Public debt markets are more opaque and concentrated than equity markets. Does that make them more prone to securities fraud? The SEC might be trying to find out.
On Friday, MainFT brought you the tale of Silver Point Capital, a top credit fund that was last week charged by the US markets regulator over how its (now deceased) bagel-throwing legal eagle Chaim Fortgang handled material non-public information that he came into possession during the Puerto Rico sovereign debt crisis five years ago.
The SEC alleges that:
48 . . . between September 17, 2019 and February 7, 2020, Silver Point purchased over $260 million of Puerto Rico bonds. Over the same period, while Fortgang was in possession of MNPI about the same Puerto Rico bonds, he had more than 500 calls with public side employees without the involvement of Compliance. At the very least, these calls should have been preapproved by Compliance pursuant to the barrier policy, so that Compliance could carry out its obligation to determine whether to approve, monitor and/or log the calls.
49. When Silver Point sold the Puerto Rico bonds it amassed during that period, it generated profits of over $29 million.
50. Silver Point’s deficient establishment and enforcement of its barrier policy as to Fortgang meant he had hundreds of opportunities to improperly share MNPI with the public side, presenting a substantial risk that Silver Point generated such profits by trading on the basis of MNPI.
Silver Point has not settled, and said it would defend itself in federal court. That promises to be a fun trial that might get into the guts of a strategy sometimes denigrated as “vulture investing”. 🍿
The Silver Point matter comes three months after another prominent fund — Marathon Asset Management — settled for $1.5mn charges that it was too loose with what the industry usually just calls MNPI (and in particular how it interacted with an investment banker who had MNPI in a live restructuring situation).
Importantly, neither Silver Point nor Marathon have been accused of insider trading; they have merely gotten in trouble for how they handled sensitive information. In a statement, Silver Point said:
We have refused to settle a matter in which there was neither any wrongdoing nor any deficiency in our information barrier policies or our compliance program. Silver Point has, at all times, behaved legally and ethically.
But Alphaville gets the sense that the Feds are suddenly getting very interested in how money is made in the paper of troubled companies and countries. As the old joke in financial journalism goes, two [cases] is a trend.
There aren’t many situations where public company shareholders have to sign a “confidentially agreement” and receive MNPI. Basically the only instances are when a company is for sale or negotiating with an activist investor, and those only apply to a select group of large institutional investors.
However, when a company needs to negotiate with its creditors, several dozen funds might control a majority of the debt. They can form “ad hoc” groups and get a lawyer and banker as advisers. The advantages of joining the group is to be able to negotiate terms.
The downside is having to sign a confidentiality agreement and becoming “restricted” — meaning you cannot trade for the duration of the negotiations. However, there are sometimes whispers about how careful (or careless) hedge funds can be with MNPI in these situations.
In the case of Silver Point, the SEC noted that the firm had very strict information barriers between its “public” trading arm and its distinct “private” side, which takes longer-term stakes in order to join restructuring negotiations.
The SEC asserts that Chaim Fortgang — hired by Silver Point as an external legal consultant — was subject to the same strict rules at all times. Silver Point’s stated defence is that legal counsel is exempt from such constraints.
This impasse is going to set up an interesting court fight, as Fortgang had been hired by Silver Point in the early 2000s to use his vast legal experience to benefit Silver Point’s investment positions. Distressed debt funds are full of people with legal backgrounds who have expertise in loan and bond documents and understand the chess match of Chapter 11.
And the SEC in its complaint pointed out that Fortgang — notwithstanding the technicalities of his employment agreement — appeared to be acting as a principal of Silver Point, often joining creditor committees as Silver Point’s sole representative. That’s a role outside lawyers typically do not assume.
From the SEC complaint:
52. From at least September 17, 2019 through February 9, 2020 (the “relevant period”), Silver Point participated in the confidential mediation as a member of an “ad hoc” creditors’ committee comprised of Puerto Rico bondholders.
53. During that same period, Silver Point was a signatory to a mediation agreement that obligated it to keep confidential “all Proposals, views, conduct, and statements made, whether oral or written, and any information, or graphic or physical evidence offered in the course of the mediation (or in advance of the mediation if so designated).” The agreement warned that “there are applicable securities laws or regulations that may, depending on the circumstances, prohibit the purchase and sale of securities by persons who possess MNPI.”
54. Fortgang was Silver Point’s sole representative in the confidential mediation for most of the relevant period. On Silver Point’s behalf, he attended mediation sessions and participated in calls with other creditors, the mediator, and representatives of Puerto Rico, offering Silver Point’s perspective on the economic terms of any deal and serving as its primary negotiator. He also received settlement proposals circulated amongst the parties and nonpublic information about Puerto Rico’s financial position — much of which constituted MNPI and was marked as such.
55. Silver Point assigned Fortgang to this role (rather than a public side analyst well versed in Puerto Rico bonds), so that its public side could rely on the information barrier to continue to trade Puerto Rico bonds while the mediation was ongoing (and while Silver Point had MNPI about Puerto Rico bonds).
56. Silver Point’s use of an information barrier and continued trading in Puerto Rico bonds while it was in possession of MNPI about Puerto Rico bonds (through Fortgang) was unique amongst the many other hedge fund participants to the mediation. Other hedge funds involved in the mediation flatly prohibited their employees from trading in Puerto Rico bonds when they had MNPI from the mediation.
57. Unbeknownst to the other participants in the mediation, the barrier policy that Silver Point was relying on to trade was not enforced as to Fortgang, even though he was Silver Point’s representative and had received MNPI from the mediation.
Insider trading itself is hard to prove (recall the instance of Dan Kamensky, the hedge fund investor who went to prison over self-dealing shenanigans in the Neiman Marcus Chapter 11, a fate that required nothing less than a surreptitiously recorded phone call by Jefferies executives).
And of course, lawyers or anyone are obviously not exempt from actual insider trading prohibitions, even if they are apparently exempt from information-handling requirements.
In any event, the SEC appears to be clearly letting the scavenger community know that they better dot their i’s and cross their t’s.
Further reading:
— SEC complaint against Silver Point Capital, December 20, 2024 (SEC)
— SEC settlement with Marathon Asset Management, September 30, 2024 (SEC)
https://www.ft.com/content/01b2642b-fae0-403c-b737-679331dd0b81
