Question Authority: Einhorn is Right to Demand Answers from Apple

David Einhorn.

David Einhorn.

When David Einhorn, the poker-playing hedge fund superstar, decides to publicly take on a company whose stock he owns (or has shorted), he usually gets results. Once you establish a reputation for astute calls on Wall Street—Mr. Einhorn’s most famous being his bearish call on Lehman in the spring of 2008—the lemmings can’t help but follow. His latest target: Apple.

Mr. Einhorn’s Greenlight Capital owns more than $600 million worth of Apple, but like others, he thinks the company needs to shake free of a months-long rut. To that end, Mr. Einhorn made clear last week his wish that the company become more flexible in how it thinks about returning cash to shareholders. It’s no small matter, considering that Apple has $137 billion of the stuff sitting on its books, and he sued the company over a possible violation of securities laws last week to make his point. The stock rallied 3 percent on Thursday as a result.

The question of whether or not Apple should do as Mr. Einhorn wishes is an interesting one. On the one hand, Apple has never kowtowed to the needs or wants of Wall Street. On the other, that was a legacy of Steve Jobs, and Mr. Jobs’s successor Tim Cook has to be somewhat concerned about the company’s precarious status as a stock market darling. Returning more cash to shareholders can only help in that regard. Smarty-pants commentators will of course point out that with no external financing needs to speak of, Apple need not pay any mind to Mr. Einhorn or any other institutional investor. But what of its employees? As singular as it may be, the company does have competitors. And when you’re trying to retain your people, a rising stock price beats a falling one.

My bet is that the company caves, but not in the precise way Mr. Einhorn wishes. These are proud people, after all, and there’s no way they’re going to let some guy from New York tell them what to do. But they’re also smart enough to know that $137 billion is too much, and that taking care of shareholders becomes a more nuanced challenge when growth begins to moderate.

In suing Apple, Mr. Einhorn took an issue everyone had already been talking about and put it on the front page. More interesting than the question itself is the fact that nearly every piece of coverage about it—in papers, on TV, in the blogosphere—invoked the label “activist investor” when describing Mr. Einhorn. The term, which is generally applied to hedge fund managers who buy a stake in and then urge companies into some sort of action, has never been explicitly derogatory. But the arrival of said “activism” is usually remarked upon (or typed) in a certain tone, as if someone had just farted at the dinner table.

Why? Perhaps it’s because its most effective (and self-promoting) practitioners have always been the most arrogant that Wall Street has to offer—from 1980s pioneers Carl Icahn and T. Boone Pickens to today’s most prominent, Daniel Loeb (he of the poison-pen letters to CEOs and boards) and his contemporary Bill Ackman. Mr. Einhorn is an unusual exception: he’s so self-effacing, it’s almost hard to believe he works on Wall Street at all, let alone as one of its most successful hedge fund managers.

The unspoken criticism of activist shareholders seems to be that they’re in it for themselves, that their activism is just Wall Street greed in one of its many costumes. That may have been true when it came to the old practice of greenmail, or when hedge funders end up profiting at the expense of others by exploiting companies’ capital structures to their sole advantage. But what about when it’s just another common shareholder like you and me? Such activism is great for everyone, isn’t it? If you own Apple stock in your IRA, Mr. Einhorn’s interests are aligned with yours. So why is this “activism” treated with distaste? Have the public equity markets become so disconnected from reality that no one expects the actual owners of companies to have a say in how they are run?

That’s not to say that activism is itself rare. Pershing Square’s Mr. Ackman has done a great—and captivating—job over the last few months of focusing other investors (and perhaps securities regulators) on a simple question: does multilevel marketing giant Herbalife have many—any?—customers beyond its distributors? If not, it’s a pyramid scheme. And if that is the case, Mr. Ackman’s short position in the stock will pay off big-time. Deride short-sellers all you want, but the man is just asking a question. Why the hell don’t more big investors do that?

(On the subject of Mr. Ackman, did you see the clip of him doing battle with Carl Icahn on CNBC? It’s a classic, and surely the first time I’ve ever told non-business types that a segment from the cable network is a must-see. Mr. Icahn came across as a bit of a jackass, particularly when he berated the reporter for the audacity of asking him questions, but in the end, he’s just an investor who actually tries to force companies into action. And he’s good at it. Thus, a mea culpa: in a previous column on Mr. Icahn and Netflix, I concluded that his agitation probably wouldn’t result in any movement in that stock. Shares of Netflix have, um, doubled since then. Whether or not it had anything to do with Mr. Icahn seems irrelevant at this point. Nice one, you old dog.)

Mr. Einhorn’s complaint is technical—he’s arguing that by bundling a proposal that would prohibit the company from being able to issue preferred stock without a shareholder vote with some other matters, Apple was somehow violating securities laws. But that’s the law for you—sometimes the only way into an issue is through the side door.

There are two reasons Apple’s other large institutional shareholders haven’t tried that door. One: Apple doesn’t give a shit what its shareholders want. It never has. So some investors have surely (and correctly) concluded that it wasn’t worth the effort. Two: institutional shareholders are a bunch of wimps. They don’t apply pressure on outrageous CEO pay, decry stupid mergers or acquisitions, or move for entire boards to be fired in instances of egregious failings of oversight. Most of them, in other words, are a CEO’s dream.

Shouldn’t an owner be able to ask questions about strategy or execution? Even CalPERS—the nation’s largest pension fund—which The Wall Street Journal referred to on Friday as “a loud voice on corporate governance,” isn’t really all that. It only became concerned about the Freedom Group—maker of the AR-15 Bushmaster, the favored gun of mass murderers—after  it was used to savage effect Newtown, Conn. That’s not activism. That’s covering your ass in the court of public opinion. Strangely, CalPERS supports Apple’s desire to restrict itself in the ways it can pay out cash to shareholders. Don’t ask me why.

Of course, if you don’t like what management is doing, you are free to sell your shares and take your money elsewhere. (Why anyone would ever own shares in Wall Street firms themselves, for example, which Andy Kessler described to me once as compensation schemes masquerading as publicly owned companies—“they literally exist to pay out half of their revenue as compensation”—is beyond me. But that’s a discussion for another time.)

And yet we still erupt in spasms of disbelief when activists make a ruckus. But really, people, which is more unbelievable? That some hedge fund guy has the audacity to ask a company to consider a change, or that the rest of us have come to accept the status quo? In an interview with CNBC last week, Mr. Einhorn said that when he finally got Apple CEO Tim Cook on the phone after failing to make headway with the company’s CFO, Mr. Cook told him that he hadn’t even been told about Mr. Einhorn’s concerns. Steve Jobs would be proud.

Blogger Barry Ritholtz chastised Mr. Einhorn in a post last Friday for trying to salvage a poorly timed investment in Apple stock by pushing the company to release more cash, and coined a “law of activist fund managers”—“No matter how much money a company makes for investors, they all eventually want more.” But why shouldn’t they? They own the damn thing.

Mr. Ritholtz knows how to get attention as effectively as the activists he mocks—he titled the post “The Colossal Gall of Bad Apple Investors”—and he decreed that Apple’s decision to sit on that obscene pile of cash is simply part of its genius. In his mind, Mr. Einhorn’s move is not a reasonable request from an owner of more than $600 million of stock but simply the sour grapes of a sore loser. But that’s absurd. By that reasoning, an owner of a stock that has gone up a lot before going down has no right to question management. The fact that we react with surprise when they do says more about us than it does about them.