May 14, 2020

Structured Finance

Structured Finance

Structured Financing Techniques
      Committee on Bankruptcy and Corporate Reorganization of the Association of the Bar of the City of New York, 50(2): 527–606 (Feb. 1995)
Although relatively new, the use of structured financing techniques has grown rapidly and now accounts for $450 billion per year of financings in the United States alone. There is nearly $2 trillion of mortgage and asset-backed financings outstanding in the United States. The possibilities seem limitless. This Report explores structured financings—their history, structural elements, and underlying legal basis.

New Developments in Structured Finance: Report by the Committee on Bankruptcy and Corporate Reorganization of The Association of the Bar of the City of New York
      Committee on Bankruptcy and Corporate Reorganization of The Association of the Bar of the City of New York , 56(1): 95 (Nov. 2000)
Since the Committee's Report on Structured Finance Techniques in the February 1995 issue of The Business Lawyer, the structured finance market has experienced exponential growth. This updated Report by the Committee explores new asset classes and structures currently in use by major market players, including leading edge financings of auto leases, stranded cost recoveries, tax liens, structured settlements, and intellectual property. The Report also discusses special problems posed by international transactions, FASB 125 and Bankruptcy Code issues, the use of single member LLCs as special purpose bankruptcy remote vehicles, and developments in corporate governance that have arisen from challenges to bankruptcy remote vehicles.

Collapsing Corporate Structures: Resolving the Tension Between Form & Substance
      Steven L. Schwarcz, 60(1): 109—145 (Nov. 2004)
When is a corporate structure legitimate, and when should it be collapsed? Although most urgent in the context of structured finance transactions, this question also arises in other important corporate contexts, including piercing the corporate veil, substantive consolidation, recharacterizing sales as transfers intended for security, and collapsing LBO transactions. In a larger sense, it is one of the most fundamental questions in corporation law, at the basis of any finding that the private ordering of a firm, or of the relationship between firms, is unenforceable or that the law should disrespect form in favor of substance. In the past, judges and scholars have attempted to formulate rules for determining when to collapse corporate structures only in isolated contexts. This article first examines and synthesizes these isolated sources of law. The synthesis reveals that judges implicitly have been grappling with one of the most difficult conceptual problems of contract law: the circumstances under which externalities should defeat contract enforcement. By addressing that problem directly through contract theory and economics, this article proposes an overall theory for collapsing corporate structures and then uses that theory to derive rules of general application. Finally, the article examines how this theory and its derivative rules might inform, or be informed by, the related debate over whether limited liability should be the default rule in corporation law.

Initial Report of the Joint Task Force on Deposit Accounts Control Agreements
      Joint Task Force on Deposit Account Control Agreements, ABA Section of Business Law, 61(2):745—796 (February 2006)

Empty Voting and Hidden (Morphable) Ownership: Taxonomy, Implications, and Reforms
     Henry T. C. Hu and Bernard Black, 61(3):1011–1070 (May 2006)
Most American publicly held corporations have a one-share, one-vote structure, in which voting power is proportional to economic ownership. This structure gives shareholders economic incentives to exercise their voting power well and helps to legitimate managers' exercise of authority over property the managers do not own. Berle-Means' "separation of ownership and control" suggests that shareholders face large collective action problems in overseeing managers. Even so, mechanisms rooted in the shareholder vote, including proxy fights and takeover bids, constrain managers from straying too far from the goal of shareholder wealth maximization.

In the past few years, the derivatives revolution, hedge fund growth, and other capital market developments have come to threaten this familiar pattern throughout the world. Both outside investors and corporate insiders can now readily decouple economic ownership of shares from voting rights to those shares. This decoupling—which we call "the new vote buying"—is often hidden from public view and is largely untouched by current law and regulation. Hedge funds, sophisticated and largely unfettered by legal rules or conflicts of interest, have been especially aggressive in decoupling. Sometimes they hold more votes than economic ownership, a pattern we call "empty voting." That is, they may have substantial voting power while having limited, zero, or even negative economic ownership. In the extreme situation of negative economic ownership, the empty voter has an incentive to vote in ways that reduce the company's share price. Sometimes hedge funds hold more economic ownership than votes, though often with "morphable" voting rights—the de facto ability to acquire the votes if needed. We call this "hidden (morphable) ownership" because under current disclosure rules, the economic ownership and (de facto) voting ownership are often not disclosed. Corporate insiders, too, can use new vote buying techniques.

