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I think were people who are just curious about things,




By JOE NOCERA;I think were people who are just curious about things, said Andrew J. Redleaf, with a tone of;mock innocence.;Mr. Redleaf, 48, runs Whitebox Advisors, a $1.8 billion Minneapolis hedge fund that has had;sparkling returns since he started it in 2000. Mr. Redleaf is one of those hedge fund guys who;write letters to investors that are filled with big ideas about the market. Hes also funny, cynical;cranky and unabashedly opportunistic.;Could that professor really be right? he continued. The professor he was referring to was Erik Lie;of the University of Iowa, who published a study last year that essentially set off the options;backdating scandal. Although Mr. Lie did not name names, his work showed, indisputably, that;there were simply too many cases where options were granted to top executives just before a nice;run-up for it to be happening randomly. He suggested that companies had to be backdating;option grants to enrich executives.;That study, in turn, piqued the interest of the Securities and Exchange Commission and The Wall;Street Journal, which began looking at individual companies. At this point, 115 companies have;been identified as being under some sort of investigation, either by the S.E.C., the Justice;Department or an internal investigation. So far, executives from two companies that backdated;options, Converse and Brocade, have been indicted. This week, Cablevision revealed that it gave;backdated options to a deceased executive making it appear as though he had received the;options while still among the living.;A few months ago, Mr. Redleaf and several of his Whitebox colleagues decided to do their own;options backdating study. They ran 6,000 companies and 60,000 options grants through;their computers. They looked at a 40-day window: 20 days before the options were granted and 20;days after. And sure enough they discovered several hundred companies whose pattern of granting;options at the precise moment the stock was about to jump was eyebrow-raising, to say the least.;And while Whitebox Advisors does not have absolute proof that options backdating took place;neither did Mr. Lie. It was statistical detective work.;Mr. Redleaf is quick to express outrage at executives who backdated options. Of the series of recent;Wall Street scandals, Mr. Redleaf told me: This is by far the worst. It is a direct transfer of wealth;from stockholders to insiders.;But lets be honest here. Hedge funds dont do deep dives into options backdating just to satisfy;their curiosity or to gain justice. Rather, they do it to find an edge and to use that edge to get;richer than they already are. What Mr. Redleaf has begun to do with this options backdating;information raises a question that is being asked a lot these days about hedge fund operators. Is he;an activist, helping to make the market a better place? Is he a holdup artist? Or is he both?;When you ask the folks at Whitebox Advisors how they make money, they have a hard time;explaining it in laymans terms. Relative value arbitrage, Mr. Redleaf replied when I asked him to;describe his fund. Generally, he continued, we focus on mispriced securities that have a;relationship to each other like a companys stock and bonds. That, he added, tends to cause us;to skew towards distressed companies.;Often, for instance, a companys bonds will send up an early warning signal that there may be;internal problems, even as its stock remains buoyant. In that mispricing is an opportunity for a;smart hedge fund guy who sniffs it out. Sometimes, though, the hedge fund guy wont be willing to;just sit on his hands while waiting for the market to catch up with his insight. Thats when he;becomes an activist.;Earlier this year, for instance, Whitebox was among a number of hedge funds that were holding;General Motors bonds. We were betting that they would cut the dividend because we thought it;was inevitable, Mr. Redleaf said. He also felt, though, that cutting the dividend was the right move;for G.M. to make so he went to Detroit and met with members of G.M.s finance team to press;that case. Sure enough, in February, when General Motors cut its dividend in half, the bond;market applauded, and Whiteboxs G.M. bonds were suddenly more valuable.;Mr. Redleaf became interested in options backdating because of another, more controversial bond;play that Whitebox and a number of hedge funds began using a few years ago. When a company;fails to file its financial documents on time, its bonds are technically in default. For decades;though, bondholders have generally looked the other way when that happened.;But Whitebox did not. Instead, it took to buying up bonds below par that is, bonds trading;below their face value of companies that had failed to deliver their financial documents on time;usually because of an accounting problem.;Then, Whitebox and other activist bondholders would tell the