UNITED STATES SENATE
COMMITTEE ON THE JUDICIARY
Hedge Funds and Independent Analysts:
How Independent are Their Relationships?-
JUNE 28, 2006
TESTIMONY OF MARC E. KASOWITZ
My name is Marc Kasowitz. I would like to thank the
Committee for inviting me to testify this morning concerning the
relationship between certain hedge funds and supposedly
independent securities analysts.
I am the senior partner of Kasowitz, Benson, Torres &
Friedman LLP, a 180-lawyer firm based in New York City with
offices around the country.
Our firm has developed considerable expertise and
experience in the subject this Committee is considering today.
We represent a number of clients who have been severely harmed
by the market manipulation activities of, and collusion among,
certain extremely powerful hedge funds and supposedly
independent securities analysts and research firms.
We already have filed a lawsuit, oil behalf of one of our
clients, against some of those hedge funds and analysts. We are
currently investigating and analyzing claims on behalf of other
clients. While the lawsuit we filed and the other
investigations are addressing the illegal activities of certain
hedge funds, I want to make clear that this is in no way a
vendetta against hedge funds generally. In fact, our firm
represents many hedge funds in a variety of matters. The
concerns raised by our investigations have nothing to do with
those and many other hedge funds, which engage in perfectly
legal and legitimate investment and market activities, and have
nothing to do with truly independent securities analysts.
However, what a number of our clients and other companies
have experienced is truly shocking. Those companies have been
targets of a pattern of egregious collusion between certain
influential hedge funds and supposedly independent analysts --
whose research, in effect, was bought and paid for by the hedge
funds -- in order to further illegal market manipulation
schemes, typically involving short-selling.
Short-sellers are investors who take positions in stocks on
the expectation that the stock price will decline. Here we are
not talking about short-sellers who trade legally based on
honestly-held and reasonably-based opinions derived from the
public record. Instead, we are talking about short-sellers who
engage in schemes to manipulate the market and drive the price
of those stocks down through, among other things, the
dissemination of unfounded or grossly exaggerated negative
research reports and other disinformation.
One particularly effective illegal strategy involves the
following scenario: the short-selling hedge fund selects a
target company; the hedge fund then colludes with a so-called
independent stock analyst firm to prepare a false and negative
"research report" on the target; the analyst firm agrees not to
release the report to the public until the hedge fund
accumulates a significant short position in the target's stock;
once the hedge fund has accumulated that large short position,
the report is disseminated widely, causing the intended decline
in the price of the target company's stock. The report that is
disseminated contains no disclosure that the analyst was paid to
prepare the report, or that the hedge fund dictated its
contents, or that the hedge fund had a substantial short
position in the target's stock. Once the false and negative
research report -- misrepresented as "independent" -- has had
its intended effect, the hedge fund then closes its position and
makes an enormous profit, at the expense of the proper
functioning of the markets, harming innocent investors who were
unaware that the game was rigged, and damaging the target
company itself and its employees.
There are a number of other ways that certain short-sellers
and their analyst co-conspirators proactively manipulate the
market to bring about the very stock price declines from which
they reap huge, illegal profits. We have seen, in increasing
frequency, orchestrated efforts by short-selling hedge funds to
drive down stock prices through surreptitious campaigns aimed at
disseminating unfounded or grossly exaggerated disinformation.
Such disinformation is spread in the financial press or internet
chat boards, in investor conference calls, at analyst
presentations, and at industry conferences. There are organized
campaigns to communicate egregiously false information to a
target company's key board members, largest shareholders,
principal banks and outside auditors. We are aware of instances
in which the perpetrators of such campaigns have sought to
instigate regulatory investigations based on disinformation, in
order to cause more adverse publicity about the targeted
companies.
The effects of these orchestrated campaigns can be
devastating. They severely erode investor confidence in the
target companies. That erosion in turn artificially depresses
stock prices, exaggerates market reactions to bad company news,
and suppresses market reactions to positive company news.
Moreover, even the mere existence of such disinformation in the
marketplace invariably leads the media and regulators to
investigate the rumors, and the resulting publicity and
investigations exponentially aggravate the severity and duration
of the negative effect. What results is a self-sustaining
downward pressure on a stock that is extremely difficult -- if
not impossible -- to reverse. And although this pressure is
artificial, the devastating impact on the company and its
shareholders can be and often is enormous.
