Activists beware!

The SEC may soon move to require activist hedge fund managers to disclose more quickly the stakes they take in companies whose management they are trying to shake up. Good for companies, bad for activists. Check out my article here at MarketWatch.

Activist investors are very likely to like Mary Schapiro

As head of the Securities and Exchange Commission, Mary Schapiro has already taken a bunch of steps to help activist shareholders-- both institutional and hedge funds -- expand their efforts. For one thing, Schapiro finally moved to axe ballot stuffing, after the SEC has waffled on the issue for years. Brokers will no longer be able to cast a vote for management's slate with uninstructed retail shares. That could shift the outcome of "Just Vote No" campaigns against particular directors in the case of some large companies, such as Bank of America, where there is a huge retail vote.

At the same time, the SEC is taking action also after years of inaction to give shareholders more say in corporate board elections. The ever contentious "shareholder access" proposal is expected to be enacted next year, giving shareholders the ability to nominate one or two director candidates to a corporate board on the corporate proxy. This, however, is unlikely to discourage big activists like Carl Icahn from running their own slates. Nevertheless, it could make it easier for labor-backed pension funds to put their candidates up for election.

Congress is quickly moving to enact 'say on pay' legislation that would give investors an ability to have a nonbinding vote on executive compensation-- all that could influence their behind-the-scenes dealmaking ability. Once the economy recovers, expect activist investors to use this leverage to press companies into deals or stock buyback initiatives. The legislation has already passed the House Financial Services Committee. Expect it to be a key part of bank reform legislation that will be approved by early 2010.

Majority voting for directors is also in legislation on Capitol Hill. Majority voting, which already takes place on a company by company basis, would require directors to receive more than 50% of the vote of participating investors. Right now management backed nominees need only one shareholder vote to win-- a director can vote one share they own themselves for themselves and presto! they're back in.

All this is going to make it easier for activist investors to press for their interests. You think the environment is already expanding for shareholder activism? Watch out, with Schapiro and a financial crisis in tow, big changes are coming.

New SEC chairmwoman was activist backer

Activist hedge fund managers may like Mary Schapiro.

The soon-to-be Securities and Exchange Commission chairwoman was a solid shareholder activist during her stint as a commissioner at the agency. So much so that governance fund manager Ralph Whitworth said "She has been a stanch and long-time supporter of shareholder rights."

RiskMetrics Inc. Director Patrick McGurn said: "You have to put [Schapiro] on the progressive side of the scale when it came to initiatives for shareholders.”

President-Elect Barack Obama chose Schapiro in December to run the controversial and embattled agency, which is likely to be restructured in response to the financial crisis.

Between 1988 and 1994, Schapiro was an independent commissioner at the SEC. During that period, the agency was headed by GOP chairmen David Ruder and Richard Breeden, and later by Democratic commissioner Arthur Levitt.

In my book I talk about how that period was critical for shareholder empowerment. Breeden, who now runs an activist hedge fund, pushed through a number of investor-empowering rules with Schapiro's critical backing. Schapiro's support for shareholder initiatives at the time indicates that she may be supportive of some major pro-investor proposals as chairwoman.

In the early 1990s, Schapiro voted to have the SEC adopt a number of rules expanding the amount of communications investors could have with each other. It also freed up communications between investors and reporters. The rules allowed investors to vote against a management proposal or director candidates as long as they didn't try to nominate their own director candidates.

She also endorsed a provision introduced by Breeden known as the short-slate rule that allowed investors to split their vote between management-nominated directors and candidates put up by dissident activist investors.

"More than a decade later, this measure was critical in establishing the world of activist hedge funds and other insurgent investors," McGurn said. "She [Schapiro] was critical to the effort to keep that controversial provision in the final shareholder communications reform package."

While at the SEC, she also backed a measure that expanded the amount of disclosure executives were required to provide about their compensation plans. Those disclosure rules were expanded in July 2006.

Shifting SEC

The Securities and Exchange Commission will be a key regulator as Washington continues to restructure itself in response to the expanding financial crisis.

