Download The Role and Importance of Securities Lawyers in Public Offerings and more Slides International Commercial Law in PDF only on Docsity!
UNIVERSITY OF NOTTINGHAM
DISSERTATION FOR DEGREE OF MASTER OF LAWS (LL.M.)
LLM in International Commercial Law
S ECURITIES LAWYERS IN PUBLIC OFFERINGS – C AN LEGAL OPINIONS
BECOME DISCLOSURE DOCUMENTS?
By
Nguyen Quang Vu, B.A. (Hanoi, Vietnam)
Candidate of the 2005-06 LLM Program
School of Law, University of Nottingham
I hereby declare that I have read and understood the regulations governing the submission ofLLM dissertations, including those relating to length and plagiarism, as contained in the LLM Manual and that this dissertation conforms to those regulations.
1. I NTRODUCTION
Lawyers hold a key role in a public offering process and legal opinions are one of the most important transactional documents in most securities transactions. Different from the auditors’ certification, legal opinions do not form part of the disclosure documents. And lawyers are subject to a lower level of liabilities than that of the auditors. However, like the auditors, securities lawyers have been blamed for contributing to Enron’s collapse and other corporate scandals in early 2000s. As a response to the securities lawyers’ failure, “up the ladder” rule was introduced. Some scholars, particularly Professor John Coffee, however want to go further by imposing public gatekeeper liabilities on securities lawyers who will give certification and verification on non-financial part in the registration statements. This proposal has raised various pro and con opinions. This research looks at the above proposal in more details by putting it in a broader context of a public offering process.^1 Part 2 and Part 3 of this research look at the jobs of securities lawyers and role of legal opinions in public offering processes respectively. Part 4 discusses what when wrong at Enron, what was wrong with their lawyers and what responses were made to such failures. In Part 5, I will examine the reasons for such failures, and whether the responses to such failures by both regulators and scholars are adequate. In particular, I would argue that making lawyers public gatekeepers and incorporating a legal opinion like in the registration statement would not resolve the failures. Finally, in Part 5, I also propose an alternative approach to the issues raised in this research.
2. ROLE OF SECURITIES LAWYERS IN PUBLIC OFFERINGS^2 In this part, I will discuss (1) the works generally done by securities lawyers, (2) legal
(^1) This research will mainly concern with US laws and US corporations because US securities laws are more developed and most notable corporate scandals occurred in the US. 2 By public offering, I mean an offering of shares of common stock that meets the following conditions: (1) it is a large scale sale of shares to the public; (2) it is subject to the Securities Act of 1933; and (3) it aims to create or there already exists a public market for the securities (e.g. in a stock exchange).
Once the draft is completed and signed by the issuer, it will be filed with the SEC for review and approval. Normally, the issuer’s counsel will handle the filing and closely follow up with the SEC until the registration is approved.^12
Together with the preparation of the registration statement, if the offering is underwritten, the issuer and underwriter and their respective counsels will need to agree on the underwriting agreement. The underwriting agreement will often require the issuer to make extensive representations and warranties concerning the issuer and its business. The issuer’s counsel would need to advise whether the issuer can make such representations and warranties. The agreement will inevitably also require the issuer’s counsel to issue a legal opinion and the issuer’s auditors to issue a comfort letter on various figures contained in the registration statement. In practice, no underwriter would affect a public offering without receipt of these two documents.^13
2.2. Why securities lawyers? Perhaps, the best place to start explaining the role of securities lawyers is from Professor Gilson’s seminal article “Value creation by Business lawyers:^14 Legal Skills and Assets Pricing”.^15 In this article, Professor Gilson examines in details why business lawyers are hired by businesses.
First, Professor Gilson observes that business lawyers help to redistribute bargaining power between businesses.^16 That is, if one party to a transaction can employ a more skilful business lawyer then it may earn a larger share of benefits from that transaction relatively than that of
(^11) Ibid. (^12) Carl Schneider et. al, “Going Public”, 19-22. In addition, regarding initial public offerings, based on the due diligence’s result, securities lawyers may advise and assist the issuer to do some preliminary preparation works to make the issuer’s stocks more floatable. This may include reorganisation, recapitalisation, and adjusting stock options, employment retirement plan (Carl Schneider et. al, “Going Public”, 25-26). 13 14 William K. Sjostrom, Jr, “The Due Diligence Defense”, 556-561. 15 One can obviously see that a securities lawyer is at first a business lawyer. 16 Ronald Gilson, “Value creation by Business lawyers: Legal skills and Assets pricing”, 94 Yale L.J. 239. Gilson, “Value creation”, 244-246.
the other party. However, according to Professor Gilson, the redistributive bargaining function of business lawyers does not increase the total value of a transaction. And all parties to the transaction can be better off by not employing business lawyers and thereby do not have to pay his fees, which accordingly makes the total benefits available to both parties larger. Therefore, the redistributive function does not make business lawyers so attractive to business communities as a whole.
This view is probably true in a public offering context whereby the shares are offered to a large number of investors who (other than large institutional investors) normally do not have chance to negotiate with the issuer. Therefore, if business lawyers are viewed as having redistributive bargaining function only then investors will tend to discount the stock prices on the assumption that the issuer with the support of highly-skilled securities lawyers will get a better share of benefits in the public offerings.
Professor Gilson’s second observation about business lawyers is their role in handling regulatory issues. Although Professor Gilson does not view the regulatory handling function of business lawyers as their main marketing power generally, in the field of securities, such function does play an important role. A public offering involves a lot of regulatory issues (e.g. the registration and approval of the registration statements) and potential liability (e.g. for making misleading statement in the registration statements).^17 Therefore, issuers and underwriters inevitably need to employ securities lawyers to assist them to handle regulatory issues in public offering processes. Indeed, the hiring of securities lawyers is one key element to the “due diligence” defence of an underwriter, should the latter face a claim regarding a
(^17) E.g. Section 11 of the Securities Act. Professor Black in “Legal and institutional preconditions” views that it is necessary to maintain a high level of liability against the issuer and the underwriter in order to make them employing securities lawyers (Black, “Legal and institutional preconditions”, 795). ABA, “Lawyers’ Role in Securities Transactions”, 1884.
lower cost means of verifying the information provided by the sellers.^24 Professor Gilson maintains that this is one method used by business lawyers as transactional engineers to reduce transaction costs.^25
Applying Professor Gilson’s analysis in the context of a public offering, one can see the transactional value of securities lawyers. Taking an underwriting transaction, for example, the role of securities lawyers in such an agreement would be similar to that of a lawyer to an acquisition transaction.^26 The issuer’s representations and warranties in an underwriting agreement are similar to those of the seller in an acquisition agreement. And finally, legal opinions issued by issuer’s counsels help to reduce the costs for verifying information by the underwriter. So together with the regulatory-handling role, the transactional cost engineering function makes securities lawyers the leading role in public offering process.
Going one step further than Gilson’s, according to Utset,^27 in a public offering, securities lawyers hold a key role because they are the cheapest information producer. According to Utset, sale of shares in a public offering involves the sale of (1) the shares themselves with dividend, voting and other rights and (2) the information bundle regarding the shares and the issuer, which allows investors to evaluate share price more accurately.^28 The information will need to be in a language that is acceptable to the market^29 and meet all regulatory
(^24) Id. 288- 293. This is because the seller’s counsel with his familiarity with the seller’s business is more likely to produce the information with lower costs. More discussion about legal opinion is at section 3. 25 Professor Gilson also notes that business lawyers when issuing third party legal opinions serve as reputational intermediaries. 26 This is because the role of a underwriter in a public offering is similar to a buyer in an acquisition agreement. The underwriter often undertakes to purchase the shares to be issued should they are not all bought by the public. 27 Manuel A. Utset, “Producing Information: Initial Public Offerings, Production Costs, and The Producing Lawyer”, 74 Or. L. Rev. 275. 28 I.d. 280-281. Utset notes that in a public offering process, there are two separate phases. The first phase is the valuation of the shares, preparation of the information bundle and the second phase is the offering after regulatory approval is obtained. This is different from an acquisition transaction whereby the two phases tend to happen simultaneously. 29 i.e. the shares will not be discounted by the market for failure to understand the information transferred.
constraints.^30
Utset argues that securities lawyers are the cheapest “mimicker” of the “IPO machine” to produce the shares and the information bundle.^31 This is because familiarity with securities regulations allows securities lawyers to have the ability to “translate” the “language” of other players (e.g. underwriters, accountants) into one common language with the lowest costs. In addition, the issue-spotting skill, which lawyers are equipped in law schools, allows them to have competitive advantage over other professions in taking the leading role in producing the information bundle.^32
In my view, there may be two other reasons for securities lawyers to take a leading role in public offering process, that is, (1) they have better access to information than others do and (2) they are subject to a lesser level of liability under securities laws. Regarding the first point, attorney-client information is protected by law^33 and lawyers are not obliged to disclose such information. In addition, attorneys are generally prohibited from acting for two clients whose interests are conflict.^34 An issuer will therefore feel more comfortable to disclose as much information including sensitive one as possible to its lawyers. With such an informational advantage, the advice and opinion given by securities lawyers will attract greater weight. Similar observation has been made with regard to the credit rating given by credit rating agencies.^35 Regarding my second point, as securities lawyers are subject to lesser liability
(^30) Utset, “Producing information”, 297. (^31) I.d., 305-310. (^32) I.d. (^33) Of course, this attorney-client privilege is subject to certain limits. See Douglas R. Richmond, “The Attorney- Client Privilege And Associated Confidentiality Concerns In The Post-Enron Era”, 110 Penn St. L. Rev. 381. 34 See Charles Hollander Q.C. and Simon Salzedo, Conflict of Interest and Chinese Wall, 2nd^ edition, Sweet & Maxwell 2004. 35 Joe Lieberman, “Rating the Raters: Enron and the Credit Rating Agencies”, Report of Committee on Governmental Affairs on 20 March 2002. The ratings given by credit rating agencies enjoy significant credibility because the rater is allowed to access to inside information without being obliged to disclose. Similar to lawyers, this provides the credit rating agencies with an informational advantage over other professionals.
closing, the underwriter will require a legal opinion from the issuer’s counsel addressed to the underwriter covering various issues regarding the issuer and the securities. Usually, the underwriting agreement contains a detailed form of the opinion of the issuer’s counsel.^44 Thirdly, also as a condition precedent for closing, the underwriter normally requires a legal opinion from its own counsel regarding the issuer and the securities.^45 However, the form of the opinion of the underwriter’s counsel is not often pre-specified.
In addition to opinions concerning the offering of securities, there are other opinions which are important in creating the securities. These are opinions often issued by the issuer’s counsel on which the rating agencies or the auditors base to give their views on the issuer’s financial performance. One typical opinion of this type is “true sale” opinions in securitization transactions. It can be said that without a true sale opinion, there will be no “securitised assets” and accordingly no securities over such assets can be offered.^46 Another example may be the lawyer’s letter addressed to auditors. Lawyer’s letters addressed to auditors express the lawyers’ view on the likelihood and materiality of issuers’ contingent liabilities. These views are very important for the auditors to decide how to present such contingent liabilities in the issuers’ financial statements.^47
3.2. What do these legal opinions say? As per the legality opinion, the SEC has interpreted “legality” to mean that the securities are “validly issued,^48 fully paid,^49 and non-assessable^50 ”. If the securities are debt instruments
(^44) See a sample opinion given to the underwriter in Appendix 3. (^45) Richard Howe, “The duties and liabilities of attorneys in rendering legal opinions”, 1989 Colum. Bus. L. Rev 283, 286-288. 46 For a more detailed discussion on true sale opinion see 4.2. Steven Schwarcz, “The limits of lawyering: Legal opinions in structured finance”, 84 Tex. L. Rev. 1. 47 48 Sterba, “Legal opinions”, 8-3 – 8-5. “Validly issued” means that the issuer has issued the securities in compliance with the relevant corporation law, the company’s charter and bylaws and that the issuer has not done anything to derive the securities from their “validly issued” status (Donald Glazer, Scott FitzGibbon and Steven Weise, “Glazer and Fitzgibbon on Legal Opinions Drafting, Interpreting and Supporting Closing Opinions in Business Transactions”, 2nd^ ed. Aspen
then the instruments must impose a binding obligation on the applicant.^51 Because the “legality” opinion must be given when the registration statement is filed and before it becomes effective, the counsel must effectively opine on a future event.^52 The opinions given by the issuer’s counsels to the underwriters cover a broader range of issues. At first, it will address general issues of the issuer such as due incorporation, valid existence, and good standing of the issuer, and the corporate power of the issuer to do business as described in the registration statement.^53 The issuer’s counsel will also have to opine on the equity capital of the issuer^54 and the validity of the securities to be offered.^55 The underwriters would also require the issuer’s counsel to confirm the “due authorisation, execution, and delivery of the underwriting agreement”^56 and a confirmation that the performance of the underwriting agreement will not violate other agreements or laws which are binding on the issuer.^57 Regarding the registration statement, the issuer’s counsel is usually required to opine that the registration statement has become effective.^58 Second, the underwriter often asks for an opinion that the registration statement “fairly summarises” the laws and regulatory framework
Publishers 2001, 350-364). 49 “Fully paid” means that the issuer has received all the considerations called for by the resolution approving the issuance of the stock and the consideration meets the requirements set out by relevant corporation law, the issuer’s charter and bylaws (Glazer and Fitzgibbon, “Legal opinion”, 365-373). 50 “Non-assessable” means regarding shares, under the relevant corporation law, the issuer is not entitled to require shareholders who have fully paid their shares to pay the issuer any additional amounts on a per share basis as a result of their share ownership ((Glazer and Fitzgibbon, “Legal opinion”, 374). 51 52 Sterba, “Legal opinion”, 6-25. For example, the opinion may state “[t]he shares of common stock, when issued and sold as contemplated in the underwriting agreement, 53 will be duly authorized, validly issued, fully paid and non-assessable.” Sterba, “Legal opinions”, 6-5. This opinion basically means that the issuer have obtained all licences and contractual rights to conduct its business. 54 55 This covers the number and type of securities that the issuer has authorized, issued, and remain outstanding. 56 Sterba, “Legal opinions”, 6-6. This opinion is similar to the “legality” opinion requested by the SEC. Sterba, “Legal opinions”, 6-10. Given that there exists uncertainty as to the binding nature of the indemnification in an underwriting agreement, usually, the underwriter does not require opinions as to the validity and binding nature of the underwriting agreement. 57 58 Sterba, “Legal opinions”, 6-11. Sterba, “Legal opinions”, 6-12. In practice, the issuer’s counsel keeps a close contact with the SEC and is normally the first person who is informed by the SEC that the registration becomes effective.
the underwriter’s counsel would demonstrate a due diligence obligation by the underwriter.^69 Second, a third-party legal opinion helps to reduce the information asymmetry in a public offering.^70 In addition to regulatory measure (e.g. mandatory disclosure), third-party legal opinions serve as a private measure to reduce the information asymmetry between the issuers and investors. By requesting the issuer’s counsel to opine on various aspects of the issuer, the underwriter effectively forces the issuer’s counsel to produce and verify information concerning the issuer with professional skills and diligence.^71 The use of issuer’s counsel would also avoid duplication of costs because the issuer can simply use its counsel or its opinions for future deals and with future underwriters without reinventing the wheel.^72 In addition, other players in the public offering may also rely on opinions of the issuer’s counsel. From a different perspective, a legal opinion can also give signal to issuer’s counter-parties about the issuer’s performance. The inability of the issuer’s counsel to issue a legal opinion of market standard would suggest the existence of certain defects on the part of the issuer.^73
Third, securities lawyers when issuing a legal opinion serve as reputational intermediaries to increase the credibility of the information concerning the issuers. Based on (again) Professor
(^69) Sterba, “Legal opinions”, 6-4. See also footnote 18. (^70) See Black, “Legal and institutional preconditions”, 786-787. Securities are intangible assets whose prices depend on the future performance of the issuers. To predict the future of the issuer, investors would need to rely on current and past information of the issuer. Since the issuer knows more about itself than investors do, there is imbalance of information or, in other words, information asymmetry between the issuer and the investors. Severe information asymmetry can make investors discount share prices heavily, which in turn discourages high-quality issuers to go to the market for capital. Eventually, only low-quality issuers remain in the capital market. This phenomenon is called “market for lemons” (George Akerlof, The Market for “Lemons”: Quality Uncertainty and the Market Mechanism, 84 Q.J. Econ. 488 (1970)) 71 Lipson, “Price, Path and Prize”, 63. During the preparation of the legal opinion, the issuer’s counsel may spot certain issues or obstacles to the transaction and may advise the issuer to correct these issues or otherwise change the opinions (e.g. addition qualification and limitations) (Glazer and FitzGibbon, “Legal opinions”, 10). 72 Consistent with Professor Gilson’s “transaction cost engineer” theory, because issuer’s lawyers have the lowest cost in producing and verifying the issuer’s information, it is logical that they are requested to give opinions on the issuers (Gilson, “Value creation”, 273-275). However, third-party legal opinions will inherently create a conflict of interest between the issuer and the issuer’s counsel which may affect the integrity of the opinions (see 5.1). 73 Lipson, “Price, Path and Price”, 81- 83. Steven Schwarcz, “The limits of lawyering: Legal opinions in structured finance”, 84 Tex. L. Rev. 1, 10-12.
Gilson’s analysis,^74 the argument can run as follows. When making investment decisions, investors or underwriters must rely on the information provided by the issuer regarding the issuer’s performance. To induce this reliance, the issuer may offer some means of verification to provide investors or underwriters with some comfort in the face of the issuer’s obvious incentive to cheat. Such means include direct verification (e.g. through representation and warranties) or third-party verification. However, as per direct verification, investors or underwriter will always be faced with the risk that the seller will cheat on its promise not to cheat. This creates a role for third parties to offer its reputation as a bond that the issuer’s information is accurate.^75 The delivery of legal opinion to the underwriter can be regarded as a law firm’s offering its reputation as a bond for the issuer’s information. The opinion-giving law firms would have the incentive to give a correct opinion as they are repeat players and are subject to liability should they fail to exercise due diligence. Their income would also depend on their level of reputation. The above argument receives empirical support from the research of Karl S. Okamoto.^76
Fourth, in terms of market efficiency, in accordance with the Efficient Capital Market Hypothesis (ECMH),^77 an accurate legal opinion would help to increase market efficiency in
(^74) Gilson, “Value creation”, 280- 293. (^75) It should however be noted that legal opinions are expressions of professional judgments not guarantees that the court will reach the same conclusion as the opinion-giving lawyers (ABA Legal Opinions Principles I.D). 76 Karl S. Okamoto, “Reputation And The Value Of Lawyers”, 74 Or. L. Rev. 15. In this article, the author examines various empirical data and find that (1) reputable or elite law firms account for large number of securities transactions which require reputation of such law firms, (2) elite law firms do not want to take on jobs with high-risk issuers to avoid losing their investment in reputation, and (3) for jobs which do not require much reputation, in-house counsels are often used. 77 Efficient Capital Market Hypothesis (ECMH) is developed and discussed in various articles notably Eugene Fama, Efficient Capital Markets: A Review of Theory and Empirical Work, 25 J. Fin. 283. (1970); Ronald J. Gilson and Reinier Kraakman, The Mechanisms of Market Efficiency, 70 Va. L. Rev. 549, 1984; John Coffee, Market Failure and the Economic Case for Mandatory Disclosure System, 70 Va. L. Rev. 717 1984; and Ronald J. Gilson and Reinier Kraakman, The Mechanisms of Market Efficiency Twenty Years Later: The Hindsight Bias, available at Social Science Research Network http://ssrn.com/abstract=462786. According to ECMH, securities price will reflect all information available in the market even if information is not immediately and costlessly available to all participants. For heavily traded securities in a well-functioning market, the price will reflect quickly (informational efficiency) and correctly (fundamental or allocative efficiency) information in the
serious flaws in the system. This part begins with a brief description about Enron^80 and its collapse, which serves as a background to examine the failure of Enron’s lawyers. 4.1. Enron First, we start with Enron’s underlying businesses. Enron started as a gas pipeline company at the time when natural gas prices were regulated.^81 By mid-1980s, when natural gas prices were deregulated and deregulation resulted in more volatile gas prices for both producers and consumers, Enron has created and sole products (e.g. forward gas sale contracts, commodity derivatives), which allows its counter-parties to hedge the risks of gas prices changes. By doing so, Enron turned itself to an energy trading company.^82 Enron was successful at the beginning with this model of business. The changes in business model also turned Enron from a stable energy manufacturing company with capital intensive assets to something like a giant commodity hedge fund^83 with light assets.^84 However, as other competitors adopted similar business model, Enron’s competitive advantages in energy trading were reduced. To maintain its market leading position, Enron’s management had to expand its trading model to other markets.^85 It was in these markets Enron suffered losses because of, among other things, initial investments in infrastructure and the lack of liquidity in these markets.^86 When its underlying businesses were in trouble, Enron’s hedge fund nature provided it with two important accounting tools^87 to keep it afloat on paper. The first is mark-to-market
