As Markets Plunge, Deal-Making Plummets

NYT DealBook, June 27, 2008:
Gloom has descended over Wall Street once again. While the price of oil is rising, the health of the financial sector is flagging, taking yet another heavy toll on the markets.
And that has hit deal-making hard as well: Global mergers and acquisitions activity fell 35 percent in the year to date to $1.579 trillion, according to the latest 2008 data from Thomson Reuters. The pain doesn’t stop there: Mergers and acquisitions bankers are bracing for more job cuts as volumes fail to recover from their first-quarter tumble, and the markets seem unlikely to recover this year.
Among the reasons for the deal-making malaise, Reuters said, is that the credit crunch kept buyout firms away from large deals and economic uncertainty made companies reluctant to push the button.
Private equity buyout activity, which underpinned the recent M&A boom, fell 66 percent in Europe to $48 billion and slumped by 86 percent in the United States to $42 billion in the first half.
With inflation rising and no end in sight for economic woes in the U.S. and Europe, it seems unlikely that volumes will recover quickly to the record levels seen for the year until June 2007, observers said.
“We won’t see a boom like early 2007 again for another three or four years,” Hermann Prelle, joint-head of EMEA investment banking at UBS, told Reuters.
Several banks, including Citigroup and Goldman Sachs have already shed M&A jobs to try to adapt to the slower market, and there could be more cuts as the slowdown in activity eats into banks’ income.
In the U.S., the world’s biggest economy, a slowdown and bleak outlook were compounded this week as U.S. consumer confidence hit a 16-year low and housing prices suffered a record annual drop.
The slowdown that started with the credit crunch last summer has spread and is now undermining much of the economic stability in Europe and the U.S. that allowed the M&A boom.
Go to Article from Reuters via The New York Times »

AMT Relief Bill

From PE Week Wire, June 26, 2008:
The U.S. House of Reps yesterday passed an AMT relief bill, which would partially be “paid” for by changing the tax treatment of carried interest from capital gains to ordinary income. Unclear if it can pass the Senate, and President Bush has promised a veto. So why are Charlie Rangel et. all going through the charade? My theory is twofold: (1) Carried interest is going to become a bargaining chip this year. Most everyone acknowledges that AMT must be dealt with at least on a temporary basis, so Rangel has preemptively created a sacrificial lamb. (2) There is now a legislative framework in place for 2009, when it’s expected that Democrats will have a few more Senators and a President Obama. With that, this change passes like taxis on a freeway.

S.E.C. Seeks to Reduce Reliance on Credit Ratings

Securities regulators proposed weaning investors and Wall Street institutions from over-reliance on credit ratings, part of changes to the rating industry prompted by the subprime mortgage crisis.
The Securities and Exchange Commission voted 3-0 on Wednesday in favor of reducing reliance on credit ratings, including proposing to eliminate a requirement that money market funds hold highly-rated securities.
“The official recognition of credit ratings… may have played a role in encouraging investors’ overreliance on ratings,” S.E.C. Chairman Christopher Cox told an open meeting of the commission.
Rating agencies such as Moody’s, McGraw-Hill’s Standard & Poor’s and Fimalac’s Fitch Ratings have been blamed for contributing to the crisis by assigning top ratings to mortgage-backed securities that later deteriorated.
“The recommendations we consider today are consistent with the objective of having investors make an independent judgment of the risks associated with a particular security,” Mr. Cox said.
Mr. Cox said high credit ratings are often not an indication of liquidity or low price volatility for structured financial products, such as mortgage-backed securities.
Fund managers would be required under the proposals to assess a security’s liquidity, or how easily the security can be bought or sold, before buying it for a money market fund.
The new rules would allow the asset to be valued based not only on credit ratings, but also on other subjective standards to determine credit risk.
Go to Article from Reuters via The New York Times »

The Return of Stealth Mode

PE Week Wire - Wednesday, June 25:

Josh Kopelman of First Round Capital is one of the better VC bloggers, and yesterday posted something called The Death of Stealth Mode. Here’s his intro:
A pre-launch, stealth-mode company just closes a seed round of funding. Three weeks go by, and the news of the company's funding starts appearing in VentureBeat, peHUB and Venturewire. The story is then picked up by mainstream tech bloggers and press.The CEO starts getting phone calls from journalists.I then receive frantic, angry phone calls and emails from the CEO that go something like this: "Dude! Did you announce the funding? We wanted to stay under the radar..."
I want to reply, "No. I didn't announce the funding. Your lawyer did."
What Josh is talking about, of course, is an SEC requirement that companies falling under Regulation D exemptions must submit a brief filing after raising capital. It should include the company’s name, business description, executive officers, significant shareholders, placement agents, amount of capital raised and what the capital will be used for. These are called Form D filings, and are what I regularly use to sniff out unannounced deals and fundraisings (when doing so, I cite “regulatory filings”).
Now Josh correctly asserts that these filings make it more difficult to keep a company in stealth mode. He also laments the fact that issuers soon will be required to submit Form D filings electronically, which will make them far more public than the current system of paper filings and reference room scouring. In other words, every blogger and their cousin will be able to “out” stealth mode companies. No need to have a colleague in DC.
But let me make a counter argument, which I’ll call The Rebirth of Stealth Mode.
What all of these Form D newbies are about to find out is that there can be more than 100 Form D filings in a single day. The majority of those have little to do with venture capital. Instead, they are capital raises from hedge funds, REITs, energy exploration companies and banks. Or small-time businesses that got $50k from Uncle Al (you can spot these quickly, because they’re often hand-written instead of typed). In other words, it takes lots of time to separate the wheat from the chafe.
Making matters worse, there are a lot of issuers that file for small Series A funding rounds that may or may not have institutional VCs behind them. I currently can identify the “real” ones because the company must list its significant shareholders. But the revised SEC restrictions remove that requirement, which means that my job is about to become much, much more difficult. For every one VC-backed deal I find via the SEC, there are another five companies I ignore because there does not appear to be institutional backing. Now the only way I can make the distinction will be through shoe-leather journalism. Not complaining about having to work hard, but pointing out that I’ll be unable to identify nearly as many deals as I do now.
The result, of course, is that more companies may slip through the cracks and remain in stealth mode. Yes there will be more people looking, but I think the change still favors secrecy. This is particularly true if/when clever lawyers tell their clients to make up bogus holding company names, so that the jazzy Web 2.0 startup funded by Sequoia now becomes Maple Holding Co. funded by anonymous. Unless I recognize the executive’s name, I’m probably skipping over it. So will most everyone else.

McCain Joins "Say on Pay" Wagon

Recently, Senator John McCain has been speaking out against excessive executive compensation and has now joined Senator Obama in calling for mandatory "say on pay." Here is a Business Week article about this - and here is an excerpt from McCain's June 10th speech:
"Americans are right to be offended when the extravagant salaries and severance deals of CEOs ... bear no relation to the success of the company or the wishes of shareholders," says McCain, adding that some of those chief executives helped bring on the country's housing crisis and market troubles. "If I am elected president, I intend to see that wrongdoing of this kind is called to account by federal prosecutors. And under my reforms, all aspects of a CEO's pay, including any severance arrangements, must be approved by shareholders."
The proposals that both Senators Obama and McCain support not only would provide shareholders an annual non-binding vote on executive pay, they would also provide shareholders with a separate non-binding vote when a company gives a golden parachute to executives while simultaneously negotiating to buy or sell the company.
With H&R Block joining the list, there are now nine companies that have agreed to a non-binding vote on pay.

