Yearly Archives: 2009

A Lobbying Approach to SOX

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, March 21, 2009
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This post comes from Yael V. Hochberg, Paola Sapienza and Annette Vissing-Jørgensen of Northwestern University.

In our forthcoming Journal of Accounting Research paper entitled A Lobbying Approach to Evaluating the Sarbanes-Oxley Act of 2002, we evaluate the impact of the Sarbanes-Oxley Act (SOX) on shareholders by studying the lobbying behavior of investors and corporate insiders in order to affect the final implemented rules under the Act.

Following the passage of SOX in 2002, Congress delegated the drafting and implementation of the principles outlined by SOX to the Securities and Exchange Commission (SEC). The various sections of SOX were divided into separate rules by the SEC, which then solicited public comments regarding the proposed rules, prior to adopting the final releases. Letters to the SEC commenting on the proposed rules were publicly available on the SEC website or through its public reference office. Following the main compliance-related titles of SOX, we classify the rules on which the SEC solicited comments into groups. We focus on three major sets of rules: provisions related to enhanced financial disclosure (including the much-discussed Section 404 assessment of internal controls), provisions related to corporate responsibility, and provisions related to auditor independence.

Our review of these comment letters revealed that Investors lobbied overwhelmingly in favor of strict implementation of SOX, while corporate insiders and business groups lobbied against strict implementation. In addition, we find that the firms most likely to lobby were firms in mature industries, with relatively low forecasted earnings growth, high profitability and poor governance. These are precisely the types of firms that Jensen’s [1986] theory of free cash flow would predict are likely to provide more opportunities to management for expropriation, perquisite consumption or mismanagement of firm resources. In contrast, our analysis of audit fees indicates that lobbying firms are unlikely to be those that expect a large relative increase in compliance costs. Rather, lobbyers on average had lower audit fees relative to initial market value pre-SOX, and their audit fees relative to size increased by less, post-SOX, than those of non-lobbying firms.

Our portfolio analysis of returns reveals that during the period leading up to passage of SOX (February to July of 2002), cumulative returns were approximately 7 percentage points higher for corporations whose insiders lobbied against one or more of the SOX ‘Enhanced Disclosure’ provisions than for non-lobbying firms of similar size, book-to-market and industry characteristics. In contrast, we find no significant evidence of higher cumulative returns for those corporations whose insiders lobbied against one or more of the SOX ‘Corporate Responsibility’ provisions or for those corporations whose insiders lobbied against one or more of the SOX ‘Auditor Independence’ provisions than for comparable non-lobbying firms. Our analysis of returns in the post-passage implementation period suggests that investors’ positive expectations with regards to the effects of the ‘Enhanced Disclosure’ provisions were warranted.

The full paper is available for download here.

Is AIG Too Big to Fail?

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Friday, March 20, 2009
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Editor’s Note: This post is based on an op-ed piece by Lucian Bebchuk published in today’s Wall Street Journal.

The AIG bailout—at $170 billion and rising—may end up as the costliest rescue of a single firm in history. There is much debate about bonuses paid to AIG’s executives. But there is far too little debate on the government’s willingness to back all of AIG’s obligations.

The company claims any failure by the government to do so would have catastrophic consequences. This claim is exaggerated. Serious consideration should be given to forcing AIG’s partners in derivative transactions—which are mainly buyers of credit default swaps from the company—to take a substantial haircut.

AIG is a holding company, conducting most of its business through insurance subsidiaries organized as separate legal entities. The financial products subsidiary, which has produced the huge losses from derivative transactions that brought AIG down, is also a separate legal entity—but AIG has guaranteed the subsidiary’s obligations.

While AIG has thus far been able to cover derivative losses using government funds, the possibility of large additional losses must be recognized. AIG recently stated that it still has about $1.6 trillion in “notional derivatives exposure.” Suppose, for example, that AIG ends up with losses equal to, say, 20% of this exposure—that is, $320 billion. Suppose also that the value of AIG’s current assets, including the shares in its insurance subsidiaries, is $160 billion. In this scenario, the government’s fully backing AIG’s obligations would produce an additional loss of $160 billion for taxpayers. Should the government be prepared to do so?

The alternative would be to put AIG into Chapter 11. In this case, AIG’s creditors, including its derivative counterparties, would obtain the company’s assets. They would end up with a 50% recovery on their claims, bearing those $160 billion of losses themselves.

