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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.