[Editor's Note:  The following Post is authored by Kirkland & Ellis LPP's James H.M Sprayregen, Christoper T. Greco, and Neal Paul Donnelly.]

Setting compensation for senior management can be among the most contentious issues facing companies reorganizing under Chapter 11 of the US Bankruptcy Code. Corporate debtors argue that such compensation—often in the form of base salary, bonuses, or stock of the reorganised company–helps retain and incentivize management, whose services are believed necessary to achieve a successful reorganisation. Creditors, by contrast, may be loath to support compensation packages that they perceive as enriching the very managers who led the company into bankruptcy.

This tension over management compensation, though long present in corporate bankruptcy cases, has been more pronounced since 2005, when the US Congress added Section 503(c) to the Bankruptcy Code. Section 503(c) limits bankrupt companies’ freedom to give management retention bonuses, severance payments, or other ancillary compensation. For instance, under the current regime, a company cannot pay managers retention bonuses unless it proves to a bankruptcy court that the managers both provide essential services to the reorganising business and that they have alternative job offers in hand. Even then, the Bankruptcy Code caps the amount of the retention bonuses. Severance payments to managers are similarly restricted by Section 503(c).

Despite these restrictions, companies continue to search for ways to boost managers’ compensation in and around the time of bankruptcy. They do so because retaining existing managers is often the best way to maximise the value of the company in a restructuring. Existing managers typically have valuable institutional knowledge and industry-specific experience that is hard to replace. They may also be vital to preserving relationships with customers, employees, and suppliers. Recognising their value, leaders of bankrupt companies often demand incentives to stay on during bankruptcy. Even where a company would prefer new management, it can be hard to recruit top people to a bankrupt company undergoing a restructuring. Companies must therefore choose how and when to compensate managers without running aground on Section 503(c) and related provisions of the Bankruptcy Code.

Click here to read the complete story.

A group of institutional investors recently filed a class action complaint against some of the world’s largest banks alleging a conspiracy fix prices and monopolize the market for Credit Default Swaps (“CDS”) in violation of the Sherman Act § 1.  Defendants include Bank of America, Barclays, Citibank, and Goldman Sachs.   The complaint also names the International Swaps and Derivatives Association (“ISDA”), a financial trade association, which the complaint alleges is controlled by the defendant banks.  The plaintiffs are claiming potentially billions of dollars in damages.

A credit default swap is a method of transferring the risk of default for a financial instrument.  The purchaser pays a fixed payment to the seller in exchange for the promise to pay off the underlying debt in the event of a default.  The complaint alleges that because of the CDS market structure is unregulated and over the counter, every transaction must be with one of the defendant banks.

The complaint characterizes the CDS market as “starkly divided” between the defendant banks “who control and distort the market” and the plaintiffs “who, in order to participate in the market, must abide their distortions.”  The complaint alleges that this is the result of an opaque trading environment in which the defendant banks manipulate the bid-ask spreads through their negotiations with individual traders.  These manipulations cost the plaintiffs billions of dollars, says the complaint.  Plaintiffs allege that several of their attempts to create and regulated exchange were rebuffed by defendants.

Both the DOJ and the European Commission have been conducting their own investigations into these activities.  In March, the EU indicated that “ISDA may have been involved in a coordinated effort of investment banks to delay or prevent exchanges from entering the credit derivatives business.”

[Editor's Note:  The following is a Wilson Sonsini Goodrich & Rosati Client Alert.]

On Friday, April 12, 2013, the Antitrust Division of the United States Department of Justice announced a reversal in policy relating to its negotiations with companies that plead guilty of criminal antitrust violations.  The new policy significantly affects how the Antitrust Division will approach the plea negotiation process and enforce the criminal antitrust laws.

First, the Antitrust Division announced that it would no longer publicly disclose the names of individuals excluded (or “carved out”) from the non-prosecution provision of company plea agreements.  This provision protects the company and its employees from further prosecution under the antitrust laws for the conduct at issue (a core benefit for companies entering into the plea), but some employees typically are carved out from this protection.  Prior to the announcement last week, the Antitrust Division had a long-standing practice of disclosing the names of these carve-out employees in the plea agreement, a practice that some have called a “perp walk.”  The division now has put an end to this practice, recognizing that “[a]bsent some significant justification, it is ordinarily not appropriate to publicly identify uncharged third-party wrongdoers.”

