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October 20, 2008 |
Financial Markets in Crisis: Critical Issues in the Current Environment

Many of our clients have been facing unprecedented new challenges as a result of the dramatic economic events that have occurred over the last month.  The financial markets continue to evolve in Washington on a real-time basis and the daily volatile gyrations in the stock markets around the world have led to uncertainty, anxiety and issues of first impression for many of our clients.  We believe that the events that occur in the coming months will shape not only the financial futures of many of our clients and their competitors, but also the world economy. The U.S. Government has taken a number of steps in an attempt to help the economy and the credit markets recover.  Among the most noteworthy programs are the following: The Treasury Department’s Troubled Asset Relief Program ("TARP" – created by the Emergency Economic Stabilization Act ("EESA") passed earlier this month), through which the government is authorized to purchase up to $700 billion in whole loans and mortgage-related securities as well as to invest directly in financial institutions; The Treasury Department’s money market mutual fund guaranty program; The Federal Reserve’s commercial paper funding facility, payment of interest on reserve balances and relaxed bank investment guidelines; The FDIC’s temporary liquidity guarantee program; and The SEC’s short selling initiatives. These programs have all been discussed in our previous client alerts. Clients Encounter Issues, Formulate Strategies and Find Solutions We are currently assisting our clients in a number of critical areas.  In light of the breadth and gravity of these issues, we felt it was important to share them with you so that you can take them into account in your own strategic planning. Liquidity Crises.  Many clients are facing current or imminent liquidity crises.  Those who have available lines of credit are in some cases drawing on those lines even before they have a need for the funds out of a concern that they may soon fail to satisfy financial covenants that must be met for drawdowns. Insolvent Lenders.  The Lehman bankruptcy has raised concern among many clients about the availability of funds under their existing credit facilities.  The potential insolvency of some lenders is yet another reason why some clients are considering early drawdowns on their lines of credit.  We have also been analyzing the implications of an insolvency of the administrative agent under both term and revolving loan facilities. Early Contingent Restructuring Planning.  After observing some of the largest and most sophisticated financial institutions in the world caught totally unprepared for the dramatic changes in the financial markets, many of our clients are proactively retaining advisors to comprehensively review their financial exposures, apply stress tests to their operating assumptions and provide contingent restructuring advice. Finding Alternative Sources of Capital.  The closure of the debt markets has obviously been abrupt and widespread.  Most of the major domestic and international financial institutions have indicated that they will significantly curtail or eliminate new financing commitments in the fourth quarter of 2008.  This has led a number of clients who need to refinance their existing debt facilities, raise capital for acquisitions or raise working capital, to explore alternative financing sources. Acquisition of Companies with Distressed Valuations.  Many of our clients with healthy balance sheets and strong cash positions are beginning to analyze both public and private buying opportunities.  In some of these situations, they are exploring "loan to own" transactions (buying a troubled company’s debt to gain effective control) instead of acquiring equity positions.  Clients also are looking more carefully at bargain opportunities through the bankruptcy Section 363 sale process. Takeover Defenses.  In light of depressed stock prices, in some cases below book value and/or available cash, many clients are revisiting their hostile takeover defenses.  Among other proactive measures, clients are preparing both ISS-approved and traditional "off the shelf" poison pills in advance of any hostile takeover activity in order to be able to nimbly respond to unwanted hostile raiders. Examination of Distressed Debt Positions.  First and second lien issues and the often unread or misunderstood contractual terms of debt instruments have continued to take center stage.  Investors are analyzing whether debt market prices fully reflect the contractual terms of those instruments.  Issuers and investors are often surprised that the actual contractual terms don’t always reflect the terms understood in the market, or that there are ambiguities in interpretation of the terms that can impact risk and valuation. Real Estate Debt Acquisitions.  Many of our clients are acquiring real estate debt despite the continuing challenges in the real estate markets.  Clients are forming investment funds and purchasing whole mortgage loans, so-called "B-pieces" of mortgage loans (as well as more junior pieces), mezzanine loans and CMBS bonds.  In the current environment, our active dialogue with the U.S. Treasury Department regarding government rescue programs has been crucial in advising on these acquisitions and dispositions. Participation in the Government’s Response.  Many of our clients are interested in participating in the multiple government programs that attempt to respond to the financial markets crisis.  Some are seeking to manage assets for the Treasury Department in the implementation of the TARP.  Other clients are interested in purchasing assets from the Treasury Department or participating in FDIC or Federal Reserve programs.  We have also worked with agencies on behalf of clients on eligibility rules. Public and Private Stock Repurchase Transactions.  Some clients with healthy balance sheets, strong cash positions and depressed stock prices are negotiating the maze of federal and state regulations to repurchase their own equity securities in the open market.  Similarly, some of our public company clients are repurchasing their securities from hedge funds and other institutional holders who need to liquidate their equity positions.  This avoids open market sales by these holders that would further depress stock prices. Short Sale Compliance.  Our broker-dealer and investment manager clients are having to quickly adapt to the SEC’s slate of new short selling requirements, including new Rules 10a-3T and 204T.  We have assisted clients in understanding and interpreting the new requirements, obtaining guidance and relief from the SEC staff, providing insights into "street practice" for complying with the rules and updating their compliance policies and supervisory procedures to reflect the new regulatory regime. SEC Disclosure Issues.  Public companies are facing the preparation of periodic reports in the midst of turmoil in the economy and upheaval in credit markets that have a serious impact on liquidity and other disclosures.  Our public company clients are evaluating and revising their liquidity and cash flow disclosures, risk factors and related disclosures as they prepare their periodic SEC reports. Labor Reduction and Related Employment Issues.  Many of our clients are facing the unfortunate task of planning and implementing layoffs, not only in compliance with laws impacting such programs, but also in a manner that will minimize fallout litigation.  Clients are also renegotiating their labor contracts with unions where financial circumstances so require, as well as dealing with a host of other labor and employment related issues. Section 401(k) Plan Lawsuits.  Some clients may also be facing ERISA "stock-drop" or "excess fee" class action suits alleging, respectively, that plan fiduciaries breached their duties to their Section 401(k) plans by continuing to offer company stock as an investment option, or that plan fiduciaries negotiated fee arrangements for services or investment purchases that are imprudently expensive. Congressional and Other Investigations.  Congressional investigators and State Attorneys General have already begun to dig into possible "causes" of the financial markets crisis.  Many financial services firms have received inquiries and/or requests for documents and testimony from the House Oversight and Government Reform Committee.  It is only a matter of time before Senate investigators follow.  In addition, the EESA either creates or gives authority to four oversight bodies – three of them new – and their roles in large part will be to scrutinize the TARP. Public Relations in Crisis Management.  Many of our clients are facing major, company-threatening crises in the increasingly complex legal and economic environment.  The preparation of a clear, concise and effective strategy for handling governmental agencies, the media, employees and the investing community is a critical component to the stability of our clients who face these challenges. We are deeply involved in assisting clients in each of the areas discussed above, and we plan to present webcasts in the near future on many of these areas to detail the issues, strategies and solutions that our clients have implemented with our assistance. We understand the difficult issues you face in these turbulent times, and we want to be part of your solution.  We pride ourselves on the expertise and creativity we bring to your matters, and our worldwide resources stand ready to assist you.  We will keep you apprised as we schedule our webcasts on these matters.   Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these developments. We have assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above. Please contact the Gibson Dunn attorney with whom you work or any member of the Financial Markets Crisis Group. © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 14, 2008 |
Financial Markets in Crisis: TARP Takes Shape: President Announces Additional Measures

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is tracking closely government responses to the turmoil that has catalyzed dramatic and rapid reshaping of our capital and credit markets. We are providing updates on key regulatory and legislative issues as well as information on legal issues that we believe could prove useful as firms and other entities navigate these challenging times. This update focuses on the status of the Treasury Department’s implementation of the Troubled Asset Relief Program ("TARP") and announcements made today after a meeting of the President’s Working Group on Financial Markets ("PWG"). Implementation of the Troubled Assets Relief Program Over the weekend, Treasury continued its efforts to rapidly implement TARP.  In a speech yesterday before the Institute of International Bankers, Treasury Interim Assistant Secretary for Financial Stability, Neel Kashkari, broadly described the status of the TARP program.  Of particular note were the following  developments:[1] Treasury has chosen the law firm Simpson, Thacher & Bartlett to advise the Department on taking equity stakes in banks. Treasury has chosen consultants Ennis Knupp & Associates to help select asset managers for TARP.  Treasury likely will announce the firms chosen to serve as asset managers in the next few days.  The Department received more than one hundred submissions for each of the whole loan and securities asset management solicitations. Treasury received seventy submissions in response to its solicitation for a custodian/auction manager.  At the time of Kashkari’s speech, Treasury had narrowed the list of possible TARP custodians down to ten.     Treasury has created seven policy teams to implement TARP.  The teams are broken down into the following policy areas: the mortgage-backed securities purchase program, the whole loan purchase program, the insurance program, the equity purchase program, homeownership preservation, executive compensation, and compliance. The policy team for the insurance program has submitted to the Federal Register a public request for comment about how to structure the program to insure troubled assets required by Section 102 of the Emergency Economic Stabilization Act ("EESA").  Responses are required by October 28, 2008. Treasury has appointed several key interim leaders of TARP.  The ones Kashkari mentioned in his speech all were serving in other government positions and most have significant private sector experience. Mr. Kashkari also discussed Treasury’s previously released statements regarding procurement procedures and conflicts of interest, which we outlined in a previous client alert.  Though Mr. Kashkari offered few new details about these policies, he did emphasize that Treasury is taking seriously its duty to manage conflicts of interest, to ensure proper oversight of the program, and to include small, veteran, minority- and women-owned businesses as TARP subcontractors. President’s Rose Garden Announcements As reported yesterday by the news media,[2] President Bush this morning announced several measures designed to strengthen banks.  He made the announcements during a Rose Garden speech that followed a meeting with his working group on financial markets.   The new measures he announced were as follows: 1. Treasury would invest part of the $700 billion authorized by EESA into banks in exchange for non-voting equity shares; 2. The FDIC would temporarily guarantee new debt issued by insured banks and would lift the cap on depository insurance for non-interest bearing transaction accounts; and 3. The Federal Reserve would "finalize work" on its program to purchase commercial paper. Details of these new measures emerged throughout the day, beginning with statements made by Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke, and FDIC Chairman Sheila Bair after the President spoke.  Additional details on new measures follow. 1. Treasury Investment in Banks:  Treasury announced this new measure as  "voluntary capital purchase program" that would be available to a "broad array" of financial institutions.    Expected for days, the program entails using $250 billion of the $700 billion authorized under the EESA to inject capital into financial institutions.   Financial institutions are to "apply" for a preferred stock investment by the Treasury.  The preferred stock is to pay cumulative dividends at five percent for year for five years and nine percent thereafter.  Nine large financial institutions  have agreed to receive an equity investment of $125 billion. [3] The reaction on Capitol Hill to the bank investment program was positive – surprisingly so for its vehemence – as Democratic and Republican leadership both claimed credit for writing the authority for the program into the EESA. 2. FDIC Temporary Liquidity Guarantee Program:  The FDIC announced this new program to guarantee newly-issued senior unsecured debt and demand deposit accounts at certain financial institutions.  The program applies to a narrower of entities than does TARP, and is limited to the following: (1) FDIC-insured depository institutions; (2) U.S. bank holding companies; (3) U.S. financial holding companies; and (4) U.S. savings and loan holding companies operating in compliance with section 4(k) of the Bank Holding Company Act.  The program is comprised of two parts, both of which will apply to eligible entities unless they affirmatively opt out.  First, a guarantee of eligible entities’ unsecured debt issued on or before June 30, 2009.  The amount of debt will be limited to 125 percent of debt outstanding as of September 30, 2008 and maturing before June 30, 2009.   The FDIC will charge an annual fee of 75 basis points for each dollar of guaranteed debt. The second component is a lifting of the Federal Deposit Insurance Act limit on the guarantee on funds in non-interest-bearing transaction deposit accounts.  Eligible accounts would have no insurance limit until December 31, 2009.  However, the FDIC will impose a 10 basis point surcharge on covered accounts.  We understand that the FDIC limited coverage to non-interest-bearing transaction deposit accounts at least in part so as not to upset the balance between bank deposits and money market mutual funds. 3. Federal Reserve Commercial Paper Funding Facility:  This facility is intended to provide a "liquidity backstop" to U.S. issuers of commercial paper.  The program begins October 27, 2008 and will operate through a special purpose vehicle ("SPV") that the Federal Reserve will create pursuant to section 13(3) of the Federal Reserve Act.   The Federal Reserve has chosen to permit only commercial paper rated at least A-1/P-1/F-1 by a nationally recognized statistical rating organization to participate in the program.  The program will stop purchasing commercial paper on April 30, 2009, though the SPV will continue holding the paper to maturity.   [1]   The full text of Mr. Kashkari’s speech can be found at: http://www.treas.gov/press/releases/hp1199.htm.   [2]   David Cho, Peter Whoriskey, & Lori Montgomery, Treasury to Use First $250B of Bailout on Bank Stakes, Wash. Post, October 13, 2008, Online Edition.   Edmund L. Andrews & Mark Landler, White House Overhauling Rescue Plan, N.Y. Times, Oct. 12, 2008.  Deborah Solomon, Damian Paletta, Aaron Lucchetti, & Jessica Holzer, Treasury to Roll Out New Approach to Credit Crisis, Wall St. J., Oct. 13, 2008, Online Edition.  [3] For the list of financial institutions see, e.g., Deborah Solomon, Damian Paletta, Jessica Holzer, Jon Hilsenrath and Aaron Lucchetti, "U.S. to Take Equity Stakes in 9 Banking Behemoths," Wall St. J., October 14, 2008, Online Edition. Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above.  Please contact Michael Bopp (202-955-8256, mbopp@gibsondunn.com) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group: Public Policy ExpertiseMel Levine – Century City (310-557-8098, mlevine@gibsondunn.com)John F. Olson – Washington, D.C. (202-955-8522, jolson@gibsondunn.com)Amy L. Goodman – Washington, D.C. (202-955-8653, agoodman@gibsondunn.com)Alan Platt – Washington, D.C. (202- 887-3660, aplatt@gibsondunn.com)Michael Bopp – Washington, D.C. (202-955-8256, mbopp@gibsondunn.com) Securities Law and Corporate Governance ExpertiseRonald O. Mueller – Washington, D.C. (202-955-8671, rmueller@gibsondunn.com)K. Susan Grafton – Washington, D.C. (202- 887-3554, sgrafton@gibsondunn.com)Brian Lane – Washington, D.C. (202-887-3646, blane@gibsondunn.com)Lewis Ferguson – Washington, D.C. (202- 955-8249, lferguson@gibsondunn.com)Barry Goldsmith – Washington, D.C. (202- 955-8580, bgoldsmith@gibsondunn.com)John H. Sturc – Washington, D.C. (202-955-8243, jsturc@gibsondunn.com)Alan Bannister – New York (212-351-2310, abannister@gibsondunn.com)Adam H. Offenhartz – New York (212-351-3808, aoffenhartz@gibsondunn.com) Financial Institutions Law ExpertiseChuck Muckenfuss – Washington, D.C. (202- 955-8514, cmuckenfuss@gibsondunn.com)Christopher Bellini – Washington, D.C. (202- 887-3693, cbellini@gibsondunn.com)Amy Rudnick – Washington, D.C. (202-955-8210, arudnick@gibsondunn.com) Corporate ExpertiseHoward Adler – Washington, D.C. (202- 955-8589, hadler@gibsondunn.com)Richard Russo – Denver (303- 298-5715, rrusso@gibsondunn.com)Dennis Friedman – New York (212- 351-3900, dfriedman@gibsondunn.com)Stephanie Tsacoumis – Washington, D.C. (202-955-8277, stsacoumis@gibsondunn.com)Robert Cunningham – New York (212-351-2308, rcunningham@gibsondunn.com)Joerg Esdorn – New York (212-351-3851, jesdorn@gibsondunn.com)Stewart McDowell – San Francisco (415-393-8322, smcdowell@gibsondunn.com)C. William Thomas, Jr. – Washington, D.C. (202-887-3735, wthomas@gibsondunn.com) Private Equity ExpertiseE. Michael Greaney – New York (212-351-4065, mgreaney@gibsondunn.com) Private Investment Funds ExpertiseEdward Sopher – New York (212) 351-3918, esopher@gibsondunn.com) Real Estate ExpertiseJesse Sharf – Century City (310-552-8512, jsharf@gibsondunn.com)Alan Samson – London (+44 20 7071 4222, asamson@gibsondunn.com)Andrew Levy – New York (212-351-4037, alevy@gibsondunn.com)Dennis Arnold – Los Angeles (213-229-7864, darnold@gibsondunn.com)Andrew Lance – New York (212-351-3871, alance@gibsondunn.com)Eric M. Feuerstein – New York (212-351-2323, efeuerstein@gibsondunn.com)David J. Furman – New York (212-351-3992, dfurman@gibsondunn.com) Crisis Management ExpertiseTheodore J. Boutrous, Jr. – Los Angeles (213-229-7804, tboutrous@gibsondunn.com) Bankruptcy Law ExpertiseMichael Rosenthal – New York (212-351-3969, mrosenthal@gibsondunn.com)Oscar Garza – Orange County (949-451-3849, ogarza@gibsondunn.com)Craig H. Millet – Orange County (949-451-3986, cmillet@gibsondunn.com)Janet M. Weiss – New York (212-351-3988, jweiss@gibsondunn.com) Tax Law ExpertiseArthur D. Pasternak – Washington, D.C. (202-955-8582, apasternak@gibsondunn.com)Paul Issler – Los Angeles (213-229-7763, pissler@gibsondunn.com) Executive and Incentive Compensation ExpertiseStephen W. Fackler – Palo Alto (650-849-5385, sfackler@gibsondunn.com)Michael J. Collins – Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)Sean C. Feller – Los Angeles (213-229-7579, sfeller@gibsondunn.com)Amber Busuttil Mullen – Los Angeles (213-229-7023, amullen@gibsondunn.com) © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 9, 2008 |
Financial Markets in Crisis: Applications Are In

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is tracking closely government responses to the turmoil that has catalyzed dramatic and rapid reshaping of our capital and credit markets. We are providing updates on key regulatory and legislative issues as well as information on legal issues that we believe could prove useful as firms and other entities navigate these challenging times. This update focuses on the status of the Treasury Department’s implementation of the Troubled Asset Relief Program (“TARP”). Hiring of Asset Managers The Treasury Department is moving quickly to implement TARP.  On Monday, it began soliciting proposals for three types of services.  The proposals were due forty-eight hours later, on Wednesday at 5:00 p.m.  The three types of services are:  whole loan asset management; securities asset management; and custodian, accounting, auction management, and other infrastructure services. Whole loan asset managers will manage a portfolio of dollar-denominated mortgage whole loans, which Treasury will purchase from financial institutions.  These whole loans will include residential first mortgages, home equity loans, second liens and commercial mortgage loans, which were originated on or before March 14, 2008. Securities asset managers will manage a portfolio of troubled assets including securities, obligations, or other instruments based on or related to residential and commercial mortgages, which were originated on or before March 14, 2008.  These securities will include Prime, Alt-A, and Subprime residential mortgage backed securities (“MBS”), commercial MBS, and MBS collateralized debt obligations.  These assets will not include securities issued or fully guaranteed by Fannie Mae and Freddie Mac. Treasury also requested proposals for companies interested in providing custodian, accounting, auction management, and other infrastructure services to TARP.  Treasury intends to select one financial agent to provide services such as custody, asset tagging, asset pricing and valuation, cash management, accounting, management reporting, and Federal Government financial reporting, as well as auction management services for reverse auctions and other asset acquisition mechanisms. The three solicitations included minimum size requirements that prevented many financial institutions from qualifying.  Treasury, however, has indicated that it is likely to issue, at a future date, separate solicitations for smaller and minority- and women-owned financial institutions.  Somewhat curiously, the whole loan asset management solicitation states that a separate solicitation “may” be issued whereas the securities asset management solicitation states that a separate one “will” be issued. Note, too, that section 107 of the EESA makes the Federal Deposit Insurance Corporation eligible for the asset management roles that were the subjects of Treasury’s Tuesday solicitations. Financial Agent Authority The Treasury Department has indicated that it may employ either or both of two mechanisms to engage private sector firms – financial agent authority and procurement contracts under the Federal Acquisition Regulation (“FAR”).  Treasury has further indicated that it will use the financial agent authority to hire asset managers.[1]  The Emergency Economic Stabilization Act (“EESA” or “the Act”), which created TARP, declares that Treasury may “designat[e] financial institutions as financial agents of the Federal Government, and such institutions shall perform all such reasonable duties related to this Act as financial agents of the Federal Government as may be required.”[2]  Under the Act, “financial institutions” are defined as “any institution, including, but not limited to, any bank, savings association, credit union, security broker or dealer, or insurance company” established and regulated under United States law.[3] Compared to the FAR authority, Treasury’s financial agent authority affords the agency much greater discretion in its arrangements with financial institutions.  Describing the relationship, Treasury has explained that, “[t]he designation of a financial institution as a financial agent creates a principal-agent relationship between Treasury and the financial agent.  As in any agency relationship, as agents of the United States, financial agents act upon the instructions of the principal, the Treasury, and answer only to the principal.”[4]  The Court of Appeals for the Federal Circuit has said of the arrangement that, “the government, as principal and in its sovereign capacity, delegates to its financial agents some of the sovereign functions that the government itself would otherwise perform.”[5]  The court likened the hiring process to the appointment of public employees, “which is not a matter of contract even when terms and conditions guide the employment relationship.”  Instead, like an appointment, a financial institution’s financial agency “results from the conferral of a status.”[6] Financial Stability Oversight Board Meeting The Financial Stability Oversight Board (“FSOB”), created by section 104 of the EESA, met for the first time on Tuesday, October 7.  We understand that, at the FSOB meeting, it was reported that the program will be sending out requests for proposals from accounting firms and law firms shortly.  Asset managers and the provider of custodial and infrastructure services is likely to be selected by early next week. Recall that, under section 101 of the EESA,  Treasury is to publish TARP guidelines within 45 days of enactment.  Guidelines must include the mechanisms for purchasing, methods for pricing and valuation, and criteria for identifying troubled assets.  The FSOB hopes to announce program guidelines within two weeks and to begin purchasing assets within a month. Possible Expansion of Program In a statement given yesterday, Secretary Paulson commented on Treasury’s ability to “inject capital into financial institutions.”[7]  Until recently, Treasury has focused on purchasing troubled assets from ailing financial institutions, but now, Treasury officials reportedly are trying to find ways to take equity stakes in struggling banks.[8]  This afternoon, it was reported that such a plan would be implemented “soon.”[9]  Paulson cautioned, however, that “even with the new Treasury authorities, some financial institutions will fail.” Regarding the Secretary’s authority to invest in banks, one might posit that he could do so under his authorities under TARP to buy “troubled assets” (section 101) and to include in the definition of “troubled assets” preferred stock (as “instruments” “related to mortgages” and the purchase of which “promotes financial market stability” (section 3)).   Treasury has not officially stated from where these authorities might derive nor whether the Secretary will exercise them. Reaction from the Hill House Speaker Nancy Pelosi wrote Secretary Paulson on Tuesday expressing dismay that the conflict of interest standards promulgated by Treasury allow financial institutions that benefit from TARP to be eligible to participate as asset managers.  She urged Secretary Paulson to strengthen the interim guidelines to avoid the appearance of conflicts of interest and to bolster Americans’ confidence in the plan.[10] Please view Gibson Dunn’s complete series of updates on the financial markets crisis on our website.   [1]   Treasury Release, Procurement Authorities and Procedures, Oct. 6, 2008.   [2]   Emergency Economic Stabilization Act of 2008, H.R. 1424, 110th Cong. § 101(c)(3) (2008) (enacted, now Pub. L. No. 110-343).   [3]   H.R. 1424 at § 3(5).   [4]   Notice of Proposed Rule Making, Management of Federal Agency Disbursements, 62 Fed. Reg. 25572 (issued Sept. 11, 1997).   [5]   Id.   [6]   Id. at 1070.   [7]   Press Release, Treasury Secretary Henry Paulson, (Oct. 8, 2008), available at http://www.treas.gov/press/releases/hp1189.htm.   [8]   Deborah Solomon, Treasury Considers Taking Stake in Banks, Wall St. J., Oct. 8, 2008.   [9]   David Cho and Benyamin Appelbaum, Treasury Dept. Plan Would Let Government Buy Stakes in Banks, Wash. Post (Oct. 9, 2008). [10]   Full text of Speaker Pelosi’s letter. Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above.  Please contact Michael Bopp (202-955-8256, mbopp@gibsondunn.com) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group: Public Policy Expertise Mel Levine – Century City (310-557-8098, mlevine@gibsondunn.com) John F. Olson – Washington, D.C. (202-955-8522, jolson@gibsondunn.com) Amy L. Goodman – Washington, D.C. (202-955-8653, agoodman@gibsondunn.com) Alan Platt – Washington, D.C. (202- 887-3660, aplatt@gibsondunn.com) Michael Bopp – Washington, D.C. (202-955-8256, mbopp@gibsondunn.com) Securities Law and Corporate Governance Expertise Ronald O. Mueller – Washington, D.C. (202-955-8671, rmueller@gibsondunn.com) K. Susan Grafton – Washington, D.C. (202- 887-3554, sgrafton@gibsondunn.com) Brian Lane – Washington, D.C. (202-887-3646, blane@gibsondunn.com) Lewis Ferguson – Washington, D.C. (202- 955-8249, lferguson@gibsondunn.com) Barry Goldsmith – Washington, D.C. (202- 955-8580, bgoldsmith@gibsondunn.com) John H. Sturc – Washington, D.C. (202-955-8243, jsturc@gibsondunn.com) Alan Bannister – New York (212-351-2310, abannister@gibsondunn.com) Adam H. Offenhartz – New York (212-351-3808, aoffenhartz@gibsondunn.com) Financial Institutions Law Expertise Chuck Muckenfuss – Washington, D.C. (202- 955-8514, cmuckenfuss@gibsondunn.com) Christopher Bellini – Washington, D.C. (202- 887-3693, cbellini@gibsondunn.com) Amy Rudnick – Washington, D.C. (202-955-8210, arudnick@gibsondunn.com) Corporate Expertise Howard Adler – Washington, D.C. (202- 955-8589, hadler@gibsondunn.com) Richard Russo – Denver (303- 298-5715, rrusso@gibsondunn.com) Dennis Friedman – New York (212- 351-3900, dfriedman@gibsondunn.com) Stephanie Tsacoumis – Washington, D.C. (202-955-8277, stsacoumis@gibsondunn.com) Robert Cunningham – New York (212-351-2308, rcunningham@gibsondunn.com) Joerg Esdorn – New York (212-351-3851, jesdorn@gibsondunn.com) Stewart McDowell – San Francisco (415-393-8322, smcdowell@gibsondunn.com) C. William Thomas, Jr. – Washington, D.C. (202-887-3735, wthomas@gibsondunn.com) Private Equity Expertise E. Michael Greaney – New York (212-351-4065, mgreaney@gibsondunn.com) Private Investment Funds Expertise Edward Sopher – New York (212) 351-3918, esopher@gibsondunn.com) Real Estate Expertise Jesse Sharf – Century City (310-552-8512, jsharf@gibsondunn.com) Alan Samson – London (+44 20 7071 4222, asamson@gibsondunn.com) Andrew Levy – New York (212-351-4037, alevy@gibsondunn.com) Dennis Arnold – Los Angeles (213-229-7864, darnold@gibsondunn.com) Andrew Lance – New York (212-351-3871, alance@gibsondunn.com) Eric M. Feuerstein – New York (212-351-2323, efeuerstein@gibsondunn.com) David J. Furman – New York (212-351-3992, dfurman@gibsondunn.com) Crisis Management Expertise Theodore J. Boutrous, Jr. – Los Angeles (213-229-7804, tboutrous@gibsondunn.com) Bankruptcy Law Expertise Michael Rosenthal – New York (212-351-3969, mrosenthal@gibsondunn.com) Oscar Garza – Orange County (949-451-3849, ogarza@gibsondunn.com) Craig H. Millet – Orange County (949-451-3986, cmillet@gibsondunn.com) Janet M. Weiss – New York (212-351-3988, jweiss@gibsondunn.com) Tax Law Expertise Arthur D. Pasternak – Washington, D.C. (202-955-8582, apasternak@gibsondunn.com) Paul Issler – Los Angeles (213-229-7763, pissler@gibsondunn.com) Executive and Incentive Compensation Expertise Stephen W. Fackler – Palo Alto (650-849-5385, sfackler@gibsondunn.com) Michael J. Collins – Washington, D.C. (202-887-3551, mcollins@gibsondunn.com) Sean C. Feller – Los Angeles (213-229-7579, sfeller@gibsondunn.com) Amber Busuttil Mullen – Los Angeles (213-229-7023, amullen@gibsondunn.com) © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 6, 2008 |
Financial Markets in Crisis: Treasury Moves to Implement TARP

