August 2006 Issue 56

Welcome to the August 2006 edition of
Business Leasing and Finance News
formerly Business Leasing News

About BLFN: David G. Mayer, a Business Group partner at Patton Boggs LLP, founded this monthly e-newsletter in January 2002. BLFN’s mission is to provide leasing and financing strategies for your success.

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FOUNDER'S NOTE
By David G. Mayer

BLN leads this issue with an important environmental development in Europe. After a lengthy grace period, the EU will now enforce broad and severe restrictions on using hazardous materials in electronics sold and financed in EU Member countries. Most financiers and lessors will not be affected if they only provide financing. The second article focuses on decision-making by all companies and provides insight into how leaders make great decisions. “Leasing 101” and BLN Case & Comment describe hedge funds, an increasingly powerful force in capital and equipment finance, capable and willing to fight off securities regulation. The hedge fund prevailed over the SEC in a major effort by the SEC to impose issuer-type regulations on them, but the fight is far from over.

Enjoy this issue and the last month of summer! Thanks again for reading BLN. I appreciate each of you and your contact with me by telephone and e-mail at

1. Sparing Financiers, EU Cracks Down on Use of Hazardous Materials in Electronics

The European Union (EU) recently implemented wide-ranging restrictions on the sale of electronics that contain hazardous environmental materials. The EU also plans to prevent, or at least greatly slow down, the increasing waste stream of old or new electronics-laden products that use parts made with hazardous materials.

On July 1, 2006, the EU began enforcing broad new environmental regulations. The new rules cover 80 percent of U.S. name brand electronics sold in the EU. U.S. producers expect compliance to cost $30 billion. See EU’S Environmental Hurdles for Electronics, The Wall Street Journal (SW Ed.), Col. 3, Page B:5 (June 29, 2006).

The EU means business.  To enforce its new rules it has required its Member States to impose penalties on non-compliant manufacturers, resellers, importers and exporters who do not switch over to environmentally friendly materials in electronics. However, it exempted most financiers of these electronics.

The regulations stem from Directive 2002/95/EC of the European Parliament and the Council of 27 January 2003 on the Restriction of the Use of Certain Hazardous Substances in Electrical and Electronic Equipment (RoHS Directive). The RoHS Directive applies to an extensive list of electrical and electronic equipment (EEE) set out in categories 1, 2, 3, 4, 5, 7 and 10 set out in Annex IA to Directive 2002/96/EC on Waste Electrical and Electronic Equipment (WEEE Directive). The WEEE Directive aims to slow the rapidly growing problem of electronic waste disposal in part through improved recycling efforts.

The WEEE and RoHS Directives (Directives) originally entered into force on February 13, 2003, but the ban on importing or marketing electronic products containing prohibited materials in the EU did not become effective until July 1, 2006. The RoHS Directive states that it “does not apply to spare parts for the repair, or to the reuse, of WEEE put on the market before July 1, 2006”. See Article 2(3) (Scope). In short, the preparation or grace period is over for anyone involved in selling or distributing the regulated EEE.

Affected Electronics

The regulated items fall within the following categories, with the noted exclusions:

1. Large household appliances;
2. Small household appliances;
3. IT and telecommunications equipment;
4. Consumer equipment;
5. Lighting equipment;
6. Electrical and electronic tools (with the exception of large-scale stationary industrial tools)
7. Toys, leisure and sports equipment;
8. Medical devices (all excluded due to the vital nature of the services provided with these items);
9. Monitoring and control instruments (all excluded); and
10. Automatic dispensers.

This list covers many assets subject to leases or secured lending facilities and substantial product sales such as mainframes, minicomputers, personal computers, copying equipment, user terminals and systems, circuit boards and telephones. Under Article 2(3) of the RoHS Directive, the list does not cover equipment “connected with the protection of the essential interests of the security of Member States, arms, munitions and war materials” that are “intended for specific military purposes.”

The objectives of the RoHS Directive and WEEE Directive include:

• preserve, protect and improve the quality of the environment and to protect human health (Recital (1) of WEEE Directive);
  
  
• ensure that, starting July 1, 2006, new EEE put on the market in the EU does not contain lead, mercury, cadmium, hexavalent, chromium, polybrominated biphenyls (PBB) or polybrominated diphenyl ethers; and
  
  
• prevent WEEE and to promote the reuse, recycling and other forms of recovery to reduce the disposal of waste. (Article 1, WEEE Directive).

*Technical Point: The Directives bind the Member States in the EU.  To implement the WEEE Directive, the individual Member States must, in turn, enact measures that affect their own citizens and others subject to their national laws. See Article 4 of RoHS Directive.