Second, the Antitrust Division announced that it no longer would carve out individuals from pleas merely for not cooperating in its investigation.  Instead, the division will carve out only those individuals who are “potential targets” of the investigation (i.e., only those whom the division has reason to believe were engaged in the criminal conduct at issue and targets for potential prosecution).  Prior to the announcement, the Antitrust Division had a long-standing practice of carving out from the non-prosecution protection of a plea agreement two categories of individuals:  (1) those the division has reason to believe were involved in criminal wrongdoing (i.e., potential targets) and (2) those who are uncooperative in its investigation or are difficult to find or contact.  Under the new policy, the division will limit the carve-outs to the first category of individuals.  The Assistant Attorney General of the Antitrust Division, Bill Baer, elaborated publicly, stating:  ”I reached the conclusion that . . . focusing on the group of people who are potentially targets of the investigation, potentially liable, [and] can be charged [] was a better way of defining our carve-out groups.”

To read the rest of the WSGR Article, click here.

More is better – or so it’s said.  That’s bad news for Dell stockholders, as the Blackstone Group has dropped its bid for the company.  Blackstone had not formally announced an offer to compete with the $13.65 per share Michael Dell hopes will take the company private.  Through the due diligence process, Blackstone became unsatisfied with the world’s third-largest PC maker’s rapidly-atrophying marketshare—notably including a 14% decline in PC volume during 2013 Q1.  With Blackstone out, the activist investor Carl Icahn is the only likely competitor.  Mr. Icahn has preliminarily discussed a $15-per-share offer, but has not yet put it on the table.  For more, see NYTimes and Business Insider.

AIG v. BAC is headed to New York state court.  American International Group’s $10 billion lawsuit against Bank of America, filed in August 2011, alleges “fraudulent misrepresentations” regarding $28 billion in residential MBSs (mortgage-backed securities) which resulted in heavy losses for the insurer.  The merits of the case have been stalled as each side has jockeyed for jurisdictional advantage.  The Second Circuit Court of Appeal ruled this morning that the lower court had improperly denied AIG’s motion the case to state court.  For more, see Reuters.

[Editor's Note:  This post is a Latham & Watkins Client Advisory.  The Network has further coverage in another post.]

On March 21, 2013, the Staff of the Division of Trading and Markets of the US Securities and Exchange Commission published guidance in the form of Frequently Asked Questions on Rule 15a-6 under the Securities Exchange Act of 1934.

The FAQs resulted from the efforts of a Task Force assembled by the Trading and Markets Subcommittee of the American Bar Association to discuss and seek clarification from the Staff with respect to certain recurring issues regarding Rule 15a-6.  This clarification was requested in the form of published FAQs to provide greater transparency to the industry and to resolve certain inconsistencies created by, among other things, Staff turnover and general confusion by the industry and other regulators as to the proper application of the Rule’s rather complex provisions to a marketplace that has become markedly more global and technologically advanced in the nearly 25 years since the Rule’s adoption.

In the FAQs, the Staff affirms the general applicability of certain previously issued interpretive guidance and addresses certain aspects of the operation of Rule 15a-6, primarily with respect to issues concerning solicitation, the dissemination of research reports, recordkeeping requirements and chaperoning arrangements between foreign broker-dealers and SEC-registered broker-dealers. Although necessarily limited in scope, the FAQs provide much welcome guidance at a time when cross-border transactions have become an integral part of the securities markets.

Background

Rule 15a-6 permits foreign broker-dealers to conduct certain limited activities in the United States and with US persons without having to register as a broker or dealer under the Exchange Act. Under Rule 15a-6, foreign broker-dealers may (i) effect “unsolicited” transactions with any person; (ii) solicit and effect securities transactions with SEC-registered broker-dealers, US banks acting in compliance with certain exceptions from the definitions of “broker” and “dealer”, certain supranational organizations, foreign persons temporarily present in the United States, US citizens resident abroad and foreign branches and agencies of US persons; and (iii) subject to a number of conditions, provide research to and effect resulting securities transactions with certain types of large institutional investors.  Rule 15a-6 also provides that a foreign broker-dealer may engage in a broader scope of activities, including soliciting and entering into transactions with specified categories of institutional investors, with the assistance or intermediation of an SEC registered broker-dealer (the establishment of such an arrangement is typically referred to as a “chaperoning arrangement” and the SEC-registered broker-dealer is often referred to as the “chaperoning broker-dealer”).

To read the rest of this Client Advisory, please click here and search the Advisory number “1495.”