(^80) We discuss Enron only as this is the typical example of corporate and securities fraud during that period. (^81) Milton C. Regan, “Teaching Enron”, 74 Fordham L. Rev. 1139, 1143- 1154. (^82) (Id.). (^83) Marianne M. Jennings, A Primer On Enron: Lessons From A Perfect Storm Of Financial Reporting, Corporate Governance And Ethical Culture Failures, 2003 California Western Law Review, 163, 173. Jonathan R. Macey, A Pox On Both Your Houses: Enron, Sarbanes-Oxley And The Debate Concerning The Relative Efficacy Of Mandatory Versus Enabling Rules, Washington University Law Quarterly, 329, 339. 84 Although it adopted light assets strategy, Enron did frequently need to invest in capital intensive assets when it wanted to get into a new market. 85 86 Enron has conducted business in broadband internet, timber, pulp, etc. 87 William Bratton, “Enron The Dark Side of Shareholder Value”, 76 Tu. L. Rev 1275, 1299-1300. Jennings, “A Primer on Enron”, 175 – 197.
accounting.^88 Utilising the ability to book revenues immediately (rather than gradually overtime) from long-term contracts, Enron recorded huge but “unrealised” profit in its financial statement.^89 The downside of this accounting approach, however, was that it forced Enron to have new long-term contracts in every new reporting period in order to book new profit. In addition, should the performance under the underlying long-term contracts are terminated then Enron would have to restate its earning. The second accounting tool is disclosure rules applicable to special purposed entities (SPEs). Usually, a reporting entity needs to consolidate its financial statements with those of its affiliates in order to provide an overall picture of the real performance of the entire group. Through consolidation, all transactions between the reporting company and its affiliates will be cancelled out. The GAAP however allows non-consolidation of financial statements between the reporting company and an affiliated SPE, if the affiliated SPE, among other things, have at least 3% outside equity and retain the right to control the SPE. Accordingly, by entering into structured financing transactions^90 with various 3% outside equity affiliates, Enron was able to transfer debts from its books to its affiliated SPEs or avoid consolidate its
(^88) Under traditional accounting methods, a company must record historical costs of the assets not their market value in their book. The company cannot recognise gain from appreciation in value of its assets until such assets are actually sold. However, investment banks or entities with assets consisting of financial instrument are allowed to record their assets according to market value which are determined according certain approved methods. In 1992, Enron was allowed to apply mark-to-market accounting (Regan, “Teaching Enron”). 89 For example, Enron’s unrealised profit for 2000 was about 50 percent of the total $1.41 billion profit originally reported (Jennings, “A Primer On Enron”, 177). 90 Schwarcz, “The limits of lawyering”, 3-6; and Regan, “Teaching Enron”, 1157-1166. In a typical structured finance transaction, a company (the “originator”) sells income-generating assets to an affiliated SPE in return for a payment from the SPE. The SPE then issues bonds or some other form of security to third-party investors either through public offerings or private placement. The issuing SPE uses the proceeds from such offering to pay the originator the purchase price of the asset. The income from the asset that the issuer owns is used to repay third-party investors. Structured finance may be called as securitization or off-balance sheet financing. Structured finance, if properly structured, is a legitimate way to reduce the cost of borrowing. For example, the originator may have a low credit rating because it already has outstanding debt. The SPE on the other hand can have a higher credit rating as it does not have outstanding debt and the loans advanced to it are secured by the SPE’s assets. The originator therefore can obtain funds in form of purchase price of the assets more cheaply than if it had borrowed directly. In addition, proceeds from the sale can be recorded as cash flow from operating activities while proceeds from a loan must be reported as cash flow from financing activities, which investors regard less favorably.
