Wednesday, September 9, 2009

We Have Moved

Please visit us at our new home:
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Friday, May 1, 2009

RICO, Goldman Sachs and TARP

Here's a very interesting take on the RICO implications of some maybe not so coincidental TARP decision making...

CONTINUE the rest of your post here.
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Thursday, April 23, 2009

Is DIP Financing Starting to Pick Up?

Bankruptcy filings have increased during this financial crisis, but debtors in possession have had trouble finding financing. That may be until now. Last week the Wall Street Journal's website reported that a few firms had choices in selecting lenders for their bankruptcies.

As Jonathan Spagat reported last week in General Growth Files for Bankruptcy the REIT filed for bankruptcy, but it had its choice in selecting lenders. In fact "a number of lenders expressed interest in providing the loan."

The WSJ Online article goes on to say that two other firms had lending choices over the past two months. Potential lenders for Aventine Renewable Energy Holdings, Inc. even had lenders go to court and fight for the opportunity to lend. Chemtura Corp, a chemical company, had two lenders to decide from. The company eventually picked Citigroup, Inc.

Increases in DIP lending may be good news for the economy and lawyers. It may indicate that banks are starting to lend again and lawyers may become busy with bankruptcy cases.

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Wednesday, April 22, 2009

Helio Castroneves Acquitted of Tax Evasion

Helio Castroneves was acquitted Friday of all five tax evasion charges stemming from his alleged formation of foreign shell corporations to hide certain racing revenue. ESPN reported that the case really ended up coming down to testimony from Castroneves's father regarding the original formation of the foreign corporations. He claimed his son never had any control or ownership interest in the corporations and that Helio had no control over their initial formation. The jury obviously believed Helio and his father regarding the tax evasion but was still hung on one conspiracy charge. The Government likely will not pursue the conspiracy issue any further though. Helio could have faced up to six years in prison had he been convicted.

Both Helio's sister, who is his business manager, and Alan Miller, Helio's attorney responsible for his financial planning and structuring, were acquitted of their tax evasion charges as well.
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Friday, April 17, 2009

Assessing TARP Strategy report from COP

Elizabeth Warren, the chair of the Congressional Oversight Panel (created to oversee the expenditure of TARP funds, and to “review the current state of financial markets and the regulatory system”) was on The Daily Show with John Stewart this week to talk about TARP and the recent report on TARP strategy released by the Panel.

On April 7, six months after the passage of the Emergency Economic Stability Act, the Congressional Oversight Panel released a report titled “Assessing TARP Strategy.” The report, relying on historical responses to past banking crises, reviews methods for evaluating the programs created to assuage the current financial crisis. The Panel identified 4 elements that were critical to historical banking crises programming: Transparency, Assertiveness, Accountability, and Clarity.

The first half of Stewart’s interview with Warren illustrated that some of these elements don’t seem to be a part of the current programs. Warren stumbled her way through questions about how much money has been spent, and what exactly that investment was worth – rather, what it wasn’t worth. She did manage, though, to point out that this general uncertainty was due in large part to Paulson’s “don’t ask, don’t tell,” policy of distribution in relation to the first $350 billion of expenditures. Warren said the Panel is calling for more transparency, more accountability, and more clarity; they want a better articulation of policy and an explanation of what exactly is going on in the current expenditure programs.

Warren also took the opportunity to advocate a need for smart regulation to bring about economic stability and prosperity. She noted that before the great depression our economic history followed a boom and bust cycle every 10-15 years. After the implementation of regulations like the FDIC, SEC, and Glass-Steagall, though, we had a long period with no financial crisis. But those regulations began to unravel, according to Warren, and we ended up where we are today. (Bonus: check out this post on Geithner’s regulatory plan).

So check out the the interview (part 1, part 2), and the report and let me know what you think...
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Credit Default Swaps Making Corporate Reorganization Impossible?

The Financial Times reports that credit default swaps may be undermining companies’ attempts to reorganize in bankruptcy. When a debtor company attempts to reorganize, the success of the reorganization often depends on creditors agreeing to reduce, extend the repayment period of, or otherwise modify the outstanding debt owed to them by the reorganizing debtor. A creditor would be willing to do this because the modified debt would lead to a larger repayment than the amount the creditor would receive in the event of a liquidation of the debtor company.

Thus, corporate reorganizations are made possible because lenders have an interest in keeping their debtors from being liquidated. However, when lenders take out credit-default swaps on debtor companies as insurance on their loans, the lenders stands to receive full or partial payment of the debt from the CDS dealer if the debtor defaults. This payout from CDS increases the total return to the lender in a debtor’s liquidation; thus, lenders holding CDS-backed debt are less willing to accept reduced and/or extended payments from debtors, and corporate reorganizations become more difficult, if not impossible, to structure.

Should the bankruptcy law be modified to somehow fix this severing of a lender's and debtor's interests? Could a bankruptcy court revive a CDS-backed lender's incentive to compromise by modifying CDS contracts or by increasing the benefits of a reorganization? Or could the CDS dealer who inherits the lender's anti-liquidation interest somehow be brought into the equation?
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Thursday, April 16, 2009

Links Roundup

  • Former NY Gov. Eliot Spitzer weighs in on the 7th Circuit Jones v. Harris case. That case was first mentioned on this blog in early March. Chicago-Kent Professor William Birdthistle, who authored a brief of amici curiae with several other law professors for the Jones v Harris case, is quoted in the Wall Street Journal commenting on a similar case from the 8th Circuit, Gallus et al. v Ameriprise Financial Inc., which makes reference to both the Posner and Easterbrook opinions in Jones.
  • “Accountability Lies with All of Us” - Tom Wilson, CEO of Allstate, wrote this Op-Ed in yesterday’s NY Times, advocating that “we must all accept responsibility for our current situation, and work together to broaden the scope of federal regulation to protect both consumers and financial markets.”
  • Hot on the heels of Northwestern’s offer to graduating students to extend their University-sponsored health care coverage, UCLA has announced that it is establishing a new LLM program for the 2009-2010 school year – the “Transition to Practice” program, which will “focus on enhancing the practical skills and development of the new lawyer.” Ironically, we have heard this idea somewhere before … for further debate on whether an apprenticeship should simply be part of the J.D. curriculum, you can click here, here, or here.
  • OMG, GGP – As Jon mentioned below, General Growth Properties filed for bankruptcy this morning. They are represented in bankruptcy by Marcia Goldstein of Weil Gotshal and James Sprayregen of Kirkland & Ellis. See extended coverage from Crain’s Chicago Business and the Trib.
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HUGE Opportunity for Corporate and IP Law Students!

Quaver Battery Management System, a student group in the Stuart School of Business, is offering law students the opportunity to draft their incorporation documents, two contracts, and three provisional patents. This is a truly unique opportunity for students to get direct transactional experience with a dynamic start-up. The docs are time sensitive so please respond ASAP if you are interested! More information below ...

Quaver Battery Management System is a student group in the Stuart School of Business. The focus is on coming up with solutions to implementing the electric car infrastructure and creating viable market entry points for this new and exciting industry. The team of ten and growing students in the Stuart School competed in Pittsburgh this Spring at the Carnegie Mellon McGinnis Venture Competition in the field of Sustainable Technology. The team has a diverse background in engineering, management and the automotive industry, and are currently represented in the Finance, Environmental Management and MBA programs.

