WASHINGTON — A new Senate bill tries to make it just a little bit harder for activist hedge funds to exploit healthy companies rather than invest in their future.
Sen. Tammy Baldwin (D-Wis.) and Jeff Merkley (D-Ore.) introduced the Brokaw Acton Thursday, which would strengthen disclosure requirements for activist hedge funds that buy parts of companies. Activist hedge funds, unlike other hedge funds, become deeply involved in the companies in which they buy a stake, steering them in a direction that most benefits the fund.
The goal of the legislation is to make it harder for these private financial actors to secretly plot takeovers of companies to drive up their short-term share price, or to use an ownership stake to covertly undermine the health of the company in order to bet against it.
Combating corporate “short-termism,” the trend of big investors pressing for immediate returns at the expense of long-term value, has become something of a crusade for Democrats in general, and Baldwin in particular. Hillary Clinton, the Democratic presidential front-runner, has outlined a plan to curb the short-term practices she and others have dubbed “quarterly capitalism.”
Baldwin and Merkley’s bill is named after the small Wisconsin town of Brokaw, where an activist hedge fund’s pressure on Wausau Paper resulted in the 2012 closure of the town mill, which bankrupted the town.
“These reforms will help ensure that no other small towns in America will fall victim to activist hedge funds on Wall Street,” Baldwin said in a statement accompanying the bill. “It is time to stand up for our Main Street economy and rewrite the rules for Wall Street so we can build an economy that works for everyone, not just those at the top.”
The new bill, which also enjoys the influential backing of progressive Senate stalwarts Elizabeth Warren (D-Mass.) and Bernie Sanders (I-Vt.), a Democratic presidential candidate, would shorten the window before investors must disclose that they have purchased an ownership stake in a company of 5 percent or more. Currently, individual investors or funds purchasing a 5 percent or higher stake can wait 10 days before disclosing their acquisition; the Brokaw Act would require them to disclose the acquisition within two days.
The measure aims to prevent hedge funds from using the disclosure window to tip off other investors about the purchase so they can join forces in what is known as a “wolf pack” to quietly buy an even larger part of the company.
The price of a share in the company remains low until the public disclosure, allowing these allied investors to make an especially lucrative profit without competition from the broader public. It also prevents the company’s management, workers and other stakeholders — who might be interested in keeping a plurality of ownership out of a hedge fund’s hands — from working to counteract the acquisition.
Baldwin contends that the 2010 Dodd-Frank financial reform law already grants the Securities and Exchange Commission the authority to shorten the disclosure window, but the agency has not done so.
The Brokaw Act would also treat allied funds with individual ownerships stakes under 5 percent as a single entity so they cannot avoid disclosure.
And it would require an activist hedge fund to disclose the derivatives it has in connection with a company in which it invested, including a “net short,” or bet against the company. That would make it easier for other stakeholders to see if the activist hedge fund was undermining the health of the company because it stands to profit from its losses or demise.
“Activists are having a chilling effect on reinvestment in the United States as they threaten companies and advocate reduced investment through share-buybacks versus investing to build long-term enterprises,” said Henry Newell, the former CEO of Wausau Paper, in a statement praising the bill.
Newell was planning ways to keep Wausau Paper more competitive in 2011, when the activist hedge fund Starboard Capital, which had begun buying shares in Wausau, publicly announced it had no confidence in Wausau’s paper business. Newell has said the statement was so damaging to investor confidence that the company then had no choice but to shutter the Brokaw paper mill.
The rise of activist investing in recent years has shined a light on short-termism more broadly — and increased skepticism of its economic benefits. That is true of Democrats like Baldwin and Clinton, but also of many conservatives, business executives and academics.
There were 551 companies pressured by activist investors in 2015, according to industry publication Activist Insight — up from 136 in 2010.
The explosion of activist investment has corresponded to a dramatic rise in the share of corporate spending dedicated to shareholder payouts in the form of dividends and stock buybacks.
At the same time, corporate investment in fixed assets is at its lowest level in decades. Investments in infrastructure, like machinery or facilities, are a key part of improving a company’s productivity. And higher productivity is more likely to generate higher returns for investors over the long term.
Companies targeted by activists hedge funds have fared particularly poorly in this regard. At companies that survived four years after a hedge fund became involved in their management, research and development spending as a share of sales dropped by over 50 percent, according to a study by the Montreal-based Institute for Governance of Private and Public Organizations.
Defenders of the bulk of activist interventions, like Harvard Law School’s Mark Roe, argue that its downsides are exaggerated, and that the dearth of corporate investment represents a prudent response to a “weak economy.”
But for policy analysts and economists who believe short-termism is enormously harmful, the Brokaw Act’s increases in hedge fund transparency represent a modest and uncontroversial attempt to address the problem.
Mike Konczal, a senior fellow at the progressive Roosevelt Institute who co-authored a paper in November proposing far more drastic measures (such as limiting stock buybacks and executive pay), called the bill a “really important first step.”
“A lot of people know the problem of short-termism for publicly traded companies,” Konczal added. “This is extending that to the world of hedge funds.”