Hedge funds as whistleblowers

Corporate managers notoriously are tempted to fudge the truth about their firms. The law’s usual strategy is to threaten an army of gatekeepers – outside directors, corporate officers, accountants, lawyers – with criminal and civil penalties for not reporting fraud. The second line of defense is to encourage whistleblowers to come forward by protecting their jobs. SOX, of course, was big on both of these approaches. The only problem is that neither approach works very well. It seems that gatekeepers and employees are stubbornly nervous about blowing up their careers by squealing.

There is another way. Whistle-blowing is all about information. Thanks to the stock market, information is, as Gordon Gekko said, “the most valuable commodity I know of.” Most trading on information (including a lot of the “insider” trading portrayed in Wall Street) is legal, and it’s done today by hedge funds. And as Bruce Kobayashi and I argue in our Insider Trading as an Incentive Device, “outsider trading can provide incentives for socially beneficial conduct. In particular, outsider trading provides an important way to capitalize on investments in information that are not otherwise protected by the intellectual property laws.”

However, outsider trading in general, and short-selling in particular, doesn’t sit well with corporate managers. They like their investors to be patient. Short-sellers don’t wait for the managers’ brilliant strategy to pay off. Short-sellers make money by exposing managers’ lies. Firms would like to see short-sellers go to jail (as Gekko ultimately did), or at least go out of business.

The public shares this view. Whistleblowers are romantic heroes. They get to be played in movies by sympathetic actors like Russell Crowe. Short-sellers and other stock traders, on the other hand, are greedy capitalists. They get played by vest-wearing actors with greasy hair. (Apparently, according to Christine, there's even a little of this in Speed Racer, reason number 5001 for not seeing it). The unsurprising result of this political dynamic is an intermittent war against shorts, as I’ve written, e.g., here and here.

Which finally brings me to Jesse Eisinger’s flattering Portfolio column on David Einhorn, a hedge fund manager who's been engaged in a long-running battle with a company he shorted, and now has written a book about the whole affair. Eisinger portrays Einhorn as a heroic whistleblower.

Maybe Eisinger's column is a sign that the tide is turning. I’m looking for Einhorn to get a movie contract. We may even get our first hedge fund movie hero – the first step toward a sensible public policy on incentives to produce information.

Comments

[michael webster]

Larry,

The short sellers historically have been derided.

In my opinion, the only commentators worth listening to are those without a conflict - no skin in the game, but getting to the story.

I believe that there was an SEC report which substantiated the incredible value of the financial press, as opposed to the various gatekeepers.

This is the most important feature of the market for reputation to get right.