Hedge Funds Results Take a Beating in 2007

Hedge funds around the world became more cautious, reducing the amount of debt they took on to buy assets by the end of last year as returns took a beating from turmoil in global credit markets, according to a study released on Monday by Greenwich Associates.
Hedge fund leverage ratios declined to about 2.1 at the end of 2007 from 2.3 a year earlier, the Greenwich Associates/Global Custodian study showed. Meanwhile, the study showed the share of hedge managers reporting returns of more than 10 percent dropped to 52 percent in 2007 from 62 percent in calendar year 2006.
Go to Article from The Associated Press via The Guardian »

Will Higher Fees Hurt Riverside’s Latest Fund-Raising?

Posted by Deal Journal @ WSJ.com, June 23, 2008, 9:34 am

Plans by Cleveland private-equity firm Riverside Co. to raise the carried-interest fee on its latest fund to 25% from 20% are causing some static on the fund-raising trail.
There are three or four past investors who will likely not re-up with the new fund, which aims to raise $900 million, several people familiar with the fund said. Stanford Management Co., which manages the endowment of Stanford University, is among them, these people said.
According to these people, Riverside said its past performance and large investment team–170 professionals across the globe–justified the increase. Riverside says on its Web site it has generated gross internal rates of return of over 50% on realized investments in North America and Europe. Riverside focuses on the lower middle market and invests in companies that have enterprise values of as much as $150 million.
According to public data from Oregon State Treasury, the 2000 Riverside Capital Appreciation Fund generated a net internal rate of return of 23.6% as of June 30. That is roughly in line with the 23.8% median return to limited partners from similar vintage funds, according to Cambridge Associates data, which is from the end of the year.
Despite the LP push back, Riverside Capital Appreciation Fund V LP is meeting with some interest. Fund V has had a first closing, one person said, declining to provide details on size. The City of Philadelphia Board of Pensions and Retirement, a new investor, has pledged $25 million to the fund.
The predecessor fund closed at $750 million in 2004.
Carried-interest fees of 25% and 30% remain rare among buyout firms. Only the best firms with the most loyal LP bases have been able to push through such a fee structure. Both Abry Partners LLC and Bain Capital LLC take 30% of their funds’ profits.

Former U.S. Attorneys Assail McNulty Memo

Joe Palazzolo, Legal Times, June 23, 2008

In the latest assault on the McNulty memo, a bipartisan group of 32 former U.S. Attorneys has written a letter to the chairman of the Senate Judiciary Committee, asking him to hold a vote on a bill that would shore up attorney-client privilege for corporations.
The letter to Sen. Patrick Leahy, D-Vt., marks the first time a group of the Justice Department’s own have panned the memo, which allows federal prosecutors to pressure, and in some circumstance force, corporations to waive their privilege, usually in return for leniency.
"The widespread practice of requiring waiver has led to the erosion not only of the privilege itself, but also to the constitutional rights of the employees who are caught up, often tangentially, in business investigations," the letter says.
The bill would bar the practice. Prosecutors would no longer be able to use a waiver as a factor in determining whether to indict a corporation, and they would also be prohibited from compelling a corporation to submit its attorneys' work product. The House passed a similar bill last fall.
Justice officials have argued that the legislation would weaken the government's ability to uncover corporate fraud and wrongdoing to the detriment of pension holders and investors. "There are some people who favor legislation. We think and continue to think that the McNulty memo is working and has worked," Attorney General Michael Mukasey told reporters earlier this month. "There were either no or very, very, very small numbers for actual requests of waiver of the privilege. There were requests for information."

SEC Approves One-Year Delay for Smaller Companies' Auditor Attestations

As proposed back in February, the SEC has approved another one-year extension of the compliance date for smaller companies to meet the Section 404(b) auditor attestation requirement of Sarbanes-Oxley. Smaller companies will now be required to provide the attestation reports in their annual reports for fiscal years ending on or after December 15, 2009.
In addition, the Office of Management and Budget is allowing the SEC to proceed with data collection for a study of the costs/benefits of Section 404, focusing on the consequences for smaller companies and the effects of the auditor attestation requirements.

Lieberman Seeks Limits to Reduce Speculation

A prominent Washington lawmaker said Wednesday that he would propose next week to ban large institutional investors, including index funds, from the nation’s booming commodity markets.
The idea is one of several outlined by Senator Joseph I. Lieberman, independent of Connecticut, who is chairman of the Senate Homeland Security and Governmental Affairs Committee. That committee will hold a hearing on June 24 to continue examining whether financial speculation is affecting the prices of crops and fuel.
Go to NYT article - http://www.nytimes.com/2008/06/12/washington/12trade.html?dlbk

CFTC to discuss energy speculators with Fed, SEC

SAN FRANCISCO (MarketWatch) -- The Commodities Futures Trading Commission said Tuesday that it is establishing a task force to study the role of speculators and index traders in commodities that will include representatives of the Federal Reserve, the Securities Exchange Commission and other agencies.
The announcement comes as the futures regulator furthers its investigation into whether financial investors are driving up the price of oil and other commodities, and if so, by how much. The task force also will include staff representatives of the Treasury Department, the Agriculture Department and the Energy Department.
The CFTC's own analysis of commodities prices and index traders, or investors who invest in commodities via a benchmark, such as the Dow Jones-AIG Commodity Index, has found no significant correlation between these financial investors and recent price spikes.
Still, under pressure by big users and producers of commodities as well as Congress, the regulator has acknowledged that it needs to dig deeper into trading data. It's already said that it will require more data from certain types of traders, such as swaps dealers and overseas oil traders.
Go to Article from MarketWatch»

CSX Grasps at Straws to Fight a Fund

CSX has scored a coup in its efforts to win a proxy fight against a pair of hedge funds, one of which is British: It has cast the battle as a matter of national security.
That has prompted howls of outrage from Congress and voluble CNN pundit Lou Dobbs. But, says Andrew Ross Sorkin in his latest DealBook column, it's an absurd situation, especially since Britain's The Children's Investment Fund isn't even seeking a majority of board seats.
Beyond that, however, CSX's fight is a case study of how a company's executives will go to defend themselves -- and how counterproductive those actions can be.

Go to Article from The New York Times»

Geithner’s Plan to Save the Financial System

NYT DealBook, June 9, 2008

Timothy F. Geithner has lived through the rockiest moments of the credit squeeze that have battered the global financial system, leading to the collapse of Bear Stearns. Now he has some ideas to help prevent a future crisis.
In Monday’s Financial Times, the president of the New York Federal Reserve Bank outlines several steps to help shore up what he calls a “fragile” financial network. Among his proposals: greater capital and liquidity requirements for big financial institutions; more robust and exacting supervision of both financial institutions and complex, highly levered derivatives; and more secure and formalized connections among the largest central banks to better work in concert should another potential catastrophe loom on the horizon.
Go to Article from The Financial Times »

Will M&A Die Under Obama or Clinton?

