, New York, New York, on the
brief), Kirkland & Ellis LLP, Washington,
D.C., for Defendants-Appellees-Cross-
Appellants.

Adam H. Offenhartz, Aric H. Wu & J. Ross
Wallin, Gibson, Dunn & Crutcher LLP, New
York, New York, for Amicus Curiae
Coalition of Private Investment
Companies.

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 Richard M. Lorenzo, James G. Szymanski &
M. Alexander Bowie II, Day Pitney LLP,
New York, New York, for Amici Curiae
Former SEC Commissioners and Officials
and Professors.

Katherine Tew Darras & Rosario Chiarenza,
International Swaps and Derivatives
Association, Inc., New York, New York;
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,
New York & 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, New York, 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-

1
The District Court described TCI and 3G as follows:

Defendants [are] The Children’s Investment Fund
Management (UK) LLP . . .[,] The Children’s Investment Fund

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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 section 13(d) of the Williams Act, 15 U.S.C. § 78m(d), CSX brought

the present action. It sought injunctions barring the Funds from any

future violations of section 13(d) and preventing the Funds from

voting CSX shares at the 2008 CSX annual shareholders’ meeting.

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 granting of the permanent injunction. On September 15, 2008, we

affirmed the District Court’s denial of the voting injunction. CSX

Corp. v. Children’s Investment Fund Management (UK) LLP, 292 F. App’x

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, 562 F. Supp. 2d

511, 518 (S.D.N.Y. 2008) (“CSX I”).

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133, 133-34 (2d Cir. 2008) (“CSX II”). In this opinion, we consider

some of the issues raised by the Funds’ cross-appeal and explain the

reasons for our earlier order in CSX’s appeal.

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.

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

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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

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from that sale. However, because of the inherent risks in short-

equity positions -– share value can be more volatile than interest

rates -- persons holding short positions in total-return equity swaps

will usually choose to purchase equivalent numbers of shares to hedge

their short exposure.

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

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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

There is evidence that at least one bank occasionally bought less
2

than the full number of CSX shares referenced in the swaps to which it
was the counterparty. CSX I, 562 F. Supp. 2d at 580 (App. 1, Image 9,
Morgan Stanley Holdings of CSX Swaps with TCI and CSX Share Hedges,
Nov. 9, 2006, to Jan. 24, 2008).

3G’s economic exposure to CSX stock, i.e., actual shares plus
3

CSX-referenced swaps, never exceeded 5 percent. Thus, 3G was able to
use a single swap counterparty, Morgan Stanley, without concern that

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vote their hedge shares but of course could vote the shares that it

owned. When a proxy fight seemed likely, TCI decreased its swap

holdings and purchased more CSX shares.

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

its counterparty’s hedge share purchases would trigger disclosure
under the Williams Act.

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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
4
13d-3(a), which defines a beneficial owner, and SEC Rule 13d-3(b),

which identifies circumstances under which a person shall be deemed to

4
Rule 13d-3(a) provides:

For purposes of sections 13(d) and 13(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:
(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.

17 C.F.R. § 240.13d-3(a).

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be a beneficial owner.5 See 17 C.F.R. § 240.13d-3(a), (b). Ultimately,

the District Court did not rule on whether TCI was a beneficial owner

under Rule 13d-3(a), see CSX I, 562 F. Supp. 2d at 548, but did rule

that TCI was deemed a beneficial owner under Rule 13d-3(b) because it

had “created and used the [swaps] with the purpose and effect of

preventing the vesting of beneficial ownership in TCI as part of a

scheme or plan to evade the reporting requirements of Section 13(d),”

id. at 552.

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

5
Rule 13d-3(b) provides:

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.

17 C.F.R. 240.13d-3(b).

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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 F. App’x at

133-34.

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 credit-default 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.

