Business Law Prof Blog

It's the Liquidity, Stupid!

Many in the market claim that we are in a "credit crunch."  In other words, folks are not loaning each other each money.  They are partially right.  There is much money on the sidelines waiting to get in; it is scared. Why?  Because of the real problem -- the liquidity crunch.  Many in the market invested in illiquid investment instruments -- these are investment instruments in thin markets that rely on good times to stay open. We are not in good times.  Once the thin markets shut down, folks holding the instruments take huge losses -- they cannot unload them and cannot even value them.  People with cash to lend stay on the sidelines until the mess clears up.  Credit swaps, asset based securities, and auction-rate securities are the current examples of illiquid investment instruments.  Holders assumed (or were misled to assume) that the thin markets in these securities would survive.  The took for granted liquidity, which occurs in boom markets but disappears when times get tough.  We are in a liquidity crisis which has spawned a credit crisis.

GE's Problems Continue

Ex-CEO John Welch has publicly criticized the current CEO Jeffry R. Immelt for not being correct in Immelt's projections of earnings.  It is a very rare public moment.  The problem is, of course, deeper.  GE's stock has slumbered since Immelt's appointment.  GE is simply too large; it's returns cannot beat the market, it is the market.  Yet the company, through management missteps, can have returns that fall behind the market.  GE needs to bust itself up.  A bust-up, once announced, would immediately drive up the stock price and reflect a board and a CEO that care about investors, not the management perquisites of size.   

Sorkin's Interview with Stephen A. Feinberg

Sorkin, noted business columnist for the New York Times, has ripped Stephen A. Feinberg, founder of Cerberus Capital Management, for being "cold and ruthless."  So, Feinberg, following the dictates of modern public relations specialists, did penance and invited Sorkin in for a rare media interview.  Feinberg's offense?  He noted that returns for investors did not necessarily mean Chrysler would survive in its present form -- that he his task was not to be a "hero."  Well how cruel and heartless.  In any event, Feinberg called in Sorkin and fell on his sword.  He noted his "national responsibility" for "American manufacturing" and that he was uncomfortable as a student at Princeton ("I should have gone to a public school").  Sorking loved it of course.  If I was an investor in Cerberus, which I am not, I would have hated it --- either he does not mean what he says or he does -- both are a problem. 

Israel, Founder of Bayou Group, a Hedge Fund, Goes to Jail

Samuel Israel, III, the co-founder of a hedge fund, Bayou Group, was sentenced to 20 years in prison two days ago.  His Connecticut based hedge fund took $400 from investors and lied to them about profits and losses.  They fabricated financial statements and siphoned money off in a phone brokerage operation.  Co-founder James G. Marquez was sentenced to four years and three months in prison.  The failure of Bayou in 2005 was one of the events fueling an outcry among commentators and academics for more regulation of hedge fund operations.  Seems like a 20 year prison sentence ought to be sobering enough.

Turn-Around Funds: Apollo and Appalossa's Woes

Turnaround private equity funds that purchased struggling companies in good times, with leverage, have found that their turnaround plans and suffering the with economy.  Plans that may have worked in good times have no chance in bad.  Apollo Management is an example.  Apollo's turnaround plans for Linen 'n Things may be unreveling and Apollo may be "throwing good money after bad" in continuing to prop up the company's debt.  Another turnaround hedge fund, Appalossa Management, has lost 17 percent last quarter.  Hopeful that Appalossa can turn it around it Carnegie Mellon that has put Appalossa's manager's name, Tepper, on its business school in exchange for $55 million.

Top Ten Hedge Funds

The Trader Monthly has data out on the top pay for hedge fund managers for last year.  The top manager, John Paulson in New York, made $3 billion, more than the GDP of Rwanda. If he made $3 billion, his funds showed a gross return of around $14 billion.  Not a bad year. Four of the top ten earners were in London.  Chris Hohn, of the London based "Children's Investment Fund" make $900 million and donated much of it to an affiliated charity.

Tough Times Mean More Pressure for Government Preferences and Setasides

Two items of interest are in the news.  First women are upset that the Small Business Administration announced rules that require at least 5 percent of all federal government contracts to go to female "controlled" companies.  Controlled companies include those managed by women or owned 51% by women.  The women wanted more, 8% perhaps.  Small business owners are upset that the agency did not increase the present 23 % set aside for small business; they want 30%.  Second, state pension funds are participating in the bailouts of banks that employ people in their states.  New Jersey's pension fund is investing in both Citigroup and Merrill Lynch (along with governments of China, Korea, Singapore, Kuwait and others) to shore both up the banks' capital.  Many states put pressure on state investment funds to invest in "local businesses." 

This is all bad.  First, the subsidies pile up and hard to eliminate when the reasons for them wane.  Why not Latino set asides?  to geographic setasides (is the suffering Midwest getting its due in contracts?)?  Second, investment returns or quality of contracts is given a back seat to social engineering.  Give grants or loans to favored businesses -- they are more transparent and do not affect the healthy competition that maximizes the quality of the product sought (investment returns or product quality).  Third, China's investment fund has done this for years.  Is this the example we want to follow?   