AIG recently stated that failure to meet all of the company’s obligations could lead to a “run on the bank” by customers seeking to surrender insurance policies and “would have sweeping impacts across the economy.” But insurance policy holders wouldn’t be at risk if AIG failed to meet its obligations. The insurance subsidiaries are not responsible for the debts of their parent AIG, and insurance policy claims are backed both by the subsidiaries’ required reserves and state insurance funds.

Still, what about the concern that losses to derivative counterparties—which are now known to include major U.S. and foreign banks—would substantially deplete the capital of some of them? That concern would be best addressed by the U.S. government (or foreign governments in the case of their banks) infusing capital directly—in return for shares—into the banks that need it. There is no reason to back AIG’s obligations as an instrument for infusing capital (with taxpayers getting nothing in return) into, say, Goldman Sachs or Spain’s Banco Santander.

It is true that the collapse of Lehman Brothers last September led to a crisis of confidence among depositors in banks and money market funds, which had a dramatic effect on markets. Letting AIG’s derivative counterparties take a significant haircut, however, should not lead to such a crisis. AIG’s obligations are to derivative counterparties, not to depositors. Moreover, governments world-wide are now committed to backing fully the claims of depositors in financial institutions.

It is important to understand that the government can also employ intermediate approaches between fully backing AIG’s derivative obligations and no backing. For example, the government could place AIG in Chapter 11, but commit to provide supplemental coverage that would make up any difference between the value that creditors would get from AIG’S reorganization and, say, an 80% recovery. Such an approach could allow setting different haircuts for different classes of creditors. The government, for example, might elect not to provide such supplemental coverage to executives owed money by AIG.

At a minimum, the government should conduct “stress tests,” estimating potential losses in alternative scenarios, and formulate a policy on the magnitude and fraction of derivative losses it would be willing to cover. A policy that doesn’t fully back AIG’s obligations should be seriously considered.

Indemnification of Director-representatives by PE Firms

Posted by Charles M. Nathan, Latham & Watkins LLP, on
Thursday, March 19, 2009
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This post is by Charles Nathan’s partners Laurie B. Smilan and Howard A. Sobel.

With the increase in private securities, derivative and bankruptcy-related litigation against portfolio companies, private equity firms need to maximize the protections for the private equity firm, the funds they organize and the individuals who agree to serve as their representatives on portfolio company boards. Ironically, however, a private equity firm’s effort to provide “more” protection to its director-representatives may be far more expensive than the firm expects or intends.

Typically, private equity firms and the funds they organize grant their representatives serving on portfolio company boards broad indemnification rights—“to the fullest extent permitted by law.” Typically, too, private equity firms and their funds require that their portfolio companies provide “fullest extent of the law” protections to these same directors. Each of the firm, the fund and the portfolio company likely will have separate insurance policies to satisfy their respective indemnification obligations. Optimally, the firm and the fund will be entitled to indemnification rights from the portfolio company pursuant to the terms of a management services agreement.

Absent thoughtful drafting, however, the broader the indemnification rights provided by the private equity firm or its fund to the individual director, the more likely it is that the firm or its fund will be liable for a disproportionate share of defense and settlement costs incurred by the director in litigation involving the portfolio company and the less likely that such costs can be fully recovered from the portfolio company or its insurer. Moreover, the broader the terms of the insurance provided by the private equity firm, the greater the chances that the portfolio company’s insurers will resist paying out the full proceeds of the portfolio company’s policy before other sources of insurance are tapped.

Often times, the allocation of responsibility for indemnification and advancement obligations as between the portfolio company and the private equity firm and the fund that holds the investment in the portfolio company are not considered until after litigation has been filed. The same holds true with respect to the terms and amount of available insurance, especially at the portfolio company level.

As the foregoing suggests, there are a number of issues that every private equity firm that designates directors on its portfolio companies’ boards must consider to maximize protection against liability to plaintiff shareholders (or trustees in bankruptcy) and minimize the risk of paying the cost of defending against such claims.

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The Defining Role of Good Faith

Posted by Andrew Tuch, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Wednesday, March 18, 2009
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The Harvard Program on Corporate Governance has issued a new discussion paper entitled “Loyalty’s Core Demand: The Defining Role of Good Faith in Corporation Law.” Co-authored by Leo E. Strine, Jr., who is Vice Chancellor of the Delaware Court of Chancery and Senior Fellow of the Program of Corporate Governance, and by Lawrence A. Hamermesh, R. Franklin Balotti and Jeffrey M. Gorris, the paper examines the role of good faith in corporate law, and its use as the key element in defining the state of mind that must motivate a loyal fiduciary. Employing an historical, etymological, and policy-oriented analysis, the authors address the particular question of whether the obligation of directors to act in good faith is a separate, free-standing fiduciary duty, or a core aspect of the duty of loyalty.

