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Hedge Funds Are New Sheriffs Of Boardroom
By Alan Murray
The Wall Street Journal
Wednesday, December 14, 2005

Good news for Paul Sarbanes and Michael Oxley:  The senator and congressman whose names were affixed to Congress's corporate-reform legislation have been knocked out of first place on the list of bogeymen haunting the corporate boardroom.

The new leader: hedge funds.

That is the word from well-known lawyer Martin Lipton, who advises corporate executives and boards, entrenched and otherwise.  Mr. Lipton sent his clients a memo at the first of this month that warned against overreacting to Sarbanes-Oxley, and instead listed the No. 1 issue for directors as "anticipating attacks by activist hedge funds seeking strategy changes by the company to boost the price of the stock."

From Mr. Lipton's perspective, having a bunch of hyperventilating hedge funds breathing down the necks of his clients is a bother.  But for shareholders, and for the economy at large, this is a welcome change.

Sarbanes-Oxley and its henchmen in New York state Attorney General Eliot Spitzer's office and at the Securities and Exchange Commission served a useful function.  In the wake of Enron, WorldCom and other corporate scandals, they forced companies to clean up their accounting and strengthen their corporate governance.

But in the process, they also distracted companies from their main mission.  Countless executives and directors have told me, and anyone else who will listen, that they've spent far too much time in the past three years talking to accountants and lawyers, and far too little time focusing on expanding their businesses.

Hedge funds are the counterweight.  While Sarbanes-Oxley forced companies to play defense, hedge funds force them to play offense.  Any risk-averse company that wants to sit on a big pile of cash waiting for a rainy day is likely to find itself under quick attack from these fast-moving pools of money that will come in, buy up stock, and agitate for change.  The hedge funds have become the new sheriffs of the boardroom.  But they are less concerned with legal processes and accounting procedures and more with returns to shareholders.

Most corporate executives, of course, don't like being hassled by hedge funds any more than they liked being hassled by Mr. Spitzer.  They criticize high-powered money managers for being willing to sacrifice the long-term health of their companies in return for a short-term "pop" in the stock price.  Those criticisms are probably overblown.  Research suggests the stock market, on average, does a pretty good job of anticipating the long-term effects of short-term measures.

What really rankles corporate executives is having someone -- anyone -- looking over their shoulder.  In the old days, they had more freedom to run their companies as they wished.  Today, they have to account to an ever-growing list of shareholder groups, regulators, attorneys general, nongovernmental organizations, and now hedge funds.  All may seem annoying if you're inside the corporate suite.  But of that group, hedge funds offer shareholders the best hope for better returns.

Even as they work to hold corporate executives accountable, however, some hedge-fund managers are scrambling to avoid accountability themselves.  They are fighting in court to stop the SEC from implementing a rule that requires them to do what mutual funds and other investment vehicles do as a matter of course:  register with the government.  And they are rushing to exploit loopholes that would let them avoid the registration requirement.

Hedge-fund managers will argue they are already held accountable by their investors.  But recent hedge-fund blowups like Bayou in Connecticut suggest even some of the so-called sophisticated investors who put their money in hedge funds haven't been doing a particularly good job at due diligence.  And increasingly, the money of less-sophisticated investors -- money from public workers' pension funds, for instance -- has moved into these funds.

Moreover, hedge funds are moving to "lock up" their investments for a minimum of two years, making it impossible for investors to pull out if they don't like the way things are going.  The reason for those lockups?  To enable hedge funds to escape the SEC rule, which exempts funds that have lockups of two years or more.

The ironies here are great.  Hedge funds thrive by poring over the records public companies are required to file with the government, even as they resist filing anything themselves.  And hedge-fund managers relish two-year lockups that shield them from "short term" swings in sentiment among their investors, even as they fight managers who want protection from the short-term demands of hedge funds.

The lesson here?  No one likes to be held to account.  But everyone probably ought to be.

Write to Alan Murray at Alan Murray's Business, published Wednesdays, examines the intersection of business, public policy and economics.  Alan shares reader reactions in the Talking Business column on Saturdays.

Alan is an assistant managing editor at The Wall Street Journal and a regular contributor to CNBC.  A graduate of the University of North Carolina, he joined the Journal in 1983;  he served for nearly a decade as the Journal's Washington bureau chief before joining CNBC in 2002.  He holds a master's degree in economics from the London School of Economics.  Alan is the author of "The Wealth of Choices: How the New Economy Puts Power in Your Hands and Money in Your Pocket."  He is also a regular panelist on Public Broadcasting Service's "Washington Week in Review."  Write to him at