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This morning Time Warner (TWX) announced it would spinoff AOL. So ends a drawing-room farce that began during our last boom-bust. Those who remember the tech bubble probably also remember that ownership runs the other way – AOL is supposed to own Time Warner, right?
To get our hands around the story lets journey back to 1992 when a small company called America Online, Inc. made a public offering on Nasdaq (424B, 3/20/92). AOL sold 2 million shares at $11.50 a pop, raising $23 million. By 1995, AOL was trading on the New York Stock Exchange at $58/share (S-3, October 1995). Although the price increase wasn’t gigantic, AOL had been issuing a tremendous volume of shares.
Because market capitalization was the name of the game – that’s what made it possible for a company with 12,100 employees and $4.8 billion in revenue (AOL 1999 10-K, 6/30/99) to buy a company with 67,500 employees and $14.6 billion in revenue (TWX 1998 10-K, 12/31/98). By 1999, AOL had 2.3 billion shares out. At $53/share that gave AOL a market capitalization of $121.5 billion (1999 10-K) – 2500 times larger than 1992’s market cap of $47.7 million (1992 AOL 10-K).
In early 2000, AOL decided to use its new paper wealth to buy a feeble, old-economy company called Time Warner Inc. AOL believed it was in a position to acquire TWX because the market had decided that AOL was the more valuable company. For purposes of the merger, AOL’s shares were valued at a very modest $53/share (in the second quarter of 1999, they went as high as $175/share). Although TWX’s shares traded higher at $83/share, TWX had fewer shares outstanding. So, TWX’s market capitalization, per the merger proxy (S-4, 2/11/00, 333-30184), was $99 billion to AOL’s $132 billion.
The merger was accomplished by organizing a new company called AOL Time Warner (ATW). Shareholders of AOL got one share of ATW for each AOL share they held. TWX shareholders got 1.5 shares. Because there were so many more AOL shareholders, they ended up with 56% of the ATW shares. In 2001, the new holding company, controlled by the former shareholders of AOL, started trading on the NYSE under the ticker AOL.
The trouble started almost immediately. In mid-2002, the Washington Post published a story about AOL’s accounting practices. Soon thereafter, the SEC began an investigation and by 2005 the Department of Justice was involved. During this period, the “AOL” started disappearing from AOL Time Warner. ATW dropped the AOL from its name and became, once again, Time Warner. It also retired the AOL ticker symbol and went back to trading under TWX.
So, AOL wanted to buy Time Warner, but by 2003 the acquisition vehicle had morphed into Time Warner and AOL was reduced to being a division of it. In the coming spinoff, AOL shares are going to be distributed to Time Warner shareholders (many of whom, presumably, were once holders of AOL shares?) for free and will reenter the secondary market – possibly on Nasdaq? We’ll have to wait to see what the opening price will be, but I’m betting on $11.50.
Last week I was in New York City presenting the first part of the Westlaw securities master class. It was a pleasure to be back in New York, but the interruption threw me off my posting schedule and I am just now starting to claw my way back. So, without further ado:
On May 20th, the President signed FERA, or the Fraud Enforcement and Recovery Act of 2009, and it became Public Law 111-21. As noted by Gibson Dunn in this post on the Harvard Corporate Governance Blog, language creating a financial crisis investigating committee made its way into the final verison. Also worth a look is Gibson Dunn's financial crisis update page.
On the same day, the President also signed the Helping Families Save Their Homes Act of 2009 (now Public Law 111-22). Besides combatting foreclosure, the law contains restrictions, including conflict of interest rules, on investors wishing to participate in the PPIP program. For more detail, see this post on Jim Hamilton's World of Securities Regulation blog.
Sticking with Jim Hamilton for the moment - he also notes that Richard Durbin proposed a bill called the The Excessive Pay Shareholder Approval Act (S. 1006) which would amend the '34 Act to require super-majority shareholder approval of compensation that is more than 100 times average employee compensation. So, there you go - that's the defintion of excessive.