In the paper, the authors outline their views as follows:

We conclude, consistent with the Delaware Supreme Court’s recent decision in Stone v. Ritter, that in the American corporate law tradition, the basic definition of the duty of loyalty is the obligation to act in good faith to advance the best interests of the corporation. What this article also shows is that the duty of loyalty has traditionally been conceived of as being much broader than the duty to avoid acting for personal financial advantage. The duty of loyalty also precludes acting for unlawful purposes, and affirmatively requires directors to make a good faith effort to monitor the corporation’s affairs and compliance with law.

The authors analyze arguments in favor of a free-standing duty of good faith separate from the duty of loyalty. While conceding the importance and enduring relevance of the duty of good faith, the authors see no basis to conclude that the traditional place of good faith — as the definition of a loyal state of mind — should be altered. Doing so to make room for such a separate duty would add confusion not clarity, the authors argue. In so stating, the authors acknowledge and discuss circumstances when the duty of loyalty remains most difficult to apply.

The paper also emphasizes a critical policy implication resulting from Stone v. Ritter – “that an independent director who is accused of having failed in her monitoring duties may only be held liable if a court finds that she breached her duty of loyalty by consciously failing to make a good faith effort to comply with her duty of care.” The authors explain that “by requiring a finding of bad faith before imposing liability on an independent director, the corporate law, as explicated by Stone, protects the policy interests underlying the business judgment role from erosion.”

The paper is available here.

Second Generation Advance Notification Bylaws

Posted by Andrew Tuch, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Tuesday, March 17, 2009
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This post comes from Marc Weingarten and Erin Magnor of Schulte Roth & Zabel LLP.

Many companies have enacted special bylaw provisions regulating the ability of shareholders to nominate directors or place items on the agenda for consideration at a company’s annual or special meeting or by consent, typically referred to as advance notification bylaws (“ANBs”). Historically, most ANBs have been straightforward, and typically advanced the date by which a shareholder was obligated to notify the company to 60 or 90 days prior to the expected meeting date. These ANBs, or First Generation ANBs, also typically required the proponent shareholder to include in the notification the same basic information about the shareholder, and if applicable the nominees, as required by the proxy rules.

More recently, however, many companies, at the urging of counsel “defending” against activist investors, have adopted new forms of ANBs, or Second Generation ANBs, that demand far more extensive disclosure from, and in some cases purport to establish eligibility qualifications for, proponent shareholders. This article describes these new provisions, which include not only longer advance notice requirements, but also requirements for the completion of company-drafted director nominee questionnaires, submission of broad undertakings by nominees to comply with company “policies,” minimum size and/or duration of holding requirements, continuous disclosure of derivative positions, disclosure of otherwise confidential compensation information, and even information regarding shareholders with whom the proponent has merely had conversations regarding the company.

First Generation ANBs were upheld by the courts because they simply provided an orderly procedure for shareholder action that helped to give the company and the other shareholders adequate time to evaluate proposals. This article analyzes the new Second Generation ANB provisions, many of which we believe are designed not to elicit the relevant information a company reasonably needs to know months in advance of a proxy contest to ensure an orderly process, but rather to erect barriers in the path of shareholders seeking to exercise their rights in an attempt to disqualify them. We believe such provisions should, and will, be declared invalid when their legitimacy is challenged. Unfortunately, shareholders will be forced to bear the expense of challenging the validity of these provisions—which no doubt was part of the calculus when companies adopted them in the first place.

Advance Notice Periods
In a 2005 article addressing First Generation ANBs, [1] we noted that courts had determined that 90-day advance-notice requirements had become commonplace. [2] Since then, some companies have adopted ANBs requiring notice of 150, or even 180, days prior to the annual meeting (in some cases keyed off the mailing date of the prior year’s proxy statement).

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Option Backdating and Board Interlocks

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Monday, March 16, 2009
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This post comes from John Bizjak of Portland State University, Michael Lemmon of the University of Utah and Hong Kong University of Science and Technology, and Ryan Whitby of Texas Tech University.

