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Monday, December 30, 2013

Books and Music from 2013

One of my goals for my first year in retirement was to read a book a week.  I failed, reading about half the goal.  I had also committed myself to reading every magazine that we subscribe to.  I succeeded in fulfilling that goal, but, because we subscribe to about 14, that turned out to be a huge commitment of time (particularly the Economist) and perhaps got in the way of achieving the book goal. Anyway, here are the two dozen or so books I enjoyed reading (there were a couple others I didn't, and they don't make the list).

Fiction

I don't read much fiction ( I find the real world far more fascinating ) but I enjoyed enormously Hilary Mantel's "Wolf Hall" and "Bring Down the Bodies" about Thomas Cromwell, consigliere and "fixer" to Henry VIII.  Much like John Gardner's "Grendel" turned the Beowulf myth inside out, Mantel turns the myth of Sir Thomas More, which is captured in the film "A Man for All Seasons" inside out, portraying him not as a paragon of virtue and conscience, but as a ideological zealot who sends people to the scaffold for minor departures from orthodoxy while Cromwell becomes a pragmatic, worldly, sometimes overwhelmed family man coping with the vicissitudes and rages of Henry. 

Also read "Up Country" by Nelson DeMille.  An ordinary cop novel enhanced by detailed depictions of life in modern, postwar Vietnam, where the author saw combat in the 60's;  "The Blue Hour" by Alfonso Cueto -- which by coincidence bears many resemblances to Up Country except that it is set in Peru and instead of the Vietcong, you have the Shining Path.  "The Big Nowhere" by James Ellroy, part of his L.A. quartet, like L.A. Confidential, but not quite as good, imo.  Overly baroque plot even by Ellroy's standards.  Began reading Ross MacDonald's L.A. crime novels, starting with "Blue City". 

General non-fiction

In Our Hands by Charles Murray.  A few years old but a good primer on the alternative to the welfare state of a guaranteed basic income.

Average is Over by Tyler Cowen.  Not quite what I was expecting - the press focused on the prediction that the world will become economically more unequal due to technology but when I read it that was a small, secondary portion of the book.  The press is  obsessed with the topic of inequality, probably because journalism is in such an unsettled state.  The book is mainly a meditation on how to find a value for human labor as technology becomes more powerful.  Cowen concludes that people will add value by guiding, filtering and interpreting the output of technology.  A surprising proportion of the book involved the use of human/computer chess as a sort of metaphor for the issue.

The Downfall of Money by Frederick Taylor.  A history of the first years of the Weimar Republic during which Germany suffered the most studied episode of hyperinflation in history.  I was surprised how little economics it contained.  Instead, it was a political history, the theme of which was the hyperinflation stemmed from the new republic's insecurity about its acceptance by the German people, due in part to the government's unpopular decision to sign the Versailles treaty, and due also in part to fears about a Soviet-style takeover along the lines of what transpired in Russia around that time.  So the government threw money at the population to tamp down social disquiet. Interesting perspective.

Lords of Finance by Liaquat Ahamed.  Won the Pulitzer for history and deserves it. Amazing research and integration, elegantly written as well.

The Great Escape by Angus Deaton.   A very high-level, broad-ranging book about the benefits of economic development with a focus on the benefits for longevity and other health measures. 

Madmen, Intellectuals and Academic Scribblers by Edward Lopez.  Intellectual history of some major ideas in political economy.  Well written for the general reader.

The Undivided Past by David Carradine.  In a similar vein as the preceding book, a wide-ranging intellectual history that argues humanity has never been as divided by race, class, religion, etc as many pundits pretend.

This Town by Mark Leibovich.  Fun, irreverent portrait of life of the political elite in DC during Obama's first term.  Good to read if you are stuck in bed with a cold or laying on a beach, requires zero mental effort.

The Story of Spanish by Nadeau & Barlow.  More a history of Spain and Latin America than of the Spanish language, but decently enjoyable nonetheless.

Books about the Financial Crisis

Other People's Money by Charles Bagli.  Journalist 's account of the flawed Stuyvesant Town real estate acquisition by Tishman Speyer.  Pretty balanced and knowledgeable.

The End of Wall Street by Roger Lowenstein.  The best journalistic account of the financial crisis of 2008.

The Fateful History of Fannie Mae by James Hagerty.  History of Fannie Mae by the WSJ reporter who covered that beat.  Straightforward and a lot more journalistically ethical than Gretchen Morgenson's book.

Books on history in the British isles

Since I was a child I have been fascinated by the history of the British isles.  When I was a pre-schooler, my parents gave me picture books on King Arthur and Robin Hood and I suppose that is where it stems from. This year I read, "The Plantagenets" by Dan Jones which filled in a gap in my knowledge about the period between William the Conqueror and the Tudors, and was written at a general reader level, which I appreciated;  "The Time Traveler's Guide to Elizabethan England" by Ian Mortimer, which was a book about daily life in that period, maybe a little dull for someone with no prior interest.  "The Reivers" by Alastair Moffat, which is a detailed history of the conflicts across the English/Scottish border in the 1400s, 1500s etc., which was of interest to me because that is where one of my surnames comes from. But it tells good stories too; "The Plantation of Ulster" by Jonathan Bardon which was an eye-opening history of the brutal invasion and settlement of northern Ireland by the English under James I and later rulers. "Shopping, Seduction and Mr. Selfridge" by Lindy Woodhead.   Biography of the man behind Selfridge's in London.  Bought it because the Masterpiece Theatre series "Mr. Selfridge" piqued my curiosity. Good history of the development of the modern day department store.  "London Under" by Peter Ackroyd.  Set of short essays about the stuff that is under modern-day London, including the sewers, the tube, Roman ruins etc.  I had no idea that there were once 10 rivers besides the Thames in the area that we now  call London - the rest have been channeled into culverts underground.


MUSIC:

Pop etc Albums:

Ivan and Alyosha:  All the Times We Had.  Seattle group, debut album.  Eclectic mix of different pop - style genres.  Fine harmonies, some George Harrison style guitar licks. Running for Cover, The Fold and Who Are You stood out.

One Republic: Native.  Great pop/rock anthems.  Particularly liked Burning Bridges, If I Lose Myself and Preacher.

Fall Out Boy:  Save Rock and Roll.  Similar to One Republic in the sense of great anthems for big arenas and stadiums.

Jack Johnson:  From Here to Now to You.  Not too many songs go better with a drink on a summer evening than his, despite being fairly formulaic.  Liked Radiate, I Got You.

Blues / Punk / Other Genres

Tedeschi Trucks Band:  Made Up Mind.  It is uncanny how closely Susan Tedeschi's voice resembles Bonnie Raitt's, and the blues-based songs she performs makes the comparison even more remarkable. Liked the title song, Part of Me and Do I Look Worried best.

Dropkick Murphy: Signed and Sealed in Blood.  Their most conventional album, as to which I had mixed emotions. None of the songs were as good as the best of their prior work, but it was still a fun album.

The Del Lords: Elvis Club.  First album in more than 20 years by what was once a New York based punk band.  This one is more conventional / alt-country, mostly acoustic, and is really very, very good. "Silverlake" was the best of a very good collection.