company that since it was in default;on its bonds it was liable for the full face amount immediately. Sometimes, the company would;wind up paying off the bonds. Other times, it would negotiate an agreement, usually a one-time;payment to the bondholders in return for a waiver. Either way, Whitebox won.;Mr. Redleaf argues that what he is doing is being vigilant in asserting our rights, unlike mutual;funds and other big institutional investors that have ill-served their investors by not fighting for;everything they are entitled to. Of course, most companies dont see it quite that way. They view;Whitebox as taking advantage of a technicality to make a quick buck.;Companies that are caught backdating options, of course, have huge accounting problems.;Options that have been backdated require a different accounting treatment, and companies;usually have to restate their financials for the years during which they were backdating. This;almost inevitably means that they will also not be able to file their current quarterly or annual;report on time. Which therefore means their bonds will technically be in default. Which therefore;means the bondholders can squeeze them.;Is it any wonder Mr. Redleaf suddenly became interested in options backdating?;Once he had his list of potential options abusers, Mr. Redleaf and his team shorted about 80 of;them. But Whitebox also went into the marketplace and bought bonds of some of the companies in;question. (In other cases, it already owned the bonds.) And then the firm got to work.;Consider the case of Affiliated Computer Services, a Texas-based technology outsourcing company;with over $4 billion in 2005 revenue and 50,000 employees. It was one of the first companies to be;fingered as a possible options backdater, and instigated an internal investigation in March. In July;when the company released its quarterly results, it also said that while the investigation wasnt;complete, it didnt think it would have to restate results. We do not believe that any director or;officer of the company has engaged in the intentional backdating of stock options grants, it;added.;Mr. Redleaf shot back in a letter he sent to the company in early August. There were 14 grants;between November 1995 and March 2005, he wrote to Darwin Deason, the chairman of the board.;Every single grant was better than a random day for the period, a 1-in-16,384 occurrence. He;added, if we look at the stock return for the 20 days after the grant, the award days were in the;91st percentile, a result very consistent with backdating but hard to square with legitimate;methods.;Within days of receiving the letter, A.C.S. announced that its previous statement about options;backdating can no longer be relied upon strongly implying that things were worse than it had;claimed a few weeks earlier. A few days later, a lawyer working for the companys audit committee;contacted Whitebox to see what the firm had found. Last week, A.C.S. announced that it had;missed the deadline for filing its annual report the exact event Whitebox was hoping would;result from its letter.;The company also reported that because of that missed deadline it may face covenant compliance;issues, meaning that it may be in default of some $2 billion worth of loans. The company said it;would seek a waiver. You know what that means: money in the pockets of Whitebox Advisors.;A spokeswoman for Affiliated Computer Services wouldnt comment on its option backdating;investigation except to say that it was a coincidence that the company made its tougher;announcement so soon after getting the letter from Mr. Redleaf. She also wouldnt comment on;Mr. Redleafs tactics.;Indeed, of the half-dozen companies I called for this column all of whom received similar letters;from Whitebox, and several of whom face the prospect of having to pay off their bonds at full value;because they missed filing deadlines only one spokesman was willing to say what they;undoubtedly all feel. That was Jeff Luth of Amkor, a company whose options problems caused it to;fail to file its quarterly report last June and is now dealing with the consequences.;We dont think opportunistic hedge funds should hold Amkor hostage for a financial windfall, he;said. We believe it siphons off corporate assets to the detriment of our shareholders.;But doesnt that also describe options backdating? As Mr. Redleaf pointed out: By cheating on;options grants these companies filed phony financial statements and they used those phony;financials to borrow money from bondholders. Shareholders have the right to fire management. All;bondholders can do is try to get their money back.;The punishment Mr. Redleaf is meting out may be harsh. And it may be a hold up. But its hardly;undeserved. Eventually, he said, the market punishes the wicked.;Copyright 2012 The New York Times Company;Back to Top;Home;Privacy Policy;Search;Corrections;XML;Help;Contact Us


Paper#30350 | Written in 18-Jul-2015

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