In our forthcoming Review of Financial Studies paper Option Backdating and Board Interlocks, we examine the role of board connections in explaining how the controversial practice of backdating employee stock options spread to a large number of firms across a wide range of industries. Given that the practice was not publicly disclosed, it is unlikely that it originated independently in each firm. We focus on the role that director interlocks played in contributing to the spread of backdating since the board of directors has primary authority over the level and structure of executive compensation, including determination of the amount and timing of option grants.

We find strong evidence that board interlocks are related to the spread of backdating. We find that a firm is more likely to begin backdating option grants if the firm has a director who is a board member of another firm that previously backdated its stock options. Our results are both statistically and economically significant. The increase in the likelihood that a firm begins to backdate stock options that can be explained by having a board member who is interlocked to a previously identified backdating firm is approximately one-third of the unconditional probability of backdating in our sample. We also find that a firm is more likely to begin to backdate option awards if directors concurrently receive a stock option grant.

In addition, we identify several other firm and governance characteristics that are associated with the adoption of option backdating. Firms with higher stock-price volatility are more likely to start to backdate options, which is consistent with the fact that higher stock-price variation provides more opportunities to backdate options. A firm is also more likely to begin to backdate, the greater the stock and option holdings of the CEO and when the CEO is younger. Finally, we find that commonalities in firms’ auditors and geographic location also help to explain the initiation of backdating. The fact that commonality in auditor choice and geographic location is associated with the initiation of backdating suggests that other linkages between firms beyond those created through board interlocks may also play a role in facilitating the spread of this practice. In contrast to some earlier research, we find little evidence that other measures of the quality of corporate governance, such as institutional ownership, board size, board independence, and whether the CEO is also the chair of the board, are systematically related to the incidence of backdating.

The full paper is available for download here.

Problems Hidden Under The TARP

Posted by the Harvard Law School Forum on Corporate Governance & Financial Regulation, on
Sunday, March 15, 2009
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Editor’s Note: This post is by J.W. Verret of the George Mason University School of Law.

In my briefing memo, The U.S. Government as Control Shareholder of the Financial and Automotive Sector: Implications and Analysis, I offer an analysis of the implications of the U.S. Treasury holding equity control over private industry. This was also the subject for recent briefings to members and staff of the U.S. Congress and the Securities and Exchange Commission, organized through my work at the Mercatus Center Financial Markets Working Group, and a forthcoming op-ed in Forbes, Why the Bailout is Self-Defeating, which is available here. My work in this area is ongoing, with a fuller article expected this submission season, and I welcome any comments.

The Treasury Department has converted its preferred shares in Citigroup into common equity, giving it a position of up to 36% of Citi’s outstanding voting equity. This means that as defined under Delaware corporate law, the securities laws, and even the CFIUS process for reviewing foreign investments in U.S. Companies, the U.S. Treasury is a control shareholder in Citigroup. Further, the remaining unconverted preferred shares in other banks, issued to the Treasury by TARP participants, give the government substantial leverage over corporate policy decisions at those banks.

The reason for the conversion is that it will artificially increase the bank’s common equity, which will give it a good tangible common equity number when the Treasury begins its promised stress testing regime for unhealthy banks. This is however an entirely artificial construct. Tangible common equity serves as a good proxy for a banks health when it reflects the market’s interest in becoming the residual beneficiary of fees from the bank’s loan portfolio, but here it merely reflects the federal government’s willingness to bail out a bank without concern for future price appreciation in its shares. If Treasury’s bank stress tests are a final exam, the teacher has given a favorite student the answers in advance.

The consequences of a government agency holding voting equity in a private bank can also be costly. Comparisons to the different forms of government ownership in Europe, Asia and South America teach that government owned banks are unequivocally used to advance political agendas to the detriment of a bank’s financial health. Advancing a political agenda may actually be easier through controlling common equity stakes, an effective semi-nationalization, than outright nationalization. A government agency using shareholder power over private companies has two unique freedoms:

i) the ability to bypass the administrative law process, the separation of powers and judicial review that constrain regulatory discretion, and instead simply require the board to initiate corporate policy changes favored by the Treasury, and

ii) the ability to bypass the federal budget process and transparency to the voters that work to constrain transfers to political interest groups, and instead require the bank to make those transfers in the form of increased lending and artificial interest rate caps entirely off the federal budget.

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The Future of Claims Against Mutual Funds

Posted by Andrew Tuch, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Saturday, March 14, 2009
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This post comes to us from David M. Geffen of Dechert LLP.

My recent article, “A Shaky Future for Securities Act Claims Against Mutual Funds“, considers the liability of mutual fund issuers under §§ 11(a) and 12(a)(2) the Securities Act.