Quant Funds: The Tower of Babel

Those running quant funds are using very sophisticated models to predict markets and programed trades to take advantage of those predictions.  The experts use mathematics, engineering and physical science; some are experts in chaos theory.  Ordinary day traders now have access to web cites that allow them to develop their own trading programs that resemble the best the quant folks could put together as little as ten years ago.  The goal?  To keep the human decision making to a minimum.  Well the past few months have taught the quants a thing or two about hubris.  First, the quants themselves mimic each other.  The community of quants is very small and inbred.  The effect is that the movement of the program trades together frustrates the programs assumptions.  Second, the quants met some trade conditions that fell outside of their assumptions.  The effect was a liquidity crunch.  And third, and most important, the quants found out that a human must, in the end decide when stop the automatic program trading in light of market conditions.  A quant could not, as hoped, just sit and watch the trades unfold.  This meant that human discretion was back in the picture and, horrors, it was often untrained and unexperienced.  A quantum physicist is no stock trader.  The quants remain optimistic:  They are buys changing the formulas to account for this year's events so they new formulas will be "perfect."  Yet another story of the overreaching of humans.

Goldman Sachs Plays Both Sides

The activities of Goldman Sachs in collecting fees by creating and funding SIVS the purchase subprime loans (as an underwriter of the SIV securities) and in profiting as an investor by shorting the subprime loan market are raising eyebrows from Wall Street to Washington.  The size of the short position does not support an argument for a pure hedging position.  At issue is whether Goldman, and other banks that may have done the same thing, mislead investors as an underwriter by pushing secuirties that another part of the bank thought were going to decline in value.  Many are carefully re-reading those underwriting prospectuses.  For private litigants, this is a 33 Act Section 11 liability claim -- easier to prove than Rule 10b-5 liability (which also may be alleged).  The SEC may have an even easier time with Section 17. 

Goldman Sachs: Playing Both Sides?

There is scuttlebutt in the markets that Goldman Sachs, while creating the SIV vehicles based by mortgage loans that issued the CDOs that had caused such massive write downs, was, at the same time shorting the sub prime market.  It took fees for creating the SIVs and investment gains on the short positions.  If true, this should attract the attention of the class action plaintiff lawyers.

The SubPrime Pain: The Big Lie

Much of the roiling in the markets has been caused by a very simple lie:  Many investors hold positions that were advertised as bankruptcy proof (very low risk) and found out, much to their anger and surprise, that the low risk promise may have been untrue.  Their response is to flee the questionable positions and no wait for assuring claims of insurance or guarantees.  There are several examples.  First and foremost are those holding money market accounts who have found out that some of the commercial paper in the accounts was from SIVs issuing asset back securities.  Surprise! They thought that commercial paper came from blue chip operating companies and that the default risk was negligible (only Penn Central has defaulted on its commercial paper).  The response?  Withdraw from money market funds and refuse to buy, even through, intermediaries, any asset back commercial paper.  It is a rational response to having been misled.  Similarly, E*Trade now has people moving deposits and investment accounts to other banks and to other brokers respectively because they have discovered that E*Trade has lost a boat load of money in CDO investments.  Surprise! You might have to rely on SDIC insurance or on SIV insurance against losses.  They do not want to claim insurance proceeds, they want their money in secure accounts as they were told they would be.  So they flee.  Those who offer the utmost security and then disappoint get severely burned, as they should. 

Another Valuable Role for Short Sellers

With true investigative journalists suffering from job cutbacks and claims of political bias, we have another source of truth telling, the short seller.  A short seller tested the clothing make by Lululemon Athletica and found that, contrary to its claim, it was not made our of "seaweed."  He toke a short position in the stock and released his study.  The New York Times picked up the study, did one of its own, and wrote a confirming story.  So now the NYT reports are watching clever short sellers for good information.

E* Trade's Troubles

E*Trade is facing the potential of a good ol' fashioned run on the bank.  Depositor in E*Trade's retail banking business and investors who hold stock through E*Trade brokerage accounts are nervous because E*Trade has substantial exposure to loses in the subprime credit markets.  The depositors and investors do not want to take the time to figure out, based on complex legal analysis of business structure and guarantees, whether their own funds are at risk; they want out now.  E*Trade is livid about the suggestion that investors and depositors are at risk, offering all sorts of assurances.  Folks, they're done.  Yet another bank is finding out that you cannot hold depositors and investors accounts under the same name as the name attached to a risky investment business.

Real Estate Flipping

I am still perplexed at how easily real estate flippers got away with false appraisals on overvalued land.  The banks loaned too much based on the true value of the underlying collateral and the seller's walked with the excess cash (often repeating the process as buyer then seller in the next cycle).  In the simple case the lending bank has a strong interest in checking the accuracy of the appraisal (or hiring its own reliable appraiser) before loaning money on a land purchase and taking back a mortgage.  Some argue that structured finance dilutes everyones incentive to check for fraud. The argument notes that the bank sells the paper to a special purpose vehicle (SPV) and the SPV sell securities to investors.  The risk of fraud is borne by the investors who do not or cannot check on the validity of any appraisals.  The investors rely on rating agencies to rate the default risk and the rating agencies are operating under conflicts because they are paid by the SPV and get consulting fees from the SPV.   The bank (and the originating broker) and the SPV no longer care because they take fees and pass on the risk.  The investors end up holding the bag.  The argument seems overly simplistic.  Most SPVs sell tranches and the lowest tranche, the so-called equity tranche, is not rated and very risky.  Those who buy the equity, usually hedge funds, have an increased risk of loan defaults and should therefore have an increased incentive to monitor the quality of the loans.  Indeed, one could argue that the equity buyers and a stronger incentive than a bank that does not sell the paper to check on the default risk in the loans because the hedge funds took more risk with each default. There were long time rumors in the market of real estate flipping. Why did the hedge funds not check out the rumors, or at least price the equity to account for the rumors?  Moreover, many of the same banks that passed on the risk to the SPV then bought SPV securities in their own hedge funds (and those funds are now in distress).  Why did the banks not have the proper incentive, when purchasing back the paper, to make sure the paper that went to the SPVs they invested in was sound?  In short, I continue to be baffled by stories of easy money (made even by gangs of thugs) on real estate flipping that overvalued land in the appraisals. 

