Sunday, March 15, 2009

Dagny Taggart Committed Securities Fraud?

Posted by Jeff Lipshaw

For reasons too irrelevant to state, I've been re-reading a canon of my youth, Ayn Rand's Atlas Shrugged.   I guess it took about forty years since I first read it, and teaching securities regulation, to realize there is either some securities fraud going on in the first 200 pages, or else we have what they call in the movies a continuity error.

Here's a quick plot summary to get us to the crucial passage.  Our beautiful, independent, productive, self-reliant brilliant heroine is Dagny Taggart, heiress, but more importantly, Vice-President of Operations of the great Taggart Transcontinental Railroad.  She has committed to rebuild the Rio Norte Line of the railroad, running from Cheyenne down to Durango, New Mexico, as the last hope of the railroad, and indeed the country, which is rapidly in the hands of those socialist, flabby, chinless, second-rate looters, like her brother, James Taggart, the president of the railroad.  Dagny has also committed to use the new and revolutionary Rearden Metal, developed by secondary hero, Hank Rearden (later to become Dagny's lover in a cataclysm of violent sex that we fifteen year old readers could only imagine), steel magnate, and like all Rand heroes, tall, thin, gaunt, with cheekbones and individualism to kill for. 

A baseless but negative report on Rearden Metal from the evil State Science Institute has caused the Taggart stock to crash. Dagny decides to save the railroad by organizing her own company to take over the Rio Norte Line and to build it as she knows it should be built (it's called the John Galt Line - that's another story).  So here's the conversation she has with James.  First, she's agreed to sever all connections with Taggart, and if the venture fails, she will not come back to the company.  Second, we have this, which begins with James' additional condition:

"Before we transfer the Rio Norte Line to you, we must have a written agreement that you will transfer it back to us, along with your controlling interest at cost, in case the Line becomes successful.  Otherwise you might try to squeeze us for a windfall profit, since we need that Line."

There was only a brief stab of shock in her eyes, then she said indifferently, the words sounding as if she were tossing alms, "By all means, Jim.  Have that stated in writing."

But only seven pages later, she's selling bonds in the John Galt Line ($8 million; she's borrowed $7 million by pledging her own Taggart stock).  Now heroic men in Ayn Rand are either tall, thin, gaunt, with cheekbones and individualism to kill for, or solid, working class born, no-bullshit guys, with individualism to kill for, and she's sold her bonds to the last eight of those guys left in the country.  She's meeting with Hank Rearden to discuss the Metal, and he immediately signs on for $1,000,000 of the bonds.  And we have this from Rearden, explaining to her why he doesn't consider it a burden to invest:

"Incidentally, I don't expect to lose this money.  I am aware of the conditions under which these bonds can be converted into stock at my option.  I therefore expect to make an inordinate profit - and you're going to earn it for me."

She laughed.  "God, Hank, I've spoken to so many yellow fools. . . .  Yes, I think I'll earn your inordinate profit for you."

So we have a convertible bond whose value is really in the equity kicker, because the risk really doesn't merit a typical fixed bond return.  Given the importance of the equity, I think we have a Virginia Bankshares situation here.  "Yes, I think I'll earn. . . ." might be an opinion, but the undisclosed fact is that she has already agreed to gut the value of the company by transferring its only asset back to Taggart at cost!

Am I reading too much into this?  Am I just projecting my own desires to be tall, thin, gaunt, with cheekbones and individualism to kill for?  Oh, who is John Galt?

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