In Washington, more of the same could shake status quo

Last week's national election left Washington's leadership lineup intact. But the re-election of President Obama and the continued split control of Congress will do anything but maintain the status quo, especially for issues that matter to dealmakers.

The two years of legislative gridlock resulting from the 2010 Republican takeover of the House is now forcing lawmakers to address the looming tax hikes and spending cuts of the "fiscal cliff" in some fashion during a lame duck session that begins Nov. 13.

More broadly, the outcome assures the continued implementation of controversial laws already in place, namely the Dodd-Frank Act's overhaul of financial reform and the 2010 healthcare reform. If Mitt Romney had captured the White House, Republicans would have made a serious stab at trying to weaken both.

It is possible policy changes could also come about because of a raft of personnel changes at key financial agencies, including the expected departures of figures who dominated the business news during Obama's first term: Treasury Secretary Timothy Geithner, Federal Reserve Board Chairman Ben Bernanke and Securities and Exchange Commission Chairwoman Mary Schapiro. Some new faces will also be named to head key committees in Congress. Finally, new competition regulators are coming to the Department of Justice's antitrust division and the Federal Trade Commission as well.

Nearly all of these factors will affect M&A.

The need to address the fiscal cliff immediately will dominate Washington's attention during the lame duck session.

Dechert LLP partner William Lawlor predicts an uptick in global M&A will occur before year's end, thanks in part to political certainty the election brings, along with a number of factors including record levels of cash on corporate balance sheets, the low cost of capital and the expiration of the Bush tax cuts.

"In the short term we'll see a significant amount of M&A, dividend and recapitalization before year-end to take advantage of lower tax rate before the Bush tax cuts expire," Lawlor said.

The medium-term M&A environment depends on what happens regarding the fiscal cliff, the one-two hit to the economy expected when the Bush tax cuts expire, and massive spending cuts kick in. (The fiscal cliff is occurring now as a result of deal brokered in summer 2010 to win necessary GOP support for raising the debt ceiling.)

A lot depends on how Obama gets along with the Republicans. "Obama and Congress would boost confidence and fuel M&A if they can deal with the fiscal cliff," said Lawlor.

Longer term, Lawlor predicted a more robust merger market can be maintained over the next several years. "There is over a trillion dollars of cash on company books and activist investors will make sure CEOs use it for mergers, dividends and other things." He also noted that private equity ratios of target companies look good compared to the "anemic" internal growth rates of potential buyers.

Other long-term factors are also setting up a "great M&A run," he said, including maturing PE funds and increased shareholder activism. In the healthcare sector, the looming Medicare surcharge will drive deals. U.S. companies will also have incentive to acquire foreign assets using overseas cash that cannot be repatriated without adverse tax consequences.

"There's a huge amount of PE fund exits lining up on the runway. Investments made from 2005 to 2007 are ripe, if not over-ripe. Buyers have lots of potential targets out there," said Lawlor.

The bad news for dealmakers is that Obama's re-election assures four more years of aggressive antitrust enforcement against mergers and continued emphasis on litigating merger challenges. A new crop of regulators is unlikely to alter the agencies' current aggressive course.

According to Matthew L. Cantor, an antitrust partner in the law firm Constantine Cannon LLP: "The economy is getting better and capital markets freeing up and so we'll likely see a greater amount of mergers in second term, particularly in healthcare because the Affordable Care Act provides incentives for healthcare providers to combine in order to create efficiencies that will compensate them for lower Medicare rates."

Although the government fully expects healthcare consolidation as a result of the law, Cantor said antitrust regulators will maintain their already tight surveillance of industry mergers. "There will be scrutiny to see if the deals are likely to lead to lower rates or simply enhance the parties' market power," he said.

More broadly, Cantor predicted the number of mergers overall will also rise, leading to more aggressive enforcement. Non-merger antitrust enforcement will continue along the lines of the E-books pricing conspiracy case the Department of Justice brought against Apple Inc. and major book publishers and the DOJ's investigation of Libor manipulation.

He also predicted that the Justice Department will at long last make good on the promise of Christine Varney, the first DOJ antitrust chief under Obama, to make more use of Section 2 of the Sherman Act, which bans unfair methods of competition. The most obvious candidate for a case is antitrust regulators investigation of Google Inc.'s dominance of the search market. "When Varney got to the antitrust division she said she'd bring a Section 2 case. It never happened but I expect it will in Obama's second term," Cantor said.

Antitrust policy is expected to be affected little by turnover in the ranks of the top regulators. Acting Assistant Attorney General Joseph Wayland has said he will step down from the DOJ's top antitrust job, putting more pressure on Congress to confirm Arnold & Porter LLP partner William Baer, who was approved by the Senate Judiciary Committee in September over strong GOP opposition.

Obama's re-election is expected to prompt Republicans to step out of the way. FTC Chairman Jon Leibowitz is rumored to be planning his exit too, with either of the two remaining commission Democrats -- Julie Brill or Edith Ramirez -- taking his place. At the Federal Communications Commission, Chairman Julius Genowchowski is rumored to be ready to step down too. Finally, Sen. Herb Kohl, D-Wis., the longtime head of the Senate Antitrust Subcommittee is retiring. His replacement will be picked when the next Congress convenes in January.

