Wells Fargo repaying its clients $1.3 Billion over auction rate securities ("ARS")

I wrote over the summer regarding New York Attorney General Cuomo's continuing campaign for state governor, that then was taking the form of threatening litigation against Charles Schwab for refusing to take responsibility or pay liability to compensate investor loss on auction rates securities ("ARS").

Briefly, the hullabaloo on ARS ... they were (the ARS market collapsed in February 2008) a financial product with variable interest rates that were determined at auction. They were represented by the banking industry as liquid; that despite the instruments frequently coming in the form of debt bonds assigned lengthy time periods, that investors would always be able to sell the ARS at the next auction. Auctions can and do fail, however: if there are not enough buyers and sellers participating, the auction fails and ARS holders are prevented from making their allegedly liquid assets liquid.

Dealbreaker posted today that Wells Fargo has bitten the bullet and is repaying clients who bought the product, to a tune of $1.9 billion. The bank is also paying a penalty of $1.9 million for misrepresenting to clients the product's liquidity. Keep in mind that Wells Fargo sold nearly $3 billion in ARS.

Wells' agreement was reached with the state securities regulators from California, Georgia, Missouri, Oregon, Texas, Utah, and Washington. The $1.9 million penalty fee is to be distributed to these states.

Back to Schwab quickly: Chuck came out angry and swinging at Cuomo over the summer, but there has been little indication from either party since of any escalation of the matter. I don't think for a moment that means the matter is closed, and perhaps the recent payments by Wells Fargo will recall to Cuomo his initial endeavor.

Tom Petters' Ponzi Scheme: $3.65 Billion

It has been speculated that the Petters ponzi trial (and conspirator trials) are getting less attention from the media and financial community in light of contemporaneous ponzi schemes: Bernie at $50 Billion and Stanford at $7 Billion.

Here's a guy who has a dicey history - college drop-out, once worked at Radio Shack and had a number of failed businesses, and was treated in rehab for a cocaine habit - turn into a billionaire for the second half of his life. Americans love a good comeback story. At the height of his success, he ran Petters Worldwide, which was a larger financial conglomerate that owned over four dozen smaller companies. Smaller is misleading; among the companies included were Polaroid (which has since filed bankruptcy paperwork), Sun County Airlines (also on the bankruptcy train), and Fingerhut. Petters was under control of substantial assets. And to think: both his legitimate and illegitimate business endeavors began with a wholesale liquidation model.

The ponzi scheme? Petters duped creditors and investors by creating false documentation of transactional activity to evidence the purchase and sale of home electronics. Allegedly, Petters bought home electronics at liquidation prices, and then made a profit by selling the electronics to larger retailers at an inflated price. The scheme ran for over a decade, and involved a number of people close to Petters. This includes a close staff member (who ratted him out to the feds), an ill reputed lawyer who laundered money for Petters through a private bank account, and a hedge fund manager that represented to creditors and investors that he frequently cashed-out Petters transactions through his hedge fund.

Conspirator trials have largely been concluded, but Petters himself is on trial right now in the District Court for Minnesota. He faces numerous criminal charges that, if convicted, threaten a potential life sentence. Prosecution rested on Monday and defense is currently presenting its case. Petters himself was on the witness stand yesterday.

Always makes for good drama! FWIW, you can check it out via the AP, Bloomberg, or the WSJ.

The Senate and Dodd release their own version of Financial Reform

The text of the draft legislation is here. I haven't read it yet, but can summarize some of the provisions receiving the most (negative?) attention.

Single Banking Regulator, Financial Institutions Regulatory Administration. Created from combining the Office of the Comptroller of the Currency and the Office of Thrift Supervision. All banking regulation is pulled under this new group; hat-tip to controversy: at the cost of the FDIC and the Fed. (Though with one hand he taketh, with the other hand he giveth: FDIC gets to take-over and break-up failing financial companies). No state agencies would any longer have banking regulatory authority and thrifts would in fact have to become banks.

