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Gov. Gray Davis and his budget planners may be having Maalox moments over the huge gaps in the state budget, but California’s financial mess is nothing but good news for San Francisco’s Orrick, Herrington & Sutcliffe. The firm is a key player in a complicated transaction that would serve up a $4.5 billion chunk of the state’s settlement with Big Tobacco immediately, instead of over 25 years. For Davis, tobacco securitization will help plug a gargantuan budget deficit. For Orrick Herrington, it’s a potentially lucrative piece of work whose complexity far outstrips the run-of-the-mill bond counsel duties the firm frequently handles for the state. The securitization deal also stands as a clear reminder of the close political connections that Orrick Herrington has developed in Sacramento, Calif. The firm was ushered into the process by the treasurer’s office, and it played a role as Davis administration officials put together the legislation that will allow California to do the transaction, according to the state officials and lawyers involved in the deal. To be sure, Orrick Herrington is a leader in such securitization transactions: It is the nation’s top legal counsel to issuers of asset-based securities. And the firm has built a nationwide list of blue-chip government clients through its bond work. Orrick Herrington also is one of California’s most aggressive corporate law firms when it comes to campaign contributions. Since January 1997 — the beginning of the last gubernatorial election cycle — the firm has contributed $207,000 to the three politicians who are set to oversee the securitization transaction, according to state campaign finance records. State Treasurer Phil Angelides received $132,250, Gov. Davis, $58,600, and Controller Kathleen Connell, $17,000 (including $1,000 to her race for mayor of Los Angeles.) But the governor’s office — still bruised by accusations that Davis administration officials improperly doled out a huge contract to campaign contributor Oracle Corp. — bristled at the suggestion that politics had anything to do with Orrick Herrington’s role. “We do not handle campaign contributions at all in the governor’s office, but I can say definitively that contributions have no connection to policy decisions, including the selection of Orrick Herrington as bond counsel,” said Hilary McLean, a spokeswoman for Gov. Davis. “Orrick does have great expertise in this specialized area of finance law. That is why we are using them.” And Orrick Herrington too, says its contract to do tobacco securitization work is about its credentials as a top public financing firm, not its political donations. “It’s not pay-to-play,” said Roger Davis, the partner who heads the firm’s public finance group. “We are the number one bond counsel firm on the planet, and we are number one in securitization. … It’s not an issue.” Politics or not, Orrick Herrington’s work on tobacco securitization means the firm is collecting government contracts like some people collect Depression glass. In the past year, Orrick Herrington led deals to securitize tobacco proceeds for San Diego, Sacramento and Sonoma counties, the states of Wisconsin and South Carolina and the District of Columbia. It was also underwriters counsel on several others. The securitization effort is the byproduct of a $206 billion agreement in 1998 that settled suits by 46 states against cigarette makers for Medicaid expenditures on smoking-related diseases. Money is being paid out over a 25-year period. To date, deals to securitize that cash have been as lucrative for Orrick Herrington as the most expensive initial public offerings were for Silicon Valley firms during the boom of the late 1990s. The firm billed Sacramento County $1 million-plus for its services, according to the county’s finance department. San Diego County guaranteed the firm $500,000 in legal fees for its transaction, though the amount may have exceeded that figure, according to county finance officials and public records. By comparison, the firm generally charges flat fees for bond counsel work that can range from $55,000 — such as a recent bond that Orrick Herrington did for three open-space assessment districts in Marin County — to $412,000 for a ballpark bond two years ago for the city of San Diego. Tobacco securitization, by contrast, “is a large, very labor-intensive and skill-intensive transaction, more characterized by higher-level work than a vanilla bond or [other type of] securitization” deal, said Orrick Herrington’s Davis. The firm, Davis said, has done about a dozen tobacco securitizations so far, including one for $1.3 billion in Wisconsin. That deal, according to Wisconsin officials, was the biggest single transaction in the state government’s history. “The firm has been marketing this service,” Davis said. “Almost from the moment of the settlement, the beneficiaries have been searching for a way to monetize it.” Orrick Herrington’s primary competitors are Chicago-based Sidley Austin Brown & Wood and New York’s Hawkins, Delafield & Wood, though Sidley Austin and Orrick Herrington, according to public officials and lawyers, have led the field. Both are among the top law firms doing asset securitization deals. According to annual rankings published by Recorder and law.com affiliate The American Lawyer magazine, Orrick Herrington ranked No. 1 and Sidley Austin No. 3 as legal counsel on issuer-side, asset-backed securities deals. On the underwriters’ side, the rankings were reversed: Sidley Austin was No. 1, and Orrick Herrington was No. 3. Eric Tashman, a Sidley Austin public finance partner in San Francisco, said his firm has seen “steady and persistent interest” in securitization. But this interest doesn’t mean firms will be able to count on securitization work forever. They have a limited supply of clients — only those cities, counties and states involved in the settlement — and securitization is a one-time only transaction for many issuers. “They can only sell their asset once. After they’ve sold it, there’s no returning to the well,” Tashman said. BIGGEST DEAL OF ALL Nonetheless, the well is very deep in California. The state’s securitization was already the biggest ever — $2.4 billion –when Davis proposed it in his January budget. But as the deficit ballooned, so too did the size of the proposed transaction. At $4.5 billion, it is so large that state officials said they are now worried they may have to do some fast footwork to ensure the markets react favorably. It’s also not universally popular. Republicans — hoping the budget deficit will be an issue in the fall election — are attacking securitization as a one-time borrowing scheme that does little to address deeper budget issues. “We have a spending problem in California, not a revenue problem,” said Nghia Nguyen, press secretary to state Senate Republican Leader Jim Brulte. Given the intense, election-year politicking and securitization’s central role in the governor’s budget plan — “it’s