Thursday, September 18, 2008 4 comments ++[ CLICK TO COMMENT ]++

How Legal Is the AIG Takeover?

That's a question I have been wondering. The AIG takeover does seem quite murky. Steven Davidoff, writing for the Deal Professor (NYT's DealBook) raises important questions pertaining to the takeover. He also suggests some answers for why things may be what thye are. From my layperson perspective, it certainly looks like some shareholder rights were run over by the steamrolling government. However, this does not mean that AIG shareholders would end up with more money in alternate scenarios. It looks as if AIG did not raise $14.5 billion they would have filed for bankruptcy. Nevertheless, this deal raises all sorts of questions.

I highly recommend reading the linked article when you feel like it. Newbies like us, who never worked in the industry, can learn a lot of the legal rights of shareholders. So even if AIG has nothing to do with you, the issues raised may help you in your future investments. I will warn, however, that laws are dependent on the jurisdiction so one shouldn't expect the same in, say, Japan. Roughly speaking, America probably offers the strongest property rights. This is doubly so for corporations incorporated in Delaware, like many are (I'm not a lawyer but Delaware is supposedly attractive due to its flexible law for businesses, no juries, large existence of past cases).

Let me quote the key issues raised by Steven Davidoff:

On the so-called Revlon Rule...

In the A.I.G. bailout, the Federal Reserve is taking 79.9 percent of the company, reportedly in warrants. A.I.G. is a Delaware company and so, in normal times, Revlon duties would apply to A.I.G.’s board. This would forestall A.I.G. from simply issuing out this controlling interest; instead, the A.I.G. board’s fiduciary duties would require it to obtain the highest price reasonably available for the company. It might be that, in these circumstances, the board actually did satisfy its Revlon duties in that there was no other price available.

In any event, A.I.G. likely also justified this issuance as an exemption from Revlon requirements under a second doctrine concerning board duties in the “zone of insolvency.” This doctrine purportedly permits the board of an insolvent company to take actions in the best interests of creditors and shareholders to protect the company itself, even actions that may be contrary to Revlon duties.

On shareholder vote...

Where is the shareholder vote here? If the Fed is indeed taking a 79.9 percent interest in warrants, A.I.G. still needs a sufficient number of authorized shares to make this share issuance. However, A.I.G. only has 5 billion shares of common stock authorized and approximately 2.67 billion outstanding. To issue enough shares to support the warrants, A.I.G. shareholders would need to approve an amendment to A.I.G.’s certificate of incorporation to authorize the issuance.

On NYSE rule requiring shareholder vote for major ownership change...

Similarly, NYSE Rule 312 requires that shareholders approve any common stock issuance when the common stock will have voting power equal to or in excess of 20 percent of the voting power outstanding before the issuance of such stock.

Here, A.I.G. will no doubt rely on the rule exception that applies if “the delay in securing stockholder approval would seriously jeopardize the financial viability of the enterprise.”

On AIG issuing debt somehow more senior to existing senior debt...

Some are wondering about A.I.G.’s other senior debt. How can the Fed take seniority to that debt and security over A.I.G.’s assets and not trigger the covenants in the other debt, which prohibit such events?

A.I.G. actually has not filed its indentures for the debt. Instead, they rely on an exception in Item 601(b)(4)(iii) of Regulation S-K that allows A.I.G. to omit filing such debt if, in the aggregate, it constitutes less than 10 percent of its total assets. At some point the Security and Exchange Commission needs to close this loophole.

My personal opinion is that Henry Paulson shouldn't have given the AIG CEO the $7 million golden parachute. I really feel that management was totally incompetent (not just the present one, but the prior CEO, Greenberg, under whose watch most of these questionable CDS insurance on CDOs was written) when it comes to running the business and it's ridiculous to get a big pay package. It's crazy to imagine that a $14.5 billion cash flow shortage put a company with a trillion in assets into near-bankruptcy.

Oh, if anyone wonders why the government is taking 79.9% ownership in AIG (same in Fannie and Freddie,) it's supposedly because, otherwise, the government has to consolidate the balance sheet of the companies into its own government balance sheet. Taking a less than 80% stake allows the government to avoid brining in the debt (and assets) of these companies onto the US balance sheet.

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4 Response to How Legal Is the AIG Takeover?

September 18, 2008 at 6:27 PM

Very interesting, thanks.

September 18, 2008 at 8:30 PM

Nice article, do you have any sources for whether the gov has to consolidate if they invest in over 80%?

September 18, 2008 at 8:48 PM

anon #2, I'm not sure where I saw it first but there is another DealBook article that refers to it... check paragraph #2 in this article...

September 19, 2008 at 11:15 AM

Thanks very much for the response sivaram

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