In Levitt v. J.P. Morgan Sec., Inc., 10-4596-CV, 2013 WL 1007678 (2d Cir. Mar. 15, 2013), the Second Circuit reversed a district court’s grant of class certification to a group of plaintiffs who alleged that Bear Sterns (subsequently bought by J.P. Morgan) had violated its duty to disclose when it did not notify investors of a fraudulent scheme by Sterling Foster, a now-defunct brokerage firm.

The case concerned allegations of fraud arising from a September 1996 IPO of ML Direct, a television marketing firm.  Sterling Foster orchestrated the IPO as the introducing broker, with Bear Sterns (subsequently acquired by J.P. Morgan) acting as the clearing broker.  In general, the clearing broker in a transaction owes no duty of disclosure to the customers of the introducing broker.  However, the plaintiffs sought to overcome this hurdle by establishing that Bear Sterns actively participated in the fraudulent scheme.

The district court agreed with the plaintiffs that Bear Sterns’s participation was extensive enough to trigger a duty to disclose.  However, the Second Circuit held that the plaintiffs had failed to allege “sufficiently direct involvement” by Bear Sterns.

The Second Circuit noted that providing “normal clearing services” do not give rise to a duty to disclose, even when the broker providing those services is aware of the introducing broker’s fraudulent intentions.  Rather, to trigger a disclosure duty, the clearing broker would have to actively depart from its normal passive clearing functions and affirmatively exert “direct control” over the introducing broker and the fraudulent trades.  The court found that Bear Sterns, by merely “allowing” such trades to proceed, had not assumed such a level of control.

The plaintiffs’ counsel characterized the ruling as “a sad day for investor protection,” stating that the court had “has for the first time held that a clearing firm has no duty to disclose that it is knowingly participating in market manipulation by its introducing broker.”

The court, however, carefully declined to address the legal implications of “market manipulation itself” on the duty to disclose, confining itself to its factual conclusion that Bear Sterns did not directly engage in such manipulation.  Underscoring the narrowness of the Second Circuit’s ruling, the New York district court refused to apply Levitt to a case where a defendant had made misleading statements, holding that the making of misleading statements constituted direct involvement.  The same district court has also recently observed that the question of market manipulation remains open.

[Editor’s Note:  The following is an Arnold & Porter LLP Client Advisory, written by Robert E. Holton, Lily J. Lu, D. Grant Vingoe, and Lauren R. Bittman.]

SEC official reminds private funds, including contacts private equity funds, that certain fund-raising and marketing activities and fees for “investment banking activities” require broker-dealer registration.

On April 5, 2013, David Blass, Chief Counsel of the Division of Trading and Markets of the Securities and Exchange Commission (SEC), spoke before the Trading and Markets Subcommittee of the American Bar Association on broker-dealer registration issues that arise in the private funds context. In his remarks, Mr. Blass warned that acting as an unregistered broker-dealer is a violation of the Securities Exchange Act of 1934, as amended (the Exchange Act), and can have serious consequences, including sanctions by the SEC and rescission rights, even when no other wrong-doing is found. Mr. Blass also noted that the SEC staff has increased its attention to the issue of broker-dealer registration, and he reminded the audience that compliance by private fund advisers with the requirements of the Investment Advisers Act of 1940, as amended, is not enough. In light of the significant consequences of acting as an unregistered broker-dealer and the SEC staff’s increased attention to this issue and the private fund space in general, private fund advisers should review their fund-raising and marketing activities, policies and procedures and contracts and arrangements with portfolio companies and solicitors to ensure compliance.

Click here to read the entire Arnold & Porter Advisory.

[Editor's Note:  The following post is a Kirkland & Ellis M&A Update, authored by Daniel E.Wolf, Sarkis Jebejian, Joshua M. Zachariah, and David B. Feirstein.]

With valuations stabilizing and the M&A market heating up, a rebirth of stock-for-stock deals, after a long period of dominance for all-cash transactions, may bein the offing.

If this happens, we expect to see renewed use of the term “merger of equals” (MOE) to describe some of these all-equity combinations.  As a starting point, it may be helpful to define what an MOE is and, equally important, what it isn’t.  The term itself lacks legal significance or definition, with no requirements to qualify as an MOE and no specific rules and doctrines applicable as a result of the label.  Rather, the designation is mostly about market perception (and attempts to shape that perception), with the intent of presenting the deal as a combination of two relatively equal enterprises rather than a takeover of one by the other.  That said, MOEs generally share certain common characteristics.  First, a significant percentage of the equity of the surviving company will be received by each party’s shareholders.  Second, a low or no premium to the pre-announcement priceis paid to shareholders of the parties. Finally, there is some meaningful sharing or participation by both parties in “social” aspects of the surviving company.

