Senate Banking Committee

Although all of the public attention and drama has focused on the health care legislation, there is news about the financial-reform bill as well.

Yesterday, March 22, the Senate Banking Committee voted in favor of the bill formulated by Christopher Dodd, of Connecticut, the commitee's chair. The Committee was split along party lines, 13 to 10.

The bill is similar to one the House of Representatives passed in December 2009, also with a split along party lines.

One important addition that this bill has and that one didn't is the Volcker rule: the prohibition of certain activities for banks that accept retail deposits. In some sense this is a return to the old Glass-Steagal Act. But not really.

Glass-Steagal created a wall between banks on the one hand and brokerage activities on the other. That is the wall that came crumbling down in the late Clinton period and this bill would not attempt to erect it anew. It would make some what more discriminating bans than that. Still, whether it would work, toward its presumed goal of limiting systemic risk, and how it would work, in specific administrative terms -- these are not easy questions to answer.

Interestingly, the Obama administration itself was late to pick up on the cause of the "Volcker rule." It showed no interest in the matter until after Scott Brown won his election in Massachusetts. Thereafter, it wanted to re-assert its populist cred, and this seemed to be an easy way to do that.

Three brief items

1. Lion's Gate has adopted a poison pill

Lion's Gate is the film and TV studio named after the "Lion's Gate" in Greater Vancouver, Canada, where the studio got its start. It is responsible for movies like The Haunting in Connecticut and Precious. It is also trying to fend off the unwanted attentions of Carl Icahn.

To that end, it is adopted this defense.

2. Part of Dodd's bill involves proxy votes

There will be a lot of talk about Christopher Dodd's plan for the reform of financial regulation in the days ahead. One intriguing fact is that Dodd has no reason to court popularity back home in Connecticut. He has already announced he will not run again. So he has come up with this.

3. Cedar Fair postpones its meeting

Cedar Fair Entertainment Company, a leader in regional amusement parks, water parks, etc., has announced the postponement of the special meeting of "unitholders" that had been planned for this week. That meeting, which will consider and vote on a merger agreement with affiliates of Apollo Global Management, has now been scheduled for April 8, 2010. The company also tells us that "additional information regarding the meeting, including time and location, will be provided at a later date.

Happy St. Patrick's Day, everyone.

The risks of "risk arb"

A couple of weeks ago, the US District Court, District of Connecticut dismissed a class action lawsuit brought against United Rental by hedge funds and other entities who had invested in it back in 2007.

Back in the still-heady days of 2007, Cerberus had represented that it would buy United Rental Inc. (URI), and this led to purchases of URI stock by various speculative third parties, engaging in a practice naturally called "merger arb," or known, sometimes, more ominously as "risk arb." At the time of such an announcement, a target stock's price on the market is generally below the acquirer's bid price -- the difference is known as the "control premium." The risk arb guys, buying the stock on the market, are better that the deal will be consummated as planned, and they can pocket the risk premium for themselves, minus their transaction costs.

Of course there is a very brief window during which that play is possible, because usually there are enough risk-arbers around to push the market price up to the big price well before the deal closes. Sometimes the market price gets above the bid price, which can mean either of a couple of things: somebody is betting that another suitor will appear, turning the deal into an auction; or there is simply a "greater fool" effect at work.

But back to 2007. By November of that year, the folks at Cerberus had troubles. They saw that the credit markets were tightening, and Chrysler -- which they ownesd at this point -- was eating up their cash. So Cerberus pulled out of the UR deal. URI's stock price took a big hit, and the company received liquidated damages.

At least the less numble of the risk arb types took a beating. They didn't take it lying down, though. They brought a lawsuit on the theory that when URI management first received intimations from Cerberus that they might need to "renegotiate" the acquisition, that fact should have been and was not made public. 07-cv-01708-JCH First New York Securities LLC, et al v. United Rentals Inc et al

That is the case that was dismissed last month, on the grounds essentially that the assertions in the complaint, accepted as true for the purpose of the motion, do not entail a strong inferenece of scienter. https://ecf.ctd.uscourts.gov/doc1/04112228541

This case may be important in the evolving understanding of how scienter must be pleaded under the evolving standards of the PSLRA. But my initial reaction to it was simply: "Man up, wimps! You knew you were taking this risk. That's how the capitalist cookie crumbles." Given that simple unsophisticated reaction, I have to give the court in this matter three cheers.

An Industry that Dodges Bullets

Entering the year of our Lord 2009, many participants in the hedge fund and alternative-investment industry in were of the opinion that the industry was on the eve of a radical transformation, at worst, effective elimination, due to government actions in a variety of jurisdictions that might result from the ongoing credit/financial crisis.

Yet it now appears that the industry may survive that impulse. I’m impressed by what hasn’t happened – by how any bullets it has dodged of late. Six come to mind at once.

1. The Insurance Department in New York appears to have lost interest in a plan, mooted last year, to regulate CDS’ as insurance.

2. The Governor of New York backed away early this year away from a plan to tax carried interest as ordinary income in that state's income tax

3.. The composition of the EU Parliament has changed in a way that will create difficulties for the implementation of new regulations of hedge fund managers there

4. Three efforts to regulate hedge funds failed in the General Assembly of Connecticut this year: although one of them had passed the state senate, they’ve all died with the end of session

5. In the US federal government, the new administration has dropped plans to radically rework the chart of its financial regulatory agencies

6. And the ban on short selling of a range of finance industry firms announce last fall was allowed to expire, and there seems no impetus to renew it.