by Matt Taibbi
So beginning in late 2002 and early 2003, they tried to kill the firm the good old-fashioned way, with a simple insider trading scheme, massively shorting the company ahead of a fake negative research report that they knew was coming long before the public did. But when the company didn’t die, they were forced to resort to extraordinary measures.
It’s here that the Fairfax story became one of the more sordid and disturbing tales in the annals of Wall Street. The handful of hyperaggressive billionaires who targeted this relatively small Canadian insurance company resorted to tactics that at first blush will seem unreal. Indeed, the targets of the scheme, the Canadians themselves, were initially paralyzed for a critical period of time by their utter inability to believe what was happening to them. In fact, many journalists, myself included, stayed away from this story for a long time, because even the baldest recitation of the facts sounds too much like bad conspiracy theory.* “It was the kind of thing you’d only expect to see in inelegantly written fiction,” says Roddy Boyd, formerly of the New York Post, who became a character in the story in the mid-2000s.
The Fairfax fiasco is a tale of harassment on a grand scale, in which the cream of America’s corporate culture followed executives, burgled information from private bank accounts, researched the Canadians’ sexual preferences for blackmail purposes, broke into hotel rooms and left threatening messages, prank-called a cancer-stricken woman in the middle of the night, and even harassed the pastor of the staid Anglican church where the Canadian CEO worshipped on Sundays. They worked tirelessly to instigate phony criminal investigations in multiple countries, tried relentlessly to scare away investors and convince ratings agencies to denounce the firm, and in general spread so many lies and false rumors to so many people using so many different false names that they needed a spreadsheet to keep track of their aliases.
Sender, by the way, wasn’t the only millionaire to commit his bloodlust to paper. DIE PREM DIE, wrote the to-this-day well-respected hedge fund manager Dan Loeb, adding:
PREM WATSA BEND OVER THE HEDGE FUNDS HAVE SOMETHING SPECIAL FOR YOU.
The campaign to destroy the Canadian insurance company was protracted and complex and ingenious and involved a lot of behavior that was almost certainly illegal, in some cases obviously so. And as in almost all these cases, the nasty/antisocial behavior of Wall Street crooks went almost completely unpunished; the system failed due to a combination of corruption, regulatory capture, pusillanimity of government officials, structural biases in the civil courts, and other factors. But for all that, the issue of legality is of secondary importance in the Fairfax case.
“Almost everyone has the same reaction when they’re first exposed to this story,” says Michael Bowe, the lawyer who ended up representing Fairfax in its lawsuit. “They’re like, ‘I don’t know if this is illegal, but it’s definitely fucked up.’ ”
What happened with this Canadian company goes far beyond the merely cynical mechanisms of insider trading and market manipulation and takes us down into an even darker place in the national psyche, into the netherworld of pure violence and aggression that rules modern Wall Street. This is where the drive for money and conquest is so intense that it crosses over into a kind of hatred and bloodlust, where the payoff stops being about money at all and becomes a search for something more desperate and seminal. It’s about winning, in the ultimate sense of the word.
Not many people in America have the stomach to really explore what that term means. But it’s all here in the Fairfax case. Thanks to the miracle of legal discovery, which turned this into the most extensively documented bear raid in history, we now know the secrets of some of America’s biggest winners. Like that they’re crazy.
Before January 2003, Prem Watsa was known in Canada as an immigrant success story of mild renown, a twenty-first-century-Toronto version of a Horatio Alger tale. He had come to his adopted country as an almost literally penniless Indian back in 1972. According to firm legend, he had just eight dollars in his pocket and six hundred dollars in the bank to cover tuition when he arrived as a business student that year in London, Ontario, at the University of Western Ontario. His South Asian education had left him with a chemical engineering degree, but in Ontario in the early 1970s, he made ends meet by selling air conditioners and furnaces, even selling greeting cards door to door.