Liquidating Hedge Funds

Now that some hedge funds are insolvent and forced to liquidate, investors are no longer gleeful over enjoying the tax benefits of a hedge fund organized abroad in tax havens such as the popular Cayman Islands.  How does one go through bankruptcy proceedings with a fund organized in the Caymans?   Our courts will have to apply the complexities of Chapter 15 of the federal bankruptcy law, which applies to oversees liquidations.  Again investors are reminded that the legal paper matters (what are the termination and redemption rights or the insolvency rights???) when the markets turn south. 

The Journalist as Sucker

At the turn of the century, financial journalists at some of our finest papers were paid by our financial titans to post news that helped out the titans stock positions.  It took some time for financial journalist to establish a reputation for trustworthiness.  The new problems seems to be financial journalists played as suckers.  The front page of the New York Times has an article by Eric Dash and Vikas Bajaj entitled "Small Investors Feel Less Pain as Stock Slide: Bigger Players Are Hit Hardest by Turmoil."  Whenever the big time financial speculators get in trouble we get calls to "little guys" from everyone with a tie to rising markets -- politicians, bankers, brokers, and large investment funds -- that the little guys "not panic."  This is an implicit recognition that although the big speculators play in the markets everyday, the smaller investors (who hold stocks and positions in mutual funds, ETFs, and private investment funds) are the backbone of the market.  Once the little guys start to move their investments out of equity and risky debt into traditionally "safe" investments, the markets, already in a roil, will take some time to rebalanced and will rebalanced at lower levels.  In short, many speculators will go broke and claims of a "healthy economy" are a bit more shallow.  Journalist's dutifully report these calming claims, complete with data ("after 2001 those who held through the crisis have recouped their losses", etc.).  I do not mind the reporting of the claims; I do mind the reporter's lack of acknowledgement that those making the pleas to the "little guy" not to panic (when the hedge funds are in a panic) are self-interested, at this time.    Unfortunately, when the little guy hears such pleas for calm it is usually too late to sell.

"Freezing Hedge Funds"

The action by the French bank to "freeze" several of its hedge funds has confused many.  What the bank did was to block  "terminations." withdrawals, by fund investors.  Hedge funds allow for liberal withdrawal rights to encourage investors to invest.  Once a fund becomes insolvent it can no longer respect terminations, they are illegal preferences.  So a "freeze" is a declaration that a fund is insolvent, must wind up and will pay investors whatever they can. 

Amaranth : Lessons on Hedge Fund Failures

The difficulty of Amaranth has three notable features.  First, there was no market panic. It caused barely a ripple.  Those who believe a hedge fund failure could take down our financial system are... well... silly.  Second, investors are learning and getting education on the effects of lock ins.  Those investors who are trying to leave Amaranth with what is left are finding their redemptions penalized in the fine print of their investment contracts.  With many funds, it costs .24 to 2% to get out before a two year lock up period expires.  If too many ask to redeem the fund can stagger repayments and so.  Moreover, investors are discovering that some negotiated for better redemption terms than others (called "side agreements").  The problems with Amaranth redemptions will not be lost on a very intelligent group of investors; risk assessments will factor in  redemption terms.  Third, investors are a bit surprised by Amaranth's COO's appearance at two "beauty shows" hawking his funds, claiming a 25% return, during the two days when the fund was starting to lose big.  Investors have hired lawyers and are looking into lawsuits based on misrepresentation.  Hedge Funds, who often use the law to attack management, are going to find that their investors know how to do this too.

Amaranth's Troubles

A big hedge fund, Amaranth Advisors, is reported to have lost over $3 billion in the natural gas market.  The healthy part of the story is how quickly Amaranth investors discovered the loss.  Several investors investigated personally Amaranth's books to determine the extent of their exposure.  The quick action of investors is very healthy and a signal that the hedge fund market is working, not that it is failing.

Hedge Fund Returns

Gregory Zuckerman writes today in the Wall Street Journal ("Hedge Funds Miss Their Target") on hedge fund returns.  As I have come to expect, he does a great job with the piece.  Behind his analysis on raw returns however is an undiscussed elephant in the room.  Hedge Fund reports to their investors (existing and potential) show tremendous variety whenever the funds hold non-publicly traded assets.  Valuation problems of privately traded assets invite hedge funds to use very, very optimistic valuations of assets, particularly the stock of privately held portfolio companies that may have fallen on hard times. The funds are very reluctant to write their values down.  There are many other such examples and there is no standardization on many difficult asset valuation issues in these funds. Given the valuation problems of many hedge funds, the data on their returns is hard to trust.  In any event, a hedge fund that reports low returns, given the leeway hedge funds have on valuation, may have really had a bad year.  I have tried to get information on hedge fund reporting many times, only to be rebuffed by those in the industry -- don't ask, we won't tell.

