Hostile Territory

What began as a nasty power struggle between the activist hedge fund Children’s Investment Fund (UK) and its latest target, U.S. railroad group CSX Corp., has escalated into an ugly court battle with potentially far-reaching consequences. If CSX prevails, activist investors everywhere may have to rethink strategies for seizing control of corporate boards.

TCI’s campaign against CSX started in October, when Christopher Hohn, the hedge fund’s 41-year-old founder and managing partner, went after the CSX management team, including CEO Michael Ward. In a letter to the CSX board, Hohn accused Ward and his team of being undisciplined spenders who didn’t understand the economics of the business.

In December, London-based TCI banded with such like-minded investors as New York–based 3G Capital Partners to nominate five directors, including Hohn, to the rail company’s board.

Unbowed, CSX sued TCI in the U.S. District Court for the Southern District of New York on March 17. The complaint alleges that TCI and 3G violated securities regulations by using swaps and swap arrangements to build up a stake in excess of 5 percent while avoiding outright stock purchases, thereby evading Securities and Exchange Commission filing requirements.

According to the suit, Snehal Amin, a partner in TCI, told CSX executives in February 2007 that “TCI owned 14 percent of CSX,” ten months before the firm disclosed to the SEC that it had a position in the group, instead of within ten days, as required by law.

CSX, which is based in Jacksonville, Florida, and operates an extensive network of freight lines and port connections in the eastern U.S., asserts that TCI and 3G used “sophisticated derivative transactions” and secretly conspired “to change or influence control of CSX by acquiring a large stake in CSX while evading the reporting requirements of the securities laws.”

Not to be outdone, TCI this month filed a counterclaim categorically denying the allegations and asserting that the rail company had sought to prevent shareholders from “even considering proposals that would strengthen CSX’s corporate governance procedures.” It added that CSX directors had gone “to extraordinary lengths to entrench themselves in their current positions,” including withholding information from shareholders and “enriching themselves by setting certain ‘spring-loaded’ stock grants for insiders while in possession of material nonpublic information.”

Both sides declined to comment. CSX shareholders will have much to consider when electing new directors in late June.