Then, when he graduated from business school in 1974, a professor helped Watsa get a job with Confederation Life, an insurance company in Toronto. Over the course of the next ten years, managing funds in the insurance business, Watsa learned about investing and became obsessed with the buy-and-hold long-term investment strategies that would eventually come to be associated with the likes of John Templeton and Warren Buffett.
But it was exposure to popular economics writer Ben Graham’s book Security Analysis that Watsa calls his “road to Damascus” moment—he was so enthralled with Graham’s ideas that he eventually named his first son Ben.
A small, carefully dressed man with a distantly beatific manner and deep cocoa-brown skin covering his almost perfectly round bald head, Watsa seems almost religiously devoted to the ideas of Graham and other value investors. When I flew to Toronto and met him in person, he came across as a True Believer of the first order. The CEO was actually rattled momentarily when I confessed I’d never read Ben Graham, and as if concerned for my welfare, he urged me to read his books as soon as possible.
Graham’s ideas stress the simple practice of finding the right price for a company, waiting for that price to fall a little to the point of being undervalued, and then buying and holding that stock with the attitude that you are now part owner of a business, one in whose success you should be invested for the long haul.
By 1985, Watsa was a proponent of these stock-picking methods and was sure he could do something with them on a grand scale. But he still had almost no money of his own. He did, however, have a reputation in the Canadian insurance business and a few influential friends, including executives at the first firm he worked for, Confederation. That year those friends and former employers helped him put together a $5 million stake to buy out a small trucking insurance company called Markel Insurance, which proved a big success.
In the late 1980s they changed the company name from Markel to Fairfax—short for “Fair and Friendly Acquisitions.” This seemingly trite homage to the firm’s self-professed Canadian niceness had me groaning, until I actually met the company leaders and realized the earnestness wasn’t an act. Under the surface, Fairfax may be all business, and ethically speaking, it’s certainly had its problems, but on the surface, the firm has an ostentatious corporate culture that stresses piety, politeness, and old-fashioned rectitude.
Which would be meaningless, except that the Fairfax name and company culture would later stand in stark, humorous contrast to the ethos of the expletive-tossing pirates who tried to attack and seize Watsa’s company. Attacking “Fair and Friendly” Fairfax would be corporate killers whose firm names would recall death metal bands, one of whose company culture would be symbolized by the giant, rotting shark that its owner purchased for tens of millions of dollars.
All that was still yet to be revealed. By the mid-1990s, Fairfax was becoming a major umbrella company in the North American insurance business. It was acquiring interests in everything from casualty to professional liability to trucking to home insurance.
Its stock soared on the Toronto Stock Exchange, moving from under 70 Canadian dollars a share, when it first listed in 1995, to highs of above $605 in 1999. The rocketing share price was due in large part to Fairfax’s decision to pursue two major investments in U.S.-based insurance companies in the late 1990s, the American subsidiary of a Swedish firm called Skandia Re (later renamed OdysseyRe), and a Morristown, New Jersey–based company called Crum & Forster.
Watsa, who just a dozen or so years before had had no money of his own and had to court rich friends and former bosses to buy a tiny trucking insurance company, bought Crum & Forster in 1998 for
the sizable sum of $680 million.
But both OdysseyRe and Crum & Forster turned out to be more problematic than many of Fairfax’s other operations. For several years the company struggled to reorganize both firms successfully, leading to a dramatic fall in Fairfax’s Canadian share price. Old asbestos claims and a string of disasters (including storms in Europe and 9/11) led to massive payouts that for a time made both American acquisitions seem like potentially crippling albatrosses. The company in 2001 lost money for the first time, and Watsa was forced to explain an 11.9 percent drop in shareholder equity to his investors in a year-end letter.
But by the middle of 2002, the company claims, things began to stabilize a bit in both operations. “We were just starting to turn things around,” says Paul Rivett, Fairfax’s president, “when all this craziness began.”
