Elliott Management Corporation:

Activist or Vulture?


Elliott Management Corporation: Activist or Vulture?
Elliott Management Corporation:
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I. Elliott Management Corporation

A hedge fund making huge profits through investments in companies and countries in crisis, Elliott has earned a complicated reputation as both an “activist fund representing the interests of minority shareholders and creditors” and a “vulture fund ruthlessly hunting down corporations and nations in crisis for profits”.

  • In May 2018, Korea's Hyundai Motor Group withdrew its governance restructuring plan aimed to improve its corporate governance due to the opposition of domestic and international stakeholders with voting rights, including Elliott Management. Under the plan, the group had sought to separate out the AS parts sector of Hyundai Mobis and merge it with Hyundai Glovis. In November 2018, Elliott, which owns a $1 billion stake in Hyundai Motors, Kia Motors, and Hyundai Mobis, renewed pressure on the Hyundai Motor Group by urging it to return excess capital to shareholders and consider selling non-core assets. The hedge fund, which acquired a 7.12% stake in Samsung C&T in 2015, also opposed the merger of Samsung C&T Corp. and Cheil Industries Inc. by objecting to the merger ratio. After losing a proxy battle to block the merger, Elliott levelled a $700 million ISD (investor-state dispute) against the South Korean government, arguing that there was unfair mediation by the Korean government and the National Pension Service in the process of approving the merger.
  • Elliott has acquired a complicated reputation and is considered the “smartest and toughest fund in Wall Street”, “a vampire”, “an activist fund that represents the interests of small shareholders and creditors”, and a “vulture fund that hunts companies and countries in crisis and takes a ruthless profit.” A “vulture fund” is a fund that buys poorly performing bonds issued by financially [1] distressed corporations or countries at highly discounted prices, then reaps substantial returns by restructuring operations in a short period of time or deploying legal actions to receive a full payout. Like its namesake bird which feeds on rotten meat, vulture funds profit from investing in companies near or in default as well as junk bonds.
  • But supporters of Elliott say that the fund engages in well-intentioned fights against frauds and corrupt governments that do not follow the rules of the market, and that activist funds such as Elliott hold in check governments or corrupt companies that do not fulfill their contracts.

A hedge fund founded by Paul Singer, the Elliott Management Corporation grew at a rapid pace throughout the recession and financial crises, achieving a 392% rate of return through the acquisition of sovereign bonds and lawsuits during the Argentine financial crisis. It has generated a 14.6% net compound annual return for the past 30 years.

  • Born in 1944 in New York, Paul Elliott Singer studied Psychology at the University of Rochester and went on to earn a doctorate in law from Harvard Law School. He started his career at an investment bank in New York in 1974 and founded a hedge fund, to which he lent his middle name, with his friends in 1977.
  • Elliott rapidly expanded through crises such as the recession and stock market crash. During the US stock market crash in 1987 and the recession of the early 1990s, Elliott made huge profits by acquiring shares of companies in financial distress at a discounted price. It purchased shares of corporations such as TWA(airline), MCI and WorldCom(communication/media) and Enron(energy), then obtain management rights through equity disputes or sell its shares for a much higher price. Since inception, Elliott has recorded a high average annual return rate of 14.6% over the past 30 years.
  • For Elliott, countries in financial/foreign exchange crises are also good investment destinations. The fund reaped enormous profits by purchasing the sovereign debt of countries near or in default such as Peru, the Democratic Republic of the Congo, and Greece at a very low price, then suing the country for full recovery. In particular, Elliott gained [2] notoriety as a vulture fund when it made a 392% return on Argentine bonds that it had purchased for a nominal value of about $630 million when the country was experiencing a severe economic crisis in 2002.
  • In the 21st century, Elliott has acquired stakes in global companies such as P&G, Shopco, Comcast, Samsung C&T, and Hyundai Motors, and generated profits by intervening in merger processes or demanding improvements in corporate structure and governance, such as expanding dividends, replacing board members, and selling non-core assets.

II. The Debt Crisis

As the debt relations between the private sector and the government grew in the 1980s, related institutions and systems were reorganized and debt-related secondary markets began to emerge. This led to the appearance of vulture funds.