Currently the team is being considered to present to the Department of Energy, and has also met with the city and a number of potential clients/ investors. After over 6 months of work, we are close to closing our first deal and need help with incorporation, two contracts, and three provisional patents. If you are interested please contact the team leader, John Brophy, at or at 773-517-5897. All of these are time sensitive so if you have time as soon as Friday to have a first meeting please let me know. Thanks!
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General Growth Files for Bankruptcy

Proclaimed as one of the biggest real estate collapses in history, Chicago's own General Growth Properties filed for bankruptcy this morning. More information can be found here. Read More......

Wednesday, April 15, 2009

NBA Might Need New Collective Bargaining Agreement

The Sports Business Journal reported this week that despite a collective bargaining agreement between NBA players and owners that runs through the end of the 2010-2011 season, a new agreement will likely have to be agreed upon.

Because of the poor economic climate and the expected low business numbers league-wide, a new agreement seems forthcoming. But, collective bargaining agreements, like most normal union labor contracts, rarely are easy to negotiate or agree upon for that matter. On the contrary, they are often difficult to hammer out, and in this economic climate there is little chance players, looking for as many incentives as possible, and owners, looking to save as much as possible, will see eye to eye on anything.
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Investors Push Towards Madoff Bankruptcy

Five of Bernard Madoff’s investors filed a petition to force Madoff into an involuntary Chapter 7 bankruptcy on Monday. The petition comes after U.S. District Judge Louis Stanton of the Southern District Court of New York ruled on Friday that bankruptcy would be the best way for investors to reclaim their lost assets and lifted a stay obtained by the Securities and Exchange Commission (SEC) to block any litigation against Madoff. Although the SEC and Department of Justice fought the lifting of the stay claiming that an involuntary bankruptcy would only delay recovery and add to administrative costs, Judge Stanton stated that those concerns were “speculative” and “outweighed by the benefits to Mr. Madoff's victims of a bankruptcy trustee's orderly and equitable administration of his individual estate." The number of investors included as creditors under the petition will undoubtedly increase as five is merely the minimum number of creditors required to file an involuntary bankruptcy under the U.S. Bankruptcy Code. Read More......

Tuesday, April 14, 2009

Bankruptcy Law Ineffective?

A recent article on MSNBC suggests that a federal law, which was enacted in 2005 to make it more difficult for Americans to file for bankruptcy, is failing.

The article is referring to the Bankruptcy Abuse and Consumer Protection Act of 2005, which aimed to prevent Americans from abusing the bankruptcy system. Essentially, this Act imposes additional requirements on Americans who wish to be eligible for bankruptcy filings. For example, the Act requires applications to pass a "mean" income test in certain situations, complete credit counseling, and provide tax returns and proof of income.

In an attempt to show that this Act is ineffective, the article presents a prediction that bankruptcies through the next year could level off at 1.6 million - the same number which prompted the creation of the new bankruptcy law. Similarly, the article says that the law has "failed" to steer people away from Chapter 7, as these filings currently account for 69% of all bankruptcy filings - a number that is only slightly slower from the proportion of Chapter 7 filings in 2004, which leveled off at 71%.

However, these statistics do not show that the 2005 Act is "failing." In 2009, Americans face one of the greatest economic crises in US history. Thus, one would expect the amount of 2009 filings to be much greater that that of previous years. The fact that the amount of 2009 bankruptcy filings is still less than that of 2004 - even if only slightly less - indicates that the Act is effective.
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Thursday, April 9, 2009

Insurance & Asset Protection

We learn in Business Organizations and other law school electives that corporations and LLCs protect their owners' assets. But how can the corporation or LLC protect its assets? David F. Rolewick of Rolewick & Gutzke, P.C. writes in the ISBA's Section on Corporations, Securities, and Business Law Forum "that insurance is first line of defense."

Insurance can protect against many potential liabilities and may come in the form of general liability, directors' and officers' liability, as well as umbrella insurance. Mr. Rolewick even provides a chart of different types of available insurance at the end of his article. He goes on to say that insurance policies may pay to defend litigation even if the litigation is over an issue excluded from the policy. However, he notes that the insurance company may reserve its right to "enforce the exclusion in a separate action." Still, having the litigation expenses covered may be invaluable because Mr. Rolewick points out that defending litigation may be a client's biggest exposure.

In conclusion, when setting up a LLC or a corporation to protect a client's asset, a practitioner may be wise to have the client consider insurance to protect the new entity's assets as well.
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News Roundup

Here are links to some interesting recent stories:

Today, Barclay's sold subsidiary iShares to private equity group CVC Capital. The price tag was somewhere between $4.2 and $4.41 billion, depending on if you are Financial Times or The Wall Street Journal.

Top Obama Economic Adviser Lawrence Summers sees an end to our current economic free fall. Summers did not, however, provide insight about when a rebound would happen and how strong it would be.

As the stress tests on banks wrap up, Reuters reports that no banks will close as a result of the tests.

According to the Housing and Urban Development Secretary, banks receiving TARP assistance will be required to participate in the
government’s mortgage modification initiatives. You can check out that story here.

And finally, Wells Fargo had a good day.
The bank rallied global stocks today when it announced expectations of $3billion in net income for the first quarter. The AP suggests that it may just be an anomaly.

CONTINUE the rest of your post here.
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Wednesday, April 8, 2009

Short Selling Under Attack Again?

The SEC seems to be moving ahead with plans to place restrictions on short selling. Short selling occurs when Party A borrows a share of a stock from Party B for a fee and sells the borrowed stock to Party C. At some date in the future, Party A must buy a share of the borrowed stock on the market and give it to Party B. If the price of the stock went down between the time of the sale to Party C and the time of Party A’s purchase of the stock on the market, Party A makes a profit. Some people believe that short selling is bad for the market because short sellers only profit when stock prices go down, and, thus, they have an incentive to spread false rumors about the companies whose stock they short to drive down the stock’s price. Also, in times of high market volatility, increased short selling in a stock could cause a sell-off panic. To combat these problems, the Commission is seeking comment on a proposed circuit-breaker rule and two proposed versions of the uptick rule. A circuit breaker rule would freeze short selling of a specific stock if its price falls a certain amount in a single trading session and the uptick rule would only allow a short sale after a stock’s price has moved up at least one tick. Although short sellers face much opposition, the SEC is sure to receive many comments against these proposals because many commentors believe that short selling is essential for price discovery. For an in-depth discussion of the proposals, see Jim Hamilton’s and Floyd Norris's blogs. Read More......

Tuesday, April 7, 2009

Rethinking the Legal Profession?

I just caught this opinion piece from last week's NY Times - it has some interesting thoughts on how law schools need to adapt their curricula to better reflect the new realities of the legal profession.
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Monday, April 6, 2009

What are the Toxic Assets Actually Worth?

As reported, FASB changed the mark-to-market pricing rules last Thursday, giving banks more discretion in reporting the value of mortgage-backed securities. Bankers bitterly complained that the current market prices were the result of distressed sales and that they should be allowed to ignore those prices and value the securities instead at their value in a normal market. But even in a "normal" market, what are the alleged toxic assets actually worth?

Treasury Secretary Timothy Geithner seems to think that these assets may actually be valuable one day, and has implemented a plan to provide “nonrecourse” loans to institutions that buy up the unwanted assets.

University of Illinois College of Law Professor Larry Ribstein, on the other hand, has declared Geithner's plan an elaborate "shell game." The government subsidizes private equity companies to buy the assets at inflated values. Instead of just giving them wheelbarrows of money, they get non-recourse loans for most of the purchase price. When we find out that the assets are actually worth what the banks really think they’re worth (as opposed to how they’re currently booked) the taxpayers, who provided most of the money, will bear most of the loss.

Unfortunately, he may be right. USC Business School has released a preliminary report, titled The Pricing of Investment Grade Credit Risk during the Financial Crisis, written by Joshua Coval and Erik Stafford (Harvard) and Jakub Jurek (Princeton). An overview of the paper can be found here. The paper presents three uneasy conclusions:

  1. Many banks are now insolvent. "...many major US banks are now legitimately insolvent. This insolvency can no longer be viewed as an artifact of bank assets being marked to artificially depressed prices coming out of an illiquid market. It means that bank assets are being fairly priced at valuations that sum to less than bank liabilities."
  2. Supporting markets in toxic assets has no purpose other than transfering money from taxpayers to banks. "...any taxpayer dollars allocated to supporting these markets will simply transfer wealth to the current owners of these securities."
  3. We're making it worse. "...policies that attempt to prevent a widespread mark-down in the value of credit-sensitive assets are likely to only delay – and perhaps even worsen – the day of reckoning."
So, what is the solution? Profesoor Ribstein says we should let the banks sell the assets for what they're worth but not make them reduce their capital for regulatory purposes.

What do you think we should do?
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Thursday, April 2, 2009

Update on Castroneves Tax Evasion

Here's an update on Helio Castroneves' tax evasion case. Apparantly Helio is in the hole for more than $2.3 million now. And, according to Joann Levitt, the IRS agent and the Government's last witness, the case hinges on whether Castroneves actually secretly owned the Panamanian shell corporation, Seven Promotions. According to Levitt he did, and the $2.3 million owed as a result of $5 million "earned" by Seven Promotions was money simply never reported on Castroneves' tax returns. More news to come in the next few weeks as the case should be put in front of a jury sooner rather than later. Castroneves, in fact, will miss the IndyCar season opener April 5 in St. Petersburg, Florida because of the recent delay in the case proceedings. Read More......

Accounting Rule Change May Improve Asset Valuation

Today the Financial Accounting Standards Board (FASB) relaxed its mark-to-market rule for certain assets. Now companies will be able to use "'significant' judgment" in pricing these assets. However the companies must provide increased information on how they value them.

The mark-to-market rule requires companies to value certain assets at their fair value or market rate--what others are willing to pay for them. However, when no one wants to buy those assets their price falls. The company must then value those assets at the fallen price on their books. This is what happened with mortgage backed securities. When they stopped trading, the entities that held them had to mark down their value on their balance sheets. However FASB now allows businesses to use their own judgment and decide what the assets are worth. The intention is to record these assets at their true value.

But value is based on how much someone is willing to pay for whatever is being valued. If the asset is not priced according to the demand for it, the value may be misleading. Even though a business' balance sheet may look better under this rule, that improvement may be artificial.
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Wednesday, April 1, 2009

Credit-Default Swaps to the Rescue?

Oliver Hart, professor of economics at Harvard University, and Luigi Zingales, professor of finance at University of Chicago's Booth School of Business make the case that credit-default swaps could be the key to getting banks out of the very trouble these instruments helped create. In short, the professors state that to prevent systemic risk, large financial institutions should have to increase their capital reserves when assets the institutions hold lose value, and that the best way to track the value of these assets is provided by the market through credit default swaps. But could turning CDS prices into a trigger for a mechanism that lowers the likelihood of default corrupt the effectiveness of CDS asset pricing? And didn't these swaps already fail to accurately value mortgage-backed securities in the first place? Read More......

2009 Spring Speaker Series

Chicago-Kent Corporate Law Society is proud to present the 2009 Spring Speaker Series! This year's Spring Speaker Series will bring together prominent practitioners and professionals to offer their perspectives and insights on the current economic and financial crisis.

Our first speaker event is this Thursday, April 2, at 4:00 pm in Room C50.

We will be joined by Ed Carter (JD '78, IIT BS, '74), Asst. Illinois Attorney General and Supervisor of the Illinois AG's Financial Crimes Prosecution Unit, and Patrick Coffey (JD '84), a partner at Locke Lord Bissell & Lidell. These two distinguished attorneys, one specializing in prosecution and the other in defense, will be discussing the topic: "White Collar Crimes in the Post-Madoff Era."

The next event will be next Tuesday, April 7, at 4:00 pm in Room C50.

Adjunct Chicago-Kent Professor Richard Mason, a partner at McGuire Woods, along with veteran bankruptcy and restructuring attorney Robert Nachman, a member at Dykema, will address "The Wave of Bankruptcies Arising from the Financial Meltdown."

The third event will be our keynote address, taking place on Thursday, April 16 at 4:30 pm in Room C50.

Paul Forrester (JD '85), a respected securities and finance attorney from Mayer Brown, and Adolfo Laurenti, Senior Economist at Mesirow Financial, will offer their views on "The Economic Crisis: Mistakes Made and Lessons Learned."

The culmination of the CLS Spring Speaker Series is an Alumni Reception immediately following the final speaker, at 5:30 pm in the 10th Floor Reception Room here at Kent. Food and drinks will be served at the reception, which will be a great opportunity for students to talk with professors and network with alumni.

Please click here for more information, or contact Professor Tom Hill at Read More......

Tuesday, March 31, 2009

Government to Back Auto Warranties

It's a vicious cycle: US automakers (GM and Chrysler in particular) must drastically increase sales to have any shot at avoiding bankruptcy, but most Americans will not buy cars from a soon-to-be-bankrupt manufacturer. So, starting Monday, consumers who buy cars from GM or Chrysler will have their manufacturer warranties guaranteed by the Obama Administration. However, will government-backed warranties save these US automakers?

As a part of this Warranty Commitment Program, a portion of TARP funds will be used to back the warranties of any US automaker that elects to participate. Although Ford is not expected to participate, GM and Chrysler will surely welcome this program in an effort to boost consumer confidence. Still, I can't imagine that the effect of the Warranty Commitment Program will be enough to save GM and Chrysler from falling into bankruptcy. Indeed, even this warranty assurance will not dissolve the cloud of negative perception that currently surrounds these failing automakers.
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Google to Start Venture Capital Fund

Google officially announced yesterday the creation of Google Ventures, a $100MM venture capital arm of the company. Unlike VC funds at other companies like Cisco and Intel, the fund will not limit investments to startups that are related to Google's business. The Google Ventures website explains that the fund's purpose is not to foster companies for later acquisition or to push Google products; rather, it appears that Google simply believes that it can earn a healthy return from the fund because Google's in-house personnel and resources put the company in position to effectively evaluate and grow new companies. Is this deviation from Google's normal line of business just another example of the company's innovative mindset or could the company be starting to lose sight of who it is? Read More......

Monday, March 30, 2009

Revamping the Regulations

Treasury Secretary Timothy Geithner finally opened the can of worms last week, proposing a far-reaching plan to reform the financial system. He said the system had failed “in fundamental ways” and would require comprehensive overhaul. “Not modest repairs at the margin,” he told Congress, “but new rules of the game.” Geithner's audience, the House Financial Services Committee, for once seemed to be satisfied with his presentation, which included regulating hedge funds and giving the government the power to seize and dismantle companies deemed a threat to the economy.

