December 22, 2007
Blankfein Pockets $69 Million for the Year
The CEO of Goldman Sachs made $69 million in salary for the year. His base salary was $600,000 (plus a charitable gift of 200,000) and the rest was in bonuses tied to the performance of Goldman this year. Cayne, the CEO of Bear Stearns, had a base of $250,000; the disastrous year for Bear Stearns meant he had few bonuses. At least for investment banks, the incentive system put in by the tax code (limiting base salary deductions to $1m thereby encouraging salary in excess of the base to be incentive driven) seems to have worked.
URI v RAM
The Delaware Court of Chancery has decided the URI v RAM case. Cerberus Capital Mgn. can walk away from its deal to buy URI on the payment of a $100 m reserve termination fee. The Court decided, after a trial, that URI had given up its right to specific performance in the acquisition contract. What makes the case noteworthy is the contractual ambiguity on a central point in the negotiated deal. Why was the contract not much clearer on the contested issue? Why was the specific performance clause in the contract not deleted altogether rather than made "subject to" the termination fee? There never should have been a trial here on this rather simple drafting question. The only trial, if at all, should have been on whether Cerberus could wake under the MAC clause and pay no reverse fee. Cerberus by agreeing to pay the fee gave up its MAC clause rights. There should have been no trial. Why do high paid lawyers draft such sloppy agreements? I suspect that Cerberus lawyers read the language and said it got what it wanted and the URI lawyers read the language and were happy that some ambiguity gave them some imagined bargaining leverage if Cerberus triggered the fee provision.
December 21, 2007
Potter v Bailey: The Wrong Debate
Several opinion writers, Floyd Norris is the latest, have noted the application of the movie "Its a Wonderful Life" to the sub-prime mess. Bailey, the idealist, versus Potter, the cold hearted investor, in evaluating the plight of sub-prime borrowers who cannot face their mortgage payments in ARM resets. Should we show compassion or be tough? "We can't [foreclose]. These families have children." [Bailey] "They're not my children" [Potter] So Congress and the Fed are ready to pass laws that look silly on their face: 1) Banks cannot loan money to those who cannot pay it back. 2) Banks must verify income figures from those presented by borrowers (stopping "liars loans") 3) Banks must check the objectivity of appraisals on property that is collateral to loans. They might as well pass a law that states 4) Banks should be profitable. The laws restate bank's obvious business incentives and perversely given borrowers the incentive to try and hook wink banks so they can sue under the new statutes. The most rational borrower under the new rules is now one that goes to a bank purposely ignorant, hoping a bank will make a mistake, so the borrower can get something for nothing. The fallout, no more sub-prime loans to anyone anywhere anytime, will hurt people with poor credit ratings the most, the sub-prime borrower.
The core of the problem in internal bank controls (whether as investor in SIVs or as originator/underwriter of SIVs) and banks are suffering huge losses because of it. We do not need legislation to correct this; banks will correct it themselves. The market has its own penalties -- CEO are getting fired, financial stock is swooning, new owners (China and Abu Dhabi) are buying stakes in our banks, investors will not longer buy any securities backed by mortgage loans -- the correction is already in place. We do not need new legislation. Prosecutions should sue those it can find who lied to people and plaintiff attorneys should be class actions against banks that did not disclose problems with internal control fast enough. The system is working the way it is.
This is another classic case of government overcorrection, fueled by bleeding-heart columnists.
Plaintiff Lawyers and Subprime
This is a crisis made in heaven for plaintiff lawyers. Solvent companies, banks, do not have the internal controls to protect themselves from fraud from within and from without the bank by those seeking closing fees at the expense of the bank holding bad obligations. Moreover, others inside the bank in different capacities, i.e. those in the investing side of the bank, are valuing the same obligations at severe discounts when investing in SIVs and hedge funds. Back up the truck for plaintiff lawyers fees.
When is There A Fiduciary Duty to Liquidate? Chrysler?
Nardelli, the new chief of Chrysler, is reported to have been asked "Are we bankrupt?" His answer -- "Technically no, operationally yes. The only thing that keeps us from going into bankruptcy is the $10 billion our investors entrusted us with." In other words, the company may well run on its cash reserves until there are none left and then go into bankruptcy. Chrysler is privately held so I am not worried about investor input. But suppose it was in public hands. When should the CEO voluntarily initiate liquidation of the company (ratified by the shareholders) in the best interest of the shareholders? Or better, when could shareholders sue the CEO for not initiating a vote on liquidation and win? Never, the CEO is protected by the Business Judgment Rule that protects all but grossly negligent management decisions. But wait, the Unocal test establishes a threshold for the business judgment rule in takeover defenses because of inherent conflicts of loyalties and perhaps we need a similar threshold for liquidation decisions, which put management positions on the line. In other words, the inherent conflict in non-liquidation decisions should make them easier to attack in shareholder suits -- they must be "reasonable" give operational losses that survive two years, for example. In other words, the prospect of future operational gains must be real and not fanciful. Would change things quite a bit.
December 20, 2007
Zell Owns the Tribune
Sam Zell, the self-professed "grave dancer," bought control of the Tribune for $8.2 billion by paying only $90 m in cash. This when the Tribune's revenues are going down and the cost of debt is going up. Whoever wrote the solvency opinion on the deal better have good indemnification protections.
MACs and Lawyers
We are watched three major cases of busted buyouts that turn on Material Adverse Change (MAC) clauses in the deal paper. It is amazing how poorly drafted the clauses are. We find lawyers fighting over "would reasonable be expected to.. have... a material effect" in place of "had... a material effect" (in how many cases would this matter? I suspect zero) yet we see no exclusions or defining language that depend on easily quantifiable risks (a percentage change in prime, for example). It would be easy to say that a change in prime did (part of the definition of material) or did not (an exclusion) break the deal. Had such simple drafting been in place these cases would not go to trial. Why fight over general language that does not matter and not deal with other language that does?
December 19, 2007
UBS's Fight to Break the Genesco Deal
UBS committed to finance $1.5 B of the purchase price in the Finish Line buyout of Genesco and then backed out when the credit crunch hit. Genesco is suing to close. At issue is the relief any court could order. If the court in Tennessee orders specific performance by Finish Line, it puts the company into bankruptcy unless UBS is also ordered to fund the deal (a double specific performance award). Genesco would just be a creditor in bankruptcy as any good trustee would move to void the deal. The court could just give Genesco contract damages for breach, but again, a substantial award could put Finish Line into bankruptcy unless Finish Line could seek indemnification from UBS for the award (arguing the UBS's breach is the true cause of the damages). A damage remedy is supposedly preferred to specific performance in contract breaches, unless the damages are too difficult to calculate or otherwise do not offer full relief. It would appear to me that the better result is a damage award against Finish Line with Finish Line and UBS adjudicating who should pay based on the commitment paper.
CFIUS on the Table Again: China Buys a 9.9% Stake in Morgan Stanley
A Chinese Sovereign wealth fund, China Investments Company, has bought stock rights in Morgan Stanley that will enable CIC to own 9.9% of the equity of the company by 2010. The agreement apparently gives no "management power" to CIC. [What does this mean? Now? Or just until 2010 when CIC is a 9.9% shareholder.] CIC is flush with dollars from China Central Bank currency purchases of dollars for yuan, designed to keep its peg of the yuan to the dollar in place. So we now have the hard case. The CIC fund is not "investor" driven, nor will it be. The fund acts on government initiatives. The CEO of Morgan Stanley, in announcing the sale admitted as much when he noted that the investment would enable Morgan to "pursue" opportunities in China. Read between the lines: A condition of the sale is that Morgan Stanley operates in China. This is not a request from an investor interested purely in the highest return, nor is it a decision from Morgan interested purely in a highest return on its new funds. CFIUS should take a close look at this.
Outside Attorney Charged in Refco Collapse
Federal prosecutors in the Southern District of New York had charged the outside lawyer for Refco, a partner with the law firm of Mayer Brown LLP, will aiding Refco financial fraud. He is charged with documenting a series of fraudulent "round trip" loans between related entities designed to keep debt off Refco's books. Lawyers are rarely charged in financial fraud cases and charges against outside lawyers are even rarer still. Yet anyone in business well knows that most modern financial fraud require the preparation and use of fraudulent legal documents that are almost always prepared by always prepared by lawyers. I welcome these prosecutions both as a warning to lawyers and as useful to lawyers in refusing requests from clients that want them to prepare such documents. Reputational and professional accountability has apparently not been enough.
The Common Element on All Sub-prime Rescue Packages: More Federalism
Beginning with the Civil War the federal government has more or less followed a pattern of dealing with financial crises by expanding the role and power of the federal government. With each new financial crisis we get new legislation that creates new prohibitions and new agencies to deal with those prohibitions. Everyone in the federal government with a remedy for the sub prime mortgage loan mess has, as part of their package, a similar part -- a move by the federal government into what has been traditionally left to state law and state enforcement authorities. Mortgage lending has traditionally been a creature of local contract law and local foreclosure laws; lending brokers have been traditionally controlled by local real estate laws. So yet another traditionally local area of the law is about to be federalized. The costs of increased federal regulation rather than local regulation are no discussed anywhere in the press or in the press releases of the reformers. Yet the costs are significant. Local law may be better. Local authorities are closer to local problems and local authorities compete with each other for sensible legal systems that attract investment (the competition produces experimentation and innovation in the rules). A major after-effect of the sub-prime reform efforts will be another stop towards a more powerful central government.
December 17, 2007
The new CBO report on IRS data from 2005 shows that the richest 5% had the largest percentage gain in income from 2000 levels. It also shows that all levels gained to some degree. What we are unhappy about is the percentage gain was not spread out more evenly. First, we should be delighted that all levels gained. We take this for granted. It may be that it is more likely than not that all levels gain if the top gains rather than the reverse. Second, the top levels pain a higher percentage of total tax. The richest 1% pay 39% of all income taxes (a gain of 2% since 2000); the richest 5% pay 60% of all income tax (a gain of 4% since 2000); the richest 10% paid 70% of all income taxes. It is hard to imagine a more progressive tax system than we have already.
December 16, 2007
Standford Gets $100 m from Exxon Mobile
Standford had cut a deal with Exxon Mobil for running a collaborative research facility. The deal with worth $100 m over 10 years. Many other universities are doing similar deals and it is not limited to technology research. A well known Midwest University has cut a deal with a hotel chain to investigate hotel management efficiencies. In many of these deals a university builds two or three new buildings and none contain a single classroom; they are research factories. The potential conflicts are obvious -- does the private sponsor have power over who uses the new facilities and what they do. In other words, does the private sponsor have control over university personnel. The university says no -- reminds me of denials involving student athletes and big time football programs. But a larger problem perhaps is whose ox is getting gored. Private companies are doing this to save money on internal research. Who is paying for the savings? The university's other constituencies, of course, which include tuition paying students (in a variety of ways other than cash, including access to well known professors), tax paying citizens that grant universities tax free status, and alumni that give deductible money to their alma mater. The private companies are getting a deal based on contributions from students and tax districts and alumni. A serious question is whether these other constituencies know of the cross-subsidy. Is it in student prochures and alumni development literature. Of course not.
SEC and SROs: Chronic Failure to Catch Insider Traders
Gretchen Morgenson is, in Sunday's NYT's business section, shocked, shocked that the SEC does not have an updated computer system designed to catch insider trading. What is shocking is that this is news to her. The split between SROs and the SEC on enforcement of the securities acts has always been a tenuous marriage. It was a political compromise in 1934 that survives today and should be scrapped. The effect, which has been evident for over forty years is that federal enforcement lags and both the SROs and the SEC blame each other. Neither has the full incentive to enforce because accountability is shared. Here the SROs says it gathers data but does not act on it other than sending it to the SEC. The SEC gets the data, which it does not gather, and attempts to sift through it to act on it. But the SEC is understaffed and overworked (the product of relying on SROs) and their computers and not totally in sync with the newer SROs systems. The result? Poor enforcement. The result is endemic to the split in enforcement responsibility and will continue to reappear in new guises -- when we can be shocked, shocked once again.