SEC Chairman Christopher Cox has called for a combination of the agency and the Commodities Futures Trading Commission, a key part of Paulson’s blueprint for regulatory reform.

Whether the agencies do combine, it won’t be under Cox’s watch. Arthur Levitt, SEC chairman during 1993 to 2001, is a potential pick for chairman. FINRA CEO Mary Schapiro is another potential choice because of her extensive experience working at both the CFTC and SEC. “To combine both these agencies you need someone with experience at both places,” said one securities attorney.

Another possible SEC chair pick is John Olson, a partner at Gibson Dunn LLP and former head of the American Bar Association’s business law section’s committee on Corporate Governance. Ex. SEC commissioners Harvey Goldschmid, Roel Campos and Annette Nazareth, are all possibilities. It would be easier for Obama to anoint an existing commissioner to the chair position. Elisse Walter, who is on the commission, could fit the bill. Lower level but still very important division chiefs at the SEC are on their way out too. John White, who heads the SEC’s corporate finance division, is expected to step down, leaving the hefty task of figuring out how to create a new derivatives disclosure regime to his successor. Stanley Keller, a partner at Edwards Angell Palmer & Dodge LLP could replace White. -- Ron Orol

Congressional Shifts on Capitol Hill

When Democrats lost seats in the 2002 midterm congressional election, then House Minority Leader Richard Gephardt quietly decided not to run for re-election for that position.

With Republicans losing House seats in both 2006 and 2008, expect GOP members to push for changes to their leadership. That could mean the ouster of House Minority Leader John Boehner, R-Ohio, or GOP Whip Roy Blunt, R-Mo. Possible replacement candidates include Reps. Paul Ryan, 38, R-Wisc. and Eric Cantor, 45, R-Va., both lawmakers that led a high profile ultimately unsuccessful effort to topple Treasury Secretary Henry Paulson’s $700 billion government purchase plan. According to Darryl Nirenberg, deputy chair in Patton Boggs public policy department, Cantor and Ryan may see the losses in their party as an opportunity to step up. The Republican study committee, a conservative caucus within the Republican party, now has a strengthened position for GOP lawmakers, Nirenberg contends. Previous members Tom Delay and Richard Cheney have gone on to strong positions within the Republican party. Opposition to Paulson’s package emerged from this committee.

One glimmer of positive news for Republicans was the re-election of Senate Minority Leader Mitch McConnell, R-Ky. McConnell understands the intricacies of the parliamentary rules on Capitol Hill and legislative observers expect that he is best positioned to protect GOP interests in the Senate. His ouster would likely have meant the installation of the less experienced Sen. Jon Kyl, R-Arizona, to the position.

On the Democratic side, look for Sen. Christopher Dodd, D-Conn., to remain chairman of the Senate Banking Committee, a panel that will be at the center of restructuring on Capitol Hill. Less likely is for Dodd to decide to be chair of the prestigious Senate Foreign Relations Committee, where vice president-elect Joe Biden is leaving a vacancy. Sen. Daniel Inouye, D-Hawaii, may take over the Senate Appropriations Committee (after the ouster of Sen. Robert Byrd, D-Va.) leaving the position of Senate Commerce Committee chairman to John Rockefeller, D- WV. All this may leave Sen. Chuck Schumer, D-NY., as chair of the prestigious and powerful Senate Rules Committee.

As far as Obama’s administration. Expect quick movement. According to the Washington Post, Rahm Emanuel is deciding whether he wants to be President-Elect Barack Obama’s chief of staff. Rahm may choose to stay on in Congress where he could one day replace House Speaker Nancy Pelosi.

Once Obama’s chief of staff is chosen, expect his White House staff and cabinet officials to be chosen quickly, in the next couple weeks.

Key cabinet official appointments should be made before Thanksgiving. The choice of Treasury Secretary, arguable the most important cabinet level job, should go to either New York Federal Reserve Bank President Timothy Geithner or New Jersey Gov. Jon Corzine, at least according to Stan Collender, managing director at Qorvis Communications in Washington. Larry Summers, a former Treasury Secretary during the Clinton Administration, is also in the running. -- Ron Orol

Sun Times Under More Pressure

Already under pressure from activist investors K Capital Management LLC of Boston, Sun-Times Media Group Inc., which announced in February it was considering a sale of assets or a privatization, is now facing a second activist investor.


