Monday, April 26, 2010

Spitzer & Black: Questions from the Goldman Scandal

By Eliot Spitzer and Bill Black, cross posted from New Deal 2.0:
Spitzer and Black argue that the Goldman revelations underscore the need for serious financial reform.
For those who have spent years investigating fraud, it was no surprise to hear that Goldman Sachs, the (self-described) jewel of Wall Street, is the latest firm to emerge from the financial crisis with tarnished reputation. According to a lawsuit brought by the Securities and Exchange Commission, Goldman misrepresented to its customers the quality of the toxic assets underlying a complex financial derivative known as a “synthetic collateralized debt obligation (CDO).”
As you may now have heard, the story involves a pair of Paulsons. As CEO of Goldman, Hank Paulson oversaw the buying of large amounts of CDOs backed by largely fraudulent “liar’s loans.” When he became U.S. Treasury Secretary, he went on to launch a successful war against securities and banking regulation. Hank Paulson’s successors at Goldman saw the writing on the wall and began to “short” CDOs. They realized that they had an unusual, brief window of opportunity to unload their losers on their customers. Being the very model of a modern investment banking firm, they thought that blowing up their customers would be fine sport.
John Paulson (unrelated), who controls a large hedge fund, also wanted to short CDOs and he, too, recognized that there was a narrow window for doing so. The reason there was a profit opportunity was that the “market” for toxic mortgages only appeared to be a functioning market. It was, in reality, a massive bubble in which ratings and “market” prices were grotesquely inflated. The inflated prices were continuing only because the huge players knew that the prices and races were fictional and were covering it up through the financial equivalent of “don’t ask; don’t tell.” According to the SEC complaint:
In January 2007, a Paulson employee explained the company’s view, saying that “rating agencies, CDO managers and underwriters have all the incentives to keep the game going, while ‘real money’ investors have neither the analytical tools nor the institutional framework to take action.”
We know from Bankruptcy Examiner Valukas’ report on Lehman that the Federal Reserve knew that the “market” prices were delusional and refused to require entities like Lehman to recognize their losses on “liar’s loans” for fear that it would expose the cover up of the losses. Valukas reports that Geithner explained to him when interviewed (p. 1502) that:
The challenge for the Government, and for troubled firms like Lehman, was to reduce risk exposure, and the act of reducing risk by selling assets could result in “collateral damage” by demonstrating weakness and exposing “air” in the marks.
Goldman and John Paulson worked together. One of the key things to understand about shorting is that it is extremely valuable if other major players short similar targets at the same time. By helping Paulson take advantage of Goldman’s customers (the ones that lacked “the analytical tools” to avoid being hosed), Goldman not only earned a substantial fee, but also aided its overall strategy of shorting the toxic paper.
Goldman created a deal in which John Paulson played a major role in selecting the toxic paper that would underlie the investment. He picked assets “most likely to fail - quickly” and studies show that he was particularly good at picking the losers. At this juncture, there is some dispute as to whether ACA was complicit with John Paulson and Goldman in picking losers (ACA initially invested in the synthetic CDO, but then transferred the risk of loss to German and English taxpayers).
What isn’t in dispute is that Goldman, ACA, and Paulson all failed to disclose to purchasers of the synthetic CDO that it was designed to be most likely to fail. The representation was the opposite: that the assets were picked by an independent entity with their interests at heart (ACA). Goldman claims it’s a victim because while it intended to sell its entire position in the synthetic CDO to its customers, it was unable to sell a chunk. One feels the firm’s pain. Goldman tried to blow up its customers to the tune of over $1 billion, but were unable to sell them the last $90 million in exposure.
The Goldman scandal raises several important questions: Did John Paulson and ACA know that Goldman was making these false disclosures to the CDO purchasers? Did they “aid and abet” what the SEC alleges was Goldman’s fraud? Why have there been no criminal charges? Why did the SEC only name a relatively low-level Goldman officer in its complaint? Where are the prosecutors?
In a December New York Times op ed, we, along with Frank Partnoy, asked for the public disclosure of AIG emails and key documents so that we can investigate the deceptive practices exposed by the Goldman case. Goldman used AIG to provide the CDS on most of these synthetic CDO deals (though not the particular one that is the subject of the SEC complaint), and Hank Paulson used tax payer money to secretly bail out Goldman when AIG’s deceptive practices drove it to failure.
The SEC’s Goldman fraud complaint points to fundamental problem in the financial sector that has been at the root of the financial crisis — one that still exists today. The market is not transparent. It has been fraudulently manipulated to enrich managers. Investors lack clear information to make decisions about what they are buying. A continuing absence of real consumer protections makes people like those trying to obtain mortgages before the crash understand that they were, in many cases, being ripped off. According to internal Goldman Sachs e-mails, the company vice president, 31-year old Fabrice Tourre, did not really understand the complex deals he was making. And yet we note that many of these Goldman-style deals were “insured” by AIG. Without transparency, regulators cannot properly see all these kinds of deals in the aggregate. So they can neither stop the fraud nor prevent catastrophic results.
We applaud the SEC lawsuit, but it will not solve the problem. Unless our financial system is reformed to put adequate protections and checks and balances in place, we can expect this kind of fraud to continue. Financial executives will continue to take risks they do not understand. Those who control the flow of capital will continue to churn out profits with socially disastrous consequences.

