May 19, 2022

DealBook: MF Global’s Trustee Sues Firm’s 3 Top Executives

 Jon Corzine, former chairman and chief executive of MF Global.Alex Wong/Getty Images Jon S. Corzine, former chairman and chief executive of MF Global.

7:23 p.m. | Updated

A bankruptcy trustee has sued Jon S. Corzine and other former MF Global executives, claiming they were “grossly negligent” in the lead-up to the brokerage firm’s collapse.

The action by the trustee, Louis J. Freeh, comes just weeks after he agreed to postpone the lawsuit and enter mediation with Mr. Corzine. By filing litigation that appeared to catch the MF Global executives off-guard, Mr. Freeh may have jeopardized those talks.

“We question why the trustee chose to file this lawsuit, which is filled with seriously flawed allegations, while he is participating in court-ordered mediation of these very claims,” said a spokesman for Mr. Corzine, Steven Goldberg.

Mr. Freeh, who represents hedge funds and other creditors of MF Global, said on Tuesday that “the mediation process is ongoing,” and that it was “in the best interests of the Chapter 11 estates to file the complaint.”

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The lawsuit, filed in United States Bankruptcy Court for the Southern District of New York late on Monday, echoes a report Mr. Freeh issued this month that blamed MF Global executives for engineering a “risky business strategy” and ignoring “glaring deficiencies” in internal controls. The report and the lawsuit accuse the executives of allowing more than $1 billion in customer money to disappear from the firm.

In the new complaint, Mr. Freeh took aim at Mr. Corzine, a former Democratic senator and New Jersey governor who became MF Global’s chief executive in 2010. Mr. Freeh, a former director of the F.B.I., also sued two of Mr. Corzine’s top deputies: Bradley I. Abelow, the chief operating officer, and Henri J. Steenkamp, the chief financial officer. Mr. Freeh labeled the men as “Corzine’s handpicked deputies.”

“Defendants, in their capacities as officers, breached their fiduciary duties of care, loyalty, and oversight over the company, and failed to act in good faith,” Mr. Freeh wrote.

The action against Mr. Abelow and Mr. Steenkamp is unusual in that both executives remained at MF Global for more than a year after the firm’s collapse, working under Mr. Freeh. They stayed to help sort through the bankruptcy process.

Gary P. Naftalis, a lawyer for Mr. Abelow, noted that Mr. Freeh had himself described that work as “invaluable.” Mr. Naftalis criticized Mr. Freeh for “now making allegations that lack any factual or legal basis.”

Mr. Goldberg, the spokesman for Mr. Corzine, also said the assertions in the suit were unsubstantiated. “There is no basis for the claim that Mr. Corzine breached his fiduciary duties or was negligent,” he said. “We look forward to proving the actual facts in court.”

The suit, which could help Mr. Freeh recover money for MF Global’s creditors, blamed Mr. Corzine for ramping up a risky bet on European debt. While the bonds were not by themselves to blame for the collapse of MF Global, the wager unnerved its investors and ratings agencies, further undermining the firm.

“Corzine engaged in risky trading strategies that strained the company’s liquidity and could not be properly monitored by the company’s inadequate controls and procedures,” Mr. Freeh said.

Mr. Goldberg in turn called the complaint “a clear case of Monday morning quarterbacking.” Mr. Corzine, he said, inherited a firm in 2010 that had lost money in each of the previous three years.

It is unclear whether the lawsuit will alter the mediation talks. While Mr. Freeh said the discussions were continuing, the lawsuit could derail or delay the mediation process.

The litigation might also complicate an effort to return money to customers. Mr. Freeh pursued his own case against Mr. Corzine, rather than join an earlier lawsuit filed by a second MF Global trustee, James W. Giddens, and some of the firm’s customers. Mr. Giddens, who has the task of recovering money for the customers, has already returned about 89 percent of the shortfall to MF Global’s clients in the United States. Some people close to the case say Mr. Giddens has identified a path to potentially making customers whole.

The lawsuit, coming on the heels of a bankruptcy judge approving Mr. Freeh’s plan to liquidate MF Global, could empower him to recover additional money for creditors. But the case might not sit well with customers.

In a statement, Mr. Giddens said he had joined the customers’ class-action lawsuit “because it was the most efficient way to get money to customers and creditors.”

Federal authorities, including the Commodity Futures Trading Commission, also continue to investigate the misuse of customer money. Mr. Corzine has not been accused of any wrongdoing by the agency, and internal e-mails suggest he was not aware that at least some of the customer money was improperly sent to the firm’s banks.

“Anyone who violates the law, and particularly anyone at MF Global who used a billion bucks of customer cash that should have been protected, should be punished appropriately,” said Bart Chilton, a member of the trading commission.

This post has been revised to reflect the following correction:

Correction: April 23, 2013

An earlier version of this article misstated when Lehman Brothers collapsed. It was 2008, not 2012.

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Financiers Bet on Rental Housing

It is February 2010. The anger behind Occupy Wall Street is building. Flicking through slides, Mr. Miller, a Treasury official working with the department’s $700 billion Troubled Asset Relief Program, lays out what caused the housing bubble: easy credit, shoddy banking, feeble regulation, and on and on.

“History has demonstrated that the financial system over all — not every piece of it, but over all — is a force for good, even if it goes off track from time to time,” Mr. Miller tells a symposium at Columbia University in remarks posted on YouTube. “As we’ve experienced, sometimes this system breaks down.”

But, it turns out, sometimes when the system breaks down, there is money to be made.

Mr. Miller, who arrived at the Treasury after working at Goldman Sachs, described himself as a “recovering banker” in the video.

Today, he has slipped back through the revolving door between Washington and Wall Street. This time, he has gone the other way, in a new company, Silver Bay Realty, which is about to go public. He is back in the investment game and out to make money with a play that was at the center of the financial crisis: American housing.

As the foreclosure crisis grinds on, knowledgeable, cash-rich investors are doing something that still gives many ordinary Americans pause: they are leaping headlong into the housing market. And not just into tricky mortgage investments, collateralized this or securitized that, but actual houses.

A flurry of private-equity giants and hedge funds have spent billions of dollars to buy thousands of foreclosed single-family homes. They are purchasing them on the cheap through bank auctions, multiple listing services, short sales and bulk purchases from local investors in need of cash, with plans to fix up the properties, rent them out and watch their values soar as the industry rebounds. They have raised as much as $8 billion to invest, according to Jade Rahmani, an analyst at Keefe Bruyette Woods.

The Blackstone Group, the New York private-equity firm run by Stephen A. Schwarzman, has spent more than $1 billion to buy 6,500 single-family homes so far this year. The Colony Capital Group, headed by the Los Angeles billionaire Thomas J. Barrack Jr., has bought 4,000.

Perhaps no investment company is staking more on this strategy, and asking stock-market investors to do the same, than the one Mr. Miller is involved with, Silver Bay Realty Trust of Minnetonka, Minn. Silver Bay is the brainchild of Two Harbors Investment, a publicly traded mortgage real estate investment trust that invests in securities backed by home mortgages.

In January, Two Harbors branched out into buying actual homes and placed them in a unit called Silver Bay. It offered few details at the time, leaving analysts guessing about where it was headed.

“They were not very forthcoming,” says Merrill Ross, an analyst at Wunderlich Securities. As of Dec. 4, Two Harbors had acquired 2,200 houses. Ms. Ross says she couldn’t find out how much Two Harbors paid or the rents it was charging. Two Harbors shares, which recently traded at $11.66, are up about 25 percent in 2012.

Two Harbors now plans to spin off Silver Bay into a separately traded public REIT. The new company will combine Silver Bay’s portfolio with Provident Real Estate Advisors’ 880-property portfolio. Silver Bay will focus on homes in Arizona, California, Florida, Georgia, North Carolina and Nevada, states where prices fell hard when the bottom dropped out.

In a filing with the Securities and Exchange Commission last week, Silver Bay said it planned to offer 13.25 million shares at an initial price of $18 to $20 a share. But it’s no slam dunk. While home prices nationwide have begun to recover — they were up 6.3 percent in October, according to a report last week from CoreLogic, a data analysis firm — prices could fall again if the economy falters anew. Millions of Americans are still struggling to hold onto their homes and avoid foreclosure.

“Recent turbulence in U.S. housing and mortgage markets has created a unique opportunity,” Silver Bay said in an S.E.C. filing. The company, which will be the first publicly traded REIT to invest solely in single-family rental homes, says its investment plan will help clear foreclosed homes from the market, spruce up neighborhoods and renovate vacant homes, presumably while enriching its new shareholders. Its portfolio will be managed by Pine River Capital Management, a hedge fund in Minnetonka that has reportedly been buying bonds backed by risky subprime mortgages. Mr. Miller is a managing director at Pine River and chief executive of Silver Bay.

Mr. Miller, through a spokesman, declined to comment for this article, citing the pending stock offering.

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Economix Blog: Nancy Folbre: The Twilight of the Public Corporation

Nancy Folbre, economist at the University of Massachusetts, Amherst.

Nancy Folbre is an economics professor at the University of Massachusetts, Amherst.

Public corporations that ordinary people can invest in and get rich from represent one of the great selling points of American capitalism – at least according to the salesmen.

Today’s Economist

Perspectives from expert contributors.

Yet public corporations, which rose to dominance in the United States economy in the second half of the 20th century, are now waning in significance.

As Gerald Davis of the Ross School of Business at the University of Michigan points out, the number of public corporations in the United States in 2009 was only half what it was in 1997. The share of employment represented by the largest 25 corporations has also declined over time.

Professor Davis asserts these trends result from increased reliance on overseas contractors for manufacturing, discussed in my last post.

Public corporations have also become less public. Professor Davis contends that share ownership has become heavily concentrated through mutual funds, such as Fidelity, which he says now holds significant blocks of 10 percent to 15 percent in many large companies. Even Fidelity’s role is overshadowed by BlackRock, proprietor of iShares Exchange Traded Funds, which, Professor Davis estimates, was the single largest shareholder in one out of five corporations in the United States in 2011.

Private companies going public often rely on “dual-class shares” that give original owners more voting rights than other investors. The founders of both Groupon and Zynga gained extra clout in this way.

The incentives to “go public” are smaller than they once were, because the rise of private equity firms and hedge funds has made it easier to raise money outside the stock market. Private companies are less subject to government regulation and oversight. As The Economist put it in a recent article discussing this trend, “Companies are like jets; the elite go private.”

The rise of shareholder activism may be contributing to the trend. The California Public Employees Retirement System, a major pension fund investor, is now campaigning strongly against dual-class shares, threatening the viability of that strategy for maintaining minority control.

