How financial lawsuits muzzle free speech
Imagine some political group runs an advertisement accusing a politician of misleading statements and covering up his true voting record. Instead of denouncing the attack or countering with a favorable ad, however, the candidate sues the political group for billions of dollars, launching a six-year, scorched-earth legal and public relations campaign.
Even though the legal battle collapses and the candidate spends about $100 million, the gambit works: The politician’s future elections are assured, because no rival or reporter dares publicly criticize the candidate lest they be sued.
An absurd example, no? Everyone knows it couldn’t happen here, in the home of the First Amendment and a free press. Yet a publicly traded company using its working capital to battle critics in court is an increasingly regular occurrence in the capital markets. Substitute a Canadian insurance conglomerate called Fairfax Financial Holdings for the politician, and you have an excellent example of the above scenario.
In July 2006, Fairfax sued a group of hedge funds and analysts over what it alleged was a conspiracy to drive down its share price. On Sept. 12 the last remnant of its once far-reaching suit was effectively tossed out of New Jersey Superior Court (though Fairfax has said it plans to appeal).
The courtroom debacle was ultimately an aside: For an estimated $100 million in legal and public relations fees over six years, Fairfax’s efforts drove its share price up, forced shorts to cover their trades and, save for a few reporters, ceased virtually all media investigation into the company’s operations. (To be fair, Fairfax’s share price was helped by a turnaround in the firm’s insurance businesses and billions of dollars in profit from a remarkably timed 2007 bet against subprime financial companies.)
I am not a passive observer to this situation. It was my reporting that Fairfax said prompted its lawsuit, and several months ago I published a story disclosing new documents that, I maintain, prove the company still has substantial liability for some tax moves it made in 2003. I also reported extensively on another Canadian company, Biovail Corp, which launched a nearly identical suit in 2006. Biovail met an ignoble fate, eventually admitting to fraud and paying hundreds of millions of dollars in settlements and penalties.
Although Fairfax has much crow to eat, its lawyers at Kasowitz, Benson, Torres & Friedman and its outside PR firm, Sitrick & Co, were relentless in promoting the erstwhile victimhood of Fairfax and Biovail, also a client, to media, regulators and politicians – the numbers make clear that suing critics can bear fruit.
Unsurprisingly, Fairfax does not agree with the notion that its lawsuit was primarily designed to stifle critics. Approached for comment, Michael Bowe, the Kasowitz Benson partner directing the litigation, emailed the following statement:
Fairfax sued not for “criticism,” but because people were spreading false claims that Fairfax was an insolvent, Enron-like fraud in order, in defendants’ own words, to “kill” the company. The Court found that there was “absolutely no question” that this intentional conduct caused Fairfax to “suffer … massive pecuniary/economic loss.” The Court’s ultimate conclusion that the law provided no legal redress for such massive losses is unfortunate and incorrect and will, we are confident, be reversed on appeal.
Nonetheless, let’s look at the math: The hedge funds sued in the Fairfax case each spent $3 million to $4 million per year on legal fees. They were able to absorb it because they were large. But a small hedge fund likely does not have an extra $4 million in cash flow to pay lawyers – and fund investors are loath to invest in smaller funds with ongoing litigation. That creates a powerful disincentive for small-fund managers to speak publicly, even if they believe their research has uncovered significant fraud.
Financial journalists, too, have incentives to keep quiet. The financial media’s ability to play a meaningful watchdog role has declined as rapidly as its economic health. The result has been shrinking staffs, bigger workloads and decreased appetites for potential conflict. Journalistically the result is a non-threatening palaver that faithfully recaps a conflict between a company and a critic, but does nothing to advance any understanding of the fight.
Ultimately, the only people who are safe speaking up in this scenario are the rich. Even though hedge fund managers like Greenlight Capital’s David Einhorn or Kynikos’s Jim Chanos have spent many millions of dollars in legal fees fighting off pointless litigation, their headaches are just that: headaches. They are profoundly wealthy and going to stay that way.
So what’s left is a for-profit speech model for the capital markets: A new breed of short-seller has emerged, happily publishing its research for all to see after selling a suitable amount of shares short. It’s often fascinating and brilliant work, but the reader is assuredly late to the party.
That a certain type of management will use corporate capital to silence critics isn’t the problem; that it works so well is. No system is perfect, and the beauty of American society is that so many voices are heard, including those opposed to financial skeptics. But is this the best we can do?
The Securities and Exchange Commission is effective in catching insider trading but is sharply less zealous in enforcing rules against issuer retaliation. In several cases, most prominently David Einhorn in his fight against Allied Capital, the SEC happily sought to investigate the whistle-blowers and not those who were formally accused of wrongdoing.
Like much else when it comes to Wall Street, the American people tolerate conduct and a worldview wholly at odds with what we demand from the rest of society. Short-sellers, investigative reporters and various scolds and skeptics often present hard truths and unpopular views just when things are getting juicy, but over time, they have a remarkable track record of identifying fundamental corporate flaws. So our habit of outsourcing freedom of speech to those who can pay to defend it is not only anti-American but also ensures that only the rich and well-connected can easily escape the next Enron or WorldCom.
PHOTO: A whelp of a Staffordshire Terrier stands between other dogs wearing muzzles during a demonstration of dog owners in Berlin, August 5,2000. REUTERS/Arnd Wiegmann