Outside The Box

Lawyering Outside The Box

Text Box: I developed a definitive white paper, disseminated widely by Kutak Rock, calling attention to the fact that SEC Rule 10b-5 applied to exempt offerings. This resulted in a major change nationally in the way municipal bonds and other exempt securities were offered to the public. This also resulted in a new role for lawyers in bond offerings, that of Underwriters’ Counsel. This greatly facilitated the growth of Kutak Rock. Here’s my story:

           I returned to Omaha in 1970 and before I joined Kutak Rock, I had teamed up with a long time friend, Vic Lich, to file the largest securities class action in Nebraska history. The defendants settled the case after I won a ruling by the Court that surprised me. The ruling was that Rule 10b-5 applied to the offering even assuming it was confined to Nebraska residents. Rule 10b-5 is the SEC’s weapon against fraud, and I had included it as a “makeweight” argument. I considered it of little value. I was surprised because the offering, not crossing state lines, was exempt from Federal  securities registration but was still subject to Federal securities regulation.

           Kutak Rock was a nationwide specialist in a type of municipal bond known as the pollution control revenue bond. It was doing pollution control deals as far away as Valdez, Alaska. Typically a municipality would issue bonds at low, tax-exempt rates and loan the money to a corporation to be used for pollution control. Investors were dependent on the corporation for a return of their capital. If the corporation defaulted, so did the bonds.

           Municipal bonds were sold throughout the country on abbreviated disclosure documents. Where corporations were involved, a page or two summarizing the business and describing where further information could be obtained was customary.

           I wondered, based upon my experience with the class action, whether Rule 10b-5 might apply. If it did, it meant that complete, up-to-date information on the corporation similar to that found in an SEC registered prospectus would have to be provided to investors.

           I quietly went about my research and prepared a white paper entitled Trends in Securities Law. The conclusion of this paper was that every one of the few cases that had considered the issue supported the application of Rule 10b-5. All that was necessary was use of the mail or interstate commerce.

           I thought Bob Kutak would be disappointed or angry, because the disclosure in the outstanding deals was deficient and could give rise to liability. But quite to the contrary, he was delighted. He saw it as a way to establish a new role in bond offerings, that of underwriters’ counsel. Previously, the firm had relied upon its ability to be named “bond counsel” in the jurisdictions where it was involved. This was a highly political matter, and the firm wasn’t always successful. Kutak convened conferences on the necessity for full disclosure in municipal bond offerings and distributed my white paper freely. News of this new view rippled through the legal community and eventually changed the way all exempt securities were issued. Lawyers pick up quickly on things supporting new fees.

Text Box: I laid the foundation for the issuance of “derivatives” of exempt securities without registration with the SEC. Here’s my story:

           Just like giant oaks from little acorns grow, solving a problem for a little company paved the way for issuing derivatives of municipal securities without destroying the exemption from registration under the Securities Act. First Municipal Leasing Company leased police cars, fire trucks and other equipment to municipalities. The client wanted to take a $5,000,000 municipal lease, and issue 1,000 fractional interests against it in $5,000 denominations. It is a basic principle of securities law that a fractional interest in a security is a “separate security.” This “separate security” does not enjoy the exemptions from registration accorded the original security. The SEC had clarified and strengthened this position in many responses to requests for no action letters.

           In order to peel back the onion and take a fresh look at the situation, I began doing research at the most elementary level. I spent considerable time researching the question, “What is the difference between a bond and a note?” An archaic principle of British common law provided a breakthrough in my thinking. It was the principle of “privity of contract.” Based on this, eleven pages of boring legal analysis were submitted to the SEC. The SEC, in the only case I know about, granted our request for a conference in advance of an adverse determination. They said there were too many people at the SEC interested in the outcome to reach a decision. After the meeting, a supplemental request was submitted, and was granted.

           Letter after letter was submitted for different programs relying on this ruling, and the kitchen was open for the slicing and dicing of municipal obligations and other exempt securities.Text Box: I acted as counsel in connection with the first insured corporate securities. I obtained the SEC no-action letters for these securities and the first insured municipal bonds. Here’s my story:

           Every once in awhile, I worked through the night at Kutak Rock. During one all-nighter, I was working on the documentation for the first insured commercial paper. It was the first time an insurance company had insured corporate debt in a public offering. It was 7:00 in the morning, and I had all the documents done except the insurance policy. Bob Kutak would show up in an hour, and I wanted to impress him by having everything done. I went to my filing cabinet and got my automobile insurance policy to use as a model. It was much too complex to serve as a model. I decided to just write something to hold the place of the insurance policy so its folder wouldn’t be empty.

           I wrote two or three sentences, which said that if the commercial paper was presented to the issuer, and was not paid on presentment, the commercial paper could be presented to Aetna, and would  be paid upon presentment. That was all. It was the shortest insurance policy you could imagine. Bob Kutak came in and read the documents. I held my breath when he came to the insurance policy. Then he looked at me and said, “I like that.” Aetna liked it too. Remarkably, it survived substantially as written. Later, in introducing Bob Kutak at a function, a senior Aetna executive said, “When we do a deal, we always write the documents. Except that when we do a deal with Kutak Rock on the other side, then they write the documents.”