This article analyzes the new vote buying and its corporate governance implications. We propose a taxonomy of the new vote buying that unpacks its functional elements. We discuss the implications of decoupling for control contests and other forms of shareholder oversight, and the circumstances in which decoupling could be beneficial or harmful to corporate governance. We also propose a near-term disclosure-based response and sketch longer-term regulatory possibilities. Our disclosure proposal would simplify and partially integrate five existing, inconsistent share-ownership disclosure regimes, and is worth considering independent of its value with respect to decoupling. In the longer term, other responses may be needed; we briefly discuss possible strategies focused on voting rights, voting architecture, and supply and demand forces in the markets on which the new vote buying relies.

Civil Liability for Aiding and Abetting
      Richard C. Mason, 61(3):1135—1182 (May 2006)
Civil liability for aiding and abetting provides a cause of action that has been asserted with increasing frequency in cases of commercial fraud, state securities actions, hostile takeovers, and, most recently, in cases of businesses alleged to be supportive of terrorist activities. The U.S. Supreme Court, in its 1994 decision in Central Bank of Denver, N.A. v. First Interstate Bank of Denver , ended decades of aiding and abetting liability in connection with federal securities actions. However, the doctrine since has flourished in suits arising from prominent commercial fraud cases, such as those concerning Enron Corporation and Parmalat, and even in federal securities cases some courts continue to impose relatively broad liability upon secondary actors. This article reviews Central Bank and its limitations, before turning to an analysis of the elements of civil liability for aiding and abetting fraud. The article then similarly identifies and analyzes the elements of liability for aiding and abetting breach of fiduciary duty, which predominantly concerns professionals, such as accountants and attorneys, that are alleged to have assisted wrongdoing by their principal. The analysis then examines aiding and abetting liability in the context of particular, frequently–occurring, factual matrices, including banking transactions, directors and officers, state securities actions, and terrorism. The article concludes by summarizing emerging principles evident from judicial decisions applying this very flexible and potent source of civil liability.

Special Report on the Preparation of Substantive Consolidation Opinions
The Committee on Structured Finance and the Committee on Bankruptcy and Corporate Reorganization of The Association of the Bar of the City of New York, 64(2): 411-432 (February 2009)

Law of Private Placements (Non–Public Offerings) Not Entitled to Benefits of Safe Harbors—A Report
      Committee on Federal Regulation of Securities, ABA Section of Business Law, 66(1): 85–124 (November 2010)

Article 9 of the UCC: Reconciling Fundamental Property Principles and Plain Language
     Thomas E. Plank; 68(2): 439-506 (February 2013) 
Article 9 of the Uniform Commercial Code, which governs (i) the grant of a security interest in personal property to secure payment or performance of an obligation—a “true security interest”—and (ii) the sale of receivables, incorporates the primary property law principle of nemo dat quod non habet—one cannot transfer an interest in property that one does not have—and its corollary —a transferee can receive what the transferor has and no more. For good policy reasons, however, Article 9 also enacts the innovative exception to nemo dat, the Filing Priority Principle codified in the “first-to-file-or-perfect rule,” that permits a secured party who first files a financing statement to obtain a superior security interest over a secured party who first obtains a security interest and would otherwise prevail under nemo dat. For true security interests, the plain language of Article 9 effectuates the policies of nemo dat and the Filing Priority Principle.