That was when Fairfax made the fateful decision to list the company on the New York Stock Exchange for the first time. It was going to be a major new source of funds and also a major step up in international status. When the firm was finally listed on the NYSE on December 18, 2002, the event was celebrated with cheers and champagne in the company’s Toronto offices. The troubles began a month later.
For a few weeks after the firm listed on the NYSE, during the Christmas holiday, things were quiet. Then, shortly after the New Year, Watsa became aware that something was, well, if not wrong exactly, a little bit odd.
“It was in the second week in January,” Watsa says now. “On the Toronto Stock Exchange, Fairfax usually would trade, I don’t know, maybe ten thousand shares a day, twenty thousand shares a day. But suddenly, on the New York exchange, we’re trading two hundred thousand shares a day. Half a million shares a day.” He shrugs. “I thought to myself, ‘Well, this must be the great New York Stock Exchange.’ ”
In what looked at the time like an incredible coincidence, the massive run-up in the trading of Fairfax stock (listed on the NYSE as FFH) immediately preceded a string of sharply negative published reports.
The first report to come out, on January 15, was by The Street’s Peter Eavis, who today writes for the New York Times business news service, DealBook. Although he didn’t throw out specific numbers, Eavis, in a piece called “Unsure Times for Insurer Fairfax Financial,” wrote that Fairfax’s American acquisitions “look deeply under-reserved.”
The substance of the Eavis article was that Fairfax, despite its claims of Buffett-style investing conservatism, was engaging in wide-scale smoke-and-mirrors accounting, using its offshore acquisitions, particularly its reinsurance subsidiaries, to make the bottom line of the parent company look better. Reinsurance is essentially insurance bought by insurance companies, as a hedge against cripplingly large numbers of claims. Insurance companies must have a certain amount of capital in reserve to cover claims. If an insurer has bought reinsurance, however, more of the insurer’s capital is freed up, and the insurer’s reserves look better.
Eavis reported that Fairfax was paying the reinsurance premiums for struggling subsidiary insurers like TIG, which were buying their reinsurance not from independent firms but from other Fairfax subsidiaries like Swiss Re and the Dublin-based ORC Re. To put it in less headache-inducing language, Fairfax was allegedly paying one group of subsidiaries to reinsure its other subsidiary insurers.
All this looked from the outside like global shell-game stuff, hiding liabilities by ginning up cloudy transactions between subsidiary companies. Furthermore, it was all going on not long after the world’s largest insurer, AIG, had faced similar questions about its reserves and about some suspicious transactions that it had entered into with a Warren Buffett–owned reinsurance company called Gen Re. It looked bad.
Still, there was no proof of impropriety, just a lot of questions. “Of course, the sniping on the Swiss Re deal may turn out to be groundless,” Eavis wrote, “but investors still need to focus hard on Fairfax’s habit of using its own offshore entities to reinsure its onshore business.”
Two days after Eavis’s article, on Friday, January 17, a report by the Memphis-based investment bank Morgan Keegan came out. It was similar to the Eavis article, only far more aggressive. Written by analyst John Gwynn, it echoed the Eavis claim that Fairfax was “under-reserved” but put a concrete number on its assertion, saying the company was undercapitalized by as much as $5 billion. That meant that it had $5 billion less than it would need, in a worst-case scenario, to pay its insurance claims and other liabilities.
The report floored the Canadians. Fairfax wasn’t that big a company. If it was really underreserved by $5 billion, that would mean it was insolvent. Gwynn was asserting that Fairfax was the next Enron, a massive accounting fraud posing as a thriving publicly traded company.
Watsa—in retrospect, naïvely—paid no attention to the report. “We laughed,” he says. “We thought, ‘It must be a joke. Nobody will take it seriously.’ ”
Watsa was wrong. On the following Monday, the New York Stock Exchange was closed, due to Martin Luther King Day, but trading was open in the Canadian exchange. That day the firm’s Canadian stock began plummeting.
“It went down like twenty-five percent in one day,” Watsa recalls. “Like a stone it went.”
