Tag: Cravath

Implications of New U.S. Derivatives Regulations on End-Users of Swaps

The following post comes to us from John White, partner in the Corporate Department and co-chair of the Corporate Governance and Board Advisory practice at Cravath, Swaine & Moore LLP. This post is based on a Cravath memorandum by William P. Rogers Jr.; the full version, including footnotes, is available here.


In the wake of the financial crisis, both the U.S. and the EU have enacted legislation to regulate the “over-the-counter” (“OTC”) swaps market and are in the process of adopting implementing rules that will make such legislation fully effective. In the U.S., Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), enacted on July 21, 2010, provides for the regulation of the swaps market and grants to the Commodity Futures Trading Commission (the “CFTC”) and the Securities and Exchange Commission (the “SEC,” and with the CFTC, each a “Commission” and together, the “Commissions”) broad authority to regulate the swaps market and its principal participants. In the EU, the European Market Infrastructure Regulation (“EMIR”) is expected to become effective during 2013 and will create a regulatory framework for the swaps markets in all EU member states.


DOJ and SEC Issue FCPA Guidance

Marc S. Rosenberg is a partner and co‑chair of the Corporate Governance and Board Advisory practice at Cravath, Swaine & Moore LLP. This post is based on a Cravath memorandum.

Last week, the Criminal Division of the Department of Justice and the Enforcement Division of the Securities and Exchange Commission released their long-awaited guidance on the application and enforcement of the U.S. Foreign Corrupt Practices Act. The release—a 120-page “Resource Guide”—confirms that FCPA enforcement remains a central priority of the U.S. government while simultaneously and most importantly identifying the circumstances when the government may decline to pursue an enforcement action. It is available at http://www.sec.gov/spotlight/fcpa/fcpa-resource-guide.pdf.

Compliance Program Guidance

While much of the guidance reaffirms statutory interpretations that practitioners have gathered from published government settlements and opinion releases, it also provides a useful tool for companies seeking to develop FCPA compliance programs that will minimize the risk of enforcement action or severe penalties in the event those systems fail to prevent a violation. Having such a compliance program in place is particularly important given the SEC’s announcement last week that it received more than 3,000 whistleblower complaints in the first year of the new whistleblower program implemented under the Dodd-Frank Act.

The Guide identifies the hallmarks of strong compliance programs generally and addresses the elements of effective FCPA controls, reiterating that there is no “one-size-fits-all” program; an effective FCPA compliance program addresses corruption risks specific to the organization and includes meaningful unique controls to mitigate those risks. Some possible risk-based compliance controls that the Guide suggests are:


Derivatives Rules under the Dodd-Frank Act Affecting End-Users

The following post comes to us from John White, partner in the Corporate Department and co-chair of the Corporate Governance and Board Advisory practice at Cravath, Swaine & Moore LLP. This post is based on a Cravath memorandum; the full version, including footnotes, is available here.

Background — The Dodd-Frank Act

Title VII of the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) provides for new Federal regulation of the swaps market, and, when fully implemented, is expected to make fundamental changes in the way the swaps market operates. Title VII seeks to reduce systemic risk, increase transparency and improve efficiency in the swaps market by requiring centralized clearing and exchange trading of swaps as well as real-time and regulatory reporting of swap transactions. Under the Dodd-Frank Act, the Commodity Futures Trading Commission (the “CFTC”) will regulate most swaps on interest rates, commodities and currencies and the Securities and Exchange Commission (the “SEC,” together with the CFTC, the “Commissions”) will regulate swaps, including equity and credit default swaps, on single securities and narrow-based securities indices. The term “swap” is defined broadly in the Dodd-Frank Act, and includes certain foreign exchange transactions, such as non-deliverable foreign currency forwards, that may not be characterized as swaps for other purposes.


Throwing Off the TARP – Implications of Repaying Uncle Sam

This post is by Philip A. Gelston’s partners B. Robbins Kiessling, Sarkis Jebejian and Erik R. Tavzel.

In October 2008, the U.S. Treasury launched the Capital Purchase Program (CPP) under the Troubled Asset Relief Program (TARP), pursuant to which the Treasury has invested nearly $200 billion in over 500 financial institutions.[1] Almost from the start, the boards and managements of many TARP-recipient institutions have focused on when and how to get out from under Uncle Sam’s umbrella.

The stress test results have now been released, and Secretary Geithner has said that adequately capitalized financial institutions “will have the opportunity to repay” their TARP capital. Conventional wisdom has been that many institutions will rush to repay the government capital. Repurchasing this capital would appear to secure several clear advantages, including the opportunity to repurchase the related warrants at low valuations, the elimination of TARP-related restrictions on executive compensation and the reduction of government influence on governance and management.

There are several issues, however, that should be considered in determining whether to redeem TARP capital. The board and management of TARP recipients should consider whether repayment will require raising new capital today and the cost of that capital, the financial institution’s future capital needs and the potential sources of capital and the likelihood of continued government, shareholder and public scrutiny of compensation practices even after the TARP repayment.

The first part of this bulletin briefly describes the conditions to repayment and the requirements regarding the source of funds for repayment. The second part discusses issues that the board and management of financial institutions that received TARP capital should consider in determining whether to repay the Treasury.

The terms of the contracts governing the CPP investments permit repayment only with the consent of the financial institution’s primary Federal regulator and require repayment during the initial three-year period after issuance to be funded entirely with the proceeds of cash sales of Tier 1 perpetual preferred stock or common stock. The economic stimulus bill, however, directed the Secretary of the Treasury to permit a TARP recipient to redeem TARP capital, after consultation with its primary Federal regulator, without regard to the source of the funds or the lapse of any period of time.

The May 6th Joint Statement issued by Treasury Secretary Tim Geithner, Federal Reserve Chairman Ben Bernanke, FDIC Chairman Sheila Bair and Comptroller of the Currency John Dugan outlined several conditions to the repayment of TARP funds:

• “Supervisors will carefully weigh an institution’s desire to redeem outstanding CPP preferred stock against the contribution of Treasury capital to the institution’s overall soundness, capital adequacy, and ability to lend, including confirming that [bank holding companies] have a comprehensive internal capital assessment process.”• “All [bank holding companies] seeking to repay CPP will be subject to existing supervisory procedures for approving redemption requests for capital instruments.”

• In order to repay, the 19 banks which underwent the stress testing process must demonstrate, based on their post-repayment capital structure, that at the end of 2010, assuming the adverse macroeconomic scenario employed in the stress tests, they will have a Tier 1 risk-based ratio of at least 6% and a Tier 1 common risk-based ratio of at least 4%.

• Additionally, these 19 banks must be able to demonstrate their “financial strength by issuing senior unsecured debt for a term greater than five years not backed by FDIC guarantees, in amounts sufficient to demonstrate a capacity to meet funding needs independent of government guarantees.”

Previously, in testimony before the Congressional Oversight Panel on April 21, 2009, Secretary Geithner had said the “ultimate test” for repayment would be whether an individual bank’s repayment would result in a reduction in the overall credit available to the economy.

Based on the above, it appears that, legally and practically speaking, the required source of funds for repayment of TARP funds will depend primarily on an institution’s financial strength, capital adequacy and liquidity, as determined by the Federal Reserve (or Office of Thrift Supervision in the case of thrift holding companies). Moreover, the approval of the regulator for any redemption (as opposed to mere consultation) may be required under existing supervisory procedures (for example, under Federal Reserve regulations and policies, if the redemption would reduce consolidated net worth by 10 percent or more or have a “material effect” on the institution’s capital base). Strong financial institutions with adequate capital and liquidity may be allowed to repay TARP capital with funds from any source, including cash on hand or retained earnings. Less well-capitalized financial institutions, however, may be required to adhere more closely to the original terms of the CPP and repay at least a substantial portion of the TARP funds with the proceeds of Tier 1 capital issuances.


(Re)regulation of Financial Services—Back to the Future?

This post is by Philip Gelston’s partners B. Robbins Kiessling, Sarkis Jebejian and Erik R. Tavzel.

As the financial crisis has deepened over the past year, first the Bush Administration and now the Obama Administration have announced ambitious plans for comprehensive reform of the financial regulatory system. Not to be left behind, at the same time current and former members of Congress and Government officials, international groups such the G-20 and even the mainstream press are weighing in on the need for reform and the shape it should take. Although the immensely complex process of actual reform has barely begun, the key players have said enough to allow a good guess as to their goals for the post-regulatory reform financial world. There will be an intense focus on regulating and reigning in “systemically important” financial institutions. Institutions will face tighter regulation of risky activities and stricter capital and funding requirements. The regulatory net will be cast much wider, capturing institutions and activities previously not subject to substantial regulatory oversight (most notably, purveyors of derivatives and credit default swaps such as AIG’s Financial Products division as well as certain private investment funds). What will these changes mean for today’s financial institutions? How will reform change the shape of the industry in the coming years?


