The shadowy market of distressed debt investing — trading in the bonds of troubled companies as they enter and exit Chapter 11 — has rarely, if ever, received the kind of public scrutiny it has been subjected to in the bankruptcy of Washington Mutual Inc., the parent of WaMu Bank.
Since 2008, when WaMu collapsed and its parent company went into Chapter 11, WMI notes were snapped up by some of the biggest players in the distressed debt game, including the hedge funds Appaloosa Management, Aurelius Capital, Centerbridge Partners, and Owl Creek Asset Management. The funds bought and sold WMI debt as the company negotiated its way to a $7 billion reorganization plan that would have paid all bondholders in full. But just as the plan was on the verge of confirmation, out-of-the-money WMI shareholders — in a truly last-ditch attempt to squeeze some money out of the WMI reorganization — claimed the hedge funds had traded on insider information about the settlement talks that led to the proposed plan.
Delaware federal bankruptcy Judge Mary Walrath gave enough credence to the shareholders’ allegations that in February she granted the equity committee’s lawyers at Susman Godfrey permission to investigate the insider-trading claims. And when she held hearings on the WMI confirmation plan in July, Susman Godfrey and Arkin Kaplan Rice (representing WMI trust-preferred securities holders) pounded hedge fund witnesses about whether they’d received confidential information about WMI’s settlement talks with JPMorgan Chase, which had acquired WaMu Bank on the cheap in 2008, and the Federal Deposit Insurance Corporation, which oversaw the WaMu sale.
Near the end of closing arguments in the confirmation hearings, Walrath asked equity committee counsel Parker Folse of Susman Godfrey whether he planned to add the two hedge funds he hadn’t already named in a proposed adversary complaint to his insider trading suit. It wasn’t entirely clear at the time whether the judge’s question was merely procedural, or was a portent of her assessment of the evidence Susman Godfrey and Arkin Kaplan put on against the hedge funds.
On Tuesday night we got the answer: it was a portent. In a shocker of a ruling, Walrath denied confirmation to a $7 billion reorganization plan she had already found to be fair and reasonable. The judge had some relatively small problems with the plan itself — most significantly, she concluded that the federal judgment rate, rather than a contract rate, should apply to post-petition interest, reversing her previous ruling — but otherwise agreed with plan supporters on most provisions of the actual deal. She rejected objectors’ arguments, for instance, that WMI had acted in bad faith by including the hedge funds and their lawyers at Fried, Frank, Harris, Shriver & Jacobson in settlement talks.