Occasionally a business story, particularly when salacious, presents an opportunity for deeper reflection upon our commercial culture beyond the scope of simple facts and narrative.
In early September Dan Kamensky, founder of hedge fund Marble Ridge Capital, was arrested and charged with fraud for allegedly abusing his fiduciary duty as a member of Neiman Marcus’s Official Committee of Unsecured Creditors in that company’s Chapter 11 proceeding. The government alleges Kamensky used his position as a member of the committee and as a client of investment banking firm Jefferies to keep the bank from offering a competing bid for shares of MyTheresa, a Neiman Marcus subsidiary that Marble Ridge wanted to acquire for itself at a lower price. Jefferies disclosed such actions to the Committee once they came to believe he had broken the law.
On one level, this is a simple tale of financial malfeasance, a drop in an ocean of similar sorry tales, or perhaps a compelling personal interest story of how a momentary lapse of judgment in the heat of commercial battle imploded an otherwise successful investing career. And I have no unique angle nor perspective from which to offer new insight on this alleged wrongdoing. Look beyond the headlines, however, and a more complex lesson emerges.
Mr. Kamensky was part of an ecosystem of distressed investing, bankruptcy, and financial restructuring, of which I too am a part (full disclosure: while I have crossed paths with Mr. Kamensky, I do not know him well). The market for distressed debt (loans and bonds) sits at the confluence of two disparate disciplines: law (primarily insolvency law) and alternative investing. Arguably, no other part of the finance and investing world is as informed by the law and requires mastery of legal concepts as is/does the world of financing restructuring, which involves the interpretation and exploitation of credit agreements, note indentures, and other financing documentation, commercial agreements and contracts, asset purchase agreements, and the like. As such, capable insolvency practitioners of all types (not just lawyers) must maintain a fluency in securities, corporate, contract, and, most importantly, bankruptcy law.
Alternative asset investing, by contrast, is a craft, not a profession like the law. One needn’t pursue a particular graduate degree or pass a qualifying exam to become an investor; many successful investors come from banking, corporate, academic, and legal backgrounds prior to embarking upon an investing career, while others “grow up” in the industry. What successful investors share in common, as with the guilds of yore, are skills developed through repetition and observation and by learning on the job. The “dark arts” of investing in alternative asset classes are difficult to codify and convey in a coherent, easily digestible manner.
Alternative investing, in contrast with a legal system grounded in Judeo-Christian principles, better resembles pre-Christian Greek and Roman mythology and its deities.
The deductive nature of the law, when combined with the preternatural character of alternative investing, forms a conflicting amalgam joined in service of a specific objective — creating “alpha,” or outsized, risk-adjusted returns. Legal conclusions are rooted in process and the derivation of logical conclusions through linear reasoning; the world of alternative investing is an axiomatic one, with success measured by outcomes and not the process by which they are achieved. How is this a durable union?
To seek an answer, let’s begin with a theology-tinged history lesson. An unappreciated feature of Western commercial law is that its language is anchored in Judeo-Christian principles. Financial agreements use terms familiar to the devout, including “obligations,” “covenants,” “claims,” “redemption,” “full faith and credit,” and the like. These concepts illustrate how moral precepts came to be embedded within legal codes, an act which presupposes that such codes are implemented by and used to administer the behavior of, and disputes between, moral actors. This parallels our founding fathers’ belief in the necessity of such preconditions as virtue and morality to sustaining freedom and self-governance. James Madison put it best: “To suppose that any form of government will secure liberty or happiness without any virtue in the people, is a chimerical idea.” A workable legal regime requires that the guardrails provided are accepted by and consistent with the habits and norms of those governed by them. While morality as expressed through organized religion now sits a good distance away from everyday commercial activity, these “moral” precursors remain ossified within our law.
The craft of alternative investing — anchored in business and financial analysis, but in fact multi-dimensional as previously noted — is antithetical to the rote application or observance of legal concepts. To be successful as an investor requires a savant’s synthesis of quantitative analysis rooted in expected value calculations, derived from possible outcomes informed by an understanding of constituent objectives, institutional limitations, externalities, and human nature. Understanding the limits created by the law is essential, but as constraints defining the art of the possible in light of other factors and not necessarily in their own right.
In this respect, alternative investing, in contrast with a legal system grounded in Judeo-Christian principles, better resembles pre-Christian Greek and Roman mythology and its deities, which provided moral instruction through fables, epics, and myths (Icarus often comes to mind in my own work). Upon closer scrutiny, the Christian New Testament can itself be seen as a synthesis of Greek thought and the Hebrew Scriptures (or Old Testament); the “New Covenant” of the New Testament offered a transformed relationship between God and the human race, offering redemption, while not cashiering the “law” of the Hebrew Scriptures. This synthesis of disparate traditions, the tension between them notwithstanding, “works” in the moral and spiritual sphere for believers — a conflict successfully bridged. The Ten Commandments may no longer be the final word in such a regime, but they still have purchase.
But what does any of this have to do with distressed debt investing?
The synthesis of Old Testament “law” and the less doctrinal, personal experience of redemption exemplified by the New Covenant finds a direct analogue in the “law and craft” world of financial restructuring. While the spread of Christianity and Judeo-Christian principals models a comparable synthesis, it is a less stable admixture within the commercial context, where the chessboard of financial markets for capital and corporate control may no longer be comprised of largely moral actors. Perhaps losing money on a trade — or the infinitesimal risk of experiencing something akin to Mr. Kamensky’s fall from grace — doesn’t provide as compelling a deterrent to aberrant behavior as eternal damnation.
Indeed, the apex of American commerce and finance as a respected quasi-profession was arguably in the last century when it was populated by uomo universale, or Renaissance men (unfortunately, it was a time when they were mostly men). Men who understood the larger world, beyond that of Wall Street, a corporate boardroom, or a counting house, made business decisions accordingly, and typically acted with a self-restraint drawn from civic, religious, and other affiliations animated at least in part by altruism, respect for tradition, and moral codes of various stripes.
As the strictures of morality, culture, and behavioral norms have fallen away from the workaday practice of modern commerce, we are left with a skeletal framework of morally derived commercial law absent the participation of moral agents, akin to a table game at a casino played by card-counters — a system to be gamed, rather than honored or feared. While we nominally remain a commercial republic of laws, how meaningful can they be when the players’ objective is to beat the house by any means necessary? It is perhaps unsurprising that opponents of free enterprise have hurled the term “casino capitalism” at modern commerce and vilify it despite widespread prosperity when its adherents themselves frequently view capitalism as a piñata, rather than worthy of respect, and capable of limitless improvement through its own dynamism to become more efficient and just.
The legal ecosystem underpinning our market republic ensued from a long-departed moral framework that once permeated Western culture more generally. If we seek to maintain a society that celebrates enterprise, and a system of laws and values that promotes it, a return to and respect for the spirit — not just the letter — of the law will be necessary.
Man, by his nature, will act badly at times. A system capable of limiting the collateral damage of such actions requires moral agents who more fully appreciate the greater good in such limitations on their commercial Id. The “redemption” so achieved need not be solely the province of bond investors seeking their money back from profligate borrowers.
Richard J. Shinder is the founder and managing partner of Theatine Partners, a financial consultancy.