Posted by Heidi N. Moore, May 29, 2008, 2:48 pm
Deal Journal, WSJ.com

While Barack Obama predicts his own victory in the Democratic presidential primaries as of June 3, deal makers fret about whether a Democratic administration would mean never being able to do a big M&A deal again.
US Airways and United Airlines, for instance, said today that they are pedaling as fast as they can to get a deal done before the Bush administration leaves. Are their fears justified?
If you go by the rhetoric, yes.
Both Obama and Democratic rival Hillary Clinton have indicated they don’t see antitrust matters as loosely as they accuse the Bush administration of doing. Obama has been more outspoken, criticizing the Bush administration for what he sees as lax enforcement of the nation’s antitrust laws. Clinton has been less so.
Here is Obama’s first salvo: “We live in a globalized economy and we probably have to update how we approach antitrust to figure out what is truly uncompetitive behavior on the part of monopolies or oligopolies and what are just big successful companies that need to be big in order to compete internationally….Some of the consolidations that have been taking place, I think, may be anticompetitive….We’re going to have an antitrust division in the Justice Department that actually believes in antitrust law. We haven’t had that for the last seven, eight years.”
Of course, Obama is campaigning, and on a Democratic platform you would expect him to talk tough on mergers. The Clinton Administration gave Microsoft a heck of a time, for instance. But some believe that the important courts right now will still be staffed by Republican judges who may not be amenable to antitrust challenges.
Hillary Clinton is a little harder to read. Her only stance on antitrust has come in the form of comments against OPEC. She has promised to amend antitrust law to confront OPEC and has threatened repeatedly to confront the cartel through the World Trade Organization.
But as first lady in the ’90s, Clinton tried to encourage hospitals to communicate with each other as part her push for universal health care; she also promised to dial down any antitrust enforcement that would prevent hospitals from sharing information with each other.
Of course, the antitrust stances of these two candidates don’t extend to their own interests: there is, after all, rampant speculation about a merger of their two campaigns.

LBO Firms Must Return Cash to Change Plan

LBO Firms Must Return Cash to Change Plan, Hands Says
By Edward Evans
May 28 (Bloomberg) -- Leveraged buyout firms should hand back investors' money if they change strategy because of the credit crunch, British financier Guy Hands said.
Buyout firms that once focused on large investments have ``suddenly'' started investing in distressed debt, while other firms with little experience beyond their local markets are targeting Asia to profit from the region's economic growth, Hands wrote in his quarterly report to investors. He didn't identify the firms in the document, which was published on his Web site.
``This approach means using the capital entrusted to one strategy to pursue another,'' Hands said. Firms should return to investors' money they haven't already spent and ask investors' permission to invest it in other ways, he added. ``The firm one chooses to back to do mega-deals may well not be the firm one chooses to back in, for example, the mid-market. The limited partners should have the opportunity to decide.''
The world's largest leveraged buyout firms are struggling to get loans for deals after the collapse of the U.S. subprime- mortgage market spurred investors to flee all but the safest forms of debt. The firms have announced $118 billion of deals this year, about a third as much as in the same period in 2007, according to data compiled by Bloomberg.
Few Return Cash
Few, if any, buyout firms have ever returned cash to investors, apart from a number of venture capital firms that were unable to find investments after the bursting of the dot- com bubble, Hands added.
Hands, who runs London-based private equity firm Terra Firma Capital Partners Ltd., said his firm's only option is to invest in areas less affected by a slowdown in the economy, targeting asset-rich companies that require changes to their management and operations. He warned investors to expect short- term losses from this strategy.
``Whilst following this strategy early in a bear market may still lead to investors suffering mark to market losses in the short term, most private equity investors are more concerned about creating value over the whole economic cycle than they are with achieving performance in any particular part of that cycle,'' Hands added.
Hands, 48, built up Nomura Holdings Inc.'s buyout business in the 1990s before quitting to run his own firm with Nomura's backing in 2002. Terra Firma is investing a 5.4 billion-euro ($8.4 billion) fund that closed in May last year.
Terra Firma bought EMI Group Plc, the record label whose acts include the Beatles, for 2.4 billion pounds ($4.9 billion) last year. New York-based Citigroup, which financed Terra Firma's bid, postponed plans last month to sell the loans because of investor anxiety about EMI's turnaround under Hands.
``This is not ideal for EMI,'' Hands wrote. ``We have worked hard, and continue to work hard, to see if there are ways to help Citigroup syndicate or sell down this loan.''

Study Claims Milberg Weiss Scheme Hurt Shareholders

Anthony Lin, New York Law Journal, May 28, 2008:

As former securities class action king Melvyn I. Weiss awaits sentencing for his role in the payment of kickbacks to named plaintiffs in shareholder suits, a conservative think tank is set to release a study purporting to show that the scheme injured shareholders.
The American Enterprise Institute Legal Center is releasing today an article by professor Michael Perino of St. John's University School of Law that takes on the argument that the Milberg Weiss kickbacks constituted a victimless crime because the payments came out of legal fees awarded to the firm and named plaintiffs had incentive to maximize class recoveries.
Examining a database of 730 Milberg Weiss class action settlements and legal fee awards, Perino compared those that were cited in the indictments against the firm and its partners and those that were not. He found the indictment cases on average actually settled for slightly less than the non-indictment cases, suggesting the kickback incentives did not improve recoveries.
On the other hand, Perino found that the legal fees requested and awarded in the indictment cases were significantly higher than those in the non-indictment cases, and also higher than those in cases handled by firms other than Milberg Weiss.
According to the report, the findings support the notion that class members were hurt by the kickbacks, as they "appear to have received a lower proportion of the settlement proceeds than class members in otherwise substantially similar non-indictment cases."
Federal prosecutors have requested a 33-month sentence for Weiss, who pleaded guilty in March. He is in turn arguing for 18 months. His sentencing is scheduled for June 2.

M&A Optimism: It’s Spreading!

Posted by WSJ Deal Journal, May 15, 2008:
After months of paring back on loans, Wall Street’s banks are finally loosing their lending for private-equity deals, according to bankers speaking at a conference in New York on Wednesday.
Banks have committed $10 billion to $20 billion in new private-equity deals during 2008, meaning the total backlog now stands less than $80B, said John Eydenberg, head of Deutsche Bank’s leveraged finance group, speaking at The Deal’s Private Capital Symposium.
“Panic has been behind us,” said Eydenberg. “About three weeks ago, backlog didn’t matter any more. People started to think about fundamentals again.”
Optimism is budding on Wall Street and that’s primarily due to the speed banks with which banks like Citigroup have been able to sell down hung bridge loans. The backlog has decreased to its current level from around $250 billion a few months ago.
People are “less sanguine” than they were at earlier stages of the credit crunch, said Peter Schoenfeld, CEO of P. Schoenfeld Asset Management LLC. “The real horror stories are gone.”
But market participants say the recovery is still at an early stage.
“You will see us walk before we run,” said Alan Jones, co-head of Morgan Stanley’s private equity group. “We will be in a normal, more protected environment,” he said. But the recovery is “going to be gradual. We are in the crawling maybe walking phase.”

SEC Scrutinizing Investment Bank Liquidity

By Rachelle Younglai and Karey Wutkowski
WASHINGTON (Reuters) - The U.S. Securities and Exchange Commission is scrutinizing the liquidity of investment banks it supervises and is planning to require the top Wall Street firms to publicly disclose their current liquidity and capital positions, SEC officials said on Wednesday.
Attention has been on funding at the biggest U.S. investment banks since March, when Bear Stearns Cos Inc nearly collapsed after a sharp decline in its liquidity.
Go to Article from The New York Times»
Go to Article from Reuters»

IPOs: Back from the Dead?

by Ben Steverman, BusinessWeek.com, May 8, 2008:
A nervous Wall Street scorned initial public offerings for months, but suddenly IPOs are popular again.
Recent stock market debuts have been successful, including the largest IPO ever—Visa's (V) $19.6 billion deal—and a herd of new offerings are hitting the market soon. The next couple weeks are expected to be the busiest time for IPOs so far this year.
Investors seem more and more willing to take chances on small, fast-growing startups. That sort of appetite for risk has been hard to find since last fall, as a bear market and a credit crisis took big bites out of many portfolios.
After a tough start to 2008, the broader stock market recovered a bit. The broad Standard & Poor's 500-stock index gained 3.5% in the month before May 6. But the IPO market is doing even better. Recent IPOs, measured by Renaissance Capital's IPO index, are up 12.2% in the past month.
Go to Article from BusinessWeek»