On Wednesday, Davidson Kempner Advisers Inc. announced an activist tack at the owner of the Chicago Sun-Times, the latest news company to be targeted by activist hedge funds. K Capital, the Sun-Times' largest shareholder with a 9.7% stake, has been a vocal advocate for a sale.

Davidson Kempner, a 5.9% Sun-Times holder, on Wednesday evening said in a Securities and Exchange Commission filing it has had and will continue to have discussions with "third parties and other shareholders and management regarding [Sun-Times], its prospects and potential means for enhancing shareholder value. In these discussions, [Davidson Kempner] may suggest or take a position with respect to future plans for the company, including, without limitation, potential changes in the business, strategy, operations, board composition, management or capital structure of the Issuer as a means of enhancing shareholder value."

The filing doesn't mention whether the two firms are working together, but Davidson Kempner's filing makes it clear that it certainly would be open to talking to a number of investors. - Ron Orol

Steel Partners closer to Goal at Point Blank

Activist turned private equity investor Warren Lichtenstein is one step closer to his goal of buying body armor maker Point Blank Solutions Inc. or having it consider strategic options, including a sale.

The insurgent, who manages the New York-based activist fund Steel Partners, took five of seven board seats on the $153 million stock market capitalization company in a proxy contest on Tuesday. The Pompano Beach, Fla.-based company's market capitalization is roughly half its size compared to a year ago, and its former Chief Executive has been arrested on charges of fraud.

"We continue to believe that Point Blank should not remain a standalone company competing on uneven terms against much larger competitors in a weakening market," Lichtenstein said in a statement. "Steel Partners is committed to maximizing stockholder value by exploring all strategic alternatives, including possible sale of all or a portion of the Company on the most favorable terms available to Point Blank stockholders."

Steel Partners, which has a 9.6% Point Blank stake, offered last year to buy the company for $281 million. The company rejected the bid.

Steel Partners, traditionally known for pushing companies to auction themselves or find other means of improving shareholder value, is no stranger to bidding or buying companies. The activist fund, together with Newcastle Partners, another hybrid activist and buyout shop manager, acquired Fox & Hound Restaurant Group in 2006. The two funds later acquired Champps Entertainment Inc. In addition to restaurant chains, Steel Partners focuses a large chunk of its activist efforts on defense industry companies. In 2004, the fund unsuccessfully bid to buy aerospace engineering systems manufacturer GenCorp. Inc.

Naked Short Selling Would Live On

One day after the Securities and Exchange Commission ended its pilot project to clamp down on naked short selling, at least one academic says any decision to extend the plan to the broader market would have some unintended consequences.


Columbia Law School professor John Coffee says he believes that if the SEC chooses to extend the temporary naked short-selling rule to the entire market, it would have the effect of driving short sellers to migrate their investments to single stock futures, the options market and cash settled equity securities, all strategies that could also drive a company stock down. The last option, also known as total return swaps, don't involve real shares but are agreements between investors and bank derivatives dealers where one party pays the other based on the performance of the underlying stock price.

"I'm not saying it's a complete substitution but people who want to avoid preborrowing stock might be able to achieve these things through these other means," Coffee says.

The agency in July set up emergency restrictions on short sales in the shares of 19 financial institutions including mortgage giants Fannie Mae and Freddie Mac through Tuesday. The emergency restrictions required short sellers in these institutions to either arrange formally to borrow shares, "preborrow." Previously, it was enough if the broker could determine that it had a reasonable basis to deliver the securities when an investor sought to borrow shares for a short sale.

It's not clear what the SEC will do after it collects all the data from this effort, but Coffee adds that he believes those investors seeking to engage in naked short selling, the practice of selling a stock short without first borrowing the shares or ensuring that the shares can be borrowed, will use these other mechanisms that fulfill the same functions. Coffee does add that even with short sellers finding these other means, he expects broad restrictions similar to those set forth in the emergency order to have some impact on discouraging the naked short- selling practice.

