Hedge Fund Bankruptcy Role Seen Probed

The SEC is reportedly looking into whether fund representatives overstated their bond positions to gain membership on creditors' committees of dist...
Stephen TaubNovember 29, 2005

The Securities and Exchange Commission is investigating the increasing role played by hedge funds in bankruptcy proceedings and whether fund representatives are lying about the size of their stakes to gain critical, sensitive information, according to Bloomberg.

Hedge funds that specialize in investing in the securities of distressed companies often try to buy up a large portion of a senior class of bonds so as to gain a position on the creditors’ committee of a company. That committee typically has a huge say in the company’s ultimate restructuring and is privy to insider information.

The SEC is looking into whether fund representatives overstated their bond positions to gain membership on creditors’ committees, according to Bloomberg. Hedge funds — loosely regulated private partnerships — are among the most aggressive investors in the paper of companies in financial distress.

“We’re very actively interested in this area,” Alistaire Bambach, chief bankruptcy counsel in the SEC’s enforcement division, told the news services. “These official committees in bankruptcy cases get tremendous amounts of confidential information, and there’s clearly a risk that they’re not all trading cleanly and by the book.”

The SEC has already brought an enforcement action against one hedge fund. Earlier this month, the commission accused Van Greenfield, who manages Blue River LLC, of fraudulently misrepresenting to the U.S. trustee overseeing the WorldCom bankruptcy case that Blue River owned $400 million in bonds in order to gain a seat on WorldCom’s bankruptcy creditors’ committee.

The SEC also asserted that Blue River failed to install written procedures to prevent the misuse of material, nonpublic information obtained by Greenfield, general securities principal of Blue River Capital, while he served as Blue River’s representative on the bankruptcy committees of WorldCom, Adelphia Communications Corp., and Globalstar LP.

Even though the distressed securities market is relatively opaque, it’s also large and growing fast. The face value of distressed debt has grown to $718 billion this year, nearly 10 times the $77 billion it amounted to in 1998, according to Bloomberg. The news service cited data compiled by Edward Altman, a professor at New York University’s Stern School of Business.

The swelling market has attracted such savvy hedge-fund managers as David Tepper of Appaloosa Management and Stephen Feinberg of Cerberus Capital, who have personally made hundreds of millions of dollars by trading in the paper. Representatives of Appaloosa, Cerberus, and Elliott Associates served on the creditors’ committee for WorldCom’s bankruptcy while Blue River’s Greenfield co-chaired the committee, according to Bloomberg.

Representatives of the W.R. Huff hedge fund and Appaloosa currently sit on the creditors’ committee for Adelphia, according to the wire service. All the hedge-fund representatives on the WorldCom and Adelphia committees were appointed by U.S. trustees. The trustees are Justice Department officials responsible for preventing abuse in bankruptcy cases. Bloomberg noted that there’s no evidence that Cerberus, Elliott, Appaloosa, or W.R. Huff made false claims to get on the committees and that the SEC hasn’t accused them of any wrongdoing.

The wire service added that representatives of the four funds either declined to comment or didn’t respond to requests for comment.