Simply Appalling: Good judgment seems to have been short-circuited in the Circuit City boardroom

From Directors & Boards E-Briefing, May, 2008:
A perennial mystery to this longtime governance observer is how a board can seemingly sit silently by and watch a management trash a business. This seems to be what’s been happening at Circuit City Stores Inc. A year ago the company announced a turnaround plan. A centerpiece of the plan was laying off a slew of more experienced salespeople, to be replaced with lower-paid hires. But get this: Those who lost their jobs could reapply for their old jobs, at the lower pay, but had to wait 10 weeks to do so. That’s simply appalling.“That’s the most cynical thing I’ve heard about in a long time,” said Peter Cappelli, in a critique of the plan published by the Wharton School’s Knowledge@Wharton newsletter. Cappelli is a management professor and director of Wharton’s Center for Human Resources . Another Wharton professor, Daniel Levinthal, termed the layoff plan “a massive de-skilling” of the company. I’m all for companies doing what they feel they must do to survive. But let’s be mindful of what Peter Drucker said: “The purpose of a business is to create a customer.”When a company takes steps that are repellent in its treatment of its human resources — its work force and its customers — is it really a business anymore? Or a business that should stay in business?I didn’t write about this abhorrent policy at the time. My personal response was to vow never to set foot in a Circuit City store again, and to leave it at that.I did wait for the follow-on announcement that the current board members all submitted their resignations — so as, in the spirit of their approved turnaround plan, to allow management to replace them with a newer, younger board, which would be paid a lower retainer and fees than the old directors received. Less experienced? Who cares about that? And the current board, after a cool-down period, would be allowed to reapply for their old seats, at the lower scale, of course. Funny … I missed that announcement. Did you, too?Well, a year has gone by, and Circuit City is now much in the news. Perhaps my personal reaction was shared by similarly offended spirits. The turnaround seems to have run aground. Circuit City’s results are punk, the stock price has collapsed, and a hedge fund, which has called the turnaround effort “disastrous,” is at the board’s throat. Then, in a bizarre turn, in mid-April Blockbuster Inc. weighed in with a merger proposal. That’s being charitable to call it bizarre. It’s also being called “crazy,” “reckless,” and “looney” by deals analysts.All I can hope is that there were some dissenting voices in the boardroom — “What are they thinking?!” —when management unveiled the HR components of its turnaround plan. It must be a sad day in the life of a director when he or she sees the company’s business and reputation about to be trashed.

Jim Kristie is the editor and associate publisher of Directors & Boards.

Wall Street, Run Amok?

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 »

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.

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.

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.”

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.

Did The Fed Push Bear Into a Bad Deal?

DealJournal - WJS.com, March 21, 2008:
There are a lot of things that look right in the heat of the moment, and highly problematic in hindsight. Is J.P. Morgan’s proposed takeover of Bear Stearns one of those things?
The Fed did not learn how bad Bear’s condition was until Bear and the SEC told the Fed late Thursday March 13, and at that point, the firm said it saw little option other than to file for bankruptcy by Friday morning. The Fed pushed Bear to find a private sector buyer before markets opened Friday, but Bear couldn’t. At 7 a.m. Friday the Fed, for the first time in its 95 year history, approved a direct loan to Bear, a step so extraordinary it required the use of two special loopholes in the Federal Reserve Act. The Fed’s priority wasn’t to minimize losses for Bear shareholders but to prevent uncertainty over Bear’s fate from causing the derivative and repo markets to dry up, which meant finding a buyer if at all possible before Monday. That you knew already; and if you didn’t, you can find the whole timeline here.
See all of Deal Journal’s posts on the fall of Bear Stearns. Plus, click here for continuing coverage from the Wall Street Journal.
Still, that’s cold comfort for shareholders. “We thought they gave us 28 days. Then they gave us 24 hours,” one person familiar with Bear told the Journal. J.P. Morgan’s deal for Bear Stearns has several unusual features that make the deal particularly favorable to J.P. Morgan and comes at the expense of Bear Stearns’s shareholders, who are losing billions on the $2.40 a share offer. It’s nearly impossible for any rival bidder to break it up, J.P. Morgan already has management oversight of Bear, J.P. Morgan can buy the building even if Bear’s board rejects the deal, and J.P. Morgan can buy up to 20% of Bear’s shares if any other buyer does the same. So in essence, the Fed didn’t just support a deal, it supported this deal, with this buyer, and anyone who doesn’t like the terms of the deal is naturally going to start dusting the Fed and Treasury for fingerprints. What might have looked like a bailout and rescue last week to many now looks like highway robbery to some.
There’s a big element of Monday-morning quarterbacking in the complaints about the deal. Remember where the regulator stood before the sale: As late as the morning of Wednesday, March 12, Bear CEO Alan Schwartz was on CNBC saying the firm’s liquidity was fine. Bear didn’t tell the Fed and the SEC that the firm was in trouble until 7:30 p.m on Thursday March 13, and at that point, the firm was threatening to file for bankruptcy by Friday morning. The Fed tried to find a private sector buyer Thursday night, but couldn’t. If Bear filed for bankruptcy, its counterparties could potentially panic and destroy the $4.5 trillion repo securities market, and potentially touch off massacres in the credit-default swaps market, too.

Financial crisis and the real economy

Corporate DealMaker, March 19, 2008:
At times of financial turmoil there's something reassuring about the term "the real economy." It would be even more reassuring if it didn't usually denote a realm threatened by forces emanating from a scary parallel universe. But when the headlines describe large, familiar financial institutions gravely damaged by securities so complex that nobody can put a price on them, it's nice to recall that there's a world out there where people are still making tractors. Let's just hope it can be kept safe from the reckless and greedy denizens of Wall Street.Lots of us think this way. Isn't the ongoing surge in commodity prices partly a revolt against weird abstractions? Forget those freaky collateralized loan obligations and, while you're at it, the U.S. dollar they rode in on. Give us some gold and oil and steel and coffee. In fact, I would be betting really big on commodities right now, except for one thing. I'm actually a little worried that commodities are forming a bubble of their own. You see, the wizards down the hall from the ones who designed those CLOs have continued to improve on the futures and options originally created so producers and users of commodities could manage price volatility. Now exchange-traded notes and other nifty new instruments may be facilitating investment flows way out of proportion to the actual demand for commodities. Well. As the great soul singer Tyrone Davis said of a situation like the one poor Mrs. Spitzer recently faced, there it is. The tensions in the often stormy, centuries-old marriage between finance and industry, between Wall Street and Main Street, have flared up once again, and there seems little doubt about who deserves the blame. Until we start the couples therapy.That's when things get messy. The conversation can't ignore people who are needlessly losing their homes and good businesses that can't get capital. Our patchwork system of regulating financial institutions obviously needs updating, and it's not just securities but also reputations that are being marked to market. It's already happening to former Fed chairman Alan Greenspan, and also to Robert Rubin. The former Clinton treasury secretary received more than $100 million as chairman of the executive committee at Citigroup over the last eight years, even as the nation's biggest financial institution helped to dig the hole we're now in. But we will do well to remember there's a relationship worth salvaging here. On one hand, Rubin arrived at Citigroup after he and Greenspan helped to remove the regulatory barriers to the merger that created it. Now it's falling to their successors to improvise some new guardrails. Another hallmark of the Greenspan-Rubin 1990s, though, was the financial diplomacy that helped turn developing economies into emerging markets for tractor-makers and then, when that project devolved into another great financial crisis, got it back on track. If either of these men wish, like Tyrone Davis, that they could turn back the hands of time on a few decisions, they haven't said so. Certainly other people in the financial world would like to. But they can't, and neither can those of us who identify more closely with the so-called real economy. We'll just have to try and make sure we get more of what we need out of the relationship in the future.--Kenneth Klee

