Are hedge funds profiting from the decline or bankruptcy of companies? In many instances they are, but what if they are manipulating events in order to bring about the failure or bankruptcy of companies they have already bet on and invested in failing? The practices of some hedge funds are raising questions about whether some are crossing the line in seeking to influence the outcomes of what they’ve already invested in.
Imagine first if a hedge fund targets a company it believes will fail, or perhaps want to fail, and purchases or holds senior notes in that company. Then a notice of default is issues, and the hedge fund buys credit default swaps, betting on the company going bankrupt. The hedge fund has priority in getting paid after the bankruptcy, and would profit from such a gamble. But it may not be such a gamble, if the managers of the hedge fund leverage political connections among elected officials and regulators, and push for investigations of the company, and accuse the compan of engaging in fraud or a pyramid scheme, etc. Those actions are designed to force the company into failure or bankruptcy, therefore making it more likely the hedge fund profits from betting on the failure of the company.
While hedge funds play a role in the free market economy, allowing an outlet to invest in failing companies and better on their failure, it’s not quite the same to place such a bet then also engage in unethical tactics to make such a failure happen. The difference here, as Derek Hunter, writing for The Daily Caller, notes, “It’s one thing to bet against a company, it’s another to bet against it and attempt to manipulate circumstances to make it happen.”
There are many example of hedge funds engaging in this behavior, such as William Ackman, of Pershing Square Capital Management LP, who has invested in a $1 billion short-sale on the stock of the vitamin and supplement company Herbalife. Ackman accused Herbalife of running a pyramid scheme, and has turned to lobbying of politicians and government regulators to investigate the company. According to Herbalife, Ackman made false statements about the company in seeking the decline of their stock value. While Ackman had hoped his campaign would destroy Herbalife, it appears that will not be the case. The company is settling for about $200 million, after a two year long investigation into charges Herbalife is running a pyramid marketing scheme. The announcement caused the company’s stock to rise 15 percent.
Another hedge fund called BlueMountain Capital Management has targeted Home Loan Servicing Solutions, Ltd. (HLSS) and its associated company, Ocwen Financial (OCN) for failure. BlueMountain has invested in a short position in the stocks of both, and has recently sent notices of default to both of them.
“It appears that BlueMountain’s assertions may be motivated by its financial interest in profiting from these short positions, rather than by any interest it may have as a holder of notes issued by the trust,” James Lauter, HLSS’ senior vice president and chief financial officer, wrote in a letter reveal in a Securities and Exchange Commission filing.
Paul Singer of Elliott Management has similarly targeted iHeartMedia, a music streaming company that is quite popular among users of smart phones. Elliott Management purchase debt in iHeartMedia, after doing so it also purchased credit default swaps. By doing this, Singer and Elliott stand to profit greatly if iHeartMedia goes into bankruptcy. “To make good on his default bets, Singer’s fund is attempting to leverage his ownership of the company’s debt to actually drive it to default,” The Street reports on Singer’s investment in the failure of iHeartMedia. As a result, Singer’s efforts to bring about the failure of this company are the subject of legal action filed in San Antonio, Texas against Elliott Management.
A number of other private-equity funds, along with Elliott, stand to profit from the failure of iHeartMedia, including Benefit Street Partners LLC, Canyon Capital Advisors, and Franklin Resources Inc.
Some investors are pulling their money out of hedge funds, and see them as underperforming. “The board of the New York City Employees Retirement System (NYCERS) voted to leave blue chip firms such as Brevan Howard and D.E. Shaw after their consultants said they can reach their targeted investment returns with less risky funds,” Yahoo Finance news reported. This makes sense, because hedge funds saw a 29.8 decline in profitability in 2014, as reported by Citi’s 2014-2015 Annual Hedge Fund Operating Metrics Survey.
It is clear that hedge funds operating this way are not investing in building growing and successful companies, the kinds of activity that create jobs and brings about prosperity for the American people. By investing in and seeking to influence events this way, some hedge funds are finding they profit more from investing in, and helping to bring about, the failure and bankruptcy of companies. There is something wrong when there are strong incentives for investing in the failure of companies, which destroys rather than creating value. What’s at stake are the jobs of thousands of Americans and billions of dollars of wealth of common investors. Many Americans are counting on these assets for their future retirement.
The more that investors see hedge funds gaming the system to profit from helping to influence the failure or bankruptcy of companies, the more like it is that those investors will withdraw investments from them. The destruction of companies simply to profit from short-sale investments or credit default swaps will only wreck American companies and cost jobs at the expense of most Americans to benefit the very few. By engaging in these tactics, hedge fund managers are helping to create ticking financial time bombs. This money and effort could be spent investing in the growth and success of companies instead of the bankruptcy and failure of them.