Key changes to TALF program

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.

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.


Delaware Bankruptcy Court Disallows Triangular Setoff

This post is by my Philip A. Gelston’s partners Richard Levin and Paul H. Zumbro.

The United States Bankruptcy Court for the District of Delaware, in a decision announced January 9, 2009, denied a creditor’s request for permission to effect a triangular setoff, that is a setoff of the creditor’s claim against one debtor against amounts the creditor owed to another debtor affiliate of the debtor (In re SemCrude, L.P., Case No. 08-11525, Docket No. 2754, Jan. 9, 2009). The decision, if widely followed, could substantially increase a company’s credit exposure if the company has multiple contracts with another corporate group’s affiliates and has relied on a provision in the contracts allowing the company to offset amounts owing to one affiliate against claims against another affiliate and if the other group’s affiliates later file bankruptcy. The bankruptcy court ruled that allowing such a setoff would be inconsistent with the Bankruptcy Code’s express setoff provision and with fairness to all creditors.

Chevron USA, Inc. had entered into numerous contracts for the purchase or sale of various petroleum products with three counterparties, SemCrude L.P., SemFuel L.P. and SemStream, L.P., each of which is a direct or indirect subsidiary of SemGroup, L.P. and each of which later filed bankruptcy. Bilateral master agreements governed the contracts. Each of the master agreements contained a broad version of a common cross-affiliate setoff provision:


Proxy Season 2009

This post from Marc Rosenberg is based on a client memo by partners at Cravath, Swaine & Moore LLP.

The outlook for proxy season 2009
This proxy season will be significantly affected by the credit crisis and the ensuing global economic turmoil. Investors and politicians have joined in an outcry over a perception of excessive executive pay, reckless risk-taking by management and inadequate board oversight at some companies. Prosecutors have launched investigations at numerous financial institutions, perceived abuses have been widely reported in the media, and Congress is seeking to reform compensation practices and give shareholders the right to vote on executive compensation.

Management and boards will be well-served at this time to reassess their compensation and governance policies and practices, as well as how they communicate with their investors. A strategic and well-analyzed response by a company and its board to these unprecedented conditions will be crucial to managing this challenging proxy season successfully.

Prepare for investor and regulatory scrutiny of executive compensation
Compensation practices undoubtedly will be an area of sharp focus this proxy season. The number and variety of shareholder proposals addressing compensation practices and policies is increasing. In particular, we are seeing an increase in proposals related to “say on pay,” “pay for performance,” “clawback” of executive pay in the event of a financial restatement and elimination of a variety of “poor pay practices” (e.g., tax gross-ups on executive perks or excise payments triggered by golden parachute payments and payment of dividend equivalents on unearned performance awards). Variations of each of these proposals have been endorsed by proxy advisor RiskMetrics (formerly ISS), an influential source of voting advice for institutional investors. RiskMetrics has also aligned its position on compensation policies and proposals for all public companies with the standards set for institutions selling equity to the federal government under the Emergency Economic Stabilization Act (“EESA”). The EESA requires, among other things, that financial institutions receiving assistance under it agree to stringent limitations on executive compensation.


Beneficial Ownership – By-Law Disclosure Proposal

This post is from Philip A. Gelston of Cravath, Swaine & Moore LLP.

My partner James C. Woolery and I have prepared a memorandum entitled “Beneficial Ownership – By-Law Disclosure Proposal,” in which we propose an innovative by-law amendment as a response to the threat posed to a company by the secret accumulation of its shares by activist investors. Secrecy is often achieved in this context through the use of total returns swaps and other derivatives, which may allow the accumulation of a large, and sometimes dominant, position in the target company. Despite legal claims that these derivative holdings are not the same as beneficial ownership – claims being tested in litigation arising from the recent CSX proxy fight – in reality activists demand that targets, and their board of directors, defer to the activists as though they were full owners of the stock represented by the derivatives.

In the memorandum we discuss a number of techniques corporations have used to protect against this threat, and we outline a proposal that involves amending advance notice by-laws governing shareholder proposals to include new continuous disclosure obligations. Compliance with this disclosure obligation is a prerequisite for giving effective notice of an intention to nominate directors or present business at a stockholders’ meeting. To our knowledge, a by-law incorporating the concepts we outline in our proposal has not yet been adopted by any corporation.

Our memorandum is available here.