The key measures of Geithner's proposal include:

  • Creating a new "sytemic risk regulator" that would have the authority to scrutinize and second-guess the operations of bank holding companies like JPMorgan Chase, insurance conglomerate American International Group and other institutions that are too big to fail.
  • Establishing a mechanism to seize and dismantle large institutions whose collapse or bankruptcy might threaten the nation's financial stability.
  • Passing tougher requirements for the amount of money and assets that financial institutions need to have on hand so they can withstand economic troubles.
  • Requiring hedge funds, private-equity firms and other private investment funds to register with the Securities and Exchange Commission and tell it about their risk-management practices.
  • Setting up a new, comprehensive framework of regulation of derivatives, including a central clearinghouse for trades in that market.
  • Developing stronger requirements for money market funds so increased withdrawals won't threaten the broader financial system.
Many of these proposals should generate a big welcoming, addressing dangers that clearly could have been addressed with simple regulatory reform. In the months ahead, Geithner said he will unveil more detailed proposals.

Nonetheless, a New York Times editorial posted today talk about the big underlying issues that Congress and the administration need to keep in mind. For instance:
  1. Is too big too fail actually exist? Such firms, like A.I.G., have proved dangerous mainly because of their involvement in a web of often conflicting financial practice and products. Geithner has called for a single regulator to police the most powerful institutions and presumably intervene in order to seize and restructure if failure seemed imminent. But, at what point should a firm ever even come close to become "too big" -- i.e. too diverse, too interconnected -- too fail?
  2. What are we trying to fix, anyway? Does anyone understand, with specificity, what brought on the financial meltdown? Can anyone actually sort out how much of the crisis is due to regulatory failure, how much to recklessness and greed, or how much to fraud and manipulation? Without the answers, the reform effort will be at best, hit or miss.
  3. Who is to carry out the reforms? For the last 30 years, there has been a serious political movement against regulation and for deregulation. In the last 10 years alone, opponents of financial regulation (e.g. Alan Greenspan) have been especially succesful in dismantling our financial regulatory scheme-- letting the market forces run free. As a result, the very agencies that were formed to protect our interests struck out -- big time. So if there is going to actually be meaningful regulatory reform, the rules will only be the first step.
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Friday, March 27, 2009

Thanks a Lot, Mr. Greenspan

The Wall Street Journal Opinion section devoted a full page to articles arguing for and against the idea that Alan Greenspan's Fed played a major role in causing the housing bubble by keeping interest rates too low. Only one article appears to back Greenspan's claim that interest rates were low thanks to increased consumer saving; the other articles all fault the Fed, and one even seems to insinuate that the Fed should be replaced by a return to the gold standard. Read More......

Thursday, March 26, 2009

Madoff Provides Big Payout in Ponzi, Lottery

A lighter post, but this was too good to not share with you all. A New York man has won $1,500 by playing the last three digits of Bernard Madoff's prison number in the New York lottery. According to the New York Daily news, the man saw the number on the front page of the paper where it was published along with Madoff's mug shot. Says the New York Daily Mail, "The $1,500 prize is a 16,000% return on his $9 investment - far more than even Madoff promised his bilked investors." Read More......

SEC Update

SEC Chairwoman Mary Schapiro spoke to the Senate Banking Committee on Thursday, and here are some of the things she talked about:

Up-Tick Rule

The SEC will consider reinstating the rule or "something much like it." The rule required short sellers to trade only when the stock increased in value. Many believe that without this rule short sellers can manipulate the share value by putting downward pressure on it.

Corporate Governace

The SEC is working t provide "meaningful opportunities for a company's owners to nominate its directors." Perhaps they could move to an online approach. Individual investors may be more inclined to particpate, however it could open the door to security (in the safety context; not the '33 Act context) issues.

Regulatory Authority

Mary Schapiro talked about creating a systemic risk regulator that would "focus on investor protection." She also talked about regulating CDOs and municipal securities. My worry about regulating CDOs though is that doing so will create a false sense of security. Creative investors and bankers will find a way around regulation. Finally, the Chairwoman talked about merging investment adviser and broker-dealer regulatory schemes in order to prevent fraudsters like Bernie Madoff.

Money Market Mutual Funds

Lastly, Schapiro talked about maintaining credit and liquidity by addressing mutual funds. She wants to avoid funds "breaking the buck" which happened last Fall. That incident is often cited as "one of the closest points to a complete freeze in the credit markets that the U.S. economy has experienced throughout this entire crisis."

Read More......

Wednesday, March 25, 2009

Despite Hard Times, Millions Used for New Florida Baseball Stadium

Above The Law recently reported on the progress of the new Florida Marlins publicly-financed baseball stadium.

What's interesting is that it finally seems as though the public has reached a tipping point in terms of what it thinks to be a reasonable public expenditure. It used to be common for taxpayers to shell out millions for their beloved home sports teams to build stadiums and new practice facilities. But now, this spending is just deemed irresponsible and characterized as all that is wrong with the relationship between professional sports and the American city. This new Marlins stadium will be built but not without major opposition from those who inadvertently paid for it.
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Some Wednesday Links

Here are a few financial market news links. Hopefully you are as crazy as me and find them entertaining:
- AIG Executive's letter of resignation to CEO Edward Liddy
- Is the repeal of Glass-Steagal to blame for the crisis?
- What exactly is liquidity, and what is the Treasury going to do to bring it back?
- Outlining the potential struture of a new Systemic Risk Regulator Read More......

Advice for Law Students, courtesy of the Conglomerate

Some sound advice for law students about job-searching in tough economic times - from the Conglomerate Blog.

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Monday, March 23, 2009

Treasury Announces Public-Private Investment Funds

As I discussed as a possibility in a previous post, the Treasury has officially announced its plan to create public-private investment funds (PPIFs) for the purchase of toxic bank assets. The plan calls for five funds with the possibility of more based on the quality of the applications received by the Treasury for the fund manager positions. Details of the plan include private control over fund asset management with FDIC oversight, FDIC guarantees on qualified assets purchased by the PPIFs, a 6-1 leverage limit, and a 50-50 split of private and public fund equity capital. Notably the Treasury has not provided any indication of how the private fund managers will be compensated. Apparently the market is satisfied with the level of detail provided by the Treasury this time around as the Dow is currently up over 250 points. See this link for Treasury Secretary Geithner's piece about the plan in the Wall Street Journal.

[UPDATE] The Dow has closed with a gain just shy of 500 points. Read More......

Wednesday, March 18, 2009

Re: On Bonuses at AIG

I just wanted to respond to Anne's recent CLS Blog posting and address the question that the Obama administration seeks to resolve: how can we get the $165 billion in bonus payouts back from AIG employees?

Taxpayers are thoroughly offended that AIG has recently distributed millions in bonus money to nearly 400 of its employees. Indeed, these employees contributed to the financial disaster that plagues AIG, which has already received $170 billion in taxpayer bailout money. So, can we get this money back, or is "a deal a deal?"

Well, some suggest that the answer lies in basic legal principles. And in response to Anne's call to 1Ls, I think I will whip out my contracts outline from last semester. Ok, so I threw that out. But, if my memory/Wikipedia serves me correctly, it seems that the impracticability doctrine - amongst other fine doctrines - could allow for AIG to rescind these employee-bonuses contracts.

Here, the nonoccurrence of AIG's financial insolvency - which would necessitate an unprecedented taxpayer takeover - seems like a basic assumption to the contract. And I suppose that it is impractical for any broke company to pay out millions of dollars in bonuses.