By 10:30 that Monday morning, January 20, the Canadian authorities were calling Watsa in a panic. Both the Ontario Securities Commission (the province’s version of the SEC) and the Toronto Stock Exchange called Fairfax, demanding to know if there was some sort of “event” going on at the company that justified the mass sell-off of the firm’s stock. When Watsa insisted that there wasn’t, the TSX told him that he had to issue a statement to try to address investors’ concerns.
So they did. Later that afternoon Fairfax issued a press release essentially saying that the analyst reports were false, that the company was not underreserved, and that there was no reason for alarm.
Hardly isolated in the investment community, Watsa called some influential friends on Wall Street, who told him his company was under attack by short sellers. But the credulous and devout Watsa was characteristically slow to digest the meaning of this news.
In fact, early in 2003, when first told he was under attack by short sellers, Watsa thought the only reason anyone would be shorting his company was that investors for some reason genuinely believed his company was a loser and that its stock was overvalued, in which case Watsa says he was convinced the firm was not in serious danger. If anything, he thought, the short attacks and the resultant plummeting stock price would provide opportunity for smart investors to buy low.
“I thought, in a way, this was good news for them,” he says now. According to the classical economic theory he believed in, it was those smart investors who would ultimately win out.
“I kept insisting that all we had to do was do well, and we’d be fine,” he says now. “I kept telling everyone at the firm, ‘Results will out.’ ”
So the company moved aggressively to improve its “results,” engaging in a series of maneuvers designed to reassure investors about the strength of the company’s reserves. Some of those transactions would later come under scrutiny (more on that later), but the key here is that the firm did not yet know that it was in an alley fight with an organized group of aggressors who had moved outside the usual realm of quarterly results and analyst reports and SEC disclosures.
Watsa would deny the existence of such attacks and cling tenaciously to his “results will out” mantra for years, having no clue that he was playing right into the hands of his antagonists. Until it was almost too late, he had absolutely no idea what was really happening to his company.
Wall Street in 2003 was a very different place from the world Ben Graham had written about in his 1934 Security Analysis. A more definitive portrait of modern finance would probably be the movie Wall Street, which had a profound effect on the city’s business culture, although probably not the effect its heavy-handed lefty director Oliver Stone expected. While the rest of America understood Michael Douglas’s iconic Gordon Gekko cha
racter as a villain, and saw his famed “greed is good” speech as incisive satire, many aspiring Wall Street traders sincerely thought—and still think—that Gekko was the movie’s hero.
In the early 1990s, Wall Street saw a massive influx of young Gekko wannabes who thought waiting any amount of time to get fabulously wealthy was for losers, or at the very least for people who had never read Sun Tzu. Many of these new world-beaters eschewed the old Wall Street career path of being a broker at a major investment bank and climbing the ladder to a partnership. Instead, they reached for a more direct path to the top.
They started hedge funds.
Hedge funds, basically big pools of money managed by professional traders, are almost totally unregulated. A fund often begins as a one-man operation, run by a smooth-talking Wall Street front man who trolls the very rich, hustling for seed money. There are no real regulatory audits of hedge funds, and no government body checks hedge funds’ trades or verifies their claims. It even came out, in the famous Bernie Madoff case, that despite numerous complaints to the SEC over the years from reputable sources, nobody in the government even checked to make sure Madoff’s hedge fund even made trades at all. Madoff actually went more than thirteen years without making a single stock purchase and yet somehow survived several SEC investigations—that’s how flimsy government regulation of hedge funds has been and still is.
Thus the right kind of fast-talking operator can quickly find himself managing hundreds of millions of dollars just by having the right rap and boasting high enough returns. Many, like Madoff, or the similar but less-well-known character Sam Israel of the infamous Bayou Fund, secured gigantic investments by promising that they had a secret system to outperform the market. In Israel’s case, the “system” he had actually learned, as a trading apprentice to early hedge fund pioneer Fred Graber, mainly revolved around a series of high-speed insider trading schemes. From the book Octopus, about Israel:
