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The U.S. Securities and Exchange Commission is investigating the practices of hedge funds that claim to make substantial investments in distressed companies, thereby allowing them to serve on creditors’ committees and gain access to inside information.
In November, the SEC settled a case with a New York hedge fund charged with substantially overstating its holdings in WorldCom, Inc. to be appointed to the creditors’ committee.
The agency issued a Cease-and-Desist order on Nov. 7 against Van D. Greenfield and Blue River Capital LLC, which included findings that Greenfield caused Blue River to enter into a simultaneous backdated purchase and short sale of $400 million in face amount of WorldCom bonds. However, shortly after being appointed to the committee, Greenfield caused Blue River to cancel its trades, leaving Blue River with only a $5.6 million position in WorldCom bonds, the SEC stated.
Hence, Greenfield and Blue River fraudulently misrepresented to the U.S. Trustee overseeing the WorldCom bankruptcy case its bond position to gain a seat on WorldCom’s official creditors’ committee, alleged the SEC.
"Had the U.S. Trustee known that Blue River’s claim was $5.6 million and not $400 million, it is unlikely that Blue River would have been appointed to WorldCom’s creditor’s committee. By obtaining membership on the committee, Greenfield indirectly misrepresented to all WorldCom constituencies and the public the magnitude of his holdings in WorldCom securities and thereby gained undue influence in WorldCom’s reorganization proceedings."
Greenfield not only served on the creditors’ committee, he also served as its co-chair, the SEC noted, and "played a significant role in negotiating with various WorldCom constituencies over the allocation of WorldCom’s reorganization value among WorldCom securities traders and other creditors.
"Greenfield’s actions also could have had the effect of depriving another legitimate creditor from obtaining a seat on WorldCom’s creditors’ committee."
Greenfield and Blue River did not admit or deny the order’s findings but agreed to pay a civil penalty of $150,000, and Greenfield was suspended from association with any broker or dealer for a period of six months. Blue River ceased active trading in 2004.
Adelphia and Globalstar
Blue River traded securities from a floor of Greenfield’s New York townhouse. Greenfield, age 60, was Blue River’s principal, manager and compliance officer. The fund’s only members were Greenfield and a family trust, but it employed three other traders.
Greenfield also served on the equity committee of the Adelphia Communications Corporation, which filed for chapter 11 bankruptcy protection, and on the informal bondholders’ committee of Globalstar, L.P., a distressed telecommunications company.
Greenfield and Blue River were accused of failing to take the required precautions to prevent the misuse of nonpublic information with regard to Greenfield’s seats on all three committees.
Greenfield directed others to make WorldCom trades while he served on the committee, and pledged not to be involved in trading decisions. However, Blue River did not have written guidelines or procedures in place to prevent the misuse of inside information, and Greenfield often walked through Blue River’s trading room, which was adjacent to his office, and asked for market quotes on Adelphia and WorldCom securities, the SEC alleged.
Blue River realized profits of $664,241 from trades in Adelphia securities, $424,290 from trades in WorldCom securities, and $167,309 from trades in Globalstar securities at the time that Greefield served on the respective committees of those issuers, stated the SEC.
The SEC is "actively interested" in the practices of hedge funds that invest in distressed companies and serve on creditors’ committees, according to a recent report by the Bloomberg news service. Because members of such committees receive confidential information, the SEC recognizes the risk that traders may use such information to their advantage, an SEC bankruptcy lawyer was quoted telling Bloomberg.
This article is presented for informational purposes only and is not intended to constitute legal advice.