Friday, May 23, 2008

Dear Mr Activist...

Hugh G. Fallis - General Partner
Chief Activist Officer
The Greenmail Fund
Main Street
Greenwich CT

Dear Mr Fallis,

Our company has existed for 117 years. We survived several financial panics, a depression, two world-wars, a syphilitic emperor, an earthquake, two nuclear bombs, hyper-inflation, an occupation by MacArthur, the great bubble, and the most prolonged doldrums the modern world has seen since the great depression. Despite this robust longevity, we now find ourselves wondering whether we will survive the pox that you have brought upon us.

All accounts tell me our founder was a wise, caring and generous man. His ingenuity, drive, and continued curiosity built our foundations. Through his success, he had acquired much land surrounding the site of original factory in town to stage our operations, and was wealthy by any measure. Most of the streets in the vicinity still carry our name in some form, even though ownership is but a distant memory. You see, when the downturn came, my great-grandfather swore he would do everything in his power to insure that the employees, who'd helped make his success, who loyally served him, and gave their energy day-in and day-out to the Company would NOT be fired and thus impoverish their families, so he and his children could continue to live in luxury and keep his land. First he cut his own household's expenses so he could decrease his draw. Then he asked his most loyal and senior managers to do the same. And then his employees. Only then did he sell the land, tsubo by tsubo, to insure that his promises were kept. And so, the Company, and its workers, survived, where many other time-honored enterprises were less fortunate. And as a result, we continued to manufacture our wares, bringing joy to our customers, livelihoods which brought food to tables of our employees - from the factory floor to the export office - and dividends and profits to her owners when times were good.

We've survived the years through understanding what our customers desire, investing in research and the latest technology to insure our products are of the best quality, and the unmitigated dedication, hard work, and harmony with our workers, and through a maintaining conservative approach to financial management which six generations of experience has taught is useful for surviving inevitable downturns, after which we've thrived when such doldrums are exited. But I do not expect you to understand the wisdom of such an approach since they do not teach it in business school, and have little respect for the knowledge of your elders, particularly when it runs counter to the parochial pursuit of short-term profit. More worryingly, they seem to be teaching you methods of so-called financial engineering that go against every instinct of prudence that we've honed from generations of actual experience.

Despite this venerable history, we are not immune to the cycles of the market and our economy. The 1990s were difficult times, requiring sacrifice and perseverance. Profits were low as was the value of our shares. You acquired your initial holdings at a good price, and I do not fault you for this. Had my family greater resources, we too would have acquired more. With such a substantial shareholding, we (admittedly with reluctance because we are cautious people) welcomed you to our constituency and after frank discussions, we did everything you asked. We paid out cash from our reserves. We increased the dividend preventing the rebuilding of reserves. We pared our R&D, and advertising budgets, and curtailed long-term investments that we otherwise would have made. Finally, we sold our cross-shareholdings to continue to pay dividends.

At first, if one looked ONLY at the share price, one would have thought your advice was to a resounding a success. But upon closer scrutiny, this was a mirage. Though our share price was rising, the only perceptible difference in ownership on our register was from entities affiliated with you, which leads me to believe that it was your own buying that caused the share price to rise, and not a vote of confidence from the market more generally. I have my suspicions about what agent/principal dilemmas might cause you to do this, thereby treating your fiduciary responsibility so callously, but this is not the time nor the place to discuss that.

But what a difference two years makes! Today, thanks to your self-serving advice, we find ourselves in a most precarious position as hard times approach. Unlike the past, today we have little reserves to weather the coming storm. Our capital equipment requires updating, but you pressured us to pay our capex budget to you in dividends. Our sales are deteriorating in line with the macro-economy, and it is likely we will slide into loss this year, further limiting our ability to invest and innovate. We could perhaps sell shares, but investors' appetite is very diminished, and with our diminished balance sheet, and our share price much reduced from levels at which you collected your large one-time non-recourse incentive fees, this is a last resort option. And the debt markets are all but closed for a smaller enterprise such ours. Historically, we'd saved for the rainy day, but thanks to you, our cupboard is bare. You, of course, can shut your doors and little will change. If we shutter our factories, a thousand families will be severely hurt, and several thousand more who make up our suppliers and our customers will be similarly impacted. And, I ask you, for what higher purpose? What noble objective have you achieved in the name of "shareholder rights", "optimal capital structure", other than a campaign that resembles "Sherman's March" or the "Sack of Rome"??

Tolstoy famously wrote: "It is worse to deceive yourself than to deceive others". Your rhetoric and your actions are disingenuous and have willfully left this place, and in turn, the earth upon which we share and dwell, a place that is worse off than you found it, whatever and however you may attempt to justify it to your conscience and your investors.

So "thank you" for NOTHING. Like your President, you have destroyed in a few short years what previous calamity, hardship, and time itself could not accomplish, and for this you should feel deeply ashamed.

Truly Yours,

A. Suzuki
Honorary Chairman
Nagoya, JAPAN


Anonymous said...


I hope Japan send those scumbag con artists packing.

James said...

Wow. You've been on blogging fire lately. good stuff!

Anonymous said...

A beautiful post, indeed!

The human side of the economy never appears on stats.

Thank you very much, Cassandra!

You should write literary short stories around the economy!


Clement Wan said...

A sad little ode to mediocrity and inefficiency. How benevolent is it to a firm's employees if it isn't able to make the investments to survive?

Here's a pretty thorough rebuttal to your posting:

Best regards,

Anonymous said...

Is this loosely based on a real-life example? A certain power company?

Also, pardon for being thick but "The Greenmail Fund"? The name implies the ultimate goal is to force the company to buy back the inflated shares. I can see how corrupt fund managers wouldn't blink in a game of chicken, losses in the fund (IE a bankruptcy) can always be explained as due to the general economic climate (and pardon while we spend our non-refundable fees on bonuses for the bosses).

"Cassandra" said...

I am pleased you enjoyed it, (except Clement who's apparently bothered more by things left & atheist, than by what I hope might be a provocative debate over activist intention upon cultural structures and traditions that react like oil & water). And for the record, CW, I am neither based in japan nor an investment banker, but an investor where Japan has been my two-decade accidental specialty.

BUT, despite its emotive tone, readers should be careful not to arrive at decisions too hastily for the issues that inflame the raw nerves of parochial activists, faithful capitalists, or those simply trying to justify the virtues of selfishness, are more complicated. Many shareholders, certainly those outside Japan, (and even some of those inside) DO deserve better. And indeed there is nothing sacrosanct about companies, many of whom for death would be welcome (and useful) for all but a few. "Activists", however, like companies, are not homogenous. Some have virtue, while others deserve slow and painful, errr.... scorn? There are seemingly as many activists on the scumbag tail - abusing laws and structures, gaming incentive fees, abusing fiduciary responsibilities as there are companies on the "they deserve it" tail. Make what you will of this conjecture: you know who you are.

But in actual fact, I was just fishing with this mythical enterprise, and hooked a big one with Miss Equity Private, who it must be said, CAN write the beard right off Marx's face! And while she has many fine points, which I concede to her, I do not agree these issues were settled twenty-five years ago Political-economic debates about structure and system are and will continue to be works i progress. For just when it appears that some smart confident yanks have triumphally settled the matter once and for-all, everything comes unstuck, and it is revealed that duct-tape was integrally in place of welds - a discovery that should cause reflective and introspective folk to do just that.

Macro Man said...

While I have no horse in this race, I was tickled that Equity Private signed his/her missive as "Hugh G. Fallis". Was I the only one sophomoric enough to get that particular joke?

Anonymous said...

Editorially, the FT has been terrible on this issue. Cassandra's take is much more firmly rooted in reality, not to mention morality.

Equally, the FT (my paper of choice by no small measure, I hasten to add) has been obtuse in its odd defense the usurious practices of Japan's consumer finance companies (RIP).

Blinded by ideology and distance from realities on the ground, no doubt.

Rest assured, MM, you had company.

Anonymous said...

Japan's got it's share of problems, but it is still the world's largest creditor nation since the 1980s, years after years of huge current account and trade surpluses, world class exporters, over 15 trillion dollars in household/postal savings....Japan must be doing something right!

I bet most Japanese would choose a slower, more sustainable growth, over the house of cards, debt bubbled fueled U.S-British style higher growth anytime.

bobo7874 said...

It is well and good for Lady Equity Private to defend the benefits of the market economy, and the evils of governmental favoritism. I hope she is as quick to criticize private equity concerns for the various governmental subsidies they receive. For example, the fact that interest is deductible, but dividends are not, subsidizes private equity concerns by favoring their strategy of levering up companies. Likewise, the fact that income derived from a private equity concern's carried interest is taxable as ordinary income subsidizes private equity concerns by favoring their strategy of taking a significant amount of compensation in the form of a partnership interest, rather than solely under a management contract. I hope the Lady is not a hypocrite.

Anonymous said...

In Nature, it is called fat. It is a virtue, not a vice, especially as winter approaches. Never give a Polar
Bear liposuction in Autumn. In spring, he will not be lean and mean, he will be dead.