Affected Suppliers; Financiers Spared

The Directives apply to each “producer” but do not apply to suppliers who exclusively provide financing under “finance agreements.” 

*Terms to Know: The Directives affect each “producer” which includes any person who, irrespective of selling technique used, (i) “manufactures and sells electrical and electronic equipment [EEE] under his own brand”; “(ii) resells under his own brand produced by other suppliers. . .” (with limitations); and (iii) “imports or exports EEE on a professional basis into [a] Member State.” Under Article 3(m) of the WEEE Directive, a “finance agreement” refers to an arrangement in which financiers such as banks, leasing companies and financing entities exclusively provide loans, leases, equipment hire agreements or deferred sale agreements. 

In other words, financiers that both produce and finance are subject to the Directives. In order to be exempt, a company must only be in the financing business. These lessors, conditional sellers and other equipment owners can remain unregulated in transactions in which they take title to the regulated product.

*Tip: Even though the Directive exempts certain equipment and parts, as a financier, conditional seller, lessor or secured lender, you should still evaluate potential for reduced residual and collateral value of financed products in the EU, as of the end of the financing period, and consider limiting transactions to those in which the products are made with hazard-free, EU compliant parts.

Complexities and Penalties

Many electronic items contain lead or other prohibited materials under the Directives. Redesigning products and their individual components to eliminate the banned materials has created enormous complexity and cost. Change is occurring, but more slowly than the EU or producers would like. Certain larger manufacturers have complied, but many other smaller to mid-size companies have not. It is complicated to comply because of the large number of items that contain prohibited materials. Finding and using the right materials creates design and production challenges for producers. As producers have begun to comply, they have also experienced some shortages of certain environmentally friendly parts.

Nonetheless, the failure to comply should create concern for U.S. companies. The Directives requires each of the Member States to adopt penalties, and the penalties must be “effective, proportionate and dissuasive.” See Article 8 of the RoHS Directive and Article 15 of the WEEE Directive. The penalties range from money payments to jail time. See EU’S Environmental Hurdles for Electronics, The Wall Street Journal (SW Ed.), Col. 3, Page B:5 (June 29, 2006).

Although some EU Members, such as the United Kingdom, may give U.S. companies some slack for a while, U.S. companies must retool their production facilities, use environmentally acceptable materials, and comply with the Directives. The future of environmental regulation for electronics is not a concern for tomorrow. It is an imperative in Europe today. Moreover, some U.S. States are considering the adoption of legislation that mirrors the EU Directives. The U.S. may benefit too as U.S. manufacturers produce one product line per electronic item. In that way, U.S. producers will not only comply with the Directives but also enhance environmental protection in the U.S.

Thanks to Daniel E. Waltz, a partner at Patton Boggs LLP, for editing this article. Dan is a member of the International Trade and Transactions group at Patton Boggs.

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2. How Do Leaders Make Great Decisions?

In its 75th Anniversary Special Issue, Fortune magazine examined the question of how to make great decisions. It illustrates how 20 decisions shaped the modern world. See: 20 That Made History, Fortune at p. 58 (June 27, 2005). For most people, their decisions will not change the world, but they can affect the success or failure of their enterprises.

Although most people despise uncertainty, decision-making may take a close second place. In the business world, decision-making defines leaders, and the quality of their decisions makes them valuable. CEOs often make hard decisions because their jobs require them to make the decisions that cannot be delegated. See Decisions, Decisions, Fortune at p. 56, Col. 1.

*Term to Know: The term “decide” comes from the Latin word “decidere.” That word literally means “to cut off.” 

A decision maker is sometimes identified as the chief, the top dog or the head honcho. However, everyone makes decisions, even if only small ones. Decision-making implies making choices based on alternatives: careers to pursue, an investment to make or a risk to take. In every case, decisions either open or close the door to new opportunities and create new uncertainties. Success or failure very seldom flows from a single decision, but instead, from many decisions, each with their own outcome. In business, decision-making is part of the daily fare. Excellence in execution of good decisions often creates value in business.

According to Fortune, there is a vital difference between a wrong decision and a bad decision. While both may have a lousy outcome, a bad decision is one you can prevent in the process of making it. Decision makers use cognition and research, insight and debate, gut instinct and great people in a collaborative effort to reach great decisions. Decisions can be wrong, but everyone makes mistakes. A bad decision is the fault of the method, which is controllable, whereas the outcome of either type of decision is not. See Fortune at p. 56. Decision-making can be rational or irrational, but almost everyone has the capability to avoid bad decisions in the context of their work. A bad decision is an error, but “the worst decision you can make is no decision at all.” See Great Escapes, Nine decision-making pitfalls—and nine simple devices to beat them, Fortune at p. 97-98 (June 27, 2006).

