BNA Securities Regulation Law Report Teaser

Republican senators have even more questions for Pequot. What's the right metaphor - Jarndyce and Jarndyce? Susan Lucci? The Hundred Years War? 40 SRLR 2109

Nice report on the SEC's most recent open meeting including why defining "annuity contract" is controversial. 40 SRLR 2102

Detailed report about the appointments of Schapiro and Gensler. 40 SRLR 2101

NYSE Circuit Breakers Extended

The New York Stock Exchange has extended until March 27th the expiration of NYSE Rule 48. Rule 48 was adopted in December of 2007 (NYSE Info Memo No. 07-110) to allow the NYSE to delay opening if there is "extremely high market volatility that would have a Floor-wide impact on the ability of specialists to arrange for the timely opening."

In October of 2008, Rule 48 was amended (NYSE Info Memo No. 08-48) to provide a suspension of "market-at-close" orders. MOC orders are placed during the trading day but executed at the close at the closing price. Information Memo 08-48 also added an section 48.10 which provides that Rule 48 will expire at the end of 2008.

The NYSE says it is extending the expiration of Rule 48 so it can move the MOC part to Rule 123C.

Detailed Look at Madoff Civil Suits

As I mentioned yesterday, I found five complaints against Madoff and his feeder funds on Westlaw. This morning I spent sometime looking them over. The stories are the same - money invested with a hedge fund changes hands until it comes to rest with Madoff - Madoff steals it. A number of things surprised me: many of the complaints try to use 10(b) to reach the feeder funds. In light of Stoneridge (see this post on Race to the Bottom) this seems a chancy strategy. I was also surprised by how little actual investment management goes on in the hedge fund biz.

For a link to a continuously-updated list of suits, see this post.

Here's a quick summary:

12/18/08, 2008 WL 5267855, SDNY, 1:08cv11002

plntf: The Calibre Fund LLP
def: J. Ezra Merkin
atty: Susman Godfrey LLP
Calibre Fund gave Merkin's Ascot Partners Fund $10 million which Merkin gave to Madoff. Calibre is trying to prevent Ascot from distributing any money.
claims:
- fraud
- negligence
- breach of fiduciary duty
- breach of contract

12/16/08, 2008 WL 5243584, SDNY, 1:08cv10922

plntf: New York Law School
defs: Ascot Partners LLP, Merkin, Bdo Seidman LLP
atty: Abbey Spanier Rodd & Abrams LLP
This is a class action complaint. NYLS gave $3 million to Ascot which it gave to Madoff.
claims:
- 10(b)
- 20(a)
- fraud
- negligent misrepresentation
- breach of fiduciary duty

12/16/08, 2008 WL 5243585, SDNY, 1:08cv10930

plntf: Scott Barrie
defs: Gabriel Capital LP, Merkin, Bdo Seidman LLP
atty: Abbey Spanier Rodd & Abrams LLP
This is a class action complaint. It was produced by the same law firm as the NYLS complaint.
- 10(b)
- 20(a)
- fraud
- negligent misrepresentation
- breach of fiduciary duty

12/15/08, 2008 WL 5267808, CD Cal, 2:08cv08260

plntf: Michael Chaleff
defs: Bernard Madoff, Bernard Madoff Investment Securities, Stanley Chais, Brighton Company
atty: Hagens Berman Sobol Shapiro LLP
This is a class action complaint. Michael Chaleff invested with an LA hedge fund called CMG, ltd. CMG gave his money to Stanley Chais who gave it to Madoff. Apparently, Chais funneled $250 million to Madoff. Chaleff obviously believes theres some money to be got from Madoff himself.
claims:
- 10(b)
- 20(a)

12/12/08, 2008 WL 5231154, EDNY, 2:08cv05026

plntf: Irwin Kellner
defs: Bernard Madoff, Bernard Madoff Investment Securities, John Does 1-100
atty: Ruskin Moscou Faltischek PC
This is a class action complaint. Kellner invested $3 million directly with Madoff. Kellner's lawyers used every arrow in their quiver.
claims:
- RICO
- 10(b)
- 12
- fraud
- negligent misrepresentation
- breach of fiduciary duty
- conversion
- unjust enrichment
- deceptive practices under NY Genl Bus Law
- fraudulent transfer under NY Debtor & Creditor Law

Lawsuits: Madoff

Last week my alma mater, New York Law School, sued (complaint here) J. Ezra Merkin the Chairman of the Board of GMAC LLC (you know, the bank). Merkin's day job is managing hedge funds, but it appears he had lots of free time because all he did was hand money to Bernie Madoff. New York Law School was a limited partner in a Merkin fund called Ascot Partners LP. Some of Merkin's other academic clients include Tufts, NYU and Yeshiva University.

Complaints against Madoff, his feeder funds and any auditors within reach are proliferating. Many of them have made their way into the FED-FILING-ALL database on Westlaw. A search for BERNARD /3 MADOFF turned up six:

New York Law School v J Ezra Merkin, Ascot Capital & BDO Seidman (2008 WL 5243584)
The Calibre Fund v J Ezra Merkin & Ascot Capital (2008 WL 5267855)
Scott Barrie v Gabriel Capital, J Ezra Merkin & BDO Seidman (2008 WL 5267808)
Michael Chaleff v. Stanley Chais & The Brighton Company (2008 WL 5267808)
Irwin Keller v Madoff & Does 1-100 (2008 WL 5231154)
SEC v. Madoff (2008 WL 5197070)

A docket search turned up:

USA v Madoff (SDNY 1:08MJ02735)
NYU v Gabriel Capital (NY Supreme Ct., 603803/2008)

A Review of Reviews

A last fond look back at 2008, from some of my favorite securities-law blogs:

From NYT DealBook:
The Deal Professor's Year-in-review.
2008 in deals.

From Reuters DealZone:
New Year's Resolutions for private equity.

From Race to the Bottom (I love this):
The Five Worst Shareholder Decisions of 2008
Introduction
5. CA, Inc. v AFSMCE, 953 A2d 227
4. McPadden v. Sidhu, 2008 WL 4017052
3. In re Trankaryotic Therapies, Inc., 954 A2d 346
2. Portnoy v Cryo-Cell Int'l, Inc., 940 A2d 43
1. Wood v Baum, 953 A2d 136

Just Don't Call it a Swap

The SEC is attempting to designate a central credit default swaps counterparty (for more on CDS counterparties see this post) for the small piece of the CDS market it can regulate (anything that isn't a swap, thank you very much Gramm-Leach-Bliley). Today it announced that it had exempted LCH.Clearnet Ltd and Liffe (the derivatives trading business of NYSE) from a whole bunch of requirements to allow them to immediately bring their CDS trading and clearing service (opened on 12/22 in Europe) here. Broker-dealers were granted an exemption to allow them to use the Liffe system.

Happy Boxing Day, GMAC

On the 26th, the Federal Reserve announced that GMAC's quest to become a bank holding company had ended succesfully. As I blogged last week, it has been a long road. Let's hope they show their appreciation by boxing up something for the poor.More from Reuters.

Blog Roundup: A State of Complete Panic!

SEC Uncertainty (everybody sing!)

NYT DealBook - Can the SEC regain its mojo? Mojo? That sure is some hep talk. I can't believe people think the Times is stuffy.

TPM Muckraker - SEC is "in a state of complete panic."

Other Stuff

DealBook: BCE sues over failed LBO

Compliance Week: Paying executives with mortgage backed securities.

Enron settlement funds to be distributed.

Commodity Online: Gary Gensler will be the new head of the CFTC. I guess thay means we're still going to have a CFTC?

