July 14 (Bloomberg) -- TCI scrapped a bid to double its stake in J-Power, ending a six-month tussle with the Japanese government, in a setback to the U.K. hedge fund's efforts to boost shareholder returns in the world's second-largest economy.

The Children's Investment Fund Management (UK) LLP, as the fund is officially known, will not pursue a ``lengthy judicial process'' by taking the government to court for rejecting the bid, it said in an e-mailed statement today. The fund, with about $10 billion in assets, added it doesn't rule out the possibility of re-applying to increase its stake.

TCI will ``continue in its quest to improve corporate governance at J-Power,'' it said in today's statement.

The government blocked TCI's bid on May 13, ordering the fund to withdraw a request to double its 9.9 percent stake in Japan's biggest power wholesaler, officially known as Electric Power Development Co. The order marked the first time Japan has invoked a law to prevent overseas acquisitions of more than 10 percent in companies within industries deemed vital to national security, including arms makers and utilities.

Trade Minister Akira Amari and Finance Minister Fukushiro Nukaga argued TCI's acquisition could threaten Japan's power supply and nuclear policy.

Process `Flawed'

TCI had until today to notify the government whether it would challenge the decision in court. While deciding against a challenge, the fund called the state's decision-making process ``flawed by erroneous fact-finding, unsound economic reasoning, misinterpretations of law and a lack of transparency.''

J-Power dropped 3.9 percent to close at 3,950 yen on the Tokyo Stock Exchange, compared with a 0.4 percent decline in the benchmark Topix Index. The shares have declined 15 percent in the past year.

J-Power, the sole operator of a transmission grid linking all four of Japan's main islands, plans to build its first nuclear power plant in the northern prefecture of Aomori. The reactor will be the first in Japan to use only reprocessed nuclear fuel. The utility won state approval in April for the 1,383-megawatt project.

Resource-poor Japan is pushing nuclear-fuel reprocessing, a technology that allows the reuse of spent nuclear fuel, to ensure energy security. The country, which imports almost all of its oil, aims to increase nuclear energy to more than 40 percent of total power output in a bid to reduce emissions of greenhouse gases that are blamed for global warming.

Proxy Fight

TCI's decision not to contest the government's rejection caps a series of defeats by the fund in its effort to raise corporate governance standards at J-Power.

During a proxy battle with the utility's board, TCI repeatedly called on J-Power to increase shareholder return and reform corporate governance. The shareholders rejected all five proposals by TCI at their annual general meeting on June 26, including doubling the annual dividend and limiting cross- shareholdings.

The rejection comes as Japan's appetite grows for investments by hedge funds and sovereign wealth funds to keep its economy growing. Foreign investors including the California Public Employees' Retirement System have urged Japanese companies and lawmakers to improve corporate governance and increase management transparency.

Last week, the government said in a report Japan should adopt measures to attract more of the almost $3 trillion managed by sovereign wealth funds and privately run pools of capital.

``Nothing has changed with our trade policy, aimed at making Japan a more open market and promoting overseas investment,'' Harufumi Mochizuki, the country's vice trade minister, said today. ``In TCI's J-Power bid, we've found a national security issue, and our rejection of the proposal was an exceptional case.''

To contact the reporters on this story: Tomoko Yamazaki in Tokyo at tyamazaki@bloomberg.net; Shigeru Sato in Tokyo at ssato10@bloomberg.net

Last Updated: July 14, 2008 04:12 EDT