U.C.C. Article 9, Filing-Based Priority, and Fundamental Property Principles: A Reply to Professor Plank
     Steven L. Harris and Charles W. Mooney, Jr., 69(1): 79-92 (November 2013)
Uniform Commercial Code Article 9 generally follows the common law principle that one cannot give rights in property that one does not have (nemo dat quod non habet). In many circumstances, however, the priority rules under Article 9, including its rule awarding priority to the first security interest that is perfected or as to which a financing statement has been filed, trump nemo dat and enable a debtor to grant a senior security interest in property that the debtor previously had encumbered. In this article, Professors Steven Harris and Charles Mooney argue that, properly understood, the first-to-file-or-perfect rule confers upon a debtor the power to create a security interest in accounts and other rights to payment that the debtor has already sold and in which it retains no interest. In doing so, the authors take issue with Professor Thomas Plank, whose argument to the contrary appeared in the February 2013 issue of The Business Lawyer.

Massey Prize for Research in Law, Innovation, and Capital Markets Symposium—Foreword
     70(2): 319-320 (Spring 2015)

Financial Innovation and Governance Mechanisms: The Evolution of Decoupling and Transparency
     Henry T. C. Hu; 70(2): 347-406 (Spring 2015)
Financial innovation has fundamental implications for the key substantive and information-based mechanisms of corporate governance. “Decoupling” undermines classic understandings of the allocation of voting rights among shareholders (via, e.g., “empty voting”), the control rights of debtholders (via, e.g., “empty crediting” and “hidden interests”/ “hidden non-interests”), and of takeover practices (via, e.g., “morphable ownership” to avoid section 13(d) disclosure and to avoid triggering certain poison pills). Stock-based compensation, the monitoring of managerial performance, the market for corporate control, and other governance mechanisms dependent on a robust informational predicate and market efficiency are undermined by the transparency challenges posed by financial innovation. The basic approach to information that the SEC has always used—the “descriptive mode,” which relies on “intermediary depictions” of objective reality—is manifestly insufficient to capture highly complex objective realities, such as the realities of major banks heavily involved with derivatives. Ironically, the primary governmental response to such transparency challenges—a new system for public disclosure that became effective in 2013, the first since the establishment of the SEC—also creates difficulties. This new parallel public disclosure system, developed by bank regulators and applicable to major financial institutions, is not directed primarily at the familiar transparency ends of investor protection and market efficiency.

As starting points, this Article offers brief overviews of: (1) the analytical framework developed in 2006−2008 for “decoupling” and its calls for reform; and (2) the analytical framework developed in 2012−2014 reconceptualizing “information” in terms of three “modes” and addressing the two parallel disclosure universes.

As to decoupling, the Article proceeds to analyze some key post- 2008 developments (including the status of efforts at reform) and the road ahead. A detailed analysis is offered as to the landmark December 2012 TELUS opinion in the Supreme Court of British Columbia, involving perhaps the most complicated public example of decoupling to date. The Article discusses recent actions on the part of the Delaware judiciary and legislature, the European Union, and bankruptcy courts—and the pressing need for more action by the SEC. At the time the debt decoupling research was introduced, available evidence as to the phenomenon’s significance was limited. This Article helps address that gap.

As to information, the Article begins by outlining the calls for reform associated with the 2012−2014 analytical framework. With revolutionary advances in computer- and web-related technologies, regulators need no longer rely almost exclusively on the descriptive mode rooted in intermediary depictions. Regulators must also begin to systematically deploy the “transfer mode” rooted in “pure information” and the “hybrid mode” rooted in “moderately pure information.” The Article then shows some of the key ways that the new analytical framework can contribute to the SEC’s comprehensive and long-needed new initiative to address “disclosure effectiveness,” including in “depiction-difficult” contexts completely unrelated to financial innovation (e.g., pension disclosures and high technology companies). The Article concludes with a concise version of the analytical framework’s thesis that the new morphology of public information—consisting of two parallel regulatory universes with divergent ends and means—is unsustainable in the long run and involve certain matters that need statutory resolution. However, certain steps involving coordination among the SEC, the Federal Reserve, and others can be taken in the interim.