Business Law Prof Blog

CFIUS Outdate: Sovereign Wealth Funds

The new Foreign Investment and National Security Act of 2007 is already out of date and the regulations under the act have yet to be written.  The threat posed by sovereign wealth funds is not just to "critical infrastructure" or "critical technologies" it is also to our financial markets.  1) If sovereign wealth funds turn from focusing on investor returns to using their funds as a mechanism for implementing a foreign country's foreign policy decisions, then our financial markets will be affected adversely.  2) The injection of reports to individual members of Congress in which districts American companies are located can only be fuel for protectionist behavior by those members.  We need and want foreign capital if the sovereign wealth funds are acting as investors and individual members of Congress ought not be encouraged to get in the way.   

Lessons From the Failed Sallie Mae Takeover

The buyout group backed out of the Sallie Mae takeover, arguing that government regulation had triggered the MAC clause.  On the threat, Wall Street told the buyout group that it would ruin its reputation for closing deals. I laughed at the claim.  On Wall Street your reputation depends on making money and closing a terrible, losing deal to "look good" will tag you as a sucker, not as a welsher.  At issue now is who pays what.  The deal paper is before the Delaware Chancery Court.    If the MAC argument holds up, the buyout group walks away clean.  It if failed, the buyout group must pay $900 million as a breakup fee--still less than the loss if it had closed the deal.  The wild card is a specific performance argument.  Can Sallie Mae force the buyout group to close.  This is more complicated that it sounds.  Does the deal paper preserve the specific performance right (this is being litigated in several other cases)? Even if not, can a court order specific performance anyway (is the deal paper binding?)?

Sovereign Wealth Funds and Corporate Constituency Statutes

"Be careful what you ask for, you might get it," my mom used to say.  States, including Ohio, passed statutes that allowed boards of directors to take into account "other constituencies" (read: non-shareholder) when making decisions.  Now foreign sovereign wealth funds are buying stakes in American corporations and our concern is that they will not act like normal controlling shareholders and focus on shareholder returns.  The foreign funds may use the funds as a branch of their foreign policy departments.  In other words, the foreign funds will take into account "other constituencies."  We are worried about the effect on our capitalist system -- the same concern that should have led us not to adopt the constituency statutes.   

The Fed Ought to Float the Funds Rate

The Open Market Committee, chaired by Ben Bernanke, of the Federal Reserve System controls monetary decisions.  It has made news the past several days by 1)lowering the federal funds rate; 2) lowering the discount rate and 3) auctioning term funds (and facilitating international swaps among banks).  The stock and bond markets fell on the news of the rate drops yesterday and, after a brief period of euphoria over the auctions today, the stock market retreated into a ho-hum close for the day.  The Fed is fast becoming unable to control market conditions as the size and speed of the global markets will come to dwarf their reserves.  Consider the power of the IMF over world currency trading; once a giant, the IMF is cutting staff and trying to find things to do.  In this regard, the Fed's efforts to peg interest rates with a symbolic funds rate declaration appears, over time, doomed to decreasing effectiveness.  The Fed ought to let member banks set their own over-night lending rates to other banks; it ought to float the rate.  The Fed has real direct market power only when it is dealing with its reserves in either loaning money as a lender of last resort (setting the discount rate or in auctioning term funds) or when itself engaging in open market transaction to affect supply and demand of currency (buying and selling treasuries or foreign currencies).  The Fed, in cooperation with the Treasury, could also. perhaps, have a saving in setting and changing bank capital holding requirements and other leverage and margin requirements in credit markets.  These are the actions that ought to consume the fed, not fixing prices for member lending institutions.  If the Fed would let the funds rate float, it would decline to a rate a bit over government money market rates (the increase would be due to the increased risk of default by private banks) and banks could choose whether or not to lend.  the rate would become just another rate set by the private markets, where it should be set. 

