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Since Sept. 11, several investment banks have been reworking the language in their underwriting agreements for initial public offerings to provide greater protection against future market disruptions. But sources say those efforts have already drawn the attention of federal securities regulators worried that underwriters will use the provision to weaken their commitments to clients. Such calamity clauses, or market-out provisions, shield underwriters against market-related events that may play havoc with an IPO. They also allow the underwriter to back out of selling the shares in an IPO in cases of war or market closures. The U.S. Securities and Exchange Commission is keeping a sharp eye on the changes to the calamity clause, legal sources said. Laird Simons, a partner with Palo Alto, Calif.-based Fenwick & West, says regulators would scrutinize this new contractual language owing to the distinctions between the two kinds of equity underwriting a bank can do. One type is a “best-efforts” deal, usually confined to small offerings. In that deal, a bank says it will do the best it can to place as many of a company’s shares as possible with investors. The more common type of IPO, and really the only kind the big investment banks do, is a “firm-commitment” underwriting. In that deal, an underwriter promises to sell all the allotted shares in an offering. The SEC and other regulatory bodies, then, will not want to see the line blurred between the two kinds of underwriting, Simons said. “The SEC wanted to make sure that when a bank purported to do a deal, it wasn’t a disguised best-efforts deal because they could walk away so easily,” Simons said. Government regulators, he added, “may say, ‘you better narrow it more.’” The SEC appears to be watching the developments through its division of market regulation, which regulates broker-dealers and underwriters. However, the SEC, one source said, is “not doing any crackdown or anything.” Still, since the terrorist attacks, the SEC’s division of corporate finance noted some changes underwriters were making and kicked the issue over to the division of market regulation, the source said. The SEC had no comment. But Brian Lane, a partner in the Washington, D.C., office of Gibson, Dunn & Crutcher and a former director of corporate finance at the SEC, acknowledged that “The SEC is likely to take some interest in the development of the amendments to the market-out.” Although rarely used, such clauses have been the focus of intensified interest the since Sept. 11 brought the financial markets to a standstill. Underwriters are “taking a hard look at their clauses to see whether they’re adequately protected, so there’s a lot of discussion about them,” Whit Conrad, a partner with New York law firm Davis Polk & Wardwell, said. “Since the unthinkable happened, [underwriters] want to make sure they provide for the next unthinkable.” “What you expect to see is an evolution of all underwriting agreements toward more stringent market-outs,” Simons said. “A number of underwriters were all looking to change their forms. Sept. 11 shook the foundations in many ways.” In fact, Goldman, Sachs & Co. and Credit Suisse First Boston have already rewritten the clauses in the agreements for at least one each of their IPOs in the past month, banking sources confirmed. Goldman spokeswoman Andrea Rachman declined to comment as did CSFB spokesman Victoria Harmon. But references to Sept. 11 increasingly are showing up in IPO-related filings and underwriters are giving themselves an easier escape hatch. Besides Goldman and CSFB, the idea is being considered by other investment banks at a rapid clip, lawyers noted. The calamity clause itself only gives the underwriter the option to terminate its participation in an IPO in the case of two extreme events: a shutdown of any stock exchanges or “an outbreak or escalation of hostilities … or calamity or crisis.” And there is only a small window of opportunity in which to exercise the provision. Underwriters can only cancel the agreement between the pricing date of the IPO — which is also the date on which the underwriting agreement is signed — and the closing date, usually four days later. “It’s a very narrow window, which is one of the reasons [the clauses] rarely, if ever, get used,” Conrad said. One underwriter recently made two key changes in the language of the clause, Simons said. One was to the type of market-related obstacles that would cause an IPO to be terminated. Instead of the “general moratorium” on banking activities, underwriters are now changing their agreements to provide for any “material disruption” in commercial banking or securities. That’s a clear broadening of the provision, Simons said. The other change was to the actual calamity clause. Added to the line about the “outbreak of hostilities,” the new language in one revised underwriting agreement now allows for “any other calamity or crisis or change in national or international financial, political or economic conditions, if it makes it impracticable or inadvisable to go forward [with the selling of shares].” That, too, is a much broader definition of the circumstances that would trigger an IPO termination. But “[t]here is not necessarily the intent to use it,” according to Simons who is rewriting the calamity clause for a client. He added that in the hundreds of IPOs he has worked on, he has never seen the market-out exercised. Another reason the clauses are rarely invoked: There is a stigma associated with the use of the calamity provision. “An investment bank’s reputation is doing deals that they promised to do,” Simons noted. An IPO termination can affect more than a bank’s reputation; it can also affect its financial statements along with those of the company planning the IPO. “No one wants to walk away if they can redo the deal,” Davis Polk’s Conrad said. “The company loses the proceeds, and the underwriters lose their fee. It’s in everyone’s interest to get the deal done.” Copyright (c)2001 TDD, LLC. All rights reserved.

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