"It would succeed at putting some sand in the gears," Coffee said. - Ron Orol

What Happened to Fiduciary Duty?, asks TCI

ailroad company CSX Corp. still refuses to seat two of four dissident director nominees, partly because the company hopes an appeals court ruling will disqualify a block of shares voted by the activist dissident investor Children's Investment Fund Management (UK) LLP.

But now the independent inspector of elections has put out its report detailing that four of five TCI nominees won election to the board at the company's June 25 annual meeting.

If the appeals court upholds the District Court finding that TCI violated securities laws, it could disqualify many votes TCI cast in favor of the dissident slate by "sterilizing" or disqualify the portion of shares TCI owned while it was allegedly in violation of the disclosure rules. In total, that means 6.4% of TCI's stake could be ruled ineligible.

That would mean dissident directors Christopher Hohn, TCI founder, and Timothy T. O'Toole would have lost the election. According to the inspector of elections, Hohn received 130,506,157 votes, edging out incumbent director Frank Royal, who only got 129,715,745, a margin of about 0.3%. Hohn would definitely not have won had 6.4% of his TCI stake been removed. O'Toole also won with less than 6.4%.

The court isn't likely to rule until September, with oral Arguments scheduled for Aug. 25.

CSX is betting that if the court decides to sterilize those TCI shares it will be easier to keep Hohn and O'Toole off if they are never seated in the first place than if they have to remove them from their seats retroactively.

But until the court acts, what happens to fiduciary duty to shareholders? Hohn and O'Toole could end up losing up to 20% of their term as directors. Will the two dissidents receive an extra few months at the end of their 12 month term if the court doesn't decide to disqualify the votes? Also, what about the two directors Hohn and O'Toole are set to replace? Are Royal and William Richardson off the board yet? - Ron Orol

Activist Labor Fund Wants Citi Split

A five-year-old effort to press for changes at Citigroup Inc. by a major activist labor union just went into high gear.

In a letter sent to Citigroup's board late Friday, shareholder the American Federation of State County and Municipal Employees, or AFSCME, said it wants the bank to complete a strategic plan that includes splitting the company into two units in light of its financial problems stemming from the subprime mortgage credit crunch. AFSCME director Richard Ferlauto says he doesn't want to dictate specific terms, but thinks Citigroup should divide its commercial banking division from its investment banking unit.

"We want to see Citigroup spin off its Citi Smith Barney division," says Ferlauto.

AFSCME's letter follows an effort by the labor union fund to have shareholders vote to remove Citigroup directors at the megabank's April annual meeting. According to Ferlauto, between 25% to 30% of shareholders voted against the re-election of some Citigroup directors at the meeting.

"This is a strong indication of unhappiness of the company's direction," Ferlauto says.

Additionally, Citi, which has lost roughly $54 billion due to the credit crisis, has already raised more than $40 billion of new capital mostly from sovereign wealth funds. - Ron Orol

InBev's Anheuser Proxy Contest: No Annual Meeting Necessary

When beer titan Anheuser-Busch Cos. set up its bylaws to allow shareholders to act by "written consent," it probably did not expect the measure would be used by a rival in a campaign to take control of the brewer in an expedited manner. But, in fact, that is exactly what appears to be happening with InBev SA's plan released Monday to use the measure to replace 13 board members, according to a Securities and Exchange Commission filing.

Some corporations permit written consent provisions in their bylaws because they want procedures in place to give investors the ability to quickly endorse debt refinancing programs in cases when shareholder approval is required for those actions. But having such a provision in place also makes the company vulnerable to dissident shareholders seeking to bring in their own director candidates.

Unlike most corporations, Anheuser-Busch has a bylaw provision permitting "written consent solicitation."

To employ written consent solicitations, the activist distributes proxy documents to other shareholders asking them to sign a card saying they want to vote their shares to remove certain directors from the board and replace them with candidates nominated by the dissident. Typically, if investors with more than half of the total shares outstanding vote to remove the incumbent directors, the activist wins and his nominees are installed on the board. The campaign is different from a traditional proxy contest because it does not take place on the day of the company's annual meeting. As a matter of fact, no meeting must take place for the consents to be approved and for the directors to be removed and replaced.

It's likely Anheuser-Busch set up its bylaws to permit written consent solicitations thinking its double-digit billion dollar stock market capitalization would discourage hostile bidders and proxy contests.

But after removing its classified board, it looks increasingly like Budweiser should have killed the written consent solicitation bylaw a long time ago. The majority of other public corporations already recognize why that bylaw shouldn't be in place. - Ron Orol

Insurgent Investor Mark Schwarz Isn’t Taking No for an Answer

After specialty property and casualty insurance company Specialty Underwriters Alliance Inc. rejected his Hallmark Financial Services Inc.’s $6.50 a share, or $115 million, bid to buy the company, Schwarz on July 1, Tuesday, sent a letter to the company’s directors outlining benefits of such a deal.

“Hallmark senior management stands ready to meet with members of the board to answer questions regarding the proposal,” Schwarz wrote in a letter attached to a Securities and Exchange Commission filing.

The specialty property and casualty insurance company last week rejected Schwarz’s unsolicited takeover bid. Schwarz owns 9.9% of Specialty Underwriters.

In the filing, Schwarz points out that his offer represents a 31% premium on the $4.96 a share Specialty Underwriters Alliance was trading at on Friday June 20, the last business day before the company made Schwarz’s offer public, Monday, June 23. Schwarz also argues that SUAI’s business model will be improved by the addition of Hallmark’s strong financial position. This transaction will allow SUAI shareholders to enjoy a much higher return on their pro-rata share of invested capital in a combined company,” Schwarz added.

Schwarz’s investment vehicle, Newcastle Partners is the controlling shareholder of Hallmark Financial. -- Ron Orol

TCI: Four of our Five Nominees Are Elected to CSX's Board

When a federal appeals court on Monday dealt CSX Corp. a major setback by refusing to block activist investor The Children's Investment Fund from voting its stock at the company's annual meeting, it was easy to see that a pending proxy contest between the insurgent investor and railroad operator could become messy. The meeting and proxy contest took place Wednesday, and it looks like the messy prognosticators were right.

TCI and another hedge fund were permitted to vote the disputed 6.4% of their 8.7% stake for their five-member slate of dissident candidates for positions on the company's 12-person board. Wednesday afternoon, TCI has issued a statement explaining gleefully that based on preliminary voting results, shareholders have elected at least four of their slate. The two sides are battling over the future of the railroad company and its operational and investment priorities.

However, the news from the CSX camp was very different: "The outcome of the election of directors at CSX's 2008 annual meeting of shareholders is too close to call at this time. The annual meeting will reconvene at 10 am ET on Friday July 25."

It's unclear at this stage exactly how close the election was, but CSX is likely banking on the possibility that the appeals court, the U.S. Court of Appeals for the 2nd Circuit in New York, will ultimately decide to "sterilize" or disqualify TCI's shares at some point down the road.

The court did provide for a middle-of-the-road type expedited hearing, leading observers to speculate that a ruling could come by August or September.

It's less likely, but a decision could still be made by the appeals court before July 25. Should the court decide to disqualify TCI's shares, the company could conceivably, retroactively, reinstall management-backed director candidates if they lost in Wednesday's election by a margin of less than 6.4% of TCI's 8.7% stake. That would be unprecedented, and many observers aren't so sure a recount would be permitted.

There is still a long way to go before the appeals court rules. It is weighing whether TCI violated securities laws by using the swaps to get around Securities and Exchange Commission disclosure rules. A lower New York district court ruled June 11 that that was exactly the case. The court already rejected CSX's petition to have TCI's shares disqualified at the meeting pending its ruling. It also rejected CSX's petition to have the whole court case expedited so that a ruling would have taken place before the annual meeting.