Link to Professor's Klee's Biography: http://www.law.ucla.edu/home/index.asp?page=564

Subprime Crisis: The PWG Weighs In

TheCorporateCounsel.net Blog, Broc Romanek and Dave Lynn, March 17, 2008:

Subprime Crisis: The PWG Weighs In
Last week, the President's Working Group on Financial Markets issued a Policy Statement on Financial Market Developments, reflecting the collective views of the Treasury, the Federal Reserve, the SEC and the CFTC on how to deal with the current market turmoil.
The report does not appear to break any new ground in describing the underlying causes of the problems: sloppy mortgage underwriting; the "erosion of discipline" in the securitization process, including failures to provide adequate risk disclosure; flaws in the credit rating process; and weaknesses in risk management and failures in banking policies to mitigate those weaknesses. The recommendations in the report might best be characterized as a suggestive – and perhaps soft – in terms of getting at these identified issues. Much of what is suggested could take years to implement – such as getting all states to implement nationwide licensing standards for mortgage brokers (if all states need to do it might not a federal licensing standard be a better idea?), compelling institutional investors to seek better risk information and better ways to evaluate risk other than through credit ratings, reforming the credit rating process, and enhancing risk management practices and prudential regulatory policies for financial institutions.
The one issue that the report actively sidesteps is what sort of concrete steps must taken with respect to the enormous OTC derivatives market that remains the 800-pound (or maybe $500 trillion) gorilla in the room. It has been the common wisdom that regulators need to continue to steer clear of the OTC derivatives market, lest they snuff out the flames of financial innovation that everyone loves until someone (or everyone) gets burned. Now we have a north of $500 trillion in notional amount market that has virtually no oversight – other than industry "oversight" – and no way to get a handle on the systemic risks posed to the worldwide financial system. Instead of suggesting any radical reforms, the PWG says that financial institution regulators should insist that the industry promptly "set ambitious standards for accuracy and timeliness of trade data submissions and the timeliness of resolutions of trade matching errors for OTC derivatives," urge the industry to amend credit derivative documentation to provide for cash settlement in the event of a credit event and ask the industry for a long terms plan for developing an integrated operational infrastructure. Whoa, some tough words on derivatives from the PWG!

The Bear Stearns Bailout: Is this the Big One?
Almost as if to underscore that the suggested fixes in the PWG report aren't going to do anything to alleviate the current state of locked-up credit markets and rapidly deteriorating asset values, news began to break early Friday about the need for a Federal Reserve lifeline to the venerable Bear Stearns. The SEC put out this press release on Friday, noting that it was monitoring Bear's capital adequacy in the light of the firm's rapidly eroding liquidity. In a conference call on Friday – memorialized in this real time blog of the call – Bear Stearns executives said that the ability to borrow against the firm's collateral from the Fed through JP Morgan was going to give them a chance to look at strategic alternatives – although they apparently weren't thinking at the time that filing for bankruptcy or selling the firm at a fire sale price within 48 hours were among those alternatives.
As noted in this article from today's WSJ, JP Morgan has agreed to purchase Bear Stearns for $236 million or $2 a share – quite a delta from the firm's market value of $3.5 billion on Friday. The Bear Stearns board was apparently cajoled by government officials, who indicated that they might not be able to bail the firm out if it did not do a deal before markets opened again this week. Shareholders interests were of little concern, it seems, as the firm's insolvency became imminent when counterparties continued to refuse to do business with Bear and prime brokerage customers ran for the exits. Apparently the Fed's credit line on Friday was not enough to stave off the "run on the bank."
The WSJ article notes that financial regulators are "scrambling to come up with new tools because the old ones aren't suited for this 21st-century crisis, in which financial innovation has rendered many institutions not 'too big too fail,' but 'too interconnected to be allowed to fail suddenly.'" Not too comforting by any stretch of the imagination.

Hedge Funds Frozen Shut

Business Week Online, March 5, 2008:

To buy time and stave off losses, more funds are blocking withdrawals. Are they just postponing the inevitable?
by Matthew Goldstein

There's a chill spreading across the hedge fund industry. With more portfolios falling victim to the credit crunch, managers by the dozen are freezing investor redemptions, preventing a mad rush to the exits that would force funds to sell beaten-down assets to raise cash. But is this unprece­dented move just postponing the day of reckoning for funds and the market?
Since November at least 24 hedge funds have barred or limited investors from taking their money out, tying up tens of billions of dollars for an indefinite period.
It's understandable why hedge funds would want to keep investors from pulling out their money en masse. In this market, any sales would almost certainly be at cut-rate prices, guaranteeing big losses in portfolios. And once managers start dumping assets, there's also the danger that big banks, which provided the funds with credit lines to amp up returns through what's known as leverage, will demand their money back as collateral shrinks. Those margin calls would prompt further sales, setting off a vicious cycle that could ensure a fund's demise.

Read article at: http://www.businessweek.com/magazine/content/08_11/b4075000870869.htm?dlbk

Study: Midmarket M&A to keep pace in '08

Corporate DealMaker, Posted on February 26, 2008 at 5:13 PM

Dealmakers at middle-market companies are generally optimistic about the current and future deal climate, according to the results of a recent survey. CFO Research Services and CIT Group Inc. surveyed 529 senior-level finance decision makers at middle-market U.S. and Canadian companies for their report "M&A in Challenging Times." According to the survey:
Although a substantial number of respondents said that M&A activity would decrease over the next year (23 percent), many respondents predicted an increase in M&A activity (47 percent), while nearly a third said they believed M&A activity would stay the same. Not surprisingly, respondents said strategic players with strong balance sheets would not be deterred by uncertainty in the credit market. The results also indicated that fundamental business factors such as the need to enter new markets and responding to competitive threats would be the main deal drivers. The survey results generally support the conclusions reported in this Dealscape, which predicts midmarket players may find good deals in the months to come as companies hurt by the sluggish IPO market, low liquidity among smaller companies and a tough economy go looking for buyers.
For more on the CIT study, including a chart, see this item on Dealscape. - Baz Hiralal

Hedge Funds Still Pose Risk to Financial System, Report Says

Despite closer monitoring by regulators, hedge funds still pose significant risks to the financial system, a government report said Monday.
The loosely regulated capital pools favored by the rich and by large financial institutions “require continued monitoring by regulators and counterparties,” according to a report released by the Government Accountability Office, the investigative arm of Congress.
The study found that hedge funds’ inclination to take substantial risks with increasingly large sums of money — and to leverage those bets — means losses can spread and be magnified throughout the financial system.
The report said banks eager to do business with hedge funds often are not critical enough when assessing the risks of their complex investment strategies.
The G.A.O. study comes at a tough time for hedge funds, which last month reported heavy average losses in a slumping stock market. In December, new money invested in hedge funds hit its lowest level in two years as investors cooled to the sector.
As it has grown in size and gained public attention, the hedge fund industry has fought a series of battles over regulation and taxation on Capitol Hill and with the U.S. Securities and Exchange Commission, with mixed results
Go to Article from BusinessWeek »
Go to Article from Reuters »

Supreme Court Continues Pro-Business Stance

In three key business rulings handed down Wednesday, the Supreme Court continued its trend toward freeing companies from the conflicting regulation of 50 different states in favor of one federal regime.
The Court favored federal pre-emption over state laws and state court remedies in the areas of medical device regulation, interstate shipping of tobacco and arbitration of contract disputes.
In announcing one of the cases from the bench, Justice Antonin Scalia said the day's decisions made it clear that "we consider it part of our business" to sort out the balance between federal and state law.
But it was not a clean sweep for business Wednesday. In LaRue v. DeWolff, Boberg & Associates, the Court ruled that employees can sue employers under the Employee Retirement Income Security Act for mismanaging their 401(k) retirement plans.
Of Wednesday's pre-emption cases, Riegel v. Medtronic may have the broadest impact. The Court ruled against the estate of Charles Riegel, who died after a catheter made by Medtronic malfunctioned during heart surgery.
Riegel sued in federal court, invoking New York state common law to argue for liability and damages. Like lower courts, the Supreme Court ruled that the federal Medical Device Amendments of 1976 specifically preclude states from imposing their own requirements on the makers of federally regulated medical devices.
Justice Ruth Bader Ginsburg dissented from the opinion authored by Scalia. Ginsburg called the ruling a "radical curtailment" of state law remedies that Congress did not intend when it passed the law.
Jon Haber, head of the American Association for Justice, the organization for trial lawyers, criticized the ruling and said it "should be narrowly viewed as applying only to certain medical device cases and should not serve as precedent for cases involving drugs and other consumer products."

