Is Daniel Loeb Really A Liar?

Daniel Loeb’s Third Point, Steve Cohen’s SAC Capital Advisors LP, Jim Chanos’ Kynikos Associates Ltd. and Exis Capital Management Inc was shorting Fairfax Financial Holdings, believing that it has significant accounting irregularities and that it might be a fraud.

Daniel Loeb wrote in a letter to his clients that Fairfax is one of the most thoroughly researched investments in Third Point’s history.

Fairfax sued short sellers in 2006, seeking more than $8 Billion in damages. According to Bloomberg News, Fairfax’s lawyers later asked for the “research documents” during the discovery phase but Third Point didn’t produce any research documents. Dan Loeb also had to admit in his deposition that he didn’t know what finite reinsurance was, despite the fact that he cited this as one of the bases for believing Fairfax was a fraud.

Does this make Dan Loeb a liar?

First, Fairfax had to restate its financial results one day after they filed suit against Loeb, Cohen, and Chanos. This is what Third Point said: “Third Point’s research regarding Fairfax was borne out when the company was forced to restate its financial statements, erasing over $235 million of shareholder equity just one day after this lawsuit was launched in 2006.”

Second, Dan Loeb doesn’t need to know what finite reinsurance is on order to short sell an insurance company. His analysts or partners can do the research. If they didn’t do the research themselves, it’s still OK. Maybe one of the other short sellers did the research and they relied on that. Jim Chanos has a reputation to short sell companies that have accounting irregularities. If we get a tip from Chanos that there’s something fishy going on at Company A, we may short sell that company too. There aren’t a lot of hedge fund managers who are as credible as Jim Chanos is.

If Chanos didn’t do the research himself and had been using outside consultants, that is still fine. What’s important is whether the claims were accurate or not. Fairfax had to restate its numbers and this gives a lot of credibility to the short sellers.

Short selling isn’t easy and short sellers do a necessary service for the financial markets by assuming enormous risks. When they are wrong, they get killed in the market. Whitney Tilson lost a bundle on his Netflix short for instance. When they are right, all they can get is 100% return. Short sellers aren’t the villians in the financial markets; they’re the underdogs.