On May 20th, the 1% rumor came to pass when the SEC voted to propose a new shareholder proxy access rule (14a-11) that would allow shareholders holding more than 1% of an issuer's stock to nominate board candidates. Wachtell Lipton was quick to criticize the proposal for "federalizing" shareholder access to proxy materials. RiskMetrics was over the moon. More from Nixon Peabody.
Because the Department of Justice is investigating two SEC lawyers for insider trading the SEC announced it is taking steps to improve its internal checks for insider trading.
The Corporate Finance Blog has a nice summary of the potential application of SEC rules to all those gee-whiz social media tools of which our corporate leaders have recently become so fond.
Corporate Law Prof has a post on the joint SEC / Department of Labor hearing on a class of mutual funds, called "target date funds," which change their asset mix depending on an investor's age.
The Wall Street Journal reports that Banco Santander SA, one of the largest Madoff "feeders," is the first such fund to offer money to settle possible legal claims brought by Irving Pickard, the bankruptcy trustee for Madoff Investment Securities.
10b-5 Daily reports that the Fourth Circuit reversed a district court's dismissal of a marketing-timing suit against Janus Capital (In re Mutual Funds Investment Litig. 2009 WL 1241574, 4th Cir. May 7, 2009). In the decision, the Circuit Court made several important holdings on fraud-on-the-market and scheme liability post-Stoneridge.
The City of Milan is suing UBS, Deutsche Bank, JPMorgan Chase and Depfa Bank for fraud related to the sale of 35 billion euros of derivatives. An Italian court seized $345 million belonging to the banks. NYT DealBook reports that the banks have decided to drop an appeal of the seizure.
D&O Diary reports that a subprime-related lawsuit against MoneyGram International has survived a dismissal motion. MoneyGram is accused by its shareholders of rigging its balance sheet to make its subprime investment losses look less catastrophic (In re MoneyGram International, Inc. Securities Litigation, 08-CV-00883, US Dist Ct. Dist. of Minn.)
D&O Diary brings to our attention another novel subprime suit that survived a motion to dismiss: Nomura Securities was sued over a securitization transaction it was involved in with LaSalle Bank. Nomura settled with LaSalle and then turned on their law firm (Cadwalader) suing them for malpractice. On May 21st, a New York Superior Court Judge let Nomura's suit against Cadwalader go forward. If you look at the original complaint on Westlaw (2006 WL 5426806) you will notice that Nomura's lawyer was Marc Dreier.
FT Alphaville has a story about how Temasek, Singapore's sovereign wealth fund, reacted to becoming an accidental investor in B of A. Its shares of Merrill Lynch were exchanged for B of A shares and after the merger Temasek owned 3% of B of A. The fund is pessimistic enough about B of A's prospects that they sold their shares and took a three-billion-dollar loss.
Well, not lies exactly - the Corporate Counsel blog analyzed a report in Bloomberg that the SEC is considering a 1 percent threshold for its shareholder access proposal and found the report not credible.
Since we're talking about the Corporate Counsel blog and things that might not be as they seem, Corporate Counsel blog has also posted a draft of Charles Schumer's Shareholder Bill of Rights. Wachtell Lipton has already issued a memo in criticizing the bill (via Race to the Bottom) *sigh*.
Reuters is reporting that two SEC lawyers are being investigated for insider trading.
The Carlyle Group has agreed to pay twenty million smackeroos to settle charges that it bribed officials of New York State's Common Retirement Fund (via The Financial Times).
On the 13th, Secretary Geithner wrote a letter to Harry Reid outlining the administration's ideas for what over-the-counter derivatives regulation should look like. The administration's proposal goes further than anything currently before Congress. Here are some highlights:
* Clearance through well-regulated central counterparties. (causing central counterparty stocks to have a very good day!)
* Capital requirements and reporting requirements for dealers
* Allowing SEC and CFTC to regulate the market
* Protection of unsophisticated investors (like the Province of Quebec?)