Hedge Fund Ratings

Moody's Investors Service published today its first public rating of individual hedge funds.  The ratings will help investors monitor their hedge fund investments and may lead hedge funds (particularly the repeat players who are constantly raising new funds) to be more transparent in an effort to improve their ratings.  Moody's success will stimulate competitive private rating services.  This is all to the good and shows that market forces can and will discipline the hedge fund industry. 

Economy

I have been out on a limb for some time, noting over six months ago that we would see a major stock market correction this year.  My argument:  Consumers have held up the economy for fifteen years and are running (have run) out of money.  The federal reserve, faced with a slowing economy will stop rate increases even though inflation threatens.  The fed politically cannot raise rates in a slowing economy even in the fact of inflation (which should be its primary concern).  The result -- tough times for a while in the stock market.   

Econ

After the Shorts

I rarely agree with Joe Nocera of the New York Times, but today's column on "Selling Short the Virtues of Short-Sellers" is one I could have written.  Indeed, I am working on an article on the topic.  His thesis is that market participants, who are overwhelming long in stocks, dislike short sellers and that the press and the SEC seem to be piling on. (See the "60 Minutes" show on Gradient Analytics/Biovail or the SEC prosecution on Overstock.com). The impact is that short sellers do not talk to the press at all any more for fear of being sued.  Let's be clear:  A short seller cannot spread false negative rumors to cash in on a short position but a short seller, like anyone else, can express validly held opinions (held in good faith) and marshal actual facts on a company's negative outlook.  Yet if  short-seller does talk to the press there is a risk of litigation from disgruntled CEOs and the SEC if the opinions are not in perfect accord with how the future bears out.  So the incentive is to take a short position and not talk, adding to the pro-long bias already in the stock market.  The muzzling of short sellers, as Nocera points out, hurts the efficiency of the pricing of the markets.  It also contributes to bubbles -- the market runs up longer than it should -- pushed by CEOs and other investors with stakes in long positions -- and crashes only when the negative become painfully inevitable.  So we have sustained run-ups followed by cliffs and precipitous declines in stock prices.

Data on Mutual Fund Voting

The WSJ today, in a nice article by Jennifer Levitz, "Do Mutual Funds Back CEO Pay?", reported on the voting patterns of mutual funds on shareholder resolutions dealing with executive compensation issues.  The information not surprising -- mutual funds back executive pay proposals over shareholder limitation proposals -- but the fact that we have it is.  The SEC new rules on transparency in mutual fund voting are paying dividends.  We will enjoy much more of this information in the future.

Merilly Lynch's Legal Woes

You have got to wonder about how Merrill Lynch got into this legal box.  Merill Lynch paid $13.5 million in March of 2005 to state regulators for "failure to supervise" three brokers who participated in the after-market, mutual fund trading scandal.  Then Merrill gets hit for $15 million in a suit by the brokers for "defamation."  Good grief. 

S&P goes Google

Home Depot, Wal-Mart, Citigroup, Google...  What do these companies have in common??  Members of the S&P 500...

Last night, S&P announced that Google Inc. will be joining the S&P 500 index, sending the shares soaring up 9% in afterhours trading.  Google will be replacing Burlington Resources Inc., the Houston-based oil producer being bought by CononcoPhillips Inc. (AP article via Yahoo!)

The addition of Google to the S&P means that many large mutual funds, which are based upon index composition, will have to purchase shares in order to "track" the S&P 500.  Also, many conservative mutual funds are limited to companies in the S&P 500, allowing them to purchase the search engine company.

Retail Sales Still Up

Retail sales surged in January.  We are still spending more than we earn.  This means the market has some steam left in it.  This cannot last.  When consumers get more sensible the market will flatten.  Could be soon; could be many months or a year or two away.

Cramer's Darling GOOG Misses

Posted by Jason R. Job

One of Prof. Oesterle's "favorite" stocks when I was a student at Ohio State was Google.  Every day in class, he would come in and discuss why he believed that Google was overvalued.  (Check out some of his discussions of GOOG: Oct. 21, 2005; Aug. 18, 2005 (Google at One); July 22, 2005).

Today, after the closing bell, Google (NASDAQ: GOOG) reported net earnings per share of $1.22 per diluted share while street estimates were $1.51 a share.  After GOOG reported earnings, its shares were halted.  Then, once the shares reopened for trading, GOOG was trading down $70 to $361 per share or 17%.

Additionally, it will be interesting what Jim Cramer has to say tonight on Mad Money when his "fan favorite" is trading down nearly 150 points from his prediction!! (Cramer expected shares of GOOG to hit $500).  BOOYAH!

New Market Indicator Needed?

