How on earth did the credit crisis on Wall Street become such a catastrophe, Ben Stein wonders in his latest column for The New York Times? How, he asks, did all of the mechanisms operated by the mind-bogglingly well-paid men and women of the Street go so wrong that we saw a major investment bank, Bear Stearns, essentially disappear?
In an effort to answer those questions, Mr. Stein, a lawyer, writer, actor and economist, points to a speech on the matter that was given on April 8 by hedge fund manager David Einhorn at a Grant’s Interest Rate Observer event.
One of Mr. Einhorn’s more troubling observations, Mr. Stein says, is that the Securities and Exchange Commission allowed broker-dealers to set their own valuations on assets and liabilities that were hard to value. And broker-dealers could assign their own creditworthiness ratings to counterparties in complex derivatives transactions when those counterparties were otherwise unrated.
In a word, Mr. Einhorn says, the S.E.C. told Wall Street to police itself to save on regulatory costs, while not bothering to “discuss the cost to society of increasing the probability that a large broker-dealer could go bust.”
A result of all this, he says, was as follows:
“The owners, employees and creditors of these institutions are rewarded when they succeed, but it is all of us, the taxpayers, who are left on the hook if they fail. This is called private profits and socialized risk. Heads, I win. Tails you lose. It is a reverse-Robin Hood system.”
In his response to Mr. Einhorn’s thesis, Mr. Stein writes:
It looks to me as if the inmates are running the asylum. One truth, that deregulation is sometimes a good thing, has been followed down so long and winding a road that it has led to an immense lie: that deregulation carried to an extreme will not lead to calamity.
To think that people of this mind-set are in charge of the finances of the nation that is the cornerstone of world freedom is terrifying.
Go to Article from The New York Times »
Monday, April 28, 2008
Thursday, April 24, 2008
A Tale of Two Public Offerings
New York Times DealBook, April 24, 2008:
With the credit market still in lockdown and the equity market on a downswing, taking a company public might seem a bit loopy. Two companies that actually took the plunge this week, American Waterworks and Intrepid Potash, exemplify how bipolar this market has become.
There has been much hand-wringing about the horrible environment for initial public offerings — but the reality is a bit more nuanced. At $24 billion, the volume of new issuances in the United States actually doubled in the first quarter from a year earlier. But if you exclude the gargantuan stock sale from Visa, the total value in the first quarter was about $5 billion, down 58 percent from last year, according to Dealogic.
Those that did brave the market have seen wildly different outcomes. Take American Waterworks, which hit the market Wednesday. The spinoff of German utility giant RWE might normally have attracted a lot of attention from risk-averse institutional investors — especially now that risk is out of fashion.
But it was far from popular, bankers working the deal said. RWE priced the stock at $21.50, 40 percent below what it originally thought it could grab last year. And investors were still not impressed — the shares fell as much as 6 percent Wednesday morning.
On the flipside, Intrepid Potash, which makes fertilizer, saw its stock pop as much as 60 percent in its debut Tuesday. Commodity-crazed investors fell over each other to buy a piece of the agricultural company, whose main product, potash, has seen a 131 percent increase in value in just seven months.
This wild market is scaring a lot of companies from going public. A total of 83 companies withdrew their initial public offerings this year and another 24 have delayed share sales, according to Ernst and Young. That is a record.
At this pace, the long-anticipated public offering from private equity giant Kohlberg Kravis Roberts might be sitting on the shelf for many more months to come.
With the credit market still in lockdown and the equity market on a downswing, taking a company public might seem a bit loopy. Two companies that actually took the plunge this week, American Waterworks and Intrepid Potash, exemplify how bipolar this market has become.
There has been much hand-wringing about the horrible environment for initial public offerings — but the reality is a bit more nuanced. At $24 billion, the volume of new issuances in the United States actually doubled in the first quarter from a year earlier. But if you exclude the gargantuan stock sale from Visa, the total value in the first quarter was about $5 billion, down 58 percent from last year, according to Dealogic.