On the subject of securities regulation reform, it is clear that the administration's thinking is clearer and more organized than that of the Congess. Why are the administration's proposals being offered in such a deferential manner? The administration knows how to play hardball. Why aren't they doing it?
Next Tuesday, I'm going to be in New York City presenting my Westlaw Securities Master Class, Part 1: Introduction to the '33 and '34 Act - twice in one day, actually. Please email if you'd like more information.
This morning, I want to wander a bit from securities regulation and talk about something close to my heart: libraries. The ecomony is being cited as the reason law firm libraries are cutting their print collections. One very senior law librarian I spoke to predicted the demise of physical library space in law firms. I find this thought personally and professionally depressing, and I think it may be too late to stop it. I have the feeling this is a bit like blaming the economy when you fire the maid who broke your mother's gravy boat.
A decade ago, when times were good, law firm administrators (whom I shall refer to as "beancounters") needed space to build more lawyer offices. They cast their jaded eyes upon the library. "Isn't everything online, now?" They wheedled. "Why do we need so many books?" Librarians and (more importantly) a few research-saavy partners stood up for the books. Print collections were cut and law firm libraries got smaller, but they didn't go away.
But, the beancounters didn't forget - the elimination of the library is still on their minds and now our economic woes have shifted the advantage their way. Shrinking or eliminating the library's footprint is no longer a way to grow the business - it is a way to survive. The research-saavy few can't hold out anymore against the reverse-luddite beancounters. Because, lets be clear, everything is not online and books often contain finding aids which haven't been, or can't be duplicated electronically.
Can the beancounters be stopped? Any ideas?
Yesterday I was listening to a West Legal Ed Center program called "Reviving Securitization," and I was struck by how much of the discussion was about fear of doing business with the government. Entities that invest in asset-backed securities are nervous about two bills making their way through Congress. Both laws aim to do the same thing: make it easier to modify mortgages that have been securitized. To accomplish this, they give mortgage servicers (the intermediary agencies that administer the underlying mortgages) more flexibility to restructure mortgages. The idea is that servicers won't renegotiate mortgages because they're afraid of being sued by ABS investors (like pension plans and hedge funds).
The first bill, HR 1106 - the Helping Families Save Their Homes Act, has passed the House and is currently before the Senate Banking Committee. It contains a section called the "Servicer Safe Harbor" which immunizes servicers from suit for modifying mortgage terms. What really has investors agitated is a section that retroactively defeats a clause that appears in most securitization agreements. Most agreements (called pooling and servicing agreements) have a clause that allows the investor to force the servicer to buy back securities under certain circumstances. Servicers see this clause as a threat that hamstrings their ability to renegotiate mortgages. Investors see this clause as a brake on abusive servicer practices.
The second bill, S 376 - the Real Estate Mortgage Investment Conduit Improvement Act of 2009, (The REMIC Improvement Act) would control the activities of REMICs by taking away their tax-exempt status. The government classifies certain real estate investment securitization entities as tax exempt (REMICs) to promote investment in the residential mortgage sector. The REMIC Improvement Act takes away REMIC status when the pooling and servicing agreement has the tyoe of buy-back provision discussed above.
If either of these laws is enacted, the lawyers will be busy. As Dechert put it in a recent memo, "all pooling and servicing agreements will need to be reviewed ... we expect that the great majority ... may need to be amended." This kind of government modification of previously settled rights is becoming more common. At the beginning of the year, Congress used an amendment to the Emergency Economic Stabilization Act to change the terms of all the TARP loan agreements. Last week, the President used moral suasion to abrogate the rights of Chrylser's senior debt holders.