We have long become accustomed to the odd phenomenon of a high tech company reporting big profits for the last quarter only to see the stock price of the company fall, sometimes dramatically.  This week we watch market corrections to earnings dissapointments in the quarterly reports of Intel and Yahoo.  Apple Computer and eBay and offering disappointing forecasts of earnings and their stock price has dropped.  The market had priced the stock in anticipation of higher profits that those that were reported.  What is noteworthy however is a sense of how often the market is overpricing stock in anticipation of profits and when disappointed, how severely the market reacts.  A market that is consistently high on predicting high-tech profits and a market that responds dramatically to earnings disappointments is a market that is overcooked.  An numerical indicator of the frequency of overpricing and the size of the overpricing would be an indicator of whether the market is overcooked. 

Market Forecast

From the "no-one should put any stock in my views, much less pay attention to them" department: Last year I noted that I was looking for a substantial market correction in the foreseeable future.  I still am.  The country runs on consumer spending (70% of the economy) and consumers spent more than they saved last year (first time since the depression).  Christmas sales were good because people spent their savings.  Real estate values are leveling (consumers use real estate value to underwrite spending), oil and gas prices are high and holding, bankrutcy laws are tougher, interest rates inverted (short are higher than long), and the fourth quarter growth of last year (less than 3%) dropped below the average for the past 10 quarters, China and India are coming one line as formidible competitors.  Not to mention the existence of several hundred religious zealots with resources and who are attempting to figure out how to injure the citizens of a major American city.  All this adds up to trouble. 

Roger Babson predicted a downturn in 1927 and repeated his view for two years before he was proved correct in 1927 (then they named a business school after him).  Incentives in our economy cause market participants to resist drops in stock value until the last gasp of hype rings hollow and harsh reality is undeniable; then and only then do we get new equilibrium values and it often comes in a rush. 

Large Investors Not Done With Wendy's

Posted by Jason R. Job

Today, Billionaire Investor Nelson Peltz told Wendy's International (NYSE: WEN) that he believes that the shares are undervalued.  In a Schedule 13D filed by Peltz's investment vehicle Trian Fund Management, Peltz notes that the purpose of his approximate 5.5% stake in Wendy's is as follows:

"The Filing Persons acquired the Shares and Options because they believe that the Shares are currently undervalued in the market place and represent an attractive investment opportunity. In early December 2005, a representative of the Filing Persons attempted to contact John T. Schuessler, the Chairman of the Board and Chief Executive Officer of the Issuer, several times. After leaving several messages for Mr. Schuessler, the representative of the Filing Persons was contacted by Mr. John Barker, Senior Vice President, Investor Relations and Financial Communications of the Issuer. The representative of the Filing Persons told Mr. Barker that “we come in peace” and that the Filing Persons had established a significant stake in the Issuer, just below the Schedule 13D 5% filing threshold. The representative of the Filing Persons requested a meeting with Mr. Schuessler, at a convenient time and location, to discuss the Filing Persons’ value creation plan, which includes (i) the immediate commencement of a 100% tax-free spinoff of Tim Hortons, (ii) the sale of the Issuer’s ancillary brands, (iii) the reevaluation of certain components of the Issuer’s previously announced strategic initiatives and (iv) a significant reduction in costs at the Issuer’s Wendy’s Old Fashioned Hamburgers business. The representative of the Filing Persons advised Mr. Barker that if the Filing Persons’ value creation plan was discussed and agreed to, the Filing Persons would possibly maintain their ownership level below 5% (and not file a Schedule 13D) since the intention of the Filing Persons was not to wage a battle in the press. On December 6, 2005, Mr. Barker informed the representative of the Filing Persons that Mr. Schuessler was currently too busy “managing the brand” to meet with representatives of the Filing Persons. A paper prepared by the Filing Persons that sets forth “A Recipe for Successful Value Creation” at the Issuer is attached hereto as Exhibit 3, and incorporated herein by reference.

The Filing Persons do not have any present plan or proposal that would relate to or result in any of the matters set forth in subparagraphs (a) – (j) of Item 4 of Schedule 13D except as set forth herein or such as would occur upon completion of any of the actions discussed above. The Filing Persons intend to review their investment in the Issuer on a continuing basis. Depending on various factors including, without limitation, the Issuer’s financial position and strategic direction, the Issuer’s response to the actions suggested by the Filing Persons, price levels of the Shares, conditions in the securities market and general economic and industry conditions, the Filing Persons may in the future take such actions with respect to their investment in the Issuer as they deem appropriate including, but not limited to, purchasing additional Issuer Securities or selling some or all of their Issuer Securities, communicating with the Issuer or other investors or conducting a proxy solicitation with respect to a minority of the Board of Directors of the Issuer at the Issuer’s next annual meeting, at which one-third of the Board of Directors of the Issuer may be elected. The Filing Persons have no intention, either alone or in concert with another person, to acquire or exercise control of the Issuer." 

The full version of the Schedule 13D filing can be found here.  A Reuters article can be found here.

This is the second time this year that a large shareholder has went after Wendy's stating that its shares are undervalued.  As described in the post An Example of The New Strategy of Hedge Funds: Wendy's, Pershing Square Capital Management pushed Wendy's to spin off a portion of its Tim Hortons business.  Pershing Square has also purchased a large stake in McDonalds, which is described in the post Will Ronald McDonald Put on His Smiley Face for the Hedge Funds.

In morning trading, Wendy's is up $1.50 to $52.87 or approximately 3%.