I. Statutory and Regulatory Framework

Section 13(d) provides in pertinent part:

(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

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 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.
15 U.S.C. § 78m(d)(1), (3).6

SEC Rule 13d-5(b)(1) provides that the section 13(d) disclosure

requirements apply to the aggregate holdings of any “group” formed

6
Section 13(d) was part of the 1968 Williams Act’s response to the
(then) growing use of tender offers to effectuate corporate takeovers,
a trend that had “removed a substantial number of corporate control
contests from the reach of existing disclosure requirements of the
federal securities laws.” Piper v. Chris-Craft Indus., Inc., 430 U.S.
1, 22 (1977). In explaining its purpose in enacting section 13(d),
Congress used the language of investor protection. See H.R. Rep. No.
90-1711, at 2-3 (1968) (“The public shareholder must, therefore, with
severely limited information, decide what course of action he should
take. . . . [N]o matter what he does, he does it without adequate
information to enable him to decide rationally what is the best
possible course of action. This is precisely the kind of dilemma
which our Federal securities laws are designed to prevent.”); see also
Rondeau v. Mosinee Paper Corp., 422 U.S. 49, 58 (1975) (“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”). Of course, one effect of the
Williams Act’s provisions is to alert not only a firm’s shareholders
but also the firm’s incumbent management to potential competitors for
control of that firm. See James D. Cox, Robert W. Hillman & Donald C.
Langevoort, Securities Regulation: Cases and Materials 969 (5th ed.
2006) (“The ostensible statutory purpose is to notify shareholders of
the target company of a potential shift in control. . . . But one
other beneficiary of the disclosure is quite clear. If it is not
already aware of the bidder’s activity, target management will take
the early warning and begin defensive efforts in earnest.”) (citation
omitted).

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“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)).

II. “Group” Violation

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

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F.3d 613, 617 (2d Cir. 2002) (emphasis added).

Endeavoring to meet the statutory standard, the District Court

found that TCI and 3G formed a group, within the meaning of section

13(d)(3), “with respect to CSX securities,” and that this group was

formed no later than February 13, 2007. See id. at 555. Then, after

identifying the Defendants’ “activities and motives throughout the

relevant period,” id. at 553, the Court stated, “These circumstances

. . . all suggest that the parties’ activities from at least as early

as February 13, 2007, were products of concerted action . . . .” Id.

at 554 (emphasis added).

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

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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.

III. Appropriateness of Injunctive Relief

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

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satisfy traditional equitable requirements for an injunction, see

Rondeau v. Mosinee Paper Corp., 422 U.S. 49, 57 (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 consequences.” 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 injunctions, see Rondeau, 422 U.S. at 57 (citing

Beacon Theatres, Inc. v. Westover, 359 U.S. 500, 506-07 (1959)), but

also “‘some cognizable danger of recurrent violations,’” Rondeau, 422

U.S. at 59 (quoting United States v. W.T. Grant Co., 345 U.S. 629, 633

(1953)).

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:

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 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
-17-
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

-18-
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

threshold, it would continue to be relevant that the District Court

has found that some of the parties “testified falsely in a number of

respects, notably including incredible claims of failed recollection.”

CSX I, 562 F. Supp. 2d at 573. The District Court was within its

discretion in concluding that people who have lied about securities

matters can reasonably be expected to attempt securities laws

violations in the future.

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.

-19-
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 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 (“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

-20-
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 (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, we

conclude that injunctive share “sterilization” was not available.

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 (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

-21-
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 (1991), and J.I.

Case Co. v. Borak, 377 U.S. 426, 431 (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 (1992), to the effect that once a federal right of action exists
there is a “traditional presumption” that courts can use “all

-22-
available remedies” unless Congress clearly has provided otherwise.

503 U.S. at 72. 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.

Conclusion

The District Court’s denial of an injunction against the voting

of shares is again affirmed, the injunction issued to prohibit future

violations of 13(d) is vacated, and the case is remanded to the

District Court for further proceedings consistent with this opinion.

In the event of a subsequent appeal, any party may restore

jurisdiction to this Court by notice to the Clerk within 30 days of

any order or judgment sought to be appealed, without a new notice of

appeal, in which event such appeal will be referred to this panel. See

United States v. Jacobson, 15 F.3d 19, 21-22 (2d Cir. 1994).

-23-
08-2988-cv(L)
CSX Corp. v. Children’s Investment

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,

1
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).

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 Section

13(d). However, an agreement or understanding between the long

and short parties to such a swap regarding the short party’s

2
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 “beneficial owner” of shares purchased

as a hedge by the short party.

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 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 information1 by single beneficial owners of more than 5

1
Information that must be disclosed under Section 13(d) includes: (1)
the background, identity, residence and citizenship of the purchaser; (2) the
name of the issuer, class of securities and aggregate amount purchased or to
be purchased; (3) the source and amount of funds or other consideration used
or to be used in making the purchase; and (4) the purpose of the acquisition.
See 15 U.S.C. § 78m(d)(1); 17 C.F.R. § 240.13d-101.

