Hedge-fund Bullies

Activist fund managers can be brutal, but there are ways to fight back.

If the Fox Network were ever to launch American Business Idol, Robert Chapman would be its Simon Cowell. The activist hedge-fund manager and founder of Chapman Capital once called the 78-year-old chairman of a target a “helpless Mr. Magoo–like figure” and referred to its CEO as “the dummy” in a 13-D filing. He called former executives at Vitesse Semiconductor “the Three Stooges.” And he once provoked the CFO of Embarcadero Technologies to swear at him and then recounted the incident, profanity included, in a Securities and Exchange Commission filing.

His actions can be just as aggressive as his words. He sometimes uses private investigators to dig up dirt on managers. Last year, Chapman demanded that Embarcadero put itself up for sale and threatened to publicly reveal the results of a probe of the board and executive team if the company did not oblige.

Chapman is one of a new breed of corporate raiders — hedge-fund activists who instill fear in managers of underperforming companies. Unlike the raiders of the 1980s, who generally took controlling interests in their targets, activist hedge funds take relatively small positions in companies and seek to impose their will by pursuing a few seats on the board and agitating for change. Their aim is to boost the stock price by pushing for a strategic move such as a spin-off, sale of assets, a large buyback or dividend, or a change in management. They can make life miserable for CFOs and other executives as they promote their agendas.

Some of their names are familiar: Carl Icahn and Nelson Peltz are among the most active. But a new group of hedge-fund managers, like Chapman, are garnering a reputation as aggressive, but effective, gadflies. Ralph Whitworth and David Batchelder, co-founders of Relational Investors LLC, are credited with shaking up Home Depot and ousting CEO Bob Nardelli. Batchelder, who forced his way onto the board in February with a measly 1 percent of the shares, claims his firm wasn’t entirely responsible for the CEO’s departure: “We showed up just in time to yell ‘timber’ on the Nardelli firing,” he told a group at the Milken Institute Global Conference in April. “The board was already working on it.” Relational Investors seems to be just as proactive in its dealings with Sprint Nextel, taking a 1 percent stake and pushing for a slowdown in capital spending and a possible sale of the company’s long-distance business.

In most cases, activist investors like to operate behind the scenes, working with management to encourage a change at the company. “Our goal isn’t to get into a fight,” says Phillip Goldstein, the managing member of activist hedge-fund firm Bulldog Investors. “It’s to try and make money.” Activist investors prey on underperforming companies that, in their view, aren’t living up to their full potential. And when one hedge fund moves in, other funds smell blood and quickly follow.

When discretion fails, some activist hedge funds will take their cases directly to the public, where their outcries can embarrass corporate management teams. In May, for instance, Icahn took out a full-page ad in the Wall Street Journal to print an open letter asking Motorola shareholders to vote him onto the board of directors. In the letter, he pilloried Motorola management for “a critical failure in oversight and leadership.” Other companies that have been the target of activist hedge funds include Wendy’s, H.J. Heinz, McDonald’s, and Bally’s Total Fitness. Citigroup is thought to be a prime target because critics claim it would be worth more broken into pieces.

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