How to Beat Hedge-Fund Bullies

Hedge funds often push company management around. But they may not be as tough as they seem.

Activist hedge funds are an intimidating lot.

There are many examples of the chaos a demanding hedge fund can create when a company refuses to bend to its wishes. For instance, the $8 billion hedge fund Atticus Capital, a 10 percent shareholder in Phelps Dodge last year, was a thorn in the copper miner’s side for most of 2006 as it urged a stock buyback and opposed Phelps’s proposed acquisition of Inco.

Investor pressure on corporate management is nothing new; activist hedge funds are a new twist on the corporate raiders of the 1980s. Today, they use their stakes to pressure management for dividend payouts, buybacks, and other actions. And, increasingly, hedge funds have been leveraging their power even further by using borrowed shares to change the outcome of shareholder votes. Such “empty voting” is certain to result in regulatory action, Securities and Exchange Commission chairman Christopher Cox told The Wall Street Journal on Friday.

But company management — particularly finance executives — face a more subtle problem: What if hedge funds simply claim they have a controlling stake — borrowed or otherwise — to make demands of management? Or what if they tell management they are ganging up with other hedge funds? Short of waiting for a hedge fund to make good on its threat in a shareholder vote, how does management know whether a fund’s claim to stock ownership, or the power to sway votes, is truthful?

“In my experience, people that claim they have the power to bring a certain amount of shareholders’ votes often don’t have any formal arrangements, or they’re not even telling the truth,” comments Richard Rowe, a partner in law firm Proskauer Rose.

Figuring out whether a hedge fund really controls the shares it claims to can be a challenge for a company. If not stymied by the lengthy deadlines for filing after-the-fact notices of beneficial ownership forms with the SEC, companies also face the problem that hedge funds often do not hold stock in their own names, but rather in the name of their broker, usually one of the large brokerage firms, industry observers note.

The SEC requires different ownership forms to be filed when anyone reaches certain shareholder milestones in a public company. For example, anyone that acquires more than 5 percent of a firm’s equity and intends to be an active investor must file Schedule 13D with the SEC and the issuer within 10 days, notes Adam Gale, an attorney at Orrick, Herrington & Sutcliffe. The detailed form reveals the purpose of the acquisition and other related contracts, such as hedging contracts.

But there are many ways for hedge funds to foil such scrutiny. For example, say a hedge fund manages more than $100 million in equities: it must file Form 13F — which discloses its equities ownership — with the SEC on a quarterly basis, within 45 days after the last day of each quarter. But a hedge fund can hide its identity by requesting confidential treatment from the SEC to protect its investment strategy, says Gale, who notes that such treatment is difficult to obtain.


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