GMAC Finance Soldiers On

It looks grim for GMAC Finance (GMAC): their quest to become a bank holding company is on the rocks again. I'm not counting them out, though - they don't give up easy.

GMAC (which is controlled by Cerberus Capital) owns a Utah-chartered bank called GMAC Bank. Ironically, the profitable GMAC Bank is a subsidiary of GMAC's mortgage-backed securities business, Residential Capital (ResCap). What GMAC would like to do is rid itself of ResCap, own GMAC Bank directly, and turn GMAC Bank into a regular deposit-taking institution. Before this can happen, GMAC needs to get approval from the Fed to be a bank holding company. The Fed won't grant GMAC's application unless GMAC improves its debt-to-equity ratio.

So, on November 20th, GMAC made offers to buy outstanding debt from large bondholders (see 8-K, 11/20/09). The debt tender period ended on December 19th with not enough takers. Plan B involved stronger incentives. GMAC attempted to coax recalcitrant bondholders who hedged their investment in GMAC by buying credit default swaps (see 8-K, 12/19/08). GMAC planned a debt-for-equity swap with ResCap that would, essentially, make all the CDS' valueless. Pacific Investment Management, a major bondholder, wasn't intimidated. They still said "no" to the debt swap.

Presumably there's a Plan C?

There's ...

... a new sheriff in town

Madoff and the Sophisticated Investor

Coverage of Bernard Madoff's scam in the New York Times has focused on how Madoff used his status in the Jewish community in Palm Beach as a lever to get money and avoid due diligence. Scams which abuse ties of trust in close-knit communities are called “affinity fraud.”

To paraphrase one prominent securities regulator, "You can trust me because I'm like you" is a siren song that has been used in recent years to defraud many investors.

Fairfax, "WITH FRIENDS LIKE THESE . . .": TOWARD A MORE EFFICACIOUS RESPONSE TO AFFINITY-BASED SECURITIES AND INVESTMENT FRAUD, 36 Ga. L. Rev. 63, 64 (2001)

Affinity fraud has been the subject of investor alerts from the SEC and the NASAA. Because this type of fraud often targets poor and minority investors there have been calls to recognize that affinity fraud causes special harm. One such proposal would increase penalties (Fairfax, 36 Ga. L. Rev. 63,(2001)) another would adopt an alternative materiality threshold to make such cases easier to maintain (Sachs, MATERIALITY AND SOCIAL CHANGE: THE CASE FOR REPLACING " THE REASONABLE INVESTOR" WITH "THE LEAST SOPHISTICATED INVESTOR" IN INEFFICIENT MARKETS 81 Tul. L. Rev. 473, 473 (2006)).

However, as the Wall Street Journal pointed out, abuse of trust cuts across lines of wealth, and class. Lisa M. Farifax, Professor of Law and Director of the Business Law Program at the University of Maryland, argues that "even generally savvy individuals will succumb to such fraud because it preys on one's ... instinct to trust members within their own affinity group." Professor Margaret V. Sachs, Robert Cotton Alston Chair in Corporate Law at the Georgia University Law School, agrees that Madoff's victims may have been "more vulnerable than they would have been under other cirucumstances." Many of Madoff’s “investors” were just as easily taken in as those with limited investment smarts.

Madoff's victims are likely to be classified as "sophisticated investors" - the least protected class of individual investors. To determine if an individual investor is sophisticated, a court will consider "wealth[,] … age, education, professional status, investment experience, and business background." (4 Bromberg & Lowenfels on Securities Fraud § 7:444 (2d ed.)) Sophisticated investors have a "duty to investigate the facts surrounding a securities transaction which [...]is greater than the corresponding duty of a novice." (Fletcher, SOPHISTICATED INVESTORS UNDER THE FEDERAL SECURITIES LAWS, 1988 Duke L.J. 1081, 1092)

Does it make sense to use wealth and age as the tests of investor sophistication? Should protections developed for the least privileged be extended to the most? Professor Sachs thinks so "concievably, in an action brought by the SEC or the DOJ, but not in a private action." Professor Fairfax concedes that "some may view such victims as less sympathetic because they appear to be more sophisticated or well off," but "they too may need protection because they are - at least in this context - especially vulnerable and thus less likely to be vigilant."

TARP Search Tool on Westlaw Business

A Troubled Asset Relief Program search criteria has recently been added to the M&A Transactions database on Westlaw Business. To find capsule descriptions of all one hundred and thirty (who knew!) transactions scroll down to the "deal description" pull-down menu and click on "EESA 2008 Transaction." Each deal summary includes dates, value and links to the relevant filings.

Pequot Infinitum

See this Compliance Week post by Bruce Carton to enjoy the mobius-strip chronology of the investigation of Pequot Capital.

Blog Roundup: Looking on the Bright Side

This post on Naked Capitalism discusses an under-reported *upside* of mark-to-market accounting. In the third quarter, banks reclassified $610 billion in assets as "level 3" under FAS 157. The reclassification gives them much more flexibility in determining what the assets are worth.

The Center for Audit Quality (via Compliance Week) has good news for issuers who have lost accelerated filer status because their stock price is in the toilet: you don't have to file that SOX 404 auditor certification!

To be an accelerated filer, an issuer must have at least $70 million in market capitalization (market capitalization is number of shares outstanding multiplied by share price). For example, Astronics Corporation (Nasdaq:ATRO) fell below the accelerated filer cut-off in late November when its share price got below $8.22. At its current price ($8.10 x 8.51 million shares out) its market cap it $68.94 million. Earlier this year, it had a market cap of $455 million! Flotek Industries (NYSE:FTK) has had an even harder come down. In January it was a "large accelerated filer" with a market cap of $842 million. Now, after a 90% decline in share price, it has a market cap of $71.07 million.

SOX 404 has been the subject of much issuer consternation and the SEC repeatedly delayed its application to non-accelerated issuers.

Securities Docket has a post about the SEC's announcement that it is planning to distribute the fair fund from the Bear Stearns market-timing case. There's also a link to the text of the distribution plan.

Race to the Bottom has a nice summary of the corporate governance provisions of the Auto Industry Financing and Restructuring Act (HR 7231) as well as a status update.

TARP COP Reports

Today, the Congressional Oversight Panel for Economic Stabilzation released its first report. The report is structured as a series of questions directed to Treasury. The questions are rather withering and it ain't hard to tell what the Panel thinks. For instance: "We ask Treasury to articulate ... its overall strategy ... and how its strategic shifts since September 2008 fit into that overall strategy." They'd also like to know if the Treasury has secured terms "comparable to those received in recent private transactions, such as those with Warren Buffet (and Goldman Sachs) and the Abu Dhabi Investment Authority (and Citigroup)?"

Corporation Finance Posts Financial Reporting Manual

SEC transparency took another giant leap forward yesterday when the Division of Corporation Finance posted their internal accountant's handbook on the web. The Financial Reporting Manual has been around since 1990, but it wasn't available to the public (though most law firm libraries seem to have a much-photocopied bootleg). Back in November, John White promised this was going to happen: "(SEC Chief Accountant) Wayne (Carnall) is in the process of updating our training manual for the Division’s accountants and, in light of the level of outside interest in getting copies of this document, we plan to publish the manual on our website in the near future."

The Manual hasn't been updated since 2000, but Compliance Week reports that Wayne Carnall called the changes "very limited." Going forward, the Manual will be updated every quarter.

Instead of Working

Take at look at the "Signs of the Apocalypse" category on the Daily Deal's Dealscape blog.

Briefly Noted: FAS 157, JP Morgan, Deal Points Study

SEC Chairman Cox thinks mark-to-market (FAS 157) is a good system, says the New York Times.

Reuters reports that the JP Morgan / Bear Stearns merger has survived a court challenge.

The Harvard Corporate Governance blog provides the full text of the ABA report on merger agreement terms, aka the "Deal Points" study. As well as the full text of the court's opinion in JP Morgan / Bear Stearns matter.

Better Disclosure for Municipal Issues

EDGAR, meet EMMA. Today, the SEC announced that it had adopted new rules designating the electronic filing system at the Municipal Securities Rulemaking Board, called EMMA, the central repository for disclosure about municipal finance transactions. Municipal securities are those issued or guaranteed by a government entity. They are exempt from '33 Act registration under section 3(a)(2).

The offering document in a muni finance deal is called an "official statement" and as any librarian who tried to obtain an official statement can tell you, the existing disclosure system is pretty spotty. Presently, there are four designated municipal finance document repositories. None have everything and not all are internet-accessible.

The rule change is, presumably, motivated by the collapse of the market for auction-rate securities. What, I hear you ask (or was that the wind?), is an auction rate security, and what do they have to do with muni finance?

Auction-rated securities were invented in the late 1980's (Tucson Electric Co., 3/88). They were marketed as an alternative to holding cash because, although they didn't mature for many years, they could, theoretically, be re-sold every few days through a private auction process. Municipalities adopted auction-rate debt as a favorite financing device. In February of 2008 the auction process ground to a halt and the securities became unsaleable. For more on the ARS debacle, read Erik Sirri's testimony here and Martha Coakley's here. If that isn't enough, how about an article from the New York Times?

Allow me to provide a concrete example: in January of 2002, the Dormitory Authority of the State of New York issued $450 million auction-rate bonds on behalf of the Sloan Kettering Memorial Cancer Center. The proceeds were used to redeem older bonds. The bonds come due in 2036, but there is supposed to be a repricing auction every seven days. The last auction before the market collapsed was in April of 2008. All the bonds were for sale and there was one bidder. This bidder offered to buy about $18 million in bonds at 2.1% interest.

I got all this info from one of the designated repositories, DAC Bond.

"Was That Michael Padfield?"

Today brought yet another legal entanglement for the lawyer also know as Marc Dreier, sole partner of the Olsen-twin-representing firm Dreier LLP. Dreier just made bail in Toronto. He's alleged to have impersonated Michael Padfield, Senior Investment Counsel for the Ontario Teachers Pension Plan, for the purpose of snookering Fortress Investment Group out of $50 million. Dreier will return to New York to face an unrelated SEC complaint alleging he's been selling phony securities.

Dreier continues the tradition, pioneered by Thomas Haythe, of Manhattan lawyers embarrassing themselves in Canada.

Primary Reserve Fund's Plan of Liquidation

Primary Reserve Fund, the giant money market fund that broke the buck earlier this year, has posted a plan of liquidation on its website. Securities Docket notes that part of the plan is to offer holders ninety-eight-and-half cents for each dollar they invested. Holders who accept the offer agree not to sue.

Shareholders Do it By Proxy

2009 is approaching and we're all getting ready for the merriest time of year: proxy season. There have been a number of developments of note and most center around rule 14a-8. 14a-8 is a mechanism allowing shareholders to get their proposals on the ballot at a company's annual meeting. Since proposals from shareholders generally make management do stuff they don't want to, management tends to fights back by asking the SEC's permission (via no-action letter) to exclude such proposals.

On November 7th, the SEC issued Staff Legal Bulletin 14D providing guidelines under 14a-8 for proposals directing the Board to amend the issuer's charter.

A group of law professors, led by Lucien Bebchuk, is suing Electronic Arts over its exclusion of a proposed resolution creating internal corporate guidelines for 14a-8 proposals. Link here to a post on Harvard Corporate Governance blog for more info and links to the briefs.

Shareholders of Alaska Air Group have proposed that the company amend its charter to limit the company's potential damages in a private lawsuit based on rule 10b-5. This has never been tried, but at least one law professor theorized that it is possible. The courts will decide, I suppose. Click to link to the proposal (via Securities Docket).

SEC Currents has a slightly weirder roundup of shareholder proposals including: Monsanto's proposed loyalty oath and Apple's attempt to avoid an environmental sustainability report.

Finally, the New York Law Journal recently published Charles Nathan's seasonal predictions.

Bank of Amerrillca is Go!

No periods today! The New York Times is reporting that the shareholders of Merrill Lynch and Bank of America have approved the merger of their respective companies. For them that's lookin', the final proxy statement was filed 11/3/08 on form DEFM14A and the S-4 is dated 10/2/08. The NYT article links to the press releases.

SEC "Restacking"

Securities Docket has a post today about office shuffling at the SEC. "The SEC has countless things that it needs to accomplish right now but its going to need to do so while living out of boxes." The move is being called the "restacking project." It has its own newsletter.

New Credit Rating Agency Rules!

On Wednesday, the SEC announced that it has voted to adopt new regulations governing the conduct of Nationally Recognized Statistical Rating Organizations. The rules themselves haven't been released yet, but based on the SEC's "Fact Sheet" they have been diluted some since being proposed in June.

More when the rules appear.

Blog Update

The Harvard Corporate Governance Blog has a post from George Bason of Davis Polk about the Treasury's final implementing regulations for the Foreign Investment National Security Act of 2007 (FINSA). FINSA amended what is known as the Exon-Florio process. Exon-Florio, administered by the Treasury's Committee on Foreign Investment in the United States, gives the President power to examine and even stop acquisitions of certain US businesses by foreign entities.

The Corporate Counsel Blog has this post about how recommendations on executive compensation from the recent meeting of the G20 look a lot like provisions of the Emergency Economic Stabilization Act.

Finally, the Business Law Prof Blog has a post about a lawsuit brought by a hedge fund called Greenwich Financial Services seeking to modify an agreement between Countrywide and 11 state Attorneys General. The agreement modified a bunch of mortgages written by Countrywide. The problem, Greenwich argues, is that Countrywide no longer owns the mortgages it agreed to modify (Greenwich Financial Services v. Countrywide Home Loan Inc., Superior Ct. for NY County, 650474/2008). More from the New York Times here.

Small Bank TARP Scorecard

Now that the 11/14 deadline is well past, it seems like a propitious time to summarize TARP money handed out to smaller banks. The deals, listed below, involve 41 banks and range from $4 million to almost $7 billion. The grand total for all the transactions is about $31 billion. Putting together this list gave me the same feeling that I used to get if I spent too long in ABC Carpet & Home - I started to lose perspective about what constitutes a lot of money. I found myself thinking "Why did Heritage Financial bother if all they got was a lousy 3.6 million bucks?"

See this post for a summary of big-bank TARP transactions, and this Reuters article for TARP scorecard of all transactions as of the date of the deadline.

If you'd like a copy of the list below as a Word doc, email me and I'll send it to you.

1st Financial Services Corp, 11/18, $16
Associated Banc-Corp, 11/21, $525
Ameris Bancorp, 11/21, $52
BB&T Corp, 11/19, $3,100
Banner Corp, 11/24, $124
Boston Private Financial, 11/24, $154
Broadway Financial Corp, 11/19, $9
Capital One Financial Corp, 11/18, $3,550
Cascade Financial, 11/26, $38
Centerstate Banks of Florida, 11/24, $4,200
City National Corp, 11/24, $395
Comerica Inc, 11/19, $2,250
Columbia Banking System Inc, 11/21, $77
First Community Bancshares, 11/24, $41
First Community Corp, 11/25, $11
First Horizon National Corp, 11/17, $866
First Niagara Financial Group, 11/25, $186
First Pactrust Bancorp Inc, 11/21, $19
HF Financial Corp, 11/24, $25
Heritage Commerce Corp, 11/26, $40
Heritage Financial Corp, 11/25, $4
Huntington Bancshares, 11/14, $1,400
KeyCorp, 11/20, $2,500
Marshall & Ilsley Corp, 11/14, $1,700
Northern Trust Corp, 11/17, $1,500
Pacific Capital Bancorp, 11/26, $180
Porter Bancorp, Inc, 11/24, $35
Provident Bankshares, 11/17, $151
Regions Financial Corp, 11/18, $3,500
Severn Bancorp, 11/24, $23
TCF Financial, 11/14, $54
Taylor Capital Group, 11/24, $104
Trustmark Corp, 11/25, $215
UCBH Holdings Inc, 11/20, $298
US Bancorp, 11/14, $6,600
Umpqua Holdings Corp, 11/14, $214
Valley National Bancorp, 11/17, $300
Washington Federal, 11/17, $200
Webster Financial Corp, 11/24, $400
Western Alliance BanCorporation, 11/25, $140
Zions Bancorporation, 11/17, $1,400

Bandaging the Buck

Last week, the SEC adopted temporary rule 22e-3T under the Investment Company Act. 22e-3T relieves money market funds of their obligation, under Investment Company Act rule 2a-7, to make sure their market price doesn't fall below $1.00. When a money market fund's price has to be adjusted below a dollar it is called "breaking the buck." Only money market funds that are being liquidated pursuant to the Treasury's money market TARP program are elgible to use 22e-3T.

In September, the Primary Reserve Fund, the largest money market fund, broke the buck and was granted SEC relief (IC-28386, 2008 WL 4468809).

SEC Update: IOSCO task forces, central clearing update

The IOSCO Technical Committee has created three task forces to study:
- short selling
- unregulated financial markets (OTC derivative)
- unregulated entities (hedge funds)

The SEC has granted a large number of fund cancellations

On December 3rd, the SEC will, maybe, talk about credit rating agency regulation

Corporation Finance has issued guidance for issuers replacing shelf registrations

Erik Sirri updated the House Ag Committee on the progress toward central clearing for credit default swaps

SEC General Counsel Brian Cartwright will resign

How Many More Tombstones in The Graveyard of Cancelled Deals?

The stock market, not content to just kill itself, clutched at two deals as it tumbled past. On Tuesday, BHP Billiton announced that it was abandoning its many-billions-of-dollars offer for Rio Tinto plc because the deal was no longer in the best interest of BHP's shareholders.

The cancellation has had ominous repercussions for Rio Tinto. Its stock is down a third and it is facing a ratings downgrade. It is planning to sell assets to pay down the debt it incurred when it bought Alcan.

Today, the private equity consortium which has, since July of 2007, been trying to buy BCE Inc. announced that their auditors were not able to certify that the post-acquisition BCE would be solvent. The $50 billion BCE transaction is a leveraged buyout. BCE would take on $33 billion in debt to fund the transaction. BCE has also gotten clobbered in trading today making it less likely that they'll be solvent by the drop-dead date of December 11th. More from Reuters here.

The BCE acquisition agreement is attached to a 13D/A filed July 5, 2007. The "Final Amending Agreement" was filed as a 6-K on July 10, 2008.

I wasn't able to find a proposed agreement in the BHP / Rio Tino deal, just lots of PowerPoints. Has anyone seen it?

TARP Updater

Davis Wright Tremaine LLP has posted a memo summarizing developments in the TARP program, including the new program for non-public institutions.

LINK

New York Delays Derivatives Regulation

The Corporate Counsel Blog reports that the New York State Insurance Department is delaying its proposed regulation of credit default swaps because federal agencies have stepped in with a more comprehensive plan for regulating all OTC derivatives.

SEC Guidance for TARP Institutions

The SEC's Division of Corporation Finance has issued Staff Guidance for financial institutions that need to get shareholder approval to issue shares to the Treasury in exchange for TARP money.

So Much Hostility!

It occurred to me yesterday that I have posted twice in the last week about developments in takeover defense practice. It made me wonder if all this anxiety is in response to real developments, or just lawyers being prudent. I did a bit of research and found it is very much the former.

To give you some perspective: in all of 2007 there were 54 hostile transactions, worth about $77 billion. These unfriendly deals accounted for 6% of all M&A activity (Thomson Reuters Third Quarter 2008 Americas M&A report).

On October 1st, CFO Magazine reported that between January and August "48 unfriendly deals had been made, worth $131 billion" (2008 WLNR 19149360). According to Thomson Reuters 3rd Q Americas M&A Report, hostile and unsolicited bids have continued apace. Between January and September of 2008, they totaled $202 billion and accounted for 22.5% of M&A.

My survey of deals announced since October first found 11 deals worth about $10 billion. Four offers were made by private equity investors and six by companies in the same industry as the target. Seven of the offers were all-cash. Three of the tenders have been withdrawn.

A Takeover Defense Renaissance?

Yesterday's SEC Currents has an article about the return of the poison pill:

"With stock prices so cheap, can companies withstand a feared rush of hostile M&A? A gleam in the eye during the frothy, high-priced days of yesteryear, hostile M&A is back, and so are the fears of it, in even bigger ways. To counter this, companies are rushing to acquire defensive-wear against these hostile attempts, including poison pills and staggered boards, among others." LINK

Helloooooooo .....Hellloooooo ...... Hellooo

It must be a pretty lonely feeling for Grand Canyon Education, Inc (LOPE). When their S-1 was declared effective on the 19th, they became the first company to go public since August. They took their lumps yesterday (IPO price was $12.00, first trade on NASDAQ was $10.00), but the last time I checked, they were trading at $12.12.

It made me wonder how many IPO dreams have been cruelly extinguished by the current crap market. 50, it turns out: the Registrations & Prospectuses search on Westlaw Business helped me find them. Under the "Deal Info" tab, I put "IPO" in the "Deal Description (contains)" field and "withdrawn" in the "Registration Status" field. This search returned 50 registrations statements withdrawn since August 1st. The list is in reverse chronological order by withdrawal date. Some of the underlying S-1s were filed as long ago as March!

Of the ten most recent withdrawals, six cite adverse market conditions as the cause - the other four don't provide an explanation. I also found a couple of deals that were withdrawn because the issuer decided to do a private placement or was merged out of existence.

Many thanks to Leroy at WB for helping me find this information!

"There is no Tomorrow"

...thunders Wachtell Lipton. After failing to convince the SEC to reinstate the Uptick Rule, Wachtell has taken its fight to the media. The full text of a memo excoriating Chairman Cox for not reinstating the rule was posted today on the New York Times DealBook blog.

Former rule 10a-1, better known as the Uptick Rule, was adopted by the SEC in 1938 because "The preponderance of available evidence points to the conclusion that in a declining market certain types of short sales are seriously destructive of stability" (Release No. 34-1548, 1938 WL 32911). 10a-1 made short sellers buy at market price or above. It was intended to prevent a "bear raid" where short sellers pile on a falling stock by betting that it will continue to fall - like what happened to Lehman.

Unlike the baroquely condemned Consolidated Supervised Entity program, which wasn't his fault, the repeal of 10a-1 can be laid at SEC Chairman Cox's door. Soon after his appointment he speechified against it and started a "pilot program" to see how we'd manage without it. His curiosity satisfied, he repealed 10a-1 in 2007 (Release No 34-55970, 2007 WL 1880054).