Small Companies and SOX

The SEC seems to be delaying yet another year the application of Section 404 of Sarbanes Oxley (enacted in 2002) to small publicly traded companies.  Companies with market capitalization of less than $75 million, a small percentage of the total market value of United States publicly traded companies but a majority in number of such companies, do not have to comply with the Section.  The small companies will not have to comply until 2009.  Currently they must comply by Dec. 15, 2008.  This is getting ridiculous.  It reminds me of State Attorneys General not enforcing "horseless carriage" laws (it is illegal to spook a horse...) still on the books.  The Section should not apply to small companies at all and they should be permanently exempted. 

Senator Dodd Gives Us A Giggle

Senator Dodd is going to fix the sub-prime mortgage mess.  He has a bill that outlaws the loaning of money to people who cannot pay it back.  So banks can no longer loan money if they know, on the distribution of the loan proceeds, that they will not get repaid.  This is good; the jails will be full.  What next?  A bill outlawing selling cars to the lowest bidder? or outlawing selling long-term life insurance to those near death?  New data from the Treasury's Financial Crimes Enforcement Network shows that over 60% of all Subprime mortgages involved fraud by the borrowers, not the lenders.  Borrowers lied about their ability to repay.

Quant Funds: The Tower of Babel

Those running quant funds are using very sophisticated models to predict markets and programed trades to take advantage of those predictions.  The experts use mathematics, engineering and physical science; some are experts in chaos theory.  Ordinary day traders now have access to web cites that allow them to develop their own trading programs that resemble the best the quant folks could put together as little as ten years ago.  The goal?  To keep the human decision making to a minimum.  Well the past few months have taught the quants a thing or two about hubris.  First, the quants themselves mimic each other.  The community of quants is very small and inbred.  The effect is that the movement of the program trades together frustrates the programs assumptions.  Second, the quants met some trade conditions that fell outside of their assumptions.  The effect was a liquidity crunch.  And third, and most important, the quants found out that a human must, in the end decide when stop the automatic program trading in light of market conditions.  A quant could not, as hoped, just sit and watch the trades unfold.  This meant that human discretion was back in the picture and, horrors, it was often untrained and unexperienced.  A quantum physicist is no stock trader.  The quants remain optimistic:  They are buys changing the formulas to account for this year's events so they new formulas will be "perfect."  Yet another story of the overreaching of humans.

IPO Flight

New evidence from the Committee on Capital Markets Regulation chronicles the flight of IPOs from American to foreign markets.  More United States companies are going abroad and more foreign companies are not coming here.  Moreover, foreign companies listed in the United States are de-listing at higher rates and those foreign companies that list here are choosing a semi-private market, Rule 144a offerings, rather than public offerings.  Our legal system is much too blame.  At issue is which part -- is it private class action and derivative litigation or is it SOX 2002 auditing and certification requirements?  It is probably elements of both -- I suspect that our private class action system is the primary culprit.   

The Fed: In A Hopeless Mess

The credit trading markets predict a large fed rate cut to help ease credit in a sticky market.  They will probably get their wish.  We all know that consumers are finding mortgage loans tougher to get and that, as a result, housing prices (new and used) are falling in most all markets.  Falling housing prices affect consumer demand at some level and we worry that the falling prices will leak into the boarder economy.  In other words, corporate profits may fall next year.  This threat, we has many labeling a "coming rescission," has spooked the Fed.  No Federal Reserve Chairman wants a recession on his or her watch (the criticism from those who lose money will be merciless) and Bernanke is no different -- he will cut rates.  The probable is, of course, that housing prices were too high and need to adjust lower. They were too high because the federal government subsidizes them with 1) the deductibility of mortgage payments and 2) with cheap credit.  We are treating the solution like an alcoholic that has the shakes because he is off the bottle -- our solution is to give him another drink.  Our treatment just delays the inevitable market correction and has side problems too boot -- like inflation and poor allocation of resources.  The Fed needs to impose tough love here but will not have the political or personnel will to do it.  Appeasement is not always the best treatment nor is it always even evidence of compassion.