September 29, 2008

The Mother of All Bailouts: Off to a Vote

Based on the thankful press releases issued last night by the President and the Treasury Secretary, you would almost think that the Emergency Economic Stabilization Act of 2008 has actually been signed into law – but, in fact, it still faces a tough vote in the House today and a vote in the Senate on Wednesday. What did happen over the weekend were marathon negotiations that brought about the current bill, which Nancy Pelosi (D-CA) has described as “frozen” (as noted in this Washington Post article). As a result, we now have a clear picture of what the “TARP” program will look like if the bill is ultimately enacted.

Mark Borges has described the latest provisions of the bill directed at executive compensation and corporate governance matters in his blog. Needless to say, executive compensation limits were retained in the bill (and apparently remained a source of debate throughout the weekend), but whether these vague provisions will impose any real changes on compensation practices at participating institutions – or set a new standard for other companies to follow – remains to be seen. What does seem to be developing that may have more of a long-term impact on executive compensation is a groundswell of public outrage over executive pay in light of the financial crisis. All weekend long, I either read or watched “man on the street” type stories where people expressed disdain for a bailout of financial institutions and their executives while so many others are struggling.

Notably, the House bill also targets mark-to-market accounting, directing the SEC to conduct a study of Financial Accounting Standard No. 157, including as a minimum:

– the effects of FAS 157 on the balance sheets of financial institutions;

– the impacts of mark-to-market accounting on bank failures in 2008;

– the impact of such standards on the quality of financial information available to investors;

– the process used by the FASB in developing accounting standards;

– the advisability and feasibility of modifications to such standards; and

– alternative accounting standards to those provided in FAS 157.

The bill also restates the SEC’s authority to suspend the application of FAS 157 if the SEC determines that such a suspension is in the public interest and protects investors. I guess this goes to prove that when all else fails, blame the accounting.

I still feel like I am missing something on the financial crisis. I don’t think I have yet heard a complete explanation of what has caused such an extreme level of apparent panic among the administration’s economic policymakers that would lead to, among other things, former Master of the Universe Hank Paulson begging on his knees to Nancy Pelosi, as reported in this NY Times article from Friday.

The Plight of Short Sellers

I have sympathy for those who have routinely employed short selling strategies to not only turn a profit, but also to hedge their positions, conduct market making activities, and exploit arbitrage opportunities. Short selling has, rightly or wrongly, become the SEC’s bogeyman in the financial crisis, and lots of unintended consequences are flowing from that status. Don’t get me wrong – I am no apologist for naked short sellers or those who engage in abusive short selling activities. Rather, I have spent an enormous amount of time thinking about short sale issues over the course of my career, and I am a firm believer in the power of short selling to maintain fair, orderly and liquid markets while helping to mitigate individual risks and market exposure.

The SEC’s ban on short sales of shares of financial firms (as amended) is now more than a week old, and is set to expire this Thursday, unless further extended. The likelihood that the ban will be extended seems high, as uncertainty reigns in the marketplace, particularly for the shares of financial institutions. But, as noted in this Wachtell Lipton memo, the ban has created confusion in the marketplace, particularly with respect to the convertible bond market. Further, as recently discussed on Q&A Forum, the short sale ban may be interfering with bona fide market-making activities, as market makers seek to widen the bid/ask spread by increasing the asked price so as to avoid going short and having a “fail to deliver.” Lastly, I fear the consequences if steps are not taken to prevent a massive market slide whenever the short sale ban is ultimately lifted, as “pent up” short selling has the potential to overwhelm an already shaky equity market.

Today is the day that Section 13(f) filers will need to file new Form S-H to report information about their short positions. Due to the SEC’s flip-flop on the public availability of this information, we won’t have access to these reports on Edgar for another two weeks. Last Friday, the SEC posted an updated submission template for Form S-H and some guidance on the disclosure required by the form.

Podcast: The Latest on the SEC’s Short Sale Actions

Last week, I spoke with Larry Bergmann, who is Special Counsel at Willkie Farr & Gallagher LLP and was Senior Associate Director in the SEC’s Division of Trading & Markets, about the emergency actions targeting short sellers and what the future might hold for short sale regulation. In this podcast, Larry discusses:

– What has the SEC done recently to target short sales?
– How are the SEC’s new rules being implemented on such short notice?
– What impact might the SEC’s recent actions have on the market?
– What else can the SEC do to address abusive short selling?

– Dave Lynn