What the 2nd Circuit does now and when it does it are key questions that need to be answered. - Ron Orol

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

SEC, Swaps and Schumer

A battle over whether some activist hedge fund managers will be able to continue to sneak up on certain target corporations is being waged in the courts, the Securities and Exchange Commission and now even on Capitol Hill

Sen. Charles Schumer, D-NY, sent a letter June 17 to SEC Chairman Christopher Cox expressing his concern that no penalties or injunctions were connected to a district judge’s ruling on June 11 that activist investor, The Children’s Investment Fund, violated securities laws by forming a group with another investor, 3G Capital Partners, and not disclosing that partnership when it was required by SEC rules. (Schedule 13D rules).

The court also ruled that TCI used so called “cash settled equity swaps,” to get around SEC disclosure rules. Railroad operator CSX Corp., TCI’s target, argues that the violations did not give executives sufficient time to prepare for the incoming TCI campaign.

CSX, frustrated with the court’s decision not to issue a substantive penalty, is appealing it to the 2nd Circuit Court of Appeals. The railroad operator is seeking to have TCI’s 8.7% equity stake “sterilized,” so these shares can’t be voted in the proxy contest.

The court argues that it was hamstrung from giving CSX the relief it sought, leaving the issue of penalties to the SEC, which may not provide that relief.

Seeing that the SEC may remain mum, Schumer has decided to prod the agency a bit, while also taking matters into his own hands. In a letter to SEC Chairman Christopher Cox, Schumer said that legislation might need to be considered to make sure penalties are included with these kinds of rulings.

“I am considering introducing legislation to correct this gap in the law, and would be very interested in discussing potential remedies, including the implications of granting CSX’s request for voting rights sterilization and increased civil penalties, with the SEC,” Schumer wrote. “The uncertainty created by this ruling will likely have a detrimental effect on the financial markets.”

And Schumer isn’t the only lawmaker prodding TCI in favor of CSX. Five lawmakers including Sen. Evan Bayh, D-Ind., is chairman of the Senate Banking Committee's Security and International Trade and Finance subcommittee, are pushing the Committee on Foreign Investment in the U.S., an interagency panel that examines U.S.-foreign deals for national security threats, to review the deal.

That would be an unusual review.

Representatives from both CSX and TCI testified before Congress earlier this year. Having lawmakers on Capitol Hill respond to TCI’s insurgency looks like it’s becoming an integral piece of CSX’s response strategy. TCI might need to hire some Washington lobbyists before this all swaps out. -- Ron Orol

Dems and Hedge Fund Taxes

Hedge fund managers can take a big sigh of relief, but watch out for 2009. Legislation that would have eliminated a tax provision allowing some hedge fund managers to defer taxes on billions of dollars of compensation came close to passing the Senate Tuesday, but in the end it was blocked.

Sen. John Kerry, D-Mass., attached a deferred tax provision to a broader energy bill, all of which was rejected by a filibuster from Republican senators. The measure would, in a nutshell, make hedge fund managers pay taxes immediately on income that is now tax-deferred.

"This vote is proof positive that Senate Republicans are more interested in helping hedge fund managers avoid taxes than helping working families," Kerry said on the Senate floor.

And while Kerry and other Democrat lawmakers remain frustrated by the outcome, hedge fund lobbying groups assert that the end of the deferment would have stifled investment and hurt the liquidity that hedge funds provide to the markets.

Of course, should Democrats obtain or get near to a filibuster proof majority of 60 senators following the upcoming election, a similar rejection might be more difficult or impossible to achieve. A Senate with 58 Democrats would have an easier time convincing (or strong-arming) a couple Republicans to break ranks and back a bill. And if not, Senate Majority Leader Harry Reid, D-Nev., could offer a few "incentives" like a bridge to nowhere. - Ron Orol

Is Activist Hedge Fund TCI A National Security Risk?

The Committee on Foreign Investment in the U.S., an interagency panel that examines U.S.-foreign deals for national security threats, may just review the activist Children's Investment Fund's large minority stake in railroad operator CSX Inc. But it would be an unusual review, if CFIUS decides to take it on.