Investor Activism Tops Last Year's Record Pace

Kaja Whitehouse of the WSJ wrote this article on Saturday: "Efforts by activist investors to fight for board seats, oppose mergers and otherwise shake up companies are on track to beat last year's record levels, contrary to expectations that activity would dry up because of unstable market conditions.
There have been 72 campaigns waged by activists so far this year, as of Feb. 11, with targeted companies ranging from Countrywide Financial Corp. to New York Times Co. Last year, when shareholder activism hit record levels, there were just 54 campaigns waged over the same time period, according to FactSet SharkWatch, which tracks proxy contests and corporate-takeover defenses.
Hedge funds continue to be big participants. More than half, or 38, of the campaigns so far this year were initiated by hedge funds, compared with 21 during last year's period, according to FactSet SharkWatch."

How acquirers can ride the restructuring wave

Steve Zuckerman, director of the Special Situations Group at Farlie Turner & Co., writes exclusively for Corporate Dealmaker on how strategic buyers can muscle through tough economic conditions. The Corporate Dealmaker, February 12, 2008.

With less liquidity in the market and tighter credit standards now in place, it is likely that credit defaults will dramatically rise and companies will no longer be able to refinance themselves out of their financial challenges. This economic climate will create opportunities to acquire companies with overleveraged capital structures -- but sound business models -- for a significant discount.

The opportunities will develop in multiple sectors -- not just among real estate developers and mortgage lenders, but also in any industry tied to the housing market such as the myriad of building product and equipment rental companies. We also expect other industries to suffer considerable challenges, including retail, casual dining, manufacturers and distributors of durable goods. Within these industries, it is smaller and midsize companies that will feel the pressure first as they typically have fewer resources and are less likely to raise institutional capital.

Strategic buyers with strong balance sheets will benefit because they will be able to capture market share by acquiring undercapitalized competitors. Private equity firms, flush with capital, are also likely to find many favorably priced deals, although they will be unable to use as much debt to finance their purchases as in the past. Still, buyers will need to be vigilant, since different rules and strategies apply in distressed M&A.

When acquiring a company that is insolvent (generally defined as a company whose liabilities exceed its assets or one that is unable to pay its debts as they come due), one of the greatest risks is being sued for a fraudulent transfer. The term "fraudulent" is somewhat of a misnomer, since neither fraud nor misconduct needs to be proved. Instead, federal and state (constructive) fraudulent transfer law permits a transfer to be unwound if the transfer was not for fair consideration and the seller was not solvent at the time of transfer or become insolvent as a result of the transfer. A failed leveraged buyout, for example, is often attacked by creditors as a fraudulent transfer. As the buyer utilizes the target's assets to finance the transaction, the target arguably received less than "reasonably equivalent" value.

There are several ways for a buyer to limit its exposure to a fraudulent transfer claim, such as obtaining a fairness opinion, a solvency opinion or consummating the transaction in the context of a bankruptcy proceeding -- which is the most foolproof approach. Another interesting wrinkle in negotiating with a distressed company is that when the company enters into the "zone of insolvency," the fiduciary responsibility of directors and officers shifts from shareholders to creditors. Buyers can gain leverage by making this point painfully clear to directors and officers.

Whether the buyer is strategic or financially oriented, an important part of the acquisition strategy should be focused on whether the assets should be acquired in or outside of bankruptcy. Acquiring distressed companies and assets through a bankruptcy proceeding provides considerable benefits, such as cleansing the assets of liens, the ability to reject unfavorable contracts and the virtual elimination of various types of liabilities. However, these benefits must be weighed against the transparency of a bankruptcy proceeding, which is designed to fully vet an asset, foster competition and garner the highest and best price. Strategic buyers also need to consider the reputational impact of a bankruptcy and the effect it could have on trade vendors. If a company has critical and irreplaceable vendors, a buyer should consider contacting such vendors to determine whether they would discontinue doing business with the company if it files bankruptcy. In the end, each distressed situation presents unique facts and buyers should rely on experienced restructuring advisers to assist them in their quest to take advantage of the challenging times that lie ahead.

Steve Zuckerman. The author is director of the Special Situations Group at Farlie Turner & Co., a Fort Lauderdale, Fla.-based investment bank serving growth-oriented middle-market companies. Recently launched, the group provides investment banking, capital raising and financial advisory services to middle-market companies experiencing financial difficulties, ranging from underperforming to significantly distressed businesses.

SEC Proposes Further Section 404 Delay

TheCorporateCounsel.net Blog:
The SEC has proposed yet another one-year delay in implementation of an independent auditor’s attestation report on the internal controls for the smallest public companies. As noted in the blog at the end of last year, Chairman Cox had promised this delay in his testimony before the House Committee on Small Business.
Under the proposal, non-accelerated filers would be required to provide auditor’s attestation reports beginning with their annual reports filed for fiscal years ending on or after December 15, 2009. The proposal does not affect the requirement that management complete its own assessment of internal control over financial reporting – which is now required for all filers, regardless of size. The proposing release is out for a 30-day comment period.
The proposed delay in fully implementing Section 404(b) – to over seven years after Sarbanes-Oxley was enacted – coincides with an announcement that the Staff has commenced its previously discussed study of the costs and benefits associated with the auditor attestation requirement for smaller companies. This is supposed to be an analysis of “real world” data in order to measure experience with the recent SEC and PCAOB guidance for management and auditors. The final results of the study are not expected for several months.

New Rules Could Shine Spotlight on Deal Fees

NYT DealBook, January 31, 2008:
New accounting rules for mergers and acquisitions are likely to have some far-reaching consequences for what such deals cost and how they get done, Compliance Week reports.
One of the most significant changes relates to transaction fees, including fees for investment bankers, attorneys and accountants. Under the new standard, those fees will generally need to be expensed when they are incurred. (Under the current rules, such fees are capitalized and amortized over time.)
Because so much deal-related work happens before a transaction is announced, companies may need to worry about tipping off the markets about a potential deal when those expenses turn up.
The new rule, set to take effect in fiscal 2009 for calendar year-end companies, could also bring more attention to the size of lawyers’ and brokers’ fees.
“Anytime you have something hitting the bottom line, it’s going to lead to more attention,” David Zagore, a partner at Squire, Sanders & Dempsey, told Compliance Week.
Go to Article from Compliance Week »