With the Emergency Economic Stabilization Act (EESA) now law, Treasury is moving quickly to choose advisers, issue regulations, and hire companies to serve as asset managers for the Troubled Asset Relief Program (TARP). Today, Secretary Paulson announced that he has selected Neel Kashkari to be the interim head of the new Office of Financial Stability, which will implement the Troubled Asset Relief Program.  Kashkari is currently Assistant Secretary for International Economics and Development and has been a key adviser to Secretary Paulson.  It is our understanding that Secretary Paulson intends to hire a small staff with expertise in asset management, accounting, and legal issues to commence the Troubled Asset Relief Program. Guidelines Announced by Treasury Today, Treasury announced a number of interim guidelines relating to the authorities created by the EESA.[1]  These interim guidelines address the hiring of asset managers, conflicts of interest, and procurement authorities and procedures.  Treasury also issued notices to financial institutions interested in providing any of the following services:  whole loan asset management; securities asset management; and custodian, accounting, auction management, and other infrastructure services.  The deadline for responding to Treasury’s solicitations is 5:00 p.m. EST on October 8, 2008. Below are brief descriptions of the guidelines issued by Treasury today.  The guidelines and Treasury’s solicitations can be found on the new EESA web page:  http://www.treas.gov/initiatives/eesa/ Asset manager selection guidelines: require Treasury to select asset managers of securities separately from asset managers of mortgage whole loans.  The same procedures, however, will apply to both types of managers. Securities managers will handle Prime, Alt-A, and Subprime residential mortgage backed securities (MBS), commercial MBS, and MBS collateralized debt obligations. Whole loan managers will handle a "range of products," which may include residential first mortgages, home equity loans, second liens, commercial mortgage loans. state that the managers will be financial agents of the United States, not contractors, which will impose a fiduciary agent-principal relationship with Treasury on the managers. state that "Financial Institutions," as defined by the EESA, will be eligible to be asset managers. require Treasury to solicit managers via public notice on the Department’s website, which will include standards for managers. require that the selection process involve several phases of evaluations.  Later phases may operate under confidentiality requirements. require that Treasury will issue separate notices for minority- and women-owned Financial Institutions which do not meet the qualifications for asset managers under the initial notices and mandates that these institutions will be designated as "sub-managers." indicate that the deadlines will be "extremely short" for submitting applications and traveling to Washington, D.C. for meetings and interviews. Conflict of interest guidelines: allow Treasury to obtain non-disclosure agreements and conflict of interest agreements. instruct that solicitations for offers should instruct prospective offerors that they must disclose any actual or potential conflicts of interests which could arise, including, in some cases, personal conflicts of interests among employees. instruct that the solicitation should identify minimum requirements or standards for conflict of interest mitigation plans. instruct that the solicitation should state if the contractor hired will owe a fiduciary duty to Treasury. require that solicitations must include non-disclosure provisions. mandate that solicitations require offerors to submit a conflict mitigation plan with their initial proposals.  Though these plans may be negotiated, the final plan will be incorporated into a successful offeror’s contract. Procurement authorities and procedures guidelines: indicate that Treasury has two mechanisms for engaging private-sector firms – financial agent authority and procurement under the Federal Acquisition Regulation. explain that the EESA expanded Treasury’s existing authority to retain financial agents.  This authority will be used when a firm is needed to conduct transactions on Treasury’s behalf, including when Treasury needs the services of asset managers. explain that the Federal Acquisition Regulation also provides authority for Treasury to obtain supplies or services through procurement contracts, typically through a solicitation of offers from all interested parties.[2] Treasury Authority to Make Equity Investments A provision of EESA that did not receive much attention during Congressional debate appears to provide the Treasury authority to make equity investments in financial institutions if "necessary to promote financial market stability."  The definition of "troubled asset" in the legislation includes not only mortgages and instruments based on or related to mortgages, but also "any other financial instrument" if the Treasury, in consultation with the Fed, determines that the purchase of the instrument "is necessary to promote financial market stability."  A report must be made to the appropriate Congressional committees if instruments are purchased under this provision. Although there is yet no gloss on how Treasury might interpret this provision, it appears broad enough to include preferred stock or other equity investments.  Economists and others critical of EESA have stated that to the extent that the Treasury plan focused on buying bad mortgage-related assets, it would not address the additional problem of capital impairment in the banking industry, as institutions recognize their losses from such bad assets or the write-down of their holdings of FNMA and FHLMC preferred stock.  It may be that this "other financial instrument" provision  provides a basis for the Treasury and Fed to address capital weaknesses in banks as the financial crisis evolves.  We will be following closely the Treasury’s views on this provision and report as developments occur. Action on the Hill Now that Congress has passed legislation to stabilize the government, it is turning its attention to the underlying causes of the financial markets’ meltdown.  Representative Henry Waxman, Chairman of the House Oversight and Government Reform Committee, has announced a series of hearings to examine Wall Street’s missteps.  Today, the topic was the Lehman bankruptcy filing.  Tomorrow, the committee will focus on AIG .  On Thursday, October 16, the committee will look into hedge funds’ role in the crisis.  On Wednesday, October 22, credit rating agencies will be scrutinized, and on Thursday, October 23, the committee will investigate federal regulatory actions. The House Financial Services Committee, the House Agriculture Committee, and the House Education & Labor Committee also have scheduled hearings relevant to the market crisis. Steps Taken by the Fed This morning, the Federal Reserve Board announced that it will begin to pay interest on depository institutions’ required and excess reserve balances.  The Fed also is increasing the size of its Term Auction Facility Auctions, as well as consulting with market participants to find new ways to support term unsecured funding markets. [3] Please view Gibson Dunn’s complete series of updates on the financial markets crisis on our website.  [1]   For the full text of these guidelines, see http://www.ustreas.gov.    [2]   When opportunities become available, they will be posted at www.fedbizopps.gov.  Businesses may submit capability statements to Treasury’s Office of the Procurement Executive at ootpe@do.treas.gov.  Small businesses can receive information on participating in Treasury contracting by contacting Treasury’s Office of Small and Disadvantaged Business Utilization at TreasuryOSDBU@do.treas.gov. [3] For more information on these actions taken by the Fed, see http://www.federalreserve.gov/newsevents/press/monetary/20081006a.htm.    Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above.  Please contact Michael Bopp (202-955-8256, mbopp@gibsondunn.com) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group: Public Policy ExpertiseMel Levine – Century City (310-557-8098, mlevine@gibsondunn.com)John F. Olson – Washington, D.C. (202-955-8522, jolson@gibsondunn.com)Amy L. Goodman – Washington, D.C. (202-955-8653, agoodman@gibsondunn.com)Alan Platt – Washington, D.C. (202- 887-3660, aplatt@gibsondunn.com)Michael Bopp – Washington, D.C. (202-955-8256, mbopp@gibsondunn.com) Securities Law and Corporate Governance ExpertiseRonald O. Mueller – Washington, D.C. (202-955-8671, rmueller@gibsondunn.com)K. Susan Grafton – Washington, D.C. (202- 887-3554, sgrafton@gibsondunn.com)Brian Lane – Washington, D.C. (202-887-3646, blane@gibsondunn.com)Lewis Ferguson – Washington, D.C. (202- 955-8249, lferguson@gibsondunn.com)Barry Goldsmith – Washington, D.C. (202- 955-8580, bgoldsmith@gibsondunn.com)John H. Sturc – Washington, D.C. (202-955-8243, jsturc@gibsondunn.com)Alan Bannister – New York (212-351-2310, abannister@gibsondunn.com) Financial Institutions Law ExpertiseChuck Muckenfuss – Washington, D.C. (202- 955-8514, cmuckenfuss@gibsondunn.com)Christopher Bellini – Washington, D.C. (202- 887-3693, cbellini@gibsondunn.com)Amy Rudnick – Washington, D.C. (202-955-8210, arudnick@gibsondunn.com) Corporate ExpertiseHoward Adler – Washington, D.C. (202- 955-8589, hadler@gibsondunn.com)Richard Russo – Denver (303- 298-5715, rrusso@gibsondunn.com)Dennis Friedman – New York (212- 351-3900, dfriedman@gibsondunn.com)Stephanie Tsacoumis – Washington, D.C. (202-955-8277, stsacoumis@gibsondunn.com)Robert Cunningham – New York (212-351-2308, rcunningham@gibsondunn.com)Joerg Esdorn – New York (212-351-3851, jesdorn@gibsondunn.com)Stewart McDowell – San Francisco (415-393-8322, smcdowell@gibsondunn.com)C. William Thomas, Jr. – Washington, D.C. (202-887-3735, wthomas@gibsondunn.com) Real Estate ExpertiseJesse Sharf – Century City (310-552-8512, jsharf@gibsondunn.com)Alan Samson – London (+44 20 7071 4222, asamson@gibsondunn.com)Andrew Levy – New York (212-351-4037, alevy@gibsondunn.com)Dennis Arnold – Los Angeles (213-229-7864, darnold@gibsondunn.com)Andrew Lance – New York (212-351-3871, alance@gibsondunn.com)Eric M. Feuerstein – New York (212-351-2323, efeuerstein@gibsondunn.com)David J. Furman – New York (212-351-3992, dfurman@gibsondunn.com) Crisis Management ExpertiseTheodore J. Boutrous, Jr. – Los Angeles (213-229-7804, tboutrous@gibsondunn.com) Bankruptcy Law ExpertiseMichael Rosenthal – New York (212-351-3969, mrosenthal@gibsondunn.com)Oscar Garza – Orange County (949-451-3849, ogarza@gibsondunn.com)Craig H. Millet – Orange County (949-451-3986, cmillet@gibsondunn.com)Janet M. Weiss – New York (212-351-3988, jweiss@gibsondunn.com) Tax Law ExpertiseArthur D. Pasternak – Washington, D.C. (202-955-8582, apasternak@gibsondunn.com)Paul Issler – Los Angeles (213-229-7763, pissler@gibsondunn.com) Executive and Incentive Compensation ExpertiseStephen W. Fackler – Palo Alto (650-849-5385, sfackler@gibsondunn.com)Michael J. Collins – Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)Sean C. Feller – Los Angeles (213-229-7579, sfeller@gibsondunn.com)Amber Busuttil Mullen – Los Angeles (213-229-7023, amullen@gibsondunn.com)  © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 3, 2008 |
Financial Markets in Crisis: Rescue Bill Reaches Finish Line

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is tracking closely government responses to the turmoil that has catalyzed dramatic and rapid reshaping of our capital and credit markets. What follows is our latest in a series of updates on key regulatory and legislative issues. Today, President Bush signed the Emergency Economic Stabilization Act of 2008 after the House of Representatives passed the legislation by a 263-171 vote.  One hundred seventy-two Democratic members  and ninety-one Republicans voted for the bill, while 63 Democrats and 91 Republican members opposed it.  After the House rejected a similar bill on Tuesday, the Senate resurrected the legislation by adding amendments to the rescue package – most notably, increasing the FDIC insurance coverage for depositors in banks and credit unions from $100,000 to $250,000 – and by adding unrelated tax and energy provisions.  These changes, together with a political climate that had shifted markedly, gave the bill enough momentum to reach the President’s desk this afternoon.  The new law provides Treasury up to $700 billion in authority to purchase troubled assets from financial institutions.  The money will be made available in tranches, allowing the Secretary immediate access to $250 billion, another $100 billion upon the President’s certification, and the final $350 billion upon request by the President, provided that Congress does not pass a joint resolution denying Treasury the additional funds.  Attached to this alert is a PowerPoint Presentation [PDF] that synopsizes the legislation and was used during a Gibson, Dunn & Crutcher Financial Markets Crisis Group webcast this afternoon.  An audio transcript of the webcast is also available by clicking on the "Play Recording" link on the webcast page. In spite of the rescue bill’s passage, the Dow Jones Industrial Average finished the day down 157.47 points. Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above.  Please contact Michael Bopp (202-955-8256, mbopp@gibsondunn.com) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group: Public Policy ExpertiseMel Levine – Century City (310-557-8098, mlevine@gibsondunn.com)John F. Olson – Washington, D.C. (202-955-8522, jolson@gibsondunn.com)Amy L. Goodman – Washington, D.C. (202-955-8653, agoodman@gibsondunn.com)Alan Platt – Washington, D.C. (202- 887-3660, aplatt@gibsondunn.com)Michael Bopp – Washington, D.C. (202-955-8256, mbopp@gibsondunn.com) Securities Law and Corporate Governance ExpertiseRonald O. Mueller – Washington, D.C. (202-955-8671, rmueller@gibsondunn.com)K. Susan Grafton – Washington, D.C. (202- 887-3554, sgrafton@gibsondunn.com)Brian Lane – Washington, D.C. (202-887-3646, blane@gibsondunn.com)Lewis Ferguson – Washington, D.C. (202- 955-8249, lferguson@gibsondunn.com)Barry Goldsmith – Washington, D.C. (202- 955-8580, bgoldsmith@gibsondunn.com)John H. Sturc – Washington, D.C. (202-955-8243, jsturc@gibsondunn.com)Alan Bannister – New York (212-351-2310, abannister@gibsondunn.com) Financial Institutions Law ExpertiseChuck Muckenfuss – Washington, D.C. (202- 955-8514, cmuckenfuss@gibsondunn.com)Christopher Bellini – Washington, D.C. (202- 887-3693, cbellini@gibsondunn.com)Amy Rudnick – Washington, D.C. (202-955-8210, arudnick@gibsondunn.com) Corporate ExpertiseHoward Adler – Washington, D.C. (202- 955-8589, hadler@gibsondunn.com)Richard Russo – Denver (303- 298-5715, rrusso@gibsondunn.com)Dennis Friedman – New York (212- 351-3900, dfriedman@gibsondunn.com)Stephanie Tsacoumis – Washington, D.C. (202-955-8277, stsacoumis@gibsondunn.com)Robert Cunningham – New York (212-351-2308, rcunningham@gibsondunn.com)Joerg Esdorn – New York (212-351-3851, jesdorn@gibsondunn.com)Stewart McDowell – San Francisco (415-393-8322, smcdowell@gibsondunn.com)C. William Thomas, Jr. – Washington, D.C. (202-887-3735, wthomas@gibsondunn.com) Real Estate ExpertiseJesse Sharf – Century City (310-552-8512, jsharf@gibsondunn.com)Alan Samson – London (+44 20 7071 4222, asamson@gibsondunn.com)Andrew Levy – New York (212-351-4037, alevy@gibsondunn.com)Dennis Arnold – Los Angeles (213-229-7864, darnold@gibsondunn.com)Andrew Lance – New York (212-351-3871, alance@gibsondunn.com)Eric M. Feuerstein – New York (212-351-2323, efeuerstein@gibsondunn.com)David J. Furman – New York (212-351-3992, dfurman@gibsondunn.com) Crisis Management ExpertiseTheodore J. Boutrous, Jr. – Los Angeles (213-229-7804, tboutrous@gibsondunn.com) Bankruptcy Law ExpertiseMichael Rosenthal – New York (212-351-3969, mrosenthal@gibsondunn.com)Oscar Garza – Orange County (949-451-3849, ogarza@gibsondunn.com)Craig H. Millet – Orange County (949-451-3986, cmillet@gibsondunn.com)Janet M. Weiss – New York (212-351-3988, jweiss@gibsondunn.com) Tax Law ExpertiseArthur D. Pasternak – Washington, D.C. (202-955-8582, apasternak@gibsondunn.com)Paul Issler – Los Angeles (213-229-7763, pissler@gibsondunn.com) Executive and Incentive Compensation ExpertiseStephen W. Fackler – Palo Alto (650-849-5385, sfackler@gibsondunn.com)Michael J. Collins – Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)Sean C. Feller – Los Angeles (213-229-7579, sfeller@gibsondunn.com)Amber Busuttil Mullen – Los Angeles (213-229-7023, amullen@gibsondunn.com) © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 3, 2008 |
Casinos Continue to Be Vulnerable to Money Laundering

The conviction in August of two former Bank of China managers and their wives in Las Vegas for money laundering and other crimes illustrates the continuing vulnerability of casinos to money laundering.  U.S. v. Xu Chaofan, et al. (2:02-CR-0674-PMP (LRL)).  Over the course of several years, the defendants facilitated the theft of $482 million from the Bank of China, established offshore shell companies, and laundered funds, including through accounts at several U.S. banks.  They also deposited a total of $3.1 million to accounts at four Las Vegas casinos by check or with currency, including four checks totaling $2 million to an account maintained by one of the casinos in Hong Kong.  This is one of several cases in recent years where gaming patrons who had engaged in illegal activity, from drug trafficking to fraud, funneled their ill-gotten gains in one form or another to casinos. Casinos that engage in transactions involving the proceeds of crime run the risk of liability for violating the criminal money laundering laws, 18 U.S.C. §§ 1956 and 1957.  Under these provisions, it generally is a crime to engage in transactions with knowledge that the funds involved are the proceeds of illegal activity.  In some cases, foreign tax evasion or evasion of foreign currency control laws can figure in money laundering cases.  Knowledge can be based on deliberate indifference or willful blindness – failure to make appropriate inquiries when faced with red flags for suspicious activity.  If any red flags were present suggesting that a patron’s source of funds was illegal and the casino did not take appropriate steps to resolve the red flags, a federal prosecutor could take issue with the apparent position of the Chief of Enforcement at the Nevada Gaming Control Board.  The Chief of Enforcement was quoted in the Las Vegas Sun in connection with the Xu Chaofan case  as saying:  "If they’re playing with cash, and they’re considered a high roller, there’s no responsibility on the casinos’ part to find out where they got the cash." The best defense to potential liability for money laundering and related forfeiture actions for casinos and other "financial institutions" subject to the requirements of the Bank Secrecy Act ("BSA") is a comprehensive Anti-Money Laundering/Bank Secrecy Act compliance program with an emphasis on identifying and timely filing Suspicious Activity Reports as required by 31 C.F.R. § 103.21.  Regulatory compliance alone, however, may not be enough to insulate a casino against liability under the money laundering statutes.  The government may expect the financial institution to take steps to prevent additional transactions with the customer.  In light of this potential liability, it is essential that casinos train employees, especially those marketing to high rollers and facilitating deposits of front money or collecting gaming debts in the United States or abroad, to be alert to red flags that a patron’s funds may be from illegal activity and to report the concerns internally.  Foreign patrons, especially those whose business activities are not transparent or who come from a country that poses a high risk for money laundering, drug trafficking, or terrorism, may call for additional due diligence.  Payments from non-bank financial institutions or banks in locations not logical for the customer or third parties also should raise concerns.  Any criminal subpoena received for patron records should result in the casino’s review of the customer’s activities to determine whether there has been any unreported suspicious activity. While the BSA requirements do not extend per se to transactions outside the United States, suspicious deposits made by casino patrons abroad once drawn down in the United States would be reportable as suspicious under the BSA and may be reportable in the country where received.  They also could be the basis for a prosecution under U.S. or foreign money laundering laws if derived from illegal sources.  Following the identification of significant suspicious activity, reasonable steps to bar the patron from further activity may be necessary to stop the activity from continuing and to protect the casino from potential criminal liability under the money laundering laws for continuing to do business with a patron whom the casino suspects may be involved in illegal activity. Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, Amy G. Rudnick (202-955-8210, arudnick@gibsondunn.com) or Linda Noonan (202-887-3595, lnoonan@gibsondunn.com) in the firm’s Washington, D.C. office, or Nicola T. Hanna (949-451-4270, nhanna@gibsondunn.com) in Orange County.  © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

October 2, 2008 |
Financial Markets in Crisis: Section-By-Section Analysis of the Emergency Economic Stabilization Act of 2008

We are pleased to provide our clients and friends with a section-by-section analysis of the Emergency Economic Stabilization Act of 2008 (hereinafter, the "Act") as passed by the Senate, by a vote of 74-25, on October 2, 2008.   The section-by-section analysis includes commentary from experts on Gibson, Dunn & Crutcher LLP’s Financial Markets Crisis Group.  We hope you find it useful as you work through the challenges and opportunities posed by the market crisis and the government’s response. On a procedural note, the Senate used H.R. 1424, which was a resolution to amend the Employment Retirement Security Act to include mental health parity provisions, as a vehicle to pass the Emergency Economic Stabilization Act.  As passed by the Senate, the bill also included energy and tax extender provisions.  We have not included those provisions in this analysis. Division A – Emergency Economic Stabilization Sec. 1:  Short Title and Table of Contents Summary: The short title of the bill will be the "Emergency Economic Stabilization Act of 2008."  Sec. 2: Purposes Summary: The Act’s purposes include providing the Secretary of the Treasury (the "Secretary") authority to restore liquidity and stability to the financial system and to ensure that the authority is used in a way to protect home values and savings, promote job growth and homeownership, maximize returns to taxpayers, and provide public accountability for its exercise. Sec. 3: Definitions Summary: The most relevant definitions of which our clients should be aware include: "Financial Institution" means any institution including, but not limited to, any bank, savings association, credit union, security broker or dealer, or insurance company which is organized and regulated under United States law or the law of the states or territories, and which has significant operations in the United States.  The definition excludes any central bank of, or institution owned by, a foreign government.  "Fund" means the Troubled Assets Insurance Financing Fund established by Section 102. "TARP" refers to the troubled asset relief program established in Section 101. "Troubled assets" include: residential or commercial mortgages and other instruments "based on or related to" such mortgages. The instruments must have been originated or issued on or before March 14, 2008, and the Secretary must determine that purchasing them will promote market stability; and any other instrument which the Secretary determines the purchase of is necessary to promote financial market stability, after consulting with the Chairman of the Federal Reserve.  The Secretary must transmit this determination in writing to Congress. Analysis: The definitions of "financial institution" and "troubled assets" are critical in terms of who and what can participate in the asset purchase program created by the bill.  Both definitions have evolved since earlier drafts and, yet, each raises a number of questions. The definition of "financial institution," for example, employs undefined terms in phrases like "significant operations in the United States" and "owned by a foreign government."  It is not clear what "significant operations" means; nor is it clear what constitutes foreign ownership.  Also, the Treasury Secretary is not granted authority to expand the scope of eligible "financial institutions" as was the case in earlier drafts.  Finally, as worded, there are technically no limits on what constitutes a "financial institution" other than that it has to be an "institution" and cannot be a central bank or an institution owned by a foreign government.  The list of institutions is just illustrative. The definition of "troubled assets" was broadened from earlier versions to include "commercial mortgages."  The language gives the Secretary the authority to expand the definition to include assets that if their purchase is necessary to promote "financial market stability."  How the Secretary will exercise this authority – and what additional assets or instruments he might include in the definition of "troubled assets," is an important question for financial institutions who would like to participate in the program. Title I:  Troubled Assets Relief ProgramSec. 101: Purchases of Troubled Assets Summary:  Authorizes the Secretary to establish TARP to purchase troubled assets from any financial institution, on terms and conditions determined by the Secretary in accordance with the Act.  Provides that the TARP program’s commencement should not be delayed by the establishment of policies, procedures, and other administrative requirements by the Secretary. Establishes an Office of Financial Stability within the Office of Domestic Finance of the Department of the Treasury and mandates that the Secretary carry out these programs through that office. Requires the Secretary to consult with the Federal Reserve Chairman, the Federal Reserve Bank of New York, the FDIC, the Comptroller of the Currency, the Director of the Office of Thrift Supervision, the Chairman of the National Credit Union Administration Board, and the Secretary of Housing and Urban Development. Allows the Secretary to have direct hiring authority to appoint employees necessary to administer the Act and allows the Secretary to enter into contracts. Allows the Secretary to designate private financial institutions as financial agents of the Federal Government. Establishes vehicles which are authorized to purchase, hold, and sell troubled assets, providing the Secretary flexibility to manage the troubled assets. Requires the Secretary to publish program guidelines before the earlier of 2 business days after first purchasing troubled assets or within 45 days of the Act’s enactment.  The guidelines will include: mechanisms for identifying, pricing, and purchasing troubled assets; and procedures for selecting asset managers. Requires the Secretary to prevent "unjust enrichment" of participating financial institutions. Analysis: The Treasury Department has proposed the hiring of experienced private asset managers to aid the government in valuing securities – as the Fed did when it hired BlackRock to manage Bear Stearns’ asset portfolio earlier this year.  The rescue bill requires the Secretary to establish procedures for choosing  asset managers.  The bill grants the Secretary broad authority to solicit proposals, manage potential conflicts of interest, and restrict information sharing by managers contracted to aid the government’s asset valuation.  Section 107 of the bill further allows the Treasury Department to hire the Federal Deposit Insurance Corporation as an asset management entity, similar to the agency’s role in the Savings & Loan bailout.  However, Secretary Paulson has publicly supported the retention of private portfolio managers.[1] Sec. 102: Insurance of Troubled Assets Summary: Requires the Secretary to establish a program to guarantee troubled assets originated or issued prior to March 14, 2008, including mortgage-backed securities, if the Secretary establishes TARP. Requires the Secretary to collect premiums for the guarantees from participating financial institutions sufficient to cover anticipated claims, and allows the Secretary to vary the rates based on credit risk.  Requires the Secretary to report to Congress about the program. Establishes a Troubled Assets Insurance Fund, which will consist of the premiums paid by participating institutions, and will be used to fulfill obligations of guarantees provided to financial institutions. Sec. 103: Considerations Summary: Requires the Secretary to take a number of considerations into account, including protecting taxpayers, providing stability to the market, and preserving home ownership.  Requires the Secretary to consider the long-term viability of a financial institution before allowing it to participate in the program. Requires the Secretary to consider the need to ensure stability for counties and towns, small financial institutions, and financial institutions serving lower income populations.  Sec. 104: Financial Stability Oversight Board Summary: Establishes the Financial Stability Oversight Board to review the exercise of authority under the Act and to make recommendations to the Secretary.  The Board will comprise the Federal Reserve Chair, the Treasury Secretary, the Director of the Federal Home Finance Agency, the Securities and Exchange Commission Chair, and the Secretary of Housing and Urban Development. Analysis: This is one of four oversight entities created or tapped into by the bill.  In addition to the Board, the bill creates a Special Inspector General for the Troubled Asset Relief Program (SIGTARP) (section 121) and a congressional oversight panel (section 125).  It also gives the Comptroller General substantial oversight and audit responsibilities and requires it to undertake a study and report on margin authority (sections 116 and 117).  This is all on top of congressional oversight and investigatory committees as well as executive branch oversight bodies.  The responsibilities of these oversight entities overlap considerably.   That is not surprising given the concerns that have been expressed repeatedly by Members of Congress over the potential cost of this legislation.  Presumably, Congress wants to hear from multiple perspectives how the asset purchase program is performing and whether it is meeting its goals.  However, the potential for these oversight entities to trip over each other in the course of their work is great. Sec. 105: Reports Summary: Requires the Secretary to make monthly reports to Congress which will include an overview of the Secretary’s actions, the obligation and expenditure of funds provided for administrative expenses during the period, and a detailed financial statement about the Secretary’s use of its authority under the Act. Requires the Secretary to provide Congress a written tranche report for every $50 billion of assets purchased about all the transactions made during the period, a description of the pricing mechanism for the transactions, and a justification for the price paid for the transaction. Requires the Secretary to submit a written Regulatory Modernization Report to Congress no later than April 30, 2009 analyzing the current state of the market, evaluating the effectiveness of the regulatory system, and providing recommendations. Sec. 106: Rights; Management; Sale of Troubled Assets; Revenues and Sale Proceeds Summary: Allows the Secretary to exercise its authorities under the Act at any time. Allows the Secretary to manage troubled assets purchased under the Act, including the ability to determine the terms and conditions associated with the disposition of troubled assets. Requires that proceeds from sales be used to reduce the national debt. Analysis: House Democrats had proposed committing a portion of profits to fund affordable housing assistance through the Housing Trust Fund and the Capital Magnet Fund.  This provision was strongly opposed by Republicans and was dropped during negotiations on the final package. Sec. 107: Contracting Procedures Summary: Allows the Secretary to waive provisions of the Federal Acquisition Regulation where urgent circumstances make compliance contrary to the public interest.  Such waivers must be submitted to Congress within 7 days.  Requires the Secretary to implement alternative standards to ensure the inclusion of minority- and women- owned businesses if the Secretary waives provisions of the Federal Acquisition Regulation pertaining to minority contracting. Requires that the FDIC be considered in the selection of asset managers.  Sec: 108: Conflicts of Interest Summary: Requires the Secretary to issue guidelines to prevent conflicts of interest relating to the execution of the authorities provided under the Act. Analysis: This provision is focused on possible conflicts with respect to (1) hiring contractors, including asset managers, (2) purchasing assets, (3) managing assets, and (4) post-employment restrictions.  The provision does not prescribe the form or content of the regulations but rather reflects significant congressional concern with conflicts that could arise during the program’s implementation. Sec. 109: Foreclosure Mitigation Efforts Summary: Requires the Secretary to implement a plan to maximize homeowner assistance and to encourage servicers of the underlying mortgages purchased through TARP to take advantage of the HOPE for Homeowners Program. Allows the Secretary to use loan guarantees and credit enhancements to facilitate loan modifications to prevent avoidable foreclosures. Requires the Secretary to consent to reasonable loan modification requests arising under existing investment contracts. Sec. 110: Assistance to Homeowners Summary: Requires the Federal Government to minimize foreclosures on properties underlying the mortgages and mortgage-backed securities the government purchases. Sec. 111: Executive Compensation and Corporate Governance Summary: Requires that if the Secretary makes direct purchases of troubled assets from a financial institution and the Secretary receives a meaningful equity or debt position in the institution, the Secretary will set executive compensation and corporate governance standards for the institution.  The standards will only apply while the Secretary holds a debt or equity position in the institutions.  The standards include: limits on compensation for senior executive officers to prevent unnecessary risk-taking; the recovery of any bonus or incentive compensation paid to a senior executive officer based on statements of earnings, gains, or other criteria that are later proven to be materially inaccurate; and a prohibition on golden parachute payments to senior executive officers. Defines "senior executive officer" as an individual who is one of the top 5 highly paid executives of a public company, whose compensation is required to be disclosed pursuant to the Securities Exchange Act of 1934, and non-public company counterparts. Provides that if the Secretary purchases an institution’s troubled assets through an auction and those purchases exceed $300 million (including direct purchases), the Secretary shall prohibit any new employment contract with a senior executive officer that provides a golden parachute in the event of involuntary termination, bankruptcy filing, insolvency, or receivership.  These provisions only apply to arrangements entered into while the TARP authorities are in effect. Analysis: The legislation does not provide a definition of the terms "employment contract" or "golden parachute;" likely, we will have to wait for Treasury to issue guidance on those terms once legislation is passed.  The provision will not apply, however, to existing golden parachute agreements. Sec. 112: Coordination With Foreign Authorities and Central Banks Summary: Requires the Secretary to coordinate with foreign financial authorities and central banks to establish programs similar to TARP. Provides that if foreign financial authorities and central banks hold troubled assets as a result of extending financing to financial institutions that have failed or defaulted on the financing, those troubled assets qualify for purchase under TARP. Sec. 113: Minimization of Long-Term Costs and Maximization of Benefits for Taxpayers Summary: Requires the Secretary to minimize long-term harm to taxpayers by holding assets to maturity and maximizing return on the assets for taxpayers and the Federal Government. Requires the Secretary to encourage the private sector to participate in purchases of troubled assets. Requires the Secretary to make purchases "at the lowest price that the Secretary determines to be consistent" with the Act’s purposes. Requires the Secretary to use market mechanisms, such as auctions or reverse auctions, to maximize efficiency of resources. Allows the Secretary to make direct purchases of assets if the Secretary determines that using market mechanisms is not appropriate. Requires the Secretary to pursue additional measures to ensure that Treasury pays reasonable prices that reflect the assets’ underlying value if Treasury makes direct purchases of assets. Requires that the Secretary receive warrants from participating financial institutions giving the Secretary the right to receive non-voting common or preferred stock in the institution.  The exercise price for the warrants will be set by the Secretary. Requires that any warrant received by the Secretary contain anti-dilution provisions. Requires the Secretary to establish an exception and alternative procedures to these requirements for any participating financial institution that is legally prohibited from issuing securities and debt instruments. Analysis: Secretary Paulson testified before the House Committee on Financial Services that the Treasury Department would employ market mechanisms to value mortgage securities.  Paulson identified key goals of the auctions as "price discovery" and "transparency."[2] The Secretary mentioned instituting reverse auctions as a means of pinpointing market prices and allowing smaller financial institutions to enter the process.  In a reverse auction, the government would accept bids from multiple sellers to offload debt, and the sellers would compete by successively lowering their bids until only one participant remained.  The government has past experience in operating reverse auctions for mineral rights, Treasury securities and wireless spectra.  The Treasury Department also may utilize the descending auction model.  In a descending auction, the government would start the auction for a particular quantity of security at a relatively high price.  The price would then be lowered gradually until supply equals demand – at the price where the aggregate of security holders wish to sell the stated auction quantity.  The descending auction would help accomplish Paulson’s "price discovery" goal, hopefully leading the secondary market to use newly acquired pricing information and re-liquidate the assets among private investors.[3] Federal Reserve Chairman Bernanke opined in questioning before the Senate Banking Committee that opening up the auctions to a greater number of institutions would increase competition and allow for market forces to determine prices with greater accuracy.  Ideally, these market forces would eventually settle prices well above the "fire-sale" point, but slightly below "hold-to-maturity" book prices.[4] In order to structure an efficient buyout, the government could set up separate auctions for an announced quantity of different classes of securities.  The Treasury may decide to auction the most widely held mortgage-backed securities first in order to create an overall pricing scheme for later, more specialized sales of collateralized-debt obligations.  Declining to give details, Secretary Paulson has merely stated that the initial auctions would probably be for "smaller" amounts.[5] Sec. 114: Market Transparency Summary: Requires the Secretary to make publicly available a description, amount, and pricing of assets acquired under the Act within 2 business days of purchase. Requires the Secretary to determine whether the public disclosures required for financial institutions authorized to use the program is adequate to provide the public with enough information about the true financial position of the institutions with regard to off-balance sheet transactions, derivatives instruments, contingent liabilities, and other sources of potential exposure. Analysis: The provision duplicates  SEC authority by providing that the Secretary shall determine whether the public disclosure by firms that sell assets to the Secretary is adequate with respect to items such as off-balance sheet disclosures. Sec. 115: Graduated Authorization to Purchase Summary: Authorizes the full $700 billion requested by Treasury to be released in tranches. Allows the Secretary to immediately use up to $250 billion. Allows the Secretary authority to use up to $350 billion if the President submits to Congress a written certification that the Secretary is exercising the authority under the Act. Allows the Secretary authority to use up to $700 billion if the President submits a written report detailing the Secretary’s plan to exercise the additional authority and Congress does not enact a joint resolution disapproving the plan. Analysis: The joint resolution of disapproval must be passed by both chambers within 15 calendar days of the President submitting a report to Congress.  That is not a lot of time and, hence, it stands to reason that there would have to be a significant groundswell of opposition to the program for the President’s plan to be rejected. Sec. 116: Oversight and Audits Summary: Requires the Comptroller General to commence ongoing oversight of the activities and performance of TARP, and to report every 60 days to Congress. Requires TARP to prepare financial statements in accordance with GAAP, which financial statements will be audited annually by the Comptroller General. Requires TARP to establish and maintain a system of internal controls that would provide reasonable assurance of the effectiveness of operations, the reliability of financial statements, and legal compliance.  Sec. 117: Study and Report on Margin Authority Summary: Requires the Comptroller General to conduct a study and report back to Congress by June 1, 2009 about the extent to which leveraging and sudden deleveraging of financial institutions was a factor behind the current financial crisis. Sec. 118: Funding Summary: Provides for the authorization and appropriation of funds consistent with Section 115 of the Act.  Sec. 119: Judicial Review and Related Matters Summary: Provides standards for judicial review and limitations of injunctive and similar relief. Provides that actions of the Secretary will be deemed unlawful if they are arbitrary, capricious, an abuse of discretion or not in accordance with law.  Sec. 120: Termination of Authority Summary: Provides that the authorities to purchase and guarantee assets under the Act terminate on December 31, 2009. Provides that the Treasury Secretary may extend the authority of the Act, upon submission of certification to Congress, to expire no later than 2 years after enactment of the Act.  Sec. 121: Special Inspector General for the Troubled Asset Relief Program Summary: Establishes the Office of the Special Inspector General for TARP to conduct, supervise, and coordinate audits and investigations of the purchase, management, and sale of assets by the Treasury Secretary under the Act. Requires the Special Inspector General to submit a report to Congress summarizing its activities and the activities of the Secretary under the Act within 60 days after confirmation of the Special Inspector General and thereafter, every calendar quarter. Analysis: This language is based on the organic statute creating the Special Inspector General for Iraq Reconstruction.  With broad authority and a $50 million budget, the SIGTARP could be a robust overseer. Sec. 122: Increase in Statutory Limit on the Public Debt Summary: Raises the debt ceiling from $10 trillion to $11.315 trillion. Sec. 123: Credit Reform Summary: Sets forth the treatment of the Act for budgetary purposes under the rules set forth in the Federal Credit Reform Act. Analysis: This means that the bill will be scored on a subsidy, as opposed to an outlay basis.  In other words, funds will not be scored as they are spent.  Rather, the Office of Management and Budget and the Congressional Budget Office will project how much the government will lose, or gain, over time, in buying and selling assets under the bill’s authority. Sec. 124: Hope for Homeowners Amendments Summary: Amends the HOPE for Homeowners program to increase eligibility for distressed borrowers and improves the tools available to prevent foreclosures. Sec. 125: Congressional Oversight Panel Summary: Establishes a Congressional Oversight Panel to conduct an ongoing review of the state of the financial markets, the regulatory system, and the effectiveness of TARP.  Requires the Congressional Oversight Panel to report to Congress every 30 days and to submit a special report on regulatory reform no later than January 20, 2009. Sets the membership of the Congressional Oversight Panel at 5 members to be appointed by the House and Senate Minority and Majority leadership.   Sec. 126: FDIC Authority Summary: Prohibits the misuse of the FDIC logo, symbols or name to falsely advertise or misrepresent that deposits or shares are insured.  Provides authority for enforcement by appropriate federal banking agencies. Authorizes the FDIC to take enforcement action against any person where the appropriate banking agency has not acted upon the FDIC’s recommendation. Protects acquirers of insured banks from being subject to litigation or damages based on standstill, confidentiality, or other agreements that would restrict or prohibit the acquisition of such banks. Analysis: Sections 126(a) and (b) of the Act provide the FDIC with broad express authority to stop and penalize any person or entity that misrepresents or implies falsely that any "deposit liability, obligation, certificate, or share" is covered by FDIC insurance.  The FDIC currently does not have express statutory authority to address false representations concerning whether such an obligation, investment or instrument issued by an entity other than an insured bank is protected by FDIC insurance. Section 126(c) of the Act broadly protects acquirers of FDIC-insured banks, or their assets, in a FDIC supervisory transaction from being subject to litigation or damages based on existing standstill, confidentiality, or other agreements that would restrict or prohibit the acquisition of such bank.  This provision would thus relieve a company from the potentially adverse effects of agreements that the target banks had entered into prior to the acquisition.  This protection extends both to the acquisitions commenced before enactment of the Act as well as to future acquisitions. It is our understanding that the FDIC requested that this authority be added to the bill in order to allow for a full range of possible buyers in the case of a bank failure, including banks that may have been involved in merger discussions with another bank before that bank failed. Sec. 127: Cooperation with the FBI Summary: Requires any federal financial regulatory agency to cooperate with the FBI or other law enforcement agencies investigating fraud, misrepresentation and malfeasance with respect to development, advertising, and sale of financial products. Sec. 128: Acceleration of Effective Date Summary: Accelerates the effective date of amendments to the Financial Services Regulatory Relief Act, which provides the Federal Reserve with the ability to pay interest on reserves. Sec. 129: Disclosures on Exercise of Loan Authority Summary: Requires the Federal Reserve to provide a report to Congress within 7 days after the use of its emergency lending authority under Section 13(3) of the Federal Reserve Act. Requires the Federal Reserve to provide status reports to Congress every 60 days while an emergency loan is outstanding. Sec. 130: Technical Corrections Summary: Makes technical amendments to the Truth in Lending Act. Sec. 131: Exchange Stabilization Fund Reimbursement Summary: Requires the Treasury Secretary to reimburse the Exchange Stabilization Fund for any funds used for the temporary money market mutual fund guaranty program. Prohibits any use of the Exchange Stabilization Fund to establish any future money market mutual fund guaranty program. Sec. 132: Authority to Suspend Mark-to-Market Accounting Summary: Authorizes the SEC to suspend for any issuer or with respect to any class or category of transaction the application of Statement of Financial Accounting Standards No. 157 ("FAS 157"), which defines fair value, establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements, if the SEC determines that the suspension is in the public interest and protects investors.   Analysis: A number of House members recently signed on to a letter to the SEC asking Chairman Christopher Cox to suspend the mark-to-market accounting rules, which have been a major source of concern throughout the debate on the rescue bill.  The new legislation, if passed, would affirm that the SEC does have the authority to suspend those rules.  In the meantime, the SEC and the Financial Accounting Standards Board have provided guidance about how mark-to-market accounting should be applied, and now will allow companies to use their own assumptions about the value of illiquid assets in their public accounting in cases where market values do not reflect the actual value of the assets because markets have ceased to function normally.  The SEC has, however, thus far elected not to suspend the rules altogether.   Sec. 133: Study on Mark-to-Market Accounting Summary: Requires the SEC, in consultation with the Federal Reserve and the Treasury, to conduct a study on mark-to-market accounting standards as provided in FAS 157 and to report to Congress within 90 days. Requires the SEC’s study to consider FAS 157’s effects on balance sheets of financial institutions, impact on bank failures, impact on the quality of financial information available to investors, and alternative accounting standards. Sec. 134: Recoupment Summary: Requires the Director of the Office of Management and Budget to submit a report to Congress within 5 years on the net amount within TARP. Requires the President to submit to Congress in 5 years a legislative proposal that recoups from the financial industry any projected losses to taxpayers. Sec. 135: Preservation of Authority Summary: Clarifies that nothing in the Act limits the authority of the Treasury Secretary or the Federal Reserve under any other provision of law. Sec. 136: Temporary Increase in Deposit and Share Insurance Coverage Summary: Temporarily increases the amount of deposit coverage for banks and share coverage for credit unions from $100,000 to $250,000.  The coverage amount reverts back to $100,000 after December 31, 2009.  Temporarily increases the borrowing limit on what banks and credit unions can borrow from the Treasury to facilitate additional coverage.  Provides that because these increases are temporary, they will not be factored into either insurance premium charges, share insurance deposit adjustments, or deposit insurance inflation adjustments. Title II: Budget-Related Provisions Sec. 201: Information for Congressional Support Agencies Summary: Requires that all information used by the Secretary in connection with activities authorized by the Act be made available to the Congressional Budget Office and Joint Committee on Taxation. Sec. 202: Reports by the Office of Management and Budget and the Congressional Budget Office Summary: Requires the Office of Management and Budget and the Congressional Budget Office to report to Congress and the President regarding exercises of authority by the Secretary. Allows the Director of the CBO to employ personnel and procure the services of experts and consultants with financial expertise.  Sec. 203: Analysis in President’s Budget Summary: Requires the President to submit with his budget proposal a separate budgetary analysis of the actions taken under the Act.  Sec. 204: Emergency Treatment Summary: Designates all provisions of the Act as an "emergency requirement," which means they will not be counted for purposes of the fiscal year 2008 budget. Title III: Tax Provisions Sec. 301: Gain or Loss from Sale or Exchange of Certain Preferred Stock Summary: Changes the tax treatment by financial institutions of gains and losses on the preferred stock of Freddie Mac and Fannie Mae. Provides that gains and losses from the sale or exchange of preferred stock in Fannie Mae or Freddie Mac by "applicable financial institutions" will be treated as ordinary gains and losses for federal income tax purposes.  "Applicable financial institutions" generally include banks (and bank holding companies), savings and loans (and savings and loan holding companies), SBICs operating under the Small Business Investment Act of 1958 and certain business development corporations (often referred to as "BDCs"). The new rules apply to stock that was either held on September 6, 2008 or was sold by the applicable financial institution on or after January 1, 2008 and before September 7, 2008. Thus, for instance, stock acquired after September 6 will not qualify for this treatment. Special rules apply to prevent entities from converting to applicable financial institutions in order to take advantage of this provision. Grants to Treasury the authority to issue regulations governing situations where the stock was acquired after September 6 in a "transferred basis" transaction. This occurs where the basis in the preferred stock is determined with reference to the basis of the stock in hands of the person who transferred the stock to the applicable financial institution, such as where the stock was transferred to the applicable financial institution as a capital contribution. Grants to Treasury the authority to issue regulations where the preferred stock is held by a partnership in which the applicable financial institution is a partner. Analysis: Many applicable financial institutions acquired preferred stock of Fannie Mae and Freddie Mac in order to satisfy their regulatory capital requirements. The preferred stock qualified as "Tier 1 capital" for these purposes. Since the stock paid a hefty dividend rate that, unlike interest on debt instruments, allowed its owners to exclude 70 percent of the return from taxable income, it was an attractive investment for financial institutions and their holding companies. When the government placed Freddie Mac and Fannie Mae into receivership in early September 2008, the preferred stock became worthless and resulted in a loss for federal income tax purposes. Since the preferred stock was a "capital asset" for tax purposes, however, its worthlessness in most cases resulted (prior to the Act) in a capital loss. Under the tax rules, capital losses may be used to offset capital gains (including capital gains realized in prior years), but not ordinary income (such as income from most banking operations). Since applicable financial institutions, especially large banks and savings and loans, generally earn relatively meager capital gains relative to their ordinary income, they would receive little if any tax benefit from the worthlessness of the preferred stock without this change in law.  Banks and their lobbying groups, including the American Bankers Association and the Independent Community Bankers of America, cried foul and sought this change of law in order to lessen the impact of the Fannie Mae and Freddie Mac receiverships.   In certain cases, the refund generated by tax losses resulting from current economic events may be among the largest assets of applicable financial institutions, because they could reach as much as 35 percent of the income upon which tax was paid during the current year and preceding two years (plus any state benefits).  We expect to see significant litigation concerning the rights to these refunds.  As a result of the Act, a loss recognized by an applicable financial institution on the preferred stock will be treated as an ordinary loss. This means that the applicable financial institution can use the loss against its ordinary income for the current tax year, and if the institution has a net operating loss for the current year, the loss could be carried back to the two preceding tax years in order to obtain a refund of taxes paid in those years (subject to certain limitations). Interestingly, the benefit extends not only to the banks and savings and loans, but to their holding companies as well. Individuals and other entities will not be entitled to this special treatment, and thus their losses on Fannie Mae and Freddie Mac preferred stock generally will be treated as capital losses.  Whether individual states will adopt conforming changes to their tax laws in order to permit the same treatment for state income tax purposes remains to be seen, but it is worth noting that certain states do not permit the carryback of net operating losses.  We have not seen estimates of the tax cost of this change, but press reports thus far seem to ignore the revised treatment of these losses when referring to the cost of the Act. Sec. 302:  Special Rules For Tax Treatment of Executive Compensation of Employers Participating in the Troubled Assets Relief Program Summary: Amends Section 162(m) of the Internal Revenue Code to limit the annual tax deduction to $500,000 for compensation paid to the CEO, CFO or one of the other three highest compensated officers of employers from whom one or more troubled assets are acquired under the Act if the aggregate amount of such assets exceeds $300 million. Amends Section 280G of the Internal Revenue Code with respect to parachute payments paid to executives of firms participating in TARP. Authorizes the Treasury Secretary to prescribe further guidance, rules, and regulations to carry out the purposes of the Act. Analysis: Section 302 addresses certain tax consequences of compensation paid to senior executives at firms that transact business with the government pursuant to the Act.  The provision contains two sets of rules: one designed to limit the deductibility of compensation deemed excessive and the other making the "golden parachute" rules applicable to certain severance benefits of top executives at participating firms. Deductibility rule, Section 302(a)–as mentioned above in this summary, Section 111 of the Act provides disparate treatment for executive compensation paid by firms selling securities to the government.  The same holds true for the tax treatment of executive compensation paid by those firms.  For instance, if a firm engages only in direct purchase transactions with the government, the firm is not treated as an "applicable employer" and the new deduction limits will not apply to that firm.  The theory here is that firms engaging in direct purchase transactions under Section 111(b) of the Act will be subject to stringent requirements imposed by Treasury relating to limits on compensation, recovery of certain bonuses, and limits on golden parachutes.  Firms that sell assets in the auction process and sell more than $300 million of securities to the government overall (including in direct purchase transactions) are the firms targeted by the deductibility limits.  While these firms are prohibited by the Act from entering into new employment contracts providing for golden parachutes, they are not prohibited from fulfilling the terms of existing agreements and are not prohibited from entering into new employment agreements providing for compensation in excess of $500,000 per year. One must parse through several defined terms in order to fully understand the deduction limits.  Below is a list of relevant terms with a summary of the definition of each: "Applicable employer":  Firms that engage in the auction process and sell more than $300 million of securities to the government.  If a firm only sells in direct purchase transactions, the firm is not an applicable employer.  However, once a firm sells assets other than through direct purchase transactions, all sales (including direct purchase sales) are counted in applying the $300 million threshold.  Entities that are treated as a single employer under the benefit plan aggregation rules (with a couple of modifications) are treated as a single employer. "Applicable taxable year":  Any taxable year that includes any portion of the period during which Treasury has authority under Section 101(a) of the Act and in which the cumulative assets acquired by the government from the applicable employer pursuant to the Act exceed $300 million.  If the employer only made sales in direct purchase transactions, however, those sales are not counted toward the $300 million threshold. "Covered executive":  An employee who, while Treasury’s authority under Section 101(a) of the Act remains in effect, is the CEO or CFO of the applicable employer or who is one of the other three "highest compensated officers" for the applicable taxable year, other than the CEO and CFO.  Whether someone is a "highest compensated officer" is determined under the SEC compensation disclosure rules (even if those rules do not apply to the employer), and the determination excludes employees who were not employed while the Treasury had authority under Section 101(a) of the Act.  Once an employee is a covered executive for an applicable employer, that person remains a covered executive of that employer for all relevant taxable years.  Thus, unlike the existing $1 million limit, which ceases to apply when the executive is no longer in the "top five," this $500,000 limit will continue to apply to deductions that arise after the executive is no longer in the top five.    "Deferred deduction executive remuneration":  Remuneration that would be "executive remuneration" for services performed in an "applicable taxable year" but for the fact that the deduction is allowable (without regard to these rules) in a later tax year.  "Executive remuneration":  Amounts that otherwise constitute deductions for compensation of the covered executive.  Certain exclusions under the existing $1 million deduction limit apply, but most notably the exclusions for commissions or other performance-based compensation (including performance bonuses and option gains) do not apply, and therefore deductions for such amounts are subject to the limits.  Executive remuneration excludes "deferred deduction executive remuneration" with respect to services performed in a prior "applicable taxable year."  Thus, for instance, if a deduction for executive remuneration for services performed in Year 1 is deferred until Year 2, that deduction is treated as deferred deduction executive remuneration in Years 1 and 2, and not as executive remuneration in Years 1 or 2.    The deduction rules as set forth in the Act are as follows:  No deduction is allowed to an applicable employer for executive remuneration for any applicable taxable year attributable to services performed by a covered executive during that applicable taxable year, to the extent the amount of remuneration exceeds $500,000; and In the case of deferred deduction executive remuneration for any taxable year for services performed during any applicable taxable year by a covered executive, no deduction will be allowed to the extent that remuneration exceeds $500,000 reduced by (a) executive remuneration for such applicable taxable year, and (b) the portion of deferred deduction executive remuneration for such services taken into account under this rule in a preceding taxable year.  The deduction rules also coordinate with the golden parachute provisions and the rules for stock compensation of employees of expatriated corporations.  These rules apply to all tax years ending on or after the date of enactment of the Act. Golden parachute excise tax rules, Section 302(b)–the second set of compensation-related tax rules apply the existing golden parachute provisions to payments made to executives of participating firms whose employment is terminated. By way of background, the golden parachute tax rules deny deductions to corporations for certain payments and other benefits, and impose a 20 percent nondeductible excise tax on the recipient of those payments or other benefits, if (a) the recipient is a "disqualified individual," (b) the payments and other benefits are deemed contingent on a change of control of the corporation, and (c) the payments and other benefits exceed three times the individual’s average compensation for the five-year period preceding the change of control.  Once the payments and other benefits exceed this three-times threshold, all payments in excess of the five-year average are subject to the deduction disallowance and the excise tax. Under the Act, a "covered executive" (described above) is automatically treated as a disqualified individual.  In addition, the rules now treat the "applicable severance from employment" of a covered executive as a change of control for purposes of applying the golden parachute rules, and treat payments that are "on account of" the "applicable severance" as payments contingent on a change of control.  "Applicable severance from employment" means any severance from employment resulting from involuntary termination or in connection with the bankruptcy, liquidation, or receivership of the employer.  The rules also substitute the term "applicable employer" for "corporation" as that term is used in Section 280G, meaning that they apply to all payments by entities subject to the deduction disallowance rules described above, and to "covered executives" with respect to such applicable employers.  Exceptions under the golden parachute rules for payments that are deemed "reasonable compensation" and for payments by private (i.e., non-publicly traded) companies or corporations that could qualify as S corporations do not apply.  Thus, private corporations and corporations that could qualify as S corporations also are subject to the golden parachute rules in the Act. The actual language implementing this particular provision is not clear.  The main area of uncertainty stems from language stating that "this section" (meaning Section 280G of the Internal Revenue Code) applies to severance payments to a covered executive.  Section 280G, however, applies only to "excess parachute payments," and we would have expected the language to say something to the effect that the applicable severance payments are to be treated as "parachute payments" under these rules instead of providing that the entire section applies to the severance payments.  Nevertheless, our sense is the rules are intended to treat payments to a covered executive on account of applicable severance from employment as parachute payments for purposes of the golden parachute rules.  If this is the case and if those severance payments exceed three times the executive’s five-year average compensation, the employer is denied a deduction and the employee incurs a nondeductible 20 percent excise tax to the extent of severance payments in excess of that five-year average.  The Act also contains a few coordinating provisions, including a rule making the excise tax provision inapplicable to any payment that would be treated as a parachute payment without regard to the new rules, and a grant of regulatory authority to Treasury in order to (a) carry out the purposes of the provision and the Act in the case of any acquisition, merger or reorganization of an applicable employer, (b) apply the deduction disallowance and the excise tax rules where payments are treated as parachute payments under the new rules and other payments are treated as parachute payments under the old rules, and (c) prevent avoidance of the rules by mischaracterizing a severance from employment as something other than "applicable severance."  These rules apply to all payments with respect to severances occurring while Treasury’s authorities under Section 101(a) of the Act are in effect. Much like the existing rules imposing limits on the deduction of compensation in excess of $1 million and limiting the deduction and imposing an excise tax on golden parachute payments, in many cases these rules will require significant clarification before they can be implemented with any degree of certainty.  While the intent to limit what is perceived as excessive compensation to senior executives of institutions that participate in asset sales under the Act is clear, the implementing rules are far from clear.  Terms like "involuntary termination," "in connection with a bankruptcy, liquidation, or receivership,"  and "on account of such applicable severance" will require more elaboration.  Moreover, it is questionable whether it makes much sense from a policy standpoint to place these limits on the compensation of persons who fall within the definition of "covered executive" while placing no such limits on employees who fall outside that fairly narrow definition. Historically, in our experience, many employers have considered the limits on deductibility in setting their compensation structures, but ultimately decide what they will pay their executives based on factors independent of tax deductions.  One would think this will be even more likely for firms selling assets under the Act, as presumably these firms are not overly concerned with income taxes given the magnitude of their tax losses resulting from the recent economic downturn.  In addition, many executive employment agreements require the employer to pay the 20 percent nondeductible excise tax incurred by the executive as a result of the receipt of golden parachute payments, as well as the additional income and excise taxes incurred by the executive resulting from those payments (since those payments by the employer are treated as additional compensation), ultimately costing the employers significantly more than they would have spent without these rules.  While Treasury has authority under the Act to limit payments to executives where it engages in direct purchase transactions, it has no such authority where it is participating in auctions (other than the limited right to prohibit golden parachutes in new employment agreements).  Therefore, the excise tax rules could result in substantially higher costs to the entities, and ultimately the shareholders or other stakeholders of those entities, that suffered huge losses leading up to the Act.  Sec. 303: Extension of Exclusion of Income From Discharge of Qualified Principal Residence Indebtedness. Summary: Extends current tax law relating to the cancellation of mortgage debt for qualified principal residences until January 1, 2013. Analysis: Section 303 of the Act simply extends the expiration date of the current provision addressing income from the cancellation of "qualified principal residence indebtedness."  Under this rule, borrowers who negotiate a reduction in indebtedness incurred to acquire their principal residence will not be required to pay tax on the reduction, provided certain conditions are met.  Without this special rule, assuming the borrower was not in bankruptcy or insolvent, the borrower would be deemed to have ordinary income equal to the amount of the reduction in his or her indebtedness.  The Act extends this rule to reductions in debt that occur prior to January 1, 2013.  Prior to the Act, this rule would apply only to cancellations that occur prior to January 1, 2010.            Interestingly, this provision does not shelter gain on sale, including gain on sale that would result from a foreclosure on a home that secures nonrecourse debt in excess of the homeowner’s tax basis in the home (e.g., where the homeowner refinanced and borrowed more than the original cost of the home plus capitalized improvements and the debt is nonrecourse).  Other Internal Revenue Code provisions may apply to shelter that gain, however. The Financial Markets Crisis Group will continue to keep our clients updated on the latest events in Washington.  Additional updates relating to the financial markets crisis are available on Gibson Dunn’s website.     [1]   Albert Bozzo, How Will the Bailout Work?  Nobody Actually Knows, CNBC.com, Sept. 25, 2008.   [2]   Patrick Temple-West and Andrew Ackerman, Paulson, Bernanke Focus on Taxpayer, The Bond Buyer, Sept. 25, 2008.   [3]   Justin Lahart, Economists Look at Ways to Structure Auctions, Wall St. J., Sept. 25, 2008.   [4]   Vikas Bajaj, Plan’s Mystery: What’s All This Stuff Worth?, N.Y. Times, Sept. 25, 2008.   [5]   Rebecca Christie and Jody Chenn, Paulson, Bernanke Put Bank Ahead of Best Deal, Bloomberg, Sept. 24, 2008.    Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above.  Please contact Michael Bopp (202-955-8256, mbopp@gibsondunn.com) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group: Public Policy ExpertiseMel Levine – Century City (310-557-8098, mlevine@gibsondunn.com)John F. Olson – Washington, D.C. (202-955-8522, jolson@gibsondunn.com)Amy L. Goodman – Washington, D.C. (202-955-8653, agoodman@gibsondunn.com)Alan Platt – Washington, D.C. (202- 887-3660, aplatt@gibsondunn.com)Michael Bopp – Washington, D.C. (202-955-8256, mbopp@gibsondunn.com) Securities Law and Corporate Governance ExpertiseRonald O. Mueller – Washington, D.C. (202-955-8671, rmueller@gibsondunn.com)K. Susan Grafton – Washington, D.C. (202- 887-3554, sgrafton@gibsondunn.com)Brian Lane – Washington, D.C. (202-887-3646, blane@gibsondunn.com)Lewis Ferguson – Washington, D.C. (202- 955-8249, lferguson@gibsondunn.com)Barry Goldsmith – Washington, D.C. (202- 955-8580, bgoldsmith@gibsondunn.com)John H. Sturc – Washington, D.C. (202-955-8243, jsturc@gibsondunn.com)Alan Bannister – New York (212-351-2310, abannister@gibsondunn.com) Financial Institutions Law ExpertiseChuck Muckenfuss – Washington, D.C. (202- 955-8514, cmuckenfuss@gibsondunn.com)Christopher Bellini – Washington, D.C. (202- 887-3693, cbellini@gibsondunn.com)Amy Rudnick – Washington, D.C. (202-955-8210, arudnick@gibsondunn.com) Corporate ExpertiseHoward Adler – Washington, D.C. (202- 955-8589, hadler@gibsondunn.com)Richard Russo – Denver (303- 298-5715, rrusso@gibsondunn.com)Dennis Friedman – New York (212- 351-3900, dfriedman@gibsondunn.com)Stephanie Tsacoumis – Washington, D.C. (202-955-8277, stsacoumis@gibsondunn.com)Robert Cunningham – New York (212-351-2308, rcunningham@gibsondunn.com)Joerg Esdorn – New York (212-351-3851, jesdorn@gibsondunn.com)Stewart McDowell – San Francisco (415-393-8322, smcdowell@gibsondunn.com)C. William Thomas, Jr. – Washington, D.C. (202-887-3735, wthomas@gibsondunn.com) Real Estate ExpertiseJesse Sharf – Century City (310-552-8512, jsharf@gibsondunn.com)Alan Samson – London (+44 20 7071 4222, asamson@gibsondunn.com)Andrew Levy – New York (212-351-4037, alevy@gibsondunn.com)Dennis Arnold – Los Angeles (213-229-7864, darnold@gibsondunn.com)Andrew Lance – New York (212-351-3871, alance@gibsondunn.com)Eric M. Feuerstein – New York (212-351-2323, efeuerstein@gibsondunn.com)David J. Furman – New York (212-351-3992, dfurman@gibsondunn.com) Crisis Management ExpertiseTheodore J. Boutrous, Jr. – Los Angeles (213-229-7804, tboutrous@gibsondunn.com) Bankruptcy Law ExpertiseMichael Rosenthal – New York (212-351-3969, mrosenthal@gibsondunn.com)Oscar Garza – Orange County (949-451-3849, ogarza@gibsondunn.com)Craig H. Millet – Orange County (949-451-3986, cmillet@gibsondunn.com)Janet M. Weiss – New York (212-351-3988, jweiss@gibsondunn.com) Tax Law ExpertiseArthur D. Pasternak – Washington, D.C. (202-955-8582, apasternak@gibsondunn.com)Paul Issler – Los Angeles (213-229-7763, pissler@gibsondunn.com) Executive and Incentive Compensation ExpertiseStephen W. Fackler – Palo Alto (650-849-5385, sfackler@gibsondunn.com)Michael J. Collins – Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)Sean C. Feller – Los Angeles (213-229-7579, sfeller@gibsondunn.com)Amber Busuttil Mullen – Los Angeles (213-229-7023, amullen@gibsondunn.com)  © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 30, 2008 |
Financial Markets in Crisis: Overview of FDIC’s Authority with Respect to Bank Failures

