Canada: CSX Decision Raises Disclosure Issues Concerning Derivative Instruments

Swaps and other derivative instruments have evolved to facilitate a variety of investment strategies with respect to a single security. The bundle of rights associated with a single share can be "unbundled" in different ways through the use of these derivative instruments. For example, investors can acquire economic exposure to a security without owning the security or even having the right to acquire it, or can hedge their exposure to a security without having to sell.

Derivative trading has for a long time figured prominently in contests for corporate control. Investors in these transactions value the ability to move quickly in and out of a large position without much market awareness of their activity.

Many of the rights acquired under derivative instruments do not fit clearly within existing categories for disclosure under the securities laws in the United States or Canada. Recent decisions in both the U.S. and Canada, however, signal that instruments previously thought to be outside of the disclosure regime may be disclosable in contests for control, or possibly if used to avoid reporting requirements in other contexts

In its 2006 decision in Sears,1 the Ontario Securities Commission noted that if swaps were used to "park securities" in the context of a take-over bid, in a deliberate effort to avoid reporting obligations and for the purpose of affecting an outstanding offer, this could constitute abusive conduct sufficient to engage the Commission's public interest jurisdiction.

More recently a U.S. federal court in New York was asked to address these issues in the context of a proxy battle for rail company CSX Corporation. This commentary discusses the facts before that court and the basis for the court's findings that a disclosure obligation existed.

CSX Decision

Facts and Findings

The CSX2 decision released in June 2008 involved a complaint by CSX Corporation against two large hedge funds (The Children's Investment Fund (TCI) and 3G Capital Partners) that initially acquired interests in CSX stock by entering into cash settled "total return" swaps. The case focuses on the use of the swaps to obtain significant market power, without disclosure, over a year before the funds launched a proxy fight for five out of the 12 positions on the CSX board.

The swaps in question gave the hedge funds the economic exposure to the CSX stock, but no ownership of the stock or any right to acquire it. The court found, however, that the bank or other financial counterparty to a large total return swap almost always hedges its position through a matching purchase of shares. In addition, the court noted that, at least in large swap transactions, it was easy for the "long" party (such as the funds) to close out the swap position by acquiring the underlying shares. Thus, the contracts enabled the funds to accumulate a substantial economic position (eventually over 14 percent of the outstanding stock in the case of TCI) through the swaps but to avoid market awareness of their position until they were ready to publicly announce their intentions with respect to the stock.

Using the anti-avoidance principles of Rule 13d-3(b) under the Securities Exchange Act of 1934 (the "Exchange Act"), the CSX court found that the funds had acquired beneficial ownership of the CSX shares through the use of the total return swaps. Accordingly, the funds should have reported their interests in the CSX stock over a year before the proxy fight was commenced. As all the material facts were eventually disclosed, however, the court did not prevent the funds from continuing the proxy battle or voting their shares.


Prior to the CSX decision, the prevailing view was that a total return swap that called for cash settlement did not confer reportable "beneficial ownership" under Section 13(d) of the Exchange Act because it did not give the "long" party the right to vote or dispose of any actual shares. This was in effect the view expressed by the staff of the U.S. Securities and Exchange Commission in a letter addressed to the court. As the funds argued, there was no obligation, just a financial incentive, for their counterparties to purchase shares to hedge the total return swap.

Ultimately, the CSX court declined to rule as to whether, in the abstract, a cash-settled total return swap creates beneficial ownership for purposes of Section 13(d). Instead, the court relied on the anti-avoidance provisions of Rule 13d-3(b) to conclude that, in this particular case, the funds had acquired beneficial ownership for the purpose of the rule because they had used the total return swap to evade the reporting requirements of Section 13(d).

Critical to the court's decision was the fact that the funds appeared to be planning a proxy fight and acting as significant shareholders of CSX long before they acquired more than their swap positions. Moreover, the funds appeared to have structured the swaps deliberately to avoid reporting requirements. For example, the court noted that the hedge funds had originally spread their positions among counterparties to ensure that no counterparty acquired more than five percent of the stock (the reporting threshold for Section 13(d)), and then later consolidated their positions in the hands of a few counterparties who were thought to be likely to vote in favor of the funds' proposals. It was therefore the motives of the two hedge funds which were at issue – rather than the instruments themselves.

What Does the CSX Decision Mean

The CSX decision raises potential issues for holders of derivative instruments. Although the court confined its comments largely to the specific facts before it, its findings (unless overturned on appeal) will require derivative investors to look closely at their intentions with respect to the issuer of the underlying securities and to be sensitive to the potential need to file under Section 13(d) in situations where a filing was not thought to be necessary.

Regulatory change could also be on the horizon. As noted by the CSX court, disclosure of certain derivative positions is required in the United Kingdom. It is also possible that the U.S. Securities and Exchange Commission will review this issue, possibly in conjunction with proxy access proposals in 2009. The Ontario Securities Commission is actively studying the issue.

Issuers are also now considering what action they should take to deal with parties who hold interests in their securities through derivative instruments. For example, in the United States, a few companies have already amended their poison pills to include derivatives when calculating levels of beneficial ownership that would trigger the pill.


1. Sears Canada Inc., Re, 22 B.L.R. (4th) 267 (Ontario Securities Commission, August 8, 2006).

2. CSX Corporation v. The Children's Investment Fund et al. (U.S. District Court for the Southern District of New York, June 11, 2008).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

In association with
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.


Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.


Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.


A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.


This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.


If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.


This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at and we will use commercially reasonable efforts to determine and correct the problem promptly.