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Oppenheimer Revolt Shows Mutual Funds’ New Mood
April, 11 2007

The Wall Street Journal, 04.11.07
Tom Lauricella

Borrowing a tactic from hedge funds and other aggressive investors, mutual funds are showing new willingness to publicly battle with companies they own.

The most recent example: OppenheimerFunds Inc., which helped toss out management at Take-Two Interactive Software Inc., the struggling maker of the popular videogame series Grand Theft Auto. Holding a big stake in a company dogged by regulatory problems and falling profits, Oppenheimer teamed up two weeks ago with several hedge funds to stage a coup and install new top executives.

Actions such as that represent a big change for mutual funds, which traditionally would simply sell shares if disputes with management arose. In Oppenheimer's case, it is the first time in the company's 46-year history to take such a step.

"We're not usually activists," says Oppenheimer portfolio manager Emmanuel Ferreira. But under the circumstances, "we thought it was in the best interest of shareholders" to bring in new management.

Oppenheimer isn't alone in getting aggressive. In the past month, T. Rowe Price Group Inc., another traditionally low-key fund company, came out against a leveraged-buyout attempt at Laureate Education and publicly opposed a planned merger of two energy companies. Money manager Pzena Investment Management LLC has been publicly battling a takeover of auto-parts supplier Lear Corp. by billionaire investor Carl Icahn.

Portfolio managers and fund-industry executives say they still prefer to work behind the scenes to influence events at companies, or to simply sell their shares if problems can't be resolved. However, a few things have changed: Fund companies must now disclose how they vote in corporate elections, leaving them open to criticism if they appear to be simply rubber-stamping executives' decisions.

At the same time, traditional mutual funds are facing increased competition for investor dollars -- and thus are willing to borrow from rivals' playbooks.

"They've taken note of the outsized returns of activist hedge funds," says Christopher Young, director of mergers-and-acquisitions research at proxy-advisory company Institutional Shareholder Services.

At Take-Two, Oppenheimer's role shows how a fund company can end up playing the role of activist investor even when it would rather not. Just six months ago, Oppenheimer was praising Take-Two's management, even as its executives were being investigated for backdating stock options, in which the date of a stock-options grant is improperly recorded in order to give the recipient an added potential benefit.

Last summer, the stock fell more than 50%, hammered by legal and financial woes. Oppenheimer, meanwhile, was the largest shareholder, with nearly 25% of Take-Two's shares outstanding. It was a top holding in funds run by 39-year-old Mr. Ferreira and 36-year-old Christopher Leavy.

Thanks largely to the success of Grand Theft Auto, a violent videogame series set against an urban backdrop, Take-Two's stock posted big gains between late 2001 and 2004. Problems started in 2005 when the company was hit by returns from retailers after a version of the game was found to contain sexually explicit scenes that could be accessed with the help of outside software.

Oppenheimer built much of its substantial stake in Take-Two during 2005 as the stock bounced back and forth in the mid-$20 range. By September it was Take-Two's largest stakeholder with 14.5 million shares. At year-end, Take-Two was the largest position in Oppenheimer's Quest Opportunity Value Fund, at nearly 5% of the portfolio, and amounted to 3% of Quest Value Fund.

In 2006, Take-Two's stock began to fall as earnings growth faltered. By April of last year, Mr. Leavy cited Take-Two's woes as a prime reason for lackluster performance in his Select Value Fund.

Things were about to get worse. In late June, the company said it was being investigated by the Manhattan district attorney over the sexually explicit images in Grand Theft Auto. And in early July, it announced it was being probed by the Securities and Exchange Commission for options backdating.

On July 11, Take-Two stock traded as low as $9.06 before rebounding slightly later in the summer to the mid-teens.

Despite the setbacks, Oppenheimer bought more shares. "Take-Two possesses a solid, creative management team," Mr. Ferreira said in a shareholder report Sept. 30, 2006. In another report at the end of October, Mr. Leavy wrote: "Take-Two's earnings power is substantial."

The stock did bounce back to nearly $20. But another development was brewing. Late in the year ZelnickMedia, led by Strauss Zelnick, a former president of BMG Entertainment and 20th Century Fox, began talking to key shareholders about ousting Take-Two's management and hiring his company to take their place.

He presented an unusual strategy: Because of a loophole in Take-Two's corporate bylaws, they could avoid the normally costly and time-consuming process of waging a formal corporate election known as a proxy fight. Take-Two's bylaws would let them simply show up at the next annual meeting, nominate their own slate of directors, and try to get more votes than the incumbents.

If successful, their board would then name Mr. Zelnick chairman and hire one of his top lieutenants as chief executive. (Mr. Zelnick's company didn't own any shares of Take-Two.)

Through early 2007, Mr. Zelnick, Oppenheimer and several large hedge-fund shareholders held meetings to discuss the strategy. With Oppenheimer holding about 25% of Take-Two shares, they would be crucial to the effort.

The Oppenheimer managers looked closely at Mr. Zelnick's background, which included successful corporate-turnaround efforts, and decided to sign on. Mr. Leavy, in explaining the switch from praising Take-Two's management to pushing for its ouster, says: "Exercising investment discretion on behalf of our clients is a fluid process."

At the end of February, Take-Two unveiled more bad earnings news and to Wall Street it looked like 2007 would be another challenging year. The stock slumped again.

A week later, Oppenheimer and the rest of Mr. Zelnick's coalition surprised Wall Street when it filed with the SEC an agreement saying they would act together to oust current management by installing six new board members. Together the group owned almost half of Take-Two's shares outstanding.

Even though the shareholders' meeting was rapidly approaching, the coup wasn't a certainty. For one thing, in terms of voting power, Oppenheimer's 24.5% stake was actually smaller than it appeared. The reason: The firm had lent some 10.3 million of its shares -- a standard money-making practice at some mutual-fund companies. By lending the shares, it no longer controlled their voting rights.

On March 29, the day of the shareholders' meeting, Mr. Ferreira for the first time in his life stood at a corporate shareholder meeting and nominated a dissident slate of directors. When he sat down, Mr. Leavy patted him on the shoulder.

After counting the votes, the results were announced: With 32 million shares cast in its favor, Mr. Zelnick's slate was elected.