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is tracking closely government responses to the turmoil that has catalyzed dramatic and rapid reshaping of our capital and credit markets. We are providing updates on key regulatory and legislative issues as well as information on legal issues that we believe could prove useful as firms and other entities navigate these challenging times. This update focuses on the receivership and conservatorship authority of the Federal Deposit Insurance Corporation (the "FDIC").   It is an executive summary of a longer memorandum [PDF] available on our website.  In view of the many and complex specific issues that may arise in this context, even the longer memorandum is necessarily an overview, but it does give particular reference to counterparty issues that might arise in the case of a relatively large complex bank such as a significant regional bank and  elements of the FDIC framework which differ from a corporate bankruptcy.  This summary provides a brief overview of key issues and background on the legal framework governing FDIC resolutions and the FDIC’s methods for handling receiverships  The longer memorandum goes into greater detail, comparing six distinctive aspects of the FDIC approach with the bankruptcy law provisions; and illustrating issues and uncertainties in  the FDIC resolutions process by discussing in greater depth two examples – treatment of loan securitizations and participations, and standby letters of credit.   Relevant additional materials include:  the pertinent provisions of the Federal Deposit Insurance (the "FDI") Act[1] and  FDIC rules[2], statements of policy[3] and advisory opinions;[4]  the FDIC Resolution Handbook[5] which reflects the FDIC’s high level description of the receivership process, including a contrast with the bankruptcy framework; recent speeches of FDIC Chairman Sheila Bair;[6] and press releases and notes with respect to failure cases.[7]  In addition to the links below, the full range of documents is available on the FDIC website. http://www.fdic.gov/index.html In view of unfolding events, these materials should be viewed both as a work in progress and as a point of departure for in depth and comprehensive analysis.  Even this overview underscores the importance of credit analysis and rigor of documentation and legal risk mitigation in connection with potentially troubled financial institution counterparties.  Any party assessing a particular relationship with a potentially troubled insured bank counterparty should assume that the FDIC will be zealous in the event of bank failure in seeking to minimize cost and maximize recovery with respect to a receivership. Points worthy of special note. First, our experience in dealing with the FDIC over an extended period of time, as well as our experience in litigating Resolution Trust Corp. ("RTC") and "goodwill" cases, makes it clear that outcomes are highly fact specific and that precision and care are rewarded.  Two parties who believe they have done the same deal may achieve different outcomes depending on their degrees of care. Second, changes in law, notably codification and more rigorous implementation of the "least cost" test and enactment of a revised priority of claims, have further underscored the risks associated with not getting it right and the need for rigorous risk assessment. Third, while the FDIC has taken steps to provide market participants with "safe harbors" and guidance to enhance predictability, it is clear that in other areas the FDIC has continued past policies, even when rebuked in the courts. Finally, in recent months, the FDIC has been preparing for large bank failures.  This is reflected in the recently promulgated regulation with respect to depositor processing of deposits in the failure of a large bank and discussion of internal table top exercises regarding large bank failures. In this light, clients should review patterns of interaction with depository counterparties that are of particular concern or where outcomes are unclear, and do in-depth analysis as appropriate.  Further, because precedent may not be an accurate predictor of outcomes, it may be well to have discussions with the FDIC  with respect to particular patterns of transactions of concern.  Note, the goal of government prior to failure is to assure market stability; the goal after failure is to minimize cost to the FDIC fund. Background Concerning FDIC Failed Bank Resolutions The FDI Act provides the framework for resolving the troubled institution, including marshalling and liquidating its assets and satisfying claims on the failed institution, and using interim devices such as bridge banks and conservatorships.  When the FDIC is appointed receiver or conservator, [8] it acts in a separate capacity distinct from its corporate capacity as insurer, regulator or supervisor of insured banks.[9] Pursuant to Section 11(c) of the FDI Act, the FDIC is appointed as receiver by a federal or state chartering authority in order to liquidate or wind up the affairs of a failed depository institution (an "institution") or as conservator to preserve the going concern value of the institution returning it to health or ultimately resulting in a receivership. It should be noted that the FDIC’s powers as conservator largely parallel its distinctive receivership authority, e.g., its contract repudiation authority. Historically, for most large financial institutions, the preferred resolution was an assisted  purchase and assumption ("P&A") transaction with whereby an acquiring bank would assume all the deposits and certain other liabilities of the failing bank and acquire some or all of the assets of the bank, plus cash from the FDIC (generally, the acquiring bank would receive the clean assets of the bank or acquire loans with a put to the receivership).  In this case, the FDIC would then liquidate the remaining assets in the receivership and pay claims on the receivership including its own claim for insured deposits paid and any funds advanced to the receivership.  The basic P&A model for handling failed institutions has been modified by changes  arising from the failures in the late 1980s-early 1990s.  Most important were  changes in the resolution process–"least-cost resolution,"[10] that is, determining the most cost-effective form of resolution;  and "depositor preference,"[11] which provides statutory priorities for depositors over other unsecured claimants.  Least-cost resolution has helped foster varied types of P&A transactions, as demonstrated by the FDIC resolution of bank failures in recent months.  The FDIC can override the "least cost" test in the case of a systemic significant institution.  The "depositor preference" regime  elevates the claims priority of a failed institution’s depositors over general creditors.  The greatest beneficiary is the FDIC itself as the insurer-subrogee to the insured depositors (for example, in the IndyMac failure, $18 billion of the bank’s $19 billion of deposits were insured).  Because uninsured depositors also get preference over general creditors, this policy tends to increase their ultimate recovery as well. With larger institutions particularly, the FDIC has made effective use of its "bridge bank" and conservatorship authority to act  rapidly to take over a troubled bank or thrift while it determines how best to sell its assets or businesses of the institution to one or more buyers. The FDIC can transfer some or all of the failed institution’s assets and liabilities to a newly chartered institution, either as a "bridge" bank to continue its operations, and manage its assets and liabilities, or as a vehicle to transfer all insured deposits and other selected assets and liabilities to an existing depository institution.  A bridge bank is a full-service national bank chartered by the Office of the Comptroller of the Currency and controlled by the FDIC. It should be noted that in the case of a failed savings association, such as IndyMac, a conservatorship is used as the vehicle for this interim arrangement because the statutory "bridge bank" provisions do no encompass savings institutions.  Overview of FDIC Authority as Receiver or Conservator 1. FDIC’s general administrative discretion This regime and the FDIC powers are set forth in Section 11 of the FDI Act, codified at 12 U.S.C. § 1821.  The often terse terms of the statute itself provide the principal reference and guidance concerning how an FDIC receivership or conservatorship may be conducted.  The FDIC’s first step as conservator or receiver is to take possession of all of the closed institution’s books and records and assets and loans. It will bring all accounts forward to the closing date and then notify other banks of the closing.  It will also create two sets of inventory books containing explanations of the disposition of the failed institution’s assets and liabilities, with one set going to the assuming institution, if applicable, and one for the receiver.  Under section 11(d)(3)(B) and (C), claimants must submit their claims (along with applicable proof of the claims) by a specified date that is no less than 90 days after FDIC notice. The FDIC is granted the power to allow or disallow any claims within the 180-day period beginning on the date the claim is filed with the FDIC as receiver.  This substantial power allows the FDIC to generally disallow any portion of a claim by a creditor or a claim of security or preference if such a claim is not proved to the satisfaction of the FDIC. 2.  Documentary Requirements The FDI Act embodies a general policy that the rights of claimants are to be determined based upon the written records of the institution and related documents and records in the hands of private parties, as they exist at the time of failure.  Under the doctrine set forth in D’Oench, Duhme & Co. v. FDIC and now codified, the FDIC is  protected from post-insolvency efforts to give claimants superior rights to assets of the institution based on an unrecorded agreement by disallowing claims by a party who asserted a claim without meeting clear documentary requirements scheme.  The documentation requirements are set out in Section 13(e) of the FDI Act. 3.  Claims Preference Under the FDI Act, claims of FHL Banks receive priority treatment, secured claims are satisfied based upon the governing security documents, and insured depositors are covered by FDIC deposit insurance (with the FDIC as subrogee taking the place of those depositors), .  As the term suggests, "depositor preference"  elevates the claims priority of depositors over other unsecured creditors, and unsecured claims are paid in the following order: (1) administrative expenses of the receiver; (2) deposit liability claims (the FDIC claim takes the position of the insured deposits); (3) other general or senior liabilities of the institution; (4) subordinated obligations; and (5) shareholder claims. 4. Contract Repudiation and Compensatory Damages Section 11(e) of the FDI Act permits the FDIC as receiver to repudiate or disaffirm any of the failed institution’s contracts.  However, subsection (e)(12) provides that the FDIC is not permitted to avoid any legally enforceable or perfected security interest in any of the institution’s assets, so long as the interest was not taken in contemplation of the institution’s insolvency or with the intent to hinder, delay or defraud the institution or its creditors. When the FDIC  repudiates a contract, section 11(e)(3) limits the damages for which it can be liable.  The damages are limited to actual compensatory damages determined as of the date of the appointment of the FDIC as receiver.  Further, the FDI Act specifically excludes any damages for lost profits, pain and suffering or punitive damages. These determinations have given rise to significant litigation based on the FDIC’s strict reading of the statute, a view often rejected by the courts (as discussed in the longer memorandum). Section 11(e)(8) provides detailed specific treatment for "Qualified Financial Contracts" ("QFCs") (which include securities contracts, commodity contracts, forward contracts, repurchase agreements, swap agreements and similar agreements, all of which are further defined within the FDI Act) and outlines the rights of the parties to such contracts.  The body of post-FIRREA cases demonstrates a judicial respect for binding contractual agreements to which the bank was a party before going into receivership.  These cases consistently hold that such agreements give rise to a provable claim for actual compensatory damages unless those damages represent lost profits or opportunity or are governed by paragraphs in Section 11(e) specifically directed at certain types of contracts such as leases. Moreover, the post-FIRREA courts have used the panoply of contract law methods in the effort to determine damages that would make whole the parties to contracts repudiated—breached—by the FDIC.  5. Fraudulent Conveyances The FDIC has the power pursuant to Section 11(e)(12) to avoid any otherwise legally enforceable or perfected security interest in any of the institution’s assets if such interest was taken in contemplation of the institution’s insolvency or with the intent to hinder, delay or defraud the institution or its creditors. 6. Stay of Litigation The FDIC’s ability to stay litigation is not automatic with the creation of the receivership or conservatorship, but is broader in scope than in bankruptcy. Section 11(d)(12) gives the FDIC the power to temporarily suspend, or "stay," ongoing litigation.  These provisions are meant to give the FDIC the ability to assess and evaluate the facts of each case.  This ability to stay litigation is not limited to matters filed prior to the entry into receivership or conservatorship and covers litigation filed after the institution’s failure. [1]     Esp. Section 11 et seq., http://www.fdic.gov/regulations/laws/rules/1000-1200.html#1000sec.11 [2]    Esp. Part 360, http://www.fdic.gov/regulations/laws/rules/2000-7800.html [3]  http://www.fdic.gov/regulations/laws/rules/5000-4300.html#5000statementop12; http://www.fdic.gov/regulations/laws/rules/5000-3500.html#5000statementop8; http://www.fdic.gov/regulations/laws/rules/5000-3900.html#5000statementop11; http://www.fdic.gov/regulations/laws/rules/5000-2800.html#5000statementop6. [4]   E.g., http://www.fdic.gov/regulations/laws/rules/4000-7990.html#400093-10; http://www.fdic.gov/regulations/laws/rules/4000-6230.html#400091-24; http://www.fdic.gov/regulations/laws/rules/4000-5120.html#400089-48. [5]     http://www.fdic.gov/bank/historical/reshandbook/ [6]  E.g., Bair speech on September, 4, 2008: http://www.fdic.gov/news/news/speeches/chairman/spsept042008.html [7] E.g., re Washington Mutual (three releases): http://www.fdic.gov/news/news/press/2008/pr08085b.html;  http://www.fdic.gov/news/news/press/2008/pr08085a.html;  http://www.fdic.gov/bank/individual/failed/wamu.html [8]   An institution’s charter determines which agency appoints the receiver for the institution in the case of failure. [9]  Indeed, this duality of roles has the consequence that the FDIC may be adverse in litigation to a receivership in its corporate capacity and two receiverships may be adverse o each other.  Also, an FDIC conservatorship is subject to the supervision of the bank’s primary regulator.  [10] See 12 C.F.R. § 360.1. [11] See 12 U.S.C. § 1821(d)(11); 12 C.F.R. § 360.3.  Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above.  Please contact Michael Bopp (202-955-8256, mbopp@gibsondunn.com) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group: Public Policy ExpertiseMel Levine – Century City (310-557-8098, mlevine@gibsondunn.com)John F. Olson – Washington, D.C. (202-955-8522, jolson@gibsondunn.com)Amy L. Goodman – Washington, D.C. (202-955-8653, agoodman@gibsondunn.com)Alan Platt – Washington, D.C. (202- 887-3660, aplatt@gibsondunn.com)Michael Bopp – Washington, D.C. (202-955-8256, mbopp@gibsondunn.com) Securities Law and Corporate Governance ExpertiseRonald O. Mueller – Washington, D.C. (202-955-8671, rmueller@gibsondunn.com)K. Susan Grafton – Washington, D.C. (202- 887-3554, sgrafton@gibsondunn.com)Brian Lane – Washington, D.C. (202-887-3646, blane@gibsondunn.com)Lewis Ferguson – Washington, D.C. (202- 955-8249, lferguson@gibsondunn.com)Barry Goldsmith – Washington, D.C. (202- 955-8580, bgoldsmith@gibsondunn.com)John H. Sturc – Washington, D.C. (202-955-8243, jsturc@gibsondunn.com)Alan Bannister – New York (212-351-2310, abannister@gibsondunn.com) Financial Institutions Law ExpertiseChuck Muckenfuss – Washington, D.C. (202- 955-8514, cmuckenfuss@gibsondunn.com)Christopher Bellini – Washington, D.C. (202- 887-3693, cbellini@gibsondunn.com)Amy Rudnick – Washington, D.C. (202-955-8210, arudnick@gibsondunn.com) Corporate ExpertiseHoward Adler – Washington, D.C. (202- 955-8589, hadler@gibsondunn.com)Richard Russo – Denver (303- 298-5715, rrusso@gibsondunn.com)Dennis Friedman – New York (212- 351-3900, dfriedman@gibsondunn.com)Stephanie Tsacoumis – Washington, D.C. (202-955-8277, stsacoumis@gibsondunn.com)Robert Cunningham – New York (212-351-2308, rcunningham@gibsondunn.com)Joerg Esdorn – New York (212-351-3851, jesdorn@gibsondunn.com)Stewart McDowell – San Francisco (415-393-8322, smcdowell@gibsondunn.com)C. William Thomas, Jr. – Washington, D.C. (202-887-3735, wthomas@gibsondunn.com) Real Estate ExpertiseJesse Sharf – Century City (310-552-8512, jsharf@gibsondunn.com)Alan Samson – London (+44 20 7071 4222, asamson@gibsondunn.com)Andrew Levy – New York (212-351-4037, alevy@gibsondunn.com)Dennis Arnold – Los Angeles (213-229-7864, darnold@gibsondunn.com)Andrew Lance – New York (212-351-3871, alance@gibsondunn.com) Crisis Management ExpertiseTheodore J. Boutrous, Jr. – Los Angeles (213-229-7804, tboutrous@gibsondunn.com) Bankruptcy Law ExpertiseMichael Rosenthal – New York (212-351-3969, mrosenthal@gibsondunn.com) Tax Law ExpertiseArthur D. Pasternak – Washington, D.C. (202-955-8582, apasternak@gibsondunn.com)Paul Issler – Los Angeles (213-229-7763, pissler@gibsondunn.com) Executive and Incentive Compensation ExpertiseStephen W. Fackler – Palo Alto (650-849-5385, sfackler@gibsondunn.com)Michael J. Collins – Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)Sean C. Feller – Los Angeles (213-229-7579, sfeller@gibsondunn.com)Amber Busuttil Mullen – Los Angeles (213-229-7023, amullen@gibsondunn.com) © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 29, 2008 |
Financial Markets in Crisis: Rescue Bill Fails in House