  • From the Great Depression up until the 1970s, the only way for a country's government to acquire external funds was through international organizations or governments of other countries. In the 1980s, commercial banks in advanced countries began to provide funds to developing countries, taking on the role once played by the governments of advanced countries. In principle, the state and its properties have immunity from foreign jurisdiction under international law, so contracts involving sovereign bonds differ from those dealing with corporate debt. However, as the bond-debt relationship between the private sector and the government escalated, the international community began to adopt stricter parameters of a country's immunity through legislation such as FSIA(the US Foreign Sovereign Immunity Act of 1976) and the United Kingdom's State Immunity Act of 1978.
  • Under these new laws, private sector creditors could sue foreign governments that had defaulted in US courts to [3] enforce execution of the contract or recover some of their bonds. This led to the growth of the sovereign lending market. As limitations on a nation’s immunity and cases involving a waiver of state immunity increased, the number of lawsuits against governments that declared defaults rose as well, as did the number of court cases in which the debtor received a favorable ruling. However, it is difficult to actually proceed with the collection process even if a court ruling favors the creditor because most countries aside from a few developed nations possess most of their national assets within national borders, and have prepared measures to protect the assets, such as conducting government-related business activities through separate (public) enterprises. (Even if the central bank issued the bonds, the assets of the central bank such as international reserves are protected under the FSIA.)
  • The Paris Club, a group of officials from OECD member countries whose role is to coordinate the negotiation of bonds/debts between countries, and the London Club, a forum for rescheduling loans from commercial banks, established a negotiation process that took into consideration the fact that it is difficult to hold a government [4] accountable in a contract. The Clubs sought to resolve disputes related to debt and reduce unnecessary litigation and to provide a syndicated loan that includes sharing clauses to prevent disputes between creditors and to provide support for debtor rehabilitation.
  • In the 1980s and 1990s, a number of emerging markets experienced defaults. In response, the United States began to provide support measures such as rescheduling or canceling debt through the Baker Plan and the Brady Plan to prevent the spread of economic crises and facilitate global economic growth. As creditor banks began to take measures against losses and debt cancellations in the late 1980s, secondary markets related to debt expanded. This is the context for the emergence of vulture funds, which buy bonds at discounted prices and collect them at face value through litigation.

While it had previously focused on purchasing corporate debts, Elliott entered the sovereign bond market and made huge profits by buying bonds issued by countries at risk of bankruptcy at discounted prices then recovering the par value through litigation and arbitration.

  • Elliott employed the strategy of buying distressed corporate securities at discounted prices then intervening in management to improve corporate value through ruthless restructuring or intervening in mergers and acquisitions to create conditions it preferred. When P&G acquired Wella, Elliott, which had bought the preferred stock, sued P&G for applying different exchange ratios for preferred and common stock depending on market prices. This eventually forced P&G to adjust the exchange rate. Motivated by the idea that sovereign debts could be as profitable as corporate debt, Paul Singer entered the sovereign bond market in the 1990s.
  • Elliott purchased Panamanian sovereign debt at a 75% discount during the country’s default crisis, then filed a lawsuit against Panama in the US courts. The court sided with Elliott, and Panama's government was forced to pay the full value of their debts to the hedge fund, as the ruling put the country in a difficult position while it was in the process of issuing new bonds in New York. Elliott is reported to have earned a 260% profit through this case.
  • Elliott also bought the sovereign debt of Peru at a 55% discounted price of $11 million during its default crisis, then took the country to court to demand full repayment. Elliott was able to gain a favorable verdict through a legal dispute that even reached the Court of Appeals, but collecting the payout proved to be difficult because Peru had barely any assets in the United States. Peru even took to using financial hubs other than New York for its international financial transactions to avoid Elliott's attempts at collection. However, Elliott took advantage of the fact that Peru had restructured its debt through Brady bonds and was required to pay interest through the Chase Manhattan Bank in New York under the terms of agreement and obtained a restraining order against Chase Manhattan Bank. Faced with the risk of defaulting on interest payments, Peru eventually paid Elliott a settlement of $58 million.
  • In 2005, at the brink of entering default, Argentina announced that it would begin restructuring its massive $82 billion sovereign debt. Nearly 76% of the defaulted bonds were exchanged for discount bonds through this program despite a considerable “haircut” of 73%. Though Argentina declared that it would not fulfill its obligations to creditors who did not participate in the program, preexisting Argentine bonds were traded at 30% of its nominal value. Elliott, which had purchased Argentine sovereign bonds at a discount, filed a lawsuit insisting on full repayment and delayed negotiations on the country's debt settlement.
  • In 2010, Argentina once again persuaded creditors who had refused to restructure its debt to accept an exchange offer. By offering a discount rate of 66.3%, the country was able to persuade two-thirds of the 24% of creditors who had rejected the previous settlement, and the percentage of bonds in restructuring rose to 91%. Still, about 9% of creditors opposed the debt and equity programs of 2005 and 2010, arguing that these programs not only significantly reduced the principal and interest but also extended bond maturity and thus excessively favored the debtor.
  • In 2011, the US courts ruled that Argentina had violated the pari passu clause, according to which all debts needed to be treated equally. In 2012, the courts ruled those holders of the original bonds and the so-called exchange bonds were each entitled to the same ratable payments. Argentina's appeal was rejected, and the country once again faced the decision between negotiating with creditors who had not participated in the restructuring or entering a default again.
  • Because Argentina needed access to the international debt market, it eventually made a settlement in 2016 after 15 years of dispute, and Elliott reportedly earned $2 billion in revenues.

