Fairfax: The Emperor Strikes Back

By Rachel Pulfer
Canadian Business Magazine
March 26, 2007

Marc Kasowitz doesn't like sitting still. A compact man in his early 50s, white hair slicked back, he paces a vast conference room attached to his corner office, which is perched high above Broadway and 51st in midtown Manhattan. He frequently pauses by the window, staring out at the Theatre District hustle below.

Kasowitz, who is a name partner with litigation boutique Kasowitz, Benson, Torres & Friedman, takes his time before answering questions. But once he starts talking, he fires off words like bullets. Today, he's discussing a lawsuit his firm launched last July on behalf of Fairfax Financial Holdings (TSX: FFH), the Toronto-based property and casualty insurer founded by the legendarily reclusive — and for a time legendarily value-creating — Prem Watsa.

Now pending in Newark federal court, the suit alleges that a group of hedge fund managers — including New York's so-called hedge fund king, Steven Cohen of S.A.C. Capital Management — conspired to defame Fairfax by disseminating false research reports that drove down its share price. The group then allegedly profited by selling the stock short. The suit charges six counts of racketeering, commercial disparagement and conspiracy, among others, and claims a cool US$6 billion in damages.

The case has yet to come to trial, and none of the allegations has been proven in court. But the suit coincides with a period of intense regulatory scrutiny of Fairfax's financial health — and it was launched a day before the company announced accounting restatements that wiped an estimated US$235.3 million off shareholder equity last year. Originally filed in state court, the case was moved to federal court last fall on the defendants' request, and is currently pending a motion to remand.

The suit is the latest, and most audacious, in a wave of legal confrontations between companies and increasingly activist U.S.-based hedge funds, sparking interest in certain trading tactics from the chair of the U.S. Securities and Exchange Commission, Christopher Cox. To hear Fairfax's chief legal officer, Paul Rivett, tell it, the lawsuit is a last resort, a preventive measure to head off a final attack from the company's tormentors. Kasowitz goes further. "Hedge funds have developed substantial market power," he says. "The type of behaviour alleged in our complaint shows certain hedge funds are abusing this power. As the light of day gets shone on these abuses, this behaviour should stop."

Yet given Fairfax's backstory, the decision to sue some of its shorts could also be a gigantic smokescreen — a heavy-handed way to silence criticism and distract attention from the company's own cash flow problems and accounting woes. Even setting aside such questions, market manipulation cases are "fiendishly difficult to prove," as New Jersey securities expert Brian Carlis puts it. Fund managers might simply have done an analysis of the company's fundamentals, determined weaknesses in its cash flow, sensed an opportunity and decided to short the stock.

The truth cannot fully be known until the lawsuit comes to trial. That will not likely be for some months, given that the issue of where it will be litigated is not yet settled. But the stakes are high. Lead defendant Cohen is widely considered the most powerful hedge fund manager on Wall Street. A reclusive figure (who reportedly paid US$8 million for British artist Damien Hirst's sculpture of a rotting shark in a tank), Cohen manages a fund worth US$12 billion. He is said to be responsible for moving 3% of the New York Stock Exchange's total trading volume each day.

Still, taking on Wall Street's biggest kahuna is what you might expect from the man Donald Trump likes to call for legal help. And the complaint Kasowitz's firm has crafted — it was actually written by another partner, Michael Bowe — is every bit as entertaining as its most famous client. Peppered with references to "The Enterprise" and "The Fairfax Project," it jaunts on for 87 pages, alleging a campaign of dirty tricks waged against Fairfax brass by hedge fund "operatives" who intended to pressure the company into revealing evidence of what they claimed was Enron-style accounting fraud, and thereby crater the stock.

It might be a difficult case to prove, but Kasowitz's and Bowe's confidence may yet prove well-founded. On March 14, one of the alleged "operatives," a self-styled independent consultant named Spyro Contogouris, was indicted on fraud charges in an unrelated case; Fairfax stock bounced from $205 to $214. (Contogouris was first arrested last November; on that news, the stock soared 10%.) What's more, in early March, co-counsel Bowe confirmed that the Fairfax side would be citing "sources with direct knowledge of the defendants' activities" as evidence.