Anonymous said...

bobo7874, those private equity leeches are perfectly fine with their cayman island corporate welfare, while lecturing the world's largest creditor nation about their supposedly superior financial acumen.

It's so absurd, it's laughable.

Anonymous said...

bobo7874 and Anonymous,

You do realize that in the US every corporation with interest-bearing debt enjoys the tax benefit to interest? Are you suggesting that fund sponsors are somehow evil for using the same rule that applies to every company?

Your link to the tax treatment of dividends is spurious as well. Dividend payments and interest payments stem from two different ownership claims upon the company. You must believe, or maybe you forgot, that if a levered firm does not have enough cash to meet both its dividend and debt obligations, the dividend is simply not paid. Since the sponsor has the claim on the company's equity, I do not see how the tax treatment of interest payments somehow aids the private equity company. This also is certainly not unique to the private equity industry - depending on the situation a firm may issue debt instead of equity to lower their cost of capital. Any solution you propose short of reducing the overall corporate tax rate rate would single out the private equity industry and deny them benefits enjoyed by everyone else. Besides, there are many other reasons PE firms gear up targets, such as arbitraging the difference in public vs private attitude towards debt.

Finally, I believe you are severely mistaken in your belief that carry is taxable as ordinary income. If it were I believe you would be much more lax in your criticism of the industry. Carry is currently taxed as capital gains, 15%. This is a debate for another post, and while it may or may not be justified, the shallow comprehension of the industry in your comments reveals ignorance rather than criticism based on fact.

bobo7874 said...


It is obvious that the deductibility of interest benefits companies in general, and not just PE portfolio companies. However, it is equally obvious that PE sponsors are big beneficiaries of this systemic bias that many countries have favoring debt over equity.

As to a carried interest, it is silly to claim that it isn't a subsidy. Recipients, be they - VC, PE, real estate, or what have you - they value the carry at $0 upon receipt and then derive a share of the partnership's capital gains profits. It is silly to take the position that the recipient derives $0 of compensation upon receipt of the carry and $0 of compensation upon deriving a share of profits from the carry. If you're going to argue there's no comp and the front-end or the back-end, that's as credible as fairy dust. And if you admit there is compensation at either end but it's not "administrable" to find it, that's because you think the tax man is as blind as Mr. Magoo.

And don't lump me in with Anonymous. I don't know what he's talking about the Cayman Islands for. And it sounds as if he thinks PE sponsors add zero value. I think the private equity funds definitely add value. PE funds, activists, and the plaintiff bar are all important in order to discourage incompetence and corruption by corporate executives. However, I don't know that any of these characters need governmental subsidies to help them along. They all seem to do pretty well for themselves.

Anonymous said...

A few comments before I hop back in the saddle...

Cassandra's nuanced view of private equity is very on target. Sometimes it helps create genuine long-term value. Sometimes it is nothing more than legal greenmail. Sometimes it is the creation of short-term value and the subsequent destruction of long-term value that is paramount.

Everything must be taken on a case-by-case basis, and over-arching missives and theses will always fail to apply at times. Square peg jammed vigorously into round hole and all that jazz. Oddly appropriate metaphor considering Mr. Fallis and what not.

Lastly, I might caution not to lionize this so-called miss equity private. The old Texas saying of "all hat, no cattle" is occasionally called to mind reading that blog.

Anonymous said...

Cassandra, Marx had a beard? What did she look like???

Anonymous said...


There is nothing unfair in the treatment of interest as an expense and the return of capital to the original funders of capital (i.e. dividend) as not being an expense.

I think you are getting confused because you are thinking about it in terms of large corporations, but if you return to think about it in terms of a more basic sole proprietorship you will find it obvious why dividends aren't tax deductible. There is no sense in an owner requiring lower taxation because he opted for a return of his capital rather than continuing to invest it.

Conversely, it is uneconomic to think that any regular cash expense incurred by a business should be ignored in the determination of owed taxes. The very basic idea of taxation is for the state to receive an appropriate 'cut' of the business owner's profit. Not accounting for interest expense in the calculation of taxable profit would allow the state to collect tax twice, collecting both on the business owner's payment of interest and on the bank's collection of interest.

Regarding carried interest, that is a different matter altogether. Ultimately, it is a derivative that not substantively different from a purely performance based bonus. To the (large) extent that those two items are not taxed the same way is wrong. The reality is that private equity professionals do not make a market-priced investment for the proceeds they receive if the fund performs well and they receive carried interest.