3
percent of a firm’s equity securities. It also requires similar

disclosure by a group of beneficial owners, who own in the

aggregate more than 5 percent of a firm’s shares, when a purpose

of the group is to acquire, hold, or dispose of such securities.

See 15 U.S.C. § 78m(d).

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

4
might be part of a control transaction in the eyes of a court.2

Rather, it specifies precise conduct constituting the disclosure

trigger: the acquisition, alone or in coordination with others,

of “beneficial ownership” of 5 percent of any “equity security”

of a company. 15 U.S.C. § 78m(d)(1).

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]

of more than 10 percent of . . . any equity security” of a firm.

15 U.S.C. § 78p(a)(1). In brief, such beneficial owners (and

directors or officers) must register, disclose their purchases

and sales, and disgorge to the firm profits they made in short-

swing trades -- i.e., from purchases and sales of the firm’s

shares within six months of each other. 15 U.S.C. §§ 78p(a),

(b).

The purpose of Section 16 is generally said to be to reveal

transactions by insiders, so defined, and to prevent short-swing

2
See, e.g., CSX Corp. v. Children’s Inv. Fund Mgmt. (UK) LLP, 562 F.
Supp. 2d. 511, 540 (S.D.N.Y. 2008) (suggesting that in establishing its
regulations under Section 13(d), the SEC sought “to cast a very broad net to
capture all situations in which the marketplace should be alerted to
circumstances that might result in a change in corporate control”).

5
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 (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 (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,

6
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.”3

17 C.F.R. § 240.16a-1(a)(1). One effect of this rule was to

apply Rules 13d-3(a) and (b) in interpreting Section 16, perhaps

a less consequential step than it seems in the context of the

present issues because no great conflicts of interpretation had

arisen. A perhaps more significant step was to apply Rule 13d-

5(b)(1), which defines a group, discussed infra, to Section 16

determinations of whether multiple holders of equity securities

are in the aggregate a “beneficial owner” of 10 percent. Thus,

SEC rules interpret the term “beneficial ownership” to be the

same under Section 13(d) as under Section 16.

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 (1995) (“The 1933 [Securities] Act, like every

Act of Congress, should not be read as a series of unrelated and

3
I note that this Rule states only that Section 13(d) standards govern
the definition of beneficial owner under Section 16. However, this does not
mean that Section 16 does not inform the interpretation of “beneficial owner”
under Section 13(d). That term was used first in Section 16 in 1934, and when
Congress adopted it for use in Section 13(d) in 1968, there was no indication
that a different meaning was intended or that the canon of statutory
construction requiring harmonization was not to apply.

7
isolated provisions. Only last Term we adhered to the ‘normal

rule of statutory construction’ that ‘identical words used in

different parts of the same act are intended to have the same

meaning.’”) (quoting Dep’t of Revenue of Or. v. ACF Indus., Inc.,

510 U.S. 332, 342 (1994)); 2A Norman J. Singer & J.D. Shambie

Singer, Sutherland Statutes and Statutory Construction § 46:6

(7th ed. 2008). The provisions of Section 16 relating to

beneficial ownership, and the caselaw under it, thus inform and

cabin any interpretation of the meaning of beneficial ownership

under Section 13(d).

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 (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

8
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. 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. The shareholder avoided

disgorgement of the profits on the second sale even though the

two sales “were effected pursuant to a single predetermined plan

9
of disposition with the overall intent and purpose of avoiding

Section 16(b) liability.”4 Id. at 421 (internal quotation marks

omitted).

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 recognized 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

4
The Supreme Court noted that the SEC had filed a brief as amicus
curiae arguing that the proper interpretation of the 1934 Act would require
disgorgement of the profits. Reliance Elec., 404 U.S. at 425-26. The Court
explicitly rejected the SEC’s proposed construction of the 1934 Act. Id. at
426-27.

10
 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 (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. 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

11
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 required

to make disclosure.5 So long as “the method used to

5
Critics who believe the Williams Act’s provisions are too lenient
have, as a result, unsuccessfully sought to shorten the time before disclosure
is required. One of the most visible efforts was the Tender Offer Disclosure
and Fairness Act of 1987, which would have reduced the Section 13(d) reporting
deadline from ten days to five days. See Report of the Senate Committee on
Banking, Housing and Urban Affairs on the Tender Offer Disclosure and Fairness
Act of 1987, S. Rep. No. 100-265, at 19 (1987). Senator William Proxmire, the
bill’s sponsor, described the motivation behind that proposal:

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

12
‘avoid’ [disclosure] is one permitted by the statute,” Reliance

Elec., 404 U.S. at 422, it does not matter that a firm or group

of firms employing that method consciously sought to avoid

disclosure under Section 13(d). That result flows from the

statutory language and is not for courts to alter. However,

perhaps because of the way this case was argued, none of the

pertinent authority established under Section 16 was discussed by

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.

