(Adds Schumer and SEC quotes, background on CSX case)
WASHINGTON, June 17 (Reuters) - Legislation might be needed to impose stiffer penalties against hedge funds that improperly conceal their corporate holdings through the use of equity swaps, a senior member of the Senate Banking Committee said on Tuesday.
New York Democrat Sen. Charles Schumer urged the U.S. Securities and Exchange Commission to clarify what is required of equity swap holders who seek to influence the voting decisions of their counterparties.
Schumer said in a letter to SEC Chairman Christopher Cox that he was “disturbed” that a federal judge ruled last week that two investment firms waging a proxy battle at railroad CSX Corp CSX.N violated securities law in acquiring large stakes in the rail company, but did not impose any significant penalties.
“The uncertainty created by this ruling will likely have a detrimental effect on the financial markets,” Schumer said in the letter.
“We certainly share the senator’s interest in a clear and consistent application of our rules regarding the disclosure of significant ownership of a public company,” said SEC spokesman John Nester.
The judge ruled last week that The Children’s Investment Fund Management and 3G Capital Partners deliberately evaded disclosure obligations as they sought to control CSX for more than a year, but he allowed them to continue their proxy fight at the upcoming annual shareholder meeting.
The judge ruled that the two funds violated securities law by planning to avoid making disclosures on beneficial ownership of shares amassed in swap positions and did not promptly disclose that they had formed a “group” of investors.
SEC staff had weighed in earlier this month, saying it disagreed with CSX’s interpretation of disclosure rules around equity swap transactions. The SEC official said the swaps were not sufficient to create beneficial ownership under federal securities laws.
Schumer said on Tuesday that it was essential for the SEC to clarify the treatment of how equity swaps must be disclosed.
He said there is little incentive for investors to adhere to disclosure requirements if there is no serious penalty for violators.
“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 said in the letter. (Reporting by Karey Wutkowski and John Poirier; editing by Maureen Bavdek)