Hiya MYNTers...
Tried (yesterday and today) to post **anything** on RB boards. To no avail. So, I'll try here...LOL. An article from yesterday's Investor's Business Daily which might be of general interest.
WorldCom's Fraud Settlement Complicates Bankruptcy Rules
BY NICK TURNER
INVESTOR'S BUSINESS DAILY
In bankruptcy cases, there's a natural order of things. First the creditors get paid, then the shareholders -- that is, if there's any money left.
Who decided that? Congress, in the 1978 Bankruptcy Reform Act. But that rule is getting a makeover, thanks in part to another congressional Act, Sarbanes-Oxley, which passed last year. It lets the Securities and Exchange Commission reimburse investors in case of fraud.
Money from SEC fines once just went into Treasury Department coffers, but now it can line the pockets of shareholders. In the case of a bankruptcy, investors may see some money before creditors do.
That's what's happening with WorldCom, which is paying a $750 million fine to shareholders to settle an SEC fraud case. Shareholders will get $500 million in cash and $250 in stock in the reorganized company, now called MCI.
The deal is good for shareholders, who may have been stiffed otherwise. But it's rankled creditors, who feel stripped of their priority.
Layers Of Complexity
What kind of precedent might this set? It makes bankruptcy, already a thorny process, even more complex. And creditors may become leery of lending money if they feel they're losