Orrick Alert

Brexit – What Now For Your Business

So, the UK has voted to leave the EU. Everyone has their own opinion and we’ve all seen the news reports and various viewpoints but what does this result mean for you in practical terms and where do we go from here? Orrick’s EU-UK Working Group is ready and waiting to answer any questions you may have (see contact details at the end of this alert) and in the meantime, here’s our overview of the key issues for your business. READ MORE

Preparing for Potential Inquiries into Designated Lender Counsel in PE Sponsored Syndicated Loans

Recent media reports have expressed alarm at the use of “designated lender counsel” in private equity-sponsored leveraged loan transactions.[1]  The phrase refers to the practice of a private equity firm instructing the investment bank arranging its syndicated loan as to which law firm the private equity firm would like the investment bank to use as the bank’s counsel.  According to the press reports, the practice (also known as “sponsor designated counsel”) has become prevalent in the syndicated loan market.  The question raised in the press is whether this practice creates a material conflict of interest, because the law firm representing the investment bank arguably generates fees based on the strength of its relationship with the private equity firm across the table.  If it does, the next question is whether that conflict could be argued to adversely affect the lending arrangement, with potential negative consequences for investors in the loan.

The attention this issue is attracting in the media will likely spark regulatory interest as well as interest among participants in the syndicated loan market.  Prominent lead arrangers in the syndicated loan market should expect inquiries from any number of potential government authorities, including the Federal Reserve, the Office of the Comptroller of the Currency (the “OCC“), the Federal Deposit Insurance Corporation (the “FDIC“) and state authorities such as attorneys general and financial supervisory agencies.  Below we offer guidance for preparing for potential inquiries and responding to any inquiries made.

Potential Regulatory Issues and Inquiries from Market Participants

Over the past several years, the most prominent regulatory guidance in the leveraged loan market has been the Interagency Guidance on Leveraged Lending that the OCC, the Federal Reserve and the FDIC jointly issued in March 2013 (the “Leveraged Lending Guidelines“), as well as various interpretative updates published by the agencies since then.[2]  The Leveraged Lending Guidelines urge banks to implement “a risk management framework that has an intensive and frequent review and monitoring process.”[3]  The general purpose of the Leveraged Lending Guidelines is to keep regulated financial institutions from “unnecessarily heighten[ing] risks by originating poorly underwritten loans,”[4] which could result in risks that “find their way into a wide variety of investment instruments and exacerbate systemic risks within the general economy.”[5]

Although the Leveraged Lending Guidelines do not address the practice described in the press reports, they do instruct regulated financial institutions to put in place policies and procedures that define conflicts of interest, provide risk management controls, permit employees to report conflicts without fear of reprisals, ensure compliance with relevant laws and provide for adequate employee training in this area.[6]   For this reason, regulated lead arrangers of syndicated loans may expect the Federal Reserve, the OCC and the FDIC to inquire whether the practice of sponsor designated counsel creates a conflict and, if so, whether the institution managed that conflict in compliance with the Leveraged Lending Guidelines.

Outside of Federal banking regulators, other government actors – particularly state attorneys general and financial supervisory agencies – might choose to focus on the practice as well. State regulators, for instance, might opt to investigate whether the practice described in the press constitutes a deceptive trade practice. New York’s statute prohibiting deceptive business practices, for example, makes unlawful “deceptive acts or practices in the conduct of any business” and authorizes the attorney general to bring an action to enjoin such acts and to “obtain restitution of any moneys or property obtained”.[7] The statute does not define “deceptive acts or practices,” so all that is necessary is that the attorney general “believe from evidence satisfactory to him” that a deceptive act or practice has occurred. (Federal and other states’ statutes have similar language.) This broad authority would permit such a government authority to launch an investigation following this media driven story.

In addition to regulatory scrutiny, lead arrangers should prepare for potential inquiries from syndicated loan purchasers, who may read the press stories and want to know whether the loans they purchased from the financial institution were reviewed by sponsor designated counsel.

