Month: September 2009

New Rules Ease the Restructuring of CMBS Loans

real-estate-roundtable

The Treasury Department released new tax rules that make it easier for property owners to restructure loans that were packaged and sold as Commercial Mortgage Backed Securities. The IRS passed relief for residential mortgage packed securities in May, 2008.

Until now, tax rules have made it impossible for borrowers who are not in default to hold restructuring talks. Altering the terms of a mortgage that is part of a CMBS has a nuclear tax result. Only those loans that are actually delinquent could be modified. The loan servicers were unable to modify terms to prevent a default.

The new guidance from the Treasury makes it clear discussions involving lowering the interest rate or stretching out the loan term “may occur at any time” without triggering tax consequences. In addition, the guidance allows servicers to modify loans regardless of when they mature. The servicer only has to believe there is “a significant risk of default” upon maturity of the loan or at an earlier date and that  “the modified loan presents a substantially reduced risk of default”.

The IRS also issued final regulations that expand the list of permitted loan modifications to include certain modifications that are often made to commercial mortgages. The regulations expand this list of permitted exceptions to include changes in collateral, guarantees, and credit enhancement of an obligation and changes to the recourse nature of an obligation.

References:

Corporate and Financial Institution Compensation Fairness Act of 2009

Capitol_dome

I had largely ignored the Corporate and Financial Institution Compensation Fairness Act of 2009 (H. R. 3269) thinking it was limited to public companies and banks. I was surprised to find that it also sweeps up investment advisers, and therefore private investment funds, with assets greater than $1 billion.

The bill does focus mostly on public companies and gives shareholders a “say on pay.” But I just noticed that the bill would have an impact on private investment funds.

Section 4, Enhanced Compensation Structure Reporting to Reduce Perverse Incentives, provides

“the appropriate Federal regulators jointly shall prescribe regulations to require each covered financial institution to disclose to the appropriate Federal regulator the structures of all incentive-based compensation arrangements offered by such covered financial institutions …”

The definition of covered financial institution includes: “an investment advisor, as such term is defined in section 202(a)(11) of the Investment Advisers Act of 1940 (15 U.S.C. 80b-2(a)(11))”. There is a later exemption for covered financial institutions with assets of less than $1,000,000,000.

The bill would empower federal regulators to:

“prescribe regulations that prohibit any incentive-based payment arrangement, or any feature of any such arrangement, that the regulators determine encourages inappropriate risks by covered financial institutions that–

  1. could threaten the safety and soundness of covered financial institutions; or
  2. could have serious adverse effects on economic conditions or financial stability.”

It seems like Congress wants to be able to limit the compensation for investment advisers, hedge fund managers, the managers of other private investment funds.

The bill was passed by the House on July 31. The Senate has not yet taken it into consideration.

References:

Image is from Wikimedia Commons: US Capitol Dome Jan 2006.

The Collapse of AIG

AIG

There have been many stories about the collapse of AIG. There have also been many stories about the internal flaws at AIG. The pitchforks were out when bonuses were announced in March. One of those executives was Jake DeSantis who wrote a New York Times OP-ED about his bonus. (AIG Bonus – My Thoughts) It turns out that Mr. DeSantis also contacted Michael Lewis.

The end result is a story in the August issue of Vanity Fair: The Man Who Crashed the World. As you can guess from the title, Lewis pins much of the blame on one man: Joe Cassano, the former president of AIG Financial Products.

After reading the article, I am not sure it’s fair to pin so much blame on Mr. Cassona. The article does provide a great deal of insight and clarity into the interconnections between AIG, sub-prime lending, credit default swaps, and the collapse of US house prices.

“There was a natural role for a blue-chip corporation with the highest credit rating to stand in the middle of swaps and long-term options and the other risk-spawning innovations. The traits required of this corporation were that it not be a bank—and thus subject to bank regulation and the need to reserve capital against the risky assets—and that it be willing and able to bury exotic risks on its balance sheet. There was no real reason that company had to be A.I.G.; it could have been any AAA-rated entity with a huge balance sheet. Berkshire Hathaway, for instance, or General Electric. A.I.G. just got there first.”

At first, credit default swaps were mostly for commercial credit risk. Then, they started to expanding to consumer credit risk. The thought inside AIG Financial Products was that it was sufficiently diverse that it was unlikely to all bad at once.  At first, the consumer products did not include sub-prime loans. Then, in 2004, the less credit-worthy sub-prime loans started becoming part of the credit pools.  They eventually pulled the plug, feeling confident that their 2005 risks would not suffer any credit losses. (They were wrong.)