SEC Update

Insider trading complaint against Mark Cuban
Linda Chatman Thomsen (the actual Director of Enforcement) on why we need the SEC.
Open meeting votes to stregthen mutual fund disclosure (nothing about credit rating agencies, though).

Tax Change Leads to Investigation at Treasury

Last week Senator Charles Grassley sent a letter to Eric Thorson, the Treasury Department's Inspector General, asking Thorson to investigate the "facts and circumstances" leading to the issuance of IRS Notice 2008-83. Notice 2008-83, issued days before the economic rescue law was enacted, changed the tax treatment under IRC section 328(h) of losses realized after one bank acquires another. At issue are losses from selling instruments for less than they cost (say, for instance, mortage-backed securities). 2008-83 removed the ceiling on the amount of such losses that can be deducted against income. For a smarter and more detailed discussion see this memo written by Annette Ahlers of Pepper Hamilton LLP.

Grassley is concerned because so many former bankers were involved in drafting 2008-83. He thinks it suggests that treasury is giving preferential treatment to banks and that there may also be an appearance of conflict of interest when former bankers give huge tax breaks to other bankers. Grassley also mentions that this tax break actually made it possible for Wells Fargo to acquire Wachovia without any government money.

Today, the New York Times reports that Thorson has opened an investigation.

Merrill / B of A: No Stay in Delaware

The Delaware Court of Chancery won't stay proceedings in County of York v. Merrill Lynch & Co. in favor of proceedings in the Southern District of New York. The Court found that a year-old SDNY suit against Merrill alleging poor risk management practices was not substantially similar to the County of York's action seeking to block Merrill's merger with B of A. (2008 WL 4824053)

CFTC Chair Proposes Replacing CFTC and SEC

In a speech before the Futures Industry Association, Walter Lukkens proposed abolishing the SEC and the CFTC in favor of three new agencies: a Systemic Risk Regulator, a Market Integrity Regulator, and an Investor Protection Regulator. This adds another to the growing pile of reform proposals. Lukken's sounds most like the "pure functional" regulatory structure advocated by Treasury in its March Blueprint. He also announced he plans to resign.

Internal SEC Spat Ends w/o Punishment

The SEC's chief administrative law judge Brenda Murray rejected a request from the SEC's Office of Inspector General to discipline Division of Enforcement personnel for their handling of the investigations of Pequot Capital and Bear Stearns. Securities Docket obtained the internal orders. They are available here.

SEC Recap - Wanted: Corp. Fin. Chief, 14a-8 Staff Bulletin

John White, the Chief of the SEC Division of Corporation Finance, recently announced that he is returning to his old job at Cravath. White was appointed by Chairman Cox in 2006.

Many thanks to diligent reader bc for correcting my huge faux pas. John White is head of Corporation Finance, not Enforcement. My excuse is that I have enforcement on the brain these days. Also, I'm dumb.

'34 Act rule 14a-8 allows shareholders, even those with very small holdings, to submit proposals for consideration at a company's annual meeting. If the company wants to exclude a shareholder's proposal, it must seek no-action letter relief. Last week, the Division of Corporation Finance issued Staff Legal Bulletin No. 14 to provide guidance and help streamline the 14a-8 process.

BNA Recap - CDS Clearinghouse, TARP Warrant Treatment

The November tenth issue of the BNA Securities Regulation Law Report summarizes, from an internal SEC document, the SEC's work on the recently announced central clearinghouse for credit default swaps. (40 SRLR 1860)

The same issue contains an interview with FASB member Leslie Seidman about accounting treatment of the warrants issued to Treasury through the TARP equity purchase program. FASB's letter to Treasury about accounting treatment of TARP warrants can be found here. (40 SRLR 1860)

Regulating Credit Rating Agencies

At the SEC open meeting on November 19th, there will be a discussion about regulation of credit rating agencies. So begins another chapter in the checkered history of the SEC's attempts to regulate these entities. In 1975, the SEC created the "concept" of the Nationally Recognized Statistical Rating Organization (NRSRO), but it didn't bother to define the term. Later that year the agency was asked, in a no-action letter, which agencies qualified as NRSROs. It named Moody's, S&P and Fitch (Coughlin & Company, Incorporated, 12/25/75, 1975 WL 10745). In the intervening years six other rating agencies received no-action recognition of their NRSRO status.

At the same time, the SEC issued a stream of rule proposals that went nowhere. A 1994 concept release (Release No. 34-34616, 1994 WL 469346) suggested a definition for NRSRO, but the resulting rule proposal was never adopted (Release No. 34-39457, 1997 WL 777260). After the Enron unpleasantness, Congress got involved. Section 702 of Sarbanes-Oxley ordered the SEC to study the role played by rating agencies. The mandated report led to a 2003 concept release, which led to a 2005 proposal which was also never adopted. Congress intervened, again. The Credit Rating Agency Reform Act of 2005 (CRARA, PL 109-291) added definitions of "credit rating agency" and NRSRO to section 3 of the '34 Act. CRARA also did away with the no-action letter approval process. In June of 2007, the SEC finalized implmenting rule 17g-1 and created form NRSRO.

Did Someone Say "Party?"

Today, the President's Working Group on Financial Markets announced a Memorandum of Understanding (MOU) between the Federal Reserve, the SEC and the CFTC. The three agencies agreed to work together to create central counterparties for credit default swaps (CDS). A central counterparty (CCP) is a third wheel who stands between the parties to a contract. Because the CCP would have to be a party to every CDS agreement, the CCP would know the size and the value of the market.

The MOU is the first salvo in the push to bring some regulation to the market in OTC traded derivatives contracts (more here). It is vaguely worded and full of caveats. Sections 2 - 7 are about what the MOU does not do. Section 8 says that the signatories will "take into account" the Group of Ten report: "Recommendation for Central Counterparties."

The South Sea Bubble

I have been handing out these mugs to a few lucky, lucky, lucky readers. The image is a political cartoon about the South Sea Bubble - the credit crisis of its time. A couple of the mug recipients have asked for more info on the South Sea Bubble and I've just discovered that the Harvard Business School Library has a great collection of South Sea Bubble-ania. So, I'm posting to give you a link to it. May I also draw attention to the excellent quotes chosen: "Tis a Long Pudding Which Has Not an End."

Beautiful

MAC Clause Survey from Nixon Peabody

Nixon Peabody has just released its annual survey of the law regarding material adverse change clauses. Deal Professor has a nice overview of the findings.

Can I Be a Bank, Too?

Experts on the Future of the SEC, Part 5

4. Regulate OTC derivatives!

According to Hazen, “the relevant regulatory failure was the failure to regulate over-the-counter derivatives.” These markets were, in his words, “an accident waiting to happen.” Fried agrees that there should be “more transparency in that market.”

In 1999 Congress passed, and President Clinton signed, the Commodity Futures Modernization Act of 2000 (PL 106-554, 7 USCA 7a-1 et seq). The CFMA, implementing recommedations made by the President's Working Group on Financial Markets, contained provisions exempting certain derivatives, including credit default swaps, from regulation by the SEC or the CFTC. As Chairman Cox put it: in this “regulatory black hole” grew a market larger than, “the GDP of every nation on earth.” The Depository Trust & Clearing Corporation (DTCC) argues that the OTC derivatives market is only half the size Cox claims it is because he counts each transaction twice, but even using the DTCC's math we're talking about a 35 trillion dollar market.

The black hole is beginning to fill with band aids. The State of New York would classify credit default swaps as insurance and regulate the piece of the market written by New York-chartered insurers (approximately 60%). DTCC recently announced the creation of a central clearing facility for OTC derivatives and a database containing information about the largest transactions. Professor Hazen called central clearing of OTC derivatives the “minimum” regulation necessary.

