TCI: Winning the battle but losing the War

It looks like The Children's Investment Fund may be winning its battle over the future of railroad operator CSX Corp. But is the hedge fund losing the war when it comes to the future of its activist strategy?

Sure, things look good for TCI and its proxy contest next Wednesday. Advisory services company RiskMetrics Group Inc. is recommending that investors vote for four of TCI's five-person slate at the meeting. That's a big boost. The 2nd Circuit Court of Appeals in New York has already rejected CSX's request to expedite the railroad company's appeal so that a ruling takes place before the meeting. The court late Friday also rejected CSX's petition to have TCI's shares "sterilized," pending the ruling, in otherwords blocked from voting, at the annual meeting. Both these measures should only help TCI gain the support they need to seat their insurgents and effect the operational changes they are seeking. All these measures should only help TCI gain the support they need to seat their insurgents and effect the operational changes they are seeking.

But let's take a step back. CSX's litigation battle has brought TCI's strategy of using a mixture of synthetic and equity shares to sneak up on target companies to the attention of the Securities and Exchange Commission. The agency had been mulling over whether it would require new synthetic share-related disclosures, but there was no urgency to the matter. Now, one person familiar with the SEC says the issue of synthetic swaps is becoming a top priority for the commission in light of the court battle.

While the agency is waiting for an appeals court ruling, which could take place in September, staffers there are very aware that a lower court's ruling on June 11 is already discouraging activist fund managers from employing swaps (and even passive investors that combine swaps and equity shares) as part of their insurgency strategy. There suddenly is an urgency for the agency to step in and provide some clarity.

The end result might just be that the SEC proposes new Schedule 13D rules requiring investors to consider synthetic swaps the equivalent of real shares for the purpose of disclosure. That means an activist with 3% equities and 2% synthetic shares would need to disclose their investment in a filing with the SEC. The agency may also propose a whole new disclosure regime for synthetic swap shares. In other words: no more sneaking up on companies.

TCI may win its battle with CSX. But it may be the last time the London-based investor can accumulate a large economic stake -- double-digit swaps plus equity below 5% of shares outstanding -- without disclosing that to the SEC. Companies soon may no longer be in the dark when it comes to activists with large hidden economic investments.

Of course, this does nothing to hurt the large number of activists that just buy equity stakes and use public pressure campaigns for their strategies.

But those activists using synthetic shares to stay in the shadows might have to become more transparent. That will give companies a better chance of responding to activists. Already a couple corporations have adjusted their poison pills to consider synthetic securities the equivalent of physical securities. This could be good news for corporations in their war against activist investors.

And while TCI may win its insurgency at CSX, its swap/equity activist strategy may be going the way of the dodo bird. - Ron Orol