Hedge Funds are Attacking Companies to Profit From Their Failure?

Hedge funds profit from destroying companies
Hedge funds profit from destroying companies

The success or failure of a business enterprise should be determined by market forces. If a company successfully markets a better product or services to its customers, it will succeed. While some investors put up money to bet on the success of a company, hedge fund investors pick the likely losers and invest in what they believe is the probable failure of those companies. What if hedge fund investors are taking actions to bring about the failure of a company they have already invested in order to profit from its failure?

Perhaps its only a logical next step, that an investor who makes a bet on the failure of a company, and backs up that bet by purchasing credit default swaps or investing in short sale of stock, will also take additional steps to make that company’s failure or bankruptcy more likely. And in doing so, the hedge fund investor is more likely to profit. While most hedge fund investors play a key role in the market, better on successes and failures and in the end helping the free market, there are a few whose tactics are raising questions. Are the actions of those few, who seek to game the system for profits, actually detrimental to businesses and consumers?

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.”

A notable example of this is 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. Ackman accused Herbalife of taking advantage of Hispanics and African-Americans to market their products, and organized a campaign to identify and profile the alleged victims of the vitamin and supplement company. Herbalife is striking back, and seeking investigation and possible prosecution of Ackman for his activities against the company.

A two year long investigation of Ackman’s allegations that Herbalife is a pyramid scheme appears headed to settlement for about $200 million, causing the company’s stock to rise by 15 percent. It appears the efforts by Ackman will fail to produce a profit from his short-sale of Herbalife stock.

Home Loan Servicing Solutions, Ltd. (HLSS) and its associated company, Ocwen Financial (OCN) are in a battle with the hedge fund BlueMountain Capital Management. The latter has invested in a short position in the stocks of both, and has recently sent notices of default to both of them. By placing such an investment and standing to profit, BlueMountain has motive for the two companies to fail.

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.

The music streaming company iHeartMedia, has similarly been attacked by hedge fund investor Paul Singer of Elliott Management. Singer purchased iHeartMedia debt, and then purchased credit default swaps. These investments will make a handsome profit for Singer if iHeartMedia fails or goes bankrupt. “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.

The behavior of the likes of Singer and Ackman are causing some investors to walk away from hedge funds that engage in these tactics that seek to deliberately destroy companies for their profit, destroying value rather than creating value, and putting at risk thousands of jobs and billions of dollars worth of common investors’ wealth. In these few instances, the hedge funds can become financial weapons of mass destruction at the detriment to our economy.