WASHINGTON (AFX) - A decision by the judge overseeing Enron Corp.'s bankruptcy has generated alarm across Wall Street, prompting warnings from investment banks, bond traders and stock investors that it could do broad harm to U.S. capital markets.
The Bond Market Association, the International Swaps & Derivatives Association, the Loan Syndications & Trading Association, and the Securities Industry Association have already filed court papers criticizing the judge's ruling. Merrill Lynch & Co., Citibank and Barclays Bank PLC joined a growing list of objectors.
The ruling, by U.S. Bankruptcy Judge Arthur Gonzalez, held that holders of claims against a bankrupt company could see those claims wiped out even if they did nothing wrong in their relationship with the company. Under the ruling, holders of bankruptcy claims could be at risk if they merely bought a claim from another creditor who may have engaged in 'inequitable conduct.'
In papers filed with the U.S. Bankruptcy Court in Manhattan, Merrill and other investment banks said the ruling would not only 'devastate' the country's $500-billion distressed-debt market but also 'spill over into the regular capital markets.' They said a federal district judge should review the bankruptcy judge's ruling.
The judge's interpretation had an immediate effect on the trading of bankruptcy claims, a market of at least $300 billion in which hedge funds and other sophisticated investors buy the right to pursue claims on behalf of creditors. Such creditors typically sell their claims against bankrupt companies either because they want an immediate payoff or because they don't have the time to recover the money themselves.
After Gonzalez issued his ruling in March, claims trading involving the debt of an Austrian bank implicated in the collapse of the U.S. commodity brokerage Refco Inc. 'ceased entirely,' according to Merrill and the other investment banks. The Austrian bank, Bawag Group P.S.K., had been accused by Refco's creditors of being 'partners in crime' in the fraud that led to Refco's collapse.
The Bond Market Association and other Wall Street trade associations made a similar assertion in court papers. Gonzalez' ruling 'evoked fear in the market: if Bawag had in fact participated in any misconduct, any bank debt previously held by Bawag could be subject to equitable subordination or disallowance, rendering the claim against Refco essentially worthless,' the associations said.
Merrill and the other banks said the problems that occurred with the trading of Refco debt are likely to occur in other bankruptcy cases if the Enron ruling stands.
Enron's lawyers have defended Gonzalez' decision and said he shouldn't permit an appeal of the ruling. They said Gonzalez helped reduce the 'very real threat of claims washing.' That threat involves a scenario in which a creditor who otherwise would have trouble directly collecting on a claim obtains a payoff simply by selling the claim.
Enron's lawyers also cited Refco and Bawag as examples. If Gonzalez had ruled the way his critics wanted him to, 'Refco would be required to pay distributions to the buyers of Bawag's claims even those claims would have been worthless in Bawag's hands.' Refco, moreover, would be forced to do so even if its chances of obtaining reimbursement from Bawag were slim.
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