Scalpel Man

Can moral probity go hand in hand with the profit motive? Can one be at once a feared hedge-fund manager and a crusader for Wall Street reform?

If so, it wouldn’t be the least of David Einhorn’s achievements.

At 44, Einhorn is one of the youngest members of the Forbes 400, with a net worth of $1.25 billion. His hedge-fund firm, Greenlight Capital, was started in 1996 with just $900,000, but today is brushing up against $9 billion in assets and has yielded annualized returns of almost 20%. Einhorn is a ferocious investor, one who is unafraid to roll up his sleeves, dig deep into the bowels of a company’s fundamentals, and then report on the patient’s vital state, good or bad. When he does, companies tremble. His talks at investor conferences are eagerly attended by the Street’s best and brightest, and the grinding exhaustiveness with which he researches firms has earned him the near-worship of money managers everywhere. Nor is he loath to stoop for his weapons: his signature strategy is the short sell, which entails betting that a firm’s stock will fall and then profiting from the drop. For this, he has been reviled by some of the Street’s more genteel spokesmen. But Einhorn is cheerfully, boyishly unrepentant. He has clashed with some of the most imposing giants on Wall Street—Lehman Brothers, Microsoft—and (usually) won.

Einhorn can thus hunt with the fiercest of the wolves. But—and this is the intriguing part—there’s also a lamb under his lupine exterior. For him, aggressive investing strategies, short-selling included, are a kind of moral scalpel for the ailing patient that is the U.S. financial system.

The New York Times’ Op-ed page, January 3, 2009: “short-sellers [are] the only market players who have a financial incentive to expose fraud and abuse.”

A case in point was Einhorn’s 2002 battle with Allied Capital, a mid-cap lender whom he accused of cooking its books and defrauding the Small Business Administration. In May of that year, after the hedge-fund manager publicly trashed the company at the Ira W. Sohn Investment Research Conference in Lincoln Center, the stock opened down 20 percent. Greenlight Capital, of course, had shorted its shares of Allied, and came out with a hefty profit. But Einhorn had to go through countless headaches for years afterwards as Allied fought a dirty campaign against him, gaining illegal access to his phone records, charging him with market manipulation, and even enlisting the SEC on its side. The SEC later vindicated Einhorn, finding evidence of collusion between Allied and its own bureau chief in charge of the investigation. The hedgie-turned-author later detailed the whole ordeal in a book, Fooling Some of the People All of the Time, arguing that good corporate governance and sound investor strategy need not, indeed should not, be in conflict.

Then there’s Einhorn’s subsequent clash with Lehman Bros., where again he was forced to state some unpleasant, if now obvious, truths. In November of 2007, he publicly criticized the now-defunct firm for being overleveraged and hiding huge liabilities on its balance sheet, principally from asset-backed securities. Once again Greenlight shorted the stock, and once again the resulting drop yielded the fund sizeable profits while simultaneously exposing the Emperor’s state of undress. Einhorn was pilloried as “rabble-rousing” and excessively bearish in the New York Times, a veritable profiteer of panic, but when Lehman went bankrupt less than a year later, the market again vindicated his predictions. He later said short-selling the firm was not just profitable but “the right thing to do.”

Einhorn has been outspoken about the systemic corruption of the American financial system. In his op-ed for the New York Times, he charges that too often, the institutions responsible for keeping Wall Street’s excesses in check, principally the SEC and credit-rating agencies such as Moody’s, have been corrupted and are now acting in tandem with the companies they are supposed to regulate. As a result, the financial system becomes ever more rabid in its quest for short-term profits—and ever more heedless of the long-term consequences, moral as well as monetary, of its actions. Einhorn’s own experiences would seem abundantly to bear this out.

Not all of Einhorn’s arrows have hit the mark. In 2012, Greenlight made some bad deals, finishing the year with a 7.9% return, significantly below the S&P’s 16%. Worse still, the fund became entangled in protracted legal squabbles with Apple, largely over technicalities, in what increasingly seemed to be a losing attempt to force the computer giant to issue preferred stock and so pay out some of its cash reserves to shareholders. This battle pitted him not just against The California Public Employees’ Retirement System and Institutional Shareholder Services (as well as Apple’s management), but against other respected investors such as Warren Buffett, and at times even against the market itself, which continued to boost Apple’s share price before it hit a high last September. But Einhorn has never been afraid to go against the grain. And as with his previous clashes, time will reveal whether his ideas are visionary or merely eccentric.

Bad calls aside, what makes Einhorn an exemplary investor is his fierce independence of mind, coupled with sound fundamental principles. The Wall Street hothouse is much given to using the epithet “genius” for anyone who trumps the market for a few quarters, but Einhorn has always followed a strategy any bright seventh-grader can understand: at the end of the day, your portfolio is only as solid as the companies it contains. Do your homework, ask the hard questions, and always do the right thing. If you don’t, sooner or later you’ll wish you had.

In his own words:

I think that there is a social value in identifying companies that are doing bad things and betting against them. I’ve seen the demise of a fair number of these companies, and it’s not because we’ve bet against them, it’s because these were flawed companies.…[With short selling,] it’s self-evidently true that if the stock goes down we are positioned to make a profit. The question is, is that the whole story? And the answer is, it really isn’t.

Indeed, with Einhorn, it really isn’t.

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Posted by Eddy Elfenbein on June 19th, 2013 at 8:34 am

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