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:

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.

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.

13
the district court, which gave overwhelming weight to the Funds’

intent.

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

security. Dodd-Frank Wall Street Reform Protection Act §

761(a)(2).

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

14
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

15
equity swap.]”6 15 U.S.C. § 78c-1(b)(2). This amendment

6
The 2000 Amendment added Section 3A to the 1934 Act, which reads:

§ 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 in section 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 in section 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 --

(A) promulgating,
interpreting, or enforcing rules; or

(B) 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).

16
contained exceptions to this prohibition with regard to the

disclosure and disgorgement provisions of Section 16 that, inter

alia, make it clear that a long party’s ownership of cash-settled

total-return equity swaps was not to be calculated in determining

beneficial ownership of 10 percent of equity shares.7 See 15

(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.

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.

7
Section 16 does not mention equity-based swaps in its definition of
persons who are 10 percent beneficial owners subject to Section 16’s reporting
and disgorgement provisions, 15 U.S.C. § 78p(a)(1), but does require that
those beneficial owners disclose purchases and sales of “security-based swap
agreement[s]” as well as “equity securit[ies],” and that they disgorge profits
from short-swing sales of both. 15 U.S.C. §§ 78p(a)(2)(C), 78p(b); 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). The reason Section 16 omitted security-based swap
agreements in determining the 10 percent ownership trigger was that its
animating concern is trading and profiting by investors with access to non-
public material information. While actual ownership of shares carries with it
voting rights, and therefore power in many cases to obtain such information,
security-based swap agreements, without provisions requiring acquisition,
disposition, or voting of hedge shares, do not vest the long party with such
voting rights and are thus irrelevant to the criteria for crossing the 10
percent ownership threshold. For investors who do meet Section 16’s
definition of a 10 percent owner, however, security-based swap agreements
offer an opportunity to profit from trading on non-public material

17
U.S.C. § 78c-1(b)(3).

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.

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

information. As a result, subjecting swaps to Section 16’s reporting and
disgorgement provisions was deemed appropriate even though such swaps were
excluded from that section’s definitional trigger. Given the Dodd-Frank
amendment discussed immediately hereafter in the text, the SEC now has power
to include holders of all security-based swaps within the term “beneficial
owner.”

18
made under Rule 13d-3 inapplicable to a person who purchases or

sells a security-based swap.” Beneficial Ownership Reporting

Requirements and Security Based Swaps, 2011 WL 933460, at *2.

The SEC’s fear appears to be that, given the prior Congressional

bar to its regulating cash-settled total-return equity based

swaps, Rule 13d-3 could not apply to such swaps before the

amendment and needed repromulgation pursuant to that amendment if

the Rule were ever to apply to such swaps.

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.

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

19
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

20
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 (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? And what are the consequences of

his deviation from duty?”).8

8
Representatives of TCI, in negotiating with CSX and elsewhere,
occasionally referred to the swaps as vesting ownership of CSX shares. Of
course, when TCI sought control, its unwinding of swaps and purchasing of
shares contradicted these assertions. Moreover, beneficial ownership is a
legal question and such remarks, which add nothing to TCI’s rights under the
swaps, do not bind a court addressing that legal question. See Kamen v.
Kemper Fin. Servs., Inc., 500 U.S. 90, 99 (1991) (“When an issue or claim is
properly before the court, the court is not limited to particular legal
theories advanced by the parties, but rather retains the independent power to
identify and apply the proper construction of governing law.”); Hankins v.
Lyght, 441 F.3d 96, 104-05 (2d Cir. 2006) (stating that a court is required to
interpret federal statutes as they are written, and is not bound by parties’
stipulations of law).
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 (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

21
 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)

SEC Rule 13d-3(a) defines beneficial owner and

provides:

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.

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

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.

22
investment or voting power over the hedge shares when the short

party purchases referenced shares as a hedge.

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.

