US Senators Tammy Baldwin (D-WI) and Jeff Merkley (D-OR) introduced legislation on Thursday to increase transparency and strengthen oversight of activist hedge funds.
The Brokaw Act is named for a small Wisconsin town that went bankrupt after an out-of-state hedge fund closed a paper mill that had provided good jobs to the town for over 100 years. The activist hedge fund bought up the legendary Wausau Paper Company, forced out its executives and demanded short-term returns like buybacks at the expense of the company’s long-term future.
“We cannot allow our economy to be hijacked by a small group of investors who seek only to enrich themselves at the expense of workers, taxpayers and communities. This legislation updates Depression-era rules to address the financial abuses being carried out by activist hedge funds who promote short-term gains at the expense of long-term growth,” said Senator Baldwin. “The Brokaw Act will take on a rigged game by increasing transparency and strengthening oversight of activist hedge funds. These reforms will help ensure that no other small towns in America will fall victim to activist hedge funds on Wall Street. 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.”
“We should measure the success of our economy not by the profits of hedge funds, but by whether working Americans can find good jobs that provide a solid foundation for their families,” said Merkley. “Hollowing out longstanding companies so that a small group of the wealthy and well-connected can reap a short-term profit is not the path to a strong and sustainable economy for our nation. It’s time to take on this rigged system and stop the short-term game playing that sells our workers, businesses and economy short.”
Put simply, short-termism—also known as “quarterly capitalism”—is the focus on short time horizons by both corporate managers and financial markets. It results in corporate funds being used for payouts to shareholders in the form of dividends and buybacks rather than investment in workers, R&D, infrastructure and long-term success.
Activist hedge funds are leading the short-termism charge in our economy. They abuse lax securities laws to gain large stakes in public companies. Once there, they often make demands to benefit themselves at the expense of the company’s long-term interests. The most common demands are for more debt, stock buybacks, reduced R&D, cost-cutting, layoffs and general reduction of any investment in long-term growth.
According to the senators, The Brokaw Act would put in place the following reforms to increase transparency and strengthen oversight of activist hedge funds:
Restore Transparency to the Marketplace
Congress has long recognized the potential for abuse when activist hedge funds form loose associations of “wolf packs” and engage in “tipping” allies to the impending 13 (d) disclosure. Dodd-Frank explicitly gave the SEC the power to address abuse, yet the Commission has been unwilling to use this authority. This legislation removes the opportunity for riskless gains that activists achieve by shortening the 10-day disclosure window to 2 days.
Protect Businesses from Wolf Packs
The Brokaw Act reforms the definition of “person or group” in order to prevent wolf packs from skirting the intent of the disclosure rules. Activists’ collective stake in a company may be well above 5 percent, but individually, they stay below the threshold to avoid disclosure. This reform identifies these funds as a single group to require disclosure.
End Secret “Net Shorts” by Requiring Derivative Disclosure:
Derivatives are part of every activist’s toolkit. In some cases they are used to create a “net short” that allows the activist to profit by secretly voting against the company’s interests. Currently, derivatives and other synthetic instruments do not require disclosures despite the fact that they can have substantial impacts on the price of the security and its issuer. This can allow funds to secretly bet against a company they are invested in. This legislation strengthens oversight of these instruments under the purview of 13(d).
The Brokaw Act is cosponsored by Senators Bernie Sanders (I-VT) and Elizabeth Warren (D-MA).
According to the senators, what happened in Wisconsin is one example of a larger problem that demands action. Activist hedge funds are a key proponent of the short-termism trend that has captivated Wall Street. The number activist campaigns have risen annually by 60 percent since 2010, and there were 348 activist campaigns in 2014. Their assets under management have grown from $12 billion in 2003 to over $200 billion today and no company is too large to escape their attacks.
Firms targeted by activists experience lower investment and R&D, provided they survive at all. Given that these investments are the lifeblood of our economy, we can assume that if this trend continues, the results will be disastrous. Our corporations no longer attempt to develop new products, train-up workers, or expand into new ventures, and ultimately, our national competitiveness will suffer.