While each of the aspects of an MOE deal will fall along a continuum of “equality” for the shareholders of each party, there are a handful of key issues that require special attention in an MOE transaction.  

Click here to read the entire Kirkland & Ellis LLP publication, discussing Social Issues, Change of Control, Shareholder Vote/Fiduciary Issues, Consideration, and Agreements.

On April 3, 2013, the Berkeley Center for Law, Business and the Economy (BCLBE) hosted a Social Entrepreneurship: Legal, Financial and Public Policy Dimensions panel moderated by Professor Eric Talley.  Panelists included legal experts R. Todd Johnson (Partner, Jones Days), Jonathan Storper (Partner, Hanson Bridgett), Kyle Westaway (Founder of Westaway Law) and Jordan Breslow (General Counsel at New Island Capital) as well as Vince Siciliano (CEO and President of the New Resources Bank).

Talley began by asking for a definition of social entrepreneurship.  Johnson offered “any organization that makes money and does social good” and Siciliano added “maximizing distribution [for a given product] while being profitable” as social enterprises attempt to maximize social impact for a given product or service.  Breslow, who works for an impact investment advisor, talked about how one of the downsides of a nonprofit, as compared to a social enterprise, is that “in giving money away [investors] lose control.”

Measuring profits is straightforward but measuring social impact is not always so easy.  However, as Johnson notes, “we need to get past the head-scratching period of asking ‘how do we measure impact’ that comes from looking at social entrepreneurship as a sector. It’s not a sector. It’s a way of doing business.”  Social impact can be applied to any business sector — health care, education, technology, etc. For some sectors, the impact equation is simple. For example, d.light solar sells solar light and power products so it is “relatively easy to calculate how much kerosene and therefore CO2 is avoided by its products.”  It is harder for other sectors, such as services, or where impact is based upon human transformation or long-term goals. “Sometimes the outcome should be obvious, but is simply hard (or expensive to capture) such as greening of supply chains.”  Westaway agreed noting that he “applauds the idea of standardization but it is hard to do.”

Talley asked the panelist to assess whether these types of enterprises are more risky than others, that perhaps, do not consider their social impact. Siciliano suggested that some social enterprises may be considered risky by traditional investors because they are not well understood.  “As a commercial bank, one of the New Resource Bank’s competitive advantages” he explained “is its sector expertise.” He offers that it is not about the risk of the underlying business model as much as that traditional commercial banks assess high risk to these enterprises because of their limited exposure to some of the new sectors these enterprises are operating in. “We don’t view these companies as risky because we better understand their markets and stage of growth.” Specific industry examples include organic products, alternative energy, energy efficiency retrofits, green real estate, and nonprofits.

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The Obama Administration has continued its aggressive prosecution of suspect players in the financial meltdown that shaped most of the President’s first term.

Four mortgage insurers, including an AIG subsidiary, have agreed to a $15 million settlement over allegations of improper ‘kickbacks’ paid to lenders for more than a decade.  The Consumer Financial Protection Bureau made the announcement today.  Its director, Richard Cordray, charged, “We believe these mortgage insurance companies funneled millions of dollars to mortgage lenders for well over a decade.”  For more, see the NYTimesand WSJ.

Also today, the U.S. Department of Justice filed a fraud suit against Golden First Mortgage Corp, alleging the company and its CEO “repeatedly lied” to the government.  The complaint claims that Golden First rushed paperwork through internally, although the company certified (to HUD and the FHA) that proper due diligence had been conducted.  According to the government, Golden First used three employees to process 100-200 loans per month—predictably leading to “extraordinarily high” default rates as high as 60% in 2007.  For more, see Thomson Reuters.

On a related note, district court Judge Victor Marrero (S.D.N.Y.) indicated that he may not accept a “neither admit nor deny” provision in SAC Capital Advisor’s insider trading settlement.  At a hearing last week, he made a point unlikely to encounter much resistance:  “There is something counterintuitive and incongruous in a party agreeing to settle a case for $600 million that might cost $1 million to defend and litigate if it truly did nothing wrong.”  Judge Marrero is not the first to question these clauses – commonly demanded by corporate litigants – but his remarks demonstrate a growing judicial skepticism with the practice.  For more, see Businessweek, Reuters, and The New Yorker.