Those that did brave the market have seen wildly different outcomes. Take American Waterworks, which hit the market Wednesday. The spinoff of German utility giant RWE might normally have attracted a lot of attention from risk-averse institutional investors — especially now that risk is out of fashion.
But it was far from popular, bankers working the deal said. RWE priced the stock at $21.50, 40 percent below what it originally thought it could grab last year. And investors were still not impressed — the shares fell as much as 6 percent Wednesday morning.
On the flipside, Intrepid Potash, which makes fertilizer, saw its stock pop as much as 60 percent in its debut Tuesday. Commodity-crazed investors fell over each other to buy a piece of the agricultural company, whose main product, potash, has seen a 131 percent increase in value in just seven months.
This wild market is scaring a lot of companies from going public. A total of 83 companies withdrew their initial public offerings this year and another 24 have delayed share sales, according to Ernst and Young. That is a record.
At this pace, the long-anticipated public offering from private equity giant Kohlberg Kravis Roberts might be sitting on the shelf for many more months to come.
Wednesday, April 23, 2008
Next Steps on the Credit Rating Fiasco
TheCorporateCounsel.net, April 23, 2008:
At yesterday's hearing of the Senate Committee on Banking, Housing and Urban Affairs entitled "Turmoil in U.S. Credit Markets: The Role of the Credit Rating Agencies," Chairman Cox defended the SEC's implementation of the Credit Rating Agency Reform Act of 2006 and spelled out some possible new rulemaking efforts on the credit rating front.
In his testimony, Chairman Cox outlined the SEC Staff's efforts in conducting ongoing examinations of the nationally recognized statistical rating organizations (NRSROs). Those efforts have included the review of thousands of pages of internal records and emails, public disclosures and rating histories by around 40 Staff members. While the examinations are not yet complete (a report is expected by early summer), Cox noted that the Staff has found so far that there was a substantial surge in ratings for structured finance deals from 2004 – 2006, with those deals involving increasingly complex products. The examination Staff's preliminary observations have been that the "ratings process used to rate these products may have been less quantitatively developed, particularly as the products became more complicated and involved different types of loans, than was generally believed." While the SEC is trying to avoid engaging in substantive regulation of the ratings process, it is interested in the adequacy of the NRSRO's disclosure about their procedures and methodologies, and whether such factors as a desire to maintain or increase market share may have caused the NRSROs to be "less conservative" than their disclosed methodologies.
Now that the SEC's NRSRO registration system is in place and other rules implementing the 2006 legislation are effective, the SEC is looking at other areas of rulemaking within its authority. Chairman Cox outlined the following possibilities:
1. Enhanced disclosure about ratings performance – this would include disclosures that allow market participants to better compare the ratings of one NRSRO with another.
2. Accountability for managing conflicts of interest – new rules might prohibit certain practices, as well as establish requirements that address potential conflicts that could impair the process for rating structured products (e.g., consulting services provided by NRSROs to issuers).
3. Annual reporting – new rules could required the NRSROs to furnish the SEC with annual reports describing internal reviews and how well the firms adhere to ratings procedures, manage conflicts of interest and comply with securities laws.
4. Enhanced disclosure of underlying assets – new rules may require disclosure of information about the assets underlying MBS, CDOs and other structured products so market participants could better analyze creditworthiness without the benefit of ratings (and to enhance the availability of data - and thus level the playing field - for subscriber-based NRSROs as compared to the "issuer pays" NRSROs).
5. Enhanced disclosure about ratings – new rules could also mandate enhanced disclosures about how the NRSROs determine their ratings for structured products, as well as ratings information that will make it possible for investors to distinguish between ratings for different types of securities.
6. Access to information – potential rules may seek to eliminate advantages (including access to information) that NRSROs following the "issuer pays" model may have over subscriber-based NRSROs.
7. SEC reliance on ratings – The SEC is revisiting its own reliance on ratings throughout its rules. This could be a big shift in the SEC's rules, including those related to corporation finance.
