October 31, 2008

Keeping an Eye on Counterparty Credit Risks

Depressed stock prices inevitably raise the temptation for stock buybacks, and recently a number of large buybacks have been announced. Further, the SEC recently sought to encourage repurchase activity by temporarily relaxing the timing and volume conditions of Rule 10b-18. Stock buybacks remain controversial, however, and it is likely that the benefits and costs of buybacks will continue to be debated in these volatile times.

One approach to buybacks that has emerged over the past few years is the “accelerated share repurchase program” or “ASR.” (For a description of ASR programs, take a look at this blog from earlier this year.) In a recent research piece, Michael Gumport, Founding Partner of MG Holdings/SIP, notes that counterparty credit risk is potentially a big consideration in entering into ASR programs. In the piece, Mike notes that “[i]n light of current economic dislocations, companies contemplating execution of complex ASRs (or with ASRs in progress) ought to weigh whether counterparty risk is attached and, if so, the adequacy of compensation.”

I think that this piece highlights the need to evaluate counterparty credit risk in a wide variety of transactions where previously the future performance of the institutional counterparty was pretty much taken as a given. Today, the assessment of counterparty credit risk is complicated by concerns about credit ratings, which often serve as the basis for evaluating risk, and (as demonstrated by Bear Stearns and Lehman Brothers) the extent to which circumstances can change very rapidly. As companies consider their overall risk management practices, the continuous evaluation of counterparty risks of all kinds needs to be high on the list of priorities.

Mark-to-Market Roundtable

On Wednesday, the SEC held its first of two roundtables on mark-to-market accounting. The purpose of the two roundtables is to develop information for the study of fair value accounting that was mandated by the Emergency Economic Stabilization Act. Wednesday’s roundtable was focused on how fair value is used by financial institutions.

In his opening remarks at the roundtable, Chairman Cox noted:

“As we begin our panel discussions, it is important to keep firmly in mind the primary role of financial reporting as a direct communication with investors. Financial reporting serves several other purposes as well, including its use by safety and soundness regulators of financial institutions. Because of the many uses of financial information, today’s topic is not simply an accounting matter. It is important that these differences between the uses of financial information by investors, regulators, and businesses themselves, among others, be recognized and appreciated.”

Earlier this week, Robert Denham, Chairman of the Financial Accounting Foundation (which is responsible for oversight of the FASB) sent a letter to Chairman Cox asking that the SEC not bow to the pressure being put on fair value accounting, noting that “it would be detrimental to investor confidence to overturn a FASB standard or otherwise suspend or restrict independent standard-setting activities of the FASB in the current environment and in response to political pressure from some financial industry groups.”

A Blow to F-Cubed Litigation?

We have posted several memos in our “Securities Litigation” Practice Area concerning the recent decision of the Second Circuit Court of Appeals in the case of Morrison v. National Australia Bank Ltd., No. 07-0583-cv, 2008 (Oct. 23, 2008). This case is notable because it has now provided some clarification on issues concerning the extraterritorial reach of the US federal securities laws that have arisen in a recent rash of “f-cubed” litigation, where foreign investors sue foreign issuers over losses incurred on foreign securities exchanges.

At the invitation of the Second Circuit, the SEC filed an amicus brief in this case which supported the views of the plaintiffs.

– Dave Lynn