These attacks consume massive amounts of corporate time,
attention, and resources that would otherwise be devoted to
running the business. The cloud under which companies targeted
by these attacks must operate frequently impairs or destroys
critical business relationships, including relationships with
major customers and other companies, lenders, banks and the
capital markets. The damage to the targeted companies as a
result of these attacks provides huge profits to the shortselling
perpetrators of the disinformation campaigns, to the
great detriment of honest investors.
Those who would prefer to avoid scrutiny of these
aggressive and illegal short-selling market manipulation
practices -- including the role of analysts in these practices
-- seek to obscure the real issue. The real issue is not
whether a robust exchange of investment ideas or legal shortselling should be permitted or enhances market efficiency, and it is not whether truly independent capital market research is
desirable. There is no question that a robust exchange of
information is critical to the capital markets. There is no
question that unbiased and uncorrupted market research is
desirable. There is no question that legal short-selling is an
appropriate and even desirable market activity.
Nor am I suggesting that there is anything wrong with
someone sharing their opinions -- whether positive or critical
concerning a company or investment -- on the internet, at
investor conferences, with journalists, or otherwise.
That is not our position at all. Our position simply is
that all such activities must be done within the law. Just as a
public company or its investors are not permitted to make
material misstatements and omissions for the purpose of
increasing the price of the stock, likewise short-sellers and
their analyst co-conspirators may not spread false, misleading,
unfounded, or exaggerated information for the purpose of
creating or accelerating a decline in stock price.
The problem of corrupted and co-opted securities research
is not a new one, and it has, in recent years, been a major
focus of regulatory attention to the securities markets. In the
late 1990's and early 2000fs, for example, analysts employed by
major investment banks were found to have adjusted their
purportedly "independent" securities research in order to
accommodate companies with which their associated investment
banking operations did -- or sought to do -- business. As a
result of the scandals arising out of these conflicts-ofinterest,
Congress, as part of the Sarbanes-Oxley legislation,
mandated that the Securities and Exchange Commission address
such conflicts.
The rules promulgated under Sarbanes-Oxley thus sought to
insulate analysts from the influence of their firmsf investment
banking business. However, an unintended consequence of those
rules was a large increase in the number of purportedly
independent research firms, certain ones of which tout their
purportedly conflict-free "unbiased" analysis, but which provide
anything but. Instead, certain of these firms provide
supposedly independent analyses, which are bought and paid for
-- and even ghost-written -- by the short-selling hedge funds.
If anything, this has made the problem worse. Whereas,
formerly, investors at least knew (or were on notice) that stock
analysts had potential conflicts because of their disclosed
employment by investment banking firms, now these analysts claim
-- falsely -- that their disengagement from those firms has
rendered them "independent." Nothing could be further from the
truth. Instead, these analysts provide custom-made research
designed to further the goals of the short-selling market
manipulators who pay them.
Prior legislation also failed to anticipate the development
of a potentially even more serious conflict arising from the
exploding growth in the hedge fund industry and in the amount of
commission revenues that industry generates for Wall Street
firms providing brokerage services. Hedge funds now control
well over a trillion dollars in capital, and their highly active
trading strategies generate huge trading commissions for Wall
Street's largest firms. As Wall Street's largest customers,
hedge funds exercise enormous power on Wall Street, which
certain hedge funds use to influence in-house analyst
recommendations and to secure privileged access to non-public
information, for the purpose of trading on that information
before it becomes available to the market.
The conduct of certain hedge funds, in collusion with
various analysts, has developed into a pervasive pattern of
market manipulation that is insidious, egregious and widespread.
While civil remedies exist to address the damage caused by such
misconduct on an individual basis, and there is a statutory
basis for prosecuting criminal collusion between hedge funds and
analysts,' this Committee should consider whether further steps
are necessary and appropriate to address and remedy this serious
and growing problem.
1 Sarbanes-Oxley included a broad and clear new securities fraud
provision, 18 U.S.C. § 1348, introduced by this Committee, which provides the Department of Justice with the authority to prosecute securities fraud involving corrupt analysts and those, including hedge funds, that work with them. Under that provision, for example, the United States Attorney in Missouri recently prosecuted a securities analyst who was attempting to extort money from a company he covered in exchange for his agreement to stop issuing negative research reports on the company. The U.S. Attorney in that case correctly observed that "[a] corrupt financial analyst can affect millions of dollars worth of investments and individuals' life savings and retirement plans" and is "intolerable."
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