crucial,” McLean said — the transaction has been mapped out by a core group from the Davis administration, the treasurer’s office and their leading counsel. “We are carrying the bill, but parties within the administration and lawyers paid by the administration drafted it,” said Alan LoFaso, chief of staff for Assemblywoman Carole Migden. Migden, a San Francisco Democrat, is sponsoring AB 2353, the legislation that would authorize the securitization transaction. James Tilton, an assistant program budget manager with the state Department of Finance who helped craft the legislation, said the deal is “unusual for the state” because of its complexity. It requires creation of a special nonprofit corporation that will be administered by California’s Public Works Board. The nonprofit will buy the tobacco settlement from the state and then issue bonds to repay the debt it incurred in the purchase. The board includes three Davis administration officials, the state controller and treasurer. From the beginning of the drafting process, the treasurer’s office made it clear that it wanted Orrick Herrington to be a part of the deal. “The treasurer identified them as part of the team,” Tilton said. Colleen Beamish, who handles press inquiries for the treasurer’s office, did not return calls seeking comment for this story. Thus, it’s unclear exactly how the treasurer’s office handled the selection process. Although Orrick Herrington serves as bond counsel for the state, securitization does not necessarily fall under the firm’s list of regular duties. It requires more time and manpower for the firm, and other firms, like Sidley Austin, are competing for the work. Orrick Herrington’s Davis said the treasurer sent out a request for proposals for bond counsel on the transaction — presumably to a small group of firms that has expertise in such matters. Orrick Herrington won the contract, and though he declined to say how much the firm is being paid, Davis said it was a fixed fee that was less than what the firm made in Sacramento County. “The fee [for the state] is lower than the fees for similarly situated tobacco securitizations in other states and in some of the counties,” Davis said. “Certain deals are simple, and this is not that. This is tough stuff, and it will be a number of months before we know whether we are coming in above or below the fixed fee. There are a whole lot of variables.” LOCALS DID IT FIRST The state deal — huge though it is — is just one in a series of tobacco securitization deals that Orrick Herrington and its competitors have done in the past few years. After states and local government agreed to settle their litigation against the tobacco companies in 1998, underwriters, investment banks and law firms almost immediately began to pursue public officials about the possibility of securitization. Their key pitch has been protection — or in lawyer parlance, “risk shifting.” Securitization allows government agencies to collect now and avoid the possibility of losing their money if at some point tobacco companies fail. “They are agreeing to pay a premium in the form of a haircut on their potential settlement proceeds to assure that the money is in the bank,” Sidley Austin’s Tashman said. One of the first in California to bite was Sacramento County. The county’s financial officer, Geoffrey Davey, said he was first approached in the fall of 1999 by investment bankers and underwriters who specialize in such deals. And Orrick Herrington was quickly tapped as counsel. In many ways, Orrick Herrington’s relationship with Sacramento mirrors its ties to the state. The firm is the county’s longtime general obligation bond counsel — giving it an inside track to the work — and Orrick Herrington lawyers have developed a close working relationship with county officials. The firm and partners also contribute to local campaigns, though in smaller amounts and less frequently than their donations to state officials. Sacramento securitized $200 million from the tobacco settlement — a pittance compared to the state’s proposal. Yet the deal was not a particularly smooth one. Securitization complicated the already difficult negotiations with the plaintiffs’ firms that handled tobacco litigation — including San Francisco’s Lieff Cabraser Heimann & Bernstein. Plaintiffs firms had handled the case on a contingency fee basis because “no one thought it would amount to much,” Davey said. But it did amount to something — $25 billion for California, its counties and several cities. Under the settlement agreement, the tobacco companies agreed to pay the state, counties and cities a sum every year until 2023. That means that instead of being paid off in one lump sum, plaintiffs’ firms were entitled to payments from the annual settlement proceeds from the counties and cities. Thus, they had a lien against the settlement money and until their claims were addressed, banks balked at securitization. “It looked like perpetual payments to the law firms, and we regretted that, but obviously we had a deal,” Davey said. As county counsel throughout California hammered out an agreement, Orrick Herrington was called in to help draw up paperwork that would calm jittery credit-rating agencies, Davey said. “Different law firms were hired to do this, but the ratings agencies rejected the original firms, saying they did not have the expertise,” Davey said. “Orrick was OK with the ratings agencies because of their experience level.” The firm was also keen on getting the deal done. Sacramento’s transaction was the first in the state for the firm, and California is one of the most lucrative markets in the country for tobacco securitization because counties and cities joined in the tobacco litigation. Completing the deal in Sacramento gave Orrick Herrington a template for other California counties. In fact, Orrick Herrington’s contract calls for the firm to rebate to the county a portion of its $1 million-plus in fees when information gained as part the Sacramento deal is used in other jurisdictions, Davey said. Not that the firm will be hurting because of the rebate. In San Diego County, Orrick Herrington billed at least 1,000 hours to securitize the county’s $466 million portion of the tobacco settlement, said William Kelly, the county’s chief financial officer. “Any time you have a new kind of [financial] product that has not been through the ringer, it’s more difficult,” Kelly said. “It’s more expensive.” And as with the state and Sacramento County, San Diego was very familiar with Orrick Herrington’s work. It had served as counsel on several bond issues. The firm was selected from among four firms that responded to a county request for proposals — though Kelly could not recall if the work was priced lower than that of the other firms. “Orrick Herrington had a depth of talent for municipal and structured finance,” Kelly said. “We were very familiar with them.” See related charts: Tobacco Securitization Deals Campaign Contributions

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