III. Vulture? Activism?

Two contradicting views exist regarding vulture funds such as Elliott. On one hand, critics argue that they harm nations in financial distress and their citizens as well as other creditors with good intentions. On the other, some applaud vulture funds for demanding compliance with the rules of the market, including the obligation to perform in accordance with the contract and enforce the correct application of legal provisions, thus revitalizing and creating a more robust sovereign bond market.

  • Critics argue the behavior of vulture funds inflicts excessive burdens and suffering onto a financially distressed country and its citizens who are already facing bankruptcy, and that it only raises the risk of default. In addition, they point out that such behavior also harms other majority creditors, who by accepting high-level haircuts have given the debtor opportunities to restructure their debt.
  • Some express concern that the courts' verdicts in favor of hedge funds in the Peru and Argentina cases will lead to the birth of even more vulture funds. However, in reality, there are few corporations like Elliott that can sustain long-term international litigation against a foreign country with such low potential of winning the battle.
  • Supporters of so-called vulture strategies deployed by Elliott and other hedge funds argue that their actions not only make the sovereign bond market sustainable but also steer it toward a better direction. In their view, such methods not only maintain order in the market through strategic litigation that enforces countries to fulfill debt obligations they have neglected out to moral laxness but also model a means of recovery for other creditors, showing them that at least a part of their investment can be regained. (And because the likelihood of debt recovery increases, creditors lend again to countries with default experience even if at a higher interest rate.)
  • Elliott argues that if debts cannot be traded in a secondary market, creditors will begin to avoid debtors in developing countries which have low credit ratings but need capital for economic growth, further hindering economic development in these countries. In addition, Elliott points out that if a creditor cannot legally force a debtor to comply with the contract, no one will buy their bonds. Thus, the argument is that Elliott is not a vulture fund but a prudent economic entity following fair, established rules of the market.
  • Elliott argues that countries such as Peru, which secretly sold sovereign bonds at a discounted price in a secondary market while negotiating a debt settlement, are the ones that should be criticized. In the fund’s view, such countries create disorder in the market because of their moral laxity, ignore the rule of law and contract agreements, and earn unfair profits by deceiving lawful creditors.
  • In the aftermath of the Elliott-Argentina conflict, there has been a surge of cases in the sovereign bond market in which bonds were issued including collective action clauses (CACs). This clause makes it difficult to use the vulture strategy of buying discounted bonds then demanding payout at face value: it allows a majority of bondholders to agree to a debt restructuring that is legally binding on all holders of the bond.

IV. Implications

There are a few implications we can consider in the case of Elliott.

  • Instances of an investment fund swooping down on companies and countries in crisis and walking away with astounding profits after using sovereign bonds and superior assets to its benefit has created a negative image encapsulated by the name “vulture fund”. When empathizing with the employees of companies or citizens of nations in financial distress, one can easily find the actions of vulture funds morally reprehensible, since they buy bonds at a steep discount then drive the indebted companies/countries into an even more difficult situation all the while raising the rate of return. However, one could also say that vulture funds are merely exercising their legal rights as creditors or shareholders when they demand a payout at face value or press for an improved governance structure and corporate efficiency. Furthermore, vulture funds are not the only ones to criticize. There is also a significant problem with countries that issue bonds to the point of triggering an economic crisis, then seek to reduce debt through restructuring even though they have the ability to repay sovereign bonds. Similarly, companies with inefficient/illegal management practices cause damage to shareholders.
  • As can be seen in the case of Peru and Argentina, the return rates achieved by vulture funds are very attractive, but the success rate of a holdout against the state is less than 30%. In comparison to corporations, it is more difficult to enforce a country to follow a contract. A government may also revise the law and apply it retrospectively to bonds issued under its laws. In fact, Greece amended relevant legislation in 2012 and added a CAC clause to its previously issued bonds. This resulted in bondholder losses of more than 70%.
  • Vulture funds including Elliott have advanced the importance of contract enforcement and rule of law in the sovereign bond market. It is also undeniable that they played an important role in limiting immunity in international trade, as well as the creation and clarification of clauses such as CAC and pari passu.

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