The bigger problem came when AIG lost its AAA rating, the day after Hank Greenberg was forced to resign. With its AAA rating, AIG has resisted being required to post collateral to back up its outstanding obligations under the derivative products it was selling. With a downgrade in its credit rating, it had agreed to post collateral. When the debt AIG insured started going bad, AIG had to put up cash collateral to back up its obligations. There was the equivalent of a run on a bank.

Lewis alludes to AIG’s risk-taking for residential loans may have been one of the factors that contributed to the dramatic run up in house prices, that eventually lead to more sub-prime borrowing, to a further increase in home prices and to more bad debt. That liquidity and poor underwriting lead to loans being made that, in retrospect, should not have been made.

Lastly, since AIG turned off its supply of risk-taking for residential mortgage loans, banks kept more of that risk on their books. That may have lead to the collapse of Bear Stearns, Merrill Lynch, and Lehman Brothers.

Lewis pins the blame on Cassano for not realizing that AIG was increasing taking on more sub-prime risk than they realized. At one point, when pools were up to 95% sub-prime, many internal risk analysts guessed that there was no more than 20%. Even when confronted with this Cassano dismissed the problem, conluding that house prices could never fall everywhere in the United States at once. (He was wrong.)

You can read the article and determine for yourself if Cassano should really be the fall guy.

In the end, the lesson to be learned for compliance and risk professionals is the importance of listening to your front line employees. They see many problems coming long before you do.

If you like that article, Michael Lewis also did a great story in the April issue of Vanity Fair on the financial collapse in Iceland: Iceland’s Meltdown.

UPDATE: The Wall Street Journal published an article indicating that Mr. Cassano is the subject of a grand jury inquiry. Prosecutors Are Poised to Impanel AIG Grand Jury. The possible case against Mr. Cassano (and others) could rely partly on tape recordings of 2007 phone calls involving AIG Financial Products employees who discussed the value of their derivatives trades.

FCPA Conviction

bangkok_film_festival

Gerald Green and Patricia Green, Los Angeles-area film executives, were found guilty of conspiracy to violate the Foreign Corrupt Practices Act and money laundering laws of the United States, as well as substantive violations of the FCPA and U.S. money laundering laws. The verdict was handed down late on Friday.

The Greens were charged by the Department of Justice with having bribed Thai authorities up to $1.8 million between 2002 and 2006 to receive approximately $14 million in government contracts and grants to run the Bangkok International Film Festival.

The conspiracy and FCPA charges each carry a maximum penalty of five years in prison, and each of the money laundering counts carries a maximum penalty of up to 20 years in prison. The false subscription of a U.S. income tax return carries a maximum penalty of three years in prison and a fine of not more than $100,000. Sentencing has been set for Dec. 17, 2009, before the Honorable George Wu in the Central District of California.

DOJ Press Release: Film Executive and Spouse Found Guilty of Paying Bribes to a Senior Thai Tourism Official to Obtain Lucrative Contracts

The Ins and Outs of CFIUS Filing

newman

The Foreign Investment and National Security Act of 2007 applies to takeovers of U.S. businesses by non-U.S. persons. That law formalized the Committee on Foreign Investment in the United States to review foreign investments that could impair national security

Back in November, I was looking at how the new CFIUS regulations would affect real estate investors with significant foreign ownership. it seems clear the purchase of a building could be considered a purchase US business. The issue would be whether the tenants in the building are government tenants and how the ownership of the building could implicate national security.

William A. Newman, of Sullivan & Worcester LLP in New York, put together an article on process for making a CFIUS application filing: The Ins and Outs of CFIUS Filing. He does not paint a pretty picture. CFIUS has estimated that the average filing requires about 100 hours.

Mr. Newman also contributes to the USA Inbound Acquisitions & Investments Blog.

Previous Posts:

How NOT to Run a Safety Drill

gun

Running drills is important. Experience with adverse circumstances is important so that you and your co-workers know what to do if there is a problem. Drills are especially important for dangerous circumstances.

There is a reason that building managers, schools and other institutions run fire drills. If there is an actual fire, you will know where to go and what to do. Of course, when you run a fire drill, you don’t light an actual fire and don’t fill the hallways with smoke.

