Non-Disclosure Agreements (“NDAs”) with distressed borrowers and issuers have become a significant piece of the restructuring puzzle. A creditor that signs up to an NDA is valuable to the borrower, because of the creditor’s willingness to participate meaningfully in the restructuring process, accept material non-public information (“MNPI”), and be “restricted” from trading – at least for a period of time. The creditor, in turn, procures influence over the restructuring, including with respect to negotiating its own economic enhancements – some of which may be at the expense of other creditor groups (or even members of the same creditor class not part of the ad hoc creditors’ committee). The creditor’s value to the company is enhanced even further if the creditor agrees to participate on a sub-committee tasked with negotiating restructuring terms on behalf of an ad hoc lender group or an ad hoc creditors’ committee informally tasked with representing a class of creditors.[1]
Rather than a casual procedural step to be signed off on quickly by a creditor’s in-house counsel (or in a world where financial institutions are increasingly relying on artificial intelligence (AI) to assist in NDA preparation, an algorithm), NDA negotiations may be complex with intricate MNPI blow-out terms (meaning terms that speak to how and when the MNPI will be made public) and restrictions on the groups of constituents with which NDA-subject creditors may discuss the restructuring. These NDA terms affect the creditor’s contractual right to trade securities issued by the distressed company until the information is blown-out and the extent of control constituents retain over negotiations, both of which may affect strategy (for the company and its creditors).
In a “best of both worlds” scenario, a creditor may elect to participate on a steering committee without executing an NDA by engaging a restructuring financial adviser that signs up to an NDA, receives MNPI, and makes recommendations to the creditor with respect to restructuring transactions terms (i.e., maturity extensions, capital raises, consents to asset sales, exchange discounts, etc., as opposed to trading recommendations). By communicating to the financial adviser and other committee members that the creditor does not want to receive MNPI, the creditor may believe it is in a position to continue trading securities issued by the company and may be especially motivated to do so if distressed debt/equities trading is core to its business.
However, a recent order issued by the SEC directed to Marathon Asset Management (“Marathon”), which serves on several ad hoc creditors’ committees per year and is sometimes on the steering committee of such committees, highlights the risks of that “one toe in” strategy. Consequently, creditors that are regulated investment advisers as well as restructuring financial advisers may wish to consider additional precautions while involved with an ad hoc creditors’ committee or ad hoc lender group, including to ensure that they are staying on the right side of the line not only with respect to their contractual obligations but also steering clear of possible regulatory or criminal exposure for insider trading.
Background
As per the SEC’s Order,[2] an undisclosed foreign-based company publicly traded on a foreign exchange (the “Issuer”) was exploring a restructuring due to Covid impacts. In July 2020, certain Marathon analysts began discussing participation on an ad hoc committee of unsecured creditors (the “Committee”) of the Issuer. While the Committee was forming, Marathon accumulated additional bonds.
About ten creditors, including Marathon, joined the Committee. Marathon also joined the steering sub-committee (“Steerco”) along with three other large bondholders. The Committee retained a leading foreign-based global restructuring financial adviser (the “FA”), which executed an NDA with respect to MNPI not available to the Committee members unless and until the committee members executed the NDA. Marathon further clarified to the FA and other Committee members that Marathon did not want to restrict trading and therefore was not signing the NDA.
The FA provided written and verbal guidance to the Committee in the fall of 2020, with Marathon analysts receiving “reports, analyses, updates and other information” from the FA. Written materials from the FA were marked prepared “on the basis of information publicly available, disclosed by the relevant company(ies) or by third parties, none of which has been independently verified nor audited by [the FA]” as well as based on “Company information [and the FA’s] assumptions.” Marathon did not receive any representations from the FA regarding the handling of MNPI, and there was no evidence that Marathon performed any diligence regarding the FA’s handling of MNPI.
The Marathon analysts communicated with a Marathon trader whereby they discussed trading strategy with respect to the Issuer, and the trader executed upon such strategy. Marathon continued to build its bond position and sold credit default swaps referencing the Issuer.
On October 29, 2020, a foreign court-appointed mediator urged Steerco members to enter into NDAs, so a deal could be negotiated. On November 5, 2020, Marathon executed an NDA and restricted trading with respect to the Issuer. After execution of the NDA, Marathon received information that had been previously provided to other Committee members under NDA. The materials were marked “private” or “restricted” information.
Marathon had two relevant written policies in place: “Policies and Procedures to Prevent Insider Trading and Information Barrier Procedures” dated December 2018 and “Key Marathon MNPI Procedures” dated November 2020.
Relevant SEC Rules and Regulations
Section 204A of the Investment Advisers Act of 1940 (“Advisers Act”) requires investment advisers to establish, maintain and enforce written policies and procedures reasonably designed, taking into consideration the nature of the adviser’s business, to prevent the misuse of MNPI by the advisers or their associated persons in violation of the Advisers Act or the Exchange Act and the rules thereunder. Rule 206(4)-7 (the Compliance Rule) requires registered investment advisers to, among other things, adopt and implement written policies and procedures reasonably designed to prevent violations by the adviser and its supervised persons of the Advisers Act and the rules thereunder and to review, at least annually, the adequacy thereof. The SEC is not required to show that an investment adviser or its persons engaged in insider trading to allege a violation of Section 204A or Rule 206(4)-7.
SEC Order
Given that ad hoc committee members may receive MNPI and that their financial advisers are tasked with analyzing companies’ MNPI, the SEC found that Marathon’s policies were not reasonably designed to address the risks specifically related to the potential (including inadvertent) receipt of MNPI from participation on ad hoc creditors’ committees. As an example, the SEC Order notes that the “Key Marathon MNPI Procedures” identified some situations where Marathon may be deemed to be in possession of MNPI and would require the relevant employee to consider putting the applicable company on the “Watch List” or “Restricted List,” including when serving on a creditors’ committee of a restructuring. Nothing in the policies specifically addressed risks of participation on ad hoc creditors’ committees or interactions with financial advisers or other consultants for ad hoc creditors’ committees. The SEC further noted that there were no policies in place encouraging due diligence concerning advisers’ evaluation or handling of MNPI or obtaining representations from advisers with respect to their MNPI policies and procedures.
As a result of the settlement with the SEC, Marathon revised its policies and trainings to address the identified deficiencies and was ordered to pay a $1,500,000 penalty.
Additional Settled SEC Order Regarding MNPI Policies and Ad Hoc Creditors’ Committees
Investment advisers that manage or invest in collateralized loan obligations (“CLOs”) and participate in ad hoc creditor’s committees or ad hoc lender groups face similar risks with respect to Section 204A of the Advisers Act and the Compliance Rule, as evidenced by another recent SEC enforcement settlement with Sound Point Capital Management (“Sound Point”), a registered investment adviser whose investment activities included managing CLOs and investing in distressed debt.[3] The SEC alleged that Sound Point sold two CLO equity tranches that included loans made to a media services company (the “Company”) after Sound Point received MNPI about the Company’s distressed financial condition through its participation on an ad hoc lender group with respect to the Company. (The SEC Order does not indicate whether Sound Point, in connection with its participation in this ad hoc lender group, executed an NDA or informed other group participants that it did not wish to receive MNPI).) The SEC Order acknowledged that Sound Point personnel recognized that the information about the media company’s financial condition constituted MNPI with respect to the Company’s securities. However, the SEC alleged that Sound Point did not have written policies and procedures to assess whether the information that it possessed concerning a company can also be MNPI when trading CLOs that hold underlying loans extended to that company, even though Sound Point often participated in ad hoc lender groups and creditor committees. For these reasons, the SEC alleged that Sound Point’s policies for preventing the misuse of MNPI were not reasonably designed, in violation of Section 204A and Rule 206(4)-7 of the Advisers Act. Sound Point subsequently enhanced its policies and procedures to consider whether MNPI that it possesses with respect to a borrower or issuer can also constitute MNPI when trading CLOs that hold loans extended to that borrower and agreed to pay a $1,800,000 penalty for these deficiencies.
Considerations for Creditors and Restructuring Financial Advisers
Receiving information that is marked as non-MNPI will not in itself insulate ad hoc creditors’ committee or ad hoc lender group participants from SEC action for trading while in possession of that information, since financial adviser guidance and written work-product that synthesizes MNPI or is created amidst the knowledge of MNPI may reasonably constitute MNPI. Further, trading securities while in possession of MNPI could in certain circumstances constitute securities fraud, even if a creditor were to act only negligently.
At a minimum, regulated investment advisers with a reasonable expectation of serving on an ad hoc creditors’ committee (i.e., an institution with core strategies in the distressed space) may wish to revisit and as appropriate update relevant policies to directly address ad hoc creditors’ committees, including procedures for their legal and compliance personnel to track information received from such committees, seek representations from restructuring financial advisers on MNPI, and conduct due diligence on how an engaged financial adviser handles MNPI (such as potentially reviewing from behind an internal wall, as necessary, a sample of materials from, and chaperoning a sample of communications involving, such financial adviser and the relevant creditor groups). Financial advisers could have at the ready written representations that they are comfortable providing and written diligence response materials with respect thereto. Initially, there may be some tension between financial advisers and clients with respect to the meaningfulness of such representations and diligence materials, but if these practices become industry standard, liability risks will be mitigated without slowing down the client engagement process.
Restructuring financial advisers could also prepare separate sets of materials for ad hoc committee members that have signed an NDA and those that have not, and host separate calls for the two groups. This should be practicable for regular ad hoc committee members that wish to be a part of a group (and any favorable economics conferred to such group) but not spearhead decision-making. However, given the lack of access to MNPI that may be essential to evaluate restructuring terms, the utility of such practice may be questionable for steering committee members that are expected to drive the restructuring process. It begs the question of whether steering committee members not willing to be “restricted” provide enough value to the restructuring process, other than in limited situations (for instance, where such creditor holds the largest position in a class). Ultimately, the creditor, their financial advisor, and the company will have to work together to agree on the appropriate juncture for the creditor to become restricted and the appropriate time for the MNPI materials to be blown out – all with the goal of having meaningful participation from the creditor in the process without the creditor being restricted for too long a period.
[1] A ad hoc creditors’ committee or ad hoc group of creditors is distinct from a Creditors’ Committee appointed by a United States Trustee in connection with a bankruptcy under the US Bankruptcy Code.
[2] Marathon Asset Mgmt, L.P., Investment Advisers Act of 1940 Release No. 6737 (September 30, 2024).
[3] Sound Point Capital Management, L.P., Investment Advisers Act of 1940 Release No. 6666 (August 24, 2024).
