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Agriculture committee bigwigs from both houses have introduced bills to bring over-the-counter (OTC) derivatives trading under the control of the Commodity Futures Trading Commission (CFTC).
Why agriculture? The first derivatives were agricultural commodity futures. The federal government began regulating them in the nineteenth century. As the universe of derivatives expanded, so did the reach of the federal derivatives regulator. The CFTC was created in 1974 and given exclusive power to regulate derivatives.
The Commodities Futures Modernization Act of 2000 (CFMA: look at HR 5660, 105th - this bill is incorporated by reference into PL 106-554) exempted from CTFC regulation certain OTC derivatives, including credit default swaps. This exemption has taken quite a bit of the blame for the explosion of the risky CDS market. The SEC has been busily trying to create a central counterparty for CDS transactions, but it looks like the champions of the CFTC are asserting themselves.
There is some sorting out to be done, though. The bills take very different approaches.
Tom Harkin, Chairman of the Senate agriculture committee, reintroduced his Derivatives Trading Integrity Act of 2008 as the Derivatives Trading Integrity Act of 2009 (S. 272). S. 272 brings OTC derivatives under CFTC control by repealing most of the CFMA. If OTC derivatives aren't exempt, they have to be traded on a CFTC-registered exchange.
Meanwhile, Collin Peterson, Chairman of the House agriculture committee, is distributing a draft revision of his Commodity Markets Transparency and Accountability Act of 2008 (HR 6604 - now renamed the Derivatives Markets Transparency and Accountability Act of 2009). Peterson's bill leaves the CFMA in place (after all, he wrote it), but requires that all OTC derivatives transactions be settled and cleared through a CFTC-designated central clearing party.
This suggests to me that those who have called for the SEC and the CFTC to be merged may face what Scott Kuschmider, spokesperson for the House agriculture committee called "an extremely uphill battle." (41 BNA SRLR 128)
The most recent issue of the BNA Securtities Regulation Law Report contains a wonderful overview of what the first part of 2009 may hold in terms of regulatory reform. (41 SRLR 128)
It also reports why the SEC's new credit default swap clearing regs may be subject to the president's rulemaking ban. (41 SRLR 106)
Finally, a group of insurers have brought suit to roll back the SEC's controversial new definition of Annuity Contract. (41 SRLR 117)
Trends noted by Westlaw Business' SEC Currents Extra:
Recent staff comment letters show that the SEC is looking more closely at how companies are spending their TARP windfall.
Part one of a two-part article on takeover defense focuses on companies that have proposed to adopt staggered board structures.
The Washington Post reports that the Treasury's top TARP watchdog is getting ready to ask companies that got TARP money to report how they've used it: "Once he makes the request, Neil M. Barofsky said the firms would have 30 days to comply."
The SEC has released two new Compliance and Disclosure Interpretations. They're in Q&A format and they "comprise the Division’s interpretations of the rules" One covers Securities Act Rules and the other is about going private transactions under rule 13e-3.
The President's Working Group announced the issuance of two reports about the hedge fund industry. Both are from private-sector committees working at the behest of the PWG. One report is from a committee of asset managers and the other is from a committee of investors. Click here for the committees' website.
Bloomberg reports that the Chair of the House Agriculture Committee is circulating a draft bill that would ban most credit default swaps.
The SEC Actions blog asks "Three Key Questions About The Future Of The SEC And Securities Regulation"
An investor in one of the Madoff feeder funds has sued the SEC. Lots of coverage of this one - Reuters, WSJ, but only this one has video of the investor crying. *sigh*
NYT DealBook unwittingly continues my French Revolution metaphor. They report that a panel at Davos turned into a "lynch mob, Davos-style" over the issue of clawing back wall street bonuses. Nassim Nicholas Taleb nominates Rick Rubin to play the Sun King. For more on Nassim Nicholas Taleb, see Joe Nocera's excellent article on Risk in the New York Times Magazine.
The idea of governments clawing back the bonuses paid to executives at bailed-out institutions isn't new, but it appears to be moving from the theoretical to the actual.