Fed is Reorganized. Specifically, Fed ability to make emergency loans to companies is curtailed, and bank and consumer protection supervision is taken away and relocated elsewhere in the federal hierarchy. Further, where private bankers currently choose six of the nine directors on each of the twelve regional bank boards, Dodd's draft legislation proposes to give this power to the Federal Reserve Board in D.C. Dodd would also give the President the power to nominate Chairmen for the regional bank boards, subject to Senate confirmation.

Council of Regulators. These folks would monitor (and presumably takes steps to remedy?) systemic risks.

Consumer Financial Protection Agency. At last - something Everyone can agree on? Will cover consumer products including credit cards and mortgages.

"Too big to fail institutions." Once identified, regulators could require a company to shed divisions and components to reduce size.

A federal insurance regulator is created; derivatives go to an exchange; rating agency liability is increased; parties selling ABS would be required to retain partial ownership; and shareholder voice is given a new, higher platform (as regards governance issues broadly, and executive compensation specifically).

It's early in the game, and House and Administration reform look very different; is difficult to say what of any of this will remain by next year at this time.

What Goldman Sachs CEO Lloyd Blankfein Should Have Said

We were fortunate to have had an extraordinary year. I am grateful to our
employees, shareholders, and the U.S. government for helping us through one of
the most challenging periods in the firm's history. Blodget
at Business Insider.

What he said instead,

I often hear references to higher compensation at Goldman. What people
fail to mention is that net income generated per head is a multiple of our peer
average. The people of Goldman Sachs are among the most productive in the
world. HuffPo via FT.

Which like his "God's work" comment, is the language he is choosing to describe - I think - the valuable role these bankers do play. For better or worse, they do make money move and produce, which is a valuable function in our economy.

On the other hand, this sort of unedited and misinterpreted commentary makes the gap between Wall St. and Main St. all the more evident and frighteningly real. FWIW.

Consumer Financial Protection Agency ("CFPA") – what's inside?

So the Consumer Financial Protection Agency ("CFPA") made it out of two House Committees last week: the Financial Services Committee and the Energy and Commerce Committee. I have blawgged before about what the legislation entailed, but that was when it was first proposed by the Administration over the summer. I wanted to follow-up with a review of what the bill looks like coming out of the Committees (and onto the House floor for a vote) (though note, early Senate sentiment is not looking too keen).

No plain vanilla provision. Let's review. At its most basic level, the vanilla provision required private financial companies to offer a standard version of whatever financial product they offered. So if for example, a private company offered consumers credit cards: the federal government would create a very basic, easily understood credit card product that the private financial company would be required to offer alongside any sophisticated credit card product.

Actors exempt from CFPA oversight include: banks with assets of $10 billion or less; insurers (ie. mortgage or title insurance); attorneys, accountants, real estate brokers, cable companies, and auto dealers. So the last few make sense, keep in mind that the intent of the CFPA is to rein in predatory credit lending and credit related products.

Watt-Moore Amendment. Recall that the legislation was originally going to allow co-regulation by federal and state regulators over the private financial actors. The battle has been lost, however: current language allows for the Comptroller of the Currency to override state laws if they interfere with federal regulation. Your guess is as good as mine as to what that means (though my money is on federal pre-emption continuing unabated).

Also recall that over the summer the CFPA was proposed as an enormous umbrella capacity for regulating all things related to consumer financial products >> taking regulatory authority from existing federal agencies, and pooling it under the auspices of the CFPA. Some of that made it out of Committee: the Federal Trade Commission (FTC) has lost oversight of the consumer credit rating agencies to the CFPA.

Financial Stability and Improvement Act of 2009

The Financial Stability and Improvement Act of 2009, otherwise known as draft legislation for the “Too Big Too Fail” institutions, was proudly unveiled last week by Treasury and the House Financial Services Committee. Here’s the meat of what it proposes:

Creation of another (?!) Council, this one the Financial Services Oversight Council, which first identifies financial companies and activities that pose a threat to systemic stability, and then monitors them. No really – without other elaboration as to how to identify or effectively achieve any of that, this is what the draft legislation proposes. This Council, evidently, has a massive data-gathering responsibility (data generated by various federal financial agencies), and has the ability to name concerns for federal action.

A fairly aggressive approach to holding company regulation. Specifically, the draft legislation removes Gramm-Leach-Bliley Act restrictions on federal power (specifically, this would allow various federal agencies to regulate). Background: Gramm-Leach-Bliley, alternatively known as the Financial Services Modernization Act of 1999, rolled back Glass-Steagall (1933) in part. But a big part. Glass-Steagull said investment banks are investment banks, and commercial banks are commercial banks, and insurance companies – very big surprise – are insurance companies >> keep your buckets separate. Gramm-Leach-Bliley, among other things, allowed these separate actors to consolidate. So one bank could offer all variety of financial services, and voila, usher in the dawn of the financial service industry.

• Following presumed enactment, no further commercial companies will be allowed to own banks, industrial loan companies ("ILCs"), or any specialty bank charters.
• Thrift holding companies would be subject to fed supervision, and such charters would be reserved for entities focused on mortgage lending.

The draft legislation has a very federal bankruptcy code-type idea. The draft legislation contains language that provides for wind-down activities. Specifically, “that shareholders and unsecured creditors bear the losses, not taxpayers.” The draft legislation delegates the FDIC with this wind-down responsibility, and costs are to be provided for by the failed company (presumably priority above the creditors; *yay* lawyer drafters). VERY INTERESTING: if the company actually does not have enough money to wind-down, a “Resolution Fund” will pay the deficit. This fund is created by “assessments on all large financial firms” (later defined as companies with assets of $10 billion or more).

Not as interesting: there are new organization models; ie., the Treasury Secretary must approve any Fed effort to provide liquidity; and banking regulators and the SEC have to come together to write rules requiring creditors (or securitizers where the loan was not originated by the creditor) to retain 5-10+ percent of any credit risk associated with loans for securitization (is it me, or was that the rule right there?).

Investor Protection Act of 2009

Because last week was hot for re-regulation, I promised a summary of what I saw. So here goes ...

The Investor Protection Act of 2009 was proposed by Treasury in July, and will probably be voted out of the House Committee on Financial Services this week for a House floor vote later this fall. Some of the more rockstar aspects of this bill include:

Should advisers and broker-dealers owe the same fiduciary duty to investors? Currently, investment advisers must act in the best interests of the client; broker-dealers, on the other hand, are only legally required to provide a suitable product for investment. Keep in mind the distinction here: investment advisers offer financial advice to individuals or asset management to funds or corporations; broker-dealers actually trade shares to benefit their own accounts (whether as an agent for a client or as a principal on their own behalf).

The bill creates new SEC powers, in two ways. First, it amends the Investment Company Act of 1940 to require mutual funds to disclose more information to investors. Second, the bill also creates an Investor Advisory Committee that represents investor interests within the SEC.

Also-also: there are whistle-blower provisions that offer protections and compensations; and investment advisory firms with assets of less than $100 million will forthwith be regulated by state securities agencies.

UPDATE (11.05.2009, 145p): The legislation was voted out of Committee yesterday (11/04) and is headed to the House floor for a vote. Controversial meat on that bone is the Garrett-Adler amendment that was successfully attached to the bill. The amendment permanently exempts small businesses from a requirement that outside auditors review a company's internal control and environment (as regards issues of accounting, fraud, and waste). Small business is defined as companies with a market value less than $75 million. This will exempt approximately half of all publicly-traded companies. Brief background: the outside auditor requirement exists as part of the post-Enron Sarbanes-Oxley ("SOX") regulation. Historically, smaller firms have been exempted from the auditor requirement due to cost concerns.

Consumer Financial Protection Agency (“CFPA”) moves forward today: to pre-empt or not to pre-empt?

The House Financial Services Committee meets again today to mark-up draft legislation on the Consumer Financial Protection Agency (“CFPA”). The hearing is scheduled at 2pm EST and a live webcast is available here. I have blawgged about the CFPA here and arguing for allowing continued pre-emption; here’s a public policy paper arguing against continued pre-emption.

Recall last week the Committee created significant news for having adopted the Miller-Moore Amendment, which exempts “small” banks and credit unions from CFPA annual examinations. (Where “small” is defined as banks with assets less than $10 billion and credit unions with assets less than $1.5 billion). The Miller-Moore exemption actually eliminates the annual examination for 8,000 of 8,200 banks (or, 98% of American banks). Per the American dream, however, that big bank 2% actually holds 80% of national banks assets, or $11.2 trillion. Bottomline: CFPA would still write rules for all banking institutions, and could investigate a consumer complaint against any bank of any size. (The headlines last week indicating the Committee had caved to special interests were largely overdone - shocker ... The amendment only exempts small banks and credit unions from annual examinations).

Photo credit: Brendan Smialowski via NYTimes.

Navel Gazing and UPDATE: Executive Compensation and Financial Markets

So I’ll admit my own distraction for the last week, but was surprised that when I tuned-in again, the issues of executive compensation and market regulation had been subject to significant movement. Seriously: this is why people are afraid to take vacations.

The Consumer Financial Protection Agency (“CFPA”) being proposed by the Obama Administration (discussed earlier here) has taken some serious heat >> members of the President’s own party are offering competing proposals that in fact contain no mention of CFPA at all. Well, sort of … in place of creating a new federal regulatory structure for financial products marketed to consumers, Representative Walt Minnick (D – Idaho) has proposed having existing state and federal regulators work with one another under a Consumer Financial Protection Council (“CFPC”). Rumor also has it that once supportive House Financial Services Committee Chairman Barney Frank (D – Mass.) has indicated that the final bill will not contain the “plain vanilla mandate;” recall, under the CFPA, the government would create standard financial products that would be required to be offered in tandem with specialty products banks and firms offered to consumers. The House Committee meets today at 10am to continue hearings on the matter; a webcast is available from the House site here.

The SEC is creating a new division of Risk, Strategy and Financial Innovation. The new division will advise the commission on how new developments, products, and trends may affect the financial market and systemic risk. The division actually pulls together functions across existing Commission divisions, including the Office of Economic Analysis and the Office of Risk Assessment.

Microsoft’s Board of Directors approved a shareholder say-on-pay proposal, giving its shareholders an advisory vote on executive compensation. The first vote will happen at this year’s shareholder meeting on November 19th, and then occur again every three years after.

The Federal Reserve itself is moving to amend compensation practices, and is seeking to expand its regulatory reach regarding the compensation of nearly all bank employees. Caps are not being sought, but evidently the Fed is toying with different methods of how to curtail the amount of risk-taking employees throughout the bank take on behalf of consumers.

Glad the Fed thinks it can fix something, because every time you hear a bell ring, another American bank fails.

And our favourite main-man – Kenneth Feinberg the Pay Czar – has announced that within the next several weeks he will be disclosing some of the compensation revealed to him and approved by him. Rumour is Feinberg is looking to set some manner of precedent.

And precedent seems to be all we will be getting out of the recent G-20 meeting on the issue of executive compensation. Each of the world leaders in attendance affirmed their intent to reform executive compensation and capital requirements at banks, and then they each exchanged promise rings and caught the next flight home.

FWIW – a few of the headlines I found in my inbox over the course of last week. My continued obsession with Bank of America (“BofA”) of course continues, and has also been hot lately. BofA warrants its own post, though, so see you at lunch!

Photo credit: Anne Geddes, as portrayed by Pauline Kaill on Playle's Online Auction.

Auction Rate Securities (what are they?): Charles Schwab and David Markowitz

Busy week. David Markowtiz, attorney under NYAG Cuomo’s Investor Protection Bureau, filed a complaint against brokerage firm Charles Schwab on Monday. The complaint contained four causes of action as regards auction rate securities (“ARS”): alleging fraud, misrepresentation, and deception under various state laws, including the Martin Act. Among the relief sought is a Schwab buy-back at par value of all the auction rate securities it sold. The complaint was not a surprise for a number of reasons. We are all familiar with the auction failures in 2008, and the subsequent series of bank buy-backs at par value. Specifically as regards Schwab, Cuomo signaled last month his intent to file the allegations. Schwab's counsel Faith Gay at Quinn Emanuel responded then with a letter accusing the NYAG of abusing its prosecutorial discretion. It was only natural then, that this Monday’s complaint would be filed in tandem to Quinn’s public disclosure of its July letter. Too, just yesterday Mr. Charles Schwab himself wrote an op-ed for the WSJ arguing the NYAG Office’s litigation effectively spells the end of the open market.

