April 2, 2009
The Gibson, Dunn & Crutcher Financial Markets Crisis Group is closely tracking government responses to the turmoil that has catalyzed a 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 Administration’s recent unveiling of a broad regulatory reform framework and a more detailed plan for addressing systemic risk. The Administration also issued draft legislation that would grant the Federal Deposit Insurance Corporation (FDIC) authority to take over and resolve financial holding companies and their non-bank subsidiaries.
The Administration is expected to announce additional components of its regulatory reform proposal over the coming months.
I. Regulatory Reform Framework
On March 26, 2009, the Treasury Department announced a new financial regulatory framework consisting of four reform principles, as follows:
- Addressing systemic risk;
- Protecting consumers and investors;
- Eliminating gaps in our regulatory structure; and
- Fostering international cooperation.
Treasury focused on the first principle — addressing systemic risk — while promising to address the other three in the future.
In testimony on the same day, Secretary Geithner indicated that the new system envisioned by the Administration would be "simpler," "more effectively enforced," rewarding of innovation, and adaptive and yet would "produce a more stable system."
Also on March 26, the Administration released draft language of a bill that would effect one of its goals; providing an appropriate federal entity resolution authority over systemically significant institutions beyond the authority the FDIC now has over banks.
This memorandum reviews the Administration’s plan for addressing systemic risk and explains how regime proposed by the resolution authority bill would operate.
II. Systemic Risk Plan
The systemic risk plan outlined by Secretary Geithner includes the following components:
1) Establishing a single entity responsible for systemic stability of major institutions and payment and settlement systems. The Administration is calling upon Congress to pass legislation that defines systemically significant institutions (SSIs). The proposal makes it clear that SSIs would not be limited to entities that own depository institutions. Rather, SSIs could include insurance companies and other financial institutions including, conceivably, managed funds. The Administration also calls upon Congress to provide stronger regulatory authority over payment and settlement systems.
2) Establishing a more conservative regulatory regime including capital requirements for large interconnected institutions posing systemic risk. The Administration proposal includes more robust capital standards on SSIs as well as more stringent liquidity, counterparty, and credit risk management requirements.
3) Requiring leveraged private investment funds above a certain size to register with the SEC. Invoking the Madoff incident, the Administration calls for hedge and other managed funds over a certain size (unspecified) to register with the SEC. The proposal calls for reporting that would permit the federal government to determine whether a managed fund is so large that its failure could pose a threat to the nation’s financial stability.
4) Establishing a comprehensive framework for oversight of the OTC derivatives market and moving the standardized parts of the market to a central clearinghouse. The Administration would require all standardized derivative contracts to be cleared through regulated central counterparties. The Administration also would "encourage greater use of exchange traded instruments." Non-standardized derivatives contracts would have to be reported to trade repositories and would be subject to disclosure and regulatory standards.
5) Developing strong requirements (under the purview of the SEC) for money market funds to reduce the risks of runs. The Administration proposal calls for more rigorous regulation of money market funds by the SEC but provides few details of the regulation envisioned.
6) Establishing a resolution mechanism for large, non-bank financial institutions. Under this proposal, the Treasury and FDIC would decide whether to assist a struggling institution or put it into conservatorship/receivership. Modeled on the resolution authority of the FDIC over banks, the conservatorship would have broad powers to fundamentally restructure an institution or to sell its assets and liabilities.
III. Resolution Authority for SSIs
Below is a description of how the Administration’s proposed resolution authority over SSIs would function.
Systemic Risk Decision by the FDIC, Fed, and Treasury. Based on a written recommendation of the Federal Reserve Board (Fed) and the "appropriate federal regulatory agency," the Treasury can decide to give authority to the FDIC to take over and resolve any "financial company." The recommendation requires a 2/3 vote of each body and must describe the effect that the default of the financial company would have on economic conditions or financial stability in the United States, as well as the nature and the extent of assistance or actions by the FDIC. The Treasury (in consultation with the President) must determine that
- the financial company is "in default or is in danger of default";
- the failure of the financial company and its resolution under otherwise applicable Federal or State law would have serious adverse effects on financial stability or economic conditions in the United States; and
- actions or assistance would avoid or mitigate such adverse effects.