Wednesday, April 21, 2010

Justice and F.T.C. Propose New Merger Guidelines

Antitrust enforcers have released proposed new guidelines describing how they approach mergers between rivals, with a range of experts describing the revisions as providing greater clarity and giving officials more discretion, Reuters reported.
The stated goal of the 34-page guidelines — which can be found at — is to update the merger guidelines to ensure they reflect the current review process.
The revision was done jointly by the Justice Department and Federal Trade Commission, which divide the work of antitrust enforcement, the news service said.
“Eighteen years have passed since the Horizontal Merger Guidelines were revised. During that time the agencies’ approach has evolved significantly, and the guidelines should reflect that,” said F.T.C. Chairman Jon Leibowitz in a statement.
Go to Article from Reuters »

Friday, April 16, 2010

M & A: Live from Tulane: Deal-Making Returns

NYT DealBook, Friday, April 16, 2010:
Hello from New Orleans, where DealBook has been covering Tulane University's Corporate Law Institute, the annual gathering of top deal-making lawyers. The mood here is markedly more optimistic than last year, as professionals predict deal-making is ready to grow. Go to DealBook's Coverage of Tulane University's 2010 Corporate Law Institute>>
Kicking off the conference, JPMorgan Chase's Douglas Braunstein says that the signs are present for renewed deal-making in 2010. Go to Item from DealBook» Just because calls have grown louder for the government to increase its regulation of companies doesn't mean that it should, a commissioner at the Securities and Exchange Commission said Thursday. Go to Item from DealBook»
A panel on public company mergers at the Corporate Law Institute mixed the serious with the sarcastic, perhaps an inevitable mix when Delaware Chancery Court Vice Chancellor Leo Strine is on hand. Go to Item from DealBook»

