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Apr 13, 2021

Justice Department urges regulator to nix CP Rail share swap ahead of merger

Very encouraged by response to Kansas City Southern deal: CP Rail CEO

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The U.S. Department of Justice urged the regulator that oversees rail mergers to keep Canadian Pacific Railway Ltd. and Kansas City Southern from combining their shares before their proposed merger and said it might intervene further in the review of the deal.

In a letter to the Surface Transportation Board, which oversees U.S. railroads, the Justice Department also called for using the tougher standard adopted in 2001 for mergers in the industry. That standard requires that mergers be in the public benefit and enhance competition.

Kansas City Southern was exempted from this higher standard at the time, in part because it was the smallest of its class of railroad in the U.S. CP has said the exemption should still apply to Kansas City Southern.

Unlike in most industries, in which the Justice Department can block deals, the Surface Transportation Board, or STB, has final word on railroad mergers and the department’s advice is non-binding. However, a major rail merger in the U.S. hasn’t been completed in more than two decades, which creates some uncertainty over how closely the two government entities will work together.

The department only has an advisory role, “but it will likely carry some influence with the STB throughout the entire process,” Brian Ossenbeck, an analyst with JPMorgan Chase & Co., said in a note to clients. Approval of the share transaction that was expected by the end of May “appears less likely after the DoJ comments.”

The letter shows the Justice Department might seek to take a more active role regarding Canadian Pacific’s move to acquire Kansas City Southern for US$25 billion.

The department said it had a “statutory right to intervene” in merger proceedings for large railroads, adding that it doesn’t yet have a view on this deal in particular. The department asked the STB “to ensure that the parties do not take any action that would undermine the Board’s ability to conduct a meaningful review.”

The railroads, which have said the transaction will be beneficial to shippers because their networks don’t overlap, proposed a voting trust to allow Kansas City shares to be exchanged for US$90 and 0.489 of a CP share before the transaction is approved. CP and Kansas City will operate separately until the regulator signs off, the railroad operators have said.

The Justice Department argued against such a share transfer in its letter, which was posted on the STB website. Kansas City Southern shareholders would have to wait as much as 17 months longer to receive payment if the voting trust is shot down, Ossenbeck said.

“The board should rarely, if ever, permit the parties to a proposed merger to use a so-called ‘voting trust’ to effectively consummate an acquisition before the board has had an opportunity to consider whether the combination would harm competition,” the department said.