Jim Collins, author of Good to Great and Built to Last, provided useful tips on decision-making. For his interview with Fortune about decision-making, Collins studied 14 years of research and interviews on the inner workings of the best organizations, looking for the distinctive qualities that separated them from the rest. See Jim Collins on Tough Calls, Fortune (June 27, 2006). His ideas provide food for thought and action, presented summarily here as a few Do’s and Don’ts of decision-making.

• Don’t ask “what” in making decisions. Do ask “who.” Collins found that the greatest decisions involved people decisions. Do select the right people to work with you.
  
  
• Don’t be afraid to say “I don’t know.” Be honest about what you know and do not know. Then, use the best research and resources at your disposal to make your decisions. Saying “I don’t know” doesn’t mean that you cannot find out or make the right decision.
  
  
• Don’t expect people to agree with you as the CEO or other decision maker. You may be persuasive, even intimidating. However, foster an environment of free-flowing information. Let people disagree with you and others in your team. Encourage independent thought. Accept that when you make a decision, not everyone will agree with you. After a decision is made, expect every member of your team to support the enterprise and put his or her differences aside.
  
  
• Don’t adapt to the outside world or try to figure it out. Look to the driving forces of your organization and the truth of your situation. Collins found that great companies are internally driven by their real core values and real aspirations, but are externally aware of the world (in particular, “how it operates and how it is changing”).
  
  
• Don’t count on luck, but don’t discount it. Collins’ research showed that the primary factors lie within your control. Understand that decision making “is ultimately a creative act” within your control.

People who can freely debate, research and question ideas and each other can make great decisions. Each decision opens new avenues to success and possibilities of failure. Decisions create uncertainty because no one can know what the outcome will be. But everyone can control the process of deciding. Most great decisions do not consist of a single act or outcome, but involve many decisions, followed in every case by solid, if not stellar, execution. Everyone can make a right decision or wrong one, sometimes even bad or irrational. Almost every decision we make in business, and individually, affects our futures and, in many cases, the future of people around us. It seems well worth developing a process to achieve great outcomes, but the decision to do so rests with each of us.

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3. Case & Comment: Hedge Funds Win Appellate Fight with SEC in Goldstein v. SEC

The attempt of the Securities and Exchange Commission (SEC) to regulate hedge funds failed on appeal in Goldstein v. SEC, No. 04-1434, DC Ct. App (June 23, 2006) (Goldstein). 

BACKGROUND: The SEC issued rules under the Investment Advisers Act of 1940, 15 U.S.C. §80b-1 et seq (Act) in its release entitled Registration Under the Advisers Act of Certain Hedge Fund Advisers, Release No. IA-2333; File No. S7-30-04, 17 CFR Parts 275 and 279 (Final Rule). The Final Rule required advisers to certain hedge funds to register with the SEC under the Act. The SEC intended to use the Final Rule to protect the public that invests in the public securities markets from alleged abuses, such as insider trading by the hedge funds. Prior to the Final Rule, the Act exempted hedge funds with “fewer than fifteen clients.” See 15 U.S.C. §80b-3(b)(3). Under the Final Rule, the SEC requires most advisers to hedge funds to register with the SEC if the funds they advise have fifteen or more “shareholders, limited partners, members, or beneficiaries.” 17 C.F.R. §275.203(b)(3)-2(a). 

According to discussion in the Goldstein decision: “‘Hedging’ transactions, from which the term ‘hedge fund’ developed, see Willa E. Gibson, Is Hedge Fund Regulation Necessary?, 73 TEMP. L. REV. 681, 684-85 & n.18 (2000), involve taking both long and short positions on debt and equity securities to reduce risk. This is still the most frequently used hedge fund strategy.” Hedge funds typically separate management from passive investors and differ from regulated mutual funds and venture capital investors by their particular investment behavior and targets.

The Petitioners argued that hedge fund “clients” were not the same as “investors” entitled to protection under the U.S. securities laws. The Goldstein court notes that clients of hedge funds typically consist of wealthy, sophisticated investors who could handle substantial risk without the regulatory safety net afforded to other investors in entities issuing securities in public markets, such as mutual funds. Mutual funds must comply with disclosure and independent boards’ rules amid other regulations by the SEC.

ISSUE: Does the SEC have the authority and jurisdiction to regulate hedge funds?

