April 21, 2010

Judicial Conference Raises Concerns About Dodd Bill

The Judicial Conference of the United States, the policy arm of the Federal judiciary, has written to Senate Judiciary Committee Chairman Pat Leahy (D-Vt.), expressing several important concerns about the effect of the legislation on the bankruptcy courts and the administration of justice.  James C. Duff's letter on behalf of the Conference notes that the bill as drafted would create an unprecedented new structure within the bankruptcy court for the District of Delaware for the purpose of ruling on a petition by the Treasury Secretary to appoint the FDIC as receiver for a failing financial firm; this might result in the removal of a case from the jurisdiction of the bankruptcy court without adequate notice and due process to affected creditors.  'Any resulting due process challenges would impose a significant burden on the courts to resolve novel issues, for which the bill provides no guidance', the letter states. The Duff letter further questioned the bill's selection of Delaware as the exclusive venue choice to deal with petitions regarding failing financial firms, noting that it may not be the proper venue under current law.  Other doubts are raised about the bill's attempt to designate three judges from Delaware's current roster of judges to the 'Orderly Liquidation Authority Panel' and the bill's limited review permitted for decisions by the Secretary to place a firm in FDIC receivership.  The letter notes that such a review may exceed the constitutional authority of the bankruptcy courts and in any event seems anomalous since designating the FDIC as receiver removes the case from the bankruptcy court and bankruptcy laws.  Among several other concerns, the letter also criticized the bill's 24-hour deadline for review by the Panel of the Secretary's decision to appoint the FDIC, concluding: '... the statutory requirement of such speed seems inconsistent with the thoughtful deliberation that would be appropriate for a decision of such great significance.'  Click here to read the full letter.

Senate Agricultural Committee Readies Derivatives Limits

The Senate Agriculture Committee today will vote on a bill that would add new restrictions to derivatives trading, the Deal Pipeline reported yesterday. The measure is a critical component of Washington's efforts to overhaul regulation in the wake of the financial crisis and is one of the most controversial of the reform effort. Senate Majority Leader Harry Reid (D-Nev.) plans to merge the derivatives bill into broader reform legislation already passed by the Senate Banking Committee when the larger bill is brought to the Senate floor, perhaps as early as Thursday. The derivatives bill, authored by Sen. Blanche Lincoln (D-Kan.) would force the vast majority of over-the-counter derivatives trading onto an exchange or central clearinghouse, with only narrow exemption for end users of commodities such as oil, agricultural products and metals who engage in hedging practices to insulate their day-to-day operations from swings in the market prices of the inputs used in their businesses. Read more. (Subscription required.)

Commentary: Bankruptcy Reform Will Limit Bailouts

Another avenue that lawmakers could examine in formulating new financial regulations would be to link bankruptcy reform to the proposed framework for regulating derivatives, according to a commentary today in the Wall Street Journal by Prof. Thomas Jackson of the University of Rochester and Prof. David Skeel of the University of Pennsylvania Law School. Derivative contracts are largely unregulated today, in part because both parties to most of the contracts are banks and other large financial institutions that were thought to be well able to protect themselves. Both the Dodd bill and the companion legislation that Sen. Blanche Lincoln (D-Ark.) has introduced in the Agriculture Committee would subject derivatives to two related kinds of regulation. First, rather than being treated as private contracts between two parties, most would be traded on public exchanges like the stock of Microsoft or General Electric. Second, a clearinghouse would serve as a middleman, assessing the creditworthiness of both parties and standing by to step in if either party failed to make good on a contract. Putting derivatives on exchanges would increase their transparency, and clearinghouses would eliminate the risk that an institution like Lehman or AIG, with thousands of derivatives, could paralyze the financial markets if it defaulted on these contracts. However, many derivative contracts are so specialized, according to the commentary, that they cannot realistically be converted into plain vanilla, exchange-traded instruments. Yet the treatment of derivatives in bankruptcy was a major excuse for the now-discredited bailouts of the 2008 financial crisis. A series of amendments to the bankruptcy laws starting in the 1980s and running through 2006 exempted derivatives from this and other core bankruptcy rules. Officials in both political parties thought that any interference with these contracts could undermine confidence in the derivatives markets. What we now know is that the threat to the financial system is much greater if thousands of contracts could be terminated and other parties tried to sell the assets that are collateralizing them all at the same time. This could create a huge downward pressure on asset values. Simply flipping the switch and giving derivatives the same treatment as other contracts in bankruptcy, according to the commentary, could break the impasse on derivatives regulation. Read the full commentary. (Subscription required.)

Hoyer Says Failure Fund 'Not Central' to Financial Reform

A top House Democrat said yesterday that a fund prepaid by the country's largest banks to cover the costs of unwinding one of them in the future is 'not central' to plans to overhaul the regulation of the financial sector, Dow Jones Daily Bankruptcy Review reported today. Casting further doubt on whether the fund would make the final cut of the regulatory-rewrite bill, House Majority Leader Steny Hoyer (D-Md.) said that he could support a bill that didn't include the provision.Senate legislation authored by Banking Committee Chairman Christopher Dodd (D., Conn.) would require large financial firms to contribute to a $50 billion fund up front that would be used in the event a future crisis caused a major financial institution to fail. The House bill includes a larger fund of $150 billion for the same purpose. Regardless of its size, the fund has emerged as a key sticking point as Senate Democrats seek to win the support of Republicans for the regulatory-overhaul legislation. Proponents, including Federal Deposit Insurance Corp. Chairman Sheila Bair, have argued that the government should have the funds necessary - paid for by large financial institutions - to shut down a failing financial firm if necessary. Republican leaders, including Minority Leader Mitch McConnell (R-Ky.), have said its mere existence could retain the belief in the financial markets that some firms are 'too big to fail.'