It made me wonder - how much will this uncertainty affect how investors gauge risk? Lucky for me, there's a ready-made example from the last economic catastrophe. In 1933 and 34, mortgage default hit an all-time high. To keep people in their homes, 27 states passed foreclosure moratoria. These laws were challenged as a violation of the contract clause, but in 1934 the Supreme Court found that the economic emergency warranted a little clause-stretching (Home Bldg. & Loan Ass'n v. Blaisdell, 290 U.S. 398, 54 S.Ct. 231, 1934). Taking away the foreclosure remedy "appear[s] to have reduced the supply of loans and made credit more expensive for subsequent borrowers." (Wheelock, Changing the Rules, Federal Reserve Bank of St. Louis Review, November / December, 2008)
Last week Mary Schapiro and Shelia Bair both asked Congress to create a systemic-risk oversight entity with some kind of resolution power. The proposal came from Chairman Bair during her testimony at a Senate hearing. Both Bair and Schapiro favor the creation of a systemic-risk council composed of regulators. Such a proposal is sitting in Congress right now (HR 1754 - stuck in the Farm Commodities Subcommittee and S 664 presently before the Senate Banking Committee), but doesn't appear to be moving forward. Also MIA is Secretary Geithner's draft resolution authority bill.
I'm sure there's an explanation - it might be strategic, or legal or maybe even psychological. In any case, it happended again last week - members of Congress introduced new bills that look exactly like existing bills.
One is a golden oldie. I think there are three bills out there already that propose repealing the Commodity Futures Modernization Act, but S 961, proposed on May 4th and titled the "Authorizing the Regulation of Swaps Act," is the most thorough. It has a section that looks like the Popular Name Table for the CFMA (USCA-POP) and repeals every section. Its later provisions underline that the law is meant to allow the SEC, the CFTC and a bunch of other agencies to regulate swaps. It then defines "swap agreement" and "purchase and sale" for swap purposes.
HR 2253 follows the more recent trend of emplanneling investigative committees. The "Financial Markets Commission Act" creates a bipartisan committee of seven with a three million dollar budget. The Commission has a year to prepare a report examining "all the causes ... of the current financial and economic crisis ... and the deterioration of the credit and housing markets." The panel is instructed to pay special attention to the role of the Fed, the SEC, the CFTC, FNMA and credit rating agencies.
Meanwhile, S 896 the "Helping Families Save Their Homes Act of 2009," which passed the Senate on May 6th, was the subject of frantic 11th-hour amending:
S Amdt. 1020 and 1021 - Allows Comptroller General to audit the Federal Reserve
S Amdt. 1038 - Provides greater oversight of PPIP
S Amdt. 1039 - Creates a TARP warrant liquidation process
Other amendments which didn't make the cut:
S Amdt. 1026 - Forbidding use of TARP money to buy common stock
S Amdt. 1030 - TARP repayments used for deficit reduction (hello John Thune!)
The odd story of Chrysler's Committee of Non-TARP Lenders came to an abrupt end last week. What began as a distressed debt investment turned into a public debate for which one side was not well prepared. The Non-TARP Lender group was composed of hedge funds executing a well-established distressed debt investment strategy. Section 510 of the bankruptcy code makes debt subordination agreements generally enforceable in bankruptcy. Thus, senior debt-holders, unlike most other investors, are almost always made whole when a company goes bankrupt. Buying the senior debt of a company in financial trouble is, in some ways, a bet that the company will go bankrupt.
70% of Chrysler's senior debt was held by banks, but 30% was acquired by hedge funds at a discount (according to Bloomberg) of between 50 and 70 cents on the dollar. Once the bankruptcy filing was made, debt-holders were offered something like 20 cents on the dollar. The funds didn't like the offer and negotiations stalemated.
In the pre-bailout world, Chrylser would probably have caved because the senior debt-holders had the law on their side. But this was only kinda about the law - the President held a press conference and chastised the Non-TARP Lenders for trying to profit at a time when everyone needed to make sacrifices. Thus, a tried-and-true investment strategy became a public relations apocalypse. The funds knocked each other down to get out and the Non-TARP Lenders group collapsed.
The Securities Law Professor Blog has a post about the SEC's case against two lawyers in Georgia who were running a "144 opinion mill" called 144 Opinions, Inc. 144 Opinions issued 29 opinions which allowed a company called Mobile Ready Entertainment to sell 22 million unregistered shares.