TCI, which is based in the U.K., together with 3G Fund LP, another investment fund, own an 8.7% CSX stake. The combo also has financial exposure to an additional 12.3% stake through "cash settled swap agreements" with eight investment banks. The funds are pressing CSX to find a buyer or complete a leveraged buyout.

The intergovernmental agency CFIUS has been under pressure from lawmakers, the public and pundits to review deals involving foreign companies gaining a "controlling interest" in U.S. assets that are well below a 51% stake. CFIUS recently went to great lengths to explain to dealmakers that "controlling interest" could mean a large minority stake, but it would have to look at each transaction on a case-by-case basis to figure out which stakes warrant a review. In other words, there is no minimum threshold below which CFIUS attorneys could count on to avoid a review.

CFIUS practitioners argue that the TCI investment in CSX fits the bill for a CFIUS review. They say the railroad operator falls under the interagency's purview as critical infrastructure because it ships hundreds of carloads of nuclear waste and services military installations. TCI's activist efforts to replace five incumbent directors on the company's 12-member board at its June 25 annual meeting along with its large minority stake could be enough to trigger foreign control.

In practicality, though, this review would be unusual because neither CSX nor TCI have any plans to submit an application to CFIUS for review. Typically, when a foreign company buys a U.S. asset, both companies decide to voluntarily submit a joint application for approval. In this case, CFIUS might send out messages that it wants both companies to submit applications. Since CSX and TCI are opponents, both parties would likely provide separate documents explaining their opposition opinions.

In any case, there is no way a CFIUS review would be completed before CSX's annual meeting.

There are some high-profile lawmakers pushing for such an examination. Sen. Evan Bayh, D-Ind., is chairman of the Senate Banking Committee's Security and International Trade and Finance subcommittee. He and five other senators want Treasury Secretary Henry Paulson to launch a review.

There is reason to make one important distinction regarding this insurgency. Many in Washington are pushing CFIUS to review deals involving sovereign wealth funds, the investment arms of foreign governments, which buy large minority stakes in U.S. assets. TCI is not a sovereign wealth fund, but rather it is an activist hedge fund, very much like the investment vehicles operated by U.S. investors such as Carl Icahn or Jana Partners' Barry Rosenstein , only TCI is operated out of the U.K. The insurgent's pre-eminent goal is for CSX to be sold or taken private. In either case, TCI cashes out with a profit, but most likely the railroad operator remains a U.S. entity by being sold to a U.S. railroad operator. If TCI gets its way and the company remains a U.S. entity, then any CFIUS review may not be warranted. - Ron Orol

Richard Breeden's Short Slates Usher In World of Activism

Former Securities and Exchange Commission Chairman Richard Breeden claims credit for the birth of the activist hedge fund movement. Breeden, who is chairman of the activist hedge fund Breeden Partners LP, may have a point.

Other regulators have done things to give activists leverage, but under Breeden's chairmanship, the agency did three things in 1992 that transformed the way activist fund managers operate today. (He was chairman during President George H.W. Bush's administration between 1989 and 1993.)

He approved rules freeing up communications among investors to talk about performance issues at companies of which they were stakeholders.
Under Breeden the commission also adopted executive compensation disclosure rules, which were the precursor to updated CEO pay regulations approved under SEC Chairman Christopher Cox.

Probably the most important change under Breeden involved the "short slate" regulation that allowed fund managers to nominate one or two candidates to a company's board rather than replace the whole slate of directors, or in cases of staggered boards, all the nominees up for election. "The only options before the short slate rule was the Wall Street walk or replace the whole board," Breeden told The Deal. "That is, leave, abandon your interests and give up in frustration or take control of the business. Shareholders had the atom bomb, but they didn't have anything as a lesser remedy to fix the situation."