In June, many stockholders of this country’s largest public corporation, Wal-Mart Stores publicly registered strong discontent with its policies. They were unable to dislodge the company’s chief executive, because the Walton family stood behind him with their substantial voting shares. It seems likely, however, that both majority owners and management were discomfited by the bad publicity.

Shareholder activism itself reflects a growing disillusionment on the part of individual investors, many of whom have quietly fled the stock market. In 2012, 53 percent of American households polled by Gallup reported that they had investments in the stock market, through individual accounts, mutual funds or retirement accounts, down from 67 percent in 2002.

Net investments in mutual funds, variable annuities, exchange-traded funds, and closed-end funds burgeoned between 2001 and 2007 only to sag in the wake of the Great Recession. They are now lower than they were in 2001 (See Figure 1.3 of the Investment Fact Book).

Declining real returns explain much of this change. As Professor Davis observes, the “first 10 years of the 21st century represented the single worst period of stock market performance in U.S. history.” The Standard Poor’s 500 index has yet to regain its 2000 level.

But disillusionment with the public corporation also plays a role. Accounting scandals, insider trading violations, and bailouts have taken a toll.

Andrew Ross Sorkin reports that three-quarters of students surveyed at 18 high schools across 11 different states agreed with the statement: “The stock market is rigged mostly to benefit greedy Wall Street bankers.”

This is a pretty dark view. No wonder Professor Davis refers to the “twilight” of the public corporation.

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DealBook: Hedge Funds Scramble to Unload Greek Debt

So much for that big fat Greek payday.

Hedge funds that in the last month or so have purchased an estimated 4 billion euros ($5.2 billion) of beaten down Greek bonds that mature on March 20 are now trying to unload their positions, according to brokers and traders.

That is because it is becoming clear to one and all that Greece — under pressure from its financial backers — is preparing to impose a broad-based haircut that would hit all investors with a loss of 50 percent or more, whether they agree to the deal or not.

The problem is that while buying the bonds over the last few months was easy, as many European banks were unloading their positions, getting out now is proving to be near impossible. Liquidity has dried up and investors are avoiding Greek paper as if it were the plague.

The poor outlook for early maturing Greek bonds was compounded on Wednesday when Christine Lagarde, managing director of the International Monetary Fund, said the public sector might have to participate in a restructuring deal with private sector creditors.

“There was a lot of volume going in, but not a lot going out,” said one broker, speaking on condition of anonymity. The broker said prices for March 2012 bonds had slipped to around 35 cents on the dollar from a range of 40 cents to 45 cents.

Starting in December, the counterintuitive, go-long Greece bet was one of the more popular pitches made to funds in New York and London.

Investment banks — Merrill Lynch was particularly aggressive in recommending the trade, investors say — argued that even though Greece was near bankrupt, those who bought the paper maturing in March could double their money when Greece received its latest bailout tranche due that month. The bulk of that tranche would be paid to bondholders to keep Greece solvent, just as was the case with past payments from the European Union and the International Monetary Fund.

Greece might well restructure its debt, brokers said, but added that was likely to happen later and would not affect the March payout.

Brokers estimate that of the 14.5 billion euros of these bonds outstanding, the largest holder is the European Central Bank, which bought these securities in 2010 at a price of around 70 cents in an early, ultimately futile attempt to boost Greece’s failing bond market. The brokers say that 4 billion to 5 billion euros of bonds are owned by hedge funds at an average cost of around 40 cents to 45 cents, with some of the larger positions being held by funds based in the United States that have large London offices.

Now, with momentum building in Europe for an agreement on a 50 percent-plus haircut to be reached before March 20 — one that would be legally binding on all holders — the smart money is not looking so smart anymore.

“It was a very binary trade,” said one hedge fund executive who listened to the pitch but took a pass. “If you got paid, you double your money in a month. But you may also look like an idiot.”

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DealBook: Oneida’s Backer Sees a Future in Flatware

Bill Croll, an Oneida designer, works on a prototype for a sterling spoon.Heather Ainsworth for The New York TimesBill Croll, an Oneida designer, works on a prototype for a sterling spoon.

ONEIDA, N.Y. — Some local residents, when eating out, instinctively turn their utensils upside-down to look for a telltale sign: the word “Oneida,” stamped into the back of the handle.

The “Oneida flip,” as it’s called, is a ritual carried over from an era when Oneida Ltd., the company headquartered here, dominated the global market in flatware, setting tables all over the world with its stainless steel forks, spoons and knives. In recent years, the ritual became a painful reminder of the company’s troubles.

Once an economic engine of upstate New York and one of the region’s largest employers, Oneida no longer makes flatware in the area. Like so many industrial players across the country, the company has struggled to compete with a flood of low-cost foreign manufacturers. As sales evaporated, factories were shut down. Retail stores were closed. And jobs were shipped overseas.

But a funny thing happened on the way to Oneida’s demise. Wall Street — an industry that has been accused of destroying jobs and stripping businesses for parts — decided the company had long-term potential.

In November, Monomoy Capital Partners, a private equity firm, bought Oneida from a group of hedge funds. The new owner wants to expand, rather than decimate its operations. It is a simple but lofty goal for a company that has been slowly recovering since its bankruptcy in 2006.

“This is a meaningful investment for us,” said Daniel Collin, the Monomoy partner who led the deal to acquire Oneida. “After years of being undercapitalized, Oneida finally has a partner willing to invest in its future.”

