September 22, 2008

Dear Treasury: Will $700 Billion Cover It?

The US Treasury’s initial draft of Congressional legislation to provide Treasury with authority to purchase up to $700 billion in mortgage-related assets is unbelievably simple, providing broad authority for the Treasury to set their own guidelines about how to spend the money. So simple that I think it was drafted on the back of a napkin. However, there is much Congressional haggling to be done over the next few days and the final product likely will look much different.

Here is a Davis Polk memo that summarizes the legislation pretty nicely – and here are some articles on the proposed legislation:

WSJ’s “Lawmakers Battle Over Rescue Plan

NY Times’ “Democrats Set Terms as Bailout Debate Begins

Washington Post’s “As Hill Debates Bailout, Wall St. Shifts Continue”

WSJ’s “Paulson Presses Congress to Act On $700 Billion Bailout Plan

NY Times’ “A Bailout Plan, but Will It All Work?

NY Times’ “Bipartisan Support for Wall St. Rescue Plan Emerges”

Bloomberg’s “Treasury Seeks Authority to Buy Mortgages Unchecked by Courts”

Between the time I drafted this blog last night and this morning, things were already changing. Things are moving so fast. One of the key bones of contention regarding the legislation is whether there should be limits on CEO pay – including severance pay – at those companies that benefit from the legislation. Last night, Mark Borges covered this story in his “Proxy Disclosure” Blog.

Patching Up the SEC’s Temporary Emergency Actions

Wow, what a wild week last week was. And I imagine this week will be more of the same as Congress seeks to act. In the SEC’s haste to take action, its temporary emergency actions had holes in them, some of which were addressed by clean-up amendments adopted on Sunday – see this SEC press release. In addition to making technical amendments, the SEC’s revised order provides that the information disclosed by investment managers on new Form SH will be nonpublic initially, but will publicly available on Edgar two weeks after it is filed with the SEC (see footnote 8 of the revised order).

Here is a WSJ article describing some of the holes and below is an excerpt from a Davis Polk alert:

“Unlike a similar action taken by the U.K. Financial Services Authority on September 18th, the prohibition is not limited to the active creation or increase of net short positions. Without this exception, it would appear that financial institutions (including those the SEC is trying to protect) and other market participants who hold convertible securities, options and other equity derivatives, cannot adjust their delta hedge positions in the underlying common stock that hedge their risk of owning the equity derivatives. Therefore, contrary to its intent, the SEC action may significantly limit the ability of the indentified financial institutions to access the convertible and equity derivative markets.

The SEC has been addressing a number of specific questions and concerns that have been noted. For example, we understand that the SEC staff has informally advised market participants that, despite the reference to ‘publicly traded security’ in the order, the order is not intended to cover debt securities.”

A few members were not happy with my dig against McCain on Friday, about his jab against SEC Chairman Cox. I just want the record to show that I had written that piece before I had read this op-ed entitled “McCain’s Scapegoat” in Friday’s WSJ, which expressed a similar sentiment. Don’t worry, I’m not gonna start blogging about politics – but that one was too hard to resist.

The Importance of Your SIC Code

On Friday morning, the SEC took temporary emergency action to prohibit short selling in 799 financial companies. These actions were effective immediately and will expire at the end of the day on October 2nd (unless extended by the SEC). For its “No Short List” (see Appendix A for the list), the SEC selected the 799 companies based on their Standard Industrial Classification code (known as a “SIC” code; these codes are a US government system for classifying industries by assigning a four-digit code to each company). A total of 31 SIC codes were included in the list.

I received a number of emails from panicky members whose financial service companies were not part on the SEC’s list. Some of these companies have SIC codes covered by the SEC’s emergency order, but they were not listed by name in the SEC’s order. For example, this situation applies to AllianceBernstein Holding, Invesco and Legg Mason. They’ve all filed Form 8-Ks stating that they believe they should be on the list since they were covered by the SIC code used by the SEC (eg. Legg Mason’s 8-K).

Others believe their companies are financial services companies and should be on the list, but their companies don’t have SIC codes – at least, as they show up in the SEC’s database (however, EDGAR shows their SIC code) – that correspond to the range of SIC codes covered by the SEC’s “No Short List.” To illustrate, CNBC reported that several companies – like General Electric – may be added to the list because their financial services businesses are substantial. GE’s SIC code in the EDGAR database shows up as “SIC: 3600 – Electronic & Other Electrical Equipment (No Computer Equip).” CNBC mentioned several other financial service companies not on the SEC’s list, including CIT Group and American Express. Watch this CNBC video, which points out the problems and quirks with the list (egs. there aren’t 799 names on the list and at least four non-trading companies were inadvertently included).

Note in the SEC’s order, the SEC took pains to say that its list was prepared on a “best efforts basis.” I’ve heard that the SEC expects to post an amended list soon.

Lesson learned? Re-consider your company’s SIC code to ensure it properly fits your company. Remember that companies pick their own SIC code when they file their Form S-1 to go public – there is a spot on the facing page – and the SEC has no input (although in theory, the Staff could question your choice). The SIC code also is submitted as part of the header when the filing is Edgarized (note a SIC code isn’t solicited on the Form ID).

Note that the SEC is one of the few – if not the only – government agency that still uses SIC codes (probably because those codes are so hard-wired into much of the SEC’s disclosure framework). The more recent – and widely used – identification system is the North American Industry Classification System (NAICS), which has largely replaced SIC codes in other contexts.

– Broc Romanek