Internal Review

Against this backdrop, there are certain considerations that a financial institution acting as lead arranger for syndicated loans should contemplate in order to address any questions that the institution’s various constituencies may raise and to ensure the institution employs best practices going forward.

  • The press reports fail to distinguish between “left lead arrangers” and other investment banks involved in syndicated loans, but substantially all loan market participants know that on any particular transaction, the “left lead arranger” assumes primary responsibility for the negotiation of loan documents with legal counsel.  As a result, financial institutions should focus their review primarily on transactions where they served as “left lead arranger” and thus directed the relationship with outside counsel.    
  • The press reports allege that a designated law firm might be serving two masters when designated by a private equity sponsor. However, if a designated law firm has a strong, historical relationship with the financial institution, the allegation is difficult to sustain. For example, if Law Firm X generates three times more revenue from its overall relationship with the financial institution than it does from its relationship with the private equity firm, the allegation that the law firm would prioritize the private equity firm’s interests over the bank’s on any particular transaction is implausible.
  • The conflict of interest being alleged is principally the law firm’s and not that of the financial institution.  Financial institutions should consider whether each law firm involved can be reasonably relied upon to manage responsibly any conflicts that may arise, taking into account the firm’s reputation and the financial institution’s own historical experience with, and knowledge of, the firm.
  • A financial institution should also review whether it has ever rejected a sponsor’s designated counsel, or hired “shadow counsel” to review the designated counsel’s documents for any reason.  If so, this would indicate that the financial institution was monitoring the risk alleged by the press articles and mitigating that risk where appropriate.
  • Although time intensive, a financial institution might wish to take a sample of recent top tier sponsor transactions where designated counsel was used and compare the loan documentation in that sample to a similar group of top tier sponsor transactions where outside counsel was not designated.  A finding that the respective sets of loan documents did not differ substantially in lender protection would go a long way toward proving the press allegations spurious.
  • Financial institutions should assess whether appropriate internal constituencies were apprised of this practice, had considered any associated risks and were monitoring on an ongoing basis whether those risks remained contained.   In a financial institution with a product group overseeing leveraged lending, one would want to know whether that group and its associated legal and supervisory functions were monitoring and mitigating those risks on an ongoing basis.

[1] Andrew Ross Sorkin, A Growing Conflict in Wall St. Buyouts, N.Y. Times, Jan. 5, 2016, http://www.nytimes.com/2016/01/05/business/dealbook/a-growing-conflict-in-wall-st-buyouts.html?ref=dealbook;

see also Dan Primack, A Private Equity Conflict Grows on Wall Street, Fortune, Jan. 5, 2016, http://fortune.com/2016/01/05/a-private-equity-conflict-grows-on-wall-street/

[2] 78 Fed. Reg. 17766 (March 22, 2013).

[3] Id. at 17771.

[4] Id.

[5] Id. at 17772.

[6] Id. at 17776.

[7] N.Y. GEN. BUS. LAW § 349(a)-(b).

Orrick Alert: Following Chapter 9 Plan, Monoline Insurer Must Continue to Make Payments on Old Bonds

Earlier this month, Judge Judith J. Gische of the Appellate Division of the Supreme Court of New York, First Judicial Department found that ACA Financial Guaranty Corporation, as bond insurer, must make future, post-confirmation principal and interest payments on municipal bonds issued pre-bankruptcy.  The Court required these payments despite the fact that the bonds were exchanged for new bonds and cancelled under the municipality’s chapter 9 plan.  This decision is an unequivocal win for holders of distressed municipal bonds wrapped by monoline insurance policies and makes clear that insurers must continue to extend coverage to bondholders after a municipal issuer files for chapter 9 and obtains a discharge of the bond debt in bankruptcy.  This outcome may impact negotiations and potential resolutions in Detroit’s chapter 9 case and other recent municipal bankruptcies and distressed scenarios, such as Puerto Rico.  To read the entire Orrick Alert, please click here.

