September 7, 2007
Lawsuit Against Deal Lawyers
The private equity firm that bought Refco, the company that collapsed with cooked books, is suing Refco's attorneys in the deal, Mayer, Brown, Rowe & Maw, for complicity in the fraud. This suit bears close watching. The PE firm alleges that Mayer Brown "knowingly" allowed its client to lie..." Deal lawyers have become experts at taking fees from questionable clients and careful limiting their exposure to criticism when a client tanks ("CYA" in the the trade). We shall see how a judge handles it.
President Bush has signed the new legislation on CFIUS (Committee on Foreign Investment in the United States), the agency responsible for reviewing foreign acquisitions of United States companies. The new legislation goes in the wrong direction on all fronts: It gives Congress more say (it should have less); It widens the categories of companies that must be reviewed (the categories should be narrowed) and it has very general, open-ended categories ("critical infrastructure" and "critical technologies"), capable of political manipulation (the standards should be crisper and less susceptible to debate). The legislation will encourage local Congresspeople to protect local firms from foreign acquisitions to keep local citizens happy. What a mess. Why did Bush sign it?
Ratings Firms and Auditors
Ratings firms, hired and paid by those they rate, and accounting firms, hired and paid by those they audit, will have inherent conflicts of interest. We attempt to ameliorate the conflicts with independent regulatory authorities, professional standards, anti-fraud rules, and Chinese wall procedures, but the conflicts remain. Ratings firms and auditors want to keep clients happy (and they personnel often want the option of working for clients on job transfers). Periodically we are reminded of the conflicts when bad news breaks and firms that may even be transparent scams have clean audits and their bonds have high rankings. In some of our worst cases, the audit and ratings stay until the eve of some company's bankruptcy declarations. The ratings firms and auditors protest any questions on their work: "We are proud professionals careful to protect our reputations for integrity and honesty. We have multiple protections in place...." A better system would be one that mirrored the one we use for testing automobile crash worthiness or hiring referees for football games. Independently funded groups (there are two) buy cars and test them. The league hires and pays the referees (can you imagine referees paid by, for example, the home team based on calls during the game?? That's what we do with auditors and ranking agencies.) Firms can hire whoever they want for advertising purposes in an attempt to convince ("see A-Rod likes our bonds"), but the SEC (and the exchanges) do not rely unequivocally on the hired services for filings or categorization. At some point, the inherent conflict of client/checker cannot be "fixed" enough by structured relief to justify our current practice.
September 5, 2007
Yet Another Special Purpose Entity Scam??
Special Purpose Entities (or Vehicles, SPVs, for short) used for off-balance sheet financing were the focus of the Enron scandal and are back in the news again. Enron "transferred" debt to SPVs and took the debt off its balance sheet. The transfer is legit only if the SPVs are independently owned (not a sub of Enron). Enron officials concealed the identity of Enron as a true majority owner of its SPVs, hence the scandal. The new game is with "conduits" and SIVs (Structured Investment Vehicles). These "independent" investment vehicles, created by investment banks (most notably Citigroup), hold assets and sell asset backed commercial paper (among other forms of debt). Banks use the vehicles to issue commercial paper and use the proceeds to purchase long-term, often illiquid assets (receivables, auto loans, and home loans), all off the balance sheet and, therefore, not a problem with bank minimum capital requirements. They learned from Enron -- ownership is independent -- but the new game is in the bank's guarantees of default. Entitled "liquidity backstops" the banks in essence guarantee the vehicles against losses but technically skirt the definition of a legal "straight guarantee" (which would make them owners). These non-guarantee, guarantees have now put the true exposure of Citigroup to vehicle insolvencies on the table and investors are not sure they like what they do not know.