How a 132-year-old flatware company ended up in the hands of a Manhattan private equity firm illustrates the woes of American manufacturing — and possibly, a way to improve its fortunes.

Last year, buyout shops bought 361 industrial companies, with many deals under $150 million, like the Oneida deal, according to Preqin, a research firm.

Monomoy, which has just 20 employees and manages a relatively small $700 million in assets, has specialized in acquiring small- to medium-size businesses that might seem antiquated to other buyout firms. Among the companies in its portfolio are Steel Parts Manufacturing, which produces clutch plates used in automatic transmission cars, and Awrey Bakeries, a 102-year-old company that makes frozen brownies, cakes and other desserts.

“A lot of times, these boring, stodgy businesses can generate consistent cash flow, and that’s important to a private equity buyer,” said Eric Hollowaty, an equity research analyst with Stephens Inc. “I don’t think many private equity firms are going to be motivated by saving an age-old brand if they don’t think they can make a handsome return.”

While Oneida’s flatware business may be traditional, its history is anything but. The company traces its roots to the Oneida Community, a utopian commune started in 1848 by an eclectic religious leader named John Humphrey Noyes. In a sprawling mansion on Kenwood Avenue, Mr. Noyes and his followers, known as Perfectionists, practiced a radical lifestyle that involved communal child-rearing, a free-love arrangement known as “complex marriage” and a rule, called “coitus reservatus,” that prohibited men from ejaculating during sex.

While the group disbanded in 1880, its entrepreneurial spirit lived on in Oneida Ltd., which grew from a manufacturing corporation formed by ex-Community members into a global behemoth. Its former ticker symbol on the New York Stock Exchange, OCQ, stood for “Oneida Community Quality.”

A third of Oneida’s roughly 450 employees still work at the company’s headquarters, a four-story granite building that stands across the street from the original Oneida Community house and doubles as a kind of living museum. Oneida advertisements from Life magazine and the Saturday Evening Post in the 1960s, some featuring then-spokesman Bob Hope, dot the walls of the office. A row of unused Kodak Carousels sits on a shelf outside the company’s in-house darkroom, long ago abandoned for a digital photography studio. Down the hall, a small group of model-makers hammers out prototypes by hand.

Paul E. Gebhardt, senior vice president of design at Oneida who is descended from the company’s founder.Heather Ainsworth for The New York TimesPaul E. Gebhardt, senior vice president of design at Oneida, is descended from the company’s founder.

“We still do it the old-fashioned way,” said Paul E. Gebhardt, Oneida’s senior vice president of design, who is also the great-great-grandson of John Humphrey Noyes, the founder of the Oneida Community.

Oneida’s financial problems were decidedly modern, and echoed the issues faced by companies in cities like Detroit and Pittsburgh. Starting in the 1990s, the company began to feel the heat of foreign competitors, who could produce utensils for a fraction of the price of American manufacturers. The attacks of Sept. 11, 2001, further hurt business, after the metal forks and knives Oneida supplied to airlines were banned on flights.

As its sales fell, Oneida hemorrhaged money — more than $157 million between January 2003 and October 2005 — and was forced to stop making flatware and close several facilities in Oneida and the surrounding cities, where the company had employed about 2,500 people at its peak. By 2006, the situation at the company, which in better times had been well-off enough to sponsor Little League teams, the golf course and other local activities, had become so dire that filing for Chapter 11 was the only option.

“Oneida tried to hang onto its manufacturing facilities as long as it could,” said James E. Joseph, Oneida’s outgoing chief executive, who is stepping down this year as part of the Monomoy transition. “From a pure business standpoint, you could argue we hung on too long.”

A few months later, Oneida exited from bankruptcy, under the control of a group of hedge funds. Led by Monarch Alternative Capital, the firms moved swiftly — if painfully — to make the company profitable. They moved a distribution center to Savannah, Ga., to save on freight costs, closed stores and struck an agreement that allowed Robinson Home Products to distribute flatware and dinnerware under Oneida’s name. The hedge funds even debated moving Oneida’s headquarters closer to New York City to give it a better shot at attracting top talent, but eventually decided against it, according to several people involved in the discussions.

Those decisions stabilized Oneida. In five years, the firms reduced the company’s debt load to around $60 million from approximately $150 million. The company now turns a small annual profit of around $15 million before interest, taxes, depreciation and amortization, according to several people with knowledge of the company’s finances who spoke on the condition of anonymity because the numbers are private. Its North American flatware business gained 3 percentage points of market share last year, according to Mr. Joseph, and still has a valuable brand name.

With the finances on the upswing, Monomoy saw an opportunity in Oneida. The private equity firm owns Anchor Hocking, a glassware maker, and Monomoy figured it could use its foothold in the food service industry to bolster Oneida’s sales to restaurants and hotels. In November, Monomoy paid around $100 million for Oneida, according to several people with knowledge of the deal terms, which were not disclosed.

Several weeks after the deal with Monomoy was announced, Mr. Joseph took to the auditorium stage in Oneida’s headquarters to reassure his employees that they were in good hands. Flanked by Mr. Collin and his Monomoy team, Mr. Joseph announced that he was stepping down and taking a job at nearby Le Moyne College, although he would keep a seat on the company’s board and remain involved in certain company projects. According to Mr. Joseph, Monomoy is not a “strip and flip” firm that will shrink Oneida down to its smallest possible size for a quick, profitable sale.

“They’re not Gordon Gekko,” he said of the firm. “It’s almost like they got together and said, ‘There’s a different way to do this.’ ”

Monomoy has already started its efforts to bolster Oneida’s bottom line. It recently sent two Oneida executives to its management boot camp, a two-week intensive course that was inspired by Toyota’s “lean manufacturing” approach. It plans to name a new chief executive shortly and has plans to campaign for business in South Korea and Brazil.

Mr. Collin, a fast-talking Wall Street deal-maker who uses “leverage” as a verb, is both optimistic and reasonable about Oneida’s expectations. While reopening the local plant in nearby Sherrill is a long shot, he hopes to strengthen Oneida so that it can be sold or taken public again within five years.

“Are they going to be creating 5,000 manufacturing jobs in the U.S.? Probably not,” he said. “But can they grow and generate profits? Sure.”

It may be too late to bring industrial revival to the Oneida region, where the largest employer is now an American Indian casino several miles down the road. And some of the psychological damage of Oneida Ltd.’s decline has already been done.

“Oneida silver used to pay for the electricity, the library, everything,” said Leo Matzke, who was Oneida’s mayor until this month. “We just don’t talk about it like we used to.”

But even if an Oneida recovery would be mostly symbolic in the region, the residents still dream. At the Marble Hill Inn, a watering hole near Oneida’s headquarters, Pamela Gilmore, who has lived in Sherrill, nicknamed “Silver City,” for 36 years, reminisced about the days when the company’s factory hummed with life.

“We’re all proud of Oneida,” she said. “We’d love for it to come back.”

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William Ackman, Carl Icahn and the Seven-Year Tiff

In one corner is Carl C. Icahn, the corporate raider who made C.E.O.’s tremble back in the 1980s and, at 75, is still chasing deals.

In the other is William A. Ackman, 45, one of Mr. Icahn’s figurative heirs and a leading practitioner of the bruising, Icahnesque craft politely known as activist investing.

These ultrarich men battled for seven years in multiple courts, over a relatively paltry $4.5 million. That might be real money to mere mortals, but to these two, it’s barely a rounding error.

So why bother? This battle, it turns out, was more about big egos than big money — and it has left both men spitting expletives. The scrape finally ended this month, with Mr. Ackman victorious. But, before it was over, the affair occupied a Who’s Who of powerful lawyers and ran up millions of dollars in legal fees, all because of an otherwise forgettable deal the pair cut back in 2004.

“The guy is a shakedown artist,” Mr. Ackman sneers. “His word is worthless.”

Mr. Icahn says: “He’s now the young gunfighter who wants to show he beat the older gunfighter with a big reputation. He just likes pounding himself on the chest.”

In the secretive world of hedge funds, most money managers prefer to keep low. Not Mr. Icahn and Mr. Ackman. They are media hounds who court public attention and regularly star at investor conferences. Both buy stakes in companies and agitate for change. Both bemoan what they see as management failures and try to shame companies into replacing their C.E.O.’s, shake up their boards and do whatever it takes to bolster the value of their investments.

In many ways, this is a generational battle, a clash of old Wall Street and new Wall Street. Mr. Icahn may at times seem trapped in the 1980s, right down to his Gecko-esque blue shirts with white collars and cuffs. After 50 years in this game, he still seems to think that most companies would be better off if they would just listen to Carl C. Icahn.

Mr. Ackman is the smart-alecky boy wonder in a crisp modern suit and a Charvet tie. He, too, has become wildly rich, albeit without the old Icahn gruffness. After losing a battle against Target in 2009, he choked up during a speech in which he quoted Martin Luther King Jr. and John F. Kennedy.

When he first met Mr. Icahn in 2003, Mr. Ackman was virtually unknown outside Wall Street circles. It looked as if he might remain so. His world was falling apart. Gotham Partners, the hedge fund he helped to found when he was in his 20s, had just blown up. The Securities and Exchange Commission and Eliot Spitzer, then attorney general of New York, were investigating him. His investors wanted their money back.

So Mr. Ackman cold-called Mr. Icahn.

He wanted to sell Hallwood Realty, a company whose stock traded at about $60. Mr. Ackman believed Hallwood was worth $140 a share. “By reputation, I knew he was a tough guy and a difficult guy,” Mr. Ackman says. “I wanted to make sure I could collect.”

He continues: “I insisted the agreement be short. I also insisted it have a mathematical example in it, so that there could be no question about the intent of the agreement.”

That’s not quite the way Mr. Icahn remembers it. He says that he was the one who was worried, and that Mr. Ackman was under investigation and desperate to sell. (Both investigations were later dropped.)

“I checked him out,” Mr. Icahn says. “He was in trouble with the S.E.C.; he had investors leaving him. A few of my friends called me up and said; ‘Don’t deal with this guy.’ ”

Mr. Icahn says he saved Mr. Ackman’s bacon, although he puts it more colorfully. The two hammered out a contract. Mr. Icahn said he would pay Mr. Ackman $80 a share and offered a form of insurance. If Mr. Icahn unloaded his shares within three years, the two would split any profit above a 10 percent return.

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DealBook: Despite a Rough Year, Hedge Funds Maintain Their Mystique

Hedge funds, the golden children of finance, are having a very rough year.

For one, they are not making money the way they used to. Returns for a number of funds, including those of star managers like John A. Paulson, have fallen by as much as half this year. And that poor performance comes just as these investment partnerships are coming under increased regulatory scrutiny.

Yet the money keeps pouring in, even for Mr. Paulson.

This year alone, more than $70 billion in new money has gone to hedge funds, mostly from pensions and endowments. A recent study by the industry tracker Preqin found that 80 percent of investors were mulling new allocations to hedge funds, and 38 percent of investors were planning to add to existing ones.

One bad year for hedge funds can be written off. But most investors rarely enjoy a bounty of returns even over the long run. The average hedge fund investor earned about 6 percent annually from 1980 to 2008 — a hair above the 5.6 percent return they would have made just holding Treasury securities, according to a study published this year in The Journal of Financial Economics.

So why would large investors pay hedge funds billions of dollars in fees over the years for poor returns? The answer highlights the financial problems at the country’s largest pensions.

As waves of workers prepare to retire, pensions find themselves in a race against time. Short of what they need by an estimated $1 trillion, according to the Pew Center on the States, public pensions are seeking outsize returns for their investments to make up the gap. And with interest rates hovering near zero and stock markets gyrating, the pensions and others are increasingly convinced that hedge funds are the only avenue to pursue.

“Even with the short-term ups and downs, at the moment there is not a credible alternative with the same risk profile for pensions,” said Robert F. De Rito, head of financial risk management at APG Asset Management US, one of the largest hedge fund investors in the world.

Hedge Fund Investments Rise

Hedge funds, once on the investing fringes, have become a mainstay for big investors, amassing huge amounts of capital and accumulating more of the risk in the financial system. The impact of this latest gold rush into hedge funds is unclear. Some argue that the hedge fund industry’s exponential growth — it has quadrupled in size over the last 10 years — has depressed returns. Others, meanwhile, wonder whether the bonanza in one of the most lightly regulated corners of the investment universe will have broader, less clear implications.

“I worry that institutions are betting on an asset class that is not well understood,” said William N. Goetzmann, a professor of finance at the Yale School of Management. “We know that the real long-term source of performance is not picking someone good at beating the market, it’s taking risks on meat and potato assets like stocks and bonds.”

The growth has been fueled in part by more sophisticated marketing — most funds now have employees whose job is to manage relationships with investors and to seek out new ones, jobs that were uncommon a decade ago. And there is still a mystique: funds that have had at least one spectacular year have excelled at raising and keeping money.

Despite the appeal of a blowout year, however, performance tends to peter out after investors jump into a hot new fund. Yet even with the lackluster returns of late, many investors have resigned themselves to sticking with hedge funds. The financial crisis taught them that even more important than making money was not losing the money you had.

Reflecting that perspective, hedge funds have started to change how they sell themselves. For decades, funds have marketed themselves as “absolute return” vehicles, meaning that they make money no matter the market conditions. But as more and more money crowds into them, the terminology has started to change. Now, managers and marketers increasingly speak of “relative returns,” or performance that simply beats the market.

“In general, they’re probably not going to have the blowout returns of the ‘80s and ‘90s,” said Francis Frecentese, who oversees hedge fund investments for the private bank at Citigroup. “But hedge funds are still a good relative return for investors and worth having in the portfolio.”

Gauging by the inflows, pensions seem to agree.

This year, major pensions in New Jersey and Texas lifted the cap on hedge fund investing by billions of dollars. The head of New York City’s pension recently said its hedge fund investments could go as high as $4 billion, a roughly tenfold increase from current levels. Illinois added another $450 million to its portfolio last month, which already managed about $1.5 billion in hedge fund investments.

About 60 percent of hedge funds’ total $2 trillion in assets comes from institutions like pensions, a big shift from the early days when hedge funds were the province of ultra-wealthy individuals.

As the investor base has changed, hedge funds themselves have grown into more institutional businesses. The biggest firms have vast marketing, compliance and legal teams. They hire top-notch accounting firms to run audits, and their technology infrastructure rivals that of major banks.

They make money even off mediocre returns. A manager overseeing $10 billion, for instance, earns $200 million in management fees simply for promising to invest the assets. Investment returns of 15 percent, or $1.5 billion, would translate into another $300 million in earnings for the hedge fund.

By contrast, a mutual fund that invests in the shares of large companies charges less than half a percent in management fees, or less than $50 million.

Psychology plays a meaningful role in hedge fund investing. Investors often pile into the hottest funds, even well after their best years are behind them.

This year’s must-have manager is John A. Thaler — despite having closed his fund to new investors last year in the face of a flood of money. While little known outside Wall Street, Mr. Thaler and his stock-picking prowess have been the talk of the hedge fund world. A former star portfolio manager at Shumway Capital Partners, Mr. Thaler developed a reputation early on as an astute analyst of media and technology companies.

His hedge fund, JAT Capital, had done well since its founding in 2007, and this year, as returns climbed to 40 percent amid the market upheaval, investors clamored to gain entry.

Then, last month, two of his biggest holdings, Netflix and Green Mountain Coffee Roasters, took a bath. His fund fell by nearly 15 percent in a few short weeks, a reminder that even high-flying managers can quickly fall back to earth.

But few hedge fund managers have risen and fallen so quickly and so publicly as Mr. Paulson, the billionaire founder of the industry giant Paulson Company.

He made his name after earning billions of dollars in 2007 and 2008 with a prescient bet against the subprime mortgage market. Afterward, investors clamored to get money into the fund, and by the start of 2011 assets had swelled to $38 billion.