Therefore, it could ultimately come down to who ought to bear the risk of this occurrence. Arguably, the AIG bonus recepients - who worked within the company's financial products unit - were in the best position to avoid the problems that resulted from poor investments and risky trading positions. So, is "a deal a deal?" Probably not.
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On Bonuses at AIG

Great op-ed in yesterday's NY Times about AIG's contractual obligations to their employees to pay out bonuses. The author brings up some really basic tenets of contract law that both the government and AIG might be able to use to avoid payouts and potential liability. 1Ls, this is your territory.
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Tuesday, March 17, 2009

We're on Spring Break

We will be back next week. Read More......

Thursday, March 12, 2009

Madoff Behind Bars

"I always knew this day would come." reports Bernie Madoff as saying in front of U.S. District Judge Denny Chin. Madoff was in court today to plead guilty to criminal charges related to his Ponzi scheme. Judge Chin remanded him to jail, and set his sentencing hearing for June 16. Madoff faces up to 150 years in prison.
The article reports that some investors believe that Madoff was not the only one involved in the scheme though. They think his family was involved as well. Could Madoff have done it alone? I would like to hear your thoughts on whether or not he could have done it by himself. Read More......

Court Grants Cert in Jones et al. v. Harris Associates, L.P.

This week the Supreme Court granted certiorari in Jones, et al. v. Harris Associates, L.P. In deciding the case (which concerns whether mutual fund shareholders can sue their financial advisers for charging excessive fees which made their losses worse) the Court will tackle competing opinions from Judge Easterbrook and Judge Posner on law and economics.

Chicago-Kent's own Professor William Birdthistle, who served as counsel of record for and authored a brief of amici curiae with several other law professors weighs in through a series of posts over at The Conglomerate. Professor Birdthistle offers insight on the case, and the ideologies of both Judges. His opinions, and others, after the jump.

Professor William Birdthistle:
Will the Supreme Court Save Our Savings?
Chief Judge Easterbrook and Classical Law & Economics
Judge Posner and Behavioral Law & Economics

Professor Birdthistle has more in his series of posts, so stay tuned at The Conglomerate.

You also should check out:
Floyd Norris at the New York Times
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Wednesday, March 11, 2009

Racing Star Uses Foreign Shell Corporations to Hide Taxable Income

Sports Illustrated recently reported on Indy Racing star Helio Castroneves's tax evasion case. The IRS and the U.S. Department of Treasury claim that Castroneves set up foreign shell corporations ran by his family to specifically hide taxable income.

The Government claims that Castroneves hid about $480,000 in taxable income in a Panamanian corporation called Seven Promotions and roughly $5 million in a shell Dutch corporation with the intent to eventually move from the United States to tax-haven countries like Andorra or Monaco with the money.

While Castroneves's celebrity reputation would normally help him in front of a jury, we need not look too far in the past to see that celebrities are not necessarily immune from serious penalties for tax violations - as evidenced by the recent three year prison sentence handed down to Wesley Snipes for failing to file tax returns.
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Congress Has Some Interesting Plans for Financial Regulation

Jim Hamilton reported yesterday on Congress’s plan to reform financial market regulation, as delivered by Barney Frank, Chair of the House Financial Services Committee. The two-pronged approach will (1) address the creation of a systemic risk regulator and (2) strengthen investor confidence by increasing investor protection. Two particular components of the plan stood out to me.

First, to prevent loan securitization from shifting the risk of default completely off the shoulders of loan originators and securitizers, Congress would place a limit on how much of a loan may be securitized.

In order to restore the discipline of the lender-borrower relationship that was substantially weakened by securitization, the legislation will make it illegal for anybody to securitize 100 percent of anything. The exact percentage of retention is open for debate, said the oversight chair, but whatever percentage Congress decides to allow must follow the principle that the first dollar of loss is borne by the securitizer. This principle is correct, he reasoned, because securitizers are the ones who have to do some checking. But some liability will also be put on the originators.

This type of limitation would force the entities that purchase loans from originators in order to securitize and sell off the loans in parts to retain some portion of the purchased loans, which causes the securitizers to suffer some losses if those loans go bad. This retention of risk should cause the investment banks, hedge funds, and other securitizers to be more wary of the quality of the loans they purchase from originators, which in turn will cause originators to use tighter, more responsible lending standards.

Second, Congress intends to revisit the notion that “sophisticated” investors do not need the protection of the federal securities laws. This notion is the basis of numerous exemptions in the various securities laws that have allowed private investment funds to avoid most federal regulation by restricting access to investors with large amounts of money/financial sophistication. However, thanks to massive frauds pulled on these “sophisticated” investors by the likes of Madoff Investments and Stanford Financial, this notion has been seriously challenged.

If the exemptions for sophisticated investors are removed and all investors are treated the same, that could spell the end of hedge funds and possibly private equity funds as we know them. Hedge funds could be forced to disclose their trading strategies and take on less risk, which would basically turn them into mutual funds. Private equity and venture capital funds could be forced to give up their long lockup periods on investor funds, which could make their long-term investment strategies far less stable. Even if the only reform is that the standard of what makes someone a sophisticated investor is raised, that could cause a permanent contraction of the private investment fund market as the pool of potential investors shrinks. Read More......

Tuesday, March 10, 2009

Investor Confidence - Thoughts?

What do you think influences investor confidence most? Do you consider yourself someone who is swayed by outside factors in your decisions? In these economic times, investor confidence means more than ever.

I noticed that the NY Times today had two articles next to each other, and it occurred to me that maybe they were more related than meets the eye.

First - the Dow Jones went up 379 points. Good news!

Then, the next headline - Madoff Guilty Plea Expected: Could Face Life in Prison.

Sure, the first article gave some convincing arguments as to why the Dow "soared" today.

A memorandum from Citigroup saying that the bank had been profitable in the first two months of the year; calls for regulatory reforms from the Federal Reserve chairman, and the possibility that the government would reinstate rules governing short sales of stocks.

But what of the likely Madoff outcome? I think we can all agree that, however irrational, hesitant investors want to see results, and fast. Whether those results come from the bailout or from the criminal courts, investors are looking for answers.

The bailout requires prudent and cautious execution. I'm not saying a criminal trial does not, but results may come faster from criminal trials (or at least charges) if investors are anxious to place blame. Should the government enforcement mechanisms and the media be focusing more on the Madoffs and Stanfords of the world to boost investor confidence?

I would love to hear your thoughts on this - please comment below!

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Back to the basics...

Apparently, the current economic downfall has people getting back to the basics of capitalism. What better reference than Ayn Rand's Atlas Shrugged? If you read the book, you can draw a lot of parallels between what's been going on in the world lately and the events of Atlas Shrugged.

Here are some links, for your reference:

Atlas Climbs the charts

From fiction to fact in 52 years

Who is John Galt?
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Some News in Sports (and Wrestling)

The WSJ Law Blog recently reported that the National Football League is now exempt from suits in the event of a terrorist attack. This protection only extends to companies' services or equipment that meet the anti-terrorism effectiveness standards established by the Department of Homeland Security.

In other sporting news (sort of), a federal judged dismissed the claims of former World Wrestling Entertainment wrestlers. The former wrestlers claimed that their employer - the WWE - denied them of health care and other benefits because the WWE misclassified its wresters as independent contractors. The judge's decision is consistent with the opinion of WWE Attorney Jerry McDevitt, who commented that the wrestlers were "big guys who signed big guy contracts." Read More......

Monday, March 9, 2009

Bank of America Exec Challenges "Misinformation"

The Wall Street Journal ran an opinion piece by Bank of America President and CEO Kenneth Lewis today in which Mr. Lewis challenges common claims about the current state of the banking world. Topics addressed include current lending activity, bank insolvency, and the effectiveness of TARP. Read More......

