The Work

September 22, 2008 6:27 PM

Wachtell Urges Action Against Short-Sellers, Review of CDS Market

Posted by Brian Baxter

Wachtell, Lipton, Rosen & Katz wants regulators to take definitive actions against short-sellers and implement a comprehensive review of the credit default swap (CDS) market in the hope of staving off a wider Wall Street crisis.

So say several memorandums penned during the past week by executive committee cochair and banking transactions rainmaker Edward Herlihy, 14-year SEC veteran and firm of counsel Theodore Levine, and associate Carmen Woo.

"In today's markets, short sales continue to be at record levels, there are false rumors in the marketplace about the demise of financial firms, bear raids, and abusive short-selling are taking place, and there is significant disruption in the fair and orderly functioning of the securities markets," said Herlihy and Levine in their first memo, on September 16. "The markets are in crisis."

Herlihy and Levine implored the SEC to execute "immediate bold measures" that can be used "to constrain the abusive short-selling and rumor mongering, to dampen volatility, and to restore confidence in the markets."

Whether or not the agency was listening is anyone's guess, but late last week the SEC instituted a moratorium on short-selling starting September 19 and continuing until October 2. Its mirror agency in the U.K., the Financial Services Authority (FSA), has instituted a short-selling ban for select financial services stocks until January 16, 2009. (Similar bans are expanding to other markets.)

But in memos issued September 17 and 18, Herlihy and Levine said the SEC's initiatives themselves fell short and necessitated further action. They requested the SEC bring enforcement actions against "manipulative" short-sellers and make public the results of its own internal investigations into short-selling activity. Herlihy and Levine also advocated that the SEC use its emergency powers to halt short-selling for a 90-day period, similar to that done by the FSA. (The FSA's ban will be reviewed after 30 days, however.)

In the wake of the federal government's $85 billion bailout of AIG, the Wachtell lawyers then focused on the clouded CDS market.

"The SEC, in cooperation with the Federal Reserve Board, the FSA, and the Treasury Department, should undertake a 60-day comprehensive review of the credit default swap market in order to determine what rules and regulations are needed and whether there has been any improper or violative conduct by those engaged in CDS transactions," the trio said in their September 18 memo. "In this market crisis, it is unacceptable that there is no regulatory structure to oversee the extraordinarily important CDS market sector."

In a subsequent memo circulated on September 22, the Wachtell lawyers praised the SEC's enactment of its emergency powers to require institutional investment managers to disclose their short positions, but maintained that "permanent solutions" are needed to stabilize the volatile marketplace, such as extending the disclosure requirements to investment managers holding less than $100 million in securities.

And while revisiting the notion that it's "indefensible that the CDS market, with trillions of dollars of notional value, has virtually no regulatory oversight," the Wachtell lawyers showed they can also compromise by cutting their requested period for a complete regulatory review from 60 days to 30.

Desperate times call for desperate measures.

Download Wachtell memo of 9-16-08: Today the SEC Must Step Up.

Download Wachtell memo of 9-17-08: Too Little Too Late.

Download Wachtell memo of 9-18-08: Bold SEC Action is Needed.

Download Wachtell memo of 9-22-08: Inter-Governmental Review of CDS Market and Permanent Solutions Are Required.

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