A federal judge ruled on Wednesday that two investment firms waging a proxy battle at railroad CSX violated securities law in acquiring large stakes in the rail company, but allowed them to continue their fight at the annual shareholder meeting.
Judge Lewis Kaplan of the U.S. District Court for the Southern District of New York wrote that The Children's Investment Fund Management (TCI) and 3G Capital Partners deliberately evaded disclosure obligations as they "sought to control CSX for over a year."
The judge added, "As obstacles to control surfaced, they adapted their strategy for achieving control, making disclosures only when convenient to their strategy."
The judge ruled that the two funds violated securities law by planning to avoid making disclosures on beneficial ownership of shares amassed in swap positions and did not promptly disclose that they had formed a "group" of investors.
But while the judge said the two funds had dodged their disclosure obligations, he added that the court could not preclude TCI and 3G from voting their CSX shares and that any penalties related to violations must come from the U.S. Securities and Exchange Commission or Department of Justice.
"We are pleased that shareholders will be able to determine the outcome of the June 25th Board election," TCI and 3G said in a statement. "We strongly believe we have complied with all securities laws and plan to appeal."
They also said they believed CSX shareholders had been fully informed for six months that the two funds have been acting as a group.
The judge also dismissed counterclaims brought by the two funds against CSX.
CSX summarized the decision in a statement that included the heading "Rules in Favor of CSX" and said: "The Court concluded that current case law prevents a ruling that would prohibit TCI and 3G from voting their shares, though 'if it were free to grant such relief it would exercise its discretion to do so.'"
CSX sued TCI and 3G Capital Partners in March, seeking to block the funds from running their slate of five board candidates at the company's annual meeting on June 25 in New Orleans.
The Jacksonville, Florida-based company argued that the funds did not properly disclose their holdings in CSX and had violated federal securities laws aimed at preventing groups of investors from secretly coordinating their efforts.
The funds countersued, accusing CSX of breaches of securities law, including unlawfully enriching corporate directors. They contend that the CSX lawsuit is the latest in "a long series of scorched earth tactical maneuvers" by the board and CEO Michael Ward to entrench themselves.
The proxy battle has been raging since last December with regular claims and counter-claims made by both sides.
The two hedge funds maintain that CSX's potential for profit over the next five years could be double what the railroad's management says it is. CSX claims in return that TCI and 3G would impede the company's growth by cutting capital expenditures, which would deprive shareholders of significant value.
Preparing For Battle
At least five major stockholders in CSX have thrown their support behind a dissident board slate at the railroad company, suggesting the campaign has a reasonable chance of success, according to sources familiar with the matter.
But the opinion of proxy advisor RiskMetrics is also expected to carry much sway with stockholders. Institutional Shareholder Services, a unit of RiskMetrics, is expected to issue a report in coming days.
CSX's annual meeting is set for June 25. The dissidents are pushing to have a slate of five nominees elected to CSX's 12-member board.
Funds supporting the dissidents include Egerton Capital, a British fund that held 3.3 million CSX shares as of March 31, and TPG Axon Capital Management, a hedge fund that holds 9.7 million shares, the sources said. Three other major shareholders holding 14.2 million shares are also supporting the dissidents, the sources said.
None of the funds would publicly disclose their intentions.
Together with the 8.7 percent stake held by TCI and 3G, the funds named by the sources as supporting the dissidents hold more than 15.5 percent in the company, according to regulatory filings. The TCI-3G group also holds swaps worth an additional 12.3 percent, but the funds do not have the right to vote those underlying shares.
Fund managers supporting the dissidents argued this week that CSX could benefit from having new board directors, particularly those with railroad experience.
The dissident director slate includes Gil Lamphere, former director of Canadian National Railway and chairman of Illinois Central Railroad, and Timothy O'Toole, former president and CEO of Conrail.
Like the other major U.S. railroads, CSX has seen rising profits in recent quarters thanks largely to strong pricing and improved network performance despite an overall slowing of the U.S. economy.
Their improved profitability has also attracted the interest of investors. Warren Buffett's Berkshire Hathaway , for instance, holds an 18 percent stake in No. 2 U.S. railroad Burlington Northern Santa Fe .
CSX shares fell $2.67, or 4 percent, to close at $63.60 on the New York Stock Exchange.