CSX asserts that expectations based on the incentives of

counterparties to buy and sell shares qualify, for the purposes

of Rule 13d-3(a), as the power to “direct the disposition” of

those shares. 17 C.F.R. § 240.13d-3(a)(2). I disagree.

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.

23
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 short parties

9
In the context of swaps, reading “influence” in an unlimited manner
would have anomalous consequences. Even in the exceptional case where the
short party does not hedge with actual shares, a long party would bear the
risk of being found to have “influenc[ed]” the purchase of shares by another
unknown party further down the line in the chain of transactions. For
example, the short party might hedge its position by entering into a separate
swap position with a third party, which, in turn, hedges its own position.
Like the initial short party, the third party might purchase actual shares as
a hedge or enter into an additional swap agreement or similar derivative
position with an additional party, and so on. The initial long party may have
no knowledge of the identity or action of the party that ultimately purchases
actual shares as a hedge. Moreover, the ultimate share purchaser may have
interests in the shares that are in direct opposition to the interests of the
initial long party.
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

24
free to act in whatever way they deem to be in their self-

interest with regard to purchases and sales of referenced shares

also does not fit within the concept of “beneficial ownership” in

the long party. Likewise, a swap agreement that accords complete

freedom to the short parties to act in their self-interest with

regard to purchases and sales of referenced shares does not

confer “beneficial ownership” in the long party in any sense in

which those words are commonly used.

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

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.

25
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).

26
 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

market or to pay the short party no less than the open market

price.

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

10
In analyzing “material facilitation” purely in terms of the effect of
swap transactions on the ability to purchase shares, I am simply addressing
the argument that CSX has raised before us. As I discuss, infra, persons may

27
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 swap

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

choose to acquire long equity swap positions for reasons other than acquiring
shares when the swap positions unwind.

11
If markets are highly illiquid, then purchasing shares to hedge short
swap positions will most likely either be impossible or prohibitively
expensive. Moreover, the frequent absence of a market price in a highly
illiquid market is likely to discourage the creation of standard equity swap
agreements for lack of an objective means of calculating the cash flows
required by changes in the referenced asset’s value. Under such
circumstances, a bank would enter into a short swap position only if it were
willing either to accept the risks of an unhedged short exposure or to hedge
its short exposure by some means other than purchasing shares. (Of course, a
bank might simply refuse to enter such an agreement at all, in light of the
hedging difficulties.) In any case, acquisition of large quantities of hedge
shares by a short swap counterparty in such a market would be highly unlikely.
Moreover, because a highly illiquid market is typically one in which the vast
majority of shares are held by only a small number of owners, takeovers via
the medium of cash tender offers in the open market -- the core concern of the
Williams Act -- are likely to be rare anyway.

28
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 shares directly,

without a detour through a cash-settled equity swap position. In

29
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 the 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 Rule 13d-3(a). 17 C.F.R. §

240.13d-3(a)(2).

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,” 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

30
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.12 Indeed, were another

putative acquirer to appear in competition with the long party,

12
As my discussion of the formation of a “group” indicates, see infra,
if the long party has an agreement with the short party as to the voting of
shares purchased as a hedge, the shareholdings of both parties would be
aggregated for purposes of tallying the percentage of shares held by
beneficial owners.

31
the long party might well find that the short party’s self-

interest was now at odds with its own. See Hu & Black, 79 S.

Cal. L. Rev. at 839.

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

shareholder votes is entirely speculative and hardly qualifies as

voting “power.”

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

32
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.

2) Rule 13d-3(b)

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:

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.

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

33
provisions or SEC rules and regulations.13 The purpose of such

“evasion provisions” is to effectuate statutory policies where

SEC rules or regulations may not literally cover an unforeseen

structure of a transaction or the creation of unforeseen

instruments that fall within the regulated area but outside the

literal terms of the pertinent regulatory provisions.

13
For example, each of former Rules 146, 240 and 242, which provided
registration exemptions for, inter alia, privately placed securities, included
a preliminary note stating that technical compliance with the rule would not
assure the exemption if the securities transaction was “part of a plan or
scheme to evade the registration requirements of the Act.” See Notice of
Adoption of Rule 146, Securities Act Release No. 5487, 1974 WL 161966, *5 (May
7, 1975); Notice of Adoption of Rule 240, Securities Act Release No. 5560,
1975 WL 160968, *3 (Jan. 24, 1975); and Exemption of Limited Offers and Sales
by Qualified Issuers, Securities Act Release No. 6180, 1980 WL 29335, *13
(Jan. 17, 1980).
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).

