From DealBook:
There have long been whispers on Wall Street that hedge funds have
hijacked the bankruptcy process, using their influence as debt holders
to obtain and trade on insider information about when and how a company
will restructure.
A federal court ruling highlighted such
concerns late Tuesday when a judge raised the possibility that four
large hedge funds might have used confidential information to trade in
the debt of Washington Mutual.
The
issue was raised amid the derailment of Washington Mutual’s emergence
from bankruptcy protection, the final chapter in the largest bank
failure in the nation’s history.
Judge Mary F. Walrath, in dismissing a proposed settlement in the
federal bankruptcy court in Delaware, wrote that four hedge funds that
had played a role in Washington Mutual’s restructuring might have
received confidential information that could have been used to trade
improperly in the bank’s debt.
The four hedge funds are Appaloosa
Management, Aurelius Capital Management, Centerbridge Partners and Owl
Creek Asset Management. All have denied any wrongdoing.
The
Washington Mutual bankruptcy, and Judge Walrath’s ruling, have slightly
thrown back the covers on the sharp-elbowed tactics used by investors in
trading the stocks and bonds of companies in Chapter 11 bankruptcy
protection. That market has exploded in recent years, driven by hedge
funds buying up the loans of companies in bankruptcy at a steep discount
in the hopes of obtaining big profits when the companies emerge from
Chapter 11.
Judge Walrath’s ruling is a victory for the Washington
Mutual shareholders who claimed that hedge funds had been using insider
knowledge to influence proceedings and seek profits. And the ruling is a
potential blow to the funds — who have long argued they acted properly —
and the large law firm Fried, Frank, Harris, Shriver & Jacobson,
which was representing some of the funds and is accused of passing them
confidential information.
Part of Judge Walrath’s ruling focused on a dispute involving $4 billion held by JPMorgan Chase
when Washington Mutual was put into bankruptcy. Early in the bankruptcy
proceedings, Washington Mutual claimed ownership of those funds, and in
confidential settlement talks, JPMorgan agreed to hand them over.
If
the public had been aware of that agreement, the value of Washington
Mutual’s bonds would probably rise, since the $4 billion could be used
to pay bondholders, including hedge funds that had bought the debt.
The deal, however, was kept secret.
Lawyers
representing some Washington Mutual shareholders, in a brief filed this
year, claimed that lawyers from Fried, Frank, Harris, Shriver &
Jacobson, which was involved in the bankruptcy negotiations, told its
clients, the hedge funds, about the secret agreement. As a result, those
hedge fund investors were able to buy bonds on the cheap, and then wait
for their value to rise when the agreement came to light.
Judge
Walrath, in her Tuesday decision, noted that certain shareholders said
that Fried, Frank “was under a written confidentiality agreement barring
it from sharing information with its clients, unless they were subject
to confidentiality agreements of their own. Nonetheless, on July 1,
2009, Fried, Frank shared summaries of the April negotiations with both
Centerbridge and Appaloosa, who were not at the time subject to a
confidentiality agreement.” Centerbridge, the judge wrote, continued to
trade in Washington Mutual bonds, while Appaloosa voluntarily restricted
its trading activities.
The hedge funds and others have argued
that though they may have had talks with Fried, Frank or others privy to
confidential information, they received no “material information” that
would rise to the level of insider trading.
The judge did not rule
on whether the hedge funds had committed wrongdoing or whether the
claims made by shareholders’ lawyers were true. Still, those
accusations, she wrote, were “a colorable claim that” the hedge funds
had “received material nonpublic information,” that could be resolved
only through further inquiry.
But first, the judge wrote, the parties should go to mediation to resolve the dispute.
Representatives
of Fried, Frank and Aurelius Capital Management declined to comment on
the judge’s ruling. Owl Creek Asset Management did not return phone
calls seeking its perspective. Centerbridge Partners declined to
comment.
