CSX/TCI: Appellate Court on Disclosures and Takeover Law

Sometime ago, we had the opportunity to discuss a decision of the U.S. District Court for the Southern District of New York pertaining to the use of cash-settled total-return equity swaps by acquirers and whether that would trigger disclosure requirements under appropriate U.S. regulations governing takeovers. Now an appellate court has pronounced its decision in which the majority of the judges do not resolve the question as to whether the existence of such a swap would make the acquirer (long party) a beneficial owner of the shares in respect of which the swap has been entered into. Only Judge Winter who issued a separate concurring opinion touched upon the issue of beneficial ownership. A post on the Harvard Corporate Governance Forum discusses the impact of that opinion:
Judge Winter’s opinion rejected the District Court’s view that equity swaps are (in Judge Winter’s words) “an underhanded means of acquiring or facilitating access to [shares] that could be used to gain control through a proxy fight or otherwise.” Judge Winter instead writes that, absent an agreement on acquiring or voting the short party’s hedge position, “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.” Judge Winter rejected the position that the shares acquired by the swap dealer to hedge the swap should be deemed beneficially owned by the long party based on a review of the statutory language; other legislation that has addressed swaps — including Dodd-Frank, which granted new authority to the SEC to promulgate rules providing that “a person [] be deemed to acquire beneficial ownership of an equity security based on the purchase or sale of a security-based swap”; and the SEC’s ongoing and, as yet, inconclusive consideration of derivatives and beneficial ownership under Section 13(d), including its recent repromulgation of Rule 13d-3.
Although the use of swaps to stay outside shareholding disclosure requirements has caught the attention of both the securities regulator and the courts in the U.S., no decisive action has yet been forthcoming to rein them in as the above statement indicates.
On the other hand, the U.K. has adopted more stringent regulations governing the use of derivatives in takeovers of companies. Amendments to the City Code on Takeovers and Mergers have expressly captured derivative contracts by acquirers such that they are treated on par with acquisition of shares for purposes of disclosures and other related requirements. It is believed that other jurisdictions in the Commonwealth have either introduced similar requirements or are actively considering doing so.
In India, the use of derivatives as a method of building up economic ownership in companies is scarcely used, if at all. Hence, this question has not assumed as much importance, although if these instruments become popular in the future that would require proper treatment for disclosure and other purposes. Commendably, the Takeover Regulations Advisory Committee (TRAC) that proposed a new set of takeover regulations took cognizance of this issue, but displayed no urgency in putting in place specific mechanisms to address it. Its report states:
16.4 The Committee noted that although at present, the derivative Futures and Options (F&O) segment is cash settled, the Board has taken a decision to permit delivery based acquisitions in this segment in the near future. Such acquisitions shall have a far-reaching effect on multiple regulations and their implications would have to be examined by the Board at the appropriate time. For example, in such event, there would be a need to review not only whether one would need to prescribe disclosures about such economic interests in securities of a target company, but also how such derivatives would influence the minimum offer price, if executed within the look-back period.
The CSX/TCI appellate decision also addressed the question of how “groups” can be formed for purposes of disclosure of collective shareholding of acquirers. Another post on the Harvard Corporate Governance Blog details the impact of the decision:
More important is that it reduces the fear that mere communication between like-minded shareholders can subject them to a lawsuit alleging that they formed an undisclosed 13d group. The Court significantly narrowed the ability of an issuer (or the SEC) to allege that such a group exists. Merely alleging “concerted action” is not enough. Instead, applying the statute literally requires that coordinated purchases must be alleged (and proven).
…, it is unlikely that a group would ever be formed for either of those purposes after the shares were independently acquired (which is presumably why the Circuit Court focused on acquisitions.) The bottom line is that general allegations of shareholders acting “in concert” are no longer sufficient to survive a motion to dismiss in my opinion. There must be a specific allegation that their purchases were coordinated.

In the US context, this might indeed aid activist shareholders. In the Indian context, the above discussion may have some relevance in the determination in similar circumstances of “parties acting in concert” under the SEBI Takeover Regulations.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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