These new rules could substantially change the ratings landscape, and most likely for the better. It certainly can’t get much worse.
For a great breakdown of the history behind securities ratings and what went wrong with the ratings on mortgage backed securities, check out Roger Lowenstein's piece entitled "Triple-A Failure" which will be published in this Sunday's New York Times Magazine.
At yesterday's hearing of the Senate Committee on Banking, Housing and Urban Affairs entitled "Turmoil in U.S. Credit Markets: The Role of the Credit Rating Agencies," Chairman Cox defended the SEC's implementation of the Credit Rating Agency Reform Act of 2006 and spelled out some possible new rulemaking efforts on the credit rating front.
In his testimony, Chairman Cox outlined the SEC Staff's efforts in conducting ongoing examinations of the nationally recognized statistical rating organizations (NRSROs). Those efforts have included the review of thousands of pages of internal records and emails, public disclosures and rating histories by around 40 Staff members. While the examinations are not yet complete (a report is expected by early summer), Cox noted that the Staff has found so far that there was a substantial surge in ratings for structured finance deals from 2004 – 2006, with those deals involving increasingly complex products. The examination Staff's preliminary observations have been that the "ratings process used to rate these products may have been less quantitatively developed, particularly as the products became more complicated and involved different types of loans, than was generally believed." While the SEC is trying to avoid engaging in substantive regulation of the ratings process, it is interested in the adequacy of the NRSRO's disclosure about their procedures and methodologies, and whether such factors as a desire to maintain or increase market share may have caused the NRSROs to be "less conservative" than their disclosed methodologies.
Now that the SEC's NRSRO registration system is in place and other rules implementing the 2006 legislation are effective, the SEC is looking at other areas of rulemaking within its authority. Chairman Cox outlined the following possibilities:
1. Enhanced disclosure about ratings performance – this would include disclosures that allow market participants to better compare the ratings of one NRSRO with another.
2. Accountability for managing conflicts of interest – new rules might prohibit certain practices, as well as establish requirements that address potential conflicts that could impair the process for rating structured products (e.g., consulting services provided by NRSROs to issuers).
3. Annual reporting – new rules could required the NRSROs to furnish the SEC with annual reports describing internal reviews and how well the firms adhere to ratings procedures, manage conflicts of interest and comply with securities laws.
4. Enhanced disclosure of underlying assets – new rules may require disclosure of information about the assets underlying MBS, CDOs and other structured products so market participants could better analyze creditworthiness without the benefit of ratings (and to enhance the availability of data - and thus level the playing field - for subscriber-based NRSROs as compared to the "issuer pays" NRSROs).
5. Enhanced disclosure about ratings – new rules could also mandate enhanced disclosures about how the NRSROs determine their ratings for structured products, as well as ratings information that will make it possible for investors to distinguish between ratings for different types of securities.
6. Access to information – potential rules may seek to eliminate advantages (including access to information) that NRSROs following the "issuer pays" model may have over subscriber-based NRSROs.
7. SEC reliance on ratings – The SEC is revisiting its own reliance on ratings throughout its rules. This could be a big shift in the SEC's rules, including those related to corporation finance.
These new rules could substantially change the ratings landscape, and most likely for the better. It certainly can’t get much worse.
For a great breakdown of the history behind securities ratings and what went wrong with the ratings on mortgage backed securities, check out Roger Lowenstein's piece entitled "Triple-A Failure" which will be published in this Sunday's New York Times Magazine.
Thursday, April 17, 2008
Are Prosecutors Telling Warren Buffet How to Run His Company?
Posted by Dan Slater, LawBlog - WSJ.com
With Eliot Spitzer cast out of politics, do his prosecutorial tactics live on in U.S. Attorneys’ offices around the country?
According to the WSJ editorial board, the ousting of Gen Re CEO Joseph Brandon, whom prosecutors named as an unindicted co-conspirator in the fraudulent reinsurance transaction between Gen Re and AIG, is proof that they do.
Here’s the back-story: Last week, Law Blog colleagues Amir Efrati and Karen Richardson reported that federal prosecutors were pressuring the Oracle of Omaha, Warren Buffett, the chairman of Gen Re parent Berkshire Hathaway, to replace Brandon after four Gen Re executives were found guilty in February for allegedly using reinsurance deals to inflate the reserves of AIG, Gen Re’s biggest client. After the trial, the prosecutors said they would “work up the ladder” to ferret out wrongdoing.
On Monday, Brandon was forced to resign, despite, according to the WSJ editorial board, being “a superb manager.” In his annual letter to shareholders two months ago, Buffett wrote, “Now, thanks to Joe Brandon . . . the luster of the company has been restored.” Buffett added that Brandon and President Tad Montross “have been running the business for six years and have been doing first-class business in a first-class way, to use the words of J. P. Morgan.”
But, regardless of Brandon’s track-record, his resignation, reports the editorial board, was a foregone conclusion. Fiduciary duty to Berkshire shareholders required Buffet to avoid a criminal indictment of Gen Re at any cost. And U.S. Attorneys can pressure companies to fire executives as a show of cooperation. Georgetown Law prof John Hasnas says prosecutors rarely if ever tell corporations to fire their target. But all they have to do is to suggest that they are considering whether to indict the corporation, and that the extent of their cooperation will be considered in the decision, and “the message gets across.”
“We have come to a strange pass in this country,” writes the editorial board, “when prosecutors who can’t prove their case can nonetheless tell Warren Buffett who can run his companies.”
With Eliot Spitzer cast out of politics, do his prosecutorial tactics live on in U.S. Attorneys’ offices around the country?
According to the WSJ editorial board, the ousting of Gen Re CEO Joseph Brandon, whom prosecutors named as an unindicted co-conspirator in the fraudulent reinsurance transaction between Gen Re and AIG, is proof that they do.
Here’s the back-story: Last week, Law Blog colleagues Amir Efrati and Karen Richardson reported that federal prosecutors were pressuring the Oracle of Omaha, Warren Buffett, the chairman of Gen Re parent Berkshire Hathaway, to replace Brandon after four Gen Re executives were found guilty in February for allegedly using reinsurance deals to inflate the reserves of AIG, Gen Re’s biggest client. After the trial, the prosecutors said they would “work up the ladder” to ferret out wrongdoing.
On Monday, Brandon was forced to resign, despite, according to the WSJ editorial board, being “a superb manager.” In his annual letter to shareholders two months ago, Buffett wrote, “Now, thanks to Joe Brandon . . . the luster of the company has been restored.” Buffett added that Brandon and President Tad Montross “have been running the business for six years and have been doing first-class business in a first-class way, to use the words of J. P. Morgan.”
But, regardless of Brandon’s track-record, his resignation, reports the editorial board, was a foregone conclusion. Fiduciary duty to Berkshire shareholders required Buffet to avoid a criminal indictment of Gen Re at any cost. And U.S. Attorneys can pressure companies to fire executives as a show of cooperation. Georgetown Law prof John Hasnas says prosecutors rarely if ever tell corporations to fire their target. But all they have to do is to suggest that they are considering whether to indict the corporation, and that the extent of their cooperation will be considered in the decision, and “the message gets across.”
“We have come to a strange pass in this country,” writes the editorial board, “when prosecutors who can’t prove their case can nonetheless tell Warren Buffett who can run his companies.”
Monday, April 07, 2008
The Tulane Conference: See You in Court
April 7, 2008, 9:00 am
Posted by Heidi Moore, DealJournal, WSJ.com:
It is a widespread human trait that people who do something fast are prouder of the speed of the performance rather than its often imperfect quality. So it is with the merger boom of 2006 and 2007, which, it has become clear, has left a legacy of hastily drafted, inexactly worded merger agreements that are now in the hands of the inevitable cleanup crew — lawyers and judges who will puzzle out how to make these agreements more specific in the future.