Botched Trade Costs Tokyo Brokerage Approximately $225M

Posted by Jason R. Job

Hans Gremiel, a writer for the AP, wrote an article about how the Japanese government has rebuked the Tokyo Stock Exchange and Mizuho Securities Co. over a typographical mistake cost Mizuho Securities over 27 billion yen, which equates to approximately $225 million.  (Article can be found here).

Basically, a trader for Mizuho Securities wanted to sell one (1) share of J-Com Co. on Thursday morning at 610,000 yen.  However, the trader incorrectly typed the trade in to sell 610,000 shares at 1 yen.  J-Com Co., a job recruiting firm, was debuting on the Tokyo Exchange with approximately 15,000 shares being offered.  Nevertheless, the Tokyo Exchange processed the sale of J-Com, even though the sale was approximately 41 times the number of outstanding shares.

According to the article, this sale cost Mizuho Securities at least 27 billion yen, but since it occurred through human error, that amount could easily increase.  Additionally, Mizuho Financial Group, the parent of Mizuho Securities and Japan's second largest bank, stated that they would fully back the losses from the erroneous trades of J-com, which could wipe out Mizuho Securities' first quarter profit of 28 billion yen, or $233 million.

I wonder if this trader was invited back for another day of trading?  Nevertheless, shouldn't the exchange caught this wacky trade?

Going Private: Dave and Buster's

Posted by Jason R. Job

One of my favorite restaurants and places to hang out when I was a law student at the Moritz College of Law at The Ohio State University was Dave and Buster's.  There was nothing like a cold brew, some good food, and a quick 18 holes of Golden Tee to take my mind off of the labors of law school.  So today, I was reading the financial news and noticed that Dave and Buster's (NYSE: DAB) has agreed to be taken private by Wellspring Capital for $18.05 a share.  (Press Release can be found here in .pdf or here in HTML).

What I found most interesting was Chief Executive Officer, Buster Corley's comment regarding Wellspring's proposal to purchase Dave and Busters.  Corley stated, "We believe that this proposal to buy the company offers all of us as shareholders a unique opportunity to realize value at a time when the company has been challenged to perform up to expectations."  For once, an honest CEO, who has decided that maybe it is time to cash in his chips and maximize shareholder value.

Recently, the stock was trading up $2.33 to $17.54 a share.

Citigroup Wins Case Versus Disgruntled Investor

Today, a Citigroup spokesman stated that a National Association of Securities Dealers panel rejected a $900 million claim brought by Donald Sturm.  Mr. Sturm, a wealthy Colorado investor, argued that he held onto nearly 21 million WorldCom shares based upon Citigroup analyst Jack Grubman's recommendation.

Citigroup's argument was that Mr. Sturm was a knowledgeable investor and should take responsibility for his decision to hold his shares of WorldCom.  Mr. Sturm attempted to argue a direct link to Mr. Grubman's research and to prove that his research was flawed.

Since arbitration hearings are private and the panel did not disclose the reasons for its ruling, we are left to speculate why it sided with Citigroup.

Reuters article can be found here.

Some People Deserve to Lose Money

I just watched Mad Money with Jim Kramer.  He recommended a Korean stock, call letters FORM.  At close the stock was down $1.00.  After his recommendation, the ticker at the bottom of the screen started to register after hours trades in the stock. Trade after trade pushed the stock from down $1.00 to up over $1.50 by the time the ticker stopped registering the after hours trades.  The name of the show is correct; this is madness.   

Shareholders Persuade Knight Ridder

Posted by Jason R. Job

As we discussed in a post entitled Largest Shareholder Pressuring Knight Ridder, two large shareholders of Knight Ridder (NYSE: KRI) urged the Knight Ridder board to pursue the competitive sale of the company.

Today, Knight Ridder, one of the largest newspaper companies in the US, announced in a press release that it was exploring strategic alternatives to enhance shareholder value. (Click here for the press release).  According to the press release, Knight Ridder has begun working with Goldman Sachs in this process.  However, Knight Ridder was cautious about a potential sale stating:

"In making this announcement, the company stated that there can be no assurance that the exploration of strategic alternatives will result in any transaction.  The company does not intend to disclose developments with respect to the exploration of strategic alternatives unless and until its Board of Directors has approved a specific transaction."

In addition to the announcement of exploring strategic alternatives, the Board also amended the company's by-laws to provide that shareholders may submit proposals for consideration and/or nominations for directors to be elected at Knight Ridder's 2006 Annual Meeting of Shareholders.

It appears that the shareholders are winning with Knight Ridder, unlike the shareholders at McDonald's. (For more discussion about McDonald's check out my post entitled: Pershing Square to McDonald's: Spin Off Restaurants).  Knight Ridder has responded to Private Capital Management LP, who threatened to nominate its own slate of directors if Knight Ridder did not pursue a sale of the company, by allowing PCM to nominate potential directors and propose potential suitors for the business.

I do not personally own any shares of Knight Ridder; however, I do personally own shares of McDonald's.  Also, I am not recommending either stock for purchase or sale.

