Trading Claims by Creditors’ Committee Members Without a Trading Order

ABI Committee News

Public Companies & Claims Trading Committee

For obvious reasons, attorneys required to advise clients about when and whether they can purchase or sell securities while serving on a creditors’ committee like bright line rules. Hence the growth of trading orders1 in major chapter 11 cases and generalized unease about the bankruptcy court’s decision in In re Spiegel.2 In that decision, one bankruptcy judge in the Southern District of New York declined to approve a trading order because he concluded that he lacked an adequate record to consider significant implications of the order.

This article explores whether the absence of a trading order means that there is no circumstance under which a member of a creditors’ committee can trade a security of the debtor. While the absence of a trading order certainly eliminates the possibility of programmatic trading, we submit that in theory there are nonetheless time periods during which committee members can trade without running afoul of the securities laws or the committee member’s fiduciary duty. We are unaware of any statute, rule or case3 which creates a per se prohibition against trading by committee members.4 Indeed Fed. R. Bankr. P. 2019(a) appears to recognize that members of an informal creditors’ committee may trade claims.5 It is also noteworthy that Congress has created special rules to address certain trading by officers, directors and 10 percent of shareholders of a company, certainly suggesting that there are not special rules concerning trading by committee members.6

Committee members often possess information that is both material and non-public and such committee members clearly cannot trade. Nonetheless, it is not always the case that committee members are in possession of such information. We submit that creditors’ committee members not in possession of material non-public information should be permitted to trade. Limitations on such trading unnecessarily discourage investors from participating in the committee process and remove liquidity from the markets, all of which is bad for creditors. The remainder of this article suggests a framework, in the context of bankruptcy cases, pursuant to which information ought to be evaluated as to whether it is material and non-public and argues that while extremely careful analysis of the facts surrounding any proposed trade is required, it need not be the case that all trading must cease.

Materiality7

In TSC Industries v. Northway Inc., the Supreme Court held that “[a]n omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important.”8 Although we are unaware of any caselaw that makes the following comparison, it is noteworthy that the Supreme Court’s definition of materiality is similar, although not identical,9 to the definition of “adequate information” contained in the Bankruptcy Code.10 Before any votes with respect to a chapter 11 plan can be solicited, the bankruptcy court must find that a disclosure statement with respect to the plan contains “adequate information.”

“[A]dequate information” means information of a kind, and in sufficient detail, as far as is reasonably practicable in light of the nature and history of the debtor and the condition of the debtor’s books and records, that would enable a hypothetical reasonable investor typical of holders of claims or interests of the relevant class to make an informed judgment about [a] plan11

We submit that the quoted definitions of “materiality” and “adequate information” are sufficiently similar to support a conclusion that information that would be required in a well-drafted disclosure statement is material and that possession of such information, if non-public, should constitute a bar against trading. More importantly, however, we submit that the converse should be true in the majority of situations. If information would not be required in a properly-drafted disclosure statement, it is difficult to understand why such information should nevertheless be considered material. Bankruptcy Courts have done significant thinking about what should be required by a creditor “to make an informed judgment” and there does not seem to be a substantial difference between the economic consequences of buying or selling a claim and of a plan becoming or not becoming effective. After all, the price of a security of a debtor in bankruptcy can be thought of as the market’s valuation of the treatment of a class of creditors, discounted for the time before distributions can actually be made.

Bankruptcy courts have developed a fairly comprehensive list of categories of information to be included in disclosure statements. These factors are:

  1. The circumstances that gave rise to the filing of the chapter 11 petition;
  2. A complete description of the available assets and their value;
  3. The anticipated future of the debtor;
  4. The source of the information provided in the disclosure statement;
  5. 12
  6. The condition and performance of the debtor while in chapter 11;
  7. Information regarding claims against the estate;
  8. A liquidation analysis setting forth the estimated return that creditors would receive under chapter 7;
  9. The accounting and valuation methods used to produce the financial information in the disclosure statement;
  10. Information regarding the future management of the debtor, including the amount of compensation to be paid to any insiders, directors, and/or officers of the debtor;
  11. A summary of the plan of reorganization;
  12. An estimate of all administrative expenses, including attorneys… fees and accountants’ fees;
  13. The collectibility of any accounts receivable;
  14. Any financial information, valuations or pro forma projections that would be relevant to creditors’ determinations of whether to accept or reject the plan;
  15. Information relevant to the risks being taken by the creditors and interest holders;
  16. The actual or projected value that can be obtained from avoidable transfers;
  17. The existence, likelihood and possible success of non-bankruptcy litigation;
  18. The tax consequences of the plan; and
  19. The relationship of the debtor with affiliates.13

We submit that a committee member not in possession of non-public information in one of the foregoing categories should be able to trade absent some unusual circumstance. Having said that, a word of caution is necessary. It is likely that a member of a committee engaged in trading will be subject to greater scrutiny than it would receive if it were not a member of a committee and such trades will be looked at with 20/20 hindsight. Moreover, one could imagine an argument that a committee member inherently has inside information by virtue of the synthesis and analysis of facts undertaken by committee professionals.