In a Securities Act § 11(a) or § 12(a)(2) action, a plaintiff complains of a materially misleading statement (misstatement) in an issuer’s registration statement (prospectus). In the article, I explain why a mutual fund issuer, by establishing a loss causation defense, should prevail in defending these actions. For a mutual fund, establishing a loss causation defense is straightforward, and a mutual fund can defeat § 11(a) and § 12(a)(2) claims at the pleading stage of a lawsuit.

Courts have described an issuer’s liability under § 11(a) and § 12(a)(2) as “strict” or “near-strict.” Therefore, the regular and successful deployment of loss causation defenses by mutual funds marks a significant change. In effect, mutual funds are largely and, perhaps, wholly insulated from Securities Act § 11(a) and § 12(a)(2) claims.

In Parts I and II of the article, I describe the elements of claims under § 11(a) and § 12(a)(2) in the context of mutual funds, including the price-depreciation measure of damages in both statutes.

The article’s core analysis is contained within its Part III, where I explain why, for a mutual fund, establishing a loss causation defense is straightforward. Unlike a security traded on an exchange, the price of a mutual fund share is calculated each day according to a statutory formula that relies on the market value of the portfolio securities owned by the fund. Shares are offered for sale by the fund continuously at each day’s calculated price and redeemed by the fund, when a fund shareholder chooses, at that day’s calculated price. There is no secondary market for a mutual fund’s shares.

Accordingly, there is no mechanism for a misstatement in a mutual fund’s prospectus to affect a fund share’s price and, therefore, there is no mechanism for a misstatement or its revelation to cause a plaintiff’s losses. Because changes in a fund share’s price cannot be caused by a prospectus misstatement, a mutual fund defendant can prevail by establishing the loss causation defense permitted by § 11(e) or § 12(b). The defense simply is that any misstatement identified by the plaintiff could not cause the fund share’s price to depreciate and, therefore, did not cause the plaintiff’s losses.

If that outcome seems harsh, consider that the justification for liability without reliance under § 11(a) and § 12(a)(2) is that a misstatement causes the market to overestimate the value of a security. A purchaser is harmed by the misstatement, even if he did not rely on it, because the market price is inflated by the misstatement. However, Congress did not consider how § 11(a) and § 12(a)(2) should apply to mutual funds. This includes considering that neither price inflation nor overpayment occurs when an investor purchases shares of a mutual fund while the fund’s prospectus contains a misstatement. Thus, price inflation and overpayment, which justify liability without reliance for non-fund issuers, do not justify similar liability for mutual funds.

Part IV presents the practical implications if plaintiffs cannot succeed against a mutual fund under § 11(a) and § 12(a)(2). A plaintiff’s inability to make out a claim under § 11(a) and § 12(a)(2) should deter plaintiffs from instigating lawsuits under the Securities Act against mutual funds based on prospectus misstatements. Plaintiffs may be relegated to claims under Rule 10b-5, the Investment Company Act and state law.

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Activist Arbitrage

Posted by Jim Naughton, co-editor, HLS Forum on Corporate Governance and Financial Regulation, on
Friday, March 13, 2009
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This post comes to us from Itay Goldstein of the Wharton School at the University of Pennsylvania.

In Activist Arbitrage: A Study of Open-Ending Attempts of Closed-End Funds, which was co-written with Michael Bradley, Alon Brav, and Wei Jiang, and which was recently accepted for publication in the Journal of Financial Economics, we conduct a comprehensive empirical study of the attempts of activist arbitrageurs to open-end closed-end funds in the U.S. Unlike the traditional pure-trading arbitrage, activist arbitrageurs do not simply wait for convergence, but rather take actions to open-end the target fund, knowing that upon open-ending the price of the fund’s shares will be forced to converge to the NAV.

Our analysis is based on a unique hand-collected dataset consisting of all activist arbitrageurs’ activities in U.S. based CEFs between 1988 and 2003. Activist arbitrage in closed end funds was quite rare until the early 1990s. However since the mid-1990s—shortly after the SEC significantly relaxed constraints on communication among shareholders of public corporations—this type of arbitrage has become very common. Several arbitrageurs—hedge funds, endowment funds, banks, and financial arms of corporations—have become quite active in initiating proxy contests and proposals targeted at open-ending discounted CEFs. In the peak years of 1999 and 2002, about 30% of the funds in our sample were targets of such attacks.

