(The following story by Susan Kitchens appeared at Forbes.com on June 18.)
NEW YORK — The grown-ups are siding with the children. Children’s Investment Fund and its ally 3G Capital Partners have acquired a valuable backer in their bid to gain influence over railroad company CSX, with a major proxy advisory firm endorsing their slate of four candidates for the company’s 12-member board.
The funds said Tuesday night that Risk-Metrics ISS Governance has come down on their side, following a court victory that allowed them to vote shares that they acquired through less-than-straightforward means. The announcement came shortly after CSX asked shareholders to ignore the hedge funds’ attempt to sway the proxy vote. (See ” CSX Implores Shareholders Not To Play Children’s Game”)
In March, CSX sued the funds, asserting that they should not be able to participate in an upcoming proxy vote. The railroad claimed they had violated U.S. Securities and Exchange Commission disclosure rules in order to secretly amass an interest of more than 5.0% in the company. That’s the level at which the SEC requires investors to publicly disclose their stakes in a company. But the funds employed the use of derivatives known as total return swaps to build up a 14.0% economic interest in the railroad concern. The SEC doesn’t require investors to disclose derivatives holdings.
Last week, Judge Lewis Kaplan found that the funds had, indeed, violated SEC disclosure rules. But based on earlier rulings, he said he could not prevent them from voting in the June 25 election. CSX has appealed the decision.
On Wednesday, CSX condemned RiskMetrics’ ISS’ decision. “RiskMetrics has inexplicably chosen to second-guess the U.S. District Court for the Southern District of New York,” it said, after finding Children’s fund principals “testified falsely in many respects” and “violated securities laws in connection with CSX.”
“In addition to trivializing the court’s findings and applying its own governance standards, RiskMetrics gave little weight to CSX’s outstanding performance and governance,” CSX said, claiming it was first or second among large U.S. railroads “in all key recognized performance measures.”
Neither the Children’s Investment Fund nor 3G were available for comment. But on their website, the funds give their rationale for the fight: “In CSX, we see the potential to be the leading railroad in the United States—providing the best service, running the safest network, generating the highest returns, and being able to meet America’s freight transportation needs now and in the future.” Instead, the firms say, CSX last year was average or below average versus its peers on “nearly every major metric of performance.”
According to the website, CSX’s operating expenses as a percentage of sales at 77.6% lags competitors Canadian National (nyse: CNI – news – people )’s 63.6% and Norfolk Southern (nyse: NSC – news – people )’s 72.6%. It also says CSX’s trains are less efficient than those of the two competitors. The trains, the funds say, sit around for an average of 23.3 hours, versus 12.5 hours for Canadian National and 21.8 hours for Norfolk Southern.
In its analysis, ISS said that based on CSX’s “lagging operational performance” and “the dissident nominees’ track record, skill sets and experience,” it recommends that shareholders support the hedge funds’ four nominees.
The nominees are Alex Behring, head of 3G and former chief executive of Latin America’s largest railroad and logistics company; Children’s Investment Fund manager Christopher Hohn; Gilbert Lamphere, a former director of Canadian National Railway; and Timothy O’Toole, managing director of the London Underground.
The Children’s Investment Fund, headquartered in London, gives a portion of its profits to a non-profit organization focused on improving the lives of children living in impoverished countries.
Adding insult injury, investors bid up CSX stock on a day the rest of the stock market was sharply lower. That indicated shareholders were not displeased by the latest turn of events. In afternon trading, CSX rose 1.6%, or $1.03, to $64.41.