Here Is Why the Blackstone-ADS Deal Is in Trouble

Posted by Heidi Moore, WSJ DealJournal:
A lot of private-equity firms probably would be happy these days to have an excuse to walk away from a $7.8 billion deal. But Blackstone Group insists it is clinging tight to the dream of acquiring Alliance Data Systems – no matter what Office of the Comptroller of the Currency says.
The OCC appeared to deal a death blow late Friday to Blackstone’s hopes of acquiring the credit-card processor by setting down requirements that Blackstone refused to meet. Blackstone said the OCC wanted the firm to take on “operational and financial burdens…that cannot be reasonably assumed.”
In wake of that announcement, ADS shares have shed more than $22, or more than 34%, to $43.23 this morning, well below the $81.75 a share Blackstone agreed in May to pay for the Dallas company.
What requirements could be so harsh as to endanger a deal for which Blackstone already had set up financing? What the OCC required, according to a person familiar with the matter, is for Blackstone to guarantee itself as “the source of strength” for ADS’s bank operation.
What, you didn’t know ADS had a bank? Actually, it owns World Financial Capital Bank, an industrial bank with a Utah charter, which puts the company under the regulatory oversight of the OCC as well as the Federal Deposit Insurance Corp. ADS cited World Financial Capital in its most recent quarterly filing as one of its four main sources of funding. The OCC wanted Blackstone to bail out ADS in the event of any trouble – with no size limit to the bailout.
Given the scary press recently about the possibility of the U.S. slipping into recession and the general dismal state of the financial sector lately, it isn’t surprising that Blackstone declined.
Blackstone will continue to talk to ADS about doing a deal, this person says, and will take up a previously mentioned plan to restructure ADS so that the acquisition can go through.
It is a good thing, too: ADS today said Blackstone would have no grounds for walking away from the deal according to the merger agreement, and added that Blackstone should continue negotiating with the OCC.
Merger-structure wonks might be excited about what comes next. What Blackstone and ADS have discussed–and avoided so far–is a move that would somehow transfer World Financial Capital to another institution. (No word on what that institution might be, however.) A partial acquisition might be better than none at all.

Alliance Data Says Blackstone Deal Is in Trouble

For months, Alliance Data Systems said that its $6.43 billion sale to the Blackstone Group was on track. In recent weeks, amid sudden, sharp declines in Alliance Data’s stock price, people briefed on the deal negotiations told DealBook and other media outlets that the acquisition was proceeding.
But on Monday, the credit-card services provider said it has received notice from Blackstone that the private equity firm does not expect to complete the deal. The notice, sent after the market’s close Friday, said that a federal regulator is asking for “extraordinary measures” in order to grant approval — and that Blackstone is unwilling to meet them.
Blackstone also said that it does not expect the regulator, the Office of the Comptroller of Currency, to consider alternative solutions that are acceptable to Blackstone, according to Alliance Data.
Alliance Data’s board said it “strongly disagrees” with Blackstone’s assessment. The company does not believe that the O.C.C.’s position is final, it said in its statement. Alliance Data also said that Blackstone’s notice does not claim any breach of the deal agreement by the company, or what is known as the declaration a material adverse change. Blackstone also has not taken issue with Alliance Data’s financial or operational performance.
A person close to Blackstone confirmed the notice and the buyout firm’s concern over the O.C.C.’s position, but reiterated that the regulator’s demands were untenable and would have exposed the private equity firm to millions of dollars in losses even after a potential sale of Alliance Data.
Alliance Data’s board is now evaluating its possible courses of action, the company said in its statement.
The deal has now joined the ranks of other buyouts that have run into trouble after the deflation of the buyout boom. Buyouts of companies ranging from Sallie Mae to United Rentals to PHH, another Blackstone deal, have collapsed for reasons ranging from legal issues to financing concerns.
Some of those deals, like those for Sallie Mae and United Rentals, have gone to court.
Go to Alliance Data Press Release via CNN Money »

The Economic Impact of Private Equity

Fron Dan Primacks' Private Equity Hub:
Last Friday, SEIU protesters at Wharton accused the private equity industry of being a callous job killer. Then The Private Equity Council released a study purporting to show that its members were actually magnanimous job creators. Not surprisingly, the truth is found somewherei n the middle.
A massive new academic study called “The Economic Impact of Private Equity” was released today in Davos, and included detailed findings on private equity employment. Among the findings:
* Two years prior to a buyout, PE-backed companies cut 4% more of their employees than do companies that are not acquired by PE. The indication here is that the typical PE-backed company is in relatively tougher shape to begin with.
* PE-backed companies cut, on average, 7% of its existing workforce over the first two years post-buyout. But they also add jobs over the same amount of time, resulting in just a 1% net employment decrease. Job growth balances out with the non-PE control group in years four and five. Expect the SEIU and other critics to inquire as to the “quality” of those new jobs — in terms of location, salary and benefits.
The study examined around 5,000 PE transactions between 1980 and 2005 (recent boom excluded, therefore), and was co-led by Josh Lerner of Harvard Biz School and Steven Davis of U Chicago. I’ll have more on this later, once I read through it all. In the meantime, you can also read it for yourself:
Executive Summary: ExecSummary.pdf
Full Report: Full_Report.pdf

Union Protest Roils Private Equity Conference

David Rubenstein was supposed to deliver the keynote speech Friday morning at the Wharton Private Equity Conference, an annual event that draws buyout professionals and academics to discuss the state of the industry. Instead, Mr. Rubenstein, managing director of the Carlyle Group, was “hooted off the stage,” as The Philadelphia Inquirer’s Joseph N. DiStefano described it, by protesters from the Service Employees International Union.
The union, which has emerged as one of the buyout industry’s fiercest critics in recent years, has been no stranger to street theater and other attention-getting events. But Friday’s protest, which Daniel Primack of PEHub.com said drew a “small army of police” to the scene, took things to another level.
George White, writing for TheDeal.com’s DealScape blog, described between 30 and 50 people streaming into the conference room at the Park Hyatt Philadelphia Hotel, shouting and passing out flyers. A woman with a megaphone “lit into” Mr. Rubenstein about his firm’s recent acquisition of ManorCare, the largest chain of nursing homes in the United States, Mr. White wrote.
The union tried to thwart that deal by questioning the effects it would have on residents’ living conditions, but it was ultimately approved by ManorCare’s shareholders as well as regulators in all the states involved.
The Service Employees International Union, which has nearly 2 million members, has moved on several fronts to raise questions about whether the recent boom in private equity deals is good for the average worker. Last summer, they organized a small demonstration in the Hamptons, a tony enclave in New York’s Long Island, where protesters pretended to be billionaires and expressed mock opposition to raising taxes on private equity fund managers.
The union has also created Web sites critical of various private equity firms as well as specific buyout deals.
On Friday, a correspondent for DealBreaker.com described Mr. Rubenstein as being rendered momentarily “speechless” by the protesters — remarkable in itself for a man who is a regular on the speech-giving circuit.
He apparently found his voice soon enough, however, telling the woman with the megaphone to “take a remedial course in English before you go any further.”
Go to Article from the Philadelphia Inquirer »
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Supreme Court Restricts Securities Lawsuits