transactions that lead to Enron’s debacle. Particularly, Enron’s attorneys involved in, among others, (1) issuing legal opinions on Enron’s structured finance transactions on which Enron’s auditor, Arthur Andersen LLP, based to approve Enron’s financial statement, (2) assisting Enron to prepare disclosure documents which, at least with hindsight, were probably misleading, and (3) conducting an internal investigation which can be viewed as whitewash.^97 As described in 4.1, a structured finance transaction in economic substance is very similar to a loan secured by receivable accounts. Therefore, structured finance transactions are always subject to recharacterisation risks by the court.^98 Given the recharacterisation risk, to approve the accounting treatment of a structured finance transaction and to allow the originator to book the proceeds of the transactions as proceeds from sale of assets, the auditor and the credit rating agencies often require a so-called “true sale” opinion from the lawyers of the originator which provide assurance that the transaction is a sale and the assets is bankruptcy remote.^99 In Enron’s case, V&E and A&K have given “true sale” and “true issuance” opinions in order for Andersen to approve the hiding of debt in Enron’s books, while in fact these transactions did not clearly qualify as true sales.^100 Regarding the disclosure issues, in various transactions between Enron and its affiliated SPEs which were controlled by Enron’s managers, Enron paid millions of dollars as compensation to its managers.^101 SEC rules require the payment of compensation to Enron’s interested
hundreds of law firms” used by Enron)). Finally, Enron had its own in-house counsel and an impressive legal department with experienced business lawyers (Regan, “Teaching Enron”, 1154). 97 Jill E. Fisch, and Kenneth M. Rosen, “Is There a Role for Lawyers in Preventing Future Enrons?” 48, 4 Villanova Law Review, 1097, 1109-1111. Robert W. Gordon, “A New Role For Lawyers?: The Corporate Counselor After Enron”, 98 35 Conn. L. Rev. 1185, 1186-1190. Alan Berg, “Recharacterisation After Enron”, JBL 2003, May, 205-238. That is the court may hold that the transactions are loans but not sale of receivables and accordingly, the financial statements of the originator must record the proceeds of sale as proceeds of loans and the assets of the SPEs will be consolidated to those of the originator in case of the latter’s bankruptcy. 99 Regan, “Teaching Enron”, 1157. John Coffee, “Can lawyers wear blinders? Gatekeepers and Third-party opinions”, 84 Tex. L. Rev. 59, 63-65. 100 101 Regan, “Teaching Enron”, 1158- 1161. Gordon, “A New Role”, 1186.
parties to be disclosed “where practicable”. Under the pressure of Enron’s managers to avoid disclosure, using technical reasoning, V&E advised that Enron did not have to disclose the compensation to its managers. In their SEC filings, V&E also asserted, as required by law, that these “related-party” transactions were negotiated at "arm's-length" and on “comparable terms” to deals with independent third parties, but did not look for any factual support for these assertions.^102 Finally, following the internal memorandum of an Enron’s officer about the alleged wrongful accounting practices, Enron requested V&E to conduct an internal investigation to determine whether further investigation by an independent law firm is required. V&E accepted to conduct the investigation and concluded that no further investigation was required.^103 V&E’s conduct of the investigation was criticised that it should have not accepted the instruction at the first place due to its own conflict-of-interest and the limited scope of instructions that hindered the finding of wrongful misconduct.^104 4.3. The responses Regulatory response - Up the ladder and minimum standards of conduct rules The involvement of lawyers in Enron and other corporate scandal did not escape the attention, first, of scholars^105 and, second, legislators.^106 In 2002, the Sarbanes-Oxley Act (SOX)^107 was adopted as a major regulatory response to Enron and other corporate scandals. The SOX was claimed as the “most far reaching reforms of American business practices since the time of
(^102) Gordon, “A New Role”, 1186-1187. (^103) V&E nevertheless warned that the “bad cosmetic” of Enron’s SPEs transactions could give rise to serious litigation and bad publicity. 104 Fisch and Rosen, “Is there a Role”, 1110-1111. Roger C. Cramton, “Enron And The Corporate Lawyer: A Primer On Legal And Ethical Issues”, 58 Bus. Law. 143, 162-168. V&E accepted to conduct the investigation without looking at accounting issues which were in Andersen’s domain and did not interview enough Enron’s employees. 105 Following reports about the role of Enron's lawyers, Professor Richard Painter, joined by forty other law professors, asked the SEC to adopt a rule requiring corporate lawyers who are aware of client misconduct to report that misconduct to the board of directors (“up the ladder” rule) (Fisch and Rosen, “Is there a role”, 1108). 106 107 Fisch and Rosen, “Is there a role”, 1108. Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (2002).
