Nobel Prize winning economist Milton Freidman argued that the sole duty of a corporation was to maximize shareholder profit. Yet a corporation is defenseless when hedge fund targets a company for destruction making it impossible for the corporation to survive.
In a piece in The New York Times Magazine, Milton Friedman wrote that the “great virtue” of the shareholder wealth maximization norm is that “it forces people to be responsible for their own actions and makes it difficult for them to ‘exploit’ other people for either selfish or unselfish purposes.”
Freidman’s argument, of course, was met with disdain by liberal social engineers who argued that corporations should be invested in other matters pertaining to social and corporate responsibility – even if it costs the corporation – and its shareholders — money.
It is doubtful, however, that either Freidman or his opponents contemplated a new investment strategy undertaken by some hedge fund managers and owners designed simply not to maximize shareholder value or undertake promote the social good but to literally destroy the corporation so they can profit on their positions betting against the firm.
Some hedge fund managers short a company stock then go to friends in the government to sabotage the company. They are undermining the free market, because they are the only ones who know that they are hiring a team of lobbyists to cause a company to be investigated. They are like the guy who purchases insurance on a business property then torches the place for the insurance money. Same with hedge fund managers who short a stock then buy up debt of a company to force a company into bankruptcy. They are like suicide bombers who blow up a company to make good on a bet that the company will burn to the ground.
One could call this strategy the Kamikaze approach to investing. Everyone in the company may suffer in the process but the hedge fund ordering the suicide missions will win the war.
Hedge Fund owner Bill Ackman has given a public clinic on the Kamikaze style of investment. Publicly, Ackman took a short position in health food and supplement company Herbalife. That is his right. A short is a bet against the future of a company, and if you believe a company will fail, rather than purchase shares, you buy shorts. Ackman was so confident, he purchased one billion dollars in shorts against the company.
Normally, an investment manager taking a short would then wait, perhaps for a bad earnings report or the lose of a critical customer. Instead, Ackman has been accused of the moral equivalent of strapping on a dynamite vest and setting out to use his friends in Washington to destroy a company for him. He publicly charged that Herbalife was a pyramid scheme and demanded a federal investigation into the company. His hedge fund was alleged to have enlisted Sen. Ed Markey (D-MA) to make similar charges. The New York Times reported he organized “protests, news conferences and letter-writing campaigns in California, Nevada, Connecticut, New York and Illinois, although several of the people who signed the letters to state and federal officials say they do not remember sending them.”
His actions drove the stock down but only temporarily. Over the proceeding time period, the Federal Trade Commission has hinted at a resolution to the allegation and Herbalife’s stock has rebounded. The Wall Street Journal reported last month that “Shares of Herbalife are currently trading hands at $65.40, the highest they have been in nearly two years. Mr. Ackman’s break-even price is in the low-$30 range.” His efforts to destroy to company have flopped.
Ackman is not alone in adopting the strategy. Martin Shkreli, a hedge fund manager, took over Turing Pharmaceuticals only to gut its research and development budget. A pharmaceutical company cannot survive over the long-term without producing more life-saving or life-benefiting drugs. Shkreli was raiding the company in the short term and was later arrested on a securities fraud charge.
Likewise Paul Singer’s hedge fund Elliot Management used the Kamikaze strategy of buying up debt, according to court papers and the New York Post, to purchase credit default swaps to file a default and send the company’s stock into a tail spin. None of the good faith investors in the company would have any reason to know about a hedge fund manager buying up debt then trying to force the company into bankruptcy.
Friedman concluded his Op Ed with this “that is why, in my book Capitalism and Freedom, I have called it a “fundamentally subversive doctrine” in a free society, and have said that in such a society, “there is one and only one social responsibility of business–to use it resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.”
One could make a strong case that a Kamikaze mission to destroy a company by covertly driving the company into bankruptcy through secretive debt swaps or by going to cronies in Washington, DC to investigate a company falls into the category of “deception or fraud.”