Pershing Square to McDonald's: Spin Off Restaurants

Today, Steven Gray at the Wall Street Journal is reporting that Pershing Square Capital Management proposed to McDonald's a plan to increase shareholder value, which was ultimately rejected by McDonald's management.  Pershing Square, which owns a 4.9% stake in McDonald's, proposed to McDonald's management a plan where McDonald's would IPO about a 65% interest in its company owned restraunts. 

Next week, Pershing is hosting a conference with several hedge-fund and institutional investors to discuss potential options for McDonald's real estate. (McDonald's owns approximately 37-percent of the land on which its restraunts sit).  After which, William Ackman, managing partner of Pershing Square, said Pershing will publicly present a new, revised proposal to McDonald's.

Wall Street Journal Report can be found here. (subscription required after next week).

Reuters discussion of the article can be found here.

Related Posts:

Ronald Frowns on Hedge Funds

Will Ronald McDonald Put on His Smiley Face for the Hedge Funds

Ronald McDonald Part II

[Jason R. Job]

In full disclosure, I personally own shares of McDonalds in a retirement account.  Also, I am not recommending the purchase or sale of the stock.

Ichan Gets An Inch

As mentioned in the previous post, Ichan Continues to Pressure Time Warner, Carl Ichan and a coalition of investors have been pushing the board of Time Warner to perform certain tasks to increase shareholder value. 

In a letter to the Time Warner Board, which can be found here, Ichan asked "Why are a majority of the same directors who signed off on the disastrous AOL merger still steering the corporate ship?" 

Well this week, Time Warner Board member and former Co-Founder, Chairman, and CEO of American Online (AOL), Steve Case resigned from the Time Warner Board of Directors to focus on a new project. (AP Story can be found here. And, a Forbes.com article about Case's new venture can be found here.)  Time Warner's response can be found here.

Also, in his letter and in a position paper filed, Ichan and his coalition asked for Time Warner to spin off its cable unit and to buy back $20 billion in stock.  Well today, in conjunction with its quarterly report (a pdf file of the quarterly report can be found here), Time Warner announced an increase in their share buyback from $5 billion to $12.5 billion.  (AP report can be found here)  Even though the Board did not announce a $20 billion share buyback nor a spin-off of its cable business, this is a clear indication that the hedge funds do have power to make a difference in corporate management.

See these related posts for other hedge funds in action:

Largest Shareholder Pressuring Knight Ridder

Kerkorian is Pressuring a Struggling GM

An Example of The New Strategy of Hedge Funds: Wendy's

Ronald McDonald Part II with related post, Will Ronald McDonald Put on His Smiley Face for the Hedge Funds... and McDonald's response discussed in this post: Ronald Frowns on Hedge Funds

[Jason Job]

Ronald Frowns on Hedge Funds

As discussed in Prof. Oesterle's post, Will Ronald McDonald Put on His Smiley Face for the Hedge Funds, Pershing Square Capital Management has been accumulating at stake in McDonald's and there had been speculation that Pershing Square would perform the same action in McDonald's as it had done with Wendy's.  As discussed in Prof. Oesterle's post, Ronald McDonald Part II, Jesse Eisinger, in a Wall Street Journal article, described how Bill Ackman, the hedge fund manager at Pershing Square had intended to with McDonald's.  According to the Journal, Ackman wanted McDonald's to spin off its franchise management business as well as create a real estate investment trust for its real estate holdings.

However, today, McDonald's CEO, Jim Skinner, sent a letter to the McDonald's System.

In the letter, which can be found here, Skinner states the following:

"I want to comment on recent speculation in the media about the possibility of a major restructuring of our Company. As a public company, we are continually looking for ways to enhance shareholder value. This is reflected in our recent announcement which stated we expect to return between roughly $5 and $6 billion to shareholders over 2006 and 2007 combined, through dividends and share repurchase."  He continues, "we have no intention to undertake a large scale restructuring either through a McOpCo spin-off or a Real Estate Investment Trust (REIT). Neither would be in the best interests of our system or our shareholders."

Clearly, Skinner has no plans to spin off either the McOpCo, the franchising business nor the real estate of McDonald's.  Also, Skinner states that keeping both of these companies in house will be in the best interests of McDonald's shareholders.  Nevertheless, after Skinner's announcement shares of McDonald's dropped over a dollar.  Granted, most of this buying and selling could be considered "knee jerk" reaction to Skinner's annoucement, but it makes one question whether shareholders actually believe keeping McOpCo and the real estate assets in house is in the best interests of its shareholders.

Also, it will be interesting to see if Pershing Square and/or other hedge funds come in and put more pressure on the board of directors.  It appears that the hedge fund rumors in the press were causing enough problems and speculation that Skinner felt that he needed to stop the rumors.  It seems that Skinner's statement was made with the hopes of getting his "team" refocused on McDonald's impressive, continuing growth plans, instead of wondering whether the "nasty" hedge funds are going to come in and cause disruption and job losses in order to unlock shareholder value.

All I know is that time will tell.

[Jason Job]

In full disclosure, I personally own shares of McDonalds in a retirement account.  Also, I am not recommending the purchase or sale of the stock.