To date, the market has reacted favorably to Fairfax's legal manoeuvring. Its shares are trading at around US$240, more than double their US$113 value on July 26 last year, the day the suit was launched. Credit rating agencies from A.M. Best to Moody's to Fitch have upgraded their outlook to Stable from Negative. Moreover, after what Wade Burton, a portfolio manager at Mackenzie Cundill, describes as six years of liquidity problems, Fairfax finally appears to be getting its fiscal house in order. Year-end financials for 2006, reported in February, included respectable net earnings of US$227.5 million in cash, up from a net loss of US$446.6 million in 2005, with US$750 million in cash, investments and securities at the holding company. (The gains were due largely to a Q4 sale of assets below book in U.S. subsidiary Odyssey Re for US$338 million.) In a follow-up research note, analyst Justin Fuller of Morningstar wrote that "Fairfax remains at risk today, but management's ongoing repair work has made its recovery prospects appealing." A promising option, in other words, for long-term investors who "don't mind a few bumps."

That said, none of the analysts who had previously reported bearish views on Fairfax would talk about the company when contacted by Canadian Business. Tom MacKinnon of Scotiabank explained he was "restricted" on Fairfax. Few Wall Street attorneys would comment, either. One said that was because Wall Street lawyers would love to have hedge fund clients. The defendants, too, are lying low. Only one of the fleet of lawyers the hedge funds have assembled returned telephone or e-mail requests for comment, and he spoke only on condition of anonymity. "All my client is accused of here is short selling," said the lawyer. "Last I checked, short selling is not illegal. This is a blatant example of a company using a lawsuit as a blunt instrument to silence criticism. That's not in the interests of the free flow of information, which is essential to the functioning of a free market." Meanwhile, an S.A.C. spokesman issued a simple statement: "This is another baseless lawsuit by a company attempting to shift the blame for its fundamental business problems. We are confident that we will prevail."

The lone remaining bear of record on Fairfax, analyst John Gwynn of Morgan Keegan, is also named as a defendant. He abandoned coverage of the stock in January. Gwynn would not return calls for comment. Elsewhere, he has claimed he had been "silenced" by litigation.

Fairfax Financial Holdings started life as a virtually bankrupt trucking insurance company, Markel Financial Holdings, which Fairfax founder and current CEO Prem Watsa bought in 1985. He reorganized the company and in 1987 renamed it Fairfax — short for "fair, friendly acquisitions." Watsa began building up the business, embarking on a strategy of growth through debt-fuelled acquisitions of on-the-skids insurance companies. He bought assets cheap, turned them around using in-house expertise and access to capital, and added the profits to an ever-expanding float, the pool of cash in the company's investment portfolio. Another Watsa-founded company, Hamblin Watsa, reinvested the float, generating an average return on equity of 20% in the period between 1987 and 2000.

With his combined role as chairman and CEO, and his exclusive ownership of all 1.5 million 10-for-1 multiple voting shares, which give him more than 50% of the votes, Watsa retains clear control over every move the company makes. He's also the largest single shareholder, and his investment in Fairfax represents 95% of his net worth. Analysts cite this fact repeatedly to show Watsa's interests are as tightly aligned with shareholders as possible. But in the past six years, his super-vested stance translated into an attitude toward disclosure that appeared to put pride in the company before inconvenient facts.

For a while, Watsa could do no wrong. By 1999, he had built Fairfax into a sprawling, complex network of subsidiaries that reached from Bermuda to Hong Kong. Disclosure of results consisted of a single page that stated revenue, earnings and earnings-per-share for a quarter or a year. Watsa ignored criticisms of his imperious management style, did not appear on company conference calls and refused all interviews, saying he preferred to focus on the bottom line and let "results speak for themselves." And speak they did. Fairfax boasted 1997 year-end net earnings of $232.5 million, up from $150.8 million the year prior. The stock price surged from $3 in 1985 to a peak of $600 in 1999. Fans referred to Watsa as the Warren Buffett of the North.