This year, Mr. Paulson has lost gobs of money on an incorrect call that the United States economy would recover. One of his major funds was down nearly 50 percent, while others fell more than 30 percent. Investors who poured money into Mr. Paulson’s hedge fund after his subprime bet have given back gains from 2009 and 2010, according to an investor analysis.

But last month, when investors had the opportunity to flee the fund that had suffered the worst losses, most instead chose to stick around. Some even put more money into Mr. Paulson’s funds, despite losing almost half of their holdings this year.

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Common Sense: John Paulson’s Golden Touch Turns Leaden

Mr. Paulson made over $15 billion for his hedge funds by betting on the collapse of the mortgage-backed securities market in 2007 and 2008, then followed up with an equally well-timed bet that large banks would survive the financial crisis and that the price of gold would soar. Last year he personally earned what has been estimated as the largest single payday in Wall Street history: $4.9 billion.

The media branded him the man with the Midas touch. Institutional and individual investors rushed to give him their money, eagerly paying management fees of 2 percent plus 20 percent of any gains, and pushed his funds’ assets earlier this year to $38 billion. In September, Forbes ranked him 17th on its list of the 400 richest Americans, with an estimated net worth of $15.5 billion. The man-who-could-do-no-wrong embarked on 2011 with confident predictions that a global economic recovery would strengthen, inflationary pressures would push gold to new highs and financial institutions would prosper.  

This week Mr. Paulson reported his results through the third quarter, which ended Sept. 30. His flagship Advantage Plus and Advantage funds were down 47 percent and 32 percent. His Recovery Fund was down 31 percent. His once high-flying gold fund lost 16 percent in September, cutting its gains this year to just 1 percent.  HSBC ranked Mr. Paulson’s Advantage Plus fund the fourth-worst-performing hedge fund in its entire universe, and that was before it recorded September’s dismal results.

It’s hard to feel all that bad for Mr. Paulson. For one thing, he remains fabulously wealthy despite his recent setbacks, and his management fees alone— 2 percent of roughly $30 billion— which depend only on the amount under management, and not performance, would amount to $600 million. His ability to stand back from the real estate mania and recognize it for the bubble it was offered the trade of a lifetime, one that few others had the courage or conviction to embrace.

At the same time, Mr. Paulson has suffered the fate of most short-sellers, investors who typically make bets on the misfortunes of others. Markets arguably need such speculators to provide liquidity and price discovery. But to many if not most people, there’s something distasteful, even offensive, about profiting from the suffering of others, especially so for the protesters occupying Zuccotti Park.

It’s not as if Mr. Paulson gained his wealth by creating new technology that transformed lives, like Steve Jobs (net worth $7 billion, according to Forbes) or Mark Zuckerberg ($17.5 billion), or by entertaining people (Oprah Winfrey, $2.7 billion) or clothing them (Ralph Lauren, $6.1 billion).  No one’s protesting against them.

Even among the elite group of billionaire hedge fund managers, Mr. Paulson is distinctive, and not only because he appears to be the richest. He was the only one of them targeted by the protestors on their march through the Upper East Side, and he displayed a tin ear when he lectured them (in a news release) about how much he pays in taxes, adding: “Instead of vilifying our most successful businesses, we should be supporting them and encouraging them to remain in New York City and continue to grow.”

More fundamentally, allegations made last year by the Securities and Exchange Commission in its civil fraud suit against Goldman Sachs Company, which Goldman settled by paying a record $550 million, made clear that Mr. Paulson didn’t earn his billions purely because of his shrewd market insights. He helped select the mortgages he was betting against, the ones most likely to default, something Goldman failed to tell the party on the other side of the bet. This wasn’t a level playing field, which contributed to the protestors’ allegations that Wall Street is a game rigged to benefit the wealthy and powerful.

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Essay: Coming Soon: ‘Invasion of the Walking Debt’

During, say, zombie movies, we Americans identify with that tough guy on horseback — the survivor with the Stetson and the rifle. It’s always the other guy, that poor sap sitting next to us, we think, who would become the half-eaten corpse.

Which, weirdly, just might explain the recent fascination with how bad things could become for the economy if the United States lost its triple-A credit rating.

Wall Street is worried that America’s gilt-edged rating will slip away. Maybe not today. Maybe not tomorrow. But a reckoning, many economists say, will come, given the nation’s staggering debts and dysfunctional politics. The possible repercussions include an even bigger budget deficit and higher borrowing costs for the government, businesses and consumers.

Just how far the shockwaves might travel is uncertain. So speculating about what an economic apocalypse might look like has become fashionable in both financial and political circles. Of course, for the millions of Americans who are out of work — some for years now — Armageddon is already here. Maybe a little hellfire — if homeowners’ insurance will cover it — is what we need to fix the mess.

But there is nothing so bad that it can’t get worse. And so last year, to great fanfare, “When Money Dies: Germany in the 1920s and the Nightmare of Deficit Spending, Devaluation and Hyperinflation,” first published in 1975, was reissued and found a cult following inside the Beltway and among hedge funds.

In “Zone One,” a forthcoming novel by the Pulitzer Prize finalist Colson Whitehead, a virus turns most of humanity into flesh-eating crazies; the narrator hunts stragglers around Wall Street. In “The Walking Dead,” the hit television series set in a zombie-infested America, an image of Atlanta’s abandoned financial district conjured an end-of-world vibe. Nothing says apocalypse, apparently, like a city without functioning A.T.M.’s.

