Beware Hedge Funds Bearing Advice

Date: Tuesday, November 27, 2007
Author: New York Times

Hedge funds can inspire terror in boardrooms these days. Whereas directors might once have trashed an angry letter from a hedge-fund manager holding a few million shares of their companies, in this age of investor activism, they are far more apt to listen — and, in many cases, go along with the fund manager’s demands.

But taking advice from a hedge fund (even one with a reputation for huge profits and great timing) can be disastrous. Just consider what would have happened if TD Ameritrade had heeded the calls of SAC Capital and Jana Partners to combine with another online brokerage firm such as E*Trade Financial.

A few months ago, SAC and Jana were writing poison-pen letters to Ameritrade’s chairman and its chief executive, accusing them of short-changing shareholders by failing to pursue a deal with E*Trade that would bring, in their words, “compelling benefits.”

In retrospect, if Ameritrade had bought E*Trade earlier this year, it would likely have gone down as one of the worst-timed transactions of 2007.

SAC, run by Steven A. Cohen, is one of the most powerful hedge funds on Wall Street. Though traditionally not an activist fund, SAC has become more aggressive about putting public pressure on companies in which it invests.

Along with Jana, SAC began targeting TD Ameritrade in May, urging the company to pursue a combination with a competitor such as Charles Schwab or E*Trade, which they said would “dramatically increase long-term shareholder value.”

In their letters, they harshly criticized certain members of TD Ameritrade’s board as “self-serving” and having “glaring and untenable conflicts of interest.” And they suggested that E*Trade would be a relatively safe merger partner, in part because it “assumes only modest credit risk.”

Modest credit risk? Since May, E*Trade has repeatedly slashed its earnings expectations because of troubles with mortgages and mortgage-related securities. One analyst recently speculated that E*Trade’s depositors could flee the bank, creating the potential for a bankruptcy filing. E*Trade has called that speculation “irresponsible,” but its stock has taken a huge hit, losing more than 75 percent of its value this year. It closed Friday at $5.33.

Over at Ameritrade, the picture is vastly different: Its shares are up about 16 percent year to date. Ameritrade’s shareholders are probably heaving a sigh of relief right now that the company’s board, and not hedge fund managers, were running the show.

Luck could have been a factor. It’s not clear that Ameritrade’s board knew anything about the troubles that would soon befall E*Trade, or whether they just benefited from procrastination.

This much is clear, though: If Ameritrade had bought E*Trade when it first heard from Mr. Cohen and friends, it would have some very angry shareholders on its hands today.