With Timothy Geitner beginning to crack his whip over the heads of the ancien regime, it seems our financial revolution has found its Robespierre.
Competition for the part of Marie Antoinette has been pretty heated. I think John Thain's office beats Rick Wagoner's airplane ride.
Candidates for Sun King abound. Fuld? Mozilo? Phil Gramm?
We may not be able to reduce crowding in the Bastille with the guillotine, but at least we have our own Devil's Island.
Today's Corporate Counsel has a nice overview of how the NYSE and the NASDAQ have been adjusting their listing standards so they can come out of this mess with a few companies still listed.
Larry Summers' letter to Congressional leaders regarding future of TARP.
Treasury loans a billion and change to Chrylser.
Lots of new executive compensation rules for TARP institutions.
Legal Currents on the new FINRA anti-rumor rule.
Westlaw Business has new pre-formatted searches to help you find the risk disclosures that are all the rage this season, including:
Bernard Madoff - Adverse Exposure Discussion Extracts issuer disclosure centering on adverse exposure to fraudulent activity involving Bernard L. Madoff Investment Securities LLC.
Risk Factors/10-K - Exposure to Auto Industry Extracts issuer disclosure in form 10-K identifying risk centering on exposure to the trends or activities associated with the automotive industry.
In a very interesting post on Compliance Week Bruce Carton explains why there's no press release about Chris Cox resigning.
This morning, Pfizer announced that it has agreed to acquire Wyeth. Consideration will amount to about $50 per Wyeth share in cash and stock. Total price is $68 million. No SEC disclosure so far, though both companies released their 2008 financials this morning. Both made money. The New York Times has a good article pointing out that this merger is unusual because (a) banks, not the federal government, loaned money and (b) both companies are doing well. Just like the halcyon days of old.
The New York Times reported today that Senators Charles Schumer and Richard Shelby introduced legislation that would allocate lots of money to fight financial fraud. You can stop looking for it. It appears that the NYT article appears was written on the strength of a press release (reprinted here by TP Muckraker). The bill has not yet been introduced.
Bloomberg reports that Bank of American has been sued over its merger with Merrill Lynch. The suit is based on the idea, explored by the Deal Professor on Monday, that B of A knew that Merrill was about to post a huge loss and neglected to include this information in the merger proxy.
The suit was filed in the Southern District of New York (Sklar v. B of A, 1:09cv00580). The complaint is available on Westlaw. Call up the docket, and you'll find a link to a pdf of the original document.
The Wall Street Journal reports that Mary Schapiro has been unanimously confirmed to be chairman of the SEC.
There's a great story in the New York Times today about how M&T Bank invested $82 million in a Deutsche Bank CDO just moments before the CDO became worthless. The CDO in question, called Gemstone CDO VII, was arranged in several tranches. The tranches M&T bought were rated AAA and AA, respectively. Within the year they had been downgraded several times. The AA tranche was rated CCC-. Ouch. M&T is suing everyone involved (0007064/2008: Supreme Ct., Erie Cty) for fraud, breach of duty, negligent misrepresentation and other claims of the sort employed by them that bought unregistered securities. The complaint (2008 WL 3819736) is a fascinating look at how CDOs were put together and why most of them flew apart immediately.
The incestuous inter-connectedness in the CDO/ABS market is head-spinning. The complaint mentions that quite a bit of the underlying assets in Gemstone weren't mortgage-backed securities - they were credit default swaps written on mortgage-backed securities. Gemstone's criteria for accumulating CDS was the credit rating of the "reference obligation." In other words, the mortgage-backed securities that the CDO wasn't buying. I had a headache before and this isn't making it go away.
Default notice of Gemstone VII
Notice of S&P ratings downgrade
I searched for this on the web. I couldn't find it so ... below is a list of some of the regulators who have a disclosure-based regulatory system and instructions for finding securities offering documents filed there.
AUSTRALIA
A list of prospectuses approved by Australia's Securities and Investment Commission can be found on the OfferList . The underlying documents aren't there, but they are required to be posted on the offerors website and there's a link.
