Jul. 1, 2010

Liquidity for Post-Reorganization Securities Under Section 1145 of the Bankruptcy Code

Are you a distressed debt creditor who has been turned into a security holder?  If so, you’re not alone.  The transformation – sometimes welcomed and sometimes not – is an increasingly common fate in the distressed community.  It happens, among other ways, when a company emerging from Chapter 11 issues new securities under its plan of reorganization in whole or partial settlement of outstanding loan or bond obligations.  If you are a creditor-cum-investor at the end of a Chapter 11 process, you face an important question: “How can I monetize the new securities that I’ve received in the claim distribution?”  In a guest article, Scott C. Budlong, a Partner at Richards Kibbe & Orbe LLP, explores a statutory provision that goes a long way toward answering that question: Section 1145 of the U.S. Bankruptcy Code.  Section 1145 offers a mechanism for unhindered public resales of securities that have been issued in exchange for creditors’ claims under a Chapter 11 plan of reorganization.  Understanding the operation and scope of §1145 is therefore crucial for a post-reorganization security holder that wishes to maximize its liquidity options.  The first part of this article provides an overview of §1145, including the ways it manipulates traditional Securities Act concepts to facilitate a debtor’s issuance of new securities in satisfaction of a class of claims against the bankruptcy estate, and to allow enhanced liquidity for creditors who receive those securities.  The second part of this article examines potential impediments to a creditor’s use of §1145 to resell post-reorganization securities, and describes how a creditor can try to preserve its access to §1145 or otherwise achieve liquidity.  This article, and a related article recently published in the Hedge Fund Law Report, provide important background and context for an upcoming breakfast discussion entitled “From Creditor to Equity Holder: How to Make Your Post-Reorganization Equity Work Harder for You.”  That breakfast discussion will be presented by Richards Kibbe & Orbe LLP, Halsey Lane Holdings, LLC and CRT Capital Group LLC, in conjunction with Hedge Fund Law Report, and will be held on Wednesday, July 14, from 8:00 a.m. to 9:30 a.m. at The Yale Club at 50 Vanderbilt Avenue, New York, New York.  To read the related article, see “From Lender to Shareholder: How to Make Your Equity Work Harder for You,” Hedge Fund Law Report, Vol. 3, No. 20 (May 21, 2010).  For more on Halsey Lane, see “Video Interview with Mark Dalton, Alex Sorokin and Neil Wessan of Halsey Lane Holdings: Key Considerations for Distressed Debt Hedge Funds that become ‘Unnatural Owners’ of Equity Following a Reorganization,” Hedge Fund Law Report, Vol. 3, No. 6 (Feb. 11, 2010).

Video Interview with Roger Liddell, CEO of LCH.Clearnet, Regarding Mechanics of OTC Derivatives Clearing and Implications for Hedge Funds

The Hedge Fund Law Report recently interviewed Roger Liddell, CEO of LCH.Clearnet, one of the largest independent clearinghouses.  Our interview focused on the mechanics and goals of clearing, especially as it relates to over-the-counter derivatives, and the relationship between clearinghouses and hedge funds, either as derivatives market participants or clearinghouse members.  (One important point from the interview is that broker-dealers and futures commission merchants generally are more natural fits for clearinghouse membership than most hedge funds.)  A video recording of the interview is available in this issue of the Hedge Fund Law Report, and we would like to thank the following attorneys for providing insight, context and derivatives expertise that informed the questions in this interview: Leigh Fraser, Partner at Ropes & Gray, LLP; Marilyn Selby Okoshi, Partner at Katten Muchin Rosenman LLP; Richard Chen, Counsel at Arnold & Porter LLP; and Fabien Carruzzo, Associate at Kramer Levin Naftalis & Frankel LLP.

