Hedge Funds Everywhere!

by
William Krehm

It is no accident that hedge funds that used to walk on gum-shoes with great discretion, suddenly seem to be all over the globe taking control. That is more than an illusion. With conventional banking on the defensive or worse under the burden of its subprime collateral debt-based assets, the very banks have become enticing victims for the huge funds to take over. Too often immobilized by their greed of yesteryears, the banks are unusually exposed to aggressors, who can spin a web of helplessness around their victims as a spider does his net. And with the latest derivative techniques of swaps, it is easy for hedge funds to disarm their victims. For indebted corporations unable to cash in their subprime assets, need money so badly to keep their creditors at bay. The strategists of the larger hedge funds, deliver a piece of the ensnared victim as bait for further partners with a far greater readiness than the victim can raise the means of mounting a defense. Contracts can be rewritten, purchase prices lowered, options on future shares imposed, while the travesty of the victim consenting when the bailiffs is on his way is cruel and ludicrous.

Nothing is too big for the larger and more unscrupulous hedge funds to attempt, and up to now get away with. However the resistance seems to be beginning.

The Wall Street Journal (13/06, “CSX Scores Partial Victory” by Dennis K. Berman and Peter Eavis): “A federal judge found that two hedge funds had consciously avoided securities laws in their proxy battle with railroad CSX Corp., in a decision that stands to reshape how activist investors move on their corporate targets.

“New York District Judge Lewis Kaplan rebuked the two funds, the Childrens Investment Fund [that does sound innocent!] and 3G Capital Partners, saying they sought to justify their actions on the basis of formalistic arguments, even when they had defeated the purpose of the law.

“The decision gives ammunition to CSX as it wages the waning days of a bitter proxy fight against 3G and TCL, one of Europes best known activist hedge funds. He found that the two funds had together plotted a bid for control of the railroad, but consciously, and illegally, failed to disclose their intentions.

“But it was not a total CSX victory, as Judge Kaplan grappled with how to punish the two funds. He said it was too late to reverse their actions, and that he was legally prevented from sterilizing or neutralizing the votes when shareholders choose a board of directors June 28. Instead. the funds were permanently enjoined from making future violations.

“The CSX case has been closely monitored by hedge funds, which were fearful that Judge Kaplan would take away some of their tools for acquiring big stakes of companies. They were especially fearful that he would take a skeptical view of swaps, which allow shareholders to create a kind of synthetic stock via private contracts with large Wall Street firms. These synthetic shares trade in tandem with a companys real shares, allowing a hedge fund to post economic gains without filing share-ownership reports required by securities law.

“Such arrangements have been legal for decades. Last week the Securities and Exchange Commission said it was largely alright with swaps, as long as they were not used to disguise takeover intentions.”

“Still Judge Kaplan found that TCI and 3G used the swaps in a way that consciously allowed them to build a position while delaying such disclosure to the broader stock market. The swaps hung like the sword of Damocles over the neck of CSX. Viewing these swaps as anything but regular shares owned outright, failed to take account of the practical realities of the world, and would be opened to the gravest abuse.

“Challenging the SEC?

“Judge Kaplan appeared to take the SEC head on, saying that its views on the swaps generally exalts form over substance.

“I think it is a big deal because there wasnt a whole lot of legal precedent in this area, said Nicolas Morgan, partner of DLA Piper. Gilbert Lamphere, one of the two people nominated by the two hedge funds for a seat on CSXs board, insisted that the funds acted properly and did it all according to the book.

“We always did what counsel said the SEC said we should do, said Mr. Lamphere, a former railroad executive who now runs Lamphere Railway Management, a private investment firm. So the question is, Whats the big deal? We didnt do anything wrong. A spokesman for CSX said that the Courts ruling speaks for itself.”