United States: Do Hedge Funds Have To Disclose Their Trades If They Form A Bankruptcy Committee?

In recent years, hedge funds and other investors in distressed debt or the equity securities of bankrupt companies have taken active roles in Chapter 11 bankruptcy cases. Often, these investors form unofficial or "ad hoc" committees. This post reports on a recent decision by a New York bankruptcy court in the Northwest Airlines case which, if ultimately enforced, could have a major impact on hedge funds, ad hoc committees, and Chapter 11 cases.

Ad Hoc Committees. Unofficial or ad hoc committees, much like official committees of unsecured creditors, equity security holders, retirees, or other constituencies, typically hire counsel and file motions and other pleadings during the course of a bankruptcy case. By acting as a group, the committee's members not only share the costs of participating in the bankruptcy case but also have the ability to wield greater influence by acting collectively instead of on an individual basis.

The Rule 2019(a) Statement. After making an appearance in a bankruptcy case, these committees, their counsel, or both will typically file what's known as a "Rule 2019(a) Statement." This is a public filing required by Rule 2019(a) of the Federal Rules of Bankruptcy Procedure, the set of procedural rules which, together with the United States Bankruptcy Code itself, govern the conduct of bankruptcy cases. Rule 2019(a) provides, in part, as follows:

[E]very entity or committee representing more than one creditor or equity security holder . . . shall file a verified statement setting forth (1) the name and address of the creditor or equity security holder; (2) the nature and amount of the claim or interest and the time of acquisition thereof unless it is alleged to have been acquired more than one year prior to the filing of the petition; (3) a recital of the pertinent facts and circumstances in connection with the employment of the entity . . . ; and (4) . . . the amounts of claims or interests owned by the entity, the members of the committee or the indenture trustee, the times when acquired, the amounts paid therefor, and any sales or other disposition thereof.

The Ad Hoc Committee In Northwest Airlines. While seemingly a dry and arcane bankruptcy rule, it has recently become anything but in the Northwest Airlines Corporation Chapter 11 case. In January 2007, an Ad Hoc Committee Of Equity Security Holders first made an appearance in the case. Its thirteen members include hedge funds and other investment entities that collectively own more than 19 million shares of Northwest Airlines stock and approximately $265 million in claims. The Ad Hoc Committee sought discovery in the case and asked that an official committee of equity security holders be appointed (a request it recently withdrew).

The Debtors Seek Additional Disclosure. In the course of litigating certain disputes, Northwest Airlines filed a motion seeking, among other relief, an order under Rule 2019 requiring the Ad Hoc Committee to disclose more detailed information about the amounts of claims or stock owned by the Committee's members, when they acquired it, how much they paid for it, and when they sold or otherwise disposed of any of their holdings. In support, Northwest Airlines made this argument:

The Ad Hoc Committee remains a mystery to the Debtors and to all the other constituencies in the Debtors’ cases, yet it seeks to make an impact at this late stage of the Debtors’ reorganization. Without the proper disclosures, the Court should refuse to allow the Ad Hoc Committee to continue to cause serious delays to the Debtors’ reorganization efforts, and operate outside of the Bankruptcy Code and the Bankruptcy Rules.

The Ad Hoc Committee Opposes The Motion. The Ad Hoc Committee opposed the motion on several grounds, including that its Rule 2019 statement was proper in form, that the purpose of the rule is only to ensure that plans of reorganization are negotiated and voted on by those authorized to act for the real parties in interest, and that this purpose was satisfied by the form of the statement already filed.

The Northwest Airlines Court's Rule 2019 Decision. On February 26, 2007, Judge Gropper issued his decision requiring the Ad Hoc Committee to file a Rule 2019 statement that provided the detailed information the Debtors had sought in their motion. The Court ruled that Rule 2019 applies to ad hoc or unofficial committees and rejected the Ad Hoc Committee's argument that the prior Rule 2019(a) statement, which did not give detailed information about dates of trades and prices paid, was adequate.

The Ad Hoc Committee's Further Motion. On March 1, 2007, the Ad Hoc Committee filed a motion for an order allowing the additional Rule 2019 statement to be filed under seal but asking that the Court stay its prior order pending further hearing. The Ad Hoc Committee argued that the trading information required under the Court's order represented trade secrets and confidential commercial information and that, to its knowledge, no other committee or party had been required to file such information publicly in any other Chapter 11 case. The Ad Hoc Committee contended that requiring its members to make that disclosure would irreparably damage them, as other investors were not required to make such disclosures but some might use that information to inform their own trades.

The Court Grants The Ad Hoc Committee's Motion. Later that same day, the Court granted the Ad Hoc Committee's motion. The Court set a fast briefing schedule and a further hearing for March 7, 2007. I will plan to report on the resolution of that motion after the Court makes its decision.

Why This Matters. While disputes over disclosure are not always worthy of motions, multiple hearings, and blog postings, this case is different. Hedge funds and other buyers of distressed debt or stock in bankrupt companies carefully guard their trading information, especially the price they've paid. If ad hoc committee members will be required to disclose this information publicly, or perhaps even privately, they may choose not to participate in unofficial committees or generally may be dissuaded from becoming active participants in Chapter 11 cases. Hedge funds and other distressed debt traders have been deploying enormous amounts of money through second lien lending in distressed situations and directly in bankruptcy cases through the purchase of claims and stock. They have also regularly taken very active roles in major Chapter 11 cases. Any ruling with the potential to reverse or impact this trend would be big news indeed.