Hedge fund activism debate: The real face of active investing?


Helen Avery
Published on:

Activist shareholders have a bad name. Helen Avery brought together a group of hedge funds to uncover the positive role that such investors can play.

Hedge fund activism: Participants

ACTIVIST HEDGE FUNDS are losing in the popularity stakes. Last month, the latest funds to suffer a public backlash were London-based Centaurus Capital and US-based Paulson & Co. The two funds, with a combined stake of 31.4% in Dutch conglomerate Stork, continued to press for a management change, and a break-up of the company’s business units. Their case: that the firm would unlock more value for all shareholders if it focused solely on its main business, aerospace. Minority shareholders Robeco and ABP, the Dutch pension fund, have publicly rejected the hedge funds’ proposal, and management of Stork has allegedly tried to dilute the managers’ stake of almost one-third by issuing preference shares. The result: a pending court investigation into the allegations.

Also in the headlines recently has been Eric Knight, of Knight Vinke Asset Management. Knight has fought a public battle as he has campaigned as a shareholder for the break-up of French utility Suez, into a water business and an energy business. With recent reports that French billionaire François Pinault is exploring a bid for the two businesses separately, Knight might finally see his ambitions for the firm fulfilled but it will not be as a result of his fight for shareholder value.

In the US, Carl Icahn is the most noted name among activist hedge funds. In 2005 and 2006 he entered into a public battle with the US’s largest media company, Time Warner Cable, as he fought for cost cuts, management changes, a $20 billion stock buyback and a break up of the business units.

Such publicly fought battles, whether intended or not, between activist hedge fund managers and management of some of the world’s largest companies have resulted in the activist segment of the hedge fund community being branded as antagonistic and troublesome.

There are an estimated 125 dedicated activist hedge fund managers, with many more hedge funds thought to be applying an active approach in conjunction with their main strategy, be that event-driven, distressed, long/short equity or merger arbitrage.

It is a growing number but often their roles in creating shareholder value and working with management go unmentioned – because they are without conflict.

Euromoney asked a selection of hedge fund managers that would be perceived as activists to discuss how they approach activism, what shareholders and indeed management can gain from their involvement, and where they see their segment of the hedge fund industry going.

BC: Activism can mean many things to different investors, ranging from nasty, confrontational letters to quietly working alongside management on strategic decisions and capital allocation. Can each of you define your approach to activist investing?

DM: We’re always active but not always activist. We’re looking for undervalued situations and will get as active as necessary. We want to be friendly activists and work with the company and the board to unlock value. In extreme cases though, we are not afraid to get much more aggressive. As shareholders, we own a piece of the business. We won’t back down when we see that the management is not doing the right thing for shareholders.

MF: The dictionary definition of activism has an adversarial connotation to it. Our style is to think and act like owners. We want to be involved with management that already gets it and that we can work with. We don’t always agree with our companies but we virtually always agree with the strategy and the business model that they’re pursuing. If you’re an owner and you’re acting like an owner, why would you put your money with someone that you thought was going to be a poor steward for your capital?

CL: Here’s the distinction between passive investing and active investing: if we don’t like what’s going on, we don’t just simply sell the stock, what people call “voting with your feet”. We get involved. Ours is a private equity mentality, so we take a view as if we’re another private equity sponsor who will do whatever it takes to make sure value is realized.

KR: We do ownership investing. Many activists just complain to the management but we try to work with them. We’ll bring in consultants, bankers, people and resources that can unlock value in the situation. Almost any company could be doing something better. Sometimes we fight with management, but we leave that in the boardroom. You’ll never see us in a public letter-writing campaign. That’s dangerous to your franchise. We’ve actually run into problems just by having the word “active” on our website. We’ve changed it to the word “ownership”, because a lot of people who call themselves active have left a bad taste in managements’ mouths.

JL: This notion of constructive activism and trying to work with a company is particularly germane to our strategy. We have found it the most efficient path to value over our 11 years in the business.

BC: Perhaps the most fundamental part of a successful activist strategy is superior security selection and accurate valuation analysis. Most activists are stock-pickers who have a true passion for their craft. How do you go about sourcing opportunities?

KR: Superior security selection is probably 70% to 80% of the game, while the unlocking of value probably gets the other 20% to 30%. If you pick a lousy company at a bad valuation, you can get them to put in a dividend but you’re going to lose money. So we always start with finding a good business. These ideas can come from trade journals, our analysts that follow certain industries, or relationships with management over time. A lot of ideas come from the due diligence you do on others. We look for industries that have recurring revenue, high return on invested capital, longevity of management and generate positive free cashflows over time. From the valuation standpoint, we look for 10% cash on cash yield, and the company has to be growing 5% a year. That will mean we double the value of our investment in five years if they do nothing else. But of course we want to help them increase the stock price, improve margins, grow faster or return capital to shareholders.

CL: The biggest source of ideas for us comes from basic screening. We focus on manufacturing, business services and healthcare. About 1,300 companies match our criteria. Three-quarters of our ideas come from looking at cashflow, ebitda and P/E multiples, and companies trading at or below private market value, also known as LBO value. For the other quarter, we’ll have a company already in our portfolio and look at its comparables and find one equally as cheap.

DM: Over the years we’ve developed an incredible network of contacts and relationships across Europe that we rely on. Europe is driven by families that still control companies. We’ve made it a point to get to know the families, even before we get to know the management teams of the companies. And Europe is full of conglomerate or holding companies that have a plethora of different operating units, where you look through the layers and across ownerships. And there may be something quirky going on, like a family fight: the brother and the sister are fighting, the brother is going to dump all his stocks just to spite the sister. We love the cases where there’s a family fight or a contentious situation: you come in as the good guy but as a result you’re able to get things at an incredible bargain, because these people are not thinking rationally.

MF: My primary asset is my Rolodex. I have about 4,000 people on it. I focus on consumer, business services and retail. If I see a name that looks undervalued, the first thing I do is see if there’s people in my database that I can contact to make sure I understand the business better than anybody else, and then leverage those relationships to add value once I get involved.

DM: Exactly. Who do you know in your network who can get you a meeting with the key guy or who can give some feedback that gets you an understanding before you even waste time going in there? Without that you’re the same as everybody else out on the street looking at the same thing.

BC: Are there any types of situations that you feel are best suited for the type of activism that you practise?

JL: We don’t do anything that is broken or distressed. Everything we’re looking at has positive cashflow, recurring revenue and earnings and a certain solidity and stability to the business model.

Over time, we have found predominantly three types of opportunities. In strategic configuration situations, an example would be three subsidiaries – two are excellent but one terrible. Secondly, operational situations, such as where merger integration has been poor or costs not taken out. Thirdly, capital structure opportunities: today that’s more likely a case of too much cash, when in the past it has been too much debt, poorly structured debt or misunderstood liabilities.

KR: We’ve seen more operating turnarounds recently. That’s not our sweet spot but that’s where the opportunities lie. In an ideal world our favourite situation is where there is a great business but for some reason the rest of Wall Street doesn’t get it. Maybe the company missed a quarter, or some external event put them out of favour for six months. Pick any of your favourite companies, take a 10-year stock chart, and at some point in those 10 years it was cheap.

MF: I like turnarounds that look worse than they are, because the street tends to discount them more than they might a bad earnings quarter. If I can find a company with a relatively high gross margin but at breakeven, it tells me if they improved their efficiency they would make more money.

DM: We look at both break-ups and turnarounds, but only businesses where there are real assets. For example, a conglomerate where there are four great businesses that have no correlation to each other, so break it up into four separate companies. Or a good business with a bad management team. Many times we’ve found that the right people are right there in the company, they just weren’t the bosses. Chop off the head, let the good guys come up and you can see amazing things happen.

How to have influence

BC: What is the optimal number of positions in your fund and why?

MF: Five is optimal but it all depends on how much edge you have. If I can have significant influence in a company that’s deeply undervalued, I’d rather have more concentration than less. At one point I had only one position. It was trading below cash, it had a lot of earning power and was breakeven cashflow. I knew I wasn’t going to lose any money, it was just a question of how long it would take to fix their expense structure.