So what are auction rate securities, who are the parties involved, and what are the various arguments for and against the NYAG’s most recent foray into market conquest.

In broad-broad strokes, what are ARS?
ARS are either debt bonds or perpetual equity instruments. Both pay variable interest rates to the holders. The interest rates are determined as the securities are bought and sold at a “Dutch auction.” Buyers at a Dutch auction place bids for ARS, specifying both the number of securities they want and the minimum interest rate they are willing to accept for that security. The lowest interest rate proposed among the bidders becomes a “clearing rate,” establishing the variable interest rate the ARS pays to holders until the next Dutch auction. Auctions are held at variable time periods, ranging anywhere between seven to thirty-five days apart.

If however, there are not enough buyers participating in a Dutch auction, the auction “fails” and no securities are bought or sold. The rate paid on the securities then is called a “fail rate” (different from the variable interest rate, and established among the terms in the origination paperwork). This failure creates the liquidity concern that is the focus of the NYAG Office's complaint. Effectively, buyers are incapacitated from selling their securities; they’re forced to hold the security for the term of the debt bond, or in perpetuity in the case of the equity instrument.

NYAG’s Markowitz’s arguments in the complaint
The complaint is like a pitbull on the matter of liquidity; every allegation and factual assertion is premised on it. Markowtiz argues, inter alia, that Schwab and its management held themselves out as a trusted financial advisor, and therefore negligently and recklessly: failed to understand the ARS market, failed to properly train and inform its sales force of the same, and failed to properly communicate the liquidity risks and product consequences to its clients. Markowitz alleges Schwab distributed ARS underwritten and managed by banks, and was then compensated for those successful sales. Further, these transactions passed through New York trading desks and via New York auctions.

Faith Gay’s arguments in Schwab’s retort letter
Gay’s arguments are many-fold. First, Schwab maintains that it did not underwrite any ARS, and therefore did not make or break any commitment to support the ARS market. Schwab maintains it did not actively market ARS to its customers, but rather, made ARS available to its customers upon request. Schwab employees who completed consumer requested ARS transactions were not in fact compensated specifically for doing so. Further, Schwab did not buy any ARS for its own account or inventory. Schwab also maintains it did not enter any support bids in the ARS market (bids which have largely been credited as the artificial liquidity of the market, and its eventual collapse last February).

Gay also criticizes the NYAG’s office for a number of the state law grounds they use, and the façade of litigation for a goal that has long been predetermined (force Schwab to buy-back the securities at par value).

A large portion of Gay’s arguments, however, relies on an unclear distinction between "upstream" (underwriter banks such as Citigroup) and "downstream" (brokers such as Schwab) actors. The gist: the upstream actors “created, sustained, and [then] abandoned” the ARS market; Schwab is as much a victim of this as are the individual consumers who now hold securities indefinitely. Problematic in this regard is the recent buy-back at par by downstream actors such as TD Ameritrade and Fidelity Investments.

This post has grown long – please excuse! – I will write more numerous, but shorter posts as the matter develops in the coming weeks. Thanks – Sls.

Consumer Financial Protection Agency (“CFPA”): the re-regulation has begun

Olga wrote me last week, bringing my attention to a discussion of whether the U.S. is re-regulating itself out of competition for global business and capital. I kept her note in my inbox, and over the course of the week a number of other articles and blawgers caught my attention on the same topic; Richard Posner among them. My motivation for discussing re-regulation here is not so much the broader perspective of – are the regulators in the best position to tell consumers and businesses how and what they should be doing, and where will that structure lead us in ten years – as much as it is what this re-regulation practically entails to those businesses and consumers immediately subject to it. And I think plenty of folks will be subject to it: in total, as of last week, there are 32 government czars. That’s a lot of administrative law (as a side note for another post: is there an issue of executive vs. legislative power here?).