J&J/Guidant Deal Update

Posted by Bill Sjostrom

A 10/28/05 article at TheDeal.com notes that “[t]he recent price-cut dance between Johnson & Johnson [JNJ] and Guidant Corp. [GDT] has arbitrageurs scurrying to review the law on material adverse effect, or MAE, clauses, the provisions in merger agreements that specify when a party may walk from a deal.”  As explained in this earlier post, on 9/30/05 there was an $8 per share arbitrage spread between the GDT market price and what J&J will pay for the shares if the deal closes.  This spread has since increased to around $13, i.e., GDT has dropped $6, following rumblings from J&J that it wants to renegotiate the price (post). 

Whether J&J will be successful in getting a lower price depends in large part on whether the recent recall, etc. by Guidant triggers a walk-away right for J&J.  I took a quick look at the merger agreement, and it looks to me that J&J can walk from the deal if the Guidant recall has had or would be expected to have a “Material Adverse Effect” on Guidant.  See sections 3.01(u), 6.02(a) and 7.01(c).  Hence, the scurrying. 

The merger agreement defines MAE as “any change, effect, event, occurrence, state of facts or development which individually or in the aggregate would reasonably be expected to result in any change or effect, that is materially adverse to the business, financial condition or results of operations of [Guidant] . . .; provided, that none of the following shall be deemed, either alone or in combination, to constitute, and none of the following shall be taken into account in determining whether there has been or will be, a Material Adverse Change or Material Adverse Effect:  (A) any change, effect, event, occurrence, state of facts or development (1) in the financial or securities markets or the economy in general, (2) in the industries in which the Company or any of its Subsidiaries operates in general, to the extent that such change, effect, event, occurrence, state of facts or development does not disproportionately impact [Guidant] or any of its Subsidiaries, or (3) resulting from any Divestiture required to be effected pursuant to the terms of this Agreement or (B) any failure, in and of itself, by [Guidant] to meet any internal or published projections, forecasts or revenue or earnings predictions (it being understood that the facts or occurrences giving rise or contributing to such failure may be deemed to constitute, or be taken into account in determining whether there has been or would reasonably be expected to be, a Material Adverse Effect or a Material Adverse Change)”  (empahsis added).

Whether the recall (and probably some other stuff too) falls within this definition may ultimately have to be decided by a court.  The merger agreement dictates that the suit would be heard in the U.S. District Court for the Southern District of New York, and Indiana contract law would apply. 

I suspect there is no Indiana case law on point.  There is, however, the 2001 Delaware decision in In re IBP Inc. which involved interpreting the MAE clause in a merger agreement between Tyson Foods and IBP under New York contract law.  In that case the court rejected Tyson’s argument that a deterioration in general economic or industry conditions, such as a downturn in the supply of cattle to IBP, constituted a MAE.  The court’s reasoning included the following: 

To a short-term speculator, the failure of a company to meet analysts' projected earnings for a quarter could be highly material. Such a failure is less important to an acquiror who seeks to purchase the company as part of a long-term strategy. To such an acquiror, the important thing is whether the company has suffered a Material Adverse Effect in its business or results of operations that is consequential to the company's earnings power over a commercially reasonable period, which one would think would be measured in years rather than months. It is odd to think that a strategic buyer would view a short-term blip in earnings as material, so long as the target's earnings-generating potential is not materially affected by that blip or the blip's cause.

Note that the Tyson/IBP merger agreement defined a MAE as “any event, occurrence or development of a state of circumstances or facts which has had or reasonably could be expected to have a Material Adverse Effect ... on the condition (financial or otherwise), business, assets, liabilities or results of operations of [IBP] and [its] Subsidiaries taken as a whole....”  (emphasis added).  As emphasized above, the J&J/Guidant merger agreement says “would reasonably,” which arguably establishes a narrower standard for what constitutes a MAE.

Basically, there is no telling how a court would rule, but I would be surprised if it actaully came to litigation.  It's probably in both company's best interests to work something out.

Chipotle Files for IPO

Posted by Bill Sjostrom

Last night Chipotle Mexican Grill, Inc., a majority owned subsidiary of McDonalds, filed with the SEC for a $100 million IPO of Class A Common Stock.  Click here for the registration statement.  Chipotle's capitalization also includes Class B Common Stock with super voting rights, most or all of which will be owned by McDonalds.  Hence, McDonalds will maintain voting control, notwithstanding the IPO.  Chipotle will be another example of what this post referred to as a public totalitarian regime, i.e., a public company controlled by one or a few shareholders.

Incidentally, I recently looked into how many calories are in a Chipotle steak burrito and was stunned to learn that there are a whopping 1,200+.  That's more than two Big Macs and about 60% of the recommended daily intake of calories.  Click here to check the number of calories in your favorite Chipotle burrito (note that this is not the Chipotle site as Chipotle does not itself provide nutritional information).  Chipotle includes the following in the Risk Factor section of its IPO prospectus:

In recent years, there has been an increased legislative, regulatory and consumer focus on nutrition and advertising practices in the food industry. Restaurants operating in the quick-service and fast-casual segments have been a particular focus. As a result, we may in the future become subject to initiatives in the area of nutrition disclosure or advertising, such as requirements to provide information about the nutritional content of our food, that could increase our expenses.

On an ironic note, McDonalds announced yesterday  that it will be including nutritional information on its packaging.  Cick here for an article.  And recall that the House just passed the Cheeseburger Bill.

Flipping Municipal Bonds

posted by Bill Sjostrom

According to a recent academic study, institutional investors are routinely flipping municipal bonds.  Click