Another agency likely to step up its actions is the Consumer Financial Protection Bureau, the watchdog agency created by the Dodd-Frank Act to guard against the predatory lending practices that contributed to the housing bubble and subsequent financial panic.

Gary L.Goldberg, a principal in SNR Denton's Public Policy and Regulation practice, said President Obama now has little incentive to rein in the bureau, which Republicans had attempted to squash by blocking confirmation of candidates to run the agency and demanding its leadership structure and its funding source be altered. Goldberg added that the CFPB will be further bolstered by the election of Elizabeth Warren, D-Mass., to a Senate seat, which gives the agency an important additional high-profile ally in Congress. Warren led the initial efforts to start up and staff the bureau, but Obama nominated Richard Cordray to be the first permanent director.

"With Warren coming to the Senate and with the administration no longer having to consider the ramifications of the CFPB's actions on the President's re-election prospects, the CFPB may end up taking even more aggressive examination and enforcement stances," Goldberg said.

As for Congress, Goldberg said, the industry will be closely watching the House Financial Services Committee, which will be under new leadership. Chairman Spencer Bachus, R-Ala., is stepping down because the post is term limited. He will be replaced by conservative Jeb Hensarling of Texas. The Democrats also will be getting a new leader with California's Maxine Waters replacing the retiring Barney Frank.

Hensarling and Waters are as far apart on the political spectrum as any two members of Congress and both also can be barbed-tongued debaters, which may not bode well for cooperation. Hensarling is likely to used his chairman's gavel to hold hearings questioning whether the Dodd-Frank Act's provision for winding down failing financial conglomerates does the opposite of what the law's supporters say it will do: end government bailouts of the largest and most important financial firms.

"I would expect continued Republican emphasis on the issue of too-big-to-fail institutions and on whether Dodd-Frank truly eliminated the chance of additional federal support for large firms," Goldberg said.

Goldberg, a former Legislative Director for Rep. Waters, noted that the committee's GOP members will continue to talk about ending Dodd-Frank or drastically limiting its scope but as practical matter neither of those options is really on the table, given Democratic control of the Senate."

John Bowman, partner in Venable LLP's financial services group and a former acting director of the Office of Thrift Supervision, said because continued Democratic control of the White House and Senate has eliminated serious threats to the Dodd-Frank Act, the administration now might feel comfortable revisiting some provisions the industry warns must be reworked if unintended consequences are to be avoided.

If Republicans had captured the White House, it's unlikely the Senate would be willing to re-open these portions of Dodd-Frank out of fear such a move could provide an opportunity for Republicans to gut the whole law.

Among the issues Bowman said need addressing are capital rules that could drive smaller banks out of basic businesses such as mortgage servicing. "Capital is king and we want the industry to have lots of it," he said.

But Dodd-Frank's capital rules, combined with new revisions to the international Basel guidelines on bank capital in combination threaten to layer down into too many bank activities, jacking up capital levels so high that smaller institutions can't afford to be in them anymore.

Bowman said bank regulators also continue to struggle to define exactly which activities are prohibited under the so-called "Volcker Rule" ban on proprietary trading by banks. Too strict a definition could make it impossible for banks to provide basic market making services to clients. "I don't think anyone out there understands the global impact the rule will have on financial services," he said.

One of the major policy questions to be answered in the next Congress is whether the White House will actively pursue reform of government sponsored entities, a key priority for congressman Hensarling and many Committee Republicans, or whether gradual improvements in the housing market will make GSE reform less of a priority for the administration.

According to Goldberg, Congresswoman Waters would be loath to take any actions that diminish the availability of affordable mortgages. However, Goldberg says that Waters has a track record of pragmatism that allows her to work closely even with her political adversaries when there are important policy reasons to do so.

"Given the unique and dominant role that the government sponsored mortgage securitizers Fannie Mae and Freddie Mac currently play in maintaining the availability of both affordable mortgage financing and the 30 year mortgage, the administration will need to carefully evaluate whether the benefits of addressing the GSEs' future and facilitating the return of the private sector to the mortgage securitization markets exceed the potential risks to affordable mortgage finance," he said.

One white collar defense and corporate lawyer said Congress or regulators may also reconsider the whistleblower provisions of the Dodd-Frank Act, which allow individuals who turn in their employers for financial crimes and rule violations to share in any fines the government obtains. The problem, he said, is that the anti-retaliation provisions as written make financial firms vulnerable to meritless accusations by workers hoping to cash in on the reward. With little risk of being fired, the employee will have nothing to lose by rolling the dice and making a possibly false claim against their company.

"The SEC is getting a tremendous number of complaints that are not meritorious and it's causing tremendous legal cost and distraction," said the lawyer, who spoke on condition of anonymity. "Unless a company can prove bad faith on the part of a whistleblower, it's hard for companies to take action against someone who files false charges."

The first indication of whether the second Obama administration will take a more accommodating tack will be if the president appoints as SEC chairman a business person along the lines of George W. Bush's second chairman, William Donaldson, who was a former investment banker and chairman of NYSE Corp.

If he picks a long-time regulator, the consideration for the business community's needs could be much less.