Through exempt transactions, corporate insiders often acquire unregistered stock of reporting issuers. Such stock is called "restricted" because it can't be resold without first being registered under section 3 of the '33 Act. Section 4 of the Act contains exemptions from that general requirement. One of the exemptions is for transactions "by a person other than an issuer, underwriter or dealer." The definition of underwriter (s. 2(a)(11)) is broad. Rule 144 was developed as a safe harbor to enumerate situations where a reseller is not an underwriter to allow unregistered securities to be resold without being registered.
FINRA says securities fraud lawsuit filings are up 86% this year. (via About Broker Fraud Blog).
GAO report says that under ex-Chair Cox the SEC was a "hinderance" to its own enforcement staff (via Bloomberg).
Robert Khuzami intends to make the Division of Enforcement "more smart" by creating specialized enforcement units (via WSJ).
The Corporate Counsel Blog on SEC enforcement past, present and future.
There was a really weird article in yesterday's New York Times about how private equity firms want to invest in ailing banks and the Fed is standing in their way. The article describes the Fed's various reasons for not letting PE funds control banks. It isn't until about halfway through that the author mentions that it really isn't up to the Fed because private equity firms can't legally control banks. The Bank Holding Company Act of 1956 (12 USCA 1841 et seq) says that a company that controls a bank can't also control "any company which is not a bank."
Private equity firms, it turns out, are lobbying to change the law so that they can buy control of banks. They've already begun finding ways around the law, but they want to operate in the open and they want government help.
Back in January, the FDIC sold OneWest (nee IndyMac) to a bunch of private equity investors (JC Flowers, John Paulson, George Soros). This transaction didn't violate the Bank Holding Company Act because none of the private equity investors controls IMB Holdco - the holding company that owns IndyMac. As long as the investors don't form an "association" or a "partnership" they won't be considered a bank holding company.
The article also describes how JC Flowers got around the law by using his own money to buy a bank in Missouri.
Great Ceasar's Ghost! Nobody needs to tell me that hedge funds are the devil (via WSJ).
Holy Cow! Carl Levin and Susan Collins also want to repeal the Commodity Fututres Modernization Act (S 961).
Jehosephat! New GAO report on SEC Enforcement (via Securities Docket).
Gadzooks! The SEC charges Primary Reserve Fund with fraud.
Land-a-goshen! Corporate Finance Law Blog has a copy of a letter about Senator Schumer's corporate governance bill.
Heavens to murgatroyd! Where is Bank of America going to find $34 billion (via Reuters DealZone)?
This weekend, a friend told me that New York City is still paying off debt incurred during the administration of John Lindsay (1966 – 1973). I’ve worked in municipal finance so that didn’t sound far-fetched, but it made me want to learn more. After doing a little research I discovered a bailout story with a familiar ring: once, a badly run institution was pulled back from the brink of bankruptcy. The rescuers were reluctant, but the institution was too important to be allowed to bust. This interesting tale didn’t help me answer the question about the Lindsay administration’s debt, but it did give me some insight into what a long road it is from bailout to stability.
In the 1970’s New York City kept its books like Enron. According to a 1977 SEC report, the city balanced its budget using "an array of gimmicks - revenue accruals, capitalization of expenses, raiding reserves ... and ... the creation of a … corporation whose purpose is to borrow funds to bail out the expense budget." Like Lehman Brothers, the City's unhealthiest habit was short-term borrowing. New York's favorite mechanism was Tax (or Revenue) Anticipation Notes - debt instruments that allow the spending this year of next year’s tax revenue.
New York City's finances began their departure from reality in the early nineteen-sixties. As the New York Times characterized it: "Mayor Wagner, to some extent, and Mayor Lindsay to a much larger extent … ignored fiscal realities ..." When the oil embargo of 1973 kicked off a nation-wide recession, New York’s tax revenues were less than anticipated. In 1974, the unfortunate Abe Beame became mayor just as NYC’s creditors were getting wise. The Beame administration trotted out the usual balance-sheet polishing tricks, but by March of 1975 no one would lend money to New York City.
The City went looking for a hand-out and was rebuffed by the state of New York and the by federal government.
The state came around, but it wanted a lot in return. The Municipal Assistance Corporation for the city of New York Act (McKinney's Public Authorities Law § 3030, L.1975, c. 169) established a new, state-run financing agency to obtain short-run operating money and the New York State Financial Emergency Act for The City of New York (McKinney’s Unconsolidated Laws s. 5401, et. seq., L 1975 c. 868) imposed fiscal discipline so that the City could get back to floating its own bonds.
The state-backed Municipal Assistance Corporation (MAC) was able to restructure the City’s outstanding short-term debt into long-term debt and in 1978 the federal government passed the New York City Loan Guarantee Act, (P.L. 95-339) which did exactly what it sounds like it did. The federal loan guarantees came with “strict limitations and conditions … for the purpose of insuring that … the city gets out from under the federal guarantees as rapidly as possible.” (S. Rep. 95-952)
The climb back to solvency was grueling. Through the MAC, the City issued its first Revenue Anticipation Notes in 1981. The MAC continued to issue bonds on the City’s behalf from 1975 until 2004 (see New York City Official Statement Archive). In 2005, a new agency called the Sales Tax Asset Receivable Corporation floated $1.869 in Sales Tax Asset Revenue Bonds for the purpose of redeeming all of the debt issued by MAC. The City remained subject to the Financial Emergency Act until 2008.
More here.
Most of the countries in Europe fell off the gold standard during World War I. When the war was over, they struggled mightily to get back on. Britain, for example, borrowed hundreds of millions of dollars to buy gold. Animating this behavior was an almost religious belief in the gold standard's power to stabilize the world's economy. Maynard Keynes disagreed. He called the gold standard a "barbarous relic."
The deregulatory fervour of the late 1990's was motivated by a similar conceptual devotion. Alan Greenspan, the high priest of this apolitical orthodoxy, was aided in his work by a wide range of politicians and bureaucrats. Together, they cast aside large pieces of a regulatory regime assembled piecemeal during the previous century.
Superficially, these events have little in common - the struggle to return to the gold standard is a conservative act and leveling the regulatory edifice is the opposite. But they resemble one another in the passion of their supporters and in the simplicity of the ideas championed. Also, in both cases, strong faith in a simple idea led smart people to make questionable decisions. It makes me wonder about the appeal of simple ideas and their capacity to inspire strong feelings in their supporters.
Bingham McCutchen has posted on its website a discussion with partners Neal Curtin and Ken Lore explaining the Treasury's PPIP program.
Stress test results delayed some more. Via Bloomberg.
If you're thinking about playing the lottery today, may I suggest the numbers 1, 3 and 7. The latest update of the financial crisis legislation spreadsheet turns up six bills (count 'em!) that add a new section 137 to the Emergency Economic Stabilization Act (EESA). There is unanimity about the need for section 137, but there is some difference of opinion about what section 137 should do. All of the proposals involve TARP repayments. Here's a summary of what the various 137's would do:
HR 2009 - allow immediate TARP repayment
HR 2118 - "additional" TARP repayment procedures
HR 2119 - assign TARP repayments to debt reduction
HR 2063 - assign TARP repayments to debt reduction
S 862 and S 869 (introduced on the same day by the same sponsor) assign TARP repayments to debt reduction
If this were a democracy, debt reduction would have a slight edge. John Thune voted twice, but I'm only counting one of them. This isn't Chicago (that was a joke - no, wait ... two jokes! That's the joke limit for this post).
Investigation is also on the agenda. H. Res 251 directs Treasury to cough up communication with AIG, HR 1929 would create a committee to investigate Fannie Mae and Freddie Mac and H Res 345 would create a committee to "make a complete and thorough investigation" of the financial crisis.
Finally, HR 1880 would give Treasury oversight over the insurance industry through an Office of National Insurance.