That’s the lesson from the 20th Annual Tulane Corporate Law Institute Conference, where it became clear that merger battles have moved out of the hands of investment bankers who strike the deals and into those of lawyers who enforce them; out of the boardrooms and into courtrooms, where legal eagles will debate the finer points of merger contracts. Most attendees predicted a dropoff in the number of deals, leaving plenty of time to pore over the minutiae of old ones: in the words of Delaware Court of Chancery Vice Chancellor Leo E. Strine Jr., “Wouldn’t the solution be to scrape up one deal and spend the year getting the terms right?”
What was clear at the annual M&A confab is that the current spate of disputed mergers is beyond current laws and precedents, and calls for new court decisions that will set the stage for the future. One valuable lesson to all who were there is that being specific and exact can save you more time than writing an agreement that is broadly worded and will end you up in court. Here are a few issues you can expect to be hammered out this year.
Specific performance: “Specific performance” is just legalese that governs whether a court can force one party to a contract to follow through, or — it helps to think about it this way — perform on a specific aspect of its contract. In the pending $19.4 billion Clear Channel Communications buyout, specific performance is in dispute in a New York court as Thomas H. Lee Partners and Bain Capital try to force six lenders to fund the deal. The lenders argue that New York courts can’t enforce a lending agreement, but can only award money damages.
Forum selection: This is more legalese that just means where a case is heard. Traditionally, the Delaware courts have had a near-monopoly on merger law, because the small state houses the physical headquarters of so few businesses that it can act as an impartial referee. (Many major companies are incorporated in Delaware, however, to have the benefit of those impartial laws.)But there might be a trend towards merger partners seeking the home-court advantage in their home states. The Clear Channel deal also will provide a new testing ground for the Texas courts which historically haven’t been very active in determining the course of mergers. In a panel at Tulane, Strine quipped about “some interesting developments from the land of brisket,” a line which drew a laugh from lawyers uncomfortable with states other than Delaware calling the shots. In the Texas Clear Channel case the company and private-equity firms are suing the banks for tortious interference, or interfering with their contract.
Reverse breakup fees: Reverse breakup fees, in which a buyer pays a fee to the seller to get out of a deal, is another legacy of Clear Channel as well as other buyouts including that of SLM Inc., or Sallie Mae. Tulane professor Eileen Nowicki questioned whether these breakup fees are high enough to discourage buyers from walking away from deals.
Return of the MAC: Material adverse effect clauses, or MACs, were at play in the defunct buyout of Harman International industries. These provisions need to be more specific to allow for changes in the market or an industry, argued Cravath Swaine & Moore partner Faiza Saeed. Right now, they are so broadly written as to be nearly useless.
Financing agreements: Unsurprisingly, these will also come under close scrutiny, argued Cleary Gottlieb Steen & Hamilton partner Meme Peponis and Citigroup banker Christina Mohr, and sellers could start providing their own financing to attract buyers for a deal. In addition, more private-equity firms could follow the lead of Hellman & Friedman, which cut out the middlemen –investment banks — by approaching lenders and hedge funds itself to finance the acquisitions of Goodman Global Holdings and Getty Images.
The investment bankers who advise on mergers, for their part, will stay busy with smaller deals and less complicated ones, according to Mark Shafir, global co-head of M&A for Lehman Brothers Holdings. He predicted that merger activity would be much quieter as private-equity firms reduce their buying by up to 80%, and “strategic,” or corporate buyers, cut back 30% this year. Overall, Wall Street investment banks, private-equity firms and their lawyers will continue to be involved in a vast legal postmortem, seeking to make sense of the merger boom that just passed and setting the legal precedents for the booms inevitably to come.
