What are we to make of the ability of hedge-fund managers and other influential investors to manipulate the market with impunity and make millions of dollars doing it?
The question was raised anew on February 16 after news broke that Daniel Loeb of Third Point LLC had sold a portion of his 8.9 million shares in Herbalife. Loeb's action, while perfectly legal under current law, deserves a thorough review by the Securities and Exchange Commission - which is supposed to protect small investors in the capital markets - and its next likely chairman, Mary Jo White.
Loeb, of course, is one of the brilliant young (and not-so-young) investors who have squared off against one another in the battle over Herbalife, the purveyor of weight-loss and other nutritional products through a network of independent distributors. Loeb came in on the long side of the fight, along with billionaire Carl Icahn, who announced on Valentine's Day that he owns almost 13 per cent of Herbalife's existing shares. They are squared off against Bill Ackman, whose Pershing Square Capital Management LP announced on December 20 that it had amassed a $1 billion short position in Herbalife, which Ackman called an illegal pyramid scheme.
Every time one of these respected hedge-fund managers or takeover kings goes on cable TV and explains his latest thinking or actions - a growing addiction, it seems - Herbalife's stock jumps or dives like a trained seal.
That was especially true on February 15, the day after Icahn announced in a filing with the SEC that he had amassed more than 14 million Herbalife shares and intended to meet with the company's management to discuss "business and strategic alternatives to enhance shareholder value, such as a recapitalisation or a going-private transaction." The stock soared 20 per cent on the news in after-hours trading on February 14, according to CNBC.
The other shoe dropped February 16, when "sources" confirmed to CNBC and the New York Post that Loeb had sold a portion of the Herbalife stock he owned into the Icahn-ignited rally. (Third Point eventually confirmed the sale.) The problem with that, in my mind, arises from Loeb's own much-heralded January 9 announcement - in a filing with the SEC and in a letter to his investors - that he had acquired 8.9 million Herbalife shares, or 8.24 per cent of the market. It was a response, he said, to the "panicked selling" that followed Ackman's December 20 announcement of his short position, which drove Herbalife stock into the mid-$20 per share.
In his letter to his Third Point investors, Loeb described the company's robust financial performance, including earnings per share that had increased "approximately 20-50 per cent each year since 2004," noting that "this type of steady non-cyclical growth is hard to find." He rejected Ackman's claim that Herbalife "exploited and harmed" its "loyal customer and distributor base" and its products were "commodities sold at inflated prices" and not supported by sufficient advertising or research and development.
Rather, Loeb wrote, the stock could easily return to its April 2012 price of about $70 per share (it was then at about $39). At a minimum, he wrote, the stock should be valued at $55 to $68 per share, offering Third Point "40-70 per cent upside from here and making the company a compelling long investment." Over the next few days, the Herbalife stock rose 10 per cent.
What I question is whether, after making a huge public commotion about buying the Herbalife stock as a "compelling long investment," it is then ethical to sell a big chunk of that stock at a price far below what you told investors it was really worth. Should it even be legal? Isn't this just taking unfair advantage of your ability to move markets?
Securities laws exist to prevent "market manipulation" of the "pump and dump" variety, whereby an investor publicly announces a large stake in a company, the market moves up on the announcement, and then the investor sells the position, or a portion of it after the market moves.
"These activist investors must be careful NOT to cross the line of creating a pump and dump, which is illegal," Ken Luskin, the president of Intrinsic Value Asset Management in Santa Monica, California, wrote in an e-mail to me after my recent column about hedge-fund investor David Einhorn's public comments on Apple. "So, if these activists do quickly sell/close out their position after talking up the merits, they could be accused of 'market manipulation'." No doubt Third Point would hotly dispute that it manipulated the market, especially because Loeb still owns some Herbalife stock - although he won't say how much - and is free to increase or decrease his stake in the future. I can easily imagine him saying that his decision to sell some of his Herbalife stock is evidence that he's not locked into a zealous viewpoint and is simply trying to make money for his investors, and that there is no worry on his end that the SEC might consider his behaviour a violation of pump and dump laws.
And that, to me, is a problem. Because the only people who end up losing in situations like this are the very ones the SEC is supposed to be protecting - the little guys.
William D. Cohan, the author of "Money and Power: How Goldman Sachs Came to Rule the World," is a Bloomberg View columnist. He was formerly an investment banker at Lazard Freres, Merrill Lynch and JPMorgan Chase. The opinions expressed are his own.