Business Law Prof Blog

Harvard's Hedge Fund

For the fiscal year ending in June, the Harvard University endowment, one of the country's largest hedge funds, earned 8.6 percent while the S&P 500, a common market index, dropped 13.1 percent.  Other schools had a median minus 4.4 percent return.  The total endowment is notw $36.9 billion.  Note also that this was tax free.  Congress in its effort to tax success, is trying to figure out how to tax the endowment  -- (Grassley :"Distribute X percent annually or loose the tax deduction??").  Harvard could add considerably to their fund tommorrow with a simple offer:  Donate $100,000 (take the tax deduction) and we will create an second, taxable fund into which you can put another $600,000 or more that will mirror the investments of our primary fund.  Investors would rush in.

Xcel Energy Settlement with Cuomo: Trouble Coming

Excel Energy has agree to disclose "climate change risks" in its annual 10-K filings to get the Attorney General of New York, Andrew Cuomo, off its back.  Excel has not thought this through.  According the Cuomo's self-congratulatory press release, Excel has agreed to disclose "present and probable future climate-change regulation and legislation,"  "climate change related litigation," and the "physical impacts of climate change."  Think of the box Excel Energy is now in.  First, the company has admitted that these items are "material," an admission that will require disclosure in other contexts and settings. [How do they avoid disclosures in the quarterly reports.]  Second, the company will have to figure out what these general disclosures require.  No doubt, whatever they disclose it will not be enough for activists.  The disclosure will depend on assumptions of a baseline of man-made climate change, which some argue is severe and some argue is not man-made at all.  And third, and most significantly, the company now opens itself up to lawsuits on the content of the disclosures that are likely to survive summary motions for dismissal.  The only way out would seem to be detailed mea culpa disclosures -- "We are so bad; we are so sorry; we pollute like old chimneys; we are endangering polar bears; and we hope to change our ways." 

Delaware Court Upholds a Deal Termination Fee

Delaware Vice Chancellor Leo Strine dismissed a claim by a shareholder of the Lear Corporation that the company's board should not have agreed to a buyout contract in which the company promised to pay a termination fee of $25 million if the Lear shareholders refused to ratify the deal.  The shareholders did reject the deal and Icahn collected the $25 million.  The clause should be unremarkable, it was not a large amount given the acquisition price (well within any concept of liquidated damages for a breach) and it was offset by an explicit increase in the acquisition price.  The board took a business risk that proved to be wrong; there was no conflict of interest.  But Delaware courts are still is operating under the flawed Omnicare case that requires "fiduciary outs" in multiple style deal clauses.  So Strine had to use a good quantity of ink justifying what should have been an easy ruling in the case.  It is extraordinary that Strine did not even mention Omnicare in prose -- a telling omission.  All we get is an ambiguous footnote 62 that commingles Unocal and Revlon in a tantilizing but totally unclear reference to "Revlon-land."  We have to slog through a rather trite analysis of a board's power, indeed its duty, to take risks in "pursuing coprorate objectives." 

UnitedHealth McGuire Settles Option Backdating Case

Old scandals take a while to play out in the courts.  By the time court resolutions roll in we are well past the scandal and occupied by new ones.  One of the biggest offenders in the compensation stock option back dating scandal had a partial resolution of his civil claims this week.  Ex-CEO of UnitedHealth, William McGuire agreed to pay $39 million to plaintiffs and forfeit another 3.7 million compensatory stock options in the settlement of a stock options backdating case.  Do not weep for him, he still is worth over three hundred million dollars.  Also in the settlement was the company's old chief legal counsel, who paid $500,000.  None of these backdating schemes could have been done without the willing cooperation of securities lawyers, in-house or retained.  Too few lawyers have been called to task for their participantion in this scandal. 

Putin: The KGB Did Not Teach Him Anything About Markets

There is no partial market economy.  Putin is finding that out.  After his war with Georgia and his other saber rattling threats to the West, the Russian stock market has dropped more than 40 percent from its highs.  Investors are, in a way, more powerful than voters and investors judgments, as Putin has discovered, too late, count.  Drive investors away from Russian companies and the whole economy suffers.  He cannot talk his way out of this one;  the market, not NATO, will bring Putin to heel.

Plaintiff's Lawyers in Enron Litigation Get $688 Million

A federal district court judge in Houston has approved $688 million in legal fees to Coughlin Stoia and Geller for the firm's representation of the plaintiffs in the Enron litigation.  The plaintiff's recovered $7.2 billion on claims of $40 billion in losses.  Coughlin claimed to have worked 280,000 hours and to have out of pocket expenses of $45 million.  The fee award was 9.5 percent of the total recovery. 

ShowTime in Delaware Court

The busted Huntsman buyout litigation in Delaware Chancery Court is high drama.  It is the first Delaware case over the busted buyout problems created by the credit crunch that stated early last year: on one side is a well-known private equity firm, Apollo, run by Leon Black and represented by 5, 5, Wachtel partners; on the other side is an irascible self-made man with deep political connections (his son is Utah's governor; his friends include Orrin Hatch and Bob Bennett).  Apollo won a bidding context for Huntsman; Huntsman's earnings collapsed.  Apollo received an opinion from Duff & Philips that if it closed the deal the new company would be immediately insolvent, unable to service its new debts that had financed the transaction.   Huntsman claimed the new company would make it and, if it could not, that Apollo had a duty to renegotiate the financing to lower the debt load.  The Court will determine whether Huntsman can satisfy both of two conditions, a solvency condition and a no "material adverse change" condition (MAC clause).  There is be well-prepared financial experts on both sides.  The press is hot on the case, the seats are full, and hedge funds are paying scalpers to get in.  This is the case of the moment -- which means that it is overblown in importance.  The Judge may not want to wander into the MAC clause thicket (which will be a major disappointment to corporate lawyers) and could decide the case on insolvency alone.  Why lawyers cannot draft buyout agreements with specific language to stop such circuses is beyond me.

A Rumor Here, a Rumor There

An Internet blog rumor that UAL, the parent of United Airlines, would file for bankruptcy was false -- but it did not matter.  The rumor started on from a post on a Florida newspaper web site.  The rumor spread and investors dumped the stock.  Stock price fell from $12 to $3 in one day before some sanity reigned and the shares returned to $10.  We are apparently getting to used to rumor mongering in the political arena (e.g., "the baby was not Palin's") and trying it in the financial markets where it really matters. 

The Fannie Mae and Freddie Mac Seizure Fallout

We are starting to get wind of who the winners and losers are in the government seizure of Fannie Mae and Freddie Mac.  It is not a pretty picture.  Holders of mortgage-backed debt of the two companies, so called agency debt, and holder of subordinated debt are the big winners.  Why? Government cash investments will be paid behind the payments to the mortgage-backed and even subordinated debt.  Any threat of a default and the government will make the payments on the debt.  Who holds this stuff.  The largest holders of agency debt are 1) foreign countries through state owned banks and through sovereign wealth funds and 2) a worldwide network of private banks and 3) United States pension funds.  The largest foreign holdings of agency debt are China ($400 billion) and Japan (($230 billion).   We are bailing out China and Japan, the world's investment banks, and our pension funds.  Who is hurt??  Shareholders.  The government gets paid back before any preferred shareholders and common shareholders get any dividends.  Some shareholders are also holders of agency debt and do not mind; their gains on the debt side will swamp their loses on the stock side.  Some American investment banks and many pension funds are in this category.  But there are some banks that hold predominately preferred stock, most of them are regional banks or commercial banks, and they are big losers.  Shares are held in the public markets and usually in diversified portfolios.

Shareholders should lose (they are the residual claimants and they elect the board) but so should the debt-holders, particularly the subordinated debt holders (they took a risk of buying an instrument very similar to preferred stock).  Many debt holders have written down the value of their debt and now, suddenly, it is worth 100 cents on the dollar.  Why bailout foreign governments and why now -- both companies had reserves -- thin ones -- and could have run on their own for another year or so?

The answer is political, regrettably.  Treasury did not want a blowup with China and Japan before the election and it wanted to create another method of subsidizing the economy (through Frannie and Freddie) that would take effect before the election. China threatened to sell not only agency debt but Treasuries and it would roil our debt markets; tight debt markets hurt GDP.  This threat is one we need to stand up to (emergency tariffs on Chinese goods are WTO legal).

GDP numbers and unemployment numbers affect votes.    In short, the seizure is a Republican effort to help Republicans in November.  It is the reason why our government should not be in the mortgage business in the first place.  It is no better than government legislation, enacted just a few short months ago, that raised the cap on mortgages that the companies  could buy (increasing their risk), and that siphoned off $500million the companies for "affordable" housing  - both measures decreasing the companies balance sheet stability.  Government could, in theory, manage the companies correctly but in practice -- it's a Barney Frankenstein mess.         

Fannie and Freddie Seized

Over the weekend the United State Government, read Treasury Secretary Henry Paulson, seized two federally charted mortgage companies, Fannie Mae and Freddie Mac.  This comes on the heels of a federally sponsored buyout of one our largest investment banks, Bearn Stearns.  Now there is news that the three largest automobile companies, GM, Ford and Chrysler, want federal loans to sustain their companies.  For any who criticize the United States for engaging in "naked capitalism,"  this is proof that they are way off the mark.  We do not have anything close to a "free" market economy -- it is heavily managed.

The seizure of Fannie Mae and Freddie Mac makes two major mistakes and two minor ones as well.  The two major mistakes -- it is a windfall bailout of the subordinated debt holders of both companies -- the government preferred stock dividends and option to buy common take behind the current obligation to pay subordinated debt holders.  The subordinated debt holders, like the stock holders of both institutions should be wiped out -- they took a risk for return gamble and it failed.  Second, the remaining companies will still play the public interest game of lending money at below market rates to stimulate the mortgage market.  The companies are not, with government ownership, any more profit driven than they were before the seizure.  This should be no surprise -- government run companies are always quasi-political animals. In other words, the government will use these companies to "stimulate" the economy - a backdoor grant system. Great.

  The minor mistakes -- first, the company should sue the previous CEOs for breach of fiduciary duty and get back some of the outrageous salary and severance benefits they claimed while running the company into the ground.  Second, we should know the names of the politicians where that carried the water for these companies for years, blocking reform efforts, so as to get campaign contributions.  Who are the Fannie Mae and Freddie Mac eight (or whatever)?