I’m not sure what Hampton Behavioral Health Center was thinking when they decided to have an unannounced safety drill. They sent in a masked gunman to demand Oxycontin from a pharmacist’s assistant. The “gunman” told her he was holding Hampton’s human resources director hostage and the phone lines were dead.

It also sounds like the drill was for situation that the employee was not trained on how to handle. In her lawsuit, she is seeking damages for assault, false imprisonment and intentional infliction of emotional distress.

September is National Preparedness Month: Ready.gov. It’s good to plan for an emergency situation, train your employees and run drills. But be sensible about it and don’t scare the crap out of them.

References:

Image is by Domingouceda: 1. http://www.flickr.com/photos/domingouceda/ / CC BY 2.0

Madoff Hearing at the Senate Banking Committee

I will be covering today’s Senate Hearing (”Oversight of the SEC’s Failure to Identify the Bernard L. Madoff Ponzi Scheme and How to Improve SEC Performance“) along with several guest panelists via the interactive discussion below. Please visit this page today at 2:30 pm to join me, Bruce Carton of Securities Docket, Compliance Week editor Matt Kelly, and others as we follow the hearing – and bring your questions!

The SEC’s Madoff Report

madoff

The SEC decided to take a look at how it failed to uncover the Madoff fraud. The SEC’s Inspector General has been running an investigation and compiling information. The SEC Inspector General, H. David Kotz, released a public version of their report on August 31: Investigation of Failure of the SEC to Uncover Bernard Madoff’s Ponzi Scheme – Public Versionpdf-icon

The big question being whether it was case of internal corruption or just incompetence. Of course, hindsight is 20/20 and the fraud looks so obvious, you have to wonder how they missed it. I think it is more important to learn from the mistakes so they can avoid this happening again. But people are still looking for heads to put in the guillotine.

Senate hearing

Of course, politicians are looking to blame someone. Today at 2:30, the Senate Banking Committee will hold a  hearing concerning Oversight of the SEC’s Failure to Identify the Bernard L. Madoff Ponzi Scheme and How to Improve SEC Performance. The witnesses currently slated are:

  • H. David Kotz, Esq., Inspector General of the U.S. Securities and Exchange Commission;
  • Mr. Harry Markopolos, Chartered Financial Analyst and Certified Fraud Examiner;
  • John Walsh, Esq. Acting Director, Office of Compliance Inspections and Examinations, SEC
  • Robert Khuzami, Esq., Director of the Division of Enforcement, SEC

Was there corruption?

The investigation did not find evidence that any SEC personnel who worked on an SEC examination or investigation of Madoff had any financial or other inappropriate connection that influenced the conduct of their examination or investigatory work. The report also concludes that former SEC Assistant Director Eric Swanson’s romantic relationship with Bernard Madoff’s niece, Shana Madoff, did not influence the conduct of the SEC examinations of Madoff. The report concludes that no senior officials at the SEC directly attempted to influence examinations or investigations of Madoff and that there was no evidence of interference with the staff’s ability to perform its work.

How much did the SEC know?

The Inspector General found that the SEC received more than ample information over the years to warrant a comprehensive investigation of Madoff. Despite three examinations and two investigations being conducted, a thorough and competent investigation or examination was never performed. Between June 1992 and December 2008 when Madoff confessed, the SEC received six substantive complaints that raised significant red flags concerning Madoff’s operations. There was enough for SEC to question whether Madoff was actually engaged in trading.

What about private investors?

I found it unusual that the Inspector General includes information from private parties about their due diligence findings of Madoff’s operations. Many sophisticated investors gave significant money to Madoff. But there were traders, funds, investment banks, and other investors who thought something was not right with Madoff. They were concerned about the suspiciously consistent returns, the lack of transparency, the use of a small captive auditing firm, and the lack of an independent custodian.

The decisions to not invest were made based upon the same red flags that the SEC considered in its investigations, but ultimately dismissed. The Inspector General concludes:

The SEC examination program should analyze the approaches utilized by private entities who conducted due diligence of Madoff’s operations and apply these methods to strengthen their program. They should also seek to learn from these private entities through training mechanisms and in fact, several private entities informed the OIG that they would be willing to conduct training of SEC examiners in their due diligence approaches. Learning from private sector efforts would improve the SEC’s ability to conduct meaningful and comprehensive examinations and detect potential fraud.

References: