Friday, April 4, 2008
Appaloosa Management, on behalf of a group of investors that planned a $2.55 billion equity investment in auto supplier Delphi Corp., which is trying to exit Chapter 11, delivered to Delphi a notice of immediate termination, asserting that Delphi had breached a number of provisions of the agreement and owed the investors a $82.5 million fee. Delphi says it's "extremely disappointed." WSJ, Group Plans to End Deal to Invest in Delphi.
The headlines are all about the Senate Banking Committee hearing yesterday on the collapse of Bear Stearns, where federal officials, including Ben Bernanke, Christopher Cox, and Timothy Geithner (New York Federal Reserve) and company officials, including Alan Schwartz (Bear) and James Dimon (JPMorgan), testified about the days before the Bear-JPMorgan deal was struck. Not a lot of new information came up, but the testimony describes a classic "run on the bank" that led to Bear's urgent need for financing on Friday March 14. Alan Schwartz first thought, when the Fed offered financing that the firm had 28 days to find a solution to its problems, but later that day learned that Bear had to make a deal by Sunday evening -- he described it as an honest misunderstanding. Treasury Secretary Paulson wanted the price for Bear stock to be low to deal with the moral hazard issue. It has been widely reported that Bear officials are upset that the Fed did not begin lending directly to investment banks until after the Bear-JPMorgan deal, and that the availability of funds earlier could have saved Bear. But that would not have happened, said Timothy Geithner, because the Fed only lends to healthy institutions. When pressed about the possibility of market manipulation in the days before the collapse, Cox said the SEC was investigating. NYTimes, Testimony Offers Details of Bear Stearns Deal ; WSJ, Officials Say They Sought
To Avoid Bear Bailout.
Thursday, April 3, 2008
Here is Chair Cox's Testimony Concerning Recent Events in the Credit Markets Before the U.S. Senate Committee on Banking, Housing and Urban Affairs on April 3, 2008, where he noted that
for the first time, a major investment bank that was well-capitalized and apparently fully liquid experienced a crisis of confidence that denied it not only unsecured financing, but short-term secured financing, even when the collateral consisted of agency securities with a market value in excess of the funds to be borrowed.
But what neither the CSE regulatory approach nor any existing regulatory model has taken into account is the possibility that secured funding, even that backed by high-quality collateral such as U.S. Treasury and agency securities, could become unavailable. The existing models for both commercial and investment banks are premised on the expectancy that secured funding, albeit perhaps on less favorable terms than normal, would be available in any market environment.
The SEC filed a civil action in the U.S. District Court for the Southern District of New York against United Kingdom-based hedge fund adviser Pentagon Capital Management PLC (PCM) and its Chief Executive Officer, Lewis Chester. The complaint alleges that PCM and Chester orchestrated a scheme to defraud mutual funds in the United States and their shareholders through late trading and deceptive market timing. PCM's advisory client, Pentagon Special Purpose Fund, Ltd., obtained approximately $62 million in illicit profits through this scheme, at the expense of U.S. mutual funds and their shareholders. The Commission named the Pentagon Fund as a relief defendant.
The Commission's complaint alleges that from approximately June 1999 through September 2003, PCM actively traded U.S. mutual funds through Pentagon Fund's accounts at numerous broker-dealers in the United States. PCM and Chester routinely engaged in late trading of U.S. mutual funds. PCM placed orders on behalf of the Pentagon Fund, to buy, redeem, or exchange mutual fund shares after the 4:00 p.m. Eastern Time (ET) market close while still receiving the current day's mutual fund price. PCM and Chester also used deceptive techniques to market time U.S. mutual funds. For example, PCM opened numerous accounts for the Pentagon Fund at various U.S. broker-dealers, and split Pentagon Fund trades among these multiple accounts to hide the extent of the Pentagon Fund's trading from mutual fund companies. PCM also used multiple accounts so that when a U.S. mutual fund detected market timing and informed the Pentagon Fund to stop, PCM would simply transfer funds to a new Pentagon Fund brokerage account that the U.S. mutual fund was unaware of, and Pentagon Fund would then resume market timing the same mutual fund.
The complaint seeks as relief a final judgment: (i) permanently enjoining PCM and Chester; (ii) ordering PCM, Chester, and the Pentagon Fund to disgorge their ill-gotten gains and to pay prejudgment interest; and (iii) imposing civil money penalties against PCM and Chester.
Federal Reserve staff are onsite at the five major investment banks to monitor their financial condition. Chair Cox will testify today before the Senate banking committee, amid inceased Cong, ressional criticism of its performance. Senator Grassley, for example, asked the SEC's inspector general to review the agency's 2005 investigation into Bear's pricing of mortgage-related assets, which the SEC closed without filing charges. WSJ, The Fed Hits the Street.
Wednesday, April 2, 2008
Senator Jack Reed (D-RI) expressed concern that the SEC is moving too fast toward mutual recognition of foreign regulators and plans to call a hearing on the concept. In addition, he wants a GAO report on the effectiveness of the SEC enforcement division. WSJ, Senate Democrats Wary Of Foreign-Regulator Plan.
Tuesday, April 1, 2008
The SEC's Office of Inspector General of the Securities and Exchange Commission conducted an audit of the SEC's process for reviewing Self-Regulatory Organization (SRO) proposed rule changes. It concluded (surprise!) that "the Commission s overall timeliness in processing proposed rule changes needs improvement." Specifically, the SEC did not approve proposed rule changes within the prescribed statutory timeframe in 8 of 15 instances that it selected to review. Additionally, the Division of Trading and Markets (TM) does not have a policy that outlines criteria to follow-up with SROs on open proposed rule changes, request SROs to withdraw proposed rule changes, and disapprove or reject proposed rule changes.
The report goes on to note that: "Timely processing assists the SROs to remain competitive with foreign and futures exchanges, electronic communications networks and alternative trading systems that can change their trading or trade new products with greater ease and without Commission review."
NASAA announced that its membership has approved a new model rule prohibiting the misleading use of senior and retiree designations. The model rule prohibits the misleading use of senior and retiree designations while also providing a means by which a securities administrator may recognize the use of certain designations conferred by an accredited organization. NASAA President Tyler said NASAA’s Model Rule on the Use of Senior-Specific Certifications and Professional Designations represents the culmination of an effort NASAA and its members launched in 2003 to focus national attention on unscrupulous behavior targeting senior investors.
The model rule addresses the growing use of financial designations or certifications that ostensibly convey expertise in advising seniors and retirees. The use of a senior designation by salespersons, whether registered or not, confers an impression that the salesperson has special qualifications or specialized education in addressing the needs of senior citizens or retirees, particular areas of finance, financial planning, estate planning, or investing.“
An interesting warning from the SROs, presumably directed at abusive short-sellers:
The Financial Industry Regulatory Authority (FINRA), NYSE Regulation, Inc., and participants of the Options Regulatory Surveillance Authority (ORSA), the self-regulatory organizations primarily responsible for surveillance of trading in the U.S. securities markets, are coordinating efforts to heighten the monitoring and investigation of trading activity in issuers that may be subject to credit market-related volatility.
Firms are reminded of the prohibitions in FINRA and NYSE Rule 435(5) and FINRA Rule 5120(e) against the circulation in any manner of sensational rumors that might reasonably be expected to affect market conditions, as well as their obligations under FINRA Rule 2110 and NYSE Rule 476 to refrain from any conduct or activity inconsistent with just and equitable principles of trade. Similarly, firms are reminded of the prohibition on trading on material, non-public information.
Market participants should be especially aware that intentionally spreading false rumors or engaging in collusive activity to impact the financial condition of an issuer will not be tolerated and will be vigorously and aggressively investigated. This type of activity is highly detrimental both to the investing public and to companies constituting important components of the U.S. financial system.
In addition, market participants should review their internal controls and procedures with regard to the aforementioned activity. Individuals and entities engaging in such unlawful activity may be subject to civil as well as criminal prosecution. Self-Regulators Warn Against Spreading False Rumors and Other Abusive Market Activity
Is the elimination last July of the uptick rule that limited short sales responsible for increased stock volatility? So argue some investors, who say that short sellers have conducted bear raids and even conspired to drive down the price of Bear Stearns stock. Nonsense, say others; the subprime and credit crisis account for the volatility, not elimination of a technical trading rule. WSJ, Blame Game: The 'Uptick' Rule Debate.
Lehman, the fourth largest securities firm that Wall St. has been watching nervously as the possibly the next Bear Stearns, plans to raise $3 billion through the sale of convertible preferred shares to unnamed American institutions. NYTimes, Lehman Tries to Quash Talk by Raising $3 Billion; WSJ, Lehman Wants To Short-Circuit Short Sellers.
UBS announced it would write down another $19 billion because of U.S. real estate and structured credit positions and that its chairman Marcel Ospel would resign. It also said it would seek shareholder approval to raise $15 billion of new capital in a rights offering. NYTimes, UBS to Write Down $19 Billion; Chair Will Depart; WSJ, UBS Seeks Fresh Capital, Expects $19 Billion in Write-Downs.
Monday, March 31, 2008
FINRA today spelled out the options available to investors holding unexpectedly illiquid auction rate securities (ARS) because of recent developments in the credit market that have resulted in many ARS auctions failures: Auction Rate Securities: What Happens When Auctions Fail. What are the options? They include continuing to hold the securities, selling in the secondary market, liquidating other investments, or borrowing on margin. With respect to the latter, FINRA provides the appropriate warnings about the dangers of borrowing on margin, but this surely is a risky and dangerous option for most investors.
Some early reactions to Secretary Paulson's Blueprint:
From the SEC: "Recent events have provided further evidence, if more were needed, that financial services regulation in the United States needs to be better integrated among fewer agencies, with clearer lines of responsibility. Just as systemic risk cannot be neatly parceled along outdated regulatory lines, the overarching objective of investor protection can't be fully achieved if it fails to encompass derivatives, insurance, and new instruments that straddle today's regulatory divides. The proposed consolidation of responsibility for investor protection and the regulation of financial products deserves serious consideration as a way to better address the realities of today's markets."
From NASAA: "The Treasury Department’s blueprint is designed to boost Wall Street’s competitiveness, not Main Street investor protection. ... NASAA’s position was, and continues to be, unambiguous: the existing regulatory system, as it pertains to the securities markets, needs no fundamental restructuring. The focus of state securities regulators is clear and singular: investor protection must remain the centerpiece of the securities regulatory system."
From SIFMA: "Treasury has delivered a thoughtful and sweeping plan which should provoke intense discussion, debate and potential legislative changes. Our present regulatory framework was born of Depression era events and is not well suited for today's environment where billions of dollars race across the globe with the click of a mouse. That fact, teamed with the current market conditions, result in an universal agreement that it is time to modernize and revitalize the current system."
From FINRA: "Today's increasingly complex financial services landscape and fragmented regulatory environment has made it nearly impossible for the average investor to navigate the marketplace and fully understand the risks they may be exposed to and the protections they are entitled to. Investors shouldn't be left exposed and confused. Retail investors should get the same basic regulatory safeguards and protections no matter which investment product they choose.
All the information about Treasury Secretary Paulson's Blueprint for a Modernized Financial Regulatory Structure, including the 218 page report itself, is available at the Treasury's website. For those who don't want to wade through the whole report, here are links to the Secretary's speech and a factsheet.
The DePaul Business and Commercial Law Journal and the Commercial Law League of America announce the Sixth Annual Symposium, Lawyers, Law Firms, & the Legal Profession: An Ethical View of the Business of Law on May 1 from 10:30 a.m. to 5 p.m. Panels include: Lawyers in a Fee Quandary: Must the Billable Hour Die?; Lawyers in Transition: Ghosts from the Old Firm Haunting the New Firm;Lawyers in the Hot Seat: The State of Ethics & Professionalism. Tickets are $75.00 on or before April 1, 2008 and $90.00 after that date. Judges and students are free. For registration and sponsorship information, contact Don Carrillo, the Symposium Editor, at (312) 362-6178 or firstname.lastname@example.org, or Paula Lucas of the Commercial Law League of America at (800) 978-2552 or email@example.com.
Treasury Secretary Paulson will hold a press conference today to announce his plan to reorganize the financial markets, which was released over the weekend. The plan, a product of the Treasury Department's group that was originally convened to reduce financial regulation, is designed to replace the current overlapping and confusing system of regulation with a more streamlined approach. There would be three principal agencies with more oversight, but less direct regulatory powers: a prudential financial regulatory agency, a conduct of business regulatory agency and a corporate finance regulator. The SEC and CFTC would be merged and the financial market's self regulatory authority would be increased. Indeed, the SEC looks to be a big loser under this plan. Any reorganization will require Congressional action and would not happen quickly. The plan got mixed reactions from Congress. WSJ, Paulson Plan Begins Battle Over How to Police Market; WPost, Long Fight Ahead for Treasury Blueprint. One criticism of the plan is that it does not do anything to relieve the current Wall St. crisis or the plight of homeowners with mortgages in default. NYTimes, A Nervous Wall St. Seems Unsure What’s Next.
Sunday, March 30, 2008
Arbitration of Shareholder Claims: Why Change is Not Always a Measure of Progress, by JENNIFER J. JOHNSON , Lewis & Clark Law School, and EDWARD BRUNET, Lewis & Clark Law School, was recently posted on SSRN. Here is the abstraact:
Two Blue Ribbon business advisory panels have recently proposed arbitration to remedy the problems endemic to shareholder class action litigation. Critics have long assailed shareholder litigation as harmful to firms without conferring a corresponding benefit upon shareholders or the public. Contemporary criticism has focused on the circularity of the remedy in shareholder suits and the charge that even the potential for shareholder litigation harms the competitive edge of the U.S. financial markets. We contend that even accepting these criticisms at face value, arbitration is not the solution. The lure of arbitration as a panacea to cure the ills of litigation is based upon myths concerning modern arbitral realities. First, arbitrators apply substantive and undefined principles of fairness and equity rather than legal rules. Such decisions, once made, are virtually insulated from judicial review. While historically such a system constituted an efficient dispute resolution system between homogenous members of trade groups, modern consumer arbitration rarely takes place between those with any common understanding of applicable norms other than the law. Second, there is a hidden societal cost to moving to an arbitration system to redress securities law claims. Experience teaches us that mandatory arbitration causes the law to atrophy. This trend would be exacerbated in shareholder litigation, which is often based upon implied causes of action, that by their nature depend upon transparent judicial interpretation. Third, modern arbitration will not cure the ills of class action litigation. Arbitration today is no longer particularly quick or efficient in that it has incorporated many of the procedural appendages such as discovery that are common in litigation. However, the procedural protections against the most vexatious lawsuits against corporations would not operate in the world of arbitration. This danger would be intensified if class action arbitrations were allowed. This essay will critique the proposals calling for arbitration of shareholder claims and conclude that arbitration is not an attractive alternative to litigation.