DTCC may be trying to address Senator Tom Harkin's stated intention (Bond Buyer, 10/16/08, 2008 WLNR 19639053) to create a CFTC-regulated exchange for OTC derivatives.

Experts on the Future of the SEC, Part 4

3. Get in the cellar! there’s a Congressional storm brewing.

All the respondents expect some kind credit crisis-related Congressional ado. “No doubt there will be legislative reaction,” says Professor Hazen, while Professor Bromberg foresees that “the next Congress will decide whether SEC survives.”

Reform proposals abound. SEC Chairman Cox, as well as the aforementioned Treasury Department blueprint, has proposed merging the SEC with the agency responsible for regulating derivatives trading, the Commodity Futures Trading Commission. Meanwhile, powerful Congressional Democrats have been publicly discussing the creation of U.K.-like super regulator. Barney Frank, in the Wall Street Journal indicated that he favors creation of a "systemic-risk regulator," with responsibility for protecting the soundness of the whole financial system. The American Banker reports that Charles Schumer favors consolidating regulation under a single agency. (American Banker, 11/11/08, 2008 WL 21485826)

Even in this overwrought atmosphere, most of the respondents expect the SEC and disclosure-based regulation to survive. Professor Hazen says: “I seriously doubt that it will be the demise of the disclosure-based regulatory approach. […] The current crisis has exposed some regulatory gaps that will probably be addressed in the coming year.”

NEXT: Regulate OTC Derivatives!

Experts on the Future of the SEC, Part 3

2. Don’t ditch the SEC. It’s not so bad.

The SEC “has been one of the more successful federal agencies in carrying out its statutory mission,” says Thomas Lee Hazen, the Cary C. Boshamer Distinguished Professor of Law at the U. North Carolina at Chapel Hill School of Law.

Alan R. Bromberg, University Distinguished Professor of Law at the SMU Dedman School of Law, singles out the Division of Enforcement for praise: the SEC, he says “deserves to survive as an enforcer.” He offers more qualified support for the agency’s other functions: “It deserves to survive as a regulator, if it can match its skills to those of the market.”

This distinction, between the SEC’s enforcement activities and its regulatory functions, was also highlighted, in recent Congressional testimony, by a former Chairman of the SEC. Any new regulatory body “must be a law enforcement agency” said Arthur Levitt, Jr. “Vigorous enforcement of the rules of the road is a powerful deterrent to bad behavior.”

The SEC’s functions are apportioned among four divisions: Enforcement, Corporation Finance, Investment Management and Trading and Markets. During the present crisis, the SEC’s own Office of Inspector General has singled out the Division of Trading and Markets for criticism. In a pair of reports (On the Consolidated Supervised Entity program and on Broker Dealer Risk Assessment) issued on September 25th, the OIG reiterated a call made six years ago for T&M to better police the risk assumed by investment banks.

However, as John C. Coates, the John F. Cogan, Jr. Professor of Law and Economics at Harvard Law School, points out thinking about how T&M should be restructured needs to take into account how little there is left for it to regulate. "Without a significant investment banking industry independent of commercial banks ... the SEC's traditional role in overseeing broker-dealers needs to be rethought." In this new, bank-controlled universe the SEC "may continue" to regulate "smaller, independent broker-dealers ... investment advisers and independent financial analysts."

NEXT: Get in the cellar!

Experts on the Future of the SEC, Part 2

Recommendation 1 - Keep disclosure-based regulation! It is a good system, and the alternatives are worse.

Disclosure-based regulation of securities transactions has been with us since the enactment, 75 years ago, of the Securities Act of 1933. The ’33 Act and the Securities Exchange Act of 1934, which regulates securities exchanges and provides for periodic disclosure to investors, form an interlocking regulatory structure built on,

“[…] a simple and straightforward concept: all investors, whether large institutions or private individuals, should have access to certain basic facts about an investment prior to buying it, and so long as they hold it. To achieve this, the SEC requires public companies to disclose meaningful financial and other information to the public. This provides a common pool of knowledge for all investors to use to judge for themselves whether to buy, sell, or hold a particular security.” (SEC website)

“No and no,” says Jesse M. Fried, Professor of Law at UC Berkeley, echoing all the respondents: disclosure-based regulation will not disappear, nor should it. In fact, adds Broc Romanek, editor of theCorporateCounsel.net, “I believe the only alternative to disclosure-based regulation for deals is merit-based regulation […] To do that, you would have to grow the SEC (or whatever agency would be in charge of transactions) tenfold or more.”

Merit review is part of the blue-sky law of many states. It consists of an analysis of whether an offering is a good investment. It is also, adds Broc Romanek, “nearly un-American because it would likely result in the government turning down companies that want to raise capital.” An ABA committee on merit regulation summarized the process this way,

“A disclosure review by a merit administrator […] may differ significantly from an SEC review in that it might focus primarily on disclosure of the facts that generate merit problems. […] The key point, however, is that merit review and disclosure review are interrelated, since the examiner may require extensive disclosure of merit issues, such as conflicts of interest and promoter compensation.”

Ad Hoc Committee on Merit Regulation of the State Regulation of Securities Committee of the American Bar Association, Report on State Merit Regulation of Securities Offerings, 41 Bus. L. 785 (1986)- [41 BUSLAW 785].

NEXT: Don’t ditch the SEC!

Experts on the Future of the SEC, Part 1

On October 23rd, Henry Waxman’s House Committee on Oversight and Government Reform began hearings on regulatory oversight of financial markets. Alan Greenspan, John Snow, and Christopher Cox testified. SEC Chairman Cox, the only currently-serving official to testify, is in a tight corner: in March, the Department of the Treasury proposed a new regulatory structure, dubbed "Pure Functional Regulation", that would see the responsibilities of the SEC distributed among new agencies. John McCain wants him fired (but that’s not so scary today, is it?) Perhaps most unfairly, he’s been blamed for the Consolidated Supervised Entity program, which was adopted almost a year before he even arrived at the SEC.

It made me think there was a real possibility that the SEC might become a casualty of the credit crisis. I even wondered whether this could mean the end of disclosure-based regulation.

To get some insight, I took a quick email poll of securities law experts. All this week, I will be summarizing the responses I received.


NEXT: Keep Disclosure-Based Regulation!

Hot and Cold Under the TARP

At the end of last week, nine banks indicated that they would be getting money from the Treasury Department's Troubled Asset Relief Program. Terms were dislcosed and agreements appended to a flood of 8-K filings:

Bank of New York Mellon Corp (8-K, 10/30)
Wells Fargo (8-K, 10/30)
Bank of America (8-K, 10/30)
Morgan Stanley (8-K, 10/31)
JP Morgan (8-K, 10/31)
Citigroup (8-K, 10/31)
State Street Corp. (8-K, 10/31)
Goldman Sachs (8-K, 10/31)

Meanwhile, at least two banks declared their intention to refuse TARP money (Home Federal Bancorp, 8-K, 10/31 and Cullen Frost Bankers Inc., 8-K, 10/31). Will this be a trend?

The American Banker's Association continued to pepper Treasury with letters expressing, "The anger of bankers over the confusion and lack of clarity of the capital [...] program's function." The ABA wants to know if the Treasury is trying to, "provide capital to strongly capitalized institutions" or, "help failing institutions."

I blogged about the treasury behaviour that's got the ABA ticked off here.

West search tips: a Westlaw Business global search for "securities purchase agreement" w/100 "troubled asset relief program" retrieved all nine of the 8-K's announing participation in the program.