Treasury and the FDIC will determine whether to provide various types of financial assistance or take over the company with the FDIC as conservator or receiver under broad authority provided. The FDIC is to take into consideration not only the cost to the general fund of the Treasury, but also "the potential to increase moral hazard on the part of creditors and shareholders" of financial companies.
The "appropriate federal regulatory agency" will most often be the FDIC. The FDIC is this agency for any affiliate of an insured bank or insurance company; the SEC for any affiliate of a broker-dealer (not affiliated with a bank or insurer); and the CFTC for any affiliate of a commodities company (not affiliated with a bank, insurer, or broker-dealer).
A "financial company" includes any bank holding company, S&L holding company, financial holding company, a holding company of an insurance company, broker or dealer, or a commodities company, and any subsidiary of any of these companies. Interestingly, though the Administration’s SSI proposal would impose new regulations on large managed funds, the resolution authority would not apply to such funds.
A financial company is "in default or in danger of default" if a bankruptcy proceeding has begun or is likely, the financial company is "critically undercapitalized," it is likely to incur losses depleting all or substantially all of its capital, its assets are likely to be less than its obligations, or it is likely to be unable to pay its obligations in the normal course of business.
FDIC Actions Other Than a Take-Over. The FDIC has broad discretion to extend credit to, to buy assets from, to provide guarantees to, or acquire equity interests in the financial company or any subsidiary. The FDIC can also sell or transfer any acquired assets, liabilities, obligations, equity interests or securities on terms and conditions it deems appropriate.
FDIC Actions as Receiver or Conservator. In general, the FDIC would have very broad powers as receiver or conservator to operate, transfer or liquidate all entities, assets and liabilities it takes over and to "take any action authorized by this section, which the FDIC determines is in the best interests of the covered financial company, its customers, its creditors, its counterparties, or the stability of the financial system." The FDIC’s powers encompass not only the same types of powers it has over insured banks, but also additional specified and incidental powers.
- Stockholders and creditors. All rights and claims of stockholders and creditors of the covered financial company are terminated, except as expressly provided. Secured creditors are generally protected, but only up to the fair market value of their collateral, as determined by the FDIC; detailed provisions address "qualified financial contracts."
- Assistance standards. To the "greatest extent practicable," the FDIC is to operate so as to maximize net present value return, minimize losses, minimize the cost to the Treasury, and "mitigate the potential for serious adverse effects to the financial system and the U.S. economy." It is to give offerors fair and consistent treatment, without discrimination on the basis of race, sex, or ethnic groups.
- Contract repudiation. The FDIC has power to repudiate "burdensome" contracts and leases and is liable only for "actual direct compensatory damages" and no damages for profits or lost opportunity or pain and suffering or punitive damages. Specific provisions address leases and other real estate contracts, service contracts, and "qualified financial contracts" including securities and commodities contracts, derivatives, forward or swaps contracts, and repurchase agreements.
- Continuation of contracts. The FDIC can enforce contracts despite default, termination, or acceleration clauses.
- Fraudulent transfers. Any transfer made within 5 years prior to appointment of the FDIC to an "institution affiliated party" or debtor of the financial company, may be avoided if taken "with the intent to hinder, delay, or defraud the covered financial company or the FDIC."
- Agreements against the interest of the FDIC. No agreement that tends to diminish or defeat the interest of the FDIC as receiver in any asset acquired by the receiver shall be valid against the receiver unless in writing and executed by an authorized officer or representative of the financial company.
Priority of claims.
- Administrative expenses of the receiver.
- Any amounts owed to the United States.
- Any other general or senior liability of the covered financial company.
- Any obligation subordinated to general creditors.