           I obtained a no action letter from the SEC for the first insured securities—which were municipal bonds. I also obtained no action letters from the SEC for the first insured corporate securities—commercial paper. Kutak Rock set up the first insurance company specifically organized to insure municipal bonds, MBIA, Inc. and the first insurance company specifically organized to insure corporate debt, Financial Security Assurance, Inc. Both are listed on the New York Stock Exchange. My ex-law partners served as CEOs of both of these organizations for many years.

Text Box: I facilitated the creation of the Single-Family Mortgage Revenue Bond, and without my input it is unlikely the security would have been born. It swept the country, and would have been the vehicle for almost all residential housing finance had not Congress stepped in and severely restricted the program. Here’s my story:

           The Internal Revenue Code used to provide that industrial development bonds could be issued for six enumerated purposes. One of these was to provide for pollution control, and another was to provide housing. Developing a suitable housing bond required considerable creativity. A municipality has no infrastructure to make loans to homeowners.

           At great expense, the firm had developed a “loan to lenders” program. A municipality would issue bonds at low tax-exempt rates, and would loan the money to a savings & loan association, which would in turn loan the money to homeowners. They had all the kinks worked out, and the first issue was scheduled for sale by the City of Tucson for Tucson Federal Savings & Loan.

           The head of the bond department came to me and said that Kutak wanted my blessing on the deal from a securities standpoint. My blessing was expected as a pro forma matter, since neither he nor I saw any problem. That is, until I looked at the Securities Act. It provided that industrial development bonds were exempt from securities registration, except for industrial development bonds issued to finance housing. It was black letter law, and I told Bob Kutak there was no way around it. He responded by telling me the firm had invested $175,000 on a contingent basis, and that henceforth I was partner-in-charge of the project. If it failed, I was to blame.

           I organized a conference with the client in Tucson, but I was a corporate lawyer, and I didn't know a municipal bond indenture from a fried egg. Once again, I was thrust into a situation I knew nothing about. When I got back to Omaha, I turned the securities question inside out, and determined that there was nothing that could be done. There was no exemption from registration and no municipality would comply with the registration requirements. In the meantime, Tucson Federal pulled out of the deal. There were too many legal fees on their side.

           I convened a meeting of the leading tax lawyers in the firm to see if there was a tax angle that would solve the problem. After discussing the problem for hours, Alan Garfinkle, head of the Omaha Tax Department, said there might be a way. He asked whether it would solve the securities problem if we forgot we were dealing with industrial development bonds, and just treated them as ordinary municipal revenue bonds. This is the type of bond municipalities issue to finance water and sewer projects, to be repaid out of assessments and use fees. The head of the Tax Department for the Washington office violently objected. This was a travesty. There was no authority to finance housing under the general revenue bond law. Alan argued that there was no affirmative power, but it wasn’t prohibited either. What’s not prohibited is permitted. At least that was the argument.

           While the Washington and Omaha tax lawyers were still quibbling, the client pitched Mayor Richard J. Daley of Chicago on the idea, and he agreed to it. With the client demanding a “go,” the pressure became intense, and Kutak Rock opted to give the opinion. I turned management of the deal back to the municipal bond lawyers.

           The Single-Family Mortgage Revenue Bond swept the country. E.F. Hutton was catapulted from a non-entity in municipal bonds to the seventh largest underwriter. The U.S. Treasury was shell-shocked. It looked like it was going to lose billions in taxes on the interest income of lenders. It persuaded Congress to pass a law against the program, limiting the use of such bonds to low and moderate-income families.

           My contribution to this deal was primarily dogged determination to find a way through the maze. I just couldn't tolerate failure. Alan Garfinkle is really the lawyer who saved our bacon.

Text Box: The legal opinion of a reputable law firm can make law. I have a philosophy that if you were involved in it, you should be willing to opine on it. Here’s my story:

           Who says lawyers have to wear a black robe to make law? A well-reasoned opinion of a reputable law firm is seldom challenged. Kutak Rock was on solid legal ground in giving the opinion on the single-family mortgage revenue bond, but we invented it as certainly as if we were endowed with legislative power.

           A lot of lawyers are stingy with their legal opinions. But a legal opinion is of tremendous benefit to a client because it removes the element of “intent” to do wrong. It also protects the lawyer by documenting what he was thinking at the time. Wrongdoing is frequently judged on the basis of hindsight, with the scope of responsibility having expanded in the meantime. A well-reasoned opinion stops the clock at the point it was given, and is judged by whether it was reasonable on the law, as it existed. It also sheds light on the lawyer’s intentions.

           If a lawyer is involved and refuses to opine, the question arises, why was he involved in the first place? Not rendering an opinion may be an even more inviting invitation to a malpractice suit or an aiding and abetting charge. It also makes the road easier for a third-party litigant by removing the opinion as a roadblock.