A search for "troubled asset relief" in the M&A-DEALS database on Westlaw retrieved profile information about four of the nine deals. I retrieved profiles of other crash-related deals by putting "department of the treasury" or "federal reserve" in the acquiror field.

New York Will Regulate Credit Default Swaps

New York's Insurance Department has issued a Circular (NY Circular Letter No. 2008-19) titled "Best Practices for Financial Guaranty Insurers." It is the first salvo in the state's campaign to regulate credit default swaps (CDS) by classifying them as insurance. Circular 2008-19 replaces a general counsel opinion from 2000 (NY General Counsel Opinion June 16, 2000).

New York's intentions are further illuminated by a press release from Governor Paterson and the testimony of NY Insurance Superintendent Eric Dinallo before the Senate Agriculture Committee. Dinallo focuses on CDS written on other people's securities. He calls such agreements, "a directional bet on a company's credit worthiness," or, as my boss Mark put it, "me buying insurance on your life."

He lays blame for the rise of these products on the Commodity Futures Modernization Act of 2000 (PL 106-554) which exempted many derivatives from state "bucket shop" laws (7 USCA 16(e)(2)). As Dinallo points out, most states outlawed derivatives in the early 20th Century. New York's anti-bucket shop law (of 1909!), for instance, forbids agreements that are, "settled ... upon the basis of the public market quotations of or prices made on any ... exchange or market upon which such commodities or securities are dealt ... without intending a bona fide purchase or sale of the same," (NY GEN BUS § 351).

TARP Money Goes to Ohio

In an 8-K filed on the 24th, PNC Finanical Services Corp. (PNC) announced that it would acquire National City Corp. (NCC). The money for the acquisition (dubbed a "take-under" because the price is below NCC's market cap) comes from the Treasury bailout fund. PNC will sell eight billion dollars in securities to Treasury. So, Treasury buys PNC and PNC uses the money to buy NCC. Apparently, NCC applied for TARP money and was turned down. As Business Law Prof observed someone in Treasury is reorganizing the Ohio banking industry.

So far the agreements aren't public, but Treasury has posted a term sheet on its website. Through TARP Treasury is buying preferred shares - they are senior to common and pay 5% return for 5 years and 9% thereafter. They also carry a veto on dividends.

Regulatory Update

Just a quick recap of what the securities regulators have been up to this week:

SEC

SEC Announces Panelists and Agenda for Mark-to-Market Accounting Roundtable
SEC Announces Fiscal 2008 Enforcement Results
Spotlight On: Fair Value Accounting Standards
Q3 List of 13(f) Securities Users
Testimony Concerning the Role of Federal Regulators: Lessons from the Credit Crisis for the Future of Regulation
Speech by SEC Staff: Compliance Through Crisis: Focus Areas for SEC Examiners and Compliance Professionals
Speech: Executive Compensation Disclosure: Observations on Year Two and a Look Forward to the Changing Landscape for 2009

NYSE

NYSE extends trading halt rules to all structured products
Amendments 2 and 3 to the proposed NYSE specialist phase-out plan: rule & news release
NYSE study on new short selling rules

FINRA

Proposed Rule Allocating Regulatory Responsibility Between BATS and FINRA

PCAOB

PCAOB to Consider Proposing Auditing Standards Related to the Auditor's Assessment of and Response to Risk: press release and open meeting notice

Indexing the Future

Every morning, I see stories like this one describing how trading in "stock index futures," predicts the movement of the market. But what, exactly, is a stock index future and how does it predict what the market will do?

A stock index future is a futures contract tied to a stock index. I know, that doesn't help very much, does it?

A futures contract is an agreement to buy something in the future at a price set now. For example: imagine that last year you made an agreement with your local gas station - you agreed that in one year you would buy 100 gallons of gas for $3.00 per gallon. You have, essentially, made a bet that gas will cost more than $3.00 when it comes time to settle up.

An index is a mechanism for measuring price fluctuations of the market as a whole. An equity index, like the S&P 500, tracks the performance of a hypothetical portfolio of stocks. The portfolio is composed of the stock of 500 large companies. For more on the S&P 500 click here.

In 1982, the Chicago Mercantile Exchange debuted a futures contract designed to track the price of the S&P 500. They work like this: you sign a contract to buy a basket of stocks resembling the S&P 500 at today's price. The amount you'll pay is arrived at by multiplying today's S&P 500 index number by 250 (it comes out to nearly $400,000 per unit). But, you don't wait until the end of the contract to find out if you're ahead or behind. The CME adjusts the contract price every morning based on closing price of the S&P 500 from the day before. If today's close is higher than yesterday's close, they put money in your account. If the price goes down, they subtract. This goes on until the end of the contract.

This is how we get to stock index futures as a predictor of tomorrow's market. Daily resetting, coupled with the fact that the contracts can be traded make them a way to gamble on whether today's closing price will be above or below yesterday's. For instance, if you think the market will end down compared to yesterday you might try to unload your index futures before the CME debits your account.

BNA SRLR Recap

For those who don't have time to read the whole thing:

40 SRLR 1681 - "Sources," tell BNA that the SEC is considering creating regulatory "circuit breakers," (sorry about all the quotes and parentheticals) that would stop short sellers from collapsing vulnerable companies.

40 SRLR 1677 - A guide to the notable parts of the just-made-public SEC Enforcement Manual.

40 SRLR 1689 - How law firms are planning to capitalize on TARP.

Rainmakers Report

Chuck Nathan, via the Harvard Corporate Governance Blog, on the state of takeover defense law.

Marty Lipton, via the Reuters Deal Zone blog, on the sorry state of things.

FASB Staff Position Sparks War of Words

A couple of weeks ago, the Financial Accounting Standars Board (FASB) issued Staff Position 157-3. 157-3 interprets and clarifies Statement on Financial Accounting Standards number 157. 157, titled Fair Value Measurements, tells auditors how to value assets. 157-3 adds further guidance about valuing assets that aren't readily salable. 157-3 comes in the wake of a joint SEC-FASB clarification of 157 issued at the end of last month.

Immediately upon the release of 157-3, the American Bankers Association (ABA) wrote a letter to the SEC asking them to ignore 157-3. The ABA's complaint is that 157-3 uses unreliable bargain sale prices to value assets.

A few days later, the Center for Audit Quality wrote a letter to the SEC protesting strongly against calls, "to suspend fair value accounting."

Notice I Didn't Say, "Leverage?"

I was just reading the transcript of the 10/06 hearing on Lehman Bros. before the House Committee on Oversight and Government Reform (2008 WL 4458226) and it got me thinking, again about borrowed money. According to Luigi Zingales, a professor at the U Chicago Graduate Business School, Lehman had borrowed 30 times more money than it had on hand. Thus (math ahead!) a 3.3% decline in the value of the stuff purchased with that borrowed money would wipe out Lehman's cash reserve.

Okay, how about an example - you have $100. On the strength of that $100, a bank loans you $3,000. With the $3,000 you buy shares of Google. The Google shares cost $30 each so you buy 100. If Google goes down to $29, you lose your $100. If it goes down to $28, you lose $200.

Zingales also points out that most of Lehman's borrowing was short-term. So, that $3,000 you borrowed from the bank is due in a week. You don't have the luxury of selling when Google is up. You're going to have to sell those shares at the end of the week, no matter what the price is.

Tracking Auction Rate Exposure

A couple of days ago, a librarian in California posted a question on pll-sis about tracking corporate exposure to losses and litigation from auction rate securties (ARS). I have a couple of suggestions for accomplishing this with West resources.