The Obama Administration has proposed the Consumer Financial Protection Agency (“CFPA”) Act of 2009 (the “Act”), intending a number of things. First, it seeks to bring under federal supervision non-regulated financial bodies that act as banks. This includes mortgage brokers and consumer-credit companies. Second, it will “consolidate[e] responsibility for consumer protection under one agency.” Third, FCPA “market-wide jurisdiction” will focus solely on how banking products and practices affect consumers. And Fourth, the FCPA will have “consolidated authority” to write, supervise, and enforce rules. For example, financial products and services that would come under this jurisdiction include but are not limited to: deposit-taking services, various forms of credit extension and loan servicing rights, as well as real property services (Ie., settlement services, title insurance services, and matters of leasing). The FCPA will have a board of five members serving terms of five years, including: the National Bank Supervisor and four additional members proposed by the President with consent of the Senate. The agency will also have a consumer advisory board (similar to the role of the Investor Advisory Board to the SEC).

The Act does have some teeth, however. Similar to the SEC’s ever-useful §10b and Rule 10b-5 violation of the Exchange Act, the FCPA would be empowered with a similar enforcement provision over similar-such fraud. This includes, among other things, fraud as regards public disclosures of consumer financial products and services, as well as sales practices. One of the most interesting provisions of the Act, however, is the CFPA responsibility to create “standard consumer product[s] or service[s].” Essentially, the CFPA will create bare-bone versions of financial products and service, and these bare-bone versions must be offered for sale alongside the other, privately-created financial products and services. Just a guess, but this “standard” product discussion is going to get pretty lively in the next several months.


Also, as part of the second intent of the FCPA - as described above, consolidating consumer protection – the Act proposes removing consumer-related functions and responsibilities from existing administrative agencies. As the Act stands now, this would affect: the Federal Reserve Board (“Fed”), the Office of the Comptroller of the Currency (“OCC”), the Office of Thrift Supervision (“OTS”), the Federal Deposit Insurance Corporation (“FDIC”), the Federal Trade Commission (“FTC”), and the National Credit Union Administration (“NCUA”). This has raised some eyebrows as the Act was introduced earlier this summer, and is also likely to create drama throughout the next several months.

The House has absorbed much of the Act in the form of bill H.R. 3126. However, the House bill does not contain reference to either the creation of a National Bank Supervisor, or removing consumer-related enforcement as delegated by the Community Reinvestment Act (“CRA”) (as regards depository institutions engaging in fair lending, overseen by the OCC, the Fed, the FDIC, and the OTS). Discussion of the bill is pending the Congressional summer adjournment (Washington reconvenes after Labor Day). Additionally, there are Senate and House bills for a Financial Product Safety Commission (S. 566 and H.R. 1705, respectively). Both bills are yet in Committee, so am unsure at the time of this post if their provisions will be absorbed by the FCPA, or forfeited altogether.

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Litigating the Credit Rating Agencies

AmLawDaily is among the media outlets that reported CalPERS filed a suit alleging negligent misrepresentation against Moody’s, Standard & Poors (via The McGraw Hill Companies), and Fitch. The suit – the first by a pension fund against a credit rating agency - also alleges that each rating agency played a role in the structuring of the investment vehicles. The litigation was filed in California state court, alleging violations of both the California Civil Code and California common law. The short of it: CalPERS (which manages $ 173 billion in assets) invested in structured finance vehicles that defendant rating agencies denoted as AAA; the subprime crisis revealed the vehicles were in fact not AAA, and CalPERS is seeking recompense of its lost investment.

There appears to be a consensus that the rating agencies will successfully plead their ratings are an expression of their First Amendment rights, and the CalPERS suit will be dismissed. Really? I am both a young attorney and new to the matter, so was surprised when I discovered that the rating agencies are not only subsidized by the federal government, but also receive compensation from the firms whose instruments they rate. Frank Pasquale at Co-Op has a great post on the topic. I am really intrigued by the issue, and so investigated what litigation in New York is among that pending against these actors.

In In re Moody’s Corp. Sec. Litig., 599 F. Supp. 2d 493, reconsideration denied, 612 F. Supp. 2d 397 (S.D.N.Y. 2009), plaintiff investors filed a class action against the rating agency and several of its officers and directors, alleging a variety of misrepresentations in violation of the Exchange Act § 10(b) and Rule 10b-5. Among the misrepresentations Moody’s is alleged to have made: as regards the independence of both itself as a rating agency and the ratings it released, in light of interested issuers of securities; as regards the meaning of Moody’s ratings themselves; as regards Moody’s structured finance revenue; and as regards its rating methodologies. Although I will not address such in this post, plaintiffs also alleged control person liability against individual defendants, under Exchange Act § 20(A). On defendant motion, the Court dismissed all allegations against defendant COO and Managing Director of Moody’s U.S. Asset Finance Group, and allegations regarding the meaning of Moody’s ratings and Moody’s structured finance revenue (meaning and derivation). The remaining claims proceeded to trial, and plaintiffs were otherwise left with leave to amend.

Although only an opinion on a motion to dismiss, it’s interesting to review what happened. The Court found plaintiffs provided sufficient evidence that Moody’s statements about its independence were indeed false. The Court relied on a number of WSJ articles that described events such as: Moody’s changing a rating so as to save a client issuer; and promotion of analysts who favored higher ratings and asked fewer questions. In finding so, the Court rejected defendant’s puffery argument; that language was “vague” and “non-specific.” The Court considered precedent which had ruled puffery as inactionable; language there took the form of declarations of intent and discussion of hope. Moody’s, on the other hand, was found to have treated its independence as a “cornerstone” of its very livelihood, and the Court found several public statements made by Moody’s to be neither “vague” or “non-specific.” The case is yet pending in the Southern District Court of New York, 07 CV. 8375 (SWK).

The topic is hot, not to mention interesting. As a new attorney to the issue, there are loads of topics to research and discuss, so I will certainly revisit the topic as the blawg moves forward (no pun on that last bit … ). Thanks – Sls.

(Image courtesy of Bank of the Ryukyus, Limited).

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More (?!) Bank Closings and New Rules for Private Equity Buyers

Is this a visual alarm bell, or just an economic system purging itself? As of Thursday, the total number of banks closed since Fall 2008 is greater than 75. At the end of Q109, the FDIC had 305 banks with $200 billion in assets on its list of "problem institutions." Interestingly, in concert with Thursday's seizures, the FDIC proposed new rules for private equity groups purchasing the banks. The online discussion since has been pretty robust.

The FDIC is juggling conflicting goals here: trying to entice the deep pocket liquidity of private equity buyers, while structuring the purchase and performance of the newly acquired banks so that future systemic problems are avoided. Critics charge that the move will deter the very private equity the FDIC is courting. Among the requirements generating the most discussion is the proposal that buyers maintain a 15% leverage ratio after they purchase the bank.

Briefly, leverage ratios are useful in understanding how a bank uses its assets, as well as predicting whether that bank can meet its financial obligations. The concept is straight-forward enough: you have $10,000 of your own money at 5% anticipated gain. Your profit is $500. But if you fully leverage yourself and borrow someone else's $9,999 against your own $10,000, your profit doubles to $1,000 (presuming the same 5% anticipated gain). The profit to be gained from more and more leverage - all on the back of your original $10,000 investment - is understandably attractive. The problem is when losses occur and downside risk has not been provided for. Plenty of commentators have identified leverage as a key factor contributing to the ongoing economic snap. The FDIC proposed leverage ratio and the subsequent pushback illustrates the indecision of what to do with this issue moving forward ...

Other proposed requirements for private equity buyers include: owning the purchased bank for at least three years; not lending to affiliates, including buyers' own portfolio companies; and disclosing buyer details, such as ownership. The proposal is subject to a 30-day comment period. This is a really intriguing matter for me, so although this post strikes more of an FYI tone, I will continue to follow the issue and update the blawg as the next several weeks unfold.


Hat tip: Kevin LaCroix at The D & O Diary.

(Photo courtesy of Wikimedia Commons).