Robert Randolph & Family Band:  Lickety Split.  The most prominent pedal steel guitarist I know of, several good jams. The very loud "Born Again" was one of my favorite songs of the year.

Eliane Elias: I Thought About You.  Album of Chet Baker songs performed by Brazil's version of Diana Krall. Good for cocktail or dinner parties.

Harry Connick, Jr. Every Man Should Know.  Some really great songs, surprisingly original material and not covers.

New Albums by Old Men:

Guy Clark: My Favorite Picture of You.  Over 70, still writing just amazing songs.  Hell Bent on a Heartache sounds just like you think it would.

Richard Thompson:  Electric.  Several good songs, in particular, Where's Home, Another Small Thing in her Favor, and Good Things Happen to Bad People.

Rod Stewart: Time.  Much to my surprise, as I have come to think of him as a washed-up caricature going through the motions, this is the best album that he has put out in at least 25 years.  "Live the Life" and "Can't Stop Me Now" were two totally upbeat, unapologetic celebrations of his life that I really enjoyed.  And he has a nice cover of "Love Has No Pride".

Miscellaneous songs that I particularly liked.

Sky Ferreira: "I Will"   Very loud driving pop/rock song.

KT Tunstall, " Feel It All".  Same.

Moby, "The Perfect Life". Majestic.  One of the best songs I heard all year.

Avicii:  "Wake Me Up" and "Hey, Brother".  Impressive fusion of pop/dance hooks with serious lyrics.

Boz Scaggs:  "Can I Change My Mind".  Soulful cover of minor 70's hit.

Bowie: "The Stars Are Out Tonight".  Lush production of a straightforward rock song with a punchy beat.

Ashley Monroe, "Like a Rose",  Understated country ballad.

Jason Isbell, "Live Oak".  Same.

George Strait, "The Night is Young" and "Give It All We Got Tonight".  What a shame he is retiring.

Joe Bonamassa and Beth Hart, "Them There Eyes".  Boisterous version of a jazz / cabaret standard from 1930, previously recorded by Billie Holiday, Peggy Lee and others.

Eugene Bridges, "Dance With You".  Sounds like a 70's soul hit.

Three great guitar instrumentals:

Ronnie Earl, "Pastorale".  Sounds like its title suggests.
Joe Satriani, "A Door Into Summer".  very LOUD!
Bill Frisell, "The Big One'.  Surf guitar by a master of the instrument.

Saturday, November 23, 2013

Barron's Cover Story About SiriusXM Illustrates an Important Point About Corporate Restructurings

The current (November 25) edition of Barron's displays a bullish cover story about SiriusXM, the satellite radio company. The article reiterates how SiriusXM was only "hours" away from filing for Chapter 11 in February, 2009, when instead it closed on a financing package from Liberty Media and avoided bankruptcy. altogether.  The article is slightly off in describing the terms of the financing:  first, press reports on the day of the closing, February 17th, reported it to have been $530 million, consisting of $430 million of new funded loans and an offer to buy up to $100 million of existing loans; and second, the package included not merely an option to acquire 40% of SXM's common, as the article says, but the actual issuance that day of 2 new series of preferred stock convertible into that proportion.  But the gist is right:  Liberty put in the capital SXM needed and got back both a dollar of high-priced secured debt for every dollar it invested and an equity stake of 40% to boot.  A great deal for LM, but one that the board evidently believed was better for stakeholders than the uncertainty of a chapter 11 case in the environment that prevailed in February, 2009. A shareholder suit challenging their judgment was thrown out as well.

What would have happened in an 11 is unknown, but what is known, as the article reports, is that SXM stock has risen over 7000% since its low of $0.05 in February 2009; it seems hard to argue in the face of that kind of value creation that any significant group of stakeholders would have been better off had SXM filed a traditional "free fall" chapter 11 in February, 2009, that could easily have stretched into 2010.

So the LM / SXM deal can stand as fairly impressive evidence of the success that can be achieved from not filing chapter 11 to effect a restructuring, at least a balance sheet restructuring, and evidence that a company does not always need to enter chapter 11 to achieve the goals of chapter 11 - to obtain a breathing spell, to keep the operations running, to maximize value, etc.

But there is a second point, along those same lines, that is less well known but deserves more attention.  The Barron's article goes on to note that "The company has spent the last five years weaning itself from oppressive contracts."  An executive is quoted stating that SXM has been able to reduce its programming costs by over one-third, from $450 million to "under $300 million".

One of the big arguments for chapter 11 is that management can use the "tools" of bankruptcy law to "fix" a company.  And the paradigmatic example of those tools is the power to reject burdensome executory contracts and unexpired leases, the damage claims arising from which are then eliminated through payment of "little bankruptcy dollars" as opposed to full 100% satisfaction.

Yet here is a company, once so deeply financially distressed that its stock traded at a nickel and it was "hours" away from entering chapter 11, that was able to rid itself of "oppressive contracts" and shrink a major source of expenses by over one-third -- without resort to the rejection powers of the bankruptcy laws and the concomitant expense and uncertainty of a full-blown bankruptcy filing.

Certainly there are companies that need to file chapter 11 and need to reject contracts and leases to fix their operations or, if those can't be fixed, to stanch the bleeding of cash on those contracts and leases to preserve the remaining value for broader constituencies of creditors.  But the SXM restructuring experience shows that bankruptcy is not always necessary, that there are more than one "tool" to achieve what the "tools" of bankruptcy can achieve in improving cash flow.

But what determines when a company can effect its operational restructuring outside of chapter 11?  It's pretty clear it's the strength of the balance sheet, the maturity profile of its debt, its access to fresh capital and its liquidity.  A company whose financial condition is strong enough can last long enough to make operational changes without filing bankruptcy.  This is obvious: solvent companies do it all the time.

And this in turn has important implications even for companies that do file for chapter 11.  It teaches that fixing the balance sheet is often perfectly sufficient to achieve the goals of chapter 11.  A company can get a breathing spell to work on its operations by lingering in chapter 11 for 18 to 24 months with a bad balance sheet, or it can get a breathing spell to work on its operations by fixing its balance sheet through a 4 to 6 month pre-negotiated or prepackaged chapter 11, and use the rest of the time it would have been in chapter 11 to work on its operations just like any other solvent company.  Companies often don't need to linger in chapter 11 to fix themselves.  It's at least as often the case that particular investor constituencies, junior debt or equity, that are the only ones who gain any benefit from delaying the emergence from 11.  (And of course bankruptcy professionals who bill by the hour ...).

This is the lesson of Barron's lookback at the progress SiriusXM has made since it restructured outside of chapter 11 in 2009 - bankruptcy is not always necessary to fix a business and effect the goals of chapter 11.  A strong balance sheet with access to sufficient liquidity and no near-term debt maturities works at least as well.

Thursday, November 21, 2013

Where I was When I Heard the News that JFK had been shothot

On November 22, 1963, I was attending first grade in St. Mary Magdalen School, a fairly new parish school serving Catholic families  in the first ring of postwar suburban migration out of Eastern cities.   The parish at that time didn't have a stand-alone church; rather, the school and church shared the same 2 story brick building; the church occupied half the first floor, and about 14 classrooms filled the rest.  But even though the building was just a few years old, the baby boom had swelled enrollment past the number that could fit in that building, and so my first grade class of 41 six-year olds was lodged in a portion of the basement of the adjacent convent where the Benedictine nuns who taught in the school lived. The underground location was touted as an advantage when we practiced atomic bomb drills. The classroom was so makeshift that the desk of our teacher, Sister Jean d'Arc, was at the foot of the stairs that led to the ground floor of the convent. 

Even for a nun in those days of Latin mass and Baltimore catechism (both of which I remember), keeping order among 41 six-year-olds was a challenge, so some of the mothers -- including mine -- pitched in to settle students in at the start of the day and help out at lunchtime.

Sometime after lunch that afternoon, the nuns' housekeeper rushed halfway down the stairs to our classroom, and told Sister Jean d'Arc -- loud enough that the whole class could hear it -- that President Kennedy had been shot in Dallas. Fifty years on, I still remember seeing her crouching down on those stairs delivering the news.  Sister Jean d'Arc was completely stunned.  She and the housekeeper must have decided that the news had to be conveyed to the rest of the school community in the main building, but neither of them thought to pick up the phone and dial the principal's office.   I suppose that can be attributed to the shock of the moment, especially since it was a Catholic school and JFK was, of course, the first Catholic President, and thus revered in so many Catholic communities.  They decided that, while the housekeeper would go back to monitoring the news, Sister would keep order in the class of 41 six-year-olds, many of whom were picking up on the adults' reactions and were themselves becoming agitated, and she would dispatch one of the first-graders to go over to the main building and deliver the news. 

I stood out a little from the 40 others in that class.  I had begun reading around the age of 3 and entered first grade reading at a fourth-grade level.  I was very interested in current events: my parents would say that, when I was three years old, I was asked by a relative what my favorite TV show was, and I answered guilelessly, "The CBS Evening News with Howard K. Smith."  (I suspect that only happened once because it probably elicited a good laugh which would have puzzled me and caused me not to repeat that answer.) 

I was also an extremely quiet and obedient boy. My mother had told me to obey nuns and never to talk in school, and I obeyed her to the letter, to the point where I thought it was wrong even to talk during recess, and thus I didn't, making recess very boring for a few weeks until someone brought this to my mother's attention and she clarified her instructions, and I became a little more socially normal.   

With this resume, however, I was, in Sister Jean d'Arc's mind at that moment, the perfect candidate to bear the news that the President had been shot to the rest of the school.  I don't recall the details of my conversation with her, but in a few minutes, I was walking across the parking lot, which doubled as our playground, to the back door of the school.  I remember that moment vividly because it was the first time I had ever been on the school grounds when they weren't bustling for recess, morning drop-off or afternoon pick-up.  The contrast to what I had always experienced out there made a lasting impression on me. Everything was so quiet and peaceful.  The sky, I still see in my mind's eye, was clear and blue. 

I entered the main school by the back door and to my right, behind a makeshift accordion partition that looked, from my six-year old vantage point, to be about 12 feet tall, was the other first-grade class, presided over by Sister Trinitas.  I knocked on the partition and she came over, slid it back enough to stick her head out, and I told her what I had been asked to relay: "Sister Trinitas, Sister Jean d'Arc told me to come over and tell you it was announced on the radio that President Kennedy has been shot in Dallas, and we should pray for him."  I don't remember her reaction in detail except that she was gracious and thanked me.  Then I went across the hall to the second grade classroom where my cousin Jean Marie was assigned, and told the same thing to her teacher Sister Anthony. 

Then I went upstairs to the rest of the classrooms, which were united by a single long hall that ran east to west.  I started at the east end because that was where the stairs let me out.  I did not know the teachers in those rooms by name, but they had little signs outside of the room with the room number and the teacher's name on them, so I read the teacher's name, knocked on the door, and when she came to the door and opened it, I repeated my message: "Sister ____, Sister Jean d'Arc told me to come over and tell you that it was announced on the radio that President Kennedy has been shot in Dallas, and we should pray for him."   Their reactions were, uniformly, one of shock.  Then they would say something to me, close the door and I would go on to the next classroom and repeat the message to another shocked teacher.  But I had watched the evening news often enough that I knew the men who reported bad news did so calmly without betraying much emotion and, as best I remember, that is how I conducted myself. 

By the time I reached the upper grades at the west end of the hall, someone had already reached them with the message.  I learned this when the teacher in one of those grades opened the door at my knock and snapped at me when I began to deliver the news, "Yes, we already know and we are praying for him! Go back to your classroom!."   Being trained to obey the nuns, I did what she said.  As I walked back to the convent basement, the sky was still clear and blue and the playground was still quiet and calm.  I went back to my classroom and waited with my classmates for my mother to come and pick me up and take me home.   

Like every other family in America that had a television set then, my family spent the next four days glued to it, watching people file past his casket as he lay in state, until on the fourth day he was buried.  It was a memorable event, obviously, for all Americans, but devout Catholics like my family felt a particular grief in the loss of a man with whom they identified through their religion.  I still remember coming in to the room where our TV set was, late in the afternoon over the weekend, when light had all disappeared outside, and the (black-and-white) TV was the only light in the room.  No one could move away, even to turn on the lights in the room as it grew dark.

Throughout my life, I have been regarded as someone who does not get perturbed in times of stress (which thankfully have been few and far between).  I wonder sometimes if that state of mind has its roots in that day, when I was called on to deliver the news just like those very serious men on the evening news I watched on television.   

But, years later, in 1988, when the 25th anniversary of the assassination was being commemorated, I watched a documentary about it, at night in my basement.  Near the end, they were showing a clip from one of the home movies taken of the motorcade that afternoon in Dallas.  JFK was looking right at the camera, smiling and waving as the limousine passed by, looking so relaxed and fully enjoying the moment, and you know as you see him smiling and waving that he had less than a minute left to live and no idea of the fate that awaited him, and his family, and his country, when the limousine would take that excruciatingly slow hairpin turn at the Texas School Book Depository, and he was smiling and waving in slow motion, and I could only think about how much life disappeared in that next minute, and I cried.









Monday, November 11, 2013

Krugismo!

Flipping through the New York Times front section today, I came across a story about the Maduro government in Venezuela sending the military in to take over a five-store retail chain selling electronics goods because they were purportedly selling at prices that were too high and Christmas is coming (and some municipal elections).  Inflation is not the result of disastrous government policy, it's the retailers' fault!  Now the military has marked down all the stock and is liquidating it at the marked-down prices.  That's quite an approach to retail insolvency they have in Venezuela. Don't bother with that chapter 7 or 11 stuff or hire Gordon Brothers to run your liquidation, just have the military do it all!  

I've written before about the use of this strategy by Argentina and some other Latin American governments -- when a party takes power on a program of increasing hand-outs to the lower class, it has to perpetually confiscate other people's property to fulfill its promises (because if you're getting handouts just for voting, why would you ever bother to get a job and work hard to create your own savings?).   And those who try to hang on to their business and savings have to be marginalized and demonized, so that public sympathy cannot build in their favor and jeopardize the officeholders' hold on power, so the confiscation program is always accompanied by rhetoric in which the confiscator aligns himself or herself with the popular will and the defenders of private property and savings are characterized as unpatriotic enemies of the state.  This is "chavismo" or "chavismo -lite" depending on how far the party in power goes, and it has been a successful electoral strategy in Argentina, Ecuador, Venezuela,  and so on.  Recently Cristina Fernandez, the president of Argentina, succeeded, for example, in disemboweling Clarin, the leading media business in that nation, on anti-trust grounds, although most would say it was because Clarin no longer gave her the unconditional support she thought was her due.  And here you can see Cristina arguing that credit rating agencies are being used by the media and people with interests contrary to Argentina to fool people.

Thus, the Times story notes that Maduro and his cronies claim "his government is facing an 'economic war' waged by what he calls the right-wing opposition in Venezuela and its backers in Colombia and the United States."  Standard operating procedure.

Of course, voters here in the United States are far too intelligent to subscribe to these kind of populist paranoid fantasies, aren't we?  No intelligent voter would ever fall for the argument that persons defending their businesses and savings against politicians' pandering to lower-income votes are "waging an 'economic war'" against the nation.

Reading on to the opinion page, I saw Paul Krugman titled his column for the day  "The Plot Against France".  Wow.  A plot?  Sure sounds sinister.   Who are the plotters?  Krugman identifies "Standard & Poors ... The Economist  ... CNN Money ... and Mr Olli Rehn, Europe's commissioner for monetary and regulatory  affairs".  An interesting cabal - 2 publications, a rating agency and a bureaucrat.  Remarkably, it's the very same coalition that Cristina in Argentina and Maduro in Venezuela are fighting against - media, rating agencies and non-complicit government figures. 

And what does the plot consist of?   In S&P's case, they downgraded France.  Quelle horreur!  And the media have published critical stories about France's external debt.  And Mr. Rehn? He called on France to stop raising taxes.  To Krugman, these evildoers are "using debt fears to advance an ideological agenda".  That "right wing opposition" that Maduro is fighting against, is everywhere!

Fortunately, we have Krugman to set them straight.  Because France's fiscal policy is "exemplary" he says.  And their "fiscal prospects look distinctly nonalarming".  This of course from the man who in January 2008 titled Europe "The Comeback Continent".  But hey, no one's perfect.  Let's look at the exemplary fiscal policy of France -- since debt is incurred in nominal dollars,  the following table compares France's general government debt to its nominal GDP. 

Here, in nominal numbers, are the debt and GDP numbers for France (trillions of euros):


2007
2008
2009
2010
2011
2012
Increase from first year to last.
Nominal government debt outstanding[1]
1.212
1.319
1.493
1.595
1.717
1.834
0.622
(50% increase)
Nominal GDP[2]
2.586
2.845
2.627
2.571
2.778
2.608
0.022
(<1% increase)

As the table shows, France has increased its debt by 50% over 6 years, yet its nominal GDP has barely budged.  For every 50 euros of additional debt, France got less than 1 euro of additional income. Which clearly puts a strain on its debt servicing capability.

Per the IMF, France has run federal budget deficits > 3% of GDP for 6 straight years. That's a pretty long experiment with Keynesian stimulus. Clearly its multiplier is bumping along the zero bound and there is no evidence for any economic growth to be gained by continued deficit spending.

To address France's debt problem, Krugman advocates "temporary tax hikes" which he says are better than spending cuts.  He cites to "research from the IMF" but the link just runs to one "working paper" which says it does not reflect the official views of the IMF.  In fact, there are many research papers the IMF has published on the subject of tax vs. spending multipliers and they find many different things, including some that find tax multipliers to be greater than spending multipliers, the antithesis of Krugman's position.  In general, the consensus is that fiscal multipliers are small for developed nations whether the policy involves tax or spending changes.

As far as France goes, with government spending constituting 56% of GDP, and a deficit of 4%, obviously tax revenue is already 52% of GDP.  All that is left to "temporarily" tax is 48% of the economy! While at the same time, the larger share of the economy already captured by the government is off limits to the Krugmaniacs of the world.   France's debt burden is to be borne entirely, under Krugmanian policy, by taking more from the private sector and cutting back privately funded consumption.   And those who take a different perspective are just "plotters against France".

Unfortunately it looks like the chavismo model of political economy is moving north with the Krugmaniacs of the world serving as its mules.  I think the northern  version needs a new name which I've decided should be "Krugismo".  But it might behoove the Times to look at what happened to Clarin and think twice about what happens to elite organizations and freedom of speech in the chavismo / Krugismo model.




[1] Source: Eurostat
[2] Source: IMF 

Monday, September 30, 2013

The Wine Spectator Serves Up An Excellent Example of The Value Added by Corporate Law

I haven't posted anything in 3 weeks, mainly because the weather has been too good to sit at a computer for any length of time.  However, I happened to come across an article in the October 15, 2013 edition of The Wine Spectator that provided a pithy example of the value of corporate law; In contrast to the populist cliche that corporate law is just about making rich people richer at others' expense, this little story shows how corporate law can solve a problem that had paralyzed a business from making good decisions and thereby enable the business to grow to make a whole community better off.

I'll set the stage (all the quotes in this post are from the article I have linked to:  "Campo de Borja" is a "quiet corner of northern Spain, a dusty red blur of rocky hills and sleepy towns located on the western border of the region of Aragon."  On the slopes of Moncayo, a mountain about 7,000 feet high near the town of Borja, garnacha (grenache in French) has been grown and made into wine for centuries.  "On a small plateau perched at 3,000 feet, a modest parcel of vines is blooming, thrusting green canes toward the sun. This is el Tablon, a vineyard where the average vine is 104 years old. Their trunks are as thick as a man's torso, undulating masses of wood that have grown slowly in this difficult environment for decades."

"Aragon was devastated by economic isolation during Francisco Franco's decades-long reign. In the 1950s, cooperatives became a way for farmers to pool their resources. Borja's cooperativa, Agricola de Borja, was founded in 1958."  Jose Sanmartin, the hero of our story, became general manager of the cooperative early in the 1980's.  "Borja was doing well selling gallons of cheap wine in bulk, but Sanmartin knew those days wouldn't last. And yet, growers were doubling down on high-volume wines, ripping out Borja's best asset by the roots.... Sanmartin believed Borja's future lay in good wine.  In 1990, the Borja cooperative began bottling its better wines, naming this new brand Borsao, the ancient Celtiberian name for Borja."  With the 1992 vintage, Sanmartin began selling Borsao to a U.S. wine importer, who was soon buying 40,000 cases a year.

Now we come to the business problem.

"One day in 1997, the U.S. importer "called Sanmartin with a problem: When he had opened wines from the latest shipment, a viscous, oily mess had oozed out of the bottles. The co-op had not dosed the wine with enough sulfur before bottling, and now the importer had 10 shipping containers—about 9,000 cases worth of wine—that were undrinkable".

Sanmartin understood exactly why the problem had arisen. "Cooperatives are not, by nature, innovative. Every grower in the organization gets a vote in company decisions. ... Men who had kept their farms afloat for decades thanks to their arrangement with the co-op were not prepared to give in without a fight. 'It was not easy to convince hundreds of winegrowers to change their minds,'says Sanmartin. 'They had to adjust to the idea that they would be more paid based on quality rather than on quantity of grapes produced.' But in the end, a majority recognized that adjustments were necessary."

And here is where corporate law provides the tool to solve the problem.

"To create a more nimble operation, Sanmartin proposed creating a separate corporation: Bodegas Borsao. This new entity would source its grapes from the co-op and produce all the wines itself. Co-op members would be shareholders in the enterprise, but the business would be run by a professional management team. And most crucially, growers would be paid based on the quality of the fruit they harvested. ...In order to compete in the new global wine world. Bodegas Borsao S.A. was incorporated in 2001."

And thereupon three things happened:  First, "Sanmartin made quality and control the main focus in the cellars."  The corporation hired a technical director in 2001. "Quality has been the first priority since he came," Sanmartin says. "He makes sure nothing goes wrong."

Second, the new corporation "authorized a cellar expansion", installing new tanks better suited to quality control.  With greater confidence in the quality of Borsao's operations, the U.S. wine importer "asked for a new product ,,, for the U.S. market" that would be of higher quality and carry a higher price point (known as "Tres Picos")..

Last, the U.S. importer introduced an Australian vintner to the region and the two of them formed a joint venture with the new corporation -- not the cooperative --which produces an even higher rated and higher priced wine (known as "Alto Moncayo").

The author of the article closes his article with a paragraph that recognizes the economic significance to the Borja community of the decision to abandon the cooperative structure for the corporate structure:

"If it weren't for the ingenuity of Bodegas Borsao, it's unclear what life would be like in this small town. Perhaps all the old vineyards would have been ripped up  ... and small growers would have abandoned their farms for the city. But today, the old vines remain rooted to the slopes of Moncayo, as timeless as the mountain on which they grow."

We live in a world in which the words "corporation" and "corporate" are stereotyped epithets, usually paired with words and phrases like "greed" or "soul-crushing".  A movie set in a corporate setting can be counted on to reinforce the populist cliches and portray the corporation as some sort of extrusion of hell on to the surface of the earth.  In contrast, other ways of organizing people, such as cooperatives or governments, are portrayed as noble expressions of democracy, regardless of the reality of their many flaws (cumbersome decisionmaking, political entrenchment, self-dealing, etc.)  More intellectual analysis from winners of the Nobel Prize for economics like Ronald Coase or Douglas North have shown that the corporation is merely a form of economic technology that improves decision-making and resource allocation over other forms of organizing people and their resources, such as contracts or, in the case of the Borja wine-growers, a cooperative.  So I set this example out as a reality based counterweight to the populist and romanticized stereotypes and I hope it serves that purpose.



Tuesday, September 10, 2013

Bruce Ackerman's Incredibly Arrogant Arguments To Maintain the Status Quo in Legal Education

On the 6th, the Washington Post published an opinion piece from Bruce Ackerman, Yale Law School professor, "Why Legal Education Should Last for Three Years" in which he argues President Obama "was dead wrong" when he suggested that law school should only last two years.  The editorial is full of hyperbole, labeling the idea "tragic" and stating "If Obama’s 'cost-cutting' measure were adopted, it would impoverish American public life." 

His main argument is that in three years of law school, students somehow acquire much deeper knowledge about "statistics" and "big data" than they could in only two.  That argument, by the way, is made entirely without any use of "statistics' or "big data", which I found both ironic and telling.  One thing I have noted about law school professors: they spend so much time listening only to themselves and people with similar views that they lack the habit of anticipating the weaknesses in their arguments that practicing lawyers develop as they operate in adversarial settings. Or maybe the statistics about the benefit of the third year of law school are so earth-shaking they are being kept secret.

Ackerman fears that without the benefit of a third year of law school, lawyers will be reduced to "secondary figures who prepare the way for 'experts' to present the crucial arguments before administrative agencies, courts and legislatures."  It's funny, I always thought clients were supposed to be the primary figures, but I guess at Yale they teach you that lawyers are to be the primary figures.  What does that relegate clients to? 

Even worse, "Decision-makers with two-year law degrees will proceed to rubber-stamp the expert testimony that seems most impressive because they aren’t prepared to test it in a serious way."  Deliciously, Ackerman seems to believe that the only competent "Decision-makers" in the future will be lawyers.  I guess the rest of the world, without the benefit of that all-important third year of law school, just has no role to play in making any decisions ever again. 

Perhaps you are starting to see why I use the phrase "Incredibly Arrogant" to describe Ackerman's perspective in the title of this post. To him, the only people who are qualified to make decisions and be primary figures in policy debates are those who have had the blessing of that third year of law school. 

But even if we ignore the condescension, look at how overstated his claim is.  All the fields he offers as examples of areas where statistics is used in debate are evolving rapidly.  It's ludicrous to think that the limited exposure one might get in the third year of law school is either sufficient to qualify a graduate to challenge an expert in a particular field ten or fifteen years later. 

Here is the final howler, the one that actually prompted me to write this post, actually: "Once two-year graduates move into practice, they won’t be able to deal adequately with bread-and-butter issues of antitrust, intellectual property or corporate law, let alone with the challenges of civil rights or environmental law. It is frivolous to suppose that these lawyers would pick up the key skills on the job."

Wow.  What kind of students are they admitting to Yale Law School these days that they could not learn "antitrust, intellectual property or corporate law" on the job?  How lucky they are to have a paternalistic figure like Ackerman to help them overcome their limitations.  Granted, Yale has a reputation for not turning out lawyers who are trained for private practice (and God knows Ackerman's ridiculous generalizations reinforce that reputation), but Ackerman seems to be saying something different, that the students he observes are inherently unable to educate themselves on the job, which is an amazing slap in the face.  

So look, here is a personal account to disprove Ackerman's condescending assertion.  At my equally prestigious law school, I had ZERO academic training in any of the main areas of a New York corporate practice --  M&A, securities offerings or credit documentation. I had ZERO practical or clinical coursework of any kind, business or litigation.  My only exposure to the Bankruptcy Code came from two classes on avoidance at the end of the segment in Commercial Transactions that covered with Article 9 of the UCC.  I cut 1/3 of my Contracts classes and every class in Evidence after the 4th one.  When I showed up for work at a top tier New York law firm after graduating, I was assigned to its banking and credit practice area, which was and is a market leader.  Within that practice area, I wound up devoting a large chunk of my time to restructurings and chapter 11s, due to the economic environment of the day. 

By Ackerman's reckoning, I must have been unable to "deal adequately" with the "bread and butter" issues of these practice areas, and my employer must have been "frivolous" to think I would learn what I needed on the job. 

Well, I spent thirty years in that firm, making partner after the first eight of them, and devoted most of those thirty to the restructuring practice for which I had received ZERO academic training, and managed to do well enough that prominent billion dollar distressed hedge funds and bulge bracket investment banks' trading desks kept me busy for most of the last two decades.  On every deal I worked on in my first five years, a partner or older associate took pains to go over my work with me and correct anything I had not done correctly.  Beyond mastering the substance of bankruptcy law on the job, in order to represent my clients in court I learned everything I know about the rules of evidence and everything I know about trial practice on the job.  And I learned quite a lot.  Frequently, I worked with expert witnesses, preparing them to testify, and cross-examining adversaries'.  I had no academic training to do that.  But I read up on these areas constantly, and as most lawyers who litigate financial matters do, I had the benefit of non-testifying experts to help guide me through the more challenging aspects of each dispute.