But for all of our serious economic problems — persistent high unemployment, spreading home foreclosures, the risks that bad policy, bad luck or both will send the economy back into recession — the United States of 2011 is nowhere near as bad as, say, the Vienna of 1918.

“When Money Dies” charts the travails of people like Anna Eisenmenger, who bartered her dead husband’s gold watch for potatoes, watched her malnourished grandson develop scurvy and saw neighbors attack mounted policemen so they could slaughter and eat the horses. Next to the Weimar Republic, higher interest rates on credit cards — a likely outcome of the current debt bickering — seem tolerable.

Indeed, Raghuram G. Rajan, an economist at the University of Chicago, argues that even if the United States were to default on its debt briefly, the world would mostly keep calm and carry on. Americans’ lives probably wouldn’t change markedly, he says. The more troubling and longer-lasting issue would be the United States’ loss of credibility among investors and overseas sovereign wealth funds.

“A failure to compromise sends a signal to the world that U.S. politicians can’t get their act together, and this nation might not be the best choice for guiding the international economy,” Mr. Rajan says. “The real risk is that investors will start looking for another country as the world’s financial standard-bearer.”

Which raises the troubling possibility that what is happening now could stretch on for years. People could remain out of work, businesses could be starved of capital and politics could impede a lasting economic recovery.

At least killing zombies feels like a job.

Debt troubles have come and gone in this country, and not only on Capitol Hill. In the 1970s, New York City defaulted on its debt, and yes, the consequences were painful. Enrollment plummeted at City University campuses, which until then had offered free education. Seven thousand police officers were laid off. Crime skyrocketed. Services for the poor disappeared.

But in the wake of that crisis, the city started changing business regulations and tax structures, setting the stage for a building boom. As blue-collar manufacturing jobs evaporated, in came white-collar jobs in finance, real estate and so on.

Out of the ashes of default, the yuppies rose — and, eventually, the banking and hedge fund classes that helped give us the late, great bubble.

On second thought, maybe we’re better off with the undead.

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DealBook: Derivatives Industry Awaits Rules, and a Timeline

With or without new rules, the derivatives industry is gearing up for big changes.

Three years ago, the complex securities wreaked havoc on Wall Street, prompting Congress to overhaul the long-unregulated market. The Dodd-Frank financial regulatory law requires companies to trade credit-default swaps and many other derivatives contracts through regulated exchanges or on a new invention known as swap execution facilities, or S.E.F.’s.

Now, even as regulators miss deadlines to complete the rules, some industry players say they are well prepared for the looming changes.

“Banks, hedge funds, insurers and other sophisticated entities are very eager and ready to begin trading on S.E.F.’s,” Ben Macdonald, global head of fixed income for Bloomberg, told the Senate Banking Committee on Wednesday. The infrastructure needed to set up the new trading platforms “certainly exists,” he added.

Regulators have estimated that 30 to 40 firms — ranging from big names like Bloomberg to growing online marketplaces like Tradeweb — will line up to become swap execution facilities, a term coined under Dodd-Frank.

Wall Street, however, is waiting for Washington to catch up. Amid internal wrangling and a broader political divide over the derivatives rules, regulators have fallen behind on several crucial issues.

The Federal Reserve announced last week that it would allow the public two additional weeks to comment on some derivatives proposals. Earlier this month, the Commodity Futures Trading Commission announced a six-month delay for many of its new derivatives regulations, including the proposal that will spell out rules for the trading facilities.

On Wednesday, the Securities and Exchange Commission finally proposed a series of new ethics standards for the derivatives industry. The proposal came more than six months after the commodities commission introduced a similar plan.

The S.E.C.’s proposed code of conduct would for the first time require banks, hedge funds and other firms that trade the opaque products to bolster their compliance departments and act in the best interests of the pension plans and local governments that use derivatives to hedge risk. Under the rules, the firms would also need to disclose a battery of information, including potential conflicts of interest and risks posed by derivatives deals.

“The standards we propose today are intended to establish a framework that protects investors and also promotes efficiency, competition and capital formation,” Mary L. Schapiro, the agency’s chairman, said at a public meeting in Washington on Wednesday.

The S.E.C. previously outlined proposals that, if enacted, would mandate how derivatives trading platforms operated.

But the pressing question is when the rules will take effect.

“We are ready to go,” Chris Bury, co-head of rates sales and trading for Jefferies Company, told the Senate committee. “The market needs the certainty of when the rules will become applicable.”

Some of the holdup stems from Wall Street’s own attacks on the rules. Industry lobbyists and Republican lawmakers led the push to delay the swap regulations. Bloomberg and other trading firms are asking regulators to tread lightly with the new rules.

“Sophisticated market participants do not really need or want federal regulators micromanaging execution protocols,” Mr. Macdonald told the banking committee.

But some advocates of regulation say delays are jeopardizing the safety of the financial system.

Before the crisis, investors bought billions of dollars’ worth of derivatives as insurance on risky mortgage-backed securities. When the underlying mortgages soured, the American International Group and other firms that sold the deals failed to honor their obligations. The government ultimately rescued A.I.G. with a $180 billion bailout.

“The biggest threat is that every day we don’t have financial reform rules in place is a day that the American taxpayers’ pockets are at risk,” said Dennis M. Kelleher, the president of Better Markets, an advocacy group.

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