25 September 2010

Bankruptcy and Transparency

A controversy about the rules of bankruptcy procedure, specifically rule 2019, has bubbled along for three years now and may be about to make a big change in the way corporate bankruptcies are handled in the U.S.

It all began in February 2007 with a "seemingly innocuous opinion" by Judge Gropper of the Manhattan bankruptcy court in the Northwest Airlines case.

Gropper held that under rule 2019, hedge funds that were a member of one of the ad hoc groups that form for the purposes of negotiating/arguing out the terms of a debtor company's reorganization have to turn over to their court information that hedge funds as such like to keep close to their vests -- information amount about interest held and the price at which that interest was purchased.

The funds tried to mitigate the harm to their traditional trading strategies that this threatened, by asking for permission to provide this information under seal. But Gropper, a few days later, shot that down, too.

Several other bankruptcy courts have considered the matter since then. No consensus has developed among them as to what 2019 means.

In August 2009, the Advisory Committee on the Federal Rules of Bankruptcy Procedure (Advisory Committee) proposed a significant revision of the rule In part, this came about because of the need for legal certainty. As important, though, it came about because many well-placed people think Gropper was right on policy grounds, and that it would be good to have a rule that is very clear about that.

The proposed rule revision would change the bankruptcy investing game in three principal ways: (1) it would widen the scope of who must disclose under Rule 2019; (2) it would widen the scope of what must be disclosed; and (3) it would give bankruptcy courts wider discretion to relieve or abridge disclosure obligations, especially disclosure regarding the prices of assets purchased in secondary market trading. This article discusses the proposed revision in depth, focusing on the potential consequences for hedge funds that invest in and around bankruptcies.

There is now a widespread expectation that there will be reform, that it will be in place by the end of 2011, and that the results will demand more transparency than anyone would have expected before Gropper put this ball in play.

For the possible significance of this, I refer you back to my explanation at the time of Gropper's stance.

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