CL: We would like seven or eight positions. What drives this for us is not so much stock selection but our capacity constraints. You can lever up on the stock selection front with more good people but you can’t deal with the activism portion by simply throwing more bodies at it. If it’s contentious, companies will do everything they can to thwart you, whether that’s keeping you off their board or not doing what you want, and you have to be on them like a cheap suit when it gets to that.

DM: Today we have 15 positions, and we would have no problem being somewhere in the 20 to 25 range. However, only a handful of those will be extreme activist situations where we are taking board seats. When you start factoring in that you will have eight to 10 meetings for each company, plus a lot of conference calls with the board, it adds up very quickly. The activist portion will always be a more concise and simple book within the bigger book. We’re active in every name, but we’re activist only where we think there is a unique opportunity.

KR: Our top 10 holdings make up 85% of the fund. Then we have another 10 positions. Our capacity is constrained by our team and what they can handle. But we also use outside resources a lot. It’s the one thing we’ve learnt from the private equity brethren; they will rely on outsiders to help.

BC: How scalable is your strategy? And what size of company are you targeting in terms of market capitalization?

JL: We’re targeting 7% to 9% stakes in companies of $300 million to $3 billion market cap. We believe our capacity is somewhere between $1 billion and $1.5 billion.

MF: It doesn’t necessarily take more people to deal with larger companies. Individuals such as Warren Buffett have scaled this strategy. But as you go up in market cap, boards tend to be more insulated, so experience is important. My current sweet spot is between $500 million and $1 billion in terms of market cap but that goes up with my experience and positive results.

DM: For us, it’s typically $3 billion and less, and we’re willing to go pretty small. Ideally the market cap is between $300 million and $700 million. We don’t want to get into the big pond with much larger funds that are doing other things and who are getting in and out with greater velocity than we have any care to be doing. The smaller market cap we go, the more opportunities we find. Everybody’s afraid of less liquid situations. You don’t see a lot of competition in the $100 million to $300 million market cap area, because most people want to know that they can trade out of it in one trading day. So we get the companies much cheaper. And at this size, we can have a much more significant influence on the changes necessary to create value. So we want to stay with the smaller size. You have to be careful not to spread the team’s knowledge base and abilities too thin, so we would probably cap ourselves at around $1 billion.

BC: What percentage of a company do you feel you need to own in order to be effective as an activist and get the attention of the management team?

KR: Just one share is enough if you have a good relationship with the management to have a rational discussion. A lot of these guys have the will but they lack the skill. In the smaller and micro cap sector, the entrepreneur/founder may have had a wonderful business, built it up, gone public because some banker told him to go public for a dumb reason, and now he’s listed, and he’s orphaned and he’s going through certain growth issues in his business. He’s willing to listen if you have good observations and good suggestions. We spend most of our time educating management, for example on how to do a buy-back, because a lot of CFOs came out of accounting and they can close a general ledger but capital structures are not necessarily their strong point. Whether you own one share or you own 20%, you’ll get a good reaction from an open-minded CFO.

MF: Once you go over 5% they know you’re there but 10% says that you’re an important shareholder. I don’t mind companies where a founding family or individual owns a lot of it as well but I try to be the largest outside shareholder.

BC: What’s your view on the time horizon for executing on your activist initiatives?

CL: Our planning horizon is two years. That said, we’ve been in some companies for four years and had others taken out from under us in three months. But we plan for two years because the companies we’re looking for have flaws and they take a little while to work out and get well rewarded for.

DM: Typically we would expect to be there 18 to 24 months, if not longer. It takes time to get the board seats, to have dialogue with the management and for them to understand. We don’t like to trade, and do not have a trader on staff. We want to buy. If you get into a good situation, you will always be able to sell it. So we focus on that good situation. Too many people think about getting out before they get in: “When am I going to sell?” “You didn’t even buy it yet!”

MF: Turnarounds have three stages. The first is cutting costs and rationalizing the business, which takes about a year. The second stage is having a stable platform and developing a growth plan – that takes another year. And the third year is where you see growth. Of course it almost never happens this way but you can always hope!

KR: Three to five years is where we usually end up. Some of the worst mistakes I’ve made are from selling too early on a good business just because you’ve had your expected upside.

BC: With an increasing number of activists entering the scene today, how does the involvement of one or more activists affect you?

CL: We are in a company now that has become almost an activist hedge fund hotel. I don’t think the management’s approach has changed dramatically. But I do think boards and management teams are becoming much more responsive, and this is good for shareholders’ needs and interests. Does having more than one activist help? Probably, but it’s hard to measure. We don’t do group deals.

BC: How do you get management to “buy in” that you truly understand the business?

MF: If you know people that management respects and they introduce you to the company and maybe even get involved, you’re respected. And I’ve always had a rule that I want to know their business better than they do. But mostly I try to find management that really understands its business but the strategic relationships are not right, or they are not skilled in capital management. I’ve had CEOs who were very good in terms of how they ran the business but the area I could be more influential than just helpful in was capital management.

CL: We are almost formulaic in this regard. We try very hard up front to add value and to show them that we can be a helpful partner. We introduce them to people, such as a potential research analyst, that aren’t covering their stock but should. We’ll try anything that tells them “as long as you’re on the right side, we’re on your side”. Only then, if it’s not happening, will we get contentious.

KR: Building respect goes right back to the identification stage. As part of the due diligence process, you have to become an expert on the company and the industry. It involves visiting competitors, talking to customers, as well as visiting management. And we won’t buy shares in a stock unless we’ve had multiple meetings with management. My team also knows there is such a thing as a dumb question. I’ve seen a portfolio manager from an investment house having a meeting with the company saying: “I own a million shares but I don’t know what you do, tell me about your company.” For a CEO, that’s disrespectful. And we go the extra mile. We joined the National Chicken Council, because we wanted to become experts in the chicken industry. I guarantee we’re the only buy-side firm that’s on the National Chicken Council. Things like this give us the industry expertise to come up with solutions.

JL: It’s a function of having a proper reputation with the management team with whom you’re dealing. You generate that in two main ways: what you’ve done in prior situations, and the level of analysis you provide.

DM: The concept of somebody vouching for you or endorsing your credibility is critical in Europe. If you are a US firm, they typically think we’re coming in for hit and runs. It takes time to show them we’re not. We have one media company in Germany where we own close to 5%. Our first conversations with management were difficult, because they questioned why we were buying their stock. We love this company, and think it is misunderstood in the market. Once that finally clicked, we have a wonderful relationship with the company’s management. At the other end of the spectrum we have a company in Sweden where we own about 20%, and went in there thinking there were some great businesses but the CEO had missed his numbers 13 quarters in a row. They were open to us, and gave us two board seats. But we couldn’t get the board to get rid of the CEO for quite some time.

Getting on board

BC: How many board seats do you have and how do the time commitments and fiduciary obligations of a director affect you as an activist?

CL: Board seats are not something that we generally want. We seek to avoid board commitments because of the time, the trading restrictions and so on, although sometimes we have to take a seat.

DM: Generally we only demand them in the most extreme cases and, once we do, we take it very seriously. But the time commitment is significant. I’m currently on four boards and I do think in those extreme cases it makes a difference. In some cases other board members may have no economic interest in the business, so by coming in with a more “we’re here to make money, the business is supposed to be run for the shareholders” attitude, it brings a new impetus to the board.

MF: You don’t want to be a lone wolf on the board as you won’t really have any influence without having alignment of interests. In addition, you already have a concentrated position, so joining the board in such a situation would mean going from being a “hostage” to basically having a life sentence. So what I look for when I’ve accepted invitations to be on boards is whether I can add value. Is the board in alignment on the plan with everybody working together towards the same goal? In other words, do the other board members also actually believe that these are the steps that need to be taken? If so, then being on the board is very productive. I’ve been invited on one board where I just didn’t honestly feel that there was enough alignment and I felt my liquidity was more important.

KR: We’ve turned down six board seats with portfolio companies where we’ve been offered board seats, and it comes back to that, are we in alignment? Are we really going to add value at the board level? And liquidity. Time constraint-wise, we limit any of our employees to three. And there’s a lot of board work that happens outside the boardroom. It’s not just showing up for a board meeting. But I’ve found that we can have a great impact when we’re in the boardrooms, because a lot of the board members quite frankly show up, have a nice dinner and then say: “See you in 90 days!” They don’t have a respect for the position.

BC: How far are you prepared to go in an activist campaign?

MF: If you’re good at reading people, analysing value, and influencing the outcome, it’s not about how mean you need to be to get them to do what should be done. It’s almost completely the opposite. In the hedge fund community, there is a general attitude that management doesn’t get it. It’s a condescending attitude. If I’m well informed and I’m dealing with the kind of people that I have assessed correctly, then a simple conversation of anywhere between 15 minutes and two hours should be enough.

CL: We have had three proxy fights in 11 years, which is less than 15% of our core positions. We did once make an offer for a company. It was one of the first investments we ever made. And we learned an important lesson – the management used our offer to say we were not aligned with the other shareholders. Most of our situations wind up being what we call aggressive advocacy. This is short of a proxy fight, but it’s above the next tier below, which we call collaborative discourse, where we’re exchanging ideas and they’re doing most of the important things with or without our input. Aggressive advocacy is where we’re having to tell the company what to do, and it could be in private, though it might end up in public. Most of our trades wind up being this type of aggressive advocacy. Dealing with M&A

BC: In Europe, you have other tools, such as calling an extraordinary general meeting. How far will you go?

DM: If we’re not on the board and we’re just not getting anywhere, we will call an EGM where we would lay out a proposal for change. But you have to be clear on what can be done, because in Germany in an EGM I can’t propose a buy-back, and I can’t propose a new management team. It is only at the annual meeting that I can propose a buy-back.

BC: How has the recent pick-up in M&A activity affected your activist strategies, and how has this activity impacted on returns?

KR: Since inception we have had about five companies taken out, which is less than 20% of the portfolio. That number will increase. All the boards I’m on are talking about M&A now, both from an acquiring standpoint but also having been approached. We’re in an M&A nirvana right now. But a lot of these board members don’t have any skills in deal-making and they don’t understand the processes. How do you hire a banker? How do you run through a strategic process? And what are they worth to someone else? The hardest part is to convince management to sell themselves to a strategic buyer.

CL: One-third of our exits have been through M&A transactions. Ironically, in two of those transactions we were opposed to the deals. One was an MBO that we thought was being picked off at a low price at an inopportune moment. The other was a company in the generic drug and drug-distribution business that was sold to a larger strategic company. In that case we couldn’t make the argument that the price was unfair but we felt that with a year’s more work that price would have been up significantly, based on the pipeline for that particular company. We’ve almost had the role of trying to be the deal-killer, which was kind of bizarre. It’s not easy. Boards are caught between the desire of management to keep their jobs and dealing with what shareholders want. So if an activist says: “What I want is a significant premium to market because now is the right time”, at least they can have that clear feedback as opposed to trying to put out a divining rod in a very diffused shareholder base and taking a guess. Similarly, you can have situations where boards don’t do a good job overseeing an exit process. We had that happen on one occasion. We were getting complaints from buyers during the sale process, and value was lost as a result. We should have gone on that board and helped oversee the process, and we’re learning from that mistake.

DM: In the last two years we’ve had one company taken out, though I think in the next six to nine months we could have as many as three. We bring something to the table because many times on the board you have people who have no economic interest. They don’t care, they like the dinner beforehand, they like the process, they like the board fees...

KR: If they sell, they’re not going to get the board fees any more either.

DM: Exactly. We waive all board fees. We’re not there to get board fees. We’re there to create value for all the shareholders.

BC: Do you have strict rules that guide your sell discipline if there’s a situation that’s not working out as planned?

JL: We maintain a certain liquidity threshold in our positions: we only buy stocks that trade 5% or more within 10 trading days. But the biggest risk that we face is fraud. We due diligence our companies to death. But if you ask what keeps me up at night, it’s not concentration and it’s not liquidity per se, it’s fraud.

KR: The two risks are controlling your destiny and proper analysis. Liquidity works two ways. It’s the same as leverage. In a rising tide liquidity and leverage are good, in a bad tide they’re bad for you, and I don’t worry as much about liquidity if the analysis is correct. If the analysis is wrong, we don’t wait, we just get out. We’ve been very rational about when we’re wrong. Don’t try to rationalize and create a new argument, just get out.

BC: What is the future of activism? Is the increase in the number of activist investors a positive or negative development?

DM: The European markets are far behind the US in terms of activism but it is just beginning to explode. For smaller names entry to new players is always going to be limited. But there’s too much money out there, so you’re going to get activists coming in for the hit and run, and I fear that will give a bad name to all types of activists.

MF: The activist fad has more to do with what I call drive-by activism. These activists have become more and more involved in derivatives and highly leveraged trades, and just like you’re seeing with the liquidity in debt markets for private equity, all these things will come to an end. But acting like an owner is a time-proven way to add value to an investment, and that’s not going to go away. It doesn’t matter if there’s one hundred people doing it or a thousand; that said if it were easy it would have been popular long ago.

CL: I’m more than willing to continue to compete and try to differentiate ourselves in the face of other funds coming in for both investor dollars, returns and reputation. My biggest concern is the traditional institutional investors and their perception of activism. We need to get their support and I think there’s been some progress made, in part because of the new SEC rules that require these institutions to disclose their proxy voting records. If they choose to side with entrenched managements and boards it’s going to come to light over time and it will impact their business model. We’ve got to get these people to wake up and differentiate the credible activists, and pay attention when we call or ask for their vote.

KR: But it’s very complex. Such institutional investors are conflicted because they generate a lot of money managing the pensions of those companies that specific dissidents are going after. These firms also have their own proxy departments that make decisions so the fund manager cannot always pull the vote. So we need to understand the lie of the land. Competition is certain to increase. You’re going to see a lot more of the private equity and hedge funds begin to push on activist funds as well.

JL: Activism is about the skills and demeanour you bring to bear on a value situation. So competition doesn’t worry me. The future’s bright for the dedicated activist, with the proper skill sets, experience and knowledge, etc. But for certain others – I call them hedge funds in activist clothing – it will be a rough road ahead. The funds I speak of have a very diversified portfolio, with relatively small activist positions, on which they are likely to spend 50% of their time. That’s a recipe for disaster. One on hand [this new activist-friendly environment] is a golden opportunity for us because of the renewed attention on shareholder value. But I fear somebody is going to have a very large-scale blow-up, and I worry about this opportunity going away.


BC: How do you deal with the filing requirements under Section 13 of the Exchange Act, which states that you must file if owning 5% of a company, particularly in the light of the SEC’s stepped-up enforcement in this area?

JL: I don’t find filing under Section 13 difficult. There is a choice of filing a D or a G, depending on whether you are going to be an active investor or a passive investor. The real issue is that law firms and investment banks are going after activists and claiming that a group has been formed, and then suing you for non-disclosure or improper disclosure.

KR: We have an in-house general counsel because you can’t afford the bad press that comes from screwing up. We file everything as a 13D and have a blanket statement that basically says we may approach management and others. We took a company private in May and we owned 9.9% of it. Working within the SEC regulations, I had our general counsel on the phone for every conversation, because I don’t want to go to jail. We’re always in discussions and you have to be careful about when you cross the line. Once you cross that line, you’ve got to put up the flag and do the right filings.

MF: I don’t find Rule 13 difficult to deal with. We’ve always done 13Ds because we don’t make an investment unless we intend to influence management. When you get over 10% it gets a little bit trickier because of the affiliate rules, and now you’re subject to 144. That’s where it’s good to be over 10% because you’re making a bigger statement to management and to the street that you believe in the company and that you want to participate in their success, but you’re also much more limited in terms of your liquidity.