Breeden added that frequently smaller changes to the board are necessary: "Too many boards have static membership. People burrow in, and maybe they were great directors in the first five years of their tenure, but in years 16, 17, they don't tend to be as involved as they might once have been," he said. - Ron Orol

Change Wants Broker Votes Out at WaMu

A large activist labor-backed institutional investor just isn't satisfied with Washington Mutual Inc.'s Kerry Killinger's decision to step down as board chairman at the country's largest savings and loan. CtW Investment Group, an organization that advises pensions for unions belonging to the Change to Win labor group, wants more.

Sure, CtW is excited that Killinger announced Monday that he will resign from his chairmanship position -- though he remains at WaMu as CEO. And it's also happy that WaMu director Mary Pugh, president of investment firm Pugh Capital Management, resigned from the WaMu board in April. But, it is still peeved that two directors on the WaMu board, James Stever and Charles M. Lillis, remain on the board. Both WaMu directors had been the target of a "just vote no" campaign orchestrated by the labor union fund.

At the WaMu annual meeting April 15, company tallies showed that 41% of shareholders opposed Stever's renomination, and 41% opposed Charles M. Lillis, a director who was targeted by another union-backed pension fund. But CtW, estimated that by counting only votes of actual shareholders, the tally for removing 50.9% for Stever and 51.2% for Lillis.

"The vote to name an independent chairman excluded uninstructed broker votes, but the disputed re-election of directors James H. Stever and Charles Lillis may have resulted from the inclusion of these phantom votes," said CtW Investment Group research director Richard Clayton in a statement. "The board needs to disclose whether Stever and Lillis received a majority of votes cast by shareholders and to request the resignation of any director who did not."

CtW asserts that Lillis and Stever were put over the top because of so-called broker nonvotes, also known as broker discretionary votes. For clients who never indicate how to vote their shares, stockbrokers are permitted to cast ballots for them in "routine matters," such as uncontested director elections, as the brokers see fit. Critics deride this practice as corporate ballot stuffing, because brokers typically back management initiatives. For CtW, the broker-nonvote issue is particularly relevant because WaMu has a majority vote policy in its corporate governance guidelines.

Paulson to the Soveriegn Rescue

Treasury Secretary Henry Paulson is taking his pro-investor message on the road to the Middle East.

On Monday he told participants in the U.S.-U.A.E. Business Council in Abu Dhabi that the U.S. is "open" to investments from sovereign wealth funds, the investment arms of governments mostly located in Asia or the Middle East.

"As we seek to open new markets abroad, America will keep our markets open at home to investment from private firms and from sovereign wealth funds," Paulson said. "We reject measures that would isolate us from the world economy."

Paulson's remarks come as some lawmakers in Washington raise concerns about possible political motivations of sovereign fund investment in the U.S. A small group of lawmakers in Washington, including Rep. Frank Wolf, R-Va., question whether sovereign funds, which recently made major investments in U.S. investment banks, could use those stakes as leverage for political goals down the road.

One key sovereign fund is based in Abu Dhabi, where Paulson made his speech. The Abu Dhabi Investment Authority reported a $7.5 billion investment in Citigroup Inc. in November. According to Paulson, that fund has taken a "constructive role on this important issue."

Paulson did temper his pro-investment comments by referring to an effort underway by the International Monetary Fund to develop a set of best practices for these funds. The IMF plans to make these recommendations, which are expected to require increased transparency and disclosure of decision-making plans and investment positions, by this fall.

"We are trying to quell calls for restrictions by urging sovereign wealth funds to endorse best practices to create a dynamic rise to the top and help allay concerns about opacity and systemic risks," Paulson said.

That may not ally fears of some lawmakers, who argue that codes of conduct and transparency will not discourage sovereign funds from making politically motivated investment decisions.

Expect more details about Washington's point of view on sovereign funds when Reps. Jim Moran, D-Va., and Tom Davis, R-Va., speak about the "Implications of Sovereign Wealth Funds for American Interests and U.S. Policies," at a National Council on U.S.-Arab Relations event on June 5. The two lawmakers, who are members of a House task force on sovereign funds, have just returned from a visit to meet sovereign fund managers and government officials in Abu Dhabi, Cairo, Dubai and Saudi Arabia, as part of an internal investigation. - Ron Orol