Potential Changes to Partnership Income Allocation Rules May Alter the Timing and Manner of Receipt of Income by Key Personnel at Hedge Fund Managers

On April 13, 2009, the Internal Revenue Service proposed regulations under Section 706(d) of the Internal Revenue Code (IRC) that could affect the timing and manner of receipt of income, gains and losses by key personnel at hedge fund management companies organized as partnerships or limited liability companies taxed as partnerships.  The proposed regulations will become effective upon adoption, but no earlier than the first partnership taxable year beginning in 2010.  Generally, the proposed regulations would require partnerships to take into account variations in partners’ interests during a taxable year and would prescribe two methods for doing so – an “interim closing of the books” method and a “proration” method.  In addition, the proposed regulations provide guidance on the appropriate allocation of “extraordinary items” and the effect on allocations of changes to partnership agreements.  Finally, the proposed regulations contain a safe harbor for services partnerships and publicly traded partnerships, clarify the allocation of deemed dispositions and amend the minority interest rule.  This article discusses the current “varying interest rule” under IRC Section 706 and details the ways in which the proposed regulations would change the current allocation regime.  In particular, this article discusses the mechanics of the two alternative allocation methods provided in the proposed regulations, timing conventions, changes in partnership allocations among contemporaneous partners, safe harbors, deemed dispositions and the minority interest rule.  This article also discusses the implications of the proposed regulations for hedge fund managers and hedge funds.  In brief, the proposed regulations are likely to have a greater impact on managers than funds because variations in interests of limited partners in hedge funds are and are accounted for as ordinary course events, while variations in interests of partners in hedge fund management companies are non-ordinary course.  That is, subscriptions to and redemptions from a hedge fund occur routinely, whereas the admission of a new partner to a management company, or the termination of such a partner, occur only once in a while.  It is the admission or termination of such key hedge fund manager personnel, or changes in interests of existing key personnel, that could be more directly impacted by the proposed regulations.

In Enforcement Action Against Investment Adviser ICP Asset Management, LLC, SEC Alleges More than $1 Billion of Improper Trades, Trades at Inflated Prices and Other Fraudulent Conduct in Connection with ICP’s Management of Triaxx CDOs

The SEC has commenced an enforcement action against investment adviser ICP Asset Management, LLC (ICP), its broker-dealer affiliate ICP Securities, LLC, holding company Institutional Credit Partners, LLC, and their principal, Thomas C. Priore.  ICP was the collateral manager of four Triaxx collateralized debt obligations (CDOs) that invested primarily in mortgage-backed securities.  The SEC claims that ICP engaged in a variety of prohibited and fraudulent conduct, including self-dealing, breach of its fiduciary duties to the Triaxx CDOs, engaging in fraudulent transactions among those CDOs, trading to benefit one CDO at the expense of the others, and making trades that benefited another ICP client at the expense of the Triaxx CDOs.  The SEC alleges violations of the Securities Act of 1933, the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 and seeks an injunction against future violations, disgorgement of profits and civil penalties.  We summarize the SEC’s complaint.  See also “Defunct Hedge Fund Basis Yield Alpha Fund (Master) Sues Goldman Sachs for Securities Fraud Arising Out of the Fund’s Investment in Goldman’s Timberwolf CDO,” Hedge Fund Law Report, Vol. 3, No. 24 (Jun. 18, 2010).

AKO Capital LLP Options Trader and Risk Manager Pleads Guilty to One Count of Insider Dealing for Directing Preferential Trades to a Broker in Exchange for Cash and Gifts

On May 18, 2010, former AKO Capital LLP options trader and risk manager Anjam Saeed Ahmad pled guilty to one count of insider dealing after entering into an agreement with the U.K.’s Financial Services Authority (FSA) under the Attorney General’s Guidelines on Plea Discussions in Cases of Serious or Complex Fraud.  On June 22, 2010, the Southwark Crown Court sentenced him to a suspended prison term, community service and a £50,000 fine.  That same day, the FSA issued a Final Notice requiring that Ahmad disgorge an additional £131,000 as restitution for profits he made from regulatory misconduct unrelated to his insider dealing.  We describe the conduct that led to the guilty plea, the relevant statutes and regulations and the FSA’s analysis of the proposed sanction (including its consideration of Ahmad’s cooperation as a mitigating factor in determining the appropriate sanction).