BC: Are there other legal, regulatory, cultural issues that you face in Europe?

DM: It’s very different in Europe, and differs by country. You don’t have to make a filing and list your intentions. But in Sweden you have to flag at 5% ownership, and 10% and 15% and 20%. If you go above 30% you have to bid for the whole company. In Portugal you flag at 2%. It’s different again in Germany. We have to understand the nuances of each country. The last thing we want to do is make a mistake on a filing, so we have counsel in different markets where we’re getting close to thresholds. There tend to be penalties for non-disclosure of a group. If we just talk to each other are they claiming that we’re a group? If I send you an email asking ‘what do you think?’, then we’re a group. Some people will call to support a situation, and you have to be very careful how you respond.

BC: Sarbanes-Oxley has dramatically heightened the focus on corporate governance. Has this made it easier to work with management?

KR: I’m a cynic on Sarbanes-Oxley. If you’re good management and you have good systems in place, Sarbanes is a drain on costs and a detriment to running a business. We’re invested in a small packaging company, with a $25 million market cap, and they’re paying $2 million a year to comply with Sarbox. There’s a great opportunity for people to go private and/or delist to avoid these costs. I’m glad they’ve made some changes recently in how it will be enforced and at what level.

MF: I’m in Kevin’s camp, I think it’s way overdone: it keeps the good good, and it might keep the marginal criminal from crossing the line. It doesn’t improve corporate governance, all it does is create a lot of stops and barriers to even doing the right thing. I’ve been in boardrooms where the whole topic was whether we would be sued, not whether it was the right thing for the company. Sarbanes-Oxley has that effect.

BC: Are there any other regulatory risks that you think are particularly important to an activist investor?

CL: This looming notion of regulating the hedge fund industry. We, as active investors, have nothing to do with Amaranth or activists who don’t file their 13Ds, or other such incidents which lead to continuing dialogue in Washington, and which would increase regulation for our type of investment fund. I find this threatening, because we don’t need to have more cost or time taken out of our business day to spend with the regulators. Our investors are extremely sophisticated; they’re smarter than any of the regulators that might get sent in, they’ve done reams of due diligence. Why do you need the SEC to protect you against me? If regulators are going to go after something, it should be to protect against systemic risk at the prime brokerage firms or wherever else the lending is going on.

The Media

BC: What’s your view of the value of media coverage in relation to activist investing?

JL: We will use the media if there is a meaningful story to get out there that’s not just a question of slamming a management team. But there’s a big difference between speaking to a reputable publication that wants to cover a story in an objective way and planting ugly pieces in the hometown newspaper of the CEO that’s going to be read at the country club. It is a tool but it has to be used judiciously and in line with what you want your strategy and your reputation to be.

KR: Some people like Carl Icahn are really good at getting on TV from a media perspective but it’s not our style. Once you start doing that, management can take a defensive nature, and you may have done more harm than good. But if it helps the business, let’s put as much PR behind it as we can.

CL: You can draw a lot more flies with honey than you can with vinegar, and you can effect change a lot better if management is working with you and not against you. Bringing in the media early can turn them against you. We would only use the media in a negative way if we were in a contentious situation such as a proxy fight. But to do it early just because you like seeing your name in print is ludicrous.

MF: I think you can also get quite a result by talking to other shareholders in a way that does not violate rule 13. You’re limited to the number of shareholders you can talk to and whether you can work with them in concert but it has more influence than an article in the press.

JL: That’s an important issue – how we deal with other shareholders. We are minority shareholders attempting to create some kind of motion within a company and need the influence of our fellow shareholders, particularly the traditional money managers. The reputation you’ve garnered among them is very important, and even more important is your reputation with ISS [Institutional Shareholder Services, a provider of proxy voting to the institutional marketplace]. Should we wind up having to take something to a proxy fight, we need to be able to get the support of ISS. And how you have approached the situation matters quite a bit.