We find that activist arbitrage has substantial impact on CEF discounts. While most of the open-ending attempts in our sample were met with resistance from the funds’ managements, quite a few led to successful open-endings despite such resistance. In addition, activists’ activities were sufficiently credible in many instances to induce fund managers to take actions themselves to reduce the size of the discount. We find that a key variable that guides activist arbitrageurs in choosing which fund to target is the fund’s discount from its NAV. Using an instrumental-variables approach and an econometric technique that allows us to estimate a simultaneous system of an endogenous dummy variable and an endogenous continuous variable, we are able to show that a one percentage point increase in the discount leads to a 1.07 percentage point increase in the probability of an open ending attempt in a given year.

To investigate the role of communication, we conduct tests using cross-sectional measures of the costs of communication in different funds. The three proxies we employ are turnover, which measures the frequency at which the shares of the CEF change hands, the average size of trade in the fund’s shares, and the percentage of institutional ownership in the fund. Overall, we find that costs of communication enhance activist arbitrage. Interestingly, the effects of the above proxies are present only after the legal reform of 1992. Our results suggest that before the 1992 Reform, communication among shareholders was so severely restricted by the SEC that cross-sectional differences in the shareholder base did not matter much for activist arbitrageurs.

Lastly, we find the governance of funds also plays an important role in determining the probability of an open-ending attempt. Funds that have pro-manager governance structures (i.e., have staggered board, supermajority voting, and ability of the board to call a special meeting) are more likely to be targets for activism after the legal reform of 1992, but not before. This is likely because communication among shareholders is particularly important when managers have more power. While managerial entrenchment attracts more attacks after 1992, we find that it lengthens the time needed to implement a successful open-ending.

The full paper is available for download here.

Key changes to TALF program

Posted by Philip A. Gelston, Cravath, Swaine & Moore LLP, on
Thursday, March 12, 2009
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This post from Philip A. Gelston is based on a client memo by my colleagues B. Robbins Kiessling, Timothy G. Massad, William V. Fogg, Julie Spellman Sweet, Sarkis Jebejian, Joel F. Herold, and Erik R. Tavzel.

For earlier posts on this Forum on the Federal Reserve’s proposed Term Asset-Backed Securities Loan Facility (TALF), including an early reform proposal by Lucian Bebchuk, please see here and here.

On March 3, 2009, the U.S. Treasury Department and the Federal Reserve announced the formal launch of the Term Asset-Backed Securities Loan Facility (TALF). The TALF provides government financing to private investors for the purchase of certain AAA-rated asset-backed securities (ABS), with the objective of making credit more readily available to consumers and small businesses. The TALF program may be attractive to a broad range of investors because it provides non-recourse financing with favorable interest rates and limited downside risk.

The Federal Reserve first announced the creation of the TALF on November 25, 2008. In connection with the formal launch of the TALF, the Treasury Department and the Federal Reserve have issued updated terms and conditions and frequently asked questions (FAQs) which modify certain of the previously announced rules.

This memo provides a brief overview of the TALF and the key changes announced on March 3 and provides a road map for investors considering participating in the TALF. Appendix A provides an indicative timeline for the April TALF funding.

TALF OVERVIEW
The Federal Reserve has authorized the Federal Reserve Bank of New York (FRBNY) to lend up to $200 billion (subject to an increase to up to $1 trillion as part of the Obama administration’s Financial Stability Plan announced on February 10, 2009) to eligible borrowers (described below) to finance investments in eligible ABS, which currently are certain AAA-rated securities backed by new and recently originated auto loans, student loans, credit card loans or small business loans fully guaranteed by the Small Business Administration (SBA). Under the TALF, the FRBNY will offer to eligible borrowers on a monthly basis three-year, non-recourse loans in an amount equal to the value of the eligible ABS purchased or owned by the borrower, less a collateral haircut of between 5-16% of their value depending on their type and expected life. The TALF loans must be fully secured by the ABS financed by the loan.

The interest rate on TALF loans will equal the three-year LIBOR swap rate plus 100 basis points for fixed-rate ABS and one-month LIBOR plus 100 basis points for floating-rate ABS (in each case, other than loans secured by ABS backed by student loans guaranteed by the Federal government and ABS backed by small business loans guaranteed by the SBA, which will have lower interest rates). Borrowers may request TALF loans in minimum amounts of $10 million and may pledge any combination of eligible ABS as collateral for a single TALF loan (as long as all the pledged ABS for a single loan are either fixed rate or floating rate securities). In addition, borrowers must pay to the FRBNY an administrative fee equal to 5 basis points of the loan amount.

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