Mar. 24, 2008

Hedge Funds Stymied By Failing “Repo” Market

Repo market, reeling from subprime mortgage crisis, is no longer a cheap viable method of accessing short term capital.
Bear Stearns sells off, Carlyle Capital liquidates and KKR Financial Holdings restructures debt for a second time in four months.
New Fed “primary dealer” repo program loans nearly $30 billion - although unavailable to hedge funds, the resulting increased liquidity may stabilize industry and support hedge funds.

Barclays predicts $80 billion in losses from counterparty CDS defaults in 2008.
Bankruptcy code exempts swaps and repos from the automatic stay, giving hedge funds accelerated right to terminate under swap agreements.
When selling CDS to a broker-dealer, hedge funds must post up-front collateral and supply additional payments if the reference asset declines in value.
Amount and timing of recoverable collateral depends whether broker-dealer liquidates under Chapter 7 or under SIPA.

SEC calls for public comment on proposed new rule 10b-21.
New rule concerns liability for deception in share ownership, intent, ability or failures to deliver securities in time for settlement.
SEC received over 400 investor complaints regarding naked short selling last year.
Comments sought on how the proposed rule may affect legitimate short sales and broker-dealer policies and procedures, and whether the rule would cause naked short sellers to move offshore.
SEC Chairman Cox claims new rulewill bring “teeth” and needed enforcement to Regulation SHO - stemming abuses such as intentional failure to deliver in order to manipulate price or avoid borrowing costs.
Significant intent or knowledge of wrongdoing required for enforcement of the rule.

Treasury Tax Legislative Counsel Michael Desmond testified before a Subcommittee of the House Ways and Means Committee.
Noted current regulatory ambiguity as to whether prepaid forward contracts should be taxed as debt, equity or a hybrid.
As more such instruments migrate into retail investors’ portfolios, the Treasury Department has increased its scrutiny of tax ramifications.
Desmond illustrated inconsistencies in alternative tax treatment based on structure of prepaid forward contracts.

Complaint alleges that funds attempted to change CSX’s corporate structure by withholding information on percentage of CSX shares controlled.
CSX claims that the funds used swap agreements to evade federal securities filing requirements and acquired more than 5% of its common stock without making required disclosures.
formed a Section 13(d)(3) group with beneficial ownership of over 5% of outstanding CSX common stock, yet allegedly failed to timely file legally required schedules - according to the complaint, to secretly accumulate CSX stock.
Allegedly TCI’s disclosures of its CSX share swap position were materially misleading, failing to disclose that swap counterparties intend to vote CSX shares in accordance with TCI’s wishes.
CSX seeks to divest funds of shares acquired and to terminate all CSX-referenced swaps from the time they should have been disclosed.
CSX requests that the funds be prohibited from (or seeks to limit) voting those shares at the 2008 annual meeting.