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is tracking closely government responses to the turmoil that has catalyzed dramatic and rapid reshaping of our capital and credit markets. What follows is our latest in a series of updates on key regulatory and legislative issues. Bipartisan Rejection Lawmakers labored over the weekend to craft a financial package that would be palatable to both Democrats and Republicans, as well as to constituents back home.  Draft legislation was circulated and tinkered with all weekend until the House Rules Committee, at 12:01 a.m. this morning, reported to the House a rule setting the parameters of the debate on the rescue legislation. Bipartisan House and Senate negotiators had reached agreement on what they believed to be a consensus bill.  But when it came time to vote, members from both sides of the aisle jumped ship, defeating the legislation by a 205-228 vote.[1]  The vote reflected strong bipartisan opposition to the rescue plan as 95 Democrats and 133 Republicans opposed the measure. Democrats are blaming Republican leadership for not producing enough votes; Republicans are blaming Democratic House Speaker Nancy Pelosi for stirring dissension in the Republican ranks with a partisan floor speech. Reacting quickly to the news, stocks plummeted and the Dow Jones Industrial Average dropped 780 points. It is not clear what happens next, but it is likely that the House will reconsider the measure – likely with some changes designed to attract more support — again this week.  After the vote, both the Administration and House Democratic leadership expressed their intent to find a way to move forward with the measure. The House has recessed until noon on Thursday for Rosh Hashanah.   [1] For a full listing of House members’ votes, see http://clerk.house.gov/evs/2008/roll674.xml.  Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above.  Please contact Michael Bopp (202-955-8256, mbopp@gibsondunn.com) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group: Public Policy ExpertiseMel Levine – Century City (310-557-8098, mlevine@gibsondunn.com)John F. Olson – Washington, D.C. (202-955-8522, jolson@gibsondunn.com)Amy L. Goodman – Washington, D.C. (202-955-8653, agoodman@gibsondunn.com)Alan Platt – Washington, D.C. (202- 887-3660, aplatt@gibsondunn.com)Michael Bopp – Washington, D.C. (202-955-8256, mbopp@gibsondunn.com) Securities Law and Corporate Governance ExpertiseRonald O. Mueller – Washington, D.C. (202-955-8671, rmueller@gibsondunn.com)K. Susan Grafton – Washington, D.C. (202- 887-3554, sgrafton@gibsondunn.com)Brian Lane – Washington, D.C. (202-887-3646, blane@gibsondunn.com)Lewis Ferguson – Washington, D.C. (202- 955-8249, lferguson@gibsondunn.com)Barry Goldsmith – Washington, D.C. (202- 955-8580, bgoldsmith@gibsondunn.com)John H. Sturc – Washington, D.C. (202-955-8243, jsturc@gibsondunn.com)Alan Bannister – New York (212-351-2310, abannister@gibsondunn.com) Financial Institutions Law ExpertiseChuck Muckenfuss – Washington, D.C. (202- 955-8514, cmuckenfuss@gibsondunn.com)Christopher Bellini – Washington, D.C. (202- 887-3693, cbellini@gibsondunn.com)Amy Rudnick – Washington, D.C. (202-955-8210, arudnick@gibsondunn.com) Corporate ExpertiseHoward Adler – Washington, D.C. (202- 955-8589, hadler@gibsondunn.com)Richard Russo – Denver (303- 298-5715, rrusso@gibsondunn.com)Dennis Friedman – New York (212- 351-3900, dfriedman@gibsondunn.com)Stephanie Tsacoumis – Washington, D.C. (202-955-8277, stsacoumis@gibsondunn.com)Robert Cunningham – New York (212-351-2308, rcunningham@gibsondunn.com)Joerg Esdorn – New York (212-351-3851, jesdorn@gibsondunn.com)Stewart McDowell – San Francisco (415-393-8322, smcdowell@gibsondunn.com)C. William Thomas, Jr. – Washington, D.C. (202-887-3735, wthomas@gibsondunn.com) Real Estate ExpertiseJesse Sharf – Century City (310-552-8512, jsharf@gibsondunn.com)Alan Samson – London (+44 20 7071 4222, asamson@gibsondunn.com)Andrew Levy – New York (212-351-4037, alevy@gibsondunn.com)Dennis Arnold – Los Angeles (213-229-7864, darnold@gibsondunn.com)Andrew Lance – New York (212-351-3871, alance@gibsondunn.com) Crisis Management ExpertiseTheodore J. Boutrous, Jr. – Los Angeles (213-229-7804, tboutrous@gibsondunn.com) Bankruptcy Law ExpertiseMichael Rosenthal – New York (212-351-3969, mrosenthal@gibsondunn.com) Tax Law ExpertiseArthur D. Pasternak – Washington, D.C. (202-955-8582, apasternak@gibsondunn.com)Paul Issler – Los Angeles (213-229-7763, pissler@gibsondunn.com) Executive and Incentive Compensation ExpertiseStephen W. Fackler – Palo Alto (650-849-5385, sfackler@gibsondunn.com)Michael J. Collins – Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)Sean C. Feller – Los Angeles (213-229-7579, sfeller@gibsondunn.com) © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 26, 2008 |
Financial Markets Crisis: Issues for Hedge Funds and Private Equity Funds

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is tracking government responses to the turmoil that has reshaped our capital and credit markets.  The following is an update on key regulatory and legislative issues that are of particular interest to and are likely to affect hedge funds and private equity funds. Federal Reserve Board Enhances Passive Investment Framework for Minority Investors in Bank Holding Companies and Banks In connection with its various efforts to increase the capital and liquidity available to the banking industry, on September 22, 2008 the Federal Reserve Board (the "Fed") issued a new policy statement providing additional guidance on making equity investments in a bank or bank holding company ("BHC").  Importantly, the issuance only acts to modify certain elements in the Fed’s existing control framework and does not change any other items, including, for example, the rules relating to aggregation, attribution and acting in concert with respect to investors. On the margin, this enhanced flexibility will benefit investors in BHCs, however, it undoubtedly does not represent the significant changes that were being sought when hedge fund and private equity fund groups petitioned the Fed to liberalize this area.  For a company, including a hedge fund or private equity fund, the policy statement describes the investment amount and certain other relationships, such as board representation, that may exist without the company being considered to control a BHC and thereby become a BHC itself under the Bank Holding Company Act ("BHC Act"). Under the guidance, a fund that is a noncontrolling minority investor ("investor") may now have a “modicum” of influence over a BHC without having a “controlling influence over the management or policies” of a BHC.  In this regard, this policy modifies the following elements in the Fed’s control framework consistent with this position. An investor may have at least one representative on a BHC’s board of directors.  It may also have two representatives when the investor’s aggregate director representation is proportionate to its total interest in the banking organization, the representation does not exceed 25 percent of the voting members of the board and another shareholder of the banking organization is a BHC that controls the banking organization under the BHC Act.[1] An investor may own a combination of voting and nonvoting shares that, when aggregated, represents less than one-third of the total equity of a BHC (and less than one-third of any class of voting securities, assuming conversion of all convertible nonvoting shares held by such investor) and does not allow the investor to own, hold or vote 15 percent or more of any class of voting securities of the BHC.[2] An investor may communicate and advocate with management for changes in a BHC’s policies or operations such as policies related to mergers, management changes, dividends, debt or equity financing, new business lines and subsidiary divestitures.  An investor may not make explicit or implicit threats to dispose of shares in the BHC or to sponsor a proxy solicitation as a condition of action or inaction by the BHC or its management in connection with these policy discussions.[3] Treasury Guaranty Program for Money Market Funds It is estimated that hedge funds hold approximately $600 billion in cash, and of that amount, $100 billion of this is held in money market funds.[4]  The Treasury Department has established a temporary guaranty program for these money market funds.  For a fee, Treasury will insure the holdings of any eligible publicly offered retail or institutional money market mutual fund for the next year.  Eligible funds include all funds that are  regulated under Rule 2a-7 of the Investment Company Act of 1940 and publicly offered and registered with the SEC.  Taxable and tax-exempt funds are eligible, and the guaranty will not affect the tax-exempt treatment of payments by tax-exempt money market funds.  The guaranty will be limited to balances that existed as of the close of business on Friday, September 19, 2008.  Treasury intends for this guaranty to bolster investor confidence and stabilize the global economy by maintaining the standard $1 net asset value of money market mutual funds.  As Treasury has proposed it, the program will be funded out of the Exchange Stabilization Fund, which currently holds approximately $50 billion of assets.[5] Although Treasury’s announced program did not include limits on the guaranty that would apply to a particular eligible money market mutual fund, early House and Senate drafts of broader capital markets rescue legislation would have limited the guaranty to the insurance provided to individual depositors under the Federal Deposit Insurance Act.  A House draft dated September 25, 2008 does not include an insurance limit but does limit the program to four months, which can be extended to one year upon a Treasury Secretary certification to Congress. Challenges Posed by Prime Broker Insolvency Our clients and friends have raised questions recently about how liquidation proceedings of U.S. prime brokers  under the Securities Investor Protection Act of 1979 (“SIPA”) would unfold, the treatment of securities and cash held in customer accounts, as well as a description of how derivative transactions, repurchase transactions and securities contracts would be treated.  Please note that this discussion applies only to accounts maintained with a U.S. office of a prime broker and that protections may differ if the accounts are maintained elsewhere. A prime broker could file its own chapter 7 stockbroker liquidation case under the United States Bankruptcy Code without a SIPA proceeding.  However, it is likely that if an insolvent prime broker were to file for chapter 7 protection, the SIPA-created Securities Investor Protection Corporation (“SIPC”) would initiate a SIPA proceeding that would supersede the chapter 7 proceeding.  As such, we will limit the following commentary to a SIPA proceeding. SIPA Proceeding Under SIPA, the first step in the liquidation process would be for the SIPC to commence a liquidation proceeding in federal district court and obtain a protective order freezing the customer activity of the prime broker.  SIPC would then appoint a SIPA trustee to oversee the liquidation, which would be moved to the bankruptcy court.  The first avenue explored in the liquidation process is an attempt to transfer customer accounts to a more stable brokerage firm.  If no transfer is available, the SIPA trustee will then seek to return the customers’ assets to them.  As part of this liquidation process, with the exception of certain “customer name securities” (non-negotiable securities registered in the name of the customer) that are returned to the particular customer, the assets of the prime brokerage customers are collected into a pool of “customer property” which is used to settle the customer accounts.  Customers would file proofs of claim with the SIPA trustee who would reconcile the claims and make a pro rata distribution of the customer property to all the customers.  Any shortfall in value will be shared pro rata by all the customers.  Under SIPA, customers receive distributions of the pooled customer property with respect to their “net equity claim.” “Customer property” includes all property, including securities and cash, that was, or should have been, set aside for the particular customer in accordance with SEC guidelines, and will include all securities that are held in “street name,” as well as any cash.  The “net equity claim” is the dollar amount of a customer’s account that would have been owed by the debtor if the debtor had hypothetically liquidated the securities positions of the customer on the date the SIPA liquidation was filed (at the then prevailing market values), minus any indebtedness of the customer to the debtor. Thus, although the customer may hold cash and securities in its account, the claim will be a dollar value claim.  We understand that it has been SIPC’s policy to return to customers securities that are held as customer property by having the SIPA trustee purchase securities rather than make cash payments for any shortfall in the number of available shares; however there is no guarantee that customers will have their original securities returned to them. Under SEC rules, a registered broker-dealer is required to maintain physical possession and control of any fully paid securities as well as securities in excess of 140% of the customer’s debit balance.  Such fully paid and excess margin securities are not to be commingled with “house” securities and generally cannot be hypothecated by the broker-dealer absent agreement. These protections, as well as a requirement to maintain certain reserve accounts, are intended to ensure that a failed broker-dealer will be able to satisfy customer net equity claims from available customer property.  In a SIPA proceeding, the SIPA trustee has access to the SIPC fund, which will provide up to $500,000 per account to cover any shortfalls, of which only $100,000 can be used to cover shortfalls of cash held in the account, and the prime broker may also have an insurance policy with the Customer Asset Protection Company (“CAPCO”) to make up any such shortfalls, in excess of the amount covered by the SIPC fund.  The CAPCO insurance would not cover losses due to appreciation in account assets after the filing date, any losses due to a delay in payment or disruption in trading etc., and at this point, given the recent downgrade of CAPCO and without knowing with any precision the magnitude of the claims that could be asserted against CAPCO, it is unclear whether CAPCO would have the financial wherewithal to respond fully to all claims. To the extent customer property, the SIPC fund advances and CAPCO insurance proceeds are not sufficient to pay or satisfy in full the net equity claims of customers, then customers participate in the estate as unsecured creditors.  Any residual claims, where the customer has an unsecured claim against the estate, are likely to be paid out at a discount. Derivatives with the Prime Broker SIPA and the United States Bankruptcy Code will protect the contractual rights to terminate, accelerate and liquidate the swap transactions, securities transactions and repurchase transactions, as well as the contractual rights to close out the transactions, net them and then enforce on any collateral posted in connection with these qualified financial contracts, notwithstanding otherwise applicable restrictions on enforcing rights and exercising remedies against a debtor.  If the customer closes out the contracts while it is “in the money” and would be owed a payment by the counterparty that is not secured by collateral, the customer would be a general unsecured creditor of the counterparty and may only therefore recover a portion of the face value of the claim in a winding up.  If the claim is secured by collateral subject to a valid, perfected security interest, the customer would be a secured creditor and would be able to enforce on its collateral and set off such amounts against the claim without seeking bankruptcy court approval.  Derivatives Between the Customer and a Third Party That Settle Through a Prime Brokerage Account In the event that the transactions are settled through an account with a prime broker that is the subject of a SIPA proceeding, the customer should change the account to which payments or deliveries will be made, as set forth in the contracts governing the transaction.  The standard ISDA Master Agreement provides that either party may change its account for receiving payment or delivery by giving the counterparty notice at least five business days prior to the scheduled date of a payment or delivery.  In addition, some contracts may contain provisions making the bankruptcy of the prime broker an event of default.  Under the ISDA Master Agreement, the prime broker may be a designated Specified Entity, which would give the customer the right, but not the obligation, to terminate the transactions on the bankruptcy of the prime broker, which bankruptcy would be an event of default that would allow the customer to close out and net the transactions.  These transactions would not be part of the prime broker’s estate.  If the customer was “in the money,” the counterparty would be required to make a termination payment to the customer’s account.  Short Selling Prohibition On September 18, 2008, the SEC issued an emergency order pursuant to Section 12(k)(2) of the Securities Exchange Act of 1934 (“Exchange Act”) prohibiting (with certain limited exceptions) any person from effecting a short sale in the publicly traded securities of certain financial firms.[6]  The SEC subsequently delegated to the relevant listing markets responsibility for posting on their respective websites their individual listed companies that are banks, savings associations, broker-dealers, investment advisers and insurance companies, whether domestic or foreign, and the owners of any of these entities  (“Included Firms”).[7]  An issuer may elect to opt-out of being an Included Firm.  This prohibition took effect September 19, 2008 at 11:59 p.m. and is currently scheduled to expire on October 2, 2008, unless further extended by the SEC.  The SEC has authority under the Exchange Act to extend the September 18, 2008 Order until midnight on October 18, 2008. Disclosure of Short Sale Positions As discussed in more detail in our client alert Short Selling Update:  Global Regulators Take Additional Action, pursuant to Section 12(k)(2) of the Exchange Act, on September 18, 2008 the SEC issued an emergency order requiring hedge funds and other institutional investment managers to disclose aggregate gross short sales across all accounts effected in certain publicly traded securities each day covered by the order.[8]  Institutional investment managers who were required to file a report on Form 13F for the calendar quarter ended June 30, 2008 will now be required to file a report on Form SH on the first business day of the calendar week immediately following a week during which the investment manager effected a short sale of a security defined in Exchange Act Rule 13f-1(c) (“Section 13(f) securities”).  Investment managers may rely upon the SEC’s official list of Section 13(f) securities when determining what classes of securities are covered, however, they are not required to report short sales in options. The SEC’s order only applies to short sales effected after 12:01 a.m. EDT on September 22, 2008; short positions taken prior to that date need not be reported.  Unless extended, the SEC’s order will terminate at 11:59 p.m. on October 2, 2008.  If the order is extended, no subsequent filings will be required where no short sales of a Section 13(f) security have been effected by the manager since the manager’s filing of the previous Form SH.  The SEC’s order also contains a de minimis exception: Investment managers do not have to report short positions if such position constitutes less than one quarter of one percent of the class of the issuer’s issued and outstanding Section 13(f) securities and the fair market value of the position is less than $1 million on every day of the reporting period.[9] Investigations into Market Manipulation On September 19, 2008, the SEC announced a sweeping expansion of its ongoing investigation into possible market manipulation in the securities of certain financial institutions, which will include requiring hedge fund managers and other investors with significant trading activity in financial issuers or positions in credit default swaps to disclose those positions under oath.[10]  SEC Chairman Christopher Cox stated that the investigation will look into the activity of investors with significant short positions in equity markets and positions in credit default swaps.  This expansion, according to Chairman Cox, supplements ongoing SEC investigations concerning the origination and securitization of sub prime mortgage loans, the involvement of credit rating agencies and insurers in the securitization process and the sale of mortgage-backed investments to investors. On September 23, many newspapers reported that the Federal Bureau of Investigation has opened preliminary investigations of activity at four major businesses which either received government assistance or filed for bankruptcy protection and was continuing investigations about mortgage related issues at twenty-six other companies nationwide. Coming in the midst of market turmoil, the SEC’s September 19 announcement stated that it had approved a formal order of private investigation authorizing its Division of Enforcement to subpoena documents and require witnesses to testify.  It also announced that FINRA and NYSE Regulation examiners would be onsite at broker-dealers to review short-selling activity.  On September 22, the Commission issued orders under Section 21(a)(1) of the Exchange Act requiring written statements from market participants regarding market positions, compliance with existing short sale rules, and details of all information shared or received about specified financial institutions.  The SEC’s use of this tool—one that has not been broadly used for several years—represents a significant escalation of its enforcement efforts in this area.  Letters requesting these sworn statements have already been issued with relatively short return dates. Separately,  on September 18, 2008, New York Attorney General Andrew Cuomo announced that he was launching a “wide-ranging” investigation into short-selling on Wall Street.  Cuomo will use New York’s Martin Act to prosecute any short sellers engaging in any improper conduct, including, but not limited to, the spreading of false rumors.  One of Mr. Cuomo’s objectives is to stabilize the markets by “root[ing] out short sellers who spread false information.”[11]        [1]   See Federal Reserve Board Policy statement on equity investments in banks and bank holding companies, available at [http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20080922b1.pdf].    [2]   See Federal Reserve Board Policy statement on equity investments in banks and bank holding companies, available at [http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20080922b1.pdf].    [3]   See Federal Reserve Board Policy statement on equity investments in banks and bank holding companies, available at [http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20080922b1.pdf].    [4]   See A. Gangahar, Hedge funds move $100bn into safe havens, Fin. Times (Sept. 24, 2008), available at [http://www.ft.com/cms/s/0/bb6ff882-8a68-11dd-a76a-0000779fd18c.html?nclick_check=1]    [5]   More information about the Fund can be found at [http://www.treas.gov/offices/international-affairs/esf/].    [6]   See Emergency Order, Exchange Act Release No. 58592 (Sept. 18, 2008), available at [http://www.sec.gov/rules/other/2008/34-58592.pdf].    [7]   See Exchange Act Release No. 58611 (Sept. 21, 2008),  available at [http://www.sec.gov/rules/other/2008/34-58611.pdf].    [8]   See Emergency Order, Exchange Act Release No. 58591 (September 18, 2008), available at [http://www.sec.gov/rules/other/2008/34-58591.pdf].    [9]   More information about the Order be found at [http://www.sec.gov/divisions/marketreg/shortsaledisclosurefaq.htm]. [10]   See SEC Expands Sweeping Investigation of Market Manipulation; Measure Will Require Statements Under Oath by Market Participants. 2008-214 (Sept. 19, 2008), available at [http://www.sec.gov/news/press/2008/2008-214.htm]. [11]   A. Lucchetti, A. Efrati, and K. Schannel, Cuomo Plans Short-Selling Probe, Wall St. J. (Sept. 18, 2008), available at available at [http://online.wsj.com/article/SB122176389889653245.html?mod=googlenews_wsj].    Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above.  Please contact Michael Bopp (202-955-8256, mbopp@gibsondunn.com) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group: Public Policy ExpertiseMel Levine – Century City (310-557-8098, mlevine@gibsondunn.com)John F. Olson – Washington, D.C. (202-955-8522, jolson@gibsondunn.com)Amy L. Goodman – Washington, D.C. (202-955-8653, agoodman@gibsondunn.com)Alan Platt – Washington, D.C. (202- 887-3660, aplatt@gibsondunn.com)Michael Bopp – Washington, D.C. (202-955-8256, mbopp@gibsondunn.com) Securities Law and Corporate Governance ExpertiseRonald O. Mueller – Washington, D.C. (202-955-8671, rmueller@gibsondunn.com)K. Susan Grafton – Washington, D.C. (202- 887-3554, sgrafton@gibsondunn.com)Brian Lane – Washington, D.C. (202-887-3646, blane@gibsondunn.com)Lewis Ferguson – Washington, D.C. (202- 955-8249, lferguson@gibsondunn.com)Barry Goldsmith – Washington, D.C. (202- 955-8580, bgoldsmith@gibsondunn.com)John H. Sturc – Washington, D.C. (202-955-8243, jsturc@gibsondunn.com)Alan Bannister – New York (212-351-2310, abannister@gibsondunn.com) Financial Institutions Law ExpertiseChuck Muckenfuss – Washington, D.C. (202- 955-8514, cmuckenfuss@gibsondunn.com)Christopher Bellini – Washington, D.C. (202- 887-3693, cbellini@gibsondunn.com)Amy Rudnick – Washington, D.C. (202-955-8210, arudnick@gibsondunn.com) Corporate ExpertiseHoward Adler – Washington, D.C. (202- 955-8589, hadler@gibsondunn.com)Richard Russo – Denver (303- 298-5715, rrusso@gibsondunn.com)Dennis Friedman – New York (212- 351-3900, dfriedman@gibsondunn.com)Stephanie Tsacoumis – Washington, D.C. (202-955-8277, stsacoumis@gibsondunn.com)Robert Cunningham – New York (212-351-2308, rcunningham@gibsondunn.com)Joerg Esdorn – New York (212-351-3851, jesdorn@gibsondunn.com)Stewart McDowell – San Francisco (415-393-8322, smcdowell@gibsondunn.com)C. William Thomas, Jr. – Washington, D.C. (202-887-3735, wthomas@gibsondunn.com) Real Estate ExpertiseJesse Sharf – Century City (310-552-8512, jsharf@gibsondunn.com)Alan Samson – London (+44 20 7071 4222, asamson@gibsondunn.com)Andrew Levy – New York (212-351-4037, alevy@gibsondunn.com)Dennis Arnold – Los Angeles (213-229-7864, darnold@gibsondunn.com)Andrew Lance – New York (212-351-3871, alance@gibsondunn.com) Crisis Management ExpertiseTheodore J. Boutrous, Jr. – Los Angeles (213-229-7804, tboutrous@gibsondunn.com) Bankruptcy Law ExpertiseMichael Rosenthal – New York (212-351-3969, mrosenthal@gibsondunn.com) Tax Law ExpertiseArthur D. Pasternak – Washington, D.C. (202-955-8582, apasternak@gibsondunn.com)Paul Issler – Los Angeles (213-229-7763, pissler@gibsondunn.com) Executive and Incentive Compensation ExpertiseStephen W. Fackler – Palo Alto (650-849-5385, sfackler@gibsondunn.com)Michael J. Collins – Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)Sean C. Feller – Los Angeles (213-229-7579, sfeller@gibsondunn.com) © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 26, 2008 |
Financial Markets in Crisis: Silence on the Rescue Deal Is Golden; Banking Giant WMBank Falls but DIF Held Harmless

