Biden administration likely to tighten bankruptcy regulations

We anticipate a more assertive regulatory enforcement agenda under the Biden administration, particularly focusing on fund manager conflicts of interest, advisor codes of conduct and related policies and procedures relating to material non-public information. . These concerns may be heightened for fund managers involved in bankruptcy proceedings, when competing fiduciary obligations arise, particularly in the context of participating in creditors committees. Below are three main concerns.

  1. Fiduciary concerns

Members of an unsecured creditors committee or other committee in bankruptcy proceedings have fiduciary duties to other bankruptcy creditors. For this reason, members of bankruptcy committees are at greater risk of being accused of fraud. Wherever there is a fiduciary duty, a breach of that duty in a securities transaction may form the basis of criminal charges by the DOJ or enforcement action by the SEC. The anti-fraud provisions of securities laws prohibit devices, schemes and artifices to defraud in the offer or sale, or in connection with the purchase or sale, of securities. The DOJ may pursue similar theories regarding postal fraud, electronic fraud, other securities fraud statutes or bankruptcy specific statutes. A breach of an obligation, especially a fiduciary duty, may be the starting point for charges of securities fraud under a theory of regime liability; for example, when an individual acts for personal gain contrary to his fiduciary duty to others.

This was manifested in a case brought to court last year, where a fund’s portfolio manager allegedly exploited his position as co-chair of the unsecured creditors committee in Neiman Marcus’ bankruptcy proceedings. As the representative of unsecured creditors, the portfolio manager had fiduciary obligations to all unsecured creditors, not just the interests of his fund. the MJ and Alleged SEC that the fund manager used his position to attempt to remove another bidder in securities he was seeking to acquire for the fund he was managing, acting to his advantage and to the detriment of other unsecured creditors to whom he owed an obligation. This was an extreme case, but one that highlights the importance and the risks associated with fiduciary obligations.

  1. Conflicts – Different parts of the capital structure

Conflicts of interest can arise when a fund manager has segregated funds that invest in different parts of the capital structure of the same company. Such conflicts are more likely to arise in bankruptcy proceedings where a fund manager may find himself in a situation where a forced liquidation or other bankruptcy action may serve his interests as a creditor, but may disadvantage its position as a shareholder. Taking any action that disproportionately disadvantages one fund while benefiting another can potentially result in a breach of fiduciary duty. These obligations are reinforced when the decision maker manages a fund with debt securities as well as another fund with stakes in the same company. If a fund manager does not have a separate decision-making structure for each fund (as well as information barriers), it might not be able to act without risking its fiduciary obligations. Managing the conflicts that accompany investments in a capital structure is an important consideration in the context of bankruptcy.

  1. Potential misuse of material non-public information (“MNPI”)

During bankruptcy proceedings, there are circumstances that could give rise to potential claims for insider trading or other abuse of MNPI. When representatives of fund managers sit on a creditors committee, the company usually creates a wall between the person who sits on the committee and others who can make business decisions. However, failures in controls can lead to misuse of this information and potential liability. A few years ago the The SEC successfully sued alleging that a representative of various creditors’ committees had engaged in insider trading in fixed income securities using information obtained through those committees.

A separate but related question is whether a fund manager’s existing compliance policies are effectively implemented to prevent misuse of information. Registered investment advisers are subject to Rule 204A of the Investment Advisers Act, which requires them to establish, maintain and apply written policies and procedures to prevent the misuse of MNPI, particularly in circumstances where the risk of obtaining MNPI is increased – such as when a representative of the fund manager is a member of the committee. The SEC continues to prosecute investment advisers for failing to adhere to rigorous policies and procedures relating to the handling of MNPI. The effectiveness of information barriers is an area on which regulators are likely to focus, especially as they increase oversight of private fund managers.

© 2021 Proskauer Rose srl. Revue nationale de droit, volume XI, number 187

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