Friday, March 6, 2009

Wanted: TARP Attorneys

Earlier this week at the ABA's white collar crime conference Neil Barofsky, the special inspector general special inspector general for the Troubled Asset Relief Program (TARP) said his office expects to hire 75 to 100 attorneys in the upcoming year.

Barofsky believes white collar crimes attorneys will see a significant increase in work as the government continues to use TARP money to infuse the private sector. Barofsky believes that up to $300 of the TARP funds may be vulnerable to fraud by banks, hedge funds, mortgage servicers and others that take funds. Barofsky believes that companies may make misrepresentations about their financial status in order to get TARP money and use the money in a manner inconsistent with TARP.

In addition Mark Mendelsohn, of the Department of Justice's Foreign Corrupt Practices Act (FCPA) is looking for attorneys as well.
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Thursday, March 5, 2009

Follow Up to the CBA YLS Bankruptcy Meeting

Judge A. Benjamin Goldgar, U.S. Bankruptcy Judge for the Northern District of Illinois spoke at the Bankruptcy meeting on this past Tuesday. He talked about what he likes to see in motions that come before him. But these tips are helpful for more than a just bankruptcy practice.

First, Judge Goldgar defined what a motion is. It is a letter to the court asking for something--usually an order. He noted that motions are not pleadings. See FRCP 7 for the distinction. After reading a motion, the judge should initially be inclined to give the writer what she is asking for.

Writing such a motion requires answering two question--what the writer wants and why the judge should give the writer what she wants. The first part requires the writer to explicitly state what she wants. Judge Goldgar thinks that the writer should put this up front. This way the reader knows at the outset what the writer is looking for. The judge does not have to go through the entire motion without knowing what the litigant wants and then finding it at the end of the motion. The second part--why the writer should get what she wants--should include facts and law.

The writer should include facts supporting the requested relief. There should be enough facts in the motion so that the judge understands the case. Judge Goldgar noted that judges are not as familiar with a case as the lawyer is--judges need background. But he also said that writer should not include too many facts. Judge Goldgar said that lawyers like to include dates in their motions. Judges see the date, and think that it must be important. Often it is not. He said that lawyers think that dates are "good anchors" for sentences and make them as writers feel more comfortable, but the motion is not for their comfort. The motion should make the judge comfortable.

The motion should also include the relevant law. The motion should state the authority the writer has for bringing the motion and the law that entitles the movant to the relief sought. Judge Goldgar points out that judges are capable of researching the law and applying it to the facts on their own, but this is not the result that a lawyer should want. If the writer leaves this up to the judge, there is no guarantee that the judge will reach the conclusion that the writer wants. Providing the judge with the relevant law, and leading her to the desired outcome, makes the judge's job easier. Motion writers want to make the judge's job easier because they are asking the judge for relief--they do not want a grumbling judge.

Finally, Judge Goldgar said that writers should proofread their motions. Typos give bad impressions. However, he noted that errors do happen. They do come up in 75 page motions. But Judge Goldgar says that writers have to try--there should not be a typo in a two page motion. He believes that these errors show that writers do not care, and if the writer does not care why should the judge trust the citations in the motion?

Seeing Judge Goldgar's presentation on Tuesday reminded me how important writing is. Writers should be clear and concise. But they should not be afraid to say what they want and why they should get it.

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US threatens prosecution of UBS top executives

The United States government is pressuring UBS once again -- but this time the target is UBS top executives. During a senate subcommittee hearing yesterday, the US Justice Department indicated that they may seek prosecution of top UBS executives. But will the Justice Department follow through on this, or is it just a tactic designed to put pressure on UBS to turn over more account information?

The Justice Department's tax division acting assistant attorney general, John DiCicco, has said that he would not, "rule out one way or the other whether there will be prosecutions."

Given the potential consequences to UBS, and even Switzerland, of disclosing more account information, the threat of prosecuting UBS executives could just be a measure designed to pressure UBS into more disclosure.

UBS is resisting more disclosure because of the interference of Swiss banking traditions and stability and the potential threat of losing clients en masse as a result. This could all deliver a big blow to the Swiss banking industry, and Switzerland may not have the resources to shore up banks like other countries have.

So, if the threat of UBS executive prosecution is just that, a threat, is it enough to force UBS into more disclosure?
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Wednesday, March 4, 2009

Supreme Court Likely to Hear NFL Case

Earlier this week, Above The Law reported that the Supreme Court will likely decide to hear an anti-trust dispute between the NFL and one if its former licensees of merchandise.

American Needle had for more than 20 years held a non-exclusive license to design and manufacturer headgear furnishing the NFL teams' names and logos. About 9 years ago, the NFL teams decided to offer an exclusive license for merchandising to Reebok, one of Needle's main competitors. Needle sued the NFL under Section 1 the Sherman Act (which prohibits "contract, combination...or conspiracy in the restraint of trade or commerce") alleging that their teams are illegally restraining trade in the NFL logo and merchandising market.

The NFL contends there is no violation because of a single-entity exemption of Section 1 of the Act which provides that there can be no conspiracy in restraint of trade where the defendant in a Section 1 suit is a single entity. The NFL has raised the single-entity defense on several occasions already and each time it has failed. The Northern District of Illinois and the 7th circuit in this case though have been decidedly more Pro-NFL. Both courts agreed that the NFL constituted one entity because, despite the competitiveness and separate ownership structure of each team, the joint licensing of the teams' trademarks for many years through a subsidiary, NFL Properties, was enough to push them into single-entity status.

Some think Needle actually has a stronger legal argument but it is clear that the NFL has a stronger legal team. It will be interesting to see on what side the Supreme Court falls.

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Government-Sponsored Investment Funds?

The Wall Street Journal reported yesterday that the Treasury’s leading idea for removing “toxic” assets from bank balance sheets would involve the creation of government-sponsored investment funds. Under the potential plan, the government would purchase $500 billion to $1 trillion worth of bad bank loans and other distressed assets in a partnership with the private sector. The government’s funds would be run by investment managers who place certain amounts of their own capital into the funds, thereby aligning the interests of the government and the managers. Other private investors would also be able to invest in the funds.

The plan to buy up distressed bank assets was originally offered by former Treasury Secretary Henry Paulson, but the first round of bailout funds were instead injected directly into banks in hope of unfreezing the credit market. The main issue that blocked the Treasury’s plan to purchase distressed assets was the pricing of these assets in an illiquid market. Taxpayers do not want the government to overpay for these assets, but banks are not willing to accept the marked-to-market prices for these assets because doing so could annihilate their balance sheets. Additionally, the government wants to make sure that the purchase of these assets provides sufficient capitalization to allow banks to resume lending.

The Obama administration’s idea of the creation of a “bad” bank to purchase these assets would force money into the markets, but pricing of these assets would be problematic because the bad bank would be one of the only participants in the market. The idea of creating multiple investment funds carrying large amounts of government funds potentially solves the illiquid market pricing problem by allowing the private-sector to price the assets through the competition of the funds’ investment managers over those assets.