Every lawyer in private practice learns most of what they need to know on the job.  If you are a commercial litigator, for instance, you are either a generalist who has to be a quick learner about the nuts and bolts of each new client's business, or you are a specialist and you acquire a deep knowledge about one particular business sector. In either case, you acquire your knowledge by working alongside people in the relevant industry and you learn what they know about it.  On the job, bereft of law school assistance.

I found the first two years of law school to be abstract and far removed from the real world.  The few courses that dealt with the day to day functioning of business, like Contracts, were all taught in a philosophical manner, because that was the mindset of the professor who taught it. It wasn't until my second year summer clerkship at a law firm that I got a sense of how law was practiced on a high level in the real world.  Then I was able to get some benefit out of my third year of law school, by taking classes in Corporate Finance, Corporate Taxation, and Commercial Transactions.  But I would have been much better off taking them in the second year, or in a training program in a law firm.

Contrary to Ackerman, I think that persons entering the legal profession and intending to practice anywhere outside of the State Department or a Supreme Court practice, will be far better served if law school were shortened to two years and they had an internship of some kind or something like the English system of articled clerkship to replace the third year.

But to do that requires that state bar admission requirements, nearly all of which require graduation from an accredited law school, be modified to permit admission to the bar after just two years, or after two years and some amount of work.  If Ackerman were as committed to statistics and data as he professes to be, he might endorse loosening those restrictions to create options for students, which would result in outcomes that could be analyzed to test his assertions versus those who disagree with him.  But he suggests nothing like that in his editorial and the paternalistic tone of it suggests that it is more of a brief to preserve the protectionism that law school professors and administrators receive from state bar admission requirements.  So I am very happy that President Obama has put that protectionism in play and hope other lawyers will join him in advancing the best interests of law students and ultimately the profession.

Update: Elie Mystal at Above The Law has an excellent response to Ackerman as well:
http://abovethelaw.com/2013/09/a-yale-professor-offers-a-most-yale-like-response-to-the-length-of-law-school-debate/

Sunday, September 8, 2013

Carlos Danger Man (with apologies to Johnny Rivers)

[To the tune of "Secret Agent Man"; original lyrics here.]

There's a man whose name is Carlos Danger
Says everyone he meets there's no one stranger
With every tweet he makes, it's Huma's heart he breaks
Odds are he won't win the vote tomorrow

Carlos Danger man, Carlos Danger man
Those single digit numbers belong to your campaign

Beware of sending pretty women sexts
You never know what web site gets them next
Ah, be careful what you tweet
Or you'll prove yourself a creep
Odds are you won't win the vote tomorrow

Carlos Danger man, Carlos Danger man
Those single digit numbers belong to your campaign

              [Lead guitar]

Carlos Danger man, Carlos Danger man
Those single digit numbers belong to your campaign

A friend of Hill and Bill, yeah, you were one day
An embarrassment to all your friends the next day
Oh, you're such a laughingstock
For texting pictures of your cock
Odds are we get rid of you tomorrow

Carlos Danger man, Carlos Danger man
Those puny little numbers belong to your campaign

              Carlos Danger man!






Friday, August 16, 2013

No Cliche Left Behind in the New York Times Ridiculously Mistaken Assault on the Detroit Swap Settlement

The New York Times ran an editorial today entitled "No Banker Left Behind" about a motion in the Detroit bankruptcy for approval of a settlement and compromise between the city and some interest-rate swap counterparties.  The editorial board of the Times was outraged that the counterparties were receiving 75% of their claim when pensioners are, according to the Times, looking at a 90% haircut.  The Times thinks that this is about "protecting pensions; protecting municipalities from Wall Street; and, at long last, revoking the obscene privileges of banks that allow them to prosper on the failings of others."  But, in truth, the only thing the editorial demonstrates is the utter ignorance of the Times about basic bankruptcy law, pension funding and the utility of interest-rate swaps in finance. I wonder where in the world the Times' editorial board got its information because it's so horribly ignorant of all the relevant facts.  I put up this post so that somewhere in the world the correct understanding will exist.

First, the Times shows no awareness of interest rate risks the city faced in 2005 when it entered into the swaps.  Interest rates rose consistently throughout 2005; from CNN/Money, Sept. 20, 2005: "The Federal Reserve raised a key short-term interest rate Tuesday and suggested more rate hikes are on the way ...The central bank's policy-makers boosted their target for the federal funds rate a quarter-percentage point to 3.75 percent, the highest level in more than four years.  The rate increase was the 11th straight since June 2004 as Alan Greenspan and other central bankers seek to keep inflation under control. In its heavily scrutinized statement, the Fed said that more "measured" rate increases were likely in the coming months."   The city reasonably must have feared further rate hikes would be another drain of its already constrained cash.  So they sought to lock in those rates by entering into a swap, where they would pay a fixed rate of interest on the notional amount and receive floating rate payments from the counterparties (which two payment streams were probably netted such that the city just kept paying its floating rate interest and also paid (or was supposed to pay) the counterparties of just the difference by which the fixed rate specified in the swap exceeded those payments).

This was economically equivalent, the Times seems not to grasp, to issuing fixed rate debt to refinance the floating rate debt.  Why didn't the city just do that?  Probably two reasons:  1) the amount of debt was large enough that the market would not have been able to absorb it all efficiently and the city would have had to pay more than it wound up paying under the swap to get the market to digest the fixed rate issue; and 2) the city's credit probably had deteriorated since the floating rate debt was issued and they wanted to preserve the lower spread or at least the optics of a lower spread.

The key takeaway here is that the transaction is no less proper or common than issuing fixed rate debt. It is economically the same thing.  The Times' editorial board, and whoever fed them the story, sadly seem not to grasp that simple fact, as it insists of shoe-horning this into the narrative it clings to of greedy speculators on Wall Street taking advantage of poor ignorant municipalities.  When it is just a commonplace, plain vanilla form of risk management.

Second, the Times fails to grasp how the claim of the counterparties arose.  The Times recognizes that it reflects interest rate movements adverse to the city; rates did not rise as they thought, they fell.  What the Times fails to recognize is that this is not particularly driven by the fact the transaction was a swap.  The city would have been faced the same problem had it just issued plain vanilla fixed rate debt.  The swap claim does not represent an extra charge of some kind, it is just the accumulation of  years of differential between the fixed rate Detroit would have paid on fixed rate bonds and the floating rate on the paper it kept outstanding.  In principle, the city should have trued up the difference between floating and fixed rates every quarter or biannually.  That is how most swaps are written.  But the city was probably too cash constrained to do that, that is, to pay regularly what it would have been paying had it just issued fixed rate debt. So effectively it seems to have financed the fixed vs floating rate spread, which is economically equivalent to getting a plain vanilla loan from the swap counterparties in an amount equal to the interest payment differential.  And it appears the counterparties were not willing to make that loan unsecured, so they took collateral.  There is nothing  out of the ordinary about making a secured loan to finance a weak credit. Had the counterparties not done that, Detroit would have run out of cash sooner.  That is the key takeaway of point 2, that this transaction was economically equivalent to a secured loan from the counterparties that was just a way to stretch Detroit's cash farther.  It would have run out of cash earlier and in some other way without this financing; the swap did not make anything worse than it would otherwise have been, once the city decided to protect itself against interest rate hikes that seemed reasonably likely before September 2008.