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is tracking closely government responses to the turmoil that has catalyzed dramatic and rapid reshaping of our capital and credit markets. What follows is our latest in a series of updates on key regulatory and legislative issues. Debate on the Hill In contrast to yesterday’s public display of political and policy wrangling, today’s activity was largely behind the scenes as designated negotiators worked to hash out the details of a rescue plan.  Though congressional leaders reported yesterday that they had reached a compromise agreement, Republicans announced that they had developed a competing proposal late Thursday night.  House Minority Leader John Boehner wrote Speaker Pelosi today to express concern that the Democrats had not addressed many of the issues Republicans had raised about the proposal before declaring that the two parties had reached a consensus.  He said that he and many other Republican members could not support Secretary Paulson’s plan until more taxpayer protections and free market principles had been incorporated into the legislation.  Members from both sides of the aisle, however, have announced that they are working together to reach an agreement quickly. The Republicans’ alternative proposal purports to place less risk on taxpayers than the Treasury and Democrats’ proposals and to incentivize private companies to finance much of the recovery.  The plan would entail the government insuring mortgage-backed securities, as opposed to purchasing them outright.  Holders of the MBS would be required to pay for the insurance premiums rather than placing that burden on taxpayers, and holders of the troubled assets would pay a higher risk-based premium.  Through tax incentives and regulatory measures, the proposal is designed encourage private companies, instead of taxpayers, to inject capital into the markets.  Like the Democrats’ plan, the Republicans’ proposal calls for more transparency and oversight than did the initial Treasury request.  Participating firms would have to disclose the value of their mortgage assets to Treasury, as well as the value of bids within the last year for those assets and their most recent audit report.  Under the plan, the SEC would audit failed companies and would review the performance of the Credit Rating Agencies.  The Republicans also seek to impose greater restrictions on government sponsored enterprises, forbidding them to securitize any unsound mortgages.  Finally, the Republican plan would create a blue ribbon panel to assess the country’s financial situation and to suggest reforms for the market by January 1, 2009. Republicans also have suggested including a "pay to play" provision, which would require participating firms to pay a set amount of money based on the amount of assets Treasury purchases, as well as creating an independent government corporation to purchase the troubled assets instead of Treasury, which would have congressional accountability and would minimize taxpayer exposure. Key Points in the Latest Draft A new draft of the rescue bill, dated September 25, 2008, includes new provisions and adds texture and detail to provisions of earlier drafts.  Key provisions in this draft include the following: limit participating financial institutions to United States institutions, meaning that they must be organized under United States law and must have significant operations in the States; defines the “troubled assets” eligible for Treasury purchase as those assets based on or related to residential or commercial mortgages which were originated or issued on or before March 14, 2008; creates an Office of Financial Stability within the Office of Domestic Finance of the Department of Treasury, through which the Secretary will implement these programs; requires that the Secretary publish program guidelines either within two days of exercising this authority or within thirty days of enactment of the legislation.  These guidelines will define how the assets will be priced and purchased and how asset managers will be selected; establishes the Financial Stability Oversight Board, which will review the Secretary’s exercise of authority and will be composed of the Federal Reserve chairman, the Federal Deposit Insurance Corporation chairman, and the SEC chairman, as well as two other members who are not governmental employees, one of whom will be appointed by the majority leader of the Senate and Speaker of the House, and one of whom will be appointed by the Senate and House minority leaders; requires the Secretary to report to Congress 60 days after the programs are initiated and every 30 days thereafter, as well as to make public the total amount of assets purchased and sold each week; mandates that the Secretary review the financial markets and submit an improvement plan to Congress by April 30, 2009; requires that at least 20 percent of any profit realized from the program be deposited into federal programs: 65 percent of that amount will be deposited into the Housing Trust Fund, and 35 percent into the Capital Magnet Fund; authorizes the Secretary to contract for services through a streamlined process not subject to the Federal Acquisition Regulation.  Sets out principles for awarding contracts, including contracts to asset managers.  The principles require the Secretary: to solicit proposals from a broad range of vendors; to ensure the inclusion of minority- and women-owned businesses in the contracting process; to consider the FDIC in the selection of asset managers. requires the Secretary to develop conflict of interest standards; charges the Secretary with a duty to assist homeowners and reduce foreclosures and requires the Secretary to alter mortgage terms when such requests are “reasonable”; implements corporate governance and executive compensation standards that would be effective for two years after a corporation enters the program.  These standards leave much to the Secretary’s discretion, placing limits on compensation which will exclude incentives for officers to take risks that the Secretary deems “inappropriate” or “excessive.  The standards also prohibit golden parachute; implements additional corporate governance standards for those institutions from which the Secretary makes a direct purchase, including proxy access for any shareholder or shareholder group representing 3 percent or more of the institution’s equity securities and a mandatory opportunity for shareholders to cast a non-binding vote on the institution’s executive compensation during any annual proxy solicitation and shareholder vote; requires the Secretary to maximize the taxpayer investment by using market mechanisms, such as auctions or reverse auctions, but allows the Secretary to make direct purchases where appropriate; requires the Secretary to obtain a warrant giving the Secretary the right to receive non-voting common stock from any institution from which the Secretary purchases troubled assets, which the Secretary may transfer freely, and which are protected from dilution by stock splits, distributions, dividends, or corporate reorganizations; limits the Secretary’s purchasing authority to $700 billion, which will be granted to the Secretary in tranches.  The initial authority will be limited to $250 billion; after a request to Congress, the authority will be limited to $350 billion; and after a final request and written report to Congress, the authority will be limited to $700 billio; grants the Comptroller General of the United States oversight of the TARP program; establishes the Office of the Special Inspector General for the Troubled Asset Relief Program; raises the public debt limit to $11.315 trillion; authorizes the Secretary to establish a temporary guaranty program for money market mutual funds; and limits tax deductions for participating institutions for executive compensation to no more than $400,000 a year per executive. We note that, it’s not clear who supports this draft as it now stands.  What is clear is that this draft will change – indeed, likely has changed – before it is voted on by the House and Senate. Timing and Procedure There is a desire among bill negotiators and others to reach agreement by the end of the weekend.  One scenario would have the House and Senate voting on a rescue plan – either as a standalone measure or as an amendment to the Continuing Resolution (CR) – this weekend or possibly Monday morning.  Another, perhaps more likely at this point, would have Congress coming back after Rosh Hashanah to finish up on Wednesday. Various sources have reported that Treasury hopes to have the program functioning within 3-4 weeks. On a procedural note, Senator Majority Leader Harry Reid filed cloture on the motion to proceed to the Continuing Resolution (CR) yesterday.  Cloture will ripen tomorrow.  This is significant in terms of timing because that means the CR may well serve as the vehicle to move (or at least vote on) the rescue bill (as will a second "stimulus" package). WMBank Goes Into Receivership:  Assets Sold to JP Morgan Chase After close of business last night, the banking operations of Washington Mutual, Inc — Washington Mutual Bank, Henderson, NV and its subsidiary, Washington Mutual Bank, FSB, Park City, UT (together, WMBank ) — were sold in a supervisory transaction.  WMBank was closed by the Office of Thrift Supervision (OTS) and the Federal Deposit Insurance Corporation (FDIC) was named receiver. Washington Mutual, Inc., the holding company for WMBank, and the interests of equity, debt holders or other creditors of Washington Mutual, Inc., are not included in the closure or receivership of  WMBank. The FDIC announced that all depositors, insured and uninsured, are fully protected and that the closure will result in no cost to the Deposit Insurance Fund. WMBank (including its subsidiary) had combined assets of $307 billion and total deposits of $188 billion. Subsequent to the closure, JPMorgan Chase acquired the assets and most of the liabilities, including covered bonds and other secured debt, of WMBank from the FDIC as Receiver. JPMorgan Chase acquired the assets, assumed the qualified financial contracts and made a payment of $1.9 billion. Claims by equity, subordinated and senior unsecured debt holders of WMBank were not acquired. The holders of equity, subordinated and senior unsecured debt in WMBank are now creditors of the receivership for WMBank.  The FDIC indicates they may file claims in the receivership for recovery of any amounts that may be due to them. However, the FDIC also stated that  under  12 U.S.C. § 1821(d)(11) claims by equity and subordinated debt holders are subordinated to claims by general creditors of the institution, with the result that equity and subordinated debt holders of the bank are expected to receive no recovery on their claims. The FDIC also addressed existing contracts with  WMBank  in its release.  It stated: "By operation of law, parties to agreements by Washington Mutual Bank may not exercise any contractual or other rights to trigger termination, acceleration, default, or other actions based upon the insolvency, the appointment of the FDIC as receiver, or the transfer of such agreements to JPMorgan Chase. The Federal Deposit Insurance Act, 12 U.S.C. §§ 1821(d) and (e)(13), prohibits the exercise of such contractual or other rights in order to promote an orderly resolution of insured depository institutions." This transaction is noteworthy in several respects:  (1) This was by far the largest failure of a U.S. depository institution (almost ten times the size of IndyMac Bank, closed in July). (2) Nevertheless, it was able to be resolved without any cost to the FDIC.  Since WMBank was one of the 10 largest banks in the country and had very extensive mortgage operations, there had been concern that its failure would be very costly to the FDIC. The FDIC estimated the IndyMac failure would cost the FDIC Fund $4 to 8 billion. (3) It has been reported that WMBank experienced a loss of deposits in excess of $15 billion in recent weeks.  The urgency of WMBank’s condition is suggested by the fact that FDIC acted to take it over midweek.  Typically, banks are closed over a weekend. The FDIC did not comment on what factors led it to make this transaction when it did. (4) All uninsured depositors were protected in the transfer to JPMorganChase (because the JPMC paid a premium and there thus was not cost to the FDIC). The FDIC did not announce the amount of uninsured deposits of WMBank; IndyMac Bank had about $1 billion of uninsured deposits, and those depositors are now claimants in that receivership. Gibson Dunn will make available subsequently to its clients and friends an overview of the receivership and conservatorship authority of the Federal Deposit Insurance Corporation. Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above.  Please contact Michael Bopp (202-955-8256, mbopp@gibsondunn.com) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group: Public Policy ExpertiseMel Levine – Century City (310-557-8098, mlevine@gibsondunn.com)John F. Olson – Washington, D.C. (202-955-8522, jolson@gibsondunn.com)Amy L. Goodman – Washington, D.C. (202-955-8653, agoodman@gibsondunn.com)Alan Platt – Washington, D.C. (202- 887-3660, aplatt@gibsondunn.com)Michael Bopp – Washington, D.C. (202-955-8256, mbopp@gibsondunn.com) Securities Law and Corporate Governance ExpertiseRonald O. Mueller – Washington, D.C. (202-955-8671, rmueller@gibsondunn.com)K. Susan Grafton – Washington, D.C. (202- 887-3554, sgrafton@gibsondunn.com)Brian Lane – Washington, D.C. (202-887-3646, blane@gibsondunn.com)Lewis Ferguson – Washington, D.C. (202- 955-8249, lferguson@gibsondunn.com)Barry Goldsmith – Washington, D.C. (202- 955-8580, bgoldsmith@gibsondunn.com)John H. Sturc – Washington, D.C. (202-955-8243, jsturc@gibsondunn.com)Alan Bannister – New York (212-351-2310, abannister@gibsondunn.com) Financial Institutions Law ExpertiseChuck Muckenfuss – Washington, D.C. (202- 955-8514, cmuckenfuss@gibsondunn.com)Christopher Bellini – Washington, D.C. (202- 887-3693, cbellini@gibsondunn.com)Amy Rudnick – Washington, D.C. (202-955-8210, arudnick@gibsondunn.com) Corporate ExpertiseHoward Adler – Washington, D.C. (202- 955-8589, hadler@gibsondunn.com)Richard Russo – Denver (303- 298-5715, rrusso@gibsondunn.com)Dennis Friedman – New York (212- 351-3900, dfriedman@gibsondunn.com)Stephanie Tsacoumis – Washington, D.C. (202-955-8277, stsacoumis@gibsondunn.com)Robert Cunningham – New York (212-351-2308, rcunningham@gibsondunn.com)Joerg Esdorn – New York (212-351-3851, jesdorn@gibsondunn.com)Stewart McDowell – San Francisco (415-393-8322, smcdowell@gibsondunn.com)C. William Thomas, Jr. – Washington, D.C. (202-887-3735, wthomas@gibsondunn.com) Real Estate ExpertiseJesse Sharf – Century City (310-552-8512, jsharf@gibsondunn.com)Alan Samson – London (+44 20 7071 4222, asamson@gibsondunn.com)Andrew Levy – New York (212-351-4037, alevy@gibsondunn.com)Dennis Arnold – Los Angeles (213-229-7864, darnold@gibsondunn.com)Andrew Lance – New York (212-351-3871, alance@gibsondunn.com) Crisis Management ExpertiseTheodore J. Boutrous, Jr. – Los Angeles (213-229-7804, tboutrous@gibsondunn.com) Bankruptcy Law ExpertiseMichael Rosenthal – New York (212-351-3969, mrosenthal@gibsondunn.com) Tax Law ExpertiseArthur D. Pasternak – Washington, D.C. (202-955-8582, apasternak@gibsondunn.com)Paul Issler – Los Angeles (213-229-7763, pissler@gibsondunn.com) Executive and Incentive Compensation ExpertiseStephen W. Fackler – Palo Alto (650-849-5385, sfackler@gibsondunn.com)Michael J. Collins – Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)Sean C. Feller – Los Angeles (213-229-7579, sfeller@gibsondunn.com) © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice

September 25, 2008 |
Financial Markets in Crisis: Deal on Rescue Bill Appears Likely, but What Will It Contain?

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is tracking closely government responses to the turmoil that has catalyzed dramatic and rapid reshaping of our capital and credit markets. What follows is our latest in a series of updates on key regulatory and legislative issues. Deal or No Deal  Legislation designed to rescue financial markets moved in fits and starts today as Capitol Hill, the Administration, and the two presidential candidates all weighed in on the measure.  As of 8:00 p.m. EST, no deal had been endorsed by all key players but a deal nonetheless appeared likely to emerge.  Last night, President Bush gave a speech designed to rally bipartisan support for quick action, while driving home the enormity of the crisis to the American public.  This afternoon, a bipartisan, bicameral group of lawmakers announced a plan that would grant funding to Treasury to bailout the financial markets.  But were the right Republicans in the room?  Soon after the agreement was announced and later in the afternoon, House Minority Leader John Boehner and Senate Banking Committee Ranking Member Richard Shelby both criticized the deal.  Senator Shelby went a step further to say that a deal would not be reached. Details of the agreement are sketchy.  But a one-page summary indicates that the plan differs from the Treasury Department’s original proposal in significant respects.  Perhaps most notably, it would give Treasury access to $250 billion immediately and another $100 billion via self-certification that the funds are needed.[1]  An additional $350 billion would be subject to a Congressional joint resolution of approval.[2]  While these components sum to the $700 billion requested by the Administration, its request was for the entire sum to be available without strings attached. According to the one-page summary, the agreement requires the Secretary to set standards to prevent excessive executive compensation for participating companies, but does not define what those standards would be.  Responding to concerns about taxpayer protection, the agreement requires than any transaction include equity sharing, and requires that if profits are made from the plan, that most of them be used to reduce the national debt.  The agreement also institutes stronger oversight than originally included in Treasury’s proposal.  The oversight provisions establish an oversight board and an independent Inspector General to monitor the program, as well as regular, specific reports to Congress and GAO audits.  The agreement also includes protections for homeowners but appears to not include a proposal, favored by some Democrats, to empower bankruptcy judges to modify the terms of mortgages.  Timing  Though Congress and the Administration will have to hammer out the details of the package, leaders on both sides of the aisle are optimistic that legislation will be passed before the markets open on Monday.  On a procedural note, Senator Majority Leader Harry Reid filed cloture on the motion to proceed to the Continuing Resolution (CR) today.  Cloture will ripen on Saturday.  This is significant in terms of timing because it is expected that bailout legislation will be offered as an amendment to the CR (as will a second "stimulus" package).  Questions About the Structure of Treasury’s Bailout Program and Asset Manager Selection  Many of our clients have raised two important questions about Treasury’s bailout program.  They want to know exactly how the purchases and sales of these troubled assets will occur and how asset managers and other contractors will be selected.  While these two issues have not been the focus of the legislative debates as of yet, they have received considerable attention in recent hearings and will become critical components of the rescue bill’s implementation.  Below, we have summarized the key points we know about these issues thus far.  As the plan evolves, we will continue to provide timely updates focusing on the specific details of the program and how those details affect our clients.   Mechanics of the Treasury Bailout Program  The mechanics of the Treasury bailout program have not been established either by Treasury in its proposal or Congress in its various bill drafts.  In hearings over the past two days, Federal Reserve Chairman Bernanke and Treasury Secretary Paulson have made it clear that, while the precise pricing mechanisms have not been determined, one mechanism that will be used is some form of reverse auction.  While there are different forms of reverse auctions, the central notion is to determine the market value of the assets by having sellers of the assets bid against each other for the purchaser’s business.  In short, the roles of buyer and seller are reversed.  During his congressional testimony, Secretary Paulson, speaking in generalized terms, emphasized the need for a process designed for "immediate implementation" and that would be "sufficiently large to have maximum impact and restore market confidence."  He explained that the process would involve market mechanisms available to “small banks, credit unions and thrifts, large banks, financial institutions of all size[s] across the country.”  For the market to determine the assets’ value, he stressed the need for participation by “hundreds, even thousands, of institutions” in a variety of different processes.  At one point Committee Chairman Frank directly asked Secretary Paulson if community banks would be allowed to participate.  Secretary Paulson responded, “Absolutely. And S&L’s and credit unions.” [3]   Hiring of Asset Managers  The Treasury proposal would authorize the Secretary broadly to contract for services as needed to carry out the authorities of the legislation.  At a minimum, Treasury is expected to retain private companies to serve as asset managers during the process of buying and selling troubled mortgages and asset-backed securities.  The draft legislation issued by the House on September 22, 2008 also provides the Secretary with broad contracting authority but imposes greater restrictions on the process for awarding contracts to asset managers.  The House legislation would require the Secretary to take "appropriate steps to manage conflicts of interest," including by requiring firms to disclose potential conflicts and to submit mitigation strategies.  The Secretary also would be required to solicit a wide range of proposals and to publish a request for information.  As with most of the mechanics of the troubled asset purchase program, these likely will be left to Treasury’s discretion within certain parameters.  We will provide our clients with updates on key developments as this effort moves forward.                  [1]Damian Paletta, Michael R. Crittenden & Patrick Yoest, Agreement Reached on Bailout Ahead of High-Level Meeting, Wall St. J., Sept. 25, 2008.                 [2] Lori Montgomery, Bailout Money to Be ‘Phased In’, Wash. Post., Sept. 25, 2008 (Business Live Coverage update).                 [3] The Future of Financial Services: Exploring Solutions for the Market Crisis: Hearing Before the H. Comm. on Financial Services, 110th Cong. (2008) (statement of Treasury Secretary Paulson).    Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above.  Please contact Michael Bopp (202-955-8256, mbopp@gibsondunn.com) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group: Public Policy ExpertiseMel Levine – Century City (310-557-8098, mlevine@gibsondunn.com)John F. Olson – Washington, D.C. (202-955-8522, jolson@gibsondunn.com)Amy L. Goodman – Washington, D.C. (202-955-8653, agoodman@gibsondunn.com)Alan Platt – Washington, D.C. (202- 887-3660, aplatt@gibsondunn.com)Michael Bopp – Washington, D.C. (202-955-8256, mbopp@gibsondunn.com) Securities Law and Corporate Governance ExpertiseRonald O. Mueller – Washington, D.C. (202-955-8671, rmueller@gibsondunn.com)K. Susan Grafton – Washington, D.C. (202- 887-3554, sgrafton@gibsondunn.com)Brian Lane – Washington, D.C. (202-887-3646, blane@gibsondunn.com)Lewis Ferguson – Washington, D.C. (202- 955-8249, lferguson@gibsondunn.com)Barry Goldsmith – Washington, D.C. (202- 955-8580, bgoldsmith@gibsondunn.com)John H. Sturc – Washington, D.C. (202-955-8243, jsturc@gibsondunn.com)Alan Bannister – New York (212-351-2310, abannister@gibsondunn.com) Financial Institutions Law ExpertiseChuck Muckenfuss – Washington, D.C. (202- 955-8514, cmuckenfuss@gibsondunn.com)Christopher Bellini – Washington, D.C. (202- 887-3693, cbellini@gibsondunn.com)Amy Rudnick – Washington, D.C. (202-955-8210, arudnick@gibsondunn.com) Corporate ExpertiseHoward Adler – Washington, D.C. (202- 955-8589, hadler@gibsondunn.com)Richard Russo – Denver (303- 298-5715, rrusso@gibsondunn.com)Dennis Friedman – New York (212- 351-3900, dfriedman@gibsondunn.com)Stephanie Tsacoumis – Washington, D.C. (202-955-8277, stsacoumis@gibsondunn.com)Robert Cunningham – New York (212-351-2308, rcunningham@gibsondunn.com)Joerg Esdorn – New York (212-351-3851, jesdorn@gibsondunn.com)Stewart McDowell – San Francisco (415-393-8322, smcdowell@gibsondunn.com)C. William Thomas, Jr. – Washington, D.C. (202-887-3735, wthomas@gibsondunn.com) Real Estate ExpertiseJesse Sharf – Century City (310-552-8512, jsharf@gibsondunn.com)Alan Samson – London (+44 20 7071 4222, asamson@gibsondunn.com)Andrew Levy – New York (212-351-4037, alevy@gibsondunn.com)Dennis Arnold – Los Angeles (213-229-7864, darnold@gibsondunn.com)Andrew Lance – New York (212-351-3871, alance@gibsondunn.com) Crisis Management ExpertiseTheodore J. Boutrous, Jr. – Los Angeles (213-229-7804, tboutrous@gibsondunn.com) Bankruptcy Law ExpertiseMichael Rosenthal – New York (212-351-3969, mrosenthal@gibsondunn.com) Tax Law ExpertiseArthur D. Pasternak – Washington, D.C. (202-955-8582, apasternak@gibsondunn.com)Paul Issler – Los Angeles (213-229-7763, pissler@gibsondunn.com) Executive and Incentive Compensation ExpertiseStephen W. Fackler – Palo Alto (650-849-5385, sfackler@gibsondunn.com)Michael J. Collins – Washington, D.C. (202-887-3551, mcollins@gibsondunn.com)Sean C. Feller – Los Angeles (213-229-7579, sfeller@gibsondunn.com) © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 24, 2008 |
Financial Markets Crisis: Congress and Administration Lurch Toward a Rescue Plan; Federal Reserve Relaxes Restrictions on Investments in Banks