The creation of this system creates a number of new questions. How many different funds would be necessary to create sufficient competition over bank assets? How will the funds’ investment managers be compensated? What are the performance expectations of the investment managers? Will the funds have boards of directors and who will select the directors? Will taxpayers have any say in this process? If the Treasury does go forward with this plan, it will need to provide a specific plan that covers all of these questions and more or else uncertainty could again cause investors to retreat from the markets as they did last month when Secretary Geithner outlined a plan to fix this problem that was simply too vague.
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Tuesday, March 3, 2009

Former CEO Sues AIG for Securities Fraud

American International Group Inc. has been sued by former Chairman and CEO Maurice “Hank” Greenberg. Greenberg alleges securities fraud stemming from the misrepresentation of billions of dollars in losses on the company’s portfolio of credit default swaps. The defendants include former directors and officers who Greenberg claims led him to acquire AIG stock at an artificially inflated price as part of a deferred compensation plan. Greenberg claims that AIG overstated its financial health and masked losses on credit default swaps that hedged default risk for at least $527 billion of debt. He alleges that AIG “recklessly ignored” facts suggesting the company was facing ever-increasing losses on the portfolio.

AIG shares closed at $57.37 on Jan. 30, 2008, the day that Greenberg acquired AIG shares through the deferred compensation plans, and closed today at 43 cents. As a result, Greenberg claims that he has lost hundreds of millions of dollars when the stock prices plummeted and now seeks to recover the difference between the price he paid for the shares and the “true and fair” value. He also claims that, as a result, he significantly overpaid income tax on the securities, and seeks to recover more than $70 million of taxes.

Greenberg led the company for almost 40 years until he was forced to resign in March 2005 amid an investigation led by former New York Attorney General Eliot Spitzer and allegations of fraud. It seems likely that the current problems would have begun during his tenure rather than in the relatively short time since his departure. As AIG's largest shareholder, and in light of his long reign at the company, Greenberg's level of knowledge regarding AIG's financial health and risks associated with the portfolio of credit default swaps should be in question.
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Monday, March 2, 2009

CBA YLS Bankruptcy Committee Meeting

Tomorrow, Tuesday March 3, at 12:15 pm the CBA YLS Bankruptcy Committee is meeting. Two Bankruptcy judges will be on hand to answer questions and give practice tips.

The CBA YLS practice committees meet once a month, and I am the Chicago-Kent Liaison to the Bankruptcy Committee. Young practicing attorneys attend the meetings each month, and it is a great way to learn about a bankruptcy practice. All are welcome to attend, but only CBA members are eligible for CLE credit.

The meeting lasts only about an hour, and it is at The Chicago Bar Association Building at 321 S. Plymouth Ct. It's right next door to The John Marshall Law School and across the street from the federal court house. Feel free to e-mail me at with any questions. I'll be there tomorrow, and I hope to blog about the meeting in my post on Thursday.
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Bankers Need to be More Susceptible to Risk

A piece in last Wednesday's Wall Street Journal argues that Wall Street's casual approach to risk was due to the abandonment of the partnership model in favor of the corporation.

[I]n a $14 trillion economy, you can't hire enough overseers to pore over everyone's books. There is, however, a better solution: expose players in the financial game to greater personal loss if their risk-taking fails. When you worry that a mistake will cause you to lose your second home, your stocks and bonds and your club memberships, then you're less likely to take the kinds of risks that expose the rest of society to your failures. A simple mechanism exists to achieve this purpose: the private partnership. Partners face liability that extends to their personal assets. They aren't protected by the corporate shield that limits losses to what the corporation itself owns (as well as the value of the stocks and bonds the corporation has issued).

[I]nvestors -- and governments -- should recognize the extra safety inherent in doing business with partnerships. In the end, the partnership -- not more regulatory intrusion -- is an efficient, even elegant, answer to the thorny risk-mitigation problem. Partnerships are less likely to make big mistakes, but, even if they do, their smaller size means they pose less of a threat to the financial system as a whole, and to the taxpayers who have to pay for the clean-up.
Indeed a compelling argument. On the other hand, Professor Larry Ribstein, of Ideoblog, thinks otherwise. While he does strongly believe that the role of the corporation needs to change, he states that "[o]ver the last generation, better governance technologies have evolved through private equity, venture capital and hedge funds. This should be the model for the reorganization of Wall Street."
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Delaware to the Rescue

On Tuesday of last week, Citigroup was victorious in the Delaware Chancery Court when the court dismissed all but one claim in a lawsuit brought by shareholders of Citigroup. The shareholders claimed the Citigroup's board had breached its fiduciary duties because the board permitted the company to invest in sub prime mortgages despite suffering huge financial losses because of Citi's investment in sub prime mortgages.

As written by Professor Davidoff, of the University of Connecticut School of Law the decision is in important for three reasons.

1. It is doubtful that Delaware courts will hold corporate boards liable for bad decisions made before the financial crisis. Thus the decision last week reinforces the business judgment rule as highlighted by this quote from Chancellor William B. Chandler III.

Oversight duties under Delaware law are not designed to subject directors, even expert directors, to personal liability for failure to predict the future and to properly evaluate business risk.
2. The court refused to dismiss the suit in favor of a New York suit which alleged similar claims and was filed first. The Delaware Court chose to implement the McWane doctrine, to retain jurisdiction over the suit even though the suit in New York had been filed first.

3. The Delaware Court dismissed the plaintiff's breach of fiduciary duty claim, which happened to be a Caremark claim. A Caremark claim created the duty a corporate board has to monitor the corporate enterprise. As stated by Chancellor William B. Chandler III, the standard for a Caremark claim is quite high.

[T]o establish oversight liability a plaintiff must show that the directors knew they were not discharging their fiduciary obligations or that the directors demonstrated a conscious disregard for their responsibilities such as by failing to act in the face of a known duty to act. The test is rooted in concepts of bad faith; indeed, a showing of bad faith is a necessary condition to director oversight liability.
For commentary on the claim sustained by the Delaware Court, check out Professor Cunningham's blog.
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Friday, February 27, 2009

Corporate Governance Standards under TARP - the Rundown

When it comes to TARP (and by TARP I mean the EESA, and by the EESA I mean the ARRA), everyone’s talking about compensation limits. But there is a lot more to the new standards imposed on recipients of TARP funds by the recent legislation, and this is your one-stop, ten-minute guide.


TARP is the Troubled Asset Relief Program, which was established under the Emergency Economic Stabilization Act of 2008 (EESA). The language of TARP was then slightly amended and finalized in the American Recovery and Reinvestment Act (ARRA), which was signed by President Obama on February 17, 2009.

You can access the full text of the ARRA
here, and the section on corporate governance and compensation limits - Division B, Title VII, Section 7001 - is at the very end. You can also access the full text of the EESA here.

What are the corporate governance requirements under TARP as amended?

All TARP recipient companies are required to establish and follow certain standards. Some are pretty non-controversial, while others might surprise you.

  • Unnecessary and Excessive Risks - Limits on incentives that encourage Senior Executive Officers (SEOs) to take “unnecessary and excessive risks that threaten the value” of the company while TARP funds are still owed.

  • Clawbacks - Recovery of any bonus paid out to a SEO or the next 20 most highly-compensated employees, if that bonus was “based on statements of earnings, revenues, gains, or other criteria that are later found to be materially inaccurate.”

  • Golden Parachutes - Prohibition on any golden parachute payment made to a SEO or the next 5 most highly-compensated employees paid out while TARP funds are still owed. “Golden parachute payment” is defined in the previous section as “any payment to a senior executive officer for departure from a company for any reason, except for payments for services performed or benefits accrued.”

