Monday, March 21, 2016

Senators Introduce Bill to Rein In Activist Hedge Funds

By John Filar Atwood

In an effort to rein in the short-termism of some activist hedge funds, Sens. Tammy Baldwin (D-Wis) and Jeff Merkley (D-Ore) have introduced legislation to increase the transparency and strengthen the oversight of the activist funds. The co-sponsors of The Brokaw Act, named for a Wisconsin town that went bankrupt after a hedge fund closed a paper mill that provided local jobs, include Sens. Bernie Sanders (I-Vt) and Elizabeth Warren (D-Mass).

According to a press release from Sen. Merkley, the bill takes aim at the focus on short time horizons by corporate managers and financial markets that can result in corporate funds being used for payouts to shareholders in the form of dividends and buybacks rather than investment in research and development, infrastructure and long-term success. He accused activist funds of short-termism, claiming that they often make demands to benefit themselves, such as stock buybacks, more debt, and layoffs, at the expense of the company’s long-term interests.

Wolf packs. The senators noted that Congress has long recognized the potential for abuse when activist hedge funds form loose associations, sometimes called “wolf packs,” and tip each other off about the impending 13(d) disclosure. The Dodd-Frank Act gives the SEC the power to address these practices, they added, but the Commission has not used its authority.

A joint press release from the senators notes that the bill would change the definition of “person or group” in order to prevent wolf packs from collecting a stake in a company that may be well above 5 percent, while individual funds stay below the threshold to avoid disclosure. The legislation proposes to identify these funds as a single group to require disclosure. The bill also proposes to eliminate the opportunity for riskless gains by activists by shortening the ten-day disclosure window to two days.

Net shorts. The legislation also would require additional derivatives disclosure to try to eliminate the use by activists of “net shorts” to secretly vote against the company’s interests. Currently, derivatives and other synthetic instruments do not require disclosures even though they can have a substantial impact on the price of the security and its issuer.

In support of their proposal, the senators argued that the number activist campaigns have risen annually by 60 percent since 2010, with a total of 348 activist campaigns in 2014. The assets under management by activist hedge funds have grown from $12 billion in 2003 to over $200 billion in 2016.