But just as it seemed invincible, "Fairfax had a misstep," as Morningstar's Fuller puts it. About eight years ago, he adds in his research note, the company acquired "several troubled insurers, believing its expertise could substantially improve their performance. Disastrous results ensued." The "troubled insurers" were U.S. property and casualty insurers Crum & Forster, a division of Xerox, bought for US$565 million in August 1998, and TIG Holdings of New York, bought for US$847 million in April 1999. With the acquisitions, Fairfax roughly doubled its size. But analysts say it used a highly risky combination of debt and reinsurance indemnities to do so.

The latter are complex and controversial forms of financing. To understand why short sellers took such an active interest in Fairfax in the first place, it helps to know how reinsurance indemnities work.

Insurance companies make money by investing funds they take in as premiums. A portion is kept in reserve to pay out claims. Insurance companies take out reinsurance policies on this pool to cover their exposure to premium risk. But one form of reinsurance, known as finite reinsurance, is more of a short-term loan than a genuine way to back up reserves, at least according to some industry observers. Fairfax uses finite reinsurance extensively.

What characterizes finite reinsurance is that the reinsurer takes on only limited risk exposure, and pays only if the pool of reserves is inadequate to meet claims. In addition, the reinsurer expects to make some money off the policy it has bought from the original insurer, as the original insurer is expected to invest those funds. According to Fuller, these reinsurance indemnities, together with debt, were what Fairfax was using to fuel its TIG and Crum acquisitions.

But in an e-mail statement transmitted via Rivett to Canadian Business, Watsa contradicts Fuller's analysis, stressing that reinsurance indemnities were not used for the deals. (However, he then says that for some of the acquisitions, "indemnifications were negotiated as part of the purchase agreement.") Rivett acknowledges the company uses finite reinsurance, but only for the purpose of reinsuring reserves.

The complexity of finite reinsurance arrangements can make them susceptible to creative accounting. One example is Australia's HIH Insurance, which collapsed in March 2001 — the largest bankruptcy in Australian corporate history. Some critics said HIH had used "finite re" more as a series of short-term loans masking the company's actual financial health than as a genuine form of reinsurance against risk.

In 2005, the U.S. Securities and Exchange Commission began investigating Fairfax's use of finite reinsurance. Some short sellers and analysts, such as Gwynn, hinted that the company used finite re to hide the extent to which it relied on short-term loans and questionable inter-subsidiary transactions to retain the appearance of solvency.

Fairfax's legal officer Rivett strongly denies such allegations. He says that, as with most insurance companies that want to keep its subsidiaries' pools of risk separate from one another, Fairfax "does not engage in the cross-collateralization" of its subsidiaries.

Still, buying Crum & Forster and TIG back in 1998–99 proved to be very expensive for Fairfax, in particular after Sept. 11, 2001. That year, Fairfax posted its first-ever loss, $346 million. It was forced to sell assets to keep cash reserves afloat. The next year, Fairfax put much of TIG into "runoff" — industry jargon that means an insurer doesn't have enough cash to take on new risk; all it can do is pay out claims. Much of TIG became a permanent drain on cash flow.

Watsa began appearing on conference calls in 2002. To raise capital, Fairfax listed its shares on the New York Stock Exchange on Dec. 18 of that year. For a company whose business was increasingly based in the United States, the listing made sense. But it also brought Fairfax under American analysts' and short sellers' radar.

Fairfax listed on the NYSE as a tightly held company with a thin public float. (It's supported to this day by a group of loyal institutional investors, such as Power Corp. and Burton's Mackenzie Cundill Funds.) On average, 165,000 shares trade daily, on 18.6 million shares outstanding. Short sellers found they could play the relatively small number of shares available for a measurable impact on the price. (In short selling, an investor borrows stock from a lender, on the understanding that the stock price will drop, then sells it to other investors. When the share value falls, the short seller buys back the stock at its lower value, pocketing the difference.) Soon after Fairfax listed on the NYSE, two million of its shares were sold short. The company now alleges this included the practice of "naked shorting," in which the short seller does not actually borrow any stock. Naked shorting is one of the trading tactics under increased regulatory scrutiny in the U.S.

On Jan. 16, 2003, Gwynn released a dramatic research report. In it, he gave Fairfax a Sector Underperform rating, estimating the company was under-reserved by US$5 billion. Gwynn wrote that he expected earnings-per-share would run to zero by 2004. He pointed out the runoff problems at TIG — a liquidity crunch exacerbated by the "high degree of financial leverage employed by the holding company," and the use of "off-balance-sheet funding mechanisms including finite reinsurance." Gwynn claimed Fairfax's debt-to-equity ratio rose to 50% in 2002, and that in the third quarter reinsurance recoverables were 3.6 times stated equity.

A week after Gwynn's report came out, Fairfax stock collapsed to US$57, losing 21% of its value in heavy trading. Fairfax shot back almost immediately in a press release, claiming Gwynn's reserve estimates were wrong.

Two weeks later, Gwynn issued a second report. In it, he announced that, effectively, he had screwed up his math. Instead of being under-reserved by US$5 billion, he wrote, Fairfax was under-reserved by only US$3 billion. However, he pointed out that Fairfax did not contradict many of his other criticisms, in particular his critique of the use of finite reinsurance. He maintained his Underperform rating, citing the collapse of HIH Insurance and hinting at parallels between its use of finite reinsurance and Fairfax's.

In an e-mail statement to Canadian Business, Watsa writes that he was comfortable with the company's reserve levels at the time, and that Gwynn did not contact the company before the report came out. Watsa says that he "did not believe Gwynn was interested in the facts, and so did not want to get engaged in a back and forth he said/she said."

In February 2003, Standard & Poor's put Fairfax's credit ratings on negative watch. Meanwhile, an article in Forbes magazine pointed out that of Fairfax's US$22.7 billion in assets, a fifth consisted of money owed by other insurers, with no collateral. It also said that another US$1 billion in assets was actually future tax savings that wouldn't be worth anything until Fairfax started showing profits on its tax returns. Watsa, in a rare interview, flatly denied Fairfax had liquidity problems.

Gwynn issued two more negative reports, in March and in April. But by this time, Fairfax had started fighting back. The company completed an initial public offering of shares in its Northbridge subsidiary and a US$300-million debt issuance in Crum & Forster, which boosted the share price to US$174 by mid-July. Institutional investors supported the stock. And the company reported healthy cash flow at year's end, with net earnings up $8 million over the year prior. At the end of the 2003 annual report, however, the company reported an astonishingly high net debt-to-equity ratio of 53%. Much of Fairfax's debt was due to mature within five years.

Going into 2004, tackling the debt monster was clearly top priority for management. In March, the company announced it was going to offer to exchange debt coming due in 2006 and 2008 for cash and new notes that wouldn't mature until 2012. But due to an unusually active hurricane season, Fairfax reported a net loss in earnings of $17.8 million for 2004. The holding company issued debt twice more that year, in August and December. Those moves eventually led to three class-action lawsuits, launched by Fairfax debtholders in the spring of 2006.

How do debt issuances result in lawsuits? For Fairfax, 2004–06 was a particularly troubled period. In April 2004, the company announced that first-quarter 2004 earnings declined by 61% from the previous quarter, thanks to increased interest expenses and significant losses at U.S. subsidiary Lindsey Morden.