ANSWER/OUTCOME: No. After discussing the complex securities issues in Goldstein, the U.S. Court of Appeals for the District of Columbia Circuit held the Final Rule to be arbitrary. It found no compelling reason for the Final Rule to exist, and struck it down.

LAW OF THE CASE: The SEC can regulate issuers of securities to the public, not to private qualified clients of high net worth and sophistication like those investors in the Petitioners. The hedge funds in Goldstein argued that the SEC misinterpreted §203(b)(3) the Act. This provision exempts from registration “any investment adviser who during the course of the preceding twelve months has had fewer than fifteen clients.” 15 U.S.C. § 80b-3(b)(3). The Act does not define the term client, though the court reviewed multiple interpretations and ambiguities of that term, as well as the SEC’s arguments for regulation. In the end it concluded: “The Commission’s rule creates a situation in which funds with one hundred or fewer investors are exempt from the more demanding Investment Company Act, but those with fifteen or more investors trigger registration under the Advisers Act. This is an arbitrary rule.”

*Comment: Hedge funds have been growing rapidly, gaining political clout and flexing their economic muscle. Hedge funds have become, and will likely continue to be, a competitive force in the investment marketplace for financial and non-financial assets. Not to be left out in the cold after the Goldstein decision, the SEC is likely to take another run at regulating hedge funds and/or their advisers, but is unlikely to appeal the decision. Hedge funds and their advisers may now be emboldened after Goldstein to fight regulation and preserve their business model of making higher risk, higher return investments for their select group of clients. See SEC official: Hedge fund appeal unlikely - Atkins doesn't think office would fight court's ruling, The Boston Globe (July 7, 2006).

Thanks to our partner, Norman Miller, for his comments on this article. Norm is a member of the firm’s Corporate Finance, Mergers and Acquisitions and Corporate Governance (Sarbanes-Oxley) groups.

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4. Leasing 101: What Is a “Hedge Fund?”

In Goldstein v. SEC, No. 04-1434, DC Ct. App (June 23, 2006) (Goldstein), the Court attempted to define a hedge fund and to distinguish it from regulated investment funds: 

“Hedge funds” are notoriously difficult to define. The term appears nowhere in the federal securities laws, and even industry participants do not agree upon a single definition. See, e.g., SEC Roundtable on Hedge Funds (May 13, 2003) . . . (comments of David A. Vaughan) (citing fourteen different definitions found in government and industry publications). The term is commonly used as a catchall for “any pooled investment vehicle that is privately organized, administered by professional investment managers, and not widely available to the public. . . . ”

Hedge funds may be defined more precisely by reference to what they are not. The Investment Company Act of 1940, 15 U.S.C. § 80a-1 et seq., directs the Commission to regulate any issuer of securities that “is or holds itself out as being engaged primarily . . . in the business of investing, reinvesting, or trading in securities.” Id. § 80a-3(a)(1)(A). Although this definition nominally describes hedge funds, most are exempt from the Investment Company Act’s coverage because they have one hundred or fewer beneficial owners and do not offer their securities to the public, id. § 80a-3(c)(1), or because their investors are all “qualified” high net-worth individuals or institutions, id. § 80a-3(c)(7). Investment vehicles that remain private and available only to highly sophisticated investors have historically been understood not to present the same dangers to public markets as more widely available investment companies, like mutual funds. See Goldstein at pp 2-3.

*Tip: Hedge funds trade in all types of assets from traditional stocks, bonds and currencies to financial derivatives and non-financial assets. Hedge funds have been expanding to market segments that typically had been the domain of lenders and lessors, such as aviation finance and even timber. 

According to Hedge Fund Research Inc., the number of hedge funds worldwide has reached 8,800, up from 2,800 a decade ago. Hedge funds control assets worth from $750 billion to $1.2 trillion. See Volatile Markets Bring Hedge Funds Under Fire, The Wall Street Journal, SW Ed., Col. 1, Page A:9 (July 1, 2006).

So what exactly is a hedge fund? The definitions vary, but in general, hedge funds are private, large, generally unregulated pools of capital, run by professional investment managers, who can use their client’s money to make risky, diverse investments, often in the form of limited liability companies or limited partnerships, with little or no management involvement of their passive investors. They basically hedge their well-placed investments or derivatives, which gave rise to the name.

Thanks again to Norman Miller, for his comments on this article.

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About Patton Boggs LLP; Recent Publications; Upcoming Speech

Patton Boggs LLP is a law firm of more than 450 lawyers located throughout the United States and internationally in Doha, Qatar. Patton Boggs most recently added offices in the New York metropolitan area. The firm has done business in over 70 countries during its almost half a century of operation, and increasingly focuses on such dynamic markets as India, China, Brazil and Western Europe in business and public policy matters.

