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A Different Perspective on CSX/TCI: Should Courts Reject a Private Right of Action Under Section 13(d)?

By Harvard Law School Program on Corporate Governance

While the bulk of the commentary about last week?s CSX/TCI opinion has focused on the requirement for disclosure of derivatives under the Williams Act, the hedge fund defendants missed a great opportunity to attack the odious practice of management using shareholder money to sue a dissident on any pretext in order to entrench itself.

Generally, courts have been getting tougher on implied rights of action and especially so in securities lawsuits. In meVC Draper Fischer Jurvetson Fund,Inc., v. Millennium Partners, 260 F. Supp. 2d 616 (S.D.N.Y., 2003), Judge Sand, citing Alexander v. Sandoval, 532 U.S. 275 (2001) and Olmsted v. Pruco Life Ins. Co. of New Jersey, 283 F.3d 429 (2002) ruled that there is no right of private action section under section 12d(1)(A) of the 1940 Investment Company Act. It dismissed prior cases finding a right of private action as belonging to an ?ancient regime.? A similar finding was made by the Third Circuit in a lawsuit brought under the Postal Reorganization Act, Wisniewski v. Rodale, Inc., 510 F.3d 294 (3rd Cir., 2007). The Wisniewski court ruled that after Sandoval a private right of action under a federal statute may be implied only if the court determines that Congress intended to create (1) a private right and (2) a private remedy.

I see no way that a court can find a principled distinction with respect to a private right of action between section 12d(1)(A) of the 1940 ICA and section 13(d) of the 1934 Act. At a minimum, after Sandoval in 2001 the issue of standing for 13(d) claims is certainly fair game. There is no ?rights creating? language in either law that would support a right of private action by a supposedly aggrieved company.

Of course, unless a defendant raises the issue, I wouldn?t expect any judge to do it on his own. In the CSX case, the hedge fund defendants blew it and Judge Kaplan perfunctorily noted in passing that there is an implied right of private action under section 13(d) based on pre-Sandoval precedents based on the premise that the ?congressional purpose was furthered by providing issuers with the right to sue ?to enforce [the] duties created by [the] statute.?? However, in dismissing one counterclaim for proxy fraud, Judge Kaplan indicated he was well aware of CSX?s real motive:

CSX?s Purposes in Bringing this Lawsuit

CSX?s March 17, 2008, press release quotes Mr. Ward as saying that ?[CSX] filed this suit . . . to ensure that all of our shareholders receive complete and accurate information.? Defendants argue that this statement is materially false and misleading.

Speaking bluntly, this contention does not warrant a serious response. If the American people do not know that not every protestation of high motive, made in a contested election, can be taken literally, there is not much hope for any of us.

This realistic observation shows why courts should reject a private right of action in 13(d) cases. They are invariably brought by a management that is under siege for the purpose of fending off a dissident and retaining control of the company. Just look at the relief sought. It is always draconian — to sterilize the votes of the dissident and/or to prevent the dissident from soliciting or voting proxies. This effort to frustrate a shareholder vote is an abuse of the law?s intent as well as a breach of fiduciary duty.

One can always justify private lawsuits to enforce any law as furthering that law?s legislative purpose. But, imagine the abuses that policy would allow without considering the costs. If I have a dispute with my neighbor about leaving his junk on his lawn, should I be able to pressure him to remove it by suing him because he does not have a valid safety inspection sticker on his car? I have no problem with issuers complaining to the SEC about alleged violations of securities laws (or a neighbor complaining to the DMV that my car inspection has expired). But, unless the law specifically allows for private lawsuits, the decision as to whether the public good is served by bringing an enforcement action (or perhaps simply asking the alleged violator for corrective action) should be determined only by the SEC, not by the management of a company faced with a proxy fight which invariably has an ulterior objective.

Thus, with respect to 13(d) lawsuits, limiting enforcement authority to the SEC is both good law and good policy. We just need some defendant to raise the issue.

Full post as published by The Harvard Law School Corporate Governance Blog on June 16, 2008 (boomark / email).