Hedge fund activism concerns advocates of corporate governance

Oct 31, 2005 @ 12:01 am

By Sara Hansard

WASHINGTON - Hedge funds have become leaders of the shareholder activism movement, and they have some groups changing sides on the corporate-governance debate.

Shareholder activism and access to company proxy ballots have been pushed by unions and social activists, but hedge funds, often seeking short-term gains, have emerged as the unforeseen champions in that area.

The traditional activists, who normally welcome groups challenging corporate management, aren't sure hedge fund activism is a good thing. Business groups, on the other hand, who normally resist corporate-governance activists, have no problem with the hedge fund activists.

Hedge fund shareholder activism would not seem to be what shareholder activists had in mind when pushing for new regulations giving shareholders greater access to company proxy ballots.

Unions and so-called socially responsible investor groups traditionally have led the fight, often pushing for labor or social reforms by corporations.

Making presence felt

But with an estimated $1 trillion in assets expected to grow to as much as $8 trillion over the next five years, hedge funds are making their presence felt in the market and likely will continue to do so.

"They are engaged in in-your-face engagement with the management and the board," said Patrick McGurn, special counsel and executive vice president of Institutional Shareholder Services Inc., a Rockville, Md., firm that advises institutional investors on proxy ballot issues. "They're not afraid to challenge for board seats or call for governance shifts."

Approximately 200 such hedge fund actions reportedly have been tallied over the past year by the anti-corporate raider group of Goldman Sachs & Co. Inc. of New York. The company refused to be interviewed on the topic, citing competitive concerns. But Mr. McGurn has his own list of examples.

Winning battles

In two recent proxy battles, hedge funds won fights for board takeovers without so much as a shareholder vote. In September, Toronto-based hedge fund Goodwood Inc. and Greenwich, Conn.-based hedge fund Burton Capital Management LLC took over printing company Cenveo Inc. of Englewood, Colo. Last May, Norwalk, Conn.-based hedge fund Pirate Capital LLC took control of Cornell Companies Inc., a Houston company that provides correctional services that are outsourced by government agencies.

While mutual funds are getting more aggressive in their proxy votes in the wake of new requirements that they make the votes public, hedge funds are "hyperactive" in their proxy fights with companies, Mr. McGurn said.

In contrast to the corporate-

governance activities of longer-term investors such as public pension funds, mutual funds, insurance companies and bank trust departments, hedge funds take large, undiversified stakes in companies looking for returns that they can give back to their shareholders over the course of a reporting period, which often is as short as a month.

This hedge fund activism is causing activists who have supported shareholder access to take different sides than they traditionally have taken. Institutional Shareholder Services, for example, has been a supporter of shareholder access initiatives - and still is.

But Mr. McGurn questions whether the short-term outlook of hedge funds is a good thing. He notes that public and corporate pension funds trying to keep the outsized returns of the late-1990s have become big investors in hedge funds.

"When does that short-term view end up conflicting with the longer-term horizons of the pension funds?" he asked. "We've met the enemy, and he is us."

"The trend in the growth of hedge funds is sort of on the alarming side," said Kurt Schacht, executive director of the CFA Centre for Financial Market Integrity in New York. The group, which has supported greater shareholder access to company proxy ballots, is the research and advocacy arm of the CFA Institute in Charlottesville, Va., which administers the chartered financial analyst designation.

Using or abusing?

"If there are certain hedge funds out there that are abusing this as a pretense to an investment strategy, maybe it's a problem," Mr. Schacht said.

However, he predicted, "if there are hedge fund investors that

are going through the corporate-

governance motions because it's trendy, if they're not effective in using it, their returns are going to stink, and people are going to find other places to invest their money."

On the other hand, the U.S. Chamber of Commerce, a foe of shareholder-access proposals that have been put forward by unions and others, supports hedge fund activism as long as it is aimed at improving shareholder value.

Hedge funds "probably have a healthier view on this" than social investors or labor unions, said David Chavern, vice president of the capital markets program at the Washington-based Chamber of Commerce.

Profit motive

"Hedge funds are trying to get a greater return on their investments," Mr. Chavern said. "That, to us, is qualitatively different than wanting to push companies around to achieve some other objective, like a union objective or some sort of other activist objective."

However, Mr. Chavern expressed some wariness about hedge fund aggressiveness.

"If hedge funds wanted to do something that would also give greater leverage to people who wanted to pursue union or social agendas, we would have a problem with that," he said.

Michael Tannenbaum, president of The Hedge Fund Association in Washington, argued that hedge funds are driving the shareholder activism movement, rather than the other way around.

He predicted that public companies will adopt more defensive measures and that hedge fund aggressiveness will result in greater regulatory scrutiny, especially now that the SEC is requiring hedge fund managers to register.

"A regulator might look into some of the motivations of some of the hedge funds and make sure it's truly in the best interests of the shareholders," said Mr. Tannenbaum, who is a partner with New York law firm Tannenbaum Helpern Syracuse & Hirschtritt LLP.

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