The following post is by "Gatzzb," a friend of Dealbreaker.
Over the last decade few investors have been more quoted - and emulated - than Warren Buffett, the Oracle of Omaha. And for good reason. Mr. Buffett remains one of the most talented investment managers, capital allocators and business managers of our generation with a track record few have come close to matching. Just read any of his letters from the last 30 years and you'll quickly understand why (sex jokes help). But with his long time passive stake in Moody's Corp (MCO), I believe Mr. Buffett has practiced what he has often preached against: putting profits before ethics.
He is invested in Moody's Corp. because it fits his major criteria - large margins and a huge "moat" given it operates under an oligopolistic umbrella provided by our government. However, Mr. Buffett clearly has no great love for the actual product Moody's produces. On numerous occasions, Mr. Buffett has stated he does not use Moody's ratings (or that of other firms such as S&P and Fitch's). On numerous other occasions, Mr. Buffett has famously discussed derivatives as being "weapons of mass destruction."
Well, in 2005-2006 over 40% of Moody's revenues came from rating these weapons such as CDOs. This surely did not elude Mr. Buffett. The danger of the AAA ratings placed on these weapons of mass destruction, by companies such as Moody's, surely did not elude Mr. Buffett either. In fact, several years ago Berkshire took great pains to remove their exposure to these types of derivatives. Yet while he actively removed Berkshire's exposure to derivatives and actively avoided using Moody's et al's flawed ratings, he did nothing to facilitate change to this poisoned model - perhaps Moody's record breaking profits had something to do with this. Certainly as the largest shareholder in Moody's and one of the most influential investors in the world he could have easily enacted such change or in the least spoken out openly about the problems.
Now here we are several years later with a financial system in ruins. AAA rated AIG went bankrupt and cost investors and taxholders billions in the process, AAA rated GE has been in a brutal downward spiral and the tailspin is not showing any signs of abating soon, FNM-FRE were AAA rated when they began their final collapse, and AAA rated derivatives helped facilitate the most spectacular financial collapse since the great depression.
But Berkshire is a passive investor, the long term holders everyone in the media loves - and activist investors, those who have pointed out problems are all bad, aren't they?
The original oracle, Buffett's teacher Benjamin Graham, once wrote, "The best opportunity for demonstrating investor intelligence is in the field of stockholder-management relationships." This tenet is the foundation for activist investing. I can't speak for Mr. Buffett on why he chooses to eschew from this pillar of Graham's thinking, but personally I think this passive behavior is dead wrong.
Media (read: sensationalism) has unfortunately helped bring us to the point where activist investing has become synonymous with a corporate raider strategy. For many - perhaps most - "Barbarians at the Gate", "Predator's Ball" "Gordon Gekko" and "Greenmail" define activist investing, Wall Street, and Hedge Funds. Meanwhile, attempts to improve shareholder value get lumped in the same "bad guy" category. Sadly, this attitude towards activist investing - and hedge funds in general, wherein they're simply cast as the villains by default-- have come at great price to shareholders over the last several years.
* David Einhorn points out borderline fraudulent activities in Allied Capital (2002) - his company, Greenlight Capital, is sued. His company is attacked by Allied Capital and the SEC. Even once fraud is found at Allied, the government issues a mild sanction and it takes over five years before Allied finally unravels. The retail investor loses hundreds of millions of dollars in this process.
* Bill Ackman details the enormous problems with MBIA and our oligopic ratings system (2002). He spends more than seventy pages detailing the faults, attempting to help save the system at a cost to potential profits for his firm. His firm, Gotham Partners, is investigated for libel. After more than five years, MBIA finally unravels. Retail investors again lost hundreds of millions of dollars.
* David Einhorn questions Lehman's accounting and health (2007). He is attacked by the firm and the press. Lehman is now bankrupt, of course. Retail investors lose hundreds of millions of dollars.
The most recent example comes from the recent Target Board of Directors proxy contest. Boards of Directors exist as an independent entity designed to lend their expertise to the company and protect the interests of the shareholders. They are an integral part of corporate governance and business management. Yet too often the board is a close knit group of members who serve only to protect their own interests, paycheck, and status quo. Witness how Target voted to extend the term limits of their board members from ten years to twelve years despite this rule having been created explicitly to enforce this occasional turnover.
When Bill Ackman launched his proxy initiative to add several independent industry experts to Target's board, he did so for the future benefit not just of his investors but of every single Target shareholder - of which he is one of the largest. He even spent his own money on this campaign. Target fought vigorously to protect their current board members and, in a funny commentary, even spent millions of shareholder dollars to do this! Target wouldn't even allow Mr. Ackman's nominees to be voted for except via special proxy card or if you traveled in person to the remote meeting location in Minnesota. Seems to me they are working very hard to protect their own interests, not that of their shareholders.
Especially distressing have been some of the media coverage and the way some have derided Mr. Ackman's efforts, painting him with the lazy, broad, 'hedge funds are bad' brush. Joe Nocera at the Times wrote a story which could have as likely come from Target's PR department. He latched on to the stereotypes of an activist investor and seemingly ignored the truth of greater matters at stake. Mr. Nocera even mocked that with his proxy fight "Somehow, [Ackman] seemed to believe, it was going to make corporate America a better place." And this is a bad thing how, exactly? At least people like Ackman have put money behind their words; critics of activist investors should try this approach!
Looking at GM, one of the reasons they failed could be that their Board had no executives with automotive experience. Target's board also has significant shortcomings:
* The board members are not independent; many of their own companies do business with Target!
* The board members do not have expertise which directly pertains to Target's business
* The board owns almost no Target stock and over the last five years has sold nearly $550mm in stock
Yet even after the past several years, where the ineptitude of many managements and misalignment of incentives between management and shareholders has reared its head, shareholders remain remarkably compliant. In both the Einhorn and Ackman situations, corporate managements were able to use a game of smoke and mirrors to counter the claims lobbied against them. The media, eschewing real investigative (read: researched) journalism, trotted out management's side of the story. Every defense needs a good story and what better story than these hedge funds, short your stock, are maliciously attacking it for their own gain - the evil hedge fund story, 101. To see respected voices such as the New York Times and Barron's (also with a critical article) not grasp the greater picture in these cases truly distresses me. Our system should be designed to protect the retail investor, yet it seems designed only to protect those in power. Each time another wave of scandals goes through Wall Street I hope that this is the one which will facilitate a true industry-wide change in actions and perceptions, but thus far each time I have been disappointed.
It is often implied that hedge funds need a little more Warren Buffett in them, but I think the reverse contains as much truth if not more. Warren Buffett needs a little more hedge fund in him. So Mr. Buffett, on behalf of all investors I beseech you - maybe one day we'll all listen more closely to an Einhorn or Ackman but right now everyone will definitely listen to you... please speak up!