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May 05, 2005

Hedge Fund Hijinks

I had written before that hedge funds and other major MCI shareholders might have been manipulating the Verizon-Qwest auction process to accept a Qwest bid loaded with equity, that they would then have to race to dump. Now, it looks as though some of them were also manipulating Qwest's share price to help keep that bid credible when it was financially unsound.

The Denver Post first reported last week that Qwest's stock spiked during the last 15 minutes of trading on the New York Stock Exchange from March 28 to March 30 to close above a critical price threshold known as a "collar."

Had Qwest's stock closed below the collar, investor confidence in Qwest's bid for MCI could have been shaken. Qwest was dueling against Verizon, which this week locked in a merger agreement with MCI.

...

Maintaining a certain stock price was key to Qwest's offer for MCI, which in late March was $26 a share in cash and stock. Qwest guaranteed the value of its stock within a 10 percent collar above and below $4.15 per share. Below the collar, MCI shareholders would receive less value for their Qwest stock.

Actually, since the number of shares, rather than the dollar value, was specified in the deal, any drop in share price would have cost MCI shareholders money. The collar was there to limit, not eliminate, such risk. Had Qwest decided to try to make up the difference with even more shares, they could have crossed the 50% threshold beyond which MCI would, in effect, have been buying a controlling interest in Qwest.

Since MCI shareholders clearly wanted cash more than they wanted to run a telecom, this wasn't quite the deal they were seeking. Moreoever, under federal M&A laws, it would have changed the entire structure of the deal, affecting valuation, taxation, and the ability of shareholders to resell their newly-acquired Qwest stock.

In fact, this kind of manipulation, if it in fact happened, is grossly illegal, and harkens back to the Wild West on Wall Street, detailed firsthand by Bernard Baruch and secondhand by Charles Geisst.

Whether or not it happened, the fact that it could have will likely be enough to stir up more calls for further regulation of hedge funds. That's too bad, because there's no inherent reason why funds, any more than individuals, should be restricted in the kinds of investments they can make.

Posted by joshuasharf at May 5, 2005 01:34 PM | TrackBack

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