Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Creditor Committees in US Bankruptcy

A recent
SEC cease-and-desist order
brings out some unpleasant facts about
official bankruptcy committees and informal bondholders committees in the US.
The order is
against Mr. Van D. Greenfield and his securities brokerage firm, Blue River LLC. The
facts as stated by the SEC are as follows:

18. WorldCom filed for bankruptcy protection on July 21, 2002 (the “Petition Date”).
On the Petition Date, Blue River owned only $6 million in face value of WorldCom unsecured
7.5% notes due 2011 (the “Notes”) and $500,000 in face amount of WorldCom 6.25% Notes due
2003.

20. On July 26, 2002, Greenfield directed Reybold …
to execute, “as of” July 19, 2002, a short sale of $400 million in face value of the Notes in one
Blue River proprietary account and a purchase of $400 million in face value of the Notes in a
another Blue River proprietary account. …

21. Also on July 26, Greenfield sent a letter to the U.S. Trustee for the Second Circuit
requesting that Blue River be appointed to WorldCom’s official unsecured creditors’ committee.
On a questionnaire attached to his letter, Greenfield represented that Blue River held a $400
million unsecured claim against WorldCom based upon the Notes. The letter did not disclose that
Blue River had no net economic interest in the notes because it also held a $400 million short
position in the Notes, that the transaction in the Notes had not yet settled, or that the purchase had
occurred after the Petition Date but was backdated to a date prior to the Petition Date. A $400
million unsecured claim would have put Blue River among the top 20 unsecured creditors of
WorldCom as disclosed in WorldCom’s schedule of the 50 largest unsecured claims against it that
was filed on the Petition Date.

22. On July 29, 2002, the U.S. Trustee for the Second Circuit appointed Blue River to
WorldCom’s official unsecured creditors’ committee and Greenfield became co-chair of the
committee. On or about July 30, 2002, Greenfield directed Reybold to cancel the $400 million
short sale and associated purchase of the Notes, leaving Blue River only with its original $6.5
million position in WorldCom debt. The $6.5 million face value claim was much smaller than the
smallest unsecured claim listed by WorldCom in the schedule of the 50 largest unsecured claims
against it, which exceeded $100 million.

The order goes on to raise issues about insider trading or as the SEC puts it
“potential misuse of material, nonpublic information in light of the conflicts of interest arising from
Greenfield’s serving as Blue River’s representative on the committees at the same time that he was
also Blue River’s compliance officer, principal owner, and general securities principal.”

The more troubling question is the total lack of diligence in the appointment of creditor committees.
Any bankruptcy process leads to a detailed listing of all creditors and their claims. That a co-chair of an
official creditors’ committee can be appointed so casually on the basis of an unsubstantiated
letter indicates either that there are no processes governing such appointments or that such processes
broke down completely in the WorldCom case. Since WorldCom was the largest ever corporate bankruptcy
in the US, one would have expected greater care in the appointment of official committees in this case.

The incident also highlights the need to reexamine the whole idea of providing confidential information
to such committees. In the old days, when everything was on paper, the idea of making
thousands of copies would have been infeasible. In this day of internet and email,
it should be possible to provide information in
a non discriminatory manner to all. The committees would still play a role in negotiating
and designing a restructuring but they need not have privileged access to information other than any
documents that the committee itself drafts. It is possible to specify that the moment
the company submits a written proposal to the committee or the other way around, these documents would be
publicly disclosed.
The SEC states in relation to another creditor’s committee that
“Greenfield on occasion had access to the terms of proposed offers by third
parties to purchase Globalstar, L.P.’s assets before the terms of those offers were disclosed
publicly.” There was no reason no justification at all for this to happen.

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