Thursday, April 15, 2010

Signs of Confidence Growing in M.&A. Market

NYT DealBook, April 14, 2010:
Corporate executives from around the globe feel more confident about making deals, with many of them planning mergers and acquisitions in the near future, according to a new survey of business confidence by Ernst & Young and the Economist Intelligence Unit.
The Capital Confidence Barometer, a survey of more than 800 professionals worldwide, found that 57 percent of businesses say they are likely or highly likely to acquire a rival in the next 12 months, with 47 percent expecting to reach a deal in the next six months. That compares with six months ago when the biannual survey found that just 33 percent were planning acquisitions over the coming 12 months, with 25 percent expecting deals in the coming six months.
The biannual survey complements another look at mergers and acquisitions released on Wednesday by the Brunswick Group, a corporate communications firm. That survey showed top bankers and lawyers were even more optimistic, with two-thirds saying they thought deal-making activity was on the increase.
The Ernst & Young study also found that confidence in credit conditions was improving, as 62 percent of respondents said they could obtain financing for major capital projects and acquisitions in the next 12 months. Up to now, most deals have been cash-based because of the lack of bank financing.
“Improving market conditions have more companies shopping again and those with capital to deploy are ahead of the game,” Richard Jeanneret, vice chairman of transaction advisory services at Ernst & Young, said in a statement. “There’s a greater focus on growth opportunities and M.&A. is one way to achieve that goal.”
The survey, which was conducted in late March, also found that 76 percent of businesses were now focused on growth, compared with 56 percent six months ago. Those executives in the automotive sector were the most confident of growth, with 81 percent of respondents expecting their businesses to expand — a result that makes sense given the pounding that the auto industry took during the financial crisis.
Meanwhile, executives in the energy and pharmaceuticals sectors said that they were very likely to focus on mergers and acquisitions, as well as divestitures. About 69 percent of oil and gas companies said they were planning to sell a piece of their businesses in the next six months.
But while there was a pickup in sentiment concerning deals, the outlook for the broader economy remained somewhat weak. with just 40 percent of respondents expecting the economic downturn to end within 12 months.
There was a wide dispersion of confidence related to the economy depending on where the respondents were based. The most optimistic countries were Australia at 93 percent, India at 91 percent, Brazil at 83 percent and China at 80 percent.
The Western developed markets were among the least confident of the group, with France at 44 percent, the United States at 56 percent and Britain at 57 percent.
– Cyrus Sanati

Wednesday, April 14, 2010

Deal Outlook Is Rosy Ahead of Tulane M.&A. Conference

NYT DealBook, April 14, 2010:
Deal-makers are feeling good about their business again ahead of Tulane University Law School’s annual Corporate Law Institute in New Orleans, which begins Thursday. (DealBook will be on the ground to give you an inside look.)
More than two-thirds of top bankers and lawyers who orchestrate mergers and acquisitions believe that deal-making activity will rise again, according to a survey released Wednesday by the Brunswick Group, a corporate communications firm.
That’s a big change from last year’s results, in only 29 percent of respondents forecast signs of recovery within 18 months.
“This year’s results reveal a substantial change in sentiment in the M.&A. world and advisors appear to be quite optimistic that the deal activity we’ve seen in the first quarter of the year will continue and potentially accelerate during the remainder of 2010,” Steven Lipin, a Brunswick senior partner, said in a statement. “While it may be premature to sing Bon Temps Rouler, overall the community is feeling much more positive.”
While the economic recovery has certainly helped propel deal-making — as DealBook noted earlier this month, mergers volumes remain up more than 18 percent from last year — deal-makers said that psychological factors will help greatly. About 36 percent of respondents said that the confidence of chief executives and corporate boards will provide the biggest boost to deal-making, more than healthy credit markets and booming stock prices.
The vast majority of respondents said that domestic mergers will dominate the landscape, and deals involving a mix of cash and stock will be the norm.Brunswick Group’s M.&A. Survey 2010

Thursday, April 08, 2010

Financial Deal-Making May Rise in 2010, PwC Says

NYT DealBook, April 8, 2010.
The first instances of consolidation among financial services firms began in earnest during the height of the financial crisis, when Bank of America purchased Merrill Lynch and Barclays Capital acquired the bulk of the failed Lehman Brothers.
More than two years later, financial services firms are still expected to partake in mergers and acquisitions, according to a report released Thursday by PricewaterhouseCoopers.
Bank auctions by the Federal Deposit Insurance Corporation, consolidation among asset management firms and possibly some deals among insurers are all expected to take place over the rest of 2010, the accounting firm said.
Already, two of the biggest deals of the year were in the financial space: the sales of two international units of the American International Group, as the insurer trudges toward recovery after its near-collapse during the financial crisis.
“We believe the current market presents a significant number of potential opportunities in the banking, asset management and insurance sectors for investors that have the liquidity and capital strength to be acquisitive and the infrastructure and capabilities to realize potential synergies,” Gary Tillett, PricewaterhouseCoopers’ financial services leader, transaction services, said in a statement.
The report cites several factors for continued deal-making among financial players. While the economy has recovered, some firms — like banks and property and casualty insurance providers — may continue to struggle with returning to big profits. And asset managers may still face pricing pressures.
Go to PricewaterhouseCoopers Press Release »
Go to PricewaterhouseCoopers Report (PDF) »

Monday, April 05, 2010

Tech M.&A. Shows More Signs of Rebounding

NYT DealBook, April 5, 2010:
The number of technology mergers and acquisitions announced in the first quarter of the year rose to its highest level since the financial crisis first gripped the market, according to the 451 Group, a technology investment research firm.. But the aggregate value of the transactions fell from the previous quarter as there were only a handful of big-ticket deals announced.
Nevertheless, many technology companies are still sitting on the sidelines with large cash reserves, so deal activity could increase as the economy improves.
Deal makers were busy in Silicon Valley last quarter, announcing 841 deals, the highest number since the second quarter of 2007, the 451 Group reports. The makeup of deals varied from a bevy of small bolt on acquisitions to some larger deals with big-name players, including CA, Google, I.B.M. and Oracle. They all announced at least three acquisitions in the just-completed quarter, including, I.B.M.’s acquisition of Initiate Systems and CA’s acquisition of Nimsoft.
But while the quarter saw 12 deals that exceeded $1 billion, the majority of deals were smaller eight- or seven-figure deals. In fact, a third of the deals volume announced originated with just one deal, Bharti Airtel $9 billion acquisition of the Zain Group’s mobile phone businesses in Africa, which skews more into the telecommunications sector rather than the pure-play technology space.
Meanwhile, smaller technology companies continued to rack up deals. The quarter saw purchases from SGI, Unica and Nuance Communications. These three companies have a combined market capitalization of $5.2 billion and more than $600 million of cash on hand, so they still have plenty of money to make further deals in the coming quarters.
In addition to acquisitions, there were also a number of money-losing divestitures from companies attempted to raise cash, like the jettisoning of HotJobs and Zimbra by Yahoo. The 451 Groups says those deals probably returned only about 50 cents on the dollar for Yahoo.
One reason for the weakness came from the lack of private equity money invested in technology deals. Private equity firms invested just $6.6 billion in technology in the first quarter, 451 Group tabulated, which was down about a third from the $9.9 billion invested by those firms in the fourth quarter of 2009.
Despite the drop in private equity interest, there were some signs that private equity firms were willing to take more risks in technology as a consortium of companies including Berkshire Partners, Bain Capital and Advent International teamed up last quarter to put forward a combined $1.1 billion for the Irish electronic education company SkillSoft. It was one of the first private equity deals that broke the $1 billion mark in nearly two and a half years, the 451 Group said.
– Cyrus Sanati
Go to Report from the 451 Group »

Thursday, April 01, 2010

The Pace of Deal-Making Picks Up

By MICHAEL J. de la MERCED, NYT DealBook blog, April 1, 2010:
CORPORATE buyers are intensifying their hunt for deals — and they’re becoming a bit bolder.
More than two years past the start of the financial crisis, deal-making is continuing an ascent as companies seek to bolster their growth through mergers and acquisitions. And as their collective appetite grows, so too does their willingness to consider more aggressive international transactions or unsolicited bids.
The last few months have brought a welter of multibillion-dollar deals, like Comcast’s purchase of a majority stake in NBC Universal, Kraft’s successful $19 billion takeover of Cadbury of Britain and the American International Group’s $51.4 billion sale of two major units. And a spate of unsolicited hostile offers has emerged, notably the Simon Property Group’s $10 billion bid for General Growth Properties, which had filed for bankruptcy.
“The next two quarters will probably be defined as a very aggressive period of speed-dating, where companies will try out different combinations to see if they make strategic sense and are actionable,” said Paul G. Parker, head of global mergers and acquisitions for Barclays Capital.
Worldwide deal volumes swelled to about $564 billion for the three months ended March 31, according to data from Thomson Reuters, 18.4 percent higher than the same time last year. That is a little over half the deal volume of the first quarter of 2007 (which was nearly the peak of mergers activity), but deal-makers say they do not expect to reach those levels for some time.
“The economy’s far from ideal, but companies now have more confidence than they have had in the last 18 months,” said Victor I. Lewkow, a partner at the law firm Cleary Gottlieb Steen & Hamilton.