Public companies with proportionately large ARS exposure would have to disclose this risk in the Risk Factors section of their 10-K. I used the 10-K search function on Westlaw Business and narrowed my search to item 1A - Risk Factors. Then, I used the free text search to look for "auction rate." I found more than 200 companies that specified their auction rate securities portfolio as a potential risk.

To find lawsuits I used Westlaw. Trial filings from ARS-related suits are included in the FC-FILINGS database (financial crisis, trial filings). I searched "auction rate" /30 "auction rate" and found 51 filings from ongoing ARS lawsuits.

To track developments going forward, both of these searches can be saved as Alerts.

CD'oh

Yesterday, I was talking to my father-in-law, a retired corporate lawyer and strong contender for smartest-guy-I-know honors, and I mentioned that I was thinking about writing something about CDOs (collateralized debt obligations). "What's that again?" he asked, "I hate that kind of jargon. It just makes my mind go blank." I made a couple of jokes about the redundancy of CDO - aren't debts obligations?

But the more I thought about it, the more it seemed that this lack of clarity might not be entirely unintentional. Words like "collateralized" gave a gloss of stability to investments that were anything but.

The entities that issued CDOs were special purpose vehicles like those discussed in this post, except instead of buying mortgages, they bought mortgage-backed securities issued by other SPVs. At the big housing-bubble banquet, the CDOs were the dog under the table. By the time the people at the table started to feel hungry, the dog was dead.

Mystery Risk

One of the things I learned from the SEC Office of Inspector General report on Bear Stearns is that way back in 1990, Congress gave the SEC the authority to police the risks taken by broker-dealers. The power was granted by the Market Reform Act of 1990 (PL 101-432).

In response, the SEC's Division of Trading and Markets promulgated rules 17h-1T and 17h-2T (57 FR 32159-01). The capital "T" stands for temporary. These rules, adopted in September of 1992 and fully effective at the end of the year, were never revisited and never made permanent. The OIG Report is very critical of Trading and Markets' decision to never finalize 17h-1T and 2T. The temporary rules require broker-dealers to file form 17-H, Risk Assessment Report for Brokers and Dealers.

I tried to find a filed form 17-H, but discovered that they are confidential (it was in the rule, but I didn't read carefully enough). So, I asked my friends at Westlaw Business to start a FOIA request to see if they could lay hands on a couple. Did you know that WB did FOIA requests? If I manage to get one, I imagine I'll still need someone to translate it for me.

In other Bear Stearns report news, Race to the Bottom has a post about the wealth of information about the SEC investigative process the report contains.

Speculative Debauch is Multimedia!

The Speculative Debauch iMix is now available on the iTunes Music Store (not an endorsement of the iTunes Music Store). This link will open iTunes to the iMix (IF you have iTunes and IF you aren't using IE). Here's the playlist:

Rags to Riches: Tony Bennett
WORK.REST.PLAY.DIE: Sub Hum Ans
Mo Money Mo Problems: The Notorious B.I.G.
Misfortune, Bad Weather and Debt: Tiger! Tiger!
Everything is Borrowed: The Streets
A Bad Debt Follows You: The Go-Betweens
Dead Presidents II: Jay-Z
Eat the Rich: Motorhead
Hallelujah, I'm a Bum!: Al Jolson
Brother, Can You Spare a Dime?: Bing Crosby
(Let's Go) Slumming on Park Avenue: Ella Fitzgerald
No Depression (In Heaven): The Carter Family
DPA Blues: Hasil Adkins
Happy Days Are Here Again!: Tiny Tim

Mark-to-Market Motivates Meeting

As reported by FEI, the SEC has announced a roundtable on mark-to-market accounting. In the same post, they report extensively on comments received as well as comment letters in the offing.

Also on the FEI blog, is this report on FSP FAS 157-3 Determining the Fair Value of a Financial Asset When the Market for that Asset is not Active - the latest clarification in the continuing saga of FAS 157.

Suggestions & Subpoenas

Two debates ago, neither candidate seemed to have given any thought to who they'd hire to be Secretary of the Treasury. A couple of blogs are offering guidance: Joe Nocera suggests Paul Volcker and Dale Oesterle likes John Thain.

Bloomberg News is reporting that the US Atty's offices in the Eastern District of New York, the Southern District of New York and the District of New Jersey have empanelled grand juries to investigate Lehman Brothers.

Enforcement You Can See Thru!

In my class on securities enforcement, I spend some time talking about the secretiveness of the SEC investigatory process. I'm going to have to change those slides. A few days ago, the SEC made its Enforcement Manual public. The Corporate Counsel opined that this isn't just the SEC making an existing document public, this is something new.

Morgan Lewis has a nice memo on the "new" Manual.

EESA Executive Comp Guidance

The Corporate Counsel blog has put together a one-stop post with all the new guidance implementing the executive compensation provisions of EESA (PL 110-343, 122 Stat. 3765).

The Hunting Party's Over

Yesterday, New York State Attorney General Andrew Cuomo sent a letter to AIG. Cuomo is annoyed that at the same time AIG was asking to be bailed out by the federal government it was sending its executives to England to hunt partridges on the company jet (and how they got on the company jet ...). Cuomo tells AIG to recover the money, or he will.

His purported weapon is section 274 of the NY Debtor and Creditor law. Briefly, s. 274 says that a conveyance is a fraud on creditors if it (1) is made without fair consideration and (2) left the transferor without sufficient capital. There are similar provisions in most state laws, the Uniform Fraudulent Transfers Act and the federal bankruptcy code. For a good treatment see FLETCHER-CYC s. 7412 and 7405 and NY Jur 2d Creditors Rights s. 363.

Presumably, Cuomo is brandishing 274 instead of the Martin Act (NY BCL s. 352c and 353) because the Martin Act requires proof of fraud. Under 274, the determination is made without regard to actual intent. Even with that lowered threshold, Business Law Prof calls it "a stretch."

Wachovia / Wells Fargo

On October 9th, Wachovia (WB) filed an 8-K announcing its merger with Wells Fargo. A number of merger-related agreements were attached. Exhibit 2.1 is the merger agreement, exhibit 2.2 is a share exchange agreement and exhibit 4.1 is a modification of Wachovia's poison pill.

Crask Explainer 4: The Market for Risk

Can we talk about the old days? Back in the old days, when a bank wrote a mortgage, the bank took a risk. If you didn't make your payments, the bank had to contend with the expensive process of taking your house and reselling it at auction. To avoid that result, the bank did its best to determine your ability and willingness to pay it back.

No longer. Our new world, created by Fannie Mae and apotheosized by Lehman Brothers and Bear Stearns, is a place where consequences become wholly untethered from actions. The risk formerly carried by your mortgage bank is titrated into a kind of default-risk toxic sludge and sold to AIG.

This then, is a brief explanation of how the geniuses on Wall Street unglued the risk from mortgage banking. First, investment banks bought the mortgage portfolios of mortgage banks. Then, the investment banks organized special-purpose corporations (SPVs) and sold the mortgages to them. With the mortgages, the SPVs also acquired the associated default risk.

The SPVs were created as mortgage-backed security conduits (for more on mortgage-backed securities see this post). The SPV-issued securities were multi-tiered, with some tiers backed by riskier mortgages than others. The securities backed by the most stable mortgages were sold to the public. The worst went back to the investment bank; the default risk that started with the mortgage bank was distilled and acquired by the investment bank.

To protect itself from these risky securities, the investment bank bought default insurance. Because this insurance swapped default risk for insurance premiums, it was called a credit default swap. Who was the largest insurer? AIG. Thus, the default risk that originated when you borrowed money to buy a house was shifted onto the policyholders of AIG, and finally, to the taxpayers.