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is tracking closely government responses to the turmoil that has catalyzed dramatic and rapid reshaping of our capital and credit markets. What follows is our latest in a series of updates on key regulatory and legislative issues. Congressional Hearings Today, Treasury Secretary Henry Paulson and Federal Reserve Board Chairman Ben Bernanke testified before the House Financial Services Committee.  Both Secretary Paulson and Chairman Bernanke reiterated the message they conveyed to the Senate Banking Committee yesterday, urging Congress to pass legislation quickly and warning of dire economic consequences if the federal government does not intervene soon.  Tomorrow, the House Financial Services Committee will hear testimony from Federal Housing Finance Agency Director James Lockhart, Fannie Mae President and CEO Herbert Allison, and Freddie Mac CEO David Moffett regarding the conservatorship of Fannie Mae and Freddie Mac. Debate on the Hill Members of Congress remain divided over the financial plan despite President Bush and Vice President Dick Cheney’s efforts to encourage a swift resolution.[1]  Nevertheless, Senate Democrats and the Administration appear to have made progress toward reaching compromises on key issues such as the plan’s oversight provisions, assistance for homeowners, and executive compensation limits.  Several senators joined Senator Schumer’s call for $700 billion in purchase authority to be granted in tranches, and, in particular, requesting that much of the funding be withheld until the new administration and Congress is in place.  This idea appears to be picking up steam, at least among Democrats.   After the House Financial Services hearing this afternoon, President Bush conceded to including executive compensation caps in the legislation, though Democrats dismissed the development as "irrelevant."[2] The House Democrats have produced a new working draft of their version of the Treasury legislation.  The draft would: Allow extensive oversight of the program by the U.S. Government Accountability Office (GAO), including comprehensive audits and regular reports to Congress starting 60 days after Treasury’s initial use of the purchasing authority and every quarter thereafter; Permit judicial review of Treasury’s actions, which Treasury’s version specifically denied.  The House Democrats’ version would not allow courts to grant injunctive or equitable relief, which could hamstring Treasury’s efforts; Establish contracting procedures requiring the Secretary to solicit proposals broadly when selecting asset managers and instituting more specific conflict of interest provisions; Provide greater assistance to troubled homeowners; Limit the program to United States financial institutions only and specifically exclude foreign government owned institutions; and Impose stricter regulations on corporate governance and executive compensation for all participants in the Treasury program. Timing Senate Majority Leader Harry Reid has stated that he is committed to staying in session past this Friday (the target adjournment date), if need be, to complete action on rescue legislation and other items.  Senator Schumer has predicted that the Senate will vote on the bill this weekend.[3]  Republican leadership predicts a resolution before Rosh Hashanah begins at sundown on Monday.  If a rescue passage is not passed by then, some say it could be shelved until after the election. Cost In prepared testimony, Congressional Budget Office ("CBO") Director Peter Orszag indicated that the plan does not have include enough details to be scored but predicted that the net cost of the plan would be "substantially less than $700 billion."[4]  He also noted, however, that significant short term increases in revenue will be necessary to fund the program.[5] It appears that the proposal will be scored by CBO and likely the Administration not on an outlay basis, but on a credit subsidy basis.  That is the way government loans and loan guarantees are scored.  In this case, CBO and the Office of Management and Budget are likely to view the purchase authority in the bill as a credit instrument in that the government would be buying loans or securities made up of loans.  The actual "score", then, of the legislation, will not be determined by how much Treasury outlays to purchase loans but by how much OMB and CBO estimate the government will lose or gain, over time, in buying and selling assets under the bill. Treasury Guaranty Program Last week, the Treasury Department announced a program to insure money market funds.  We discussed this program in our September 22, 2008 publication, Capital Markets in Crisis: The Government Formulates a Response.  While Treasury’s announced program did not include limits on the guaranty that would apply to a particular eligible money market mutual fund, both House and Senate drafts of broader financial markets rescue legislation would limit the guaranty to the insurance provided to individual depositors under the Federal Deposit Insurance Act.  We understand, however, that new draft legislation will remove the cap placed on the amount of funds insured under the program. Federal Reserve Board Enhances Passive Investment Framework for Minority Investors in Bank Holding Companies and Banks. In connection with its various efforts to increase the capital and liquidity available to the banking industry, the Federal Reserve Board (“Fed”) has issued a new policy statement providing additional guidance on making equity investments in a bank or bank holding company (“BHC”).  Importantly, the issuance only acts to modify certain elements in the Fed’s existing control framework and does not change any other items, for example, the rules relating to aggregation, attribution and acting in concert with respect to investors. On the margin, this enhanced flexibility will benefit investors in BHCs, however, it undoubtedly does not represent the significant changes that were being sought when fund groups petition the Fed to liberalize this area.  For a company, including a hedge fund or private equity fund, the policy statement describes the investment amount and certain other relationships, such as board representation, that may exist without the company being considered to control a BHC and thereby become a BHC itself under the Bank Holding Company Act (“BHC Act”). Under the guidance, a company or fund that is a noncontrolling minority investor (“investor”) may now have a “modicum” of influence over a BHC without it constituting having a “controlling influence over the management or policies” of a BHC.  In this regard, this policy modifies the following elements in the Fed’s control framework consistent with this position. 1.  Director Representation.  An investor may have at least one representative on a BHC’s board of directors.  It may also have two representatives “when the investor’s aggregate director representation is proportionate to its total interest in the banking organization [that is, the greater of the investor’s voting interest or total equity in the organization], but does not exceed 25 percent of the voting members of the board, and another shareholder of the banking organization is a [BHC] that controls the banking organization under the BHC Act.” (footnotes omitted). 2.  Increased Maximum Investment.  An investor may own “a combination of voting and nonvoting shares that, when aggregated, represents less than one-third [33%] of the total equity of the organization (and less than one-third of any class of voting securities, assuming conversion of all convertible nonvoting shares held by the investor) and does not allow the investor to own, hold or vote 15 percent or more of any class of voting securities of the organization.” 3.  Enhanced Consultations with Management.  An investor may communicate and advocate with management for changes in a BHC’s policies or operations such as policies related to mergers, management changes, dividends, debt or equity financing, new business lines, and subsidiary divestitures.  An investor may not make explicit or implicit threats to dispose of shares in the BHC or to sponsor a proxy solicitation as a condition of action or non-action by the BHC or its management in connection with these policy discussions. ____________________    [1]   Steven T. Dennis & Emily Pierce, Bush Push Lacks Traction: Bailout Pitch Lands with a Thud, Roll Call, Sept. 24, 2008.   [2]   Jennifer Bendery, Frank Dismisses Bush Concession on Executive Pay, Roll Call, Sept. 24, 2008.   [3]   Schumer: Senate Has ‘Consensus’ on Need for Bailout Bill, Wall St. J., Sept. 24, 2008.   [4]   Budget Impact of Financial Bailout Remains Murky, Congressional Quarterly, Midday Update, Sept. 24, 2008.   [5]   Jared Allen, CBO Director Says Market Depends on Bailout, The Hill, Sept. 24, 2008.   Gibson Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above.  Please contact Michael Bopp (202-955-8256, mbopp@gibsondunn.com) in the firm’s Washington, D.C. office or any of the following members of the Financial Markets Crisis Group: Public Policy ExpertiseMel Levine (310-557-8098, mlevine@gibsondunn.com)John F. Olson (202-955-8522, jolson@gibsondunn.com)Amy L. Goodman (202-955-8653, agoodman@gibsondunn.com)Alan Platt (202- 887-3660, aplatt@gibsondunn.com)Michael Bopp (202-955-8256, mbopp@gibsondunn.com) Securities Law and Corporate Governance ExpertiseRonald O. Mueller (202-955-8671, rmueller@gibsondunn.com)K. Susan Grafton (202- 887-3554, sgrafton@gibsondunn.com)Brian Lane (202-887-3646, blane@gibsondunn.com)Lewis Ferguson (202- 955-8249, lferguson@gibsondunn.com)Barry Goldsmith (202- 955-8580, bgoldsmith@gibsondunn.com)John H. Sturc (202-955-8243, jsturc@gibsondunn.com)Alan Bannister (212-351-2310, abannister@gibsondunn.com) Financial Institutions Law ExpertiseChuck Muckenfuss (202- 955-8514, cmuckenfuss@gibsondunn.com)Christopher Bellini (202- 887-3693, cbellini@gibsondunn.com)Amy Rudnick (202-955-8210, arudnick@gibsondunn.com) Corporate ExpertiseHoward Adler (202- 955-8589, hadler@gibsondunn.com)Richard Russo (303- 298-5715, rrusso@gibsondunn.com)Dennis Friedman (212- 351-3900, dfriedman@gibsondunn.com)Stephanie Tsacoumis (202-955-8277, stsacoumis@gibsondunn.com)Robert Cunningham (212-351-2308, rcunningham@gibsondunn.com)Joerg Esdorn (212-351-3851, jesdorn@gibsondunn.com)Stewart McDowell (415-393-8322, smcdowell@gibsondunn.com)C. William Thomas, Jr. (202-887-3735, wthomas@gibsondunn.com) Real Estate ExpertiseJesse Sharf (310-552-8512, jsharf@gibsondunn.com)Alan Samson (+44 20 7071 4222, asamson@gibsondunn.com)Andrew Levy (212-351-4037, alevy@gibsondunn.com)Dennis Arnold (213-229-7864, darnold@gibsondunn.com)Andrew Lance (212-351-3871, alance@gibsondunn.com) Crisis Management ExpertiseTheodore J. Boutrous, Jr. (213-229-7804, tboutrous@gibsondunn.com)  Bankruptcy Law ExpertiseMichael Rosenthal (212-351-3969, mrosenthal@gibsondunn.com) Tax Law Expertise Arthur D. Pasternak (202-955-8582, apasternak@gibsondunn.com)Paul Issler (213-229-7763, pissler@gibsondunn.com)   © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 23, 2008 |
Congressional and Administrative Status Update Regarding Economic Bailout

The Gibson, Dunn & Crutcher Financial Markets Crisis Group is tracking closely government responses to the turmoil that has catalyzed dramatic and rapid reshaping of our capital and credit markets. What follows is our latest in a series of updates on key regulatory and legislative issues. Senate Banking Committee Hearing The Senate Banking Committee met today to hear testimony from Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke, Securities and Exchange Commission Chair Chris Cox, and Federal Housing Finance Agency Director James Lockhart. Treasury Secretary Paulson continued to advocate for a narrowly tailored bill without additional corporate governance provisions which could slow down approval of the legislation.  Though he maintained that approval of the legislation needed to be quick and administration of the program efficient, he seemingly relented slightly to congressional demands for stronger oversight of the program.  He stated that Treasury is considering auctioning one asset class at a time.[1]  Finally, he called for economic structural reform to come after the country weathers this initial crisis.[2] Federal Reserve Chairman Bernanke said the $700 billion dollar plan to purchase troubled mortgage backed assets would stabilize the financial markets, and offered a grim picture of the economy if Congress does not act on the legislation.  Bernanke urged that Treasury not buy the assets at "fire-sale" prices, but purchase them at "hold-to-maturity" prices.  Though the lower fire-sale prices would benefit taxpayers when the assets rose again, a massive government purchase of the assets at those prices would depress the market even further. He suggested that an auction mechanism would be the most appropriate way to determine the hold-to-maturity values.[3] SEC Chair Chris Cox focused his testimony on the SEC’s role as a law enforcement agency and discussed the various investigations the SEC has undertaken in the subprime market.  He also urged Congress to give the SEC greater authority to regulate the national market in credit default swaps.[4] FHFA Director James Lockhart discussed the market conditions that he believes led to Fannie Mae and Freddie Mac’s deterioration and the FHFA’s decision to place the government sponsored enterprises into conservatorship.[5] Debate on the Hill Reportedly, the Democrats are pushing for issues such as executive compensation and bankruptcy laws to be addressed in the bailout legislation, while Treasury is focused on producing a more narrowly tailored bill.  Secretary Paulson argues that such provisions could discourage small banks and credit unions, among other institutions, from participating in the program.[6]  At least one compromise option has been suggested, which would apply executive compensation limits only on those firms to which Treasury provides a significant amount of capital.[7]  Republicans primarily are concerned with protecting taxpayers and many have expressed doubts about writing the federal government an enormous blank check to bail out private companies.[8]  Former Speaker of the House Newt Gingrich urged congressional members to vote against Treasury’s bailout plan and predicted that no plan would be passed if one has not been passed by Friday night.[9] During the Banking Committee Hearing, Senator Schumer called for the $700 billion in purchasing authority to be given to Treasury in tranches to better protect taxpayer interests. Congressional members from both parties have proposed postponing their election year recess to stay in Washington and devote more time to the legislation.[10] Other Developments Treasury has agreed to include stricter oversight of the bailout plan and assistance to homeowners facing foreclosure in the bailout plan, which have been two of the Democrat legislators’ main priorities.[11]  The draft tax title of the financial package, released today, would reduce executive compensation deductibility from $1 million to $400,000 for the top five executives of participating corporations and would impose a 20 percent excise tax on golden parachute outlays above a limit set by Treasury.  The tax title would permit many banks to treat their losses from their preferred stock holdings in Fannie Mae and Freddie Mac as ordinary losses which reduce the banks’ need to raise more capital.  The tax provisions also would prevent sales of bad mortgages to Treasury from Real Estate Mortgage Investment Conduits from triggering a 100 percent tax penalty, and would extend a provision from the July housing relief bill that allows homeowners to avoid paying taxes on forgiven mortgage debts.[12] Both Republicans and Democrats have agreed to allow Treasury to take an equity stake in financial institutions that sell assets to the government, though the details of that plan have not been resolved.[13] Yesterday, September 22, the IRS announced that Treasury and the IRS will not assert that the Treasury-initiated program to insure the holdings of money market funds violates any restrictions placed on tax-exempt money market funds.  Thus, eligible money market funds may participate in the Treasury program and still claim their regular benefits from tax exemption. Yesterday, the FHFA announced new chairmen of Fannie Mae and Freddie Mac.  Former Chairman of Ernst & Young, Philip Laskawy, has taken over as the new chair of Fannie Mae, and John Koskinen, former President and CEO of Palmieri Company and former Deputy Director for Management at the OMB has taken over as chair of Freddie Mac.[14] _____________________                  [1]  Bernanke Goes Off Script to Address Fire Sale Risks, Wall St. J., Sept. 23, 2008 at http://online.wsj.com/page/lexis.html ("Real Time Economics" Blog).                 [2]  Testimony of Treasury Secretary Paulson to the Senate Committee on Banking, Housing, and Urban Affairs, Sept. 23, 2008 [http://banking.senate.gov/public/_files/PAULSONTestimony92308.pdf]                 [3]  Bernanke Goes Off Script to Address Fire Sale Risks, Wall St. J., Sept. 23, 2008 at http://online.wsj.com/page/lexis.html (“Real Time Economics” Blog).                 [4]  Transcript of SEC Chairman Chris Cox’s testimony to the Senate Committee on Banking, Housing, and Urban Affairs, Sept. 23, 2008 [http://www.sec.gov/news/testimony/2008/ts092308cc.htm]                 [5]  Testimony of FHFA Director James Lockhart to the Senate Committee on Banking, Housing, and Urban Affairs, Sept. 23, 2008 [http://banking.senate.gov/public/_files/LOCKHARTStmt92308.pdf]                 [6]  Greg Hitt, Deborah Solomon, & Michael M. Phipps, Treasury Relents on Key Points, Wall St. J., Sept. 23, 2008                        [7]  Id.                 [8]  Jackie Kucinich and J. Taylor Rushing, Republicans express more skepticism on bailout plan, The Hill, Sept. 23, 2008;                 [9]  Sam Youngman, Gingrich urges vote against ‘stupid’ Paulson Plan, The Hill, Sept. 23, 2008.                    [10]  Emily Pierce, Senators Wary of Bailout Bill, Roll Call, Sept. 23, 2008.                 [11]  Greg Hitt, Deborah Solomon, & Michael M. Phipps, Treasury Relents on Key Points, Wall St. J., Sept. 23, 2008.                 [12]  CQ Staff, Tax Title to Bailout Bill Targets Executive Pay, CQ Today Online News – Taxes, Sept. 23, 2008.                 [13]  Id.                 [14]  Testimony of FHFA Director James Lockhart to the Senate Committee on Banking, Housing, and Urban Affairs, Sept. 23, 2008 [http://banking.senate.gov/public/_files/LOCKHARTStmt92308.pdf] Gibson, Dunn & Crutcher has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above.  Please contact the attorney with whom you work, Michael Bopp (202-955-8256, mbopp@gibsondunn.com) in the firm’s Washington, D.C. office, or any of the following members of the Financial Markets Crisis Group: Public Policy Expertise Mel Levine (310-557-8098, mlevine@gibsondunn.com)John F. Olson (202-955-8522, jolson@gibsondunn.com)Ronald O. Mueller (202-955-8671, rmueller@gibsondunn.com)Alan Platt (202- 887-3660, aplatt@gibsondunn.com)Michael Bopp (202-955-8256, mbopp@gibsondunn.com) Securities Law and Corporate Governance Expertise Amy L. Goodman (202-955-8653, agoodman@gibsondunn.com)K. Susan Grafton (202- 887-3554, sgrafton@gibsondunn.com)Brian Lane (202-887-3646, blane@gibsondunn.com)Lewis Ferguson (202- 955-8249, lferguson@gibsondunn.com)Barry Goldsmith (202- 955-8580, bgoldsmith@gibsondunn.com) Banking Law Expertise Chuck Muckenfuss (202- 955-8514, cmuckenfuss@gibsondunn.com)Christopher Bellini (202- 887-3693, cbellini@gibsondunn.com)Amy Rudnick (202-955-8210, arudnick@gibsondunn.com) Corporate Expertise Howard Adler (202- 955-8589, hadler@gibsondunn.com)Richard Russo (303- 298-5715, rrusso@gibsondunn.com)Dennis Friedman (212- 351-3900, dfriedman@gibsondunn.com)Stephanie Tsacoumis (202-955-8277, stsacoumis@gibsondunn.com)Robert Cunningham (212-351-2308, rcunningham@gibsondunn.com)Joerg Esdorn (212-351-3851, jesdorn@gibsondunn.com) Real Estate Expertise Jesse Sharf (310-552-8512, jsharf@gibsondunn.com)Alan Samson (+44 20 7071 4222, asamson@gibsondunn.com)Dennis Arnold (213-229-7864, darnold@gibsondunn.com) Bankruptcy Law Expertise Michael Rosenthal (212-351-3969, mrosenthal@gibsondunn.com)   Tax Law Expertise    Arthur D. Pasternak (202-955-8582, apasternak@gibsondunn.com)   © 2008 Gibson, Dunn & Crutcher LLP   Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 22, 2008 |
Capital Markets in Crisis: The Government Formulates a Response