Orrick Alert: IRS Issues Changes to the Mixed Straddle Regulations

On August 2, the IRS issued temporary regulations relating to accrued gain or loss associated with a position that becomes part of a section 1092(b)(2) identified mixed straddle.  The temporary regulations segregate pre-identification gain and loss on a mixed straddle position from post-identification gain and loss, preventing taxpayers from using identified mixed straddles as an alternative to selling assets to accelerate gain or loss.  For the complete Orrick alert, please click here.

Russian Note Trustee (a Bondholders Representative) and Other Changes in Corporate Bond Regulations

This Orrick law alert relates to the changes made in the Russian securities law by Federal Law No. 210-FZ dated July 23 (On Amendments to the Federal Law on the Securities Market and to Certain Russian Laws and Regulations).  Specifically, said Law has introduced the concept of a bondholders’ representative and expanded the concept of a general meeting of bondholders.  The new amendments also set out in more detail how to redeem or repurchase Russian bonds before maturity.  Orrick has actively assisted the Association of Russian Regional Banks in the drafting and promotion of the new law.  For the complete alert, please click here.

SEC Lifts Ban on General Solicitation, Adopts “Bad Actor” Disqualification Rules and Proposes Amendments to Form D Filings

On April 5, 2012, the Jumpstart Our Business Startups Act (the JOBS Act) was enacted.  Title II of the JOBS Act mandated the Securities and Exchange Commission to amend applicable rules within 90 days of its enactment (i.e., July 5, 2012) in order to eliminate the prohibitions against general solicitation or general advertising in Rule 506 of Regulation D under the Securities Act of 1933, as amended, and under Rule 144A under the Securities Act.  In August 2012, the Commission proposed a new Rule 506(c) and an amendment to Rule 144A to implement Title II.  During an open meeting on July 10, 2013, the Commission issued two releases (33-9414 (bad actor) and 33-9415 (Rule 506, Rule 144A and Form D)) which adopted new rules.  For more information on the adopted rules, please click here.

Commentary: Five Lessons from the Municipal Derivatives Litigation Front

Pre-financial crisis, interest rate derivatives were widely recognized as a valuable part of the municipal issuer’s financial toolkit.  Post-crisis, they have been a thorn in the side of many issuers, resulting in expensive litigation with failed swap providers – most notably the Lehman and Ambac derivatives trading subsidiaries – and public criticism of municipal issuers said to have fallen prey to more sophisticated providers.  There are several lessons to be learned from the recent spate of litigation, which Orrick covered in an article recently published in The Bond Buyer.

Shareholders Allege Improper Takeover of Fannie and Freddie by the Government

Can shareholders of a government-sponsored enterprise successfully challenge the constitutionality of a government takeover of the entity?  Shareholders of Fannie Mae and Freddie Mac will try to do so in a $41 billion class action filed against the United States in the Court of Federal Claims on June 10.  Plaintiffs allege that even though the Federal Housing Finance Authority’s 2008 takeover of the mortgage giants benefited the nation as a whole, it harmed the companies’ shareholders and violated their constitutionally protected private ownership rights.  For more information on this suit and to visit our Securities Litigation blog, please click here.

SDNY Holds Trustee Cannot Evade Section 546(g) Safe Harbor

On June 11, Southern District of New York Judge Jed Rakoff dismissed the complaint of the Trustee for the SemGroup estate seeking to avoid a novation made to Barclays pre-bankruptcy under a swap agreement.  The Court held that the pre-bankruptcy transaction constituted a safe harbored transfer made in connection with a swap agreement and thus could not be avoided by the estate.  This case is one of a number in recent years that treats the safe harbors, and particularly the section 546 safe harbors, as broadly protective of non-debtor transferees in financial transactions.  For more information, please click here.