Then, in August 2004, a public dispute erupted between Fairfax and another agency, Fitch Ratings. Fitch analyst Brett Lawless, who is named as a defendant in Fairfax's suit, released a critical report that put the company's junk debt on "negative ratings watch." Lawless wrote that Fairfax "may have averted a liquidity squeeze in the second quarter of 2004" by using US$200 million in funds taken in an "arm's-length fee transaction" by a U.S. subsidiary, Odyssey Re, to finance some of its U.S. runoff. In other words, Lawless implied Fairfax was staying afloat by moving money around its network of subsidiaries. Moreover, Lawless alleged, beyond an SEC filing made by Odyssey Re, Fairfax did not disclose the nature of these transactions to shareholders at the time. Lawless also raised questions about a reinsurance policy Fairfax had with nSpire Re, stating that, excluding its indirect $1.7-billion investment in Fairfax Inc., nSpire's capital was roughly negative $200 million at year-end 2003. "Fitch has reservations as to whether nSpire Re will be in any position to fund future reserve shortfalls," he wrote.

Fairfax reacted by demanding Fitch withdraw Lawless's analysis. A column in The Globe and Mail, titled "Fairfax hissy fit doesn't change fact Fitch is right," asserted that Watsa then proceeded to attack all credit rating agencies at the company's annual meeting, saying that "one of their biases is that companies that haven't done well in the past are unlikely to do well in future. We think that's wrong."

In 2005, the debate over Fairfax's cash flow position and transactions within its opaque structure intensified. In June and then again in September, the company announced it was being investigated by the SEC. Then, on a conference call in February 2006, Watsa commented that having conducted an internal review, the company discovered errors and made minor restatements in Odyssey Re. "And that," he said, "is all the restatements there are going to be."

But more subpoenas followed, making rating agencies jittery. That March, Moody's switched its outlook on Fairfax debt to Negative, from Stable. By spring 2006, three separate groups of debtholders decided to sue. Plaintiffs Glenn Fisher and Carol Trivette, among others, charged that Fairfax's management had sold them debt at artificially inflated prices, after making "false and misleading statements regarding the company's financial performance by improperly accounting for transactions relating to finite contracts and treaties at Odyssey Re." Two of the suits have since been voluntarily withdrawn. The third, according to lead counsel for the plaintiff's side, Geoffrey Jarvis, is pending a motion for dismissal.

According to the complaint drawn up by Kasowitz and Bowe, it was over 2005–06 that the "Enterprise" kicked its alleged dirty tricks campaign against Fairfax into high gear.

Spyro Contogouris and Max Bernstein were in New York over the period in question; ostensibly, they worked as independent consultants for a firm called MI4 Reconnaissance. The Fairfax complaint alleges the hedge funds hired Contogouris and Bernstein as "operatives" to carry out harassment tactics designed to intimidate company executives into revealing what Contogouris and Bernstein hoped were Enron-style off-balance-sheet accounting fraud at the firm. (Fairfax's Rivett strongly denies the company uses off-balance-sheet mechanisms to facilitate accounting fraud of any kind.)

The lengths to which Contogouris and Bernstein went in their efforts to extract information from Fairfax executives, at least according to the Fairfax lawsuit, are colourful in the extreme. For example, the complaint charges that on Nov. 9, 2005, Watsa's pastor at St. Paul's Anglican Church in Toronto allegedly received a mysterious package from a "P. Fate." The package contained an account of an insurance fraud perpetrated by convicted scam artist Marty Frankel throughout the 1990s. (Frankel had founded an insurance company, then moved money around through a maze of subsidiaries in order to siphon cash into his private accounts and abscond with the money.) Accompanying the package was a note warning the pastor not to let Watsa manage the church's financial affairs. It hinted at parallels between Frankel's behaviour and Watsa's, and urged the pastor to demand "a full and fair confession" from Watsa. The complaint claims the package was actually sent by Max Bernstein. As evidence, co-counsel Bowe points to an identical e-mail sent to Watsa. Bowe claims a trace performed by MFX, an IT tracing company hired by Fairfax, found that the e-mail was actually sent from an account assigned to Bernstein.

The complaint further alleges that over the fall of 2005 and spring of 2006, Contogouris and Bernstein contacted the company's then-CFO, Trevor Ambridge, claiming their contacts in regulatory agencies and the FBI were investigating Fairfax. By e-mail and in person, they allegedly encouraged Ambridge to reveal accounting misdeeds in exchange for leniency at the hands of regulators. The complaint states that under legal advice, Ambridge played along. The e-mails he allegedly received from Contogouris and Bernstein are now being used as evidence of the harassment campaign.

As further evidence of Contogouris's link to the "Enterprise," Fairfax co-counsel Bowe points to a sworn deposition Contogouris made in December 2005. In it, Contogouris states he was employed by Exis Capital and Third Point — funds that are both named as defendants. (Contogouris's lawyer Joe Tacopina earlier stated that his client denies all allegations. After Contogouris was indicted for wire fraud in an unrelated case on March 14, Tacopina did not return calls for further comment. Bernstein was not reachable for comment.) FBI spokespersons will not confirm whether Contogouris ever worked with the agency, as is standard procedure. But interestingly, the Fairfax complaint claims it has records of a call Contogouris made to the company to tell management it would be receiving an SEC subpoena the day before the company actually received one, in September 2005.

For his part, Ambridge left the CFO post at Fairfax in May 2006. He now works at an affiliate in London. In an e-mail statement forwarded through Rivett, Ambridge says he left in order to help the affiliate, Advent, "transition to a U.K.-listed company."

Rivett, a Canadian lawyer who worked in securities litigation before joining Fairfax, says it was his idea to engage Kasowitz. "What was happening to us was unheard of," he says, sitting in his office at Fairfax holding company HQ at York and Wellington in Toronto. "People coming into our offices all around the world to investigate and to take photographs, people showing up at our homes. The culture here is to keep our heads down and hope it goes away, but I was the new guy, and I thought what was happening to us was crazy. So I asked everyone to keep track of these attacks."

Then, in March 2006, Biovail, another Canadian company that claims its stock has suffered mercilessly at the hands of short sellers on the NYSE, launched a suit against S.A.C. Capital Management and a group of hedge funds, alleging a short-selling scheme had attempted to defame the company for profit. "I read Biovail's complaint, and thought, ‘That's us. Here's someone that's put all the pieces together.' So I got in touch with their [Biovail's] lawyer in April." Rivett laid out evidence of the attacks, and Gwynn's and Lawless's reports, and asked Kasowitz and Bowe to investigate.

As Rivett, Bowe and Kasowitz were building a case against the hedge funds, rumours were building around Fairfax. That summer, the short position surged to 4.5 million amid, says Rivett, increased "noise" that "Prem was going to leave the country with stolen funds, or that we were being investigated by the RCMP." The share price wobbled, hovering around US$110, then dropped to US$90 on June 23. Rivett says the increased rumours and trading volume show the funds were getting desperate to drive down the share price, having incurred considerable losses in fees paid on long-held short positions. (According to Exis Capital counsel David Zensky, who would not comment beyond pointing to quotes he gave in a recent article in Fortune, his clients have in fact booked substantial losses from their short position in Fairfax.)

Things came to a head, Rivett says, when Goldman Sachs called the company in late June, asking whether the company was on the brink of insolvency. "Then, on July 8, I got a call from Bowe saying they had determined who was behind the activities, and had information that a major attack was about to be launched against the company," he recalls. Bowe urged Rivett to consider filing a suit. A board meeting was called, and the company asked Bowe to draw up the complaint.

Fairfax launched its lawsuit on July 26, 2006. One day later, the company issued a press release that, in any other circumstances, would have grabbed all the headlines.

In it, Fairfax announced that accounting irregularities stemming from, among other things, currency accounting after the NYSE listing meant that it was now restating financial results dating back to January 2001. (Just 16 months prior, in April 2005, Fairfax had issued a statement announcing its internal accounting controls had been investigated and were given a clean bill of health.) Management underplayed the hit to shareholders. In a press release, CFO Greg Taylor estimated the restatements represented a loss of US$175 million to US$190 million. But in November, the company announced a second restatement, and in its year-end report Fairfax put the cost of the first restatement at US$235.3 million — US$60 million higher than management's initial prognosis.

"I know it looks odd," says Rivett of the decision to launch the suit the day before announcing the first restatement. "But there is no timing connection."

Still, the combination of dramatic litigation and dramatic accounting screw-ups suggests Fairfax will remain in the public eye for some time to come. At least one U.S. attorney, securities arbitration and litigation specialist Brian Carlis, of Stark & Stark in New Jersey, isn't sure Kasowitz will even be able to make stick the simple charge that short selling caused egregious damage to the stock. "It went down temporarily, but then the stock bounced to $175," Carlis says, "so it seemed to me that if there was an effort to depress the stock, it wasn't very successful. The short sellers who didn't close were left holding the bag." In other words, it's tough to cry victim if you aren't one.

What's more, says Carlis, Kasowitz and Bowe "need to be able to prove intent for some of the charges. You need tape-recorded conversations, e-mail conversations that show the mindset of the people committing the acts they are accused of. And there has to be evidence of collusion, that these people intended to commit these acts as a group, prior to the acts being committed. That is very difficult to prove. You can't just show phone records to indicate a call has been made; you need to show the substance of the call. And if a number of people who happen to sell short also happen to know one another, that doesn't prove conspiracy, either."

Rivett answers Carlis's assessment by saying Fairfax has lost significant market value due to illegal market manipulation tactics. In mid-March, just as two of the debtholders' suits had been wound up, two other proposed class-action lawsuits emerged in Kasowitz's wake. Both demand damages from a group of hedge funds headed by S.A.C. Capital Management on behalf of Fairfax shareholders; both allege short selling artificially depressed the stock. A slew of other, similar lawsuits prompted SEC chairman Cox to comment in a Forbes article last July that he would work to close loopholes that allow "abusive trading" such as naked shorting.

As of press time, the hedge funds are preparing their defence, while waiting to hear if Kasowitz's motion to remand to state court has been successful. The sole defence attorney who spoke to Canadian Business explained he was planning to request a stay in discovery, and then have the case dismissed on the grounds that short selling is not illegal. Court filings show the defence will be citing Fairfax's 2005 year-end financials, in which the company posted enormous losses and acknowledged lax internal accounting controls. There's also an SEC commission report and expert testimony on how short selling is an effective means of keeping management honest and accountable to shareholders.

If the case gets to discovery (the period in which lawyers can subpoena witnesses and request documents from the other side), the defence will doubtless request more detailed information about Fairfax's accounting and financing structures than has ever before come to light. The plaintiffs will request equally probing information, lending unprecedented insight into how hedge funds make their millions. It will be an interesting ride, if the case ever gets that far.

Back in Kasowitz's office, co-counsel Bowe — a youthful-looking man who, with black braces holding up crisply tailored trousers, positively exudes an air of Manhattan self-assurance — is heading for the door after sitting in on an interview. He's not concerned about the defence's argument, claiming the evidence will show what the plaintiff is alleging is not short selling, but rather manipulative short selling involving false research reports. The plan, he says, is to get the case returned to state court, where it was launched. (Why state court? Bowe says if they win in federal court the other side might appeal based on the fact that federal court doesn't have the jurisdiction to hear some of the evidence.) Unlike the defence, "We want to get the case to discovery as soon as possible," he says. In discovery, Fairfax's team intends to demand e-mails and other information from the hedge funds. These e-mails, Bowe says, will prove the prior existence of the "Enterprise" conspiracy, and of its intent to defame Fairfax and short the stock for profit.

Bowe turns, and walks back along the hall. Then he pauses. One of the braces holding up his trousers has come undone at the back.

[ RGM Short Selling Home page ]