Last, the Times falsely equates the counterparties, who were clearly secured according to the Times' narrative, with the unsecured retirees and further overstates the retirees' haircut.  Obviously, as any one with financial or legal experience knows, secured creditors are entitled to be paid in full from their collateral in bankruptcy.  They do not have to compete with unsecured creditors.  And it would be crazy to make them do so.  They are not insurers of pension benefits.  Back when ERISA was set up, a political choice was made to not cover public sector workers.  This enabled state and local politicians and public sector unions to engage in mutual back-scratching practices over the past four decades without the nuisance of a federal regulator telling them the promises were unsupportable.

The Times' presentation of a 90% haircut of the pensions is totally false.  First, recoveries are estimated to be closer to 20% but more important, the 90% figure ignores the funds already transferred to the city pension fund and the value earned thereon, which is functionally the retirees' collateral.  The haircut is only applicable to the unfunded portion, not the whole pension!

It's super-pathetic that the Times puts out such nonsense based on such fundamental ignorance of so many key aspects of the motion.  I do really wonder where they got it into their head to write an editorial about this -- was it some union, a progressive activist,  a politician with an agenda or a reporter?  In any case, the person who brought it to their attention is equally ignorant, or perhaps outright mis-representing the facts and the law to the Times' editors.

Saturday, August 3, 2013

UK Supreme Court Resolves that Contributions to Underfunded Pensions of an Affiliate Are Not "Expenses of Administration" Even Though Assessed Post-Insolvency-Proceeding

Traveling in the UK and elsewhere towards the end of July, I read in one of the UK papers a story about a decision of the Supreme Court of the UK in the insolvency proceedings of Nortel and Lehman.  The court held that pension liabilities are pari passu with general unsecured claims in insolvency proceedings. Returning home, I read the opinion online (here: scroll down to 24 July judgments).  I found it interesting how much the court's reasoning parallels US bankruptcy law (without actually mentioning so).  Here is a short summary:

1.  The Pensions Act of 1995 establishes (section 75) minimum funding requirements for pension plans ("schemes" in the UK parlance; but I will generally use American parlance throughout this post as I assume most readers of this blog are US-centric) and specifies that deficiencies in funding are "provable debts" (equivalent to the US's "general unsecured claims") in insolvencies.  Much like section 502(b) of the US Bankruptcy Code, it states that  "a section 75 debt is to be taken, for the purposes of an employer’s insolvency, to arise immediately before the occurrence of the insolvency event."  The Lehman UK and Nortel UK plans were underfunded.

2.  By the Pensions Act 2004 (30 years after ERISA!), the UK appointed a pensions regulator and set up a pension protection fund to backstop pensions, funded by taxes on pension plans themselves.  To protect the fund against corporate asset-shuffling, the law empowers the regulator, inter alia, and regardless of whether the plan sponsor is in insolvency proceedings or not, to issue "Financial Support Directions" ("FSD"), which may require a variety of actions from the target companies to support their affiliate's pension plan.  A specific form of FSD is a "Contribution Notice" ("CN") which requires the targets to pay a specific amount of money. toward the pension plan sponsor's funding deficiency. Such potential liability is similar to the liability ERISA imposes on "commonly controlled entities", although it seems to be ad hoc and discretionary, as opposed to strict and automatic under ERISA.  The CN, because it requires payment of a specific amount of money, would clearly be a "claim" in a US proceeding, whereas theoretically some forms of FSD might, under a KovacsMidlantic National Bank line of reasoning, escape "claim" characterization and be seen as a non-dischargable regulatory obligation.

3. Post the entry of Lehman and Nortel's UK companies into administration, the pensions regulator conducted an investigation into the respective pension plans' funding status and determined to issue some kind of FSD's to certain of their affiliates, which the court presumed, would "in due course" eventually take the form of CN's to contribute to the underfunding.  The actual issuance of those FSD's was "informally stayed" pending litigation of the ranking the resulting liability would have in the insolvencies.

4. The issue was a familiar one: whether the post-insolvency-proceeding FSD was an "expense of administration" in the proceedings of the companies targeted, simply because it was promulgated post-commencement of insolvency proceedings, or whether the issuance of an FSD merely crystallized a contingent liability that loomed over the targeted companies prior to the insolvency by virtue of being in a corporate group with an underfunded pension plan, such that it was merely a pre-petition claim, to use American parlance.  Similar to the US bankruptcy laws, an expense of administration is the highest priority unsecured claim in a UK insolvency proceeding (and even has priority over floating charges, but not fixed charges).  (Also, by way of clarification, there are two types of insolvency proceedings in the UK: administration and winding-up/liquidation; but the opinion explains that the issue operates identically regardless whether the company enters one or the other, or whether it begins in administration and then transitions to a winding up). Thus, the characterization determined whether the pension funding claims would be fully satisfied as admin expenses, or only partially satisfied, pari passu with other general unsecured debts.

5.  Reversing both lower courts, the high court held the FSD liability should be classified a pre-petition claim.  Its reasoning resembles very much the reasoning that US courts go through in analyzing an admin expense / general unsecured claim issue.

6.  The court's reasoning (isn't this just like one of those case summaries law students write up?) begins at paragraph 58: "on the face of it, the sensible and fair answer would appear to be that the potential liability of a target, under a FSD issued after an insolvency event, and in particular the liability under a CN issued thereafter, should be treated as a provable debt. There seems no particular sense in the rights of the pension scheme trustees to receive a sum which the legislature considers they should be entitled to receive having any greater or any lesser priority than the rights of any other unsecured creditor."

7.  Continuing: "if a CN had been issued in respect of a company before an insolvency event, it would give rise to a provable debt, and the courts below considered that, if a CN were issued after an insolvency event, it would give rise to a provable debt if it was based on a FSD issued before the insolvency event. It appears somewhat arbitrary that the characterisation and treatment of the liability under the FSD regime should turn on when the FSD or CN happens to have been issued, if it is based on a state of affairs which existed before the insolvency event."  The court noted the practical consequences of an "expense of administration" ruling: "Where the Regulator is proposing to issue a FSD in respect of a company not yet in administration or liquidation, it would be well advised to wait for the insolvency event, if the decisions below are right, because the amount recoverable under a subsequent CN would inevitably be greater than under a CN issued following a FSD issued before the insolvency event."

8. The court also noted the illogic and unsound policy of treating the debtors in a corporate group differently: "It would be strange if the employer company’s statutory obligation to make good a shortfall in its employees’ pension scheme ranked lower in its insolvency than the more indirect statutory obligation of a target to make that deficiency good ranked in the target’s insolvency."

9. The court also discusses at length whether the affiliates' liability is a "provable debt" at all, what we in the US used to call the "Frenville" issue until that case was overruled by the Third Circuit.  The reasoning is again very similar to the US analysis of whether something is a "claim" that can be discharged in a chapter 11:
"Where a liability arises after the insolvency event as a result of a contract entered into by a company, there is no real problem. The contract, in so far as it imposes any actual or contingent liabilities on the company, can fairly be said to impose the incurred obligation. Accordingly, in such a case the question whether the liability falls within para (b) will depend on whether the contract was entered into before or after the insolvency event."

