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.