  • Long Term Restricted Stock - Prohibition of any bonus or incentive compensation other than long-term restricted stock, provided that the stock does not fully vest while TARP funds are still owed, and is not greater than 1/3 of the receiving employee’s total annual compensation. This one is unique, however, because the amount of employees it applies to depends on how much in TARP funds the company has received. The number is a sliding scale between 1 and 20, but each level includes a clause that states “or such higher number as the Secretary may determine is in the public interest” - hence the numbers are just a minimum guideline.

  • Manipulation of Reported Earnings (or what I like to call the “duh” provision) - Prohibition of any compensation plan that would “encourage manipulation of the reported earnings” so as to increase compensation of any of employees.

  • Compensation Committees - Establishment of a Board Compensation Committee that is “comprised entirely of independent directors” and meets at least semi-annually. TARP recipients that are privately-held may have their Board of Directors stand in for the independent compensation committee.

  • Luxury Expenditures - Establishment of a “company-wide policy regarding excessive or luxury expenditures” such as “entertainment or events; office and facility renovations; aviation or other transportation services.” (See Bank of America, Northern Trust, Merrill Lynch, the Auto CEOs, et al. I think we’re all pretty familiar with why this section was necessary.)

  • Certification of Compliance - The CEO and CFO of each TARP recipient has to file a certification of compliance; if the company is publicly traded, the compliance certification goes with the annual SEC filings. As those of us who have taken Securities Regulation know, certifying compliance can be a painstaking and risk-laden process, but that’s why you keep attorneys around.

Now here are some of the more interesting requirements:

  • Say-on-Pay - All TARP recipients must institute a say-on-pay policy. A say-on-pay provision is a non-binding advisory vote by shareholders on executive compensation plans as disclosed in the CD&A section of SEC filings. Boards do not have to follow the results of the shareholder vote, but are strongly encouraged to do so. Say-on-pay has had some momentum in recent years, mostly from institutional investors, but this is the first time the practice has been mandated in any way.

  • Retroactive Review of Executive Compensation - The Treasury must review all “bonuses, retention awards, and other compensation” paid out to SEOs and the next 20 most highly-compensated employees for each TARP recipient to “determine whether such payments were inconsistent with” the purposes of TARP or contrary to the public interest. If the Treasury finds inconsistency, they will negotiate appropriate reimbursement to the federal government. Okay, but here’s the catch - while most people are assuming that the Treasury is only going to be reviewing 2008 and 2009 bonuses, there is no actual time limit to retroactivity set out in the legislation. While a recipient could argue that bonuses paid out before 2008 were irrelevant to the current economic crisis or to the compensation limits in the legislation, the Treasury still retains the right to review any compensation practices for the applicable employees going back in time indefinitely.

  • Repayment - This section was added to the legislation after opponents of Barney Frank’s amendments (say-on-pay) argued that we were getting ahead of ourselves in oversight. Therefore, TARP recipients reserve the right to repay TARP funds “without regard to whether [they have] replaced such funds from any other source.” Also, the Treasury must liquidate warrants associated with the recipient’s funds at the current market price. While understandable that the emphasis here is on repayment, this provision has the potential to be incredibly dangerous.

So what now?

Look for more discussion on say-on-pay initiatives. Say-on-pay is a very effective way for boards to give the appearance of relinquishing control over executive compensation while not really being bound to the shareholders’ decision. But it also carries the power to make boards accountable by highlighting situations when they choose to override shareholders’ decisions, and perhaps pay the consequences with a proxy fight.

Also, it will be interesting to see the how the final section on repayment plays out. I know we’re getting ahead of ourselves discussing repayment already, but the fact that TARP recipients themselves have the power to decide how and when repayment takes place puts the spotlight squarely on the corporate boards who are seen as having created the mess in the first place.

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Geithner Interview on Banking Stress Tests

The NPR Planet Money Podcast interviewed Treasury Secretary Timothy Geithner on Wednesday about the Treasury's stress testing of U.S. banks. The interview explains a lot of the banking portion of the financial crisis in simple terminology and provides a map of the government's plans to alleviate the credit crunch. Read More......

Thursday, February 26, 2009

SEC & CFTC May Get Bigger Budgets

According to The Wall Street Journal President Obama is asking for a 13 percent increase in the SEC's budget and a 44 percent increase for the CFTC.

This would put the SEC's budget at over $1 billion and the CFTC would be at $160 million. The administration hopes the SEC will use the additional funds to "pursue a risk-based, efficient regulatory structure that will better detect fraud and strengthen markets." With the money, the CFTC would increase staff, and would like to regulate credit derivatives.

I am not taking issue with the spending, but I am interested in knowing what the money would be better spent on. Should the SEC and the CFTC spend more on prosecuting violations, imposing additional rules, or some combination of the two?

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Wall Street Bountyhunters?

The Freakonomics blog discusses the possibility of the SEC instituting bounties for frauds exposed by whistleblowers. This sounded unrealistic to me until Steven Dubner pointed out that the IRS already does this. Read More......

Wednesday, February 25, 2009

Index Funds Losing Popularity?

The Wall Street Journal reports that E-Trade will be closing down all four of its index-linked mutual funds. E-Trade claims that the company is financially healthy, so this step may be a response to a reduction in investor demand in index funds.

Index funds seek to replicate market returns, instead of attempting to generate absolute returns. This means that unlike an actively-managed fund that aims to "beat the market" by picking winning stocks and to turn a profit whether or not the market is in a slump, an index fund's purpose is to match the market return, even when that return is negative. Investing through an index fund allows an investor to eliminate much microeconomic, company-level risk through the high level of diversification achieved by investing in an entire index of stocks rather than just a few stocks.

However, index funds are still subject to the macroeconomic risks that affect the entire economy like inflation and credit illiquidity. As the current economy continues to sink into recession, stock indicies are unlikely to see much growth in the near future, making index fund investing a losing strategy in the short run. Index fund investors may now be heading for the doors to gain short-term gains through actively-managed funds or to prevent further losses by retreating from the capital markets entirely. Either way, this trend may only last as long as the recession because once investor optimism returns (however long that takes), investors will likely once again see index funds as the best way to ride the wave of a rising economy.
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Tuesday, February 24, 2009

Inside Trader Gets Comeuppance

The New York Times reports that today Judge Deborah A. Batts sentenced former broker David Tavdy to 63 months in minimum-security federal prison.

A year ago Tavdy pleaded guilty to conspiracy and securities fraud charges filed by the Securities and Exchanges Committee following the exposure of a massive insider trading ring on Wall Street. Tavdy was one of 13 involved in what authorities at the time considered "one of the most pervasive insider trading rings since the 1980s."

Between 2002 and 2006, Tavdy made 10.3 million dollars off of security transactions made after receiving tips from Mitchel S. Guttenberg, a former UBS executive. Guttenberg was sentenced to 6.5 years last November for his part in the scheme.

Despite Tavdy's statement that "I made a mistake and I regret it," Judge Batts reflected that this was not an isolated case and Tavdy and his cohorts made millions off of insider information. The year time between the pleading and the sentencing tends to dull the severity of Tavdy's actions. Some might even ascribe to the mentality that Tavdy made a few mistakes and got caught up in a bad situation.

However, if you look back at some of the details reported a year ago in The New York Sun, the only mistake Tavdy and his cohorts seem to have made was getting caught. Cash deals, disposable phones, secret codes, blackmail, and bribery - sounds more like an organized crime ring than a simple broker getting caught up in the paper chase. Furthermore, Tavdy wasn't just some average joe who stumbled upon some nonpublic information. He knew exactly what he was doing. He was a broker. He payed for nonpublic information. He used the information to make massive illegitimate profits. He should be punished accordingly.
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