- Any obligation to shareholders or holders of equity interests.
Liability of officers, directors, agents, and service providers. In general, officers and directors may be held "personally liable" for actions for gross negligence or "intentional tortious conduct." Further, in any proceeding related to any claim against a financial company’s director, officer, employee, agent, attorney, accountant, appraiser, or any other party employed by or providing services to a financial company, recoverable damages resulting from the "improvident or otherwise improper use or investment of any financial company’s assets" include principal losses and appropriate interest.
Judicial review of FDIC actions. In general, "no court may take any action to restrain or affect the exercise of powers or functions of the conservator or receiver," unless specifically provided. Further, the express discretion granted the FDIC is likely to lead reviewing courts to give great deference to its determinations and actions. The timing and procedures for seeking judicial review of administrative claims determinations are set forth. Successful claims are deemed administrative expenses eligible for the highest priority in payment.
Bridge Financial Companies. The FDIC can organize a bridge financial company and appoint its board of directors. A bridge financial company is not an agency or instrumentality of the United States. At FDIC’s discretion, it can operate with or without any capital, and have assets and liabilities as transferred by the FDIC. The FDIC can fund this company if it is otherwise not able to get funding. The company shall terminate after 2 years, a period that can be extended for 3 additional 1-year periods. Termination includes the sale of 80 percent, or more, of the capital stock of the bridge financial company to third party.
Foreign investigations. The FDIC can seek assistance of and give assistance to any foreign financial authorities.
FDIC Funding. Resolutions would not be funded by the FDIC deposit insurance fund. The bill appropriates to the FDIC "such sums as are necessary," without fiscal year limitation, subject to the goals of cost minimization and systemic stabilization stated in the bill. The FDIC is empowered to recover funds "not otherwise recouped" through one or more emergency special assessments on financial companies, as imposed in a joint FDIC-Treasury rule.
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)
Dorothee Fischer-Appelt – London (+44 20 7071 4224, dfischerappelt@gibsondunn.com)
Alan Bannister – New York (212-351-2310, abannister@gibsondunn.com)
Adam H. Offenhartz – New York (212-351-3808, aoffenhartz@gibsondunn.com)
Mark K. Schonfeld – New York (212-351-2433, mschonfeld@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)
Dhiya El-Saden – Los Angeles (213-229-7196, delsaden@gibsondunn.com)
Kimble C. Cannon – Los Angeles (213-229-7084, kcannon@gibsondunn.com)
Rachel Couter – London (+44 20 7071 4217, rcouter@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)
Wayne P.J. McArdle – London (+44 20 7071 4237, wmcardle@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)
Jennifer Bellah Maguire – Los Angeles (213-229-7986, jbellah@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)
Fred Pillon – San Francisco (415-393-8241, fpillon@gibsondunn.com)
Dennis Arnold – Los Angeles (213-229-7864, darnold@gibsondunn.com)
Michael F. Sfregola – Los Angeles (213-229-7558, msfregola@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)
David M. Feldman – New York (212-351-2366, dfeldman@gibsondunn.com)
Oscar Garza – Orange County (949-451-3849, ogarza@gibsondunn.com)
Craig H. Millet – Orange County (949-451-3986, cmillet@gibsondunn.com)
Thomas M. Budd – London (+44 20 7071 4234, tbudd@gibsondunn.com)
Gregory A. Campbell – London (+44 20 7071 4236, gcampbell@gibsondunn.com)
Janet M. Weiss – New York (212-351-3988, jweiss@gibsondunn.com)
Matthew J. Williams – New York (212-351-2322, mjwilliams@gibsondunn.com)
J. Eric Wise – New York (212-351-2620, ewise@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)
Charles F. Feldman – New York (212-351-3908, cfeldman@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)
© 2009 Gibson, Dunn & Crutcher LLP
Attorney Advertising: The enclosed materials have been prepared for general informational purposes only and are not intended as legal advice.