Patton Boggs has major practice areas: Business Transactions, Intellectual Property, Public Policy and Litigation. These groups are composed of many practice groups designed specifically to meet client needs and developing markets. I often focus on aviation, power, infrastructure and technology matters as a member of the 120-member Business Transactions Group.

The firm provides a broad array of skills in domestic and international business transactions. BLN covers a small part of the skills available at the firm. These capabilities include equipment finance and leasing, corporate finance, secured transactions, syndications, mezzanine finance, enhanced use and other federal leasing, project finance, real estate, healthcare, pharmaceuticals and technology transactions and public policy work. We devote a significant part of our time to wind power, cogeneration and oil and gas matters worldwide. We also address related creditors’ rights/bankruptcy in structuring transactions and resolving troubled credits.

We assist our clients with buying, selling, financing, and leasing real and personal property, including business and commercial aircraft, energy assets, facilities, vehicles, production equipment, technology hardware and software, and health care equipment as well as highways and other infrastructure projects. We have specific teams for aviation, infrastructure/power, healthcare, federal leasing/finance/marketing, municipal leasing/finance, and international transactions by region or country. We provide extensive, and newly expanded, litigation resources with the addition of high-profile litigators in our New Jersey office.

You are welcome to call me at 214.758.1545 or e-mail me at dmayer@pattonboggs.com. We value your contact with us on any topic, including questions arising from BLN articles or about our law practice.

Recent Publications

The following is representative of recent works by David G. Mayer:

• Aviation finance will take flight under Cape Town Treaty by David G. Mayer, Ft. Worth Business Press (Feb. 13, 2006).
  
  
• Federal Leasing: A Lifeline in a Sea of Red Ink? – The Feds need us, by David G. Mayer, ELT Magazine, the leasing publication of the Equipment Leasing Association (Jan.- Feb. 2006). Thanks to Jack Helmly of GTSI Financial Services and Michael Guiffre of Patton Boggs LLP for their editing and input on this article.
  
  
• Legal Opinions and Title Insurance Mitigate Risk Under The Cape Town Convention, by David G. Mayer and Frank Polk, aviation partner at McAfee & Taft, LNJ’s Equipment Leasing Newsletter (Nov. 2005).
  
  
• True Leases Under Attack: Lessors Face Persistent Challenges to True Lease Transactions, by David G. Mayer, Journal of Equipment Lease Financing (Special Issue, Fall 2005), a 17,000-word article. Special thanks go to the many editors, including Patton Boggs bankruptcy partner, Jeff LeForce; Patton Boggs tax partner, George Schutzer; Patton Boggs Associate, Joel A. Bannister; three members of the ELA's Legal Committee; and two Foundation reviewers. 2005 JELF ARTICLE OF THE YEAR!
  
  
• The Cape Town Convention: New Complexities and Opportunities, by David G. Mayer and Frank Polk, aviation partner at McAfee & Taft, LNJ’s Equipment Leasing Newsletter (Oct. 2005).

Upcoming Speech

• On September 18-20, 2006, the Equipment Leasing Association will sponsor the Lease Accountants Conference at the Omni La Mansion del Rio • San Antonio, TX. On September 20, at 9:00 a.m. to 10:15 a.m. Joseph P. Sebik of JP Morgan Chase Capital and David Mayer of Patton Boggs LLP will be present, in a Breakout Session, fundamentals of Lease Documentation.

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Thanks to BLFN’s Team

I would like to thank BLFN’s team at Patton Boggs LLP. The team includes J. Atwood Jeter, a senior associate in the firm’s business transactions, real estate, and wind energy groups; the Patton Boggs staff editors, Paul Dumansky and Adrian Nicole McCoy; our Project Manager, Melissa Green; Claire Campbell; and our designer, Winston Jackson. Thanks also to Douglas C. Boggs, a Business Group/Securities partner and web site reviewer for BLFN, and our Marketing Chief, Mary Kimber, for assisting BLFN through our firm’s editing, design, and posting process.

All the best,

David

David G. Mayer
Founder: Business Leasing and Finance News
(formerly Business Leasing News)
Partner: Patton Boggs LLP
2001 Ross Avenue
Suite 3000
Dallas, Texas 75201
(214) 758-1545 (phone)
(214) 758-1550 (fax)

E-Mail: dmayer@pattonboggs.com

© David G. Mayer 2002-2007