A looming decision in a heated lawsuit brought by railroad giant CSX Corp. could shut down a loophole used by activist hedge funds to hide their stake from the market.
CSX alleges that two big hedge funds – The Children’s Investment Fund (TCI) and 3G Capital Partners – used complex swap agreements with investment banks to secretly hide their 12 percent ownership stake in the rail operator.
TCI boss Christopher Hohn admitted in a bench trial Thursday to buying millions of dollars worth of swaps for CSX shares early last year.
Hohn, the son of working-class Jamaican parents who emigrated to London, disclosed his position in CSX last December and has launched a proxy contest to unseat five of the company’s directors.
A decision against TCI and 3G Capital, which could come June 12, could cause major activists like billionaires Nelson Peltz and Carl Icahn to disclose the interest they have in a company through swaps contracts earlier, according to legal experts.
Buying swaps through the investment banks – in this case Citibank and Deutsche Bank – allowed TCI to get around the decades-old 13D rule, which requires investors to disclose their position when they own 5 percent or more of a company’s shares.
Hohn said in testimony that the swaps were bought to avoid tipping off other investors to TCI’s purchases, which could have triggered a run-up in CSX’s stock price. But Hohn did admit that he selectively encouraged other hedge funds to buy CSX shares before he disclosed his position.
Critics argue that the swap contracts allow activist hedge funds to accumulate many more votes than are reflected in the number of shares they actually own.
Activists counter that while swaps allow them to hide their interest for a period of time, they can’t tell the investment banks how to vote.
But US District Judge Lewis Kaplan indicated last week that he favors early disclosure.
Most attorneys who advise corporate boards believe the investment banks that control the swaps will vote in favor of their clients, which pay them millions in fees.