In one of the most closely watched business cases in years, the Supreme Court on Tuesday upheld protections for secondary players in securities-fraud schemes, as opposed to the primary engineers of those plots.
The court ruled, 5 to 3, against plaintiffs who had sued two cable television equipment suppliers whose dealings with a cable television company had allowed the cable outfit to inflate its earnings and hide its failure to achieve its financial goals.
Although the outcome of the case, Stoneridge Investment Partners v. Scientific-Atlanta, No. 06-43, hinged on terminology that might seem technical and arcane to a layman, the case is likely to be felt far beyond Wall Street, as lawyers for investors and businesses fight over who can be sued and who cannot.
The majority noted that, whatever deception was committed by the defendants, “their deceptive acts were not communicated to the investing public during the relevant times,” and that it was Charter that misled auditors and filed fraudulent financial statements.
The plaintiffs were unable to show any public reliance on the defendants’ actions “except in an indirect chain that we find too remote for liability,” Justice Anthony M. Kennedy wrote for the majority.
The Stoneridge ruling appears to offer protection for accountants, lawyers and others who may know about corporate shenanigans but can establish that they are not directly involved in them. Defense lawyers in shareholders’ suits often complain that defendants can be forced to settle claims with little merit rather than risk prolonged and costly litigation.
“The court held that you are not your brother’s bookkeeper,” said Jerrold J. Ganzfried, a former assistant to the solicitor general and now head of the Howrey law firm’s Supreme Court and appellate litigation group.
A key question in the case decided on Tuesday was whether Scientific-Atlanta and the other defendant, Motorola, were “primary violators” in a sham bookkeeping transaction with Charter, or if they were guilty only of “aiding and abetting” a fraud engineered by Charter.
At the request of Charter, which in mid-2000 was falling short of its cash-flow target, Scientific-Atlanta and Motorola agreed to increase their prices for the cable boxes they sold to Charter and to use the extra money to buy advertising on Charter’s cable stations. The arrangement allowed Charter to treat the advertising purchases as current revenue while listing the money spent on cable boxes as a capital expense.
Four Charter executives eventually pleaded guilty to criminal charges, and Charter paid $144 million to settle a suit brought by Stoneridge on behalf of shareholders.
When the case was argued before the justices on Oct. 9, the lawyer for Scientific-Atlanta and Motorola asserted that, at worst, his clients had aided and abetted Charter’s fraud, and thus should not be liable.
Subtle or not, the difference between a primary violation and aiding and abetting was all-important in the case decided on Tuesday. The reason is that in a 1994 case, Central Bank of Denver v. First Interstate Bank, the Supreme Court ruled that laws governing securities did not provide for any liability for “aiding and abetting.”
Although Congress responded to that decision by giving the Securities and Exchange Commission the authority to bring lawsuits for aiding and abetting, it did not give private plaintiffs the authority to do so.
Any decision to give private litigants the power to sue aiders and abetters “is thus for the Congress, not for this court,” Justice Kennedy wrote. Joining him were Chief Justice John G. Roberts Jr. and Justices Antonin Scalia, Clarence Thomas and Samuel A. Alito Jr.
Lawyers involved in securities litigation said the ruling continues a trend in which the court shows itself “less inclined to finish up legislation for Congress” than earlier lineups of justices, as Bob Pietrzak, co-head of litigation in Sidley Austin’s New York City office put it.
“The court’s decision continues its recognition that expanding the U.S. securities laws beyond the reach expressly intended by Congress is not only legally incorrect but endangers the competitive position of the United States in the global marketplaces,” Mr. Pietrzak said. “Non-U.S. entities can feel more comfortable that doing business in the United States will not have the unintended consequence of exposing them to liability under the U.S. securities laws.”
Go to Article from The New York Times »
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Congress asks Prince and O’Neal to testify on pay

A United States Congressional committee has asked Charles O. Prince III, the former chairman and chief executive of Citigroup, and E. Stanley O'Neal, his counterpart at Merrill Lynch, to justify their exit pay packages when they were forced to leave the banks.
Go to Article from Financial News»

VCs raise $34.7B in 2007

The final results are in, and it looks as if venture capitalists will have plenty of capital to invest over the next three to five years; new stats from the National Venture Capital Association and Thompson Financial show that last year's fundraising reached its highest level since 2001.
Two hundred and thirty-five new vehicles closed with $34.7 billion in 2007, an increase of 9.4% from the $31.6 billion in 2006. Additionally, 2007 fundraising dollars reached the highest level since 2001 when venture capitalists raised $38.8 billion from 318 funds. Early-stage funds grabbed $9.7 billion, but balanced stage funds raised the most with $10.6 billion. Later-stage vehicles secured $7.2 billion while expansion-focused funds raised $4.8 billion.
Back in 2001, (the last time VCs had so much in their coffers) venture firms received $38.8 billion for new funds before everyone realized that the party was over, resulting in negative IRRs, returned capital and shuttered funds for a number of firms. Although today there's no bubble approaching the size of the one inflating at the turn of the century, venture capitalists are once again looking at an iffy environment. With startups needing less money than ever to get off the ground, an economic slowdown (hopefully without a recession) and valuations in their most attractive industries - cleantech and Web 2.0 - reaching sky-high levels, venture firms may once again have a tough time deploying all the cash they raised. Still, venture capitalists have reason to be optimistic even during a downturn, as companies like Google Inc., Facebook Inc., MySpace.com and others that were funded after 2001 show there's still money to be made even in tough times. - George White
Souce: The Deal.com, 1/14/08

Study Sparks Regulator Scrutiny of Merger Arbitrage

With the rise of proprietary trading desks, investment banks sometimes find themselves taking positions in the stocks of companies they are advising in merger talks. At least a few of those instances are probably coincidental, and the firms will certainly argue that they are.
But an academic study released last month suggests something more troubling: that as investment banks advise companies in takeover situations, they are also investing in the targets of these merger talks. The research, which says the rate of such investments is too high to be merely coincidental, has now interested securities regulators as well, The Wall Street Journal reported Monday.
The Journal, by reviewing stock-ownership and deal records, identified dozens of instances in which investment banks appeared to be buying shares in target companies around the same time their bankers were advising the acquirers. The transactions involved most of the major investment banks, including Citigroup, Credit Suisse Group, Goldman Sachs, Merrill Lynch and Morgan Stanley.
The firms either declined to comment or said they found no problems with the trading, The Journal said.
The issue is “definitely on our radar screen,” says Stephen Luparello, a top official at the Financial Industry Regulatory Authority, or Finra, formed last year when the National Association of Securities Dealers and the enforcement unit of the New York Stock Exchange merged.
Finra has asked banks for their trading data, but Mr. Luparello told The Journal the inquiry may not find any problems.
Go to Study via SSRN »
Go to Article from The Wall Street Journal »

DOL Guidance on Proxy Proposals

The U.S. Department of Labor recently issued Advisory Opinion 2007-07A to the U.S. Chamber of Commerce, responding to the Chamber’s concerns about “the use of pension plan assets by plan fiduciaries to further public policy debates and political activities through proxy resolutions that have no connection to enhancing the value of the plan’s investment in a company.”
Mike Melbinger notes in his CompensationStandards.com blog: “By way of background for those not familiar with ERISA, the DOL has long considered the right to vote proxies related to a retirement plan's stock holdings as a valuable asset of the plan. In Advisory Opinion 2007-07A, the DOL said:
‘Under section 404(a)(1)(A) and (B) of ERISA, plan fiduciaries must act solely in the interest of participants and beneficiaries and for the exclusive purpose of paying benefits and defraying reasonable administrative expenses. In our view, plan fiduciaries risk violating the exclusive purpose rule when they exercise their fiduciary authority in an attempt to further legislative, regulatory or public policy issues through the proxy process when there is no clear economic benefit to the plan. In such cases, the Department would expect fiduciaries to be able to demonstrate in enforcement actions their compliance with the requirements of section 404(a)(1)(A) and (B).* * *Consistent with these various pronouncements, the use of pension plan assets by plan fiduciaries to further policy or political issues through proxy resolutions that have no connection to enhancing the value of the plan’s investment in a corporation would, in the view of the Department, violate the prudence and exclusive purpose requirements of section 404(a)(1)(A) and (B).’
Those of us familiar with ERISA's fiduciary requirements were sometimes curious as to how some union plan fiduciaries could square their proxy activism with ERISA. Apparently, the DOL was too.”