The conditions that foster successful deal-making are continuing to improve. The stock markets have largely stabilized, with the Standard & Poor’s 500-stock index rising almost 5 percent for the quarter, providing greater clarity into how much companies are worth and helping instill confidence in management teams about potential deals they may be considering.
Just as important, robust stock and credit markets have continued to make financing available for buyers contemplating a takeover. Interest rates remain low, and many strategic companies are drawing upon hoards of cash they stockpiled over the past year.
“The debt markets are wide open,” said Mark Shafir, Citigroup’s global head of mergers and acquisitions. “There’s a lot of capacity in the marketplace.”
Whereas mergers activity last year was dominated primarily by health care and financial services companies, deal-makers say now they are spending time on a broad range of industries.
“It’s across the board,” said Eduardo G. Mestre, vice chairman of Evercore Partners. “I have a very hard time saying that one sector is more active than another sector.”
The economic recovery has also helped alter the dynamics of buyers and sellers. The average worldwide deal premium has fallen nearly 5 percentage points, to 27.5 percent, for the first quarter, according to Thomson Reuters, although it rose 25 percent for transactions in the United States.
While buyers have gained more confidence in pursuing their targets, companies eyed as acquisitions have gotten a better sense of how much they are worth — and more are deciding that the best way to grow is to sell themselves.
“Many companies have moved toward new 52-week highs,” said Chris Ventresca, a co-head of North America mergers and acquisitions at JPMorgan Chase. “They still have uncertainty with regard to their business outlook and don’t see a catalyst for significant stock price appreciation. That provides some basis for sellers to think about traditional premiums over their current stock performance.”
Still, other potential acquisitions say that they are better equipped to grow alone, leaving insistent suitors to ponder whether to try a hostile takeover. Beyond Simon, Air Products and Chemicals, Astellas Pharma, Carl C. Icahn and Elliott Management are among those that have chosen to make unfriendly bids.
The improvement in the debt markets has also helped the private equity industry — largely relegated to the margins in 2009 — assert itself as an active presence once again. Leveraged buyout firms struck about $31.7 billion worth of deals during the first quarter of 2010, amounting to about 5.6 percent of all mergers activity worldwide.
Private equity firms like the Blackstone Group and Kohlberg Kravis Roberts have spoken of their billions of dollars in “dry powder,” or committed investor capital, for some time. Now, with banks proving willing to lend and investors comfortable with riskier bond and loan offerings, such firms are expected to push for bigger deals again, though not as large as the immense leveraged buyouts of three years ago.
Some are also finding buyers for some of their portfolio companies, like Apax Partners’ $3 billion sale of Tommy Hilfiger to Phillips-Van Heusen and Oak Hill Capital Partners’ $1.1 billion sale of Duane Reade to Walgreen. These sales help the buyout firms generate profit and clear room for future acquisitions.
“Private equity firms spent most of last year helping their portfolio companies,” said Randi C. Lesnick, a partner at the law firm Jones Day. “What we’ve been seeing and hearing is an uptick in their interest in new deals.”
Deals have also taken on a more international character: Cross-border transactions added up to about 36.6 percent of all mergers for the first quarter, nearly doubling last year’s number. Deal-makers point to a wide array of mergers, like the Kraft-Cadbury deal and the takeover of A.I.G.’s Asian life insurance arm by Prudential of Britain.
Emerging markets like China and Brazil have proved a font of deal activity: they accounted for $181.7 billion of deals this quarter, according to Thomson Reuters, or 32.2 percent of worldwide volume.
Their expanding presence in mergers and acquisitions has manifested itself both directly, as in Geely of China’s agreement to pay $1.8 billion for Volvo, and indirectly, as in Prudential’s effort to expand its Asian presence through its A.I.G. deal and Kraft’s desire for Cadbury’s footprint in India, Russia and other countries. (A few deals, including Sichuan Tengzhong Heavy Industrial Machines’ $150 million offer for Hummer, fell apart, reportedly because of regulatory troubles.)
Deal-makers say that as China and other developing countries continue to seek natural resources and to put their swelling coffers to good use, they will be seeking even bigger pieces of the mergers pie. “They are emerged markets,” said Antonio Weiss, Lazard’s global head of investment banking. “It’s become old-fashioned to think of these regions as emerging.”
Go to DealBook’s Spring 2010 Special Section »