SEC Considers New Rules on Bank Debt

The Securities and Exchange Commission is considering new rules that would prevent financial firms from masking the risks they take by temporarily lowering their debt levels before quarterly reports to the public are due, the Wall Street Journal reported today. SEC Chairwoman Mary Schapiro's disclosure, at a hearing of the House Committee on Financial Services, came two weeks after the Wall Street Journal reported that 18 large banks had consistently lowered one type of debt at the end of each of the past five quarters, reducing it on average by 42 percent from quarterly peaks. That practice, if done intentionally to deceive, already violates SEC guidelines, an official said. But now, the SEC is weighing requiring stricter disclosure and a clearer rationale from firms about their quarter-end borrowing activities. The agency may also extend these rules to all companies, not just banks. Read more. (Subscription required.)

In related news, the Financial Accounting Standards Board, which sets U.S. accounting rules, will consider whether to change repo accounting rules after U.S. securities regulators finish a review of current practices at U.S. banks and financial firms, Reuters reported yesterday. In written testimony released by the U.S. House Financial Services Committee on Tuesday, FASB Chairman Robert Herz said the board would 'work closely' with the U.S. Securities and Exchange Commission to decide whether any changes to accounting rules are necessary after accounting practices employed by Lehman Brothers Holdings Inc. known as 'Repo 105' and 'Repo 108' have come under fire. According to a report released by Lehman's court-appointed examiner, Anton Valukas, in March, Lehman accounted for Repo 105 and Repo 108 transactions as sales, without disclosing that practice to investors and regulators. The transactions allowed Lehman to temporarily remove some $50 billion in assets from its balance sheet, presenting a stronger financial picture than existed, according to the report. The SEC has since asked several large financial firms to provide information on their repo activities over the past few years. Read more.

Judge Approves Lenders' Chapter 11 Plan For Young Broadcasting

Bankruptcy Judge Arthur J. Gonzales on Monday approved Young Broadcasting Inc.'s lenders' plan to bring the company out of bankruptcy over a rival bid put forth by the TV-station owner's bondholders, Dow Jones Daily Bankruptcy Review reported today. Judge Gonzales rejected the rival plan filed by Young Broadcasting's creditors' committee, which included representatives of bondholders who will see their investment in $484 million of bond debt all but wiped out - because of his skepticism about the company's ability to repay its loans when they mature 2 1/2 years from now. The committee's plan called for the reinstatement of the senior lenders' loans, which would have to be paid off in November 2012, through either a sale or a refinancing. Judge Gonzales's confirmation of the plan puts the company on track to emerge from bankruptcy more than eight months after he approved the lenders' $220 million purchase of Young Broadcasting last July. The judge had insisted, however, that the sale be consummated through a confirmed reorganization plan rather than through a 363 sale.

Smurfit Stone, Shareholders Begin Debate on Bankruptcy Plan

Bankrupt packaging company Smurfit Stone Container Corp. began a legal battle with shareholders today that will hinge on whether it undervalued its business, unfairly wiping out its stock, Reuters reported yesterday. Smurfit, the second-largest containerboard producer in North America, has gotten creditor approval for its plan to reorganize the company by paying secured lenders in cash and giving unsecured claim holders equity in the company. The plan, which Smurfit presented in court yesterday, proposes to wipe out shareholders' stakes. The company's analysis values the business at as little as $3.4 billion, below $4.4 billion in claims that Smurfit said take priority over shareholders. Shareholders hired experts who established a value at as much as $5.8 billion, according to court documents. Read more.

Chrysler Lost $4 Billion but Sees Signs of Improvement

Chrysler said today that it had lost $4 billion since emerging from bankruptcy protection almost a year ago, but also reported positive cash flow and a small operating profit in the first quarter of 2010, the New York Times reported today. The results are the first official look at the U.S. automaker?s finances since it came out of bankruptcy June 10 under the control of the Italian automaker Fiat. The chief executive of both companies, Sergio Marchionne, said Chrysler is on track to meet its 2010 targets, including a break-even-or-better performance, when excluding one-time charges. On that basis, Chrysler earned $143 million in the first quarter on revenue of $9.7 billion. Counting one-off charges, Chrysler lost $197 million in the first quarter, mostly due to interest payments, compared with a $2.5 billion loss in the fourth quarter. Read more.

Paulson Confronts Goldman Fallout

John Paulson hasn't been accused of any wrongdoing, but the hedge-fund billionaire has gone on the offensive to reassure investors that his huge firm will emerge unscathed from a case that has drawn him into a political and legal vortex, the Wall Street Journal reported today. The steps, including a conference call with about 100 investors late Monday, come amid indications from some clients that they might withdraw money from his firm after a lawsuit brought by the government against Goldman Sachs Group Inc. related to an investment created at his firm's request. Paulson sent a letter to investors yesterday saying that in 2007 his firm wasn't seen as an experienced mortgage investor, and that 'many of the most sophisticated investors in the world' were 'more than willing to bet against us.' Read more.(Subscription required.)

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