10.  But, "Where the liability arises other than under a contract, the position is not necessarily so straightforward....the mere fact that a company could become under a liability pursuant to a provision in a statute which was in force before the insolvency event, cannot mean that, where the liability arises after the insolvency event, it" should be viewed as a pre-petition debt.  As a general principle, the court said, to have incurred a pre-petition "debt", the company "must have taken, or been subjected to, some step or combination of steps which (a) had some legal effect (such as putting it under some legal duty or into some legal relationship), and which (b) resulted in it being vulnerable to the specific liability in question, such that there would be a real prospect of that liability being incurred."

11.   The court then proceeds to determine that the contingent FSD liability satisfies the two conditions: "if one asks whether those potential liabilities of the Target companies in these two appeals satisfy the requirements ... the answer is yes."

"As to the first requirement, on the date they went into administration, each of the Target companies had become a member of a group of companies, and had been such a member for the whole of the preceding two years – the crucial look-back period under the 2004 [Pensions] Act. Membership of a group of companies is undoubtedly a significant relationship in terms of law: it carries with it many legal rights and obligations in revenue, company and common law.

"As to the second requirement, by the date they went into administration, the group concerned included either a service company with a pension scheme, or an insufficiently resourced company with a pension scheme, and that had been the position for more than two years. Accordingly, the Target companies were precisely the type of entities who were intended to be rendered liable under the FSD regime. Given that the group in each case was in very serious financial difficulties at the time the Target companies went into administration, this point is particularly telling. In other words, the Target companies were not in the sunlight, free of the FSD regime, but were well inside the penumbra of the regime, even though they were not in the full shadow of the receipt of a FSD, let alone in the darkness of the receipt of a CN."

In other words, the court seems to say, the day before the insolvency, there was a pretty decent prospect the regulator would issue an FSD to the affiliates, and that determines their contingent liability should be treated as a pre-petition debt.

This is, I think, a very similar result and analysis to what you would see in the US.  It is probably a good idea for management of multinational insolvencies that the US and UK take a similar approach to this kind of issue.

Friday, August 2, 2013

What Can Lawyers Learn from the Outcome of the SEC v. Tourre Trial?

I was out of the country on vacation for most of the trial of SEC v. Tourre, about which I had posted previously.  From the articles I read this week,  three things jump out at me that might be relevant to practitioners and have not, AFAIK, been covered elsewhere.

1.  Term sheets and preliminary deal discussions need to be treated as potentially career-terminating powderkegs.  The supposed misrepresentations about Paulson & Co signing up for the equity tranche only occurred in informal, preliminary deal discussions with ACA, not in the final offering and sale documentation. Multiple witnesses for the SEC who worked at ACA testified that the statements made in those preliminary contexts were "critical" to their underwriting. The jury seems to have credited those assertions, despite the fact that there seems to be no evidence that ACA ever sought to include in the deal documentation a condition to closing that the insurer receive documentation evidencing Paulson's supposedly "critical" subscription for that tranche, which I find highly suspicious since it is the basic job of a lawyer for a party to a deal to include in the closing conditions delivery of all the documentation that the client considers "critical" to its involvement in the deal.

Also, although it was undisputed that Paulson and ACA representatives met to discuss portfolio selection, I didn't see any evidence of ACA confirming Paulson would be the equity investor at those meetings.  However absurd ACA's claims may appear to me as a lawyer who worked on structured deals, the jury obviously had to credit them to find for the SEC, and thus one has to conclude that all the language that is usually put at the top of term sheets and transmittal letters about non-binding, no representations, subject to final documentation etc., don't protect one's client (or oneself) from a career-killing SEC investigation or lawsuit.  I foresee an increased use of "pre-negotiation agreements", one of those god-awful mechanisms that people began using in recent years, and many billable hours devoted to the terms thereof. But I don't even know if those would help against a rabid SEC investigation. Lawyers who advise on IPO roadshows and the like have known this for years and that is why clients spend money on lawyers in those contexts.  But it's definitely not the norm in structured deals, where a party is represented by counsel who can comment on the final document, to think that comments made in the preliminary, structuring phase need the kind of lawyering oversight that travels with IPO roadshows.

2.  The trial seems to have turned on an utterly subjective version of materiality that I find highly dubious and questionable.  Although the SEC doesn't have to prove reliance, a great deal of the testimony focused on the importance that the senior tranche's insurer, ACA, purportedly placed on the identity of the equity investor. There was no evidence reported of any other investor finding that material to its investment decision.  On cross-examination, one of the Goldman employees called as a witness by the SEC testified he would not consider that material, but obviously the jury credited ACA's subjective assertion of materiality (despite, as I note above, no evidence that ACA manifested the supposed materiality to the rest of the working group in the customary fashion, by negotiating for a closing deliverable demonstrating receipt of the desired equity investment).

Certainly I have seen deals where the identity of an equity investor is important.  Large private equity shops get better terms from lenders than smaller ones, and probably better execution, too, for instance.  Then there is the groupie phenomenon in which an investment by someone with prior successes in similar situations can, in and of itself, persuade others to co-invest in a deal they might otherwise not have paid much attention to. So it's not out of the question.  But what I don't see in the ABACUS deal (besides any customary manifestation that ACA really cared at the time) is any financial reason why it would matter, and, if the ACA witnesses were testifying truthfully, one has to question whether they understood the deal ACA was insuring at all.  ABACUS was structured so that a 100% short position could be bought against the portfolio; it was inherent in the deal that someone was 100% short.  Also, the long side of the trade was highly levered, more than 6 to 1.  So the equity long position was a small fraction of the overall money in the trade, of the panoply of views on the trade.  But you've got ACA executives on the stand claiming to have viewed the identity of the relatively small equity investor as "critical"  --  while never attaching equal,  let alone proportionate, importance to ascertaining the identity of the person who put on a much larger short position.  I find this pretty incoherent, which is why I think they either did not grasp the basic nature of the deal, or they just made up a story after the fact to divert blame from themselves for bad underwriting.  ACA was in the business of insuring structured deals, so how they could claim they were misled by someone else on such a deal is just mind-boggling.  But I imagine its executives were highly motivated to maintain that position, due to other pending or threatened litigation against them.

But what are the implications of that set of facts for documenting deals in the future? It seems that lawyers will have to really dumb down documentation, not just in registered deals that might wind up in the public markets someday, because that has already happened, but even in sophisticated deals that would not hitherto have been thought to be so closely scrutinized, to reach a level that even a really dumb investor would not be able to claim misled it.  And that certainly provides further confirmation that "big boy" letters won't be of any value in fending off an SEC investigation or proceedings, although there have been cases on that for a while now.

 3.  As Tourre is not a US native, the potential sanctions against him don't seem particularly meaningful. Banning him from the US securities industry is not all that significant as he's not in it right now anyway and, in any event, finance is global and the ban does not preclude him from working in Paris, London, etc., although a future employer would have to be careful to keep him off US-impacting deals.  And whatever fines might be imposed seem difficult to collect were he to move out of the US.  For those and other reasons that have been mentioned in the press and thus I won't bother to repeat, the trial seems to have been mostly a show trial, designed to prove to someone that the SEC can win a trial, if they only throw gazillions of resources into it, which will undoubtedly be noted frequently in its next appropriations request.