Gibson, Dunn & Crutcher Deploys a Team of Experts Many of our clients are facing new challenges because of the dramatic economic events that have occurred over the last two weeks and as a result of changes that in their scope and reach we have not seen since the Depression.  Financial markets are literally being reshaped in Washington on a real-time basis.  As the Administration and Congress move forward to address the liquidity crisis and related problems, we are positioned to keep our clients apprised of key developments and to ensure that their voices are heard in the debate about how to repair our financial infrastructure. To that end, Gibson, Dunn has assembled a team of attorneys with a broad range of experience in the securities, financial, corporate, real estate, tax, bankruptcy, and public policy fields to shape, monitor, understand, analyze, and respond to developments.  The team roster can be found at the conclusion of this client alert. The Administration recently has taken a number of important steps to help the economy recover.  Among the most critical steps are the following: The Treasury Department has proposed legislation to enable it to support the failing mortgage markets and resume the free flow of credit into the economy; The Federal Reserve has instituted a program to lend money to depository institutions to purchase asset-backed securities; Treasury has initiated a guaranty program for money market funds; and The U.S. Securities and Exchange Commission (the “SEC”) has taken emergency actions to restore fair and orderly markets, including banning naked short selling, prohibiting most short sales in the public-traded securities of certain financial institutions, requiring institutional investment managers to report daily short positions, and lifting restrictions on issuer repurchases. Proposed Treasury Legislation On Friday, September 19th, the Treasury Department circulated  groundbreaking legislation to Congress.  The legislation would grant the Treasury Secretary broad authority to purchase asset-backed securities from financial institutions.  Significantly, the Treasury plan: grants Treasury authority to issue up to $700 billion of Treasury securities to purchase mortgage-related assets and other assets the Secretary deems necessary to stabilize the financial markets.  Though the process for purchasing the securities has not been determined, Treasury is considering auction and reverse auction options; gives Treasury authority to purchase assets originated or issued on or before September 17, 2008.  Treasury’s authority to continue purchasing these assets sunsets after two years;  allows Treasury to purchase asset-backed securities primarily from American institutions, but also from international institutions that have significant operations in America, as well as other institutions the Secretary identifies as necessary to stabilizing the economy;  authorizes Treasury to choose private asset managers who will act as government agents to manage the assets. Treasury will have full discretion over the management; raises the federal debt limit by $700 billion, to $11.315 trillion, to fund this Treasury program.  While members of Congress have expressed a willingness to grant Treasury substantial leeway to conduct this program, the most recent discussions between Congress and the Administration have focused on, among other things, the following: How the program will be overseen; The categories of assets Treasury will be authorized to purchase; Whether the bill should include taxpayer and homeowner mortgage assistance; Executive compensation limits and other corporate governance provisions; and Taxpayer protections. Depository Institution Lending On Friday, September 19, the Federal Reserve announced that it would establish a lending program to assist depository institutions and bank holding companies to purchase asset-backed securities, which will provide liquidity to the asset-backed commercial paper markets.[1]  Eligible borrowers include United States depository institutions, bank holding companies, and United States branches and agencies of foreign banks.  The borrowers may borrow funds to purchase asset-backed commercial paper from funds that qualify as money market mutual funds under Securities and Exchange Commission Rule 2a-7, issued pursuant to the Investment Company Act of 1940.  Eligible issues of asset backed commercial paper are limited to U.S. dollar denominated issues from U.S. issuers which have been rated First-Tier Securities under Rule 2a-7.[2]  The Federal Reserve Bank of Boston will administer the program, but eligible borrowers may settle their loans through their accounts with any Federal Reserve Bank.  Loans made under the program will be made at a rate equal to the primary credit rate in effect on the date the loan is initiated.  Because advances under the program are non-recourse to the Federal Reserve Bank of Boston, borrowers are at no risk of loss unless the asset backed commercial paper is found to be non-conforming.[3]  The program began on September 19, 2008, and will continue until January 30, 2009, unless the Federal Reserve Board extends the program to a later date.[4]  Treasury Guaranty Program for Money Market Funds The Treasury Department has established a temporary guaranty program for money market mutual funds.  For a fee, Treasury will insure the holdings of any eligible publicly offered retail or institutional money market mutual fund for the next year.  Eligible funds include all funds regulated under Rule 2a-7 of the Investment Company Act of 1940 and that are publicly offered and registered with the SEC.  Taxable and tax-exempt funds are eligible, and the guaranty will not affect the tax-exempt treatment of payments by tax-exempt money market funds.  The guaranty will be limited to balances that existed as of the close of business on Friday, September 19, 2008.  Treasury intends for this guaranty to bolster investor confidence and stabilize the global economy by maintaining the standard $1 net asset value of money market mutual funds.  The program will be funded out of the Exchange Stabilization Fund, which currently holds approximately $50 billion of assets.[5]  While Treasury’s announced program did not include limits on the guaranty that would apply to a particular eligible money market mutual fund, both House and Senate drafts of broader capital markets rescue legislation would limit the guaranty to the insurance provided to individual depositors under the Federal Deposit Insurance Act.  SEC Emergency Orders The SEC has issued emergency orders that, among other things: Ban short selling, subject to certain exceptions, in the securities of certain financial institutions selected by the listing markets;[6] Adopt a new antifraud rule, Rule 10b-21, which prohibits naked short selling;[7] Require institutional investment managers (i.e., persons required to file Form 13F), to report daily net short positions beginning September 29, 2008 for trading during the week of September 22, 2008;[8] and Adopt temporary Rule 204T, which imposes hard close out requirements on failures to deliver and mandatory pre-borrow requirements on all equity sales transactions.[9] The emergency orders expire October 2, 2008 unless further extended by the SEC, which has authority to extend the orders until October 18, 2008.  Although Rule 204T was adopted on an interim final basis, the SEC is accepting comments for 30 days. Finally, the SEC issued an emergency order on September 19 which suspended the timing and volume restrictions of Rule 10b-18.  Rule 10b-18 states that repurchases by a company will not be viewed as manipulative if they are effected in accordance with the rule.  The SEC emergency order allows repurchases to be made at any time during the day and raises the volume of permissible repurchases to 100% of the average daily trading volume.  The emergency order does not, however, alleviate potential insider trading concerns, so companies should continue to assess whether they possess any material nonpublic information before they effect discretionary transactions in the open market.  This order will expire on October 2, 2008 unless further extended by the SEC.[10] ____________________    [1]   Press Release, The Board of Governors of the Federal Reserve System, (September 19, 2008), http://www.federalreserve.gov/newsevents/press/monetary/20080919a.htm.   [2]   Federal Reserve Frequently Asked Questions about ABCP MMMF Liquidity Facility (AMLF or "the Facility"), http://www.frbdiscountwindow.org/mmmf.cfm?hdrID=14.   [3]   Id.   [4]   Id.   [5]   More information about the Fund can be found at: http://www.treas.gov/offices/international-affairs/esf/.    [6]   See Exchange Act Release No. 58592 [http://www.sec.gov/rules/other/2008/34-58592.pdf.] and Exchange Act Release No. 58622 [http://www.sec.gov/rules/other/2008/34-58611.pdf.]   [7]   See Exchange Act Release No. 58572 [http://www.sec.gov/rules/other/2008/34-58572.pdf.]   [8]   See Exchange Act Release No. 58591 [http://www.sec.gov/rules/other/2008/34-58591.pdf.]  and Exchange Act Release No. 58591A [http://www.sec.gov/rules/other/2008/34-58591a.pdf.]   [9]   See Exchange Act Release No. 58572 [http://www.sec.gov/rules/other/2008/34-58572.pdf.] [10]   See Exchange Act Release No. 58588 [http://www.sec.gov/rules/other/2008/34-58588.pdf.] Gibson, Dunn has assembled a team of experts who are prepared to meet client needs as they arise in conjunction with the issues discussed above.  Please contact Michael Bopp (202-955-8256, mbopp@gibsondunn.com) in the firm’s Washington, D.C. office or any of the following team members. Public Policy Expertise Mel Levine (310-557-8098, mlevine@gibsondunn.com):  Chairs firm’s Public Policy practice group. He previously served for ten years as a Democratic member of Congress from California. He retains close ties with the leadership of the US Senate and House of Representatives and senior members of the key Committees of the Congress. John F. Olson (202-955-8522, jolson@gibsondunn.com):  Extensive experience in general representation of business organizations as to corporate governance, corporate securities, corporate finance and merger and acquisition matters.  He has counseled many boards of directors and board committees on governance issues and in assessing shareholder litigation, responding to business combination proposals and conducting internal investigations. Ronald O. Mueller (202-955-8671, rmueller@gibsondunn.com):  Strong policy background and extensive experience in areas of securities law and corporate governance. His practice focuses on proxy and disclosure issues, corporate governance, executive compensation and corporate transactions. Alan Platt (202-887-3660, aplatt@gibsondunn.com):  Key member of the firm’s Public Policy Group for the past fifteen years where he has focused on economic issues. Prior to joining the firm, he held senior positions in the US Department of State and the US Senate. He is the author of three books and more than thirty articles on a wide range of international policy issues. Michael Bopp (202-955-8256, mbopp@gibsondunn.com):  Served for more than two years as Associate Director of the White House Office of Management and Budget where he set budgets and coordinated policy for multiple agencies including the Treasury Department, the Department of Housing and Urban Development, the new Federal Housing Financing Agency, and the financial services regulatory agencies.  He also served for eleven years on Capitol Hill running investigations and as a Legislative Director and as Staff Director and Chief Counsel of the Senate Homeland Security and Governmental Affairs Committee.   Michael has extensive high level contacts within the Administration and on Capitol Hill. Securities Law and Corporate Governance Expertise Amy L. Goodman (202-955-8653, agoodman@gibsondunn.com):  Served eleven years on the SEC staff in the Divisions of Corporation Finance and Investment Management and in the Chairman’s office.  In addition to advising clients on securities regulation and disclosure matters, she is a nationally recognized corporate governance expert, advising companies and their boards of directors and board committees on regulatory matters, best practices and D&O insurance and indemnification. K. Susan Grafton (202-887-3554, sgrafton@gibsondunn.com):  Chair of the American Bar Association’s’ Subcommittee on Market Regulation.  Advises broker-dealers, hedge funds and other market participants on a wide variety of sales, trading, financial and operational issues, including Regulation SHO.  Joined the firm after nearly 7 years at Goldman, Sachs & Co., where she advised the Securities Division on sales and trading issues. Brian Lane (202-887-3646, blane@gibsondunn.com):  Extensive expertise in a wide range of SEC issues.  He counsels companies on the most sophisticated corporate governance and regulatory issues under the federal securities laws.  He is a nationally recognized expert in his field as an author, media commentator, and conference speaker. Lewis Ferguson (202-955-8249, lferguson@gibsondunn.com):  Served for more than three yeas as the first General Counsel of the Public Company Accounting Oversight Board where he was in charge of all legal affairs and was involved in drafting the PCAOB’s rules and regulations and auditing standards.  His practice focuses on the representation of accounting and auditing firms and their employees, securities regulation and disclosure issues and corporate governance matters. Barry Goldsmith (202-955-8580, bgoldsmith@gibsondunn.com):  Served as Executive Vice President for Enforcement of the National Association of Securities Dealers (now the Financial Industry Regulatory Authority), the primary private-sector regulator of the country’s securities industry, during a period of major change and enforcement activity on Wall Street.  His practice focuses on the representation of securities firms, broker-dealers, investment companies and investment advisers and other financial institutions and their employees.  He has been recognized as one of the top securities regulatory and enforcement attorneys in the District of Columbia. Banking Law Expertise Chuck Muckenfuss (202-955-8514, cmuckenfuss@gibsondunn.com):  For more than twenty-five years has represented financial institutions in a broad spectrum of regulatory and policy matters.  Before joining the firm in 1981, Mr. Muckenfuss was Senior Deputy Comptroller for policy at the Office of the Comptroller of the Currency (1978-81) and Special Assistant to the Director (1974-77) and Counsel to the Chairman (1977-78) of the Federal Deposit Insurance Corporation. Christopher Bellini (202-887-3693, cbellini@gibsondunn.com):  Co-chairs firm’s financial institutions group.  Advises clients in financial services industry concerning mergers and acquisitions, strategic investments, legislation, regulatory matters and government investigations and enforcement actions.  As counsel to the mutual fund industry, negotiated the compromise with the Federal Reserve Board and other banking agencies on the financial holding company functional regulation provisions of the Gramm-Leach-Bliley Act. Served for five years in the Office of the General Counsel at the Federal Reserve Board and for three years as a senior auditor at Arthur Andersen. Amy Rudnick (202-955-8210, arudnick@gibsondunn.com):  Specializes in representing clients in criminal and regulatory enforcement actions, internal investigations, and compliance and due diligence reviews involving anti-money laundering laws and regulations, including the Bank Secrecy Act, as amended by the USA PATRIOT Act. She counsels financial institution holding companies, domestic and foreign banks, securities broker-dealers, investment companies, insurance companies, hedge funds, finance companies, money services businesses, other financial services businesses, and multinational corporations with respect to risk-based anti-money laundering compliance programs, customer identification and enhanced due diligence procedures, currency transaction and suspicious activity reporting, and other USA PATRIOT Act requirements. Corporate Expertise Howard Adler (202-955-8589, hadler@gibsondunn.com):  Co-chairs the firm’s corporate transactions practice group.  He represents major corporations, investment banks, merchant banks and financial institutions in securities offerings, mergers and acquisitions, joint ventures, venture capital investments, and other matters.  He is regularly listed in legal publications as one of the country’s top corporate lawyers. Richard Russo (303-298-5715, rrusso@gibsondunn.com):  Co-chairs firm’s corporate transactions practice group and is senior corporate partner in firm’s Denver office.  He focuses on the representation of business entities, with emphasis on securities and disclosure matters, mergers and acquisitions, restructurings and corporate governance.  He is regularly listed in legal publications as one of the country’s top corporate lawyers. Dennis Friedman (212-351-3900, dfriedman@gibsondunn.com):  Co-chairs the firm’s mergers and acquisitions practice group.  He has extensive experience, over a legal career of more than thirty years, in mergers and acquisitions, corporate governance, and capital markets.  He served for several years as a an investment banker at major Wall Street firms and as the head of a merchant banking group.  He is regularly listed in legal publications as one of the country’s top corporate lawyers. Stephanie Tsacoumis (202-955-8277, stsacoumis@gibsondunn.com): More than twenty five years’ of experience representing clients in the financial services industry in a broad range of sophisticated transactional and advisory matters.  From her involvement in one of the earliest credit card securitizations to her representation of debtholders in major recapitalizations to handling acquisitions from the Resolution Trust Corporation to representing clients in loan and servicing portfolio transactions to representing underwriters in finance company securities offerings, she has experience in a wide variety of financial services-related matters.  Following the savings and loan crisis in the late 1980’s, Ms. Tsacoumis handled dozens of acquisitions of failed thrifts and thrift assets.  She also was instrumental in assisting the FDIC and RTC revise their forms of asset purchase agreement.  She is regularly listed in legal publications as one of the country’s top corporate lawyers. Robert Cunningham (212-351-2308, rcunningham@gibsondunn.com):  Co-chairs firm’ s global finance practice group.  He has extensive experience in a wide range of financing arrangements, including secured and unsecured, multi-borrower, multi-currency revolving credit, term loan, letter of credit and BA facilities, first lien/second lien financings, acquisition and bridge financings, project financings, restructurings and DIP facilities, bankruptcy exit financings, complex structured financings, asset monetizations and securitizations, leveraged lease financings, and private placements.  He was recently named Vice Chair of the American Bar Association First Lien/Second Lien Model Intercreditor Agreement Task Force. Joerg Esdorn (212-351-3851, jesdorn@gibsondunn.com): Co-Chair of the firm’s Global Finance Group. He focuses on the representation of providers of capital and issuers/borrowers in a wide variety of financing transactions and in workouts and restructurings, including those involving real estate assets. He is regularly listed in legal publications as one of the country’s top finance lawyers.  Real Estate Expertise Jesse Sharf (310-552-8512, jsharf@gibsondunn.com):  Co-chairs firm’s real estate group where he represents financial institutions, investors and developers in all manner of real estate transactions, including acquiring and disposing of portfolios of loans and REO, forming entities to acquire these and other real estate and real estate debt instruments, creating and unwinding complex syndication, participation and other structures used to own real estate and real estate related debt, and workouts and restructurings of real estate transactions.  Alan Samson (+44 20 7071 4222, asamson@gibsondunn.com):  Co-chairs firm’s real estate group.  Based in London and dual UK/US qualified, he represents real estate opportunity funds, financial institutions and private equity investors in the full range of real estate transactions, including acquiring and disposing of portfolios of loans (whole loans, structured pieces and CMBS) and other real estate debt instruments and participations, and workouts and restructurings of real estate transactions. Dennis Arnold (213-229-7864, darnold@gibsondunn.com): Extensive experience in all aspects of commercial and residential real estate and finance, as well as workouts, bankruptcy and debt restructure. He is a nationally recognized expert in real estate, finance, insolvency and commercial law, including significant expertise in UCC remedies and mezzanine loan foreclosures. His primary areas of concentration include real estate, banking and finance, commercial law (including Articles 3, 5 and 9 of the Uniform Commercial Code), workouts, bankruptcy and debt restructure. Bankruptcy Law Expertise Michael Rosenthal (212-351-3969, mrosenthal@gibsondunn.com):  Co-chairs the firm’s business restructuring and reorganization practice group. Focuses on insolvency, corporate reorganization, workouts and debt restructuring matters and has a particular expertise in the representation of debtors, creditors and acquirors of distressed businesses. Among other matters in the financial services sector, he has been heavily involved in the recent failure of a large financial services firm. Tax Law Expertise  Arthur D. Pasternak (202-955-8582, apasternak@gibsondunn.com):  Chairs the firm’s tax practice group.  Areas of expertise include tax advice to domestic corporations and partnerships on U.S. tax issues generally.  Strong background in mergers and acquisitions and in transactions involving major financial institutions.  © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

September 22, 2008 |
Recent Senate Hearing Targets Dividend Tax Avoidance by Large Financial Firms with Offshore Entities

A key Senate investigative body has issued its latest findings in its investigation of alleged abusive tax practices, which is now in its seventh year.  The investigation has examined alleged offshore tax havens, the way tax shelters are promoted, how assets are "hidden" offshore, and, most recently, dividend tax abuse.  While it is not clear where the investigation will focus next, it is highly likely that it will continue.   On September 11, 2008, the Senate Permanent Subcommittee on Investigations issued a report alleging that large financial firms have facilitated the avoidance of U.S. taxes by offshore entities on dividends paid by U.S. corporations.  The subcommittee, which is chaired by Carl M. Levin (D-Mich.), issued its report in connection with a hearing held September 11, 2008.  Representatives of several Wall Street firms testified at the hearing, during which the subcommittee discussed six case studies of alleged abuse of the tax system.  The subcommittee focused on two forms of transactions–equity swaps and stock loans–that allow non-U.S. entities to avoid withholding taxes on dividends paid from U.S. companies.  This most recent hearing is the latest in a series of subcommittee investigations into large U.S. financial firms that offer tax savings to their offshore clients.   Recent Inquiries Conducted by the Permanent Subcommittee on Investigations   The Senate Permanent Subcommittee on Investigations, which has the broadest investigative mission in the Senate, has a history of investigating offshore tax abuses that dates back twenty-five years.  Since 2001, the subcommittee has conducted six separate investigations into offshore tax havens.  The subcommittee typically uses case studies to illustrate different types of alleged tax abuses and customarily calls upon its corporate and individual investigative targets to testify.  The subcommittee has focused both on entities that engage in alleged tax abuses and those who promote them.  Earlier this year, the subcommittee’s staff issued a report criticizing firms for "using an armada of tax attorneys, accountants, bankers, brokers, corporate service providers, trust administrators, and others" to promote "tax havens to U.S. citizens as a means to avoid U.S. taxes."[1] Dividend Tax Abuse Investigation The subcommittee’s most recent report singled out for criticism two types of transactions that allow foreign investors to avoid a withholding tax on U.S.-issued dividends that can be as much as 30% of the amount of the dividend.[2]  The subcommittee asserted that it has found "substantial evidence that U.S. financial institutions knowingly developed, marketed, and implemented a wide range of transactions" aimed at avoiding withholding taxes on dividends paid by U.S. corporations. The first type of transaction is known as an "equity swap," whereby an offshore fund enters into a swap contract with a financial institution.  The financial institution is obligated to pay the total return on the swapped stock, including any gains and dividends paid.  But under a current IRS regulation, the total return swap payments are not subject to the withholding tax that would be due on dividend payments to foreign investors.  The second type of transaction highlighted by the subcommittee is a combination stock loan and swap arrangement between an offshore fund, an offshore subsidiary of a U.S. financial institution and the U.S. financial institution.  Under this transaction, the U.S. corporation makes a total return swap payment to its offshore subsidiary which in turn makes  a "substitute dividend" payment to the offshore fund.  The parties to the arrangement take the position that the substitute dividend payment is not subject to withholding. As Forbes noted after the hearing, the subcommittee’s main targets were the "investment banks that designed and marketed" these products, and "not the offshore investment vehicles that profited from them."[3]  Chairman Levin pointed to the companies’ internal emails, marketing documents, and promotional literature in alleging that the primary motivation behind these two products was purely tax avoidance.  Firm representatives testifying at the hearing were asked to defend their marketing literature that promoted tax savings and to explain the non-tax benefits of equity swaps and stock loans.  What Firms Should Know 1.  The Senate Permanent Subcommittee on Investigations is continuing its investigation of tax abuses that began seven years ago.  The subcommittee is extremely aggressive in conducting its investigations and is not afraid to use its unusually broad subpoena authority. 2.  This most recent phase of the subcommittee’s investigation was the end product of more than a dozen subpoenas and numerous interviews of bank executives, tax lawyers, and hedge fund managers.  In all, the subcommittee compiled its report after reviewing hundreds of thousands of documents gleaned from the financial firms being investigated.  3.  The subcommittee is pressuring the IRS and the Treasury Department to increase their enforcement actions and to revise notices and interpretations of the tax code in order to eliminate offshore dividend tax avoidance.  4.  Firms subject to the subcommittee’s investigative power can be expected to account for marketing literature, internal communications, and other documents that promote tax savings, as well as to explain the non-tax benefits of financial products offered to clients.  They also should anticipate being called as witnesses at a subcommittee hearing. 5.  Firms under investigation should have a clear understanding of the differences between Congressional and other government investigations and should adjust their defense strategies accordingly. One key difference involves the mechanisms used to enforce requests for documents, other information, and testimony. These must be understood in order to make informed decisions on how to respond to Congressional committees. _______________________   [1]   Senate Permanent Subcommittee on Investigations, Staff Report, "Tax Haven Banks and U.S. Tax Compliance," July 17, 2008, p. 17, available at http://hsgac.senate.gov/public/_files/071708PSIReport.pdf.   [2]   The September 11 report issued by the Subcommittee on Permanent Investigations, "Dividend Tax Abuse: How Offshore Entities Dodges Taxes on U.S. Stock Dividends," is available online at http://levin.senate.gov/newsroom/supporting/2008/091108DividendTaxAbuse.pdf.   [3]   Anita Raghavan, "The Tax-Dodge Derivative," Forbes.com, Sept. 11, 2008, available at http://www.forbes.com/businessinthebeltway/2008/09/11/senate-dividends-tax-biz-beltway-cx_ar_0911divtax.html.  Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have about these developments.  Please contact the Gibson Dunn attorney with whom you work, or any of the following:   Michael Bopp (202-955-8256, mbopp@gibsondunn.com) Mel Levine (310-557-8098, mlevine@gibsondunn.com) Arthur D. Pasternak (202-955-8582, apasternak@gibsondunn.com) John H. Sturc (202-955-8243, jsturc@gibsondunn.com)F. Joseph Warin (202-887-3609, fwarin@gibsondunn.com) © 2008 Gibson, Dunn & Crutcher LLP Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

December 17, 2007 |
Internet Gambling Rules Would Enlist Banks to Fight Uphill Battle

Washington, D.C. Partner Amy Rudnick and New York Associate Anthony Mahajan are authors of “Internet Gambling Rules Would Enlist Banks to Fight Uphill Battle” [PDF] published in BNA’s Banking Report.

November 26, 2007 |
Treasury Issues New Bank Secrecy Act Guidance for Casinos and Card Clubs

On November 14, 2007, for the first time in several years, the Department of the Treasury, Financial Crimes Enforcement Network ("FinCEN"), issued Bank Secrecy Act ("BSA") compliance guidance for casinos and card clubs, Frequently Asked Questions:  Casino Recordkeeping, Reporting, and Compliance Program Requirements (FIN-2007-G005).  The guidance, which is in the form of twenty-three questions and answers, addresses questions about what types of gaming establishments are subject to the BSA requirements and questions about compliance with the BSA requirements by casinos and card clubs, including currency transaction reporting (31 C.F.R. § 103.22), recordkeeping (31 C.F.R. §§ 103.33 and 103.36), suspicious activity reporting (31 C.F.R. § 103.21), and maintenance of a BSA compliance program (31 C.F.R. § 103.64). Among the highlights of the guidance, FinCEN concludes that: If state (or tribal) law defines a slot machine or video lottery operation at a racetrack or "racino" as a "casino, gambling casino, or gaming establishment," and the gross annual gaming revenues of the slot machines and video lottery operation exceed $1 million, the operation would be a casino under the BSA subject to all of the BSA requirements for casinos. Establishments in Nevada and tribal jurisdictions that offer only off track betting are casinos under the BSA if the establishments offer "account wagering" and the gross annual gaming revenue exceeds $1 million. However, a horse racetrack that offers pari-mutuel or other wagering only on races at the track would not be considered a casino under the BSA. Unlike coin transactions, paper money transactions for slot club accountholders identified through slot monitoring systems must be aggregated with other "cash-in" transactions for currency transaction reporting ("CTR-C") purposes. If a casino were to "turn off the dollar counter" slot machine feature, it could be subject to an enforcement action under the BSA. Casinos are no longer required to file a CTR-C (FinCEN Form 103) to report slot jackpot wins paid in currency in excess of $10,000. In order to comply with the suspicious activity reporting requirement, as part of its internal controls, a casino or card club must develop procedures for using all available information, including information in its automated systems, surveillance system, and surveillance logs to identify transactions or patterns of suspicious activity. While not required, a casino should develop an internal control to document the basis for its determination that a transaction was determined not to be suspicious after investigation, i.e., a decision not to file a suspicious activity report.  The guidance can be accessed at FinCEN Casino FAQs Final.pdf. Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. Please contact the Gibson Dunn attorney with whom you work, or Amy Rudnick (202-955-8210, arudnick@gibsondunn.com), Linda Noonan (202-887-3595, lnoonan@gibsondunn.com), in the firm’s Washington, D.C. office or Nicola T. Hanna (949-451-4270, nhanna@gibsondunn.com), in the firm’s Orange County office.  © 2007 Gibson, Dunn & Crutcher LLP, 333 South Grand Avenue, Los Angeles, CA 90071 Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.

November 1, 2007 |
The Mixing of Banking and Commerce: A conference summary

Washington, D.C. partner C.F. Muckenfuss III was quoted in the article, "The Mixing of Banking and Commerce: A conference summary" [PDF] published in the November 2007 issue of The Federal Reserve Bank of Chicago’s Chicago Fed Letter.

March 15, 2007 |
U.S. Treasury Department Formally Severs Ties Between U.S. Financial Institutions and Banco Delta Asia

On March 14, 2007, Stuart Levey, the Undersecretary for Terrorism and Financial Intelligence at the U.S. Treasury Department, announced the issuance of a final rule under Section 311 of the USA PATRIOT Act that, in 30 days, will bar U.S. banks and certain other financial institutions from opening, maintaining, or managing correspondent accounts for Macau-based Banco Delta Asia and its subsidiaries (collectively, "BDA"). BDA also will be prohibited from directly or indirectly accessing the U.S. financial system. These measures are identical to the measures imposed against the Commercial Bank of Syria (Syria) and the Syrian Lebanese Commercial Bank (Lebanon) last April.  The announcement follows an 18-month investigation that began when the Treasury Department designated BDA as a financial institution of "primary money laundering concern" in 2005 because of some of its dealings with North Korean clients. Additionally, press reports indicate that the results of this investigation may enable overseas regulators to release some of the approximately $24 million that was frozen following the 2005 designation. Those frozen funds have recently become a major stumbling block in the United States’ negotiations with North Korea regarding its nuclear program.  In September 2005, the Treasury Department designated BDA as a financial institution of "primary money laundering concern" based on its determination that BDA is used to facilitate and promote money laundering and other financial crimes, particularly in connection with alleged North Korean counterfeiting, smuggling, and drug trafficking. At the same time, the Treasury Department issued a Notice of Proposed Rulemaking proposing that U.S. banks and other financial institutions prohibit BDA from directly or indirectly opening or maintaining correspondent accounts in the United States. Following the Treasury Department’s action, many U.S. and foreign banks began voluntarily terminating their relationships with BDA, and the Macanese government intervened, froze all funds held by the bank in accounts relating to North Korea, and cooperated with the Treasury Department’s investigation. The Macanese authorities also took substantial steps to strengthen Macau’s anti-money laundering and anti-terrorist regime.  This issue resurfaced recently when North Korea reportedly linked the release of the frozen funds to its willingness to enter into and abide by an agreement to halt development of its nuclear weapons program.  Undersecretary Levey said that the Treasury Department decided to isolate BDA from the entire U.S. financial system because the investigation confirmed that BDA was willing to turn a blind eye to the illegal activities of some of its clients and that its client due diligence practices were grossly inadequate. The final rule does not target Macau as a jurisdiction of primary money laundering concern; it only targets BDA as a financial institution. The rule applies to U.S. banks, securities broker-dealers, futures commission merchants and introducing brokers, and mutual funds. Because nearly all U.S. financial institutions have already voluntarily terminated their relationships with BDA, the Treasury Department’s action merely should formalize the current situation. However, the covered U.S. financial institutions now also will have to take reasonable due diligence measures, consistent with the regulations, to ensure that the correspondent accounts of other foreign financial institution clients are not being used to conduct transactions on behalf of BDA. In addition, press reports indicate that the conclusion of the investigation and the Treasury Department’s action may pave the way for the Macanese government to release between $8 million and $12 million of the frozen funds because the information gathered during the investigation may assist Macanese authorities in identifying some of the frozen accounts as unlikely to have a connection to illicit activities. This action, in turn, should remove one of the stumbling blocks to reaching an agreement to halt development of North Korea’s nuclear program. Undersecretary Levey did leave open the possibility that the rule could be rescinded in the future if BDA were to address the concerns of the Department and demonstrate responsible management and business practices. * * * * * Gibson, Dunn & Crutcher lawyers are available to assist in addressing any questions you may have regarding these issues. For further information, please contact the Gibson Dunn attorney with whom you work or  Judith A. Lee (202-887-3591, jalee@gibsondunn.com) Daniel J. Plaine (202-955-8286, dplaine@gibsondunn.com)Amy G. Rudnick (202-955-8210, arudnick@gibsondunn.com)Linda Noonan (202-887-3595, lnoonan@gibsondunn.com)Jill S. Henderson (202-955-8220, jhenderson@gibsondunn.com)Patrick Speice (202-887-3776, pspeiceJr@gibsondunn.com) © 2007 Gibson, Dunn & Crutcher LLP The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.