CANADA
Canada doesn't have a national securities regulator. Under a jointly-adopted rule called National Instrument 31-101 offerings are approved by the provincial securities regulator in the issuer's principal jursidiction. Disclosure documents are posted on a shared disclosure system called SEDAR
HONG KONG
The Hong Kong Securities and Futures Commission publishes this list of approved prospectuses with links to some of the underlying documents.
They also list current M&A transactions
INDIA
The Securities and Exchange Board of India has links to offering and takeover documents
EU Jurisdictions, are subject to the EU Prospectus Directive. The Prospectus Directive is similar to Canada's National Instrument 31-101 in that once the offering document has been approved by one EU regulator it is "passported" and can be used throughout the EU. Each EU country passed its own adopting rules for the Prospectus Directive so there are variations in how documents are made available.
IRELAND
Financial Services Regulatory Authority-approved prospectuses are listed here with links to the full-text offering documents.
Passported prospectuses are listed here.
LUXEMBOURG
Prospectuses are available from the Luxembourg Stock Exchange. You can search without registering, but free registration is required to open the offering documents.
Scroll down to "CONSULTATION" and look for "security search" or "issuer search."
UK
A unit of the Financial Services Authority called the UK Listing Agency maintains the list of approved prospectuses, but the list doesn't give access to the offering document.
Prospectuses for LSE-listed issues area available on the LSE market news search page. Search for headline type, "publication or prospectus." The news release will have a link to the document.
UK-Passported prospectuses are listed here.
All kinds of excitement at the SEC this week. Wait, did I say "excitement?" I need a vacation.
Peter M. Uhlmann, Chief of Staff of the Securities and Exchange Commission, announced that he will step down.
In a speech, Commissioner Aguliar argued that the SEC should be able to bring criminal cases. Also see this article from the American Lawyer.
The SEC announced that it would extend the deadline for a report on the costs and benefits of SOX 404.
The Financial Executives blog has a good post (with links) about the SEC's Report about updating the disclosure system.
I like lists. They're so organized.
D&O Diary is keeping a running list of lawsuits against Madoff and his feeder funds.
Dealscape has a list of all the banks that have failed and been seized by the FDIC since this whole unpleasantness began.
We knew it was coming, but still ... Securities Docket reports that Chris Cox resigned effective yesterday at noon.
Following the president's lead, I offer gloomy news:
A Reuters story says that the frozen IPO market is clobbering investment bank profits.
A report from Jones Day predicts more bank failures.
A post on FT Alphaville reports that the market in CDS' on US and UK debt are crashing.
*sigh*
An indenture is a contract governing the rights of bondholders.
The word was coined to describe a medieval service contract (thus, someone who signed an indenture was "indentured"). Medieval indentures were written in duplicate on one big piece of paper and then cut apart. Each party got a half. The cut was intentionally made wavy, "indented," so that when the pieces were reunited, it was clear they were originals.
I can't explain how this term came to the world of corporate debt. If you know, please tell me!
The earliest corporate debt indentures created a trust for the benefit of bondholders. Issuer assets were placed in the trust and administered by a trustee for the benefit of the bondholders. So, if the issuer missed a payment the trustee could sell the assets. The indenture protected the bondholder's investment and guaranteed that all bonds were worth the same amount.
The Trust Indenture Act (15 USCA s. 77aaa) requires that debt sold to the public be governed by an indenture and that there be a trustee.
No assets are transferred in modern indentures. Instead, the trustee acts as the bondholder's representative. It oversees a trust containing the bondholder's contract rights. "Modern" is a relative term in the indenture context - the most important book on the subject, Commentaries on Model Debenture Indenture Provisions was written in 1965.
Let's look at an example: last year, General Motors Corporation entered into an indenture with The Bank of New York as trustee (ex. 10.3 to 8-K filed 2/25/08). The indenture is a 60-page contract. It contains very broad language about what kind of debt will be issued and very specific language about the duties of the issuer and the trustee. For example, if GM defaults the trustee is empowered to "declare the principal amount ... immediately due and payable" and to "instigate any action or proceeding at law," on behalf of the bondholders.
An indenture is meant to be a durable document. GM's previous indenture was signed in 1995. Also attached to the same 8-K is the first supplemental indenture (ex 10.4) which adds a new section to the indenture describing "4,372,500,000 - 6.75% Series U Convertible Senior Debentures."
A couple of days ago, the Corporate Counsel blog had a post about steps, outlined on the phone by SEC staff, that will allow issuers who lose WKSI status to continue to use an existing automatic shelf registration.
WKSI is an acronym of "well-known and seasoned issuer," an issuer category created by the '33 Act reforms which became effective in December of 2005 (release 33-8591 (pdf)). A company is a WKSI if it has $700 million in market capitalization and a year of '34 act reports filed and up-to-date. Because of falling stock prices, many WKSIs have dropped below the $700 million threshold. First Midwest Bancorp (FMSI), for instance, was a WKSI yesterday. Since yesterday their share price has gone down about a dollar and their market cap it currently $686.09 million. See this memo from Paul Hastings for more on what happens when you lose WKSI status.
WKSI status confers a bunch of benefits. See this White & Case Q&A for a quick summary and this giant Sullivan & Cromwell memo (pdf) for a very thorough treatment.
Mary Schapiro's written testimony (pdf) is available on the Senate Banking Committee's website.
The Harvard Corporate Governance blog has posted Francis G. X. Pileggi's rebuttal (complete with sneaky digs, "My cursory review ... is not as scholarly ... I do not have the time (thankfully, due to my busy practice)" to Race to the Bottom's 5 Worst Delaware Cases of 2008.
The House is currently considering HR 384: The TARP Reform and Accountability Act of 2009, proposed by Barney Frank. It's a big bill. In addition to imposing lots of requirements on institutions that got TARP money it has provisions aimed directly at benefiting homeowners and car companies.
Another day, another giant ponzi scheme. Is it me, or is this getting depressing?
Release 33-8996 adopting rules 151A and 12h-7: the defintions of "annuity contract" and "optional annuity contract," and, yes, the dissent.
Release 33-8995: the new oil and gas reporting rules.
Appointment of acting chief accountant and acting head of the Division of Corporation Finance.
Agenda for the Commission's 1/7 open meeting.
Another terrific article from the increasingly genuis Currents Extra on banks that have gone back for more TARP money.
And ... Pequot. Again!
Today's WB Currents Extra has a nice article about companies that have announced they are getting into the CDS trading and/or clearing business. The article points out (as has been noted here) that the SEC has bestowed the mantle of "offical" CDS trading and clearing facility on an NYSE sub. However, the SEC's power to regulate credit default swaps is pretty limited so lots of companies are trying to get into the business.
I guess that's how the New York City subway got built.
Today I'm starting a series of posts that explain legal concepts that I wish someone had explained to me when I was a law librarian. After the discussion, some research tips. Coming soon: indenture, underwriter, derivative and multi-jurisidictional disclosure. If there's something you want explainified, let me know. Enjoy?
POISON PILL ZERO
To give you an idea of how a poison pill works, I’ll tell you the story of the very first poison pill …Once upon a time, in the go-go 80’s, Brown-Forman, manufacturer of Jack Daniels, decided that its liquor cabinet would not be complete without Lenox Inc., stodgy manufacturer of presidential china. The president of BF approached Lenox about a merger on friendly terms. The Southern ruffians were rebuffed. So, on June 8, 1983, BF launched a hostile tender offer at $87 per share, a 60% premium over Lenox’s market price. The next day Lenox shares shot up to $86.50.
Lenox hired Wachtell Lipton partner Martin Lipton to oversee its takeover defense. Lipton gets credit for inventing the poison pill. On June fifteenth, Lenox activated its pill. The board rejected BF’s offer and issued a “special cumulative dividend” to Lenox shareholders. The cumulative dividend was in the form of the right to purchase shares (called a share purchase right). Now watch closely: in the event that BF and Lenox merged the share purchase right would entitle the holder to buy, at a steep discount, Class A shares of Brown-Forman. Class A shares were the only voting shares of BF and they were held only by the Brown family. After the merger, the former stockholders of Lenox would control BF! How, I hear you ask, could Lenox think this would work? Contract law: if BF acquired Lenox, BF would become successor-in-interest to Lenox’s contracts. So, BF would be responsible for Lenox’s contract responsibilities.
This is a flip-over. No one has yet had the courage to challenge this mechanism in court. In my opinion, “poison pill,” with its images of a spy taking cyanide to avoid capture, is a deceptive name. This thing is more like the Trojan horse. You may be taking us over, but surprise, we’re taking you over, too! It also brings to mind the atomic bomb – a weapon so frightening that the bidder has no choice but to negotiate. A poison pill can be adopted by the board without shareholder approval. Once the pill has been activated, only the board can turn it off. In fact, the whole edifice rests on the power of the board to use the pill without resort to the shareholders. Starting with Moran v. Household Insurance in 1985, courts have consistently found that the adoption of a pill is within the board’s power under the business judgment rule.
The present model for poison pills follows the Lenox blueprint: the target issues share purchase rights. An event (or trigger) activates the rights. The activated rights give target shareholders power to complete a lucrative transaction that injures the bidder. A share purchase right is like a coupon – it is an option contract that offers to sell something at a discount. The rights are created and governed by an agreement between the company and a third party called a shareholder rights agreement. The third party is called the rights agent. The rights agreement sets out the mechanics of the pill. When the rights are created, they are “attached” to the common shares and can’t be exercised, if the triggering event happens, they “detach.”
What causes the rights to activate? A typical plan works this way:
TRIGGER 1: If there is a tender offer for a set percentage of the company’s securities the rights agent distributes the rights. Existing shareholders, except the bidder, are issued rights. As initially issued, rights have unfavorable terms.
REDEMPTION: Between triggers is a period called the “redemption window:” typically a few days. During that time, rights may be redeemed by the board for very little, often a tenth of a cent on the dollar.
TRIGGER 2: Closing by the bidder of a share purchase transaction activates the rights. Activation changes the terms from very unfavorable to very favorable.
And what does your share purchase right give you the right to purchase?
Flip-in rights: give the holder the right to purchase discounted shares of the target. Flip-in is also used to describe the first trigger.
Flip-over rights: give the holder the right to buy discounted shares of the merged entity, or of the acquirer.
EDGAR SEARCH TIPS:
Adoption or amendment of a poison pill is an 8-K event. Item 601 of Regulation S-K requires that an in-force shareholder rights agreement be attached as exhibit 4 to every registration statement and form 10-K.
WESTLAW RESOURCES
Treatises:
Corporate Anti-Takeover Defense: The Poison Pill Device (SECPILL). A handbook for drafting rights agreements, by Joy Marlene Bryan. Contains brief discussion, definitions, and sample language.
Special Study for Corporate Counsel on Poison Pills (CCPPILLS). A West publication containing discussion of the law and sample documents – it is updated every year and has a drafter’s checklist.
BNA Corporate Practice Series 6-3: Responses to Takeover Bids (BNACPS-RTB). This publication contains an overview of the process of responding to a takeover bid including a discussion of defensive mechanisms - updated monthly.
Reports:
Poison Pill Reports database from SDC Platinum (POISONPILL). Contains reports summarizing every pill ever adopted starting with Lenox Inc - updated daily.
For those that need to know the ending: BF managed to acquire Lenox for more than $400 million. In 2005, BF sold most of Lenox to Department 56 for $190 million. Wachtell Lipton respresented BF.
In case you missed it (I did) the new year has already brought changes.
From DealBook: about $40 billion in bank mergers closed when B of A bought Merrill Lynch and Wells Fargo bought Wachovia.
From the Harvard Law School Corporate Governance blog: The SEC's eProxy rules took effect.
