Distressing disclosures

A hearing at the end of this week could significantly change the change the landscape in the US for distressed debt investors, who may have to disclose more sensitive information about their investments in the future.

At issue is Rule 2019 in the bankruptcy code, which lays out what groups or “ad hoc committees” need to publicly reveal about bankruptcy deals in court, including identity of the members represented, the dates each member acquired their claims and the amounts paid. In recent years hedge funds and other distressed debt private equity investors have formed such committees when buying into bankrupt companies in order to wield greater influence and save money on expenses such as lawyers.

In the past the rule was rarely evoked, and even when it was, a simple disclosure of a list of the members of the committee and their aggregate holdings was usually enough to satisfy judges. But with the wave of restructurings in the last few years attracting more hedge fund and private equity investors, and leading to an increase in the use of 2019 in litigations, several recent court rulings have introduced uncertainty and confusion about what such investors are actually required to do.

“Certain judges have interpreted the rule strictly, requiring the investors on an ad hoc committee to disclose everything about their ownership: what they hold, when they bought it, and how much they paid for it,” said Jonathan Henes, partner in the restructuring group at Kirkland & Ellis. “That’s something hedge fund and distressed investors don’t want to disclose, that’s kind of their secret sauce. Other judges have looked at the rule, however, and said no, the investors on a committee do not need to disclose that information.”

A judge in one of those cases, Robert Gerber of the US Bankruptcy Court in Manhattan, will be among those testifying Friday before the Advisory Committee on Bankruptcy Rules on a proposal to broaden Rule 2019 to require more information about when investors bought into bankrupt companies and at what price, which could lead to disclosure of credit derivative swap position, short positions and holdings in other classes. While Gerber supports most of these measures, he has come out against price discovery.

Investors and attorneys will also be testifying, and banking committee officials have already said they have received numerous comments from industry figures warning about the damage that could incur if they are forced to reveal the timing of their purchases. One official told the Financial Times that the committee is leaning toward concluding that such pricing information is not relevant.

“I think the rule will look similar to how it does now; it will be a little more clear,” Henes said. “I don’t think at the end of the day that hedge funds and other distressed investors are going to need to disclose when they bought securities and how much they paid, but they may need to disclose if they hold short positions. Investors and stakeholders have diametrically different views on how disclosure is needed.”