34
 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 APW 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

35
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

financing14 and make preliminary inquiries of large shareholders

that may facilitate the rapid acquisition of shares once the

desired moment to strike has arrived and before the ten-day

disclosure period has expired. None of this triggers Section

13(d) disclosure until ten days after the 5 percent threshold has

14
Arrangements to line up financing for stock acquisitions might
trigger Section 13(d)’s “group” provisions with respect to the lender and the
borrower, depending upon the specific circumstances and conditions of the
financing. See, e.g., Roth v. Jennings, 489 F.3d 499, 502, 511-13 (2d Cir.
2007) (holding that dismissal of a Section 16 suit for disgorgement of short-
swing profits was unjustified when there were allegations that a loan had been
made to a borrower in furtherance of an agreement between the lender and the
borrower “to work together to effect a change of control or similar
transaction involving [the company whose shares were purchased with the
borrowed money]”) (internal quotation marks omitted).

36
been passed, despite being steps in pursuit of an acquisition and

fully designed literally to prevent the vesting of ownership of 5

percent in order to avoid disclosure.

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

37
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;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 cost of

15
I do not disagree with the district court’s analysis. I note,
however, that a long party has no interest in putting a short party under a
Section 13(d) disclosure obligation. Such disclosure is costly to the short
party, and the costs will be passed on to the long party.

38
purchasing CSX shares later. Id. at 549.

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

39
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 (“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

40
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 (1936) (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

31995, at *2 (Feb. 3, 1936) (citing Gregory v. Helvering, 293

U.S. 465 (1936)).

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

41
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

42
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), 15 U.S.C. § 78m(d), is not

present in cash-settled total-return equity swaps because the

16
Because my reasoning does not rely on the creation of a false
appearance, I do not reach the role of such conduct under Rule 13d-3(b).

43
swaps themselves provide no means of exercising control. As

explained in the discussion of Rule 13d-3(a), an owner of such

swaps cannot seek to exercise control without buying the actual

shares in an open competitive market. In the present case, when

the Funds could not persuade CSX to change its policies, they had

to make actual purchases of CSX stock, a step that would have

been unnecessary if the swaps they held were the substantial

equivalent of beneficial ownership.

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

44
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

45
justifies a court treating cash-settled total-return swaps as an

evasion of Section 13(d).

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.

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 requirements are allayed by the group concept.

Any agreement or understanding between various funds for the

purposes set out in Rule 13d-5(b)(1) would cause the aggregation

of shares beneficially owned by each member of the group for

purposes of Section 13(d). Also, any agreement or understanding

between long and short swap parties regarding: (i) the purchase

of shares by the short party as a hedge; (ii) the sale of such

shares to the long party when the swaps are unwound (as in

settled-in-kind equity swaps); or (iii) the voting of such shares

purchased by the short party, would cause the shares purchased as

a hedge and any shares owned by the long party to be aggregated

and counted in determining the 5 percent trigger. (Of course, as

46
discussed supra, such an understanding might also render the long

party a “beneficial owner” under Rule 13d-3(a). See 17 C.F.R. §

240.13d-3(a).)17

With respect to whether there was such an agreement or

understanding between the Funds, the district court found that

17
This application of Section 13(d)’s “group” provisions to equity
swaps was not precluded at the time of the district court’s decision by
Section 3A’s general prohibition of most SEC regulation of security-based
swaps. The pertinent part of Section 3A, 15 U.S.C. 78c-1(b), explicitly
adopts the definition of “security-based swap agreement” provided by Section
206B of the Gramm-Leach-Bliley Act, which in turn incorporates the definition
of “swap agreement” provided by Section 206A of that Act. 15 U.S.C. §§ 78c-
1(b), 78c note. Section 206A’s definition explicitly excludes:

(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 . . . .

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).

47
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

18
With respect to a group involving both long and short parties, the
district court noted that TCI had communications with Deutsche Bank and with
one of Deutsche Bank’s hedge funds, Austin Friars, which held a substantial
amount of CSX stock. CSX Corp., 562 F. Supp. 2d at 530. The court noted that
these communications (in 2008) might be sufficient to create a group under
Rule 13d-5(b)(1), 17 C.F.R. § 240.13d-5(b)(1), but did not resolve the
question. Id. at 543-45.
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.

48
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

49
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 hardly

amounts to an agreement to buy CSX shares.

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.

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 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.

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