Posted by Heidi Moore, DealJournal, WSJ.com:
It is a widespread human trait that people who do something fast are prouder of the speed of the performance rather than its often imperfect quality. So it is with the merger boom of 2006 and 2007, which, it has become clear, has left a legacy of hastily drafted, inexactly worded merger agreements that are now in the hands of the inevitable cleanup crew — lawyers and judges who will puzzle out how to make these agreements more specific in the future.
That’s the lesson from the 20th Annual Tulane Corporate Law Institute Conference, where it became clear that merger battles have moved out of the hands of investment bankers who strike the deals and into those of lawyers who enforce them; out of the boardrooms and into courtrooms, where legal eagles will debate the finer points of merger contracts. Most attendees predicted a dropoff in the number of deals, leaving plenty of time to pore over the minutiae of old ones: in the words of Delaware Court of Chancery Vice Chancellor Leo E. Strine Jr., “Wouldn’t the solution be to scrape up one deal and spend the year getting the terms right?”
What was clear at the annual M&A confab is that the current spate of disputed mergers is beyond current laws and precedents, and calls for new court decisions that will set the stage for the future. One valuable lesson to all who were there is that being specific and exact can save you more time than writing an agreement that is broadly worded and will end you up in court. Here are a few issues you can expect to be hammered out this year.
Specific performance: “Specific performance” is just legalese that governs whether a court can force one party to a contract to follow through, or — it helps to think about it this way — perform on a specific aspect of its contract. In the pending $19.4 billion Clear Channel Communications buyout, specific performance is in dispute in a New York court as Thomas H. Lee Partners and Bain Capital try to force six lenders to fund the deal. The lenders argue that New York courts can’t enforce a lending agreement, but can only award money damages.
Forum selection: This is more legalese that just means where a case is heard. Traditionally, the Delaware courts have had a near-monopoly on merger law, because the small state houses the physical headquarters of so few businesses that it can act as an impartial referee. (Many major companies are incorporated in Delaware, however, to have the benefit of those impartial laws.)But there might be a trend towards merger partners seeking the home-court advantage in their home states. The Clear Channel deal also will provide a new testing ground for the Texas courts which historically haven’t been very active in determining the course of mergers. In a panel at Tulane, Strine quipped about “some interesting developments from the land of brisket,” a line which drew a laugh from lawyers uncomfortable with states other than Delaware calling the shots. In the Texas Clear Channel case the company and private-equity firms are suing the banks for tortious interference, or interfering with their contract.
Reverse breakup fees: Reverse breakup fees, in which a buyer pays a fee to the seller to get out of a deal, is another legacy of Clear Channel as well as other buyouts including that of SLM Inc., or Sallie Mae. Tulane professor Eileen Nowicki questioned whether these breakup fees are high enough to discourage buyers from walking away from deals.
Return of the MAC: Material adverse effect clauses, or MACs, were at play in the defunct buyout of Harman International industries. These provisions need to be more specific to allow for changes in the market or an industry, argued Cravath Swaine & Moore partner Faiza Saeed. Right now, they are so broadly written as to be nearly useless.
Financing agreements: Unsurprisingly, these will also come under close scrutiny, argued Cleary Gottlieb Steen & Hamilton partner Meme Peponis and Citigroup banker Christina Mohr, and sellers could start providing their own financing to attract buyers for a deal. In addition, more private-equity firms could follow the lead of Hellman & Friedman, which cut out the middlemen –investment banks — by approaching lenders and hedge funds itself to finance the acquisitions of Goodman Global Holdings and Getty Images.
The investment bankers who advise on mergers, for their part, will stay busy with smaller deals and less complicated ones, according to Mark Shafir, global co-head of M&A for Lehman Brothers Holdings. He predicted that merger activity would be much quieter as private-equity firms reduce their buying by up to 80%, and “strategic,” or corporate buyers, cut back 30% this year. Overall, Wall Street investment banks, private-equity firms and their lawyers will continue to be involved in a vast legal postmortem, seeking to make sense of the merger boom that just passed and setting the legal precedents for the booms inevitably to come.
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