Public Information

Disclosure of information means “disclosure of basic facts so that outsiders may draw upon their evaluative expertise”… [and] [s]uch a fact must be effectively disclosed to the investment public prior to the commencement of insider trading in the corporation’s securities.”14 Moreover, information is not truly public until a reasonable time after its dissemination.15

In a bankruptcy case, information contained in documents filed with the bankruptcy court are by statute “public records and open to examination by an entity at reasonable times without charge.”16 A reasonable investor would be hard pressed to suggest it should not be expected to review bankruptcy court filings of a company known to be in bankruptcy so long as it is given a reasonable time after filing to review the record. This is particularly true now that most court documents are readily accessible on the Internet. Similarly, documents on file with the Securities and Exchange Commission, also now available over the Internet, should also be considered public.17 A word of caution is in order with respect here as well. Bankruptcy files are sometimes voluminous. An argument could be advanced that information, while technically on file, is still non-public because it is buried in a voluminous file. Again, we note that any inquiry in this area will be fact intensive and examined with 20/20 hindsight.

Conclusion

Service on a creditors’ committee will limit the ability of the entity serving on the committee to trade. Nonetheless, there are sometimes important reasons to trade. With careful review of the information in a committee member’s possession, it may well be possible to find an opportunity to trade. It must be recognized, however, that questions regarding the applicability of the securities laws in this context remain largely unresolved and institutional investors would be well-served by further judicial pronouncements in this area.

Footnotes

  1. A trading order is an order of a bankruptcy court that permits institutions serving on creditors’ committees to trade debt securities provided that the institution implements a court-approved screening system that insures that the individuals engaged in trading activities do not have access to any of the information provided to individuals serving on the committee. .
  2. In re Spiegel, 292 B.R. 748 (Bankr. S.D.N.Y. 2003). .
  3. There may also be contractual limitations on trading embodied in agreements between a debtor and a committee member pursuant to which the committee member is granted access to confidential information. .
  4. The Third Circuit has noted that a large stockholder and board member of a debtor corporation may have a fiduciary duty to disclose its intent to purchase debt securities of the debtor. Citicorp Venture Capital Ltd. v. Committee of Unsecured Creditors (In re Papercraft Corporation), 160 F.3d 982, 988 (3d Cir. 1998). We are unaware of any cases that extend the corporate opportunity doctrine to members of a creditors’ committee. .
  5. Fed. R. Bankr. P. 2019 requires disclosure of holdings of the members of informal committees. It also requires supplemental statements to “be filed promptly, setting forth any material changes in the facts…”.
  6. 15 U.S.C. §78p(a), commonly referred to as §16(a) of the Securities Exchange Act of 1934, deals with short-wing trading. .
  7. The following discussion relates to materiality in the context of omissions, which is the critical inquiry when trading through a broker-dealer. Material misstatements become important when there are direct negotiations. .
  8. TSC Industries v. Northway Inc., 426 U.S. 438, 449 (1976). .
  9. The biggest difference between the two definitions is that the definition of “adequate information” addresses the possibility that a debtor’s books and records may be in poor condition. Since the condition of a debtor’s books and records may be material, a committee member with knowledge regarding the condition of a debtor’s books and records should not trade unless that information becomes public. .
  10. But cf Century Glove Inc. v. First American Bank of New York, (In re Century Glove), 860 F.2d 94, 101 (3d. Cir. 1988) (Bankruptcy Code §1125(b) “is not an anti-fraud device.”); In re Revere Copper and Brass Inc., 58 B.R. 1 (Bankr. S.D.N.Y. 1985) (assignee of claims failed to show that creditor received sufficient information to make informed judgement). .
  11. 11 U.S.C. §1125(a)(1) (emphasis applied). .
  12. Factor five discusses the disclaimer that typically is included with a disclosure statement that is irrelevant for purposes of this discussion. .
  13. In re Scioto Valley Mortgage Co., 88 B.R. 168 (Bankr. S.D. Ohio 1988); In re United Brass Corp., 194 B.R. 420, 424 (Bankr. E.D. Tex. 1996); 3 Collier Bankruptcy Manual ¶1125.02[2] (Third Edition Revised 2004). .
  14. Securities and Exchange Commission v. Texas Gulf Sulphur Co., 401 F.2d 833, 849 (2d Cir. 1968) cert denied sub nom Coates v. SEC, 394 U.S. 976 (1969). .
  15. Id. at 854. .
  16. 11 U.S.C. §107(a). See also In re Davis, 936 F.2d 771, 774 (4th Cir. 1991) (claims docket is public record that can be checked); Most v. Alleghany Corp., [1969-1970 Transfer Binder] CCH Fed. Sec. L. Rep. ¶92,583, at 98,666; 1970 WL 239, at 7 (S.D.N.Y. 1970) (Exchange Offer did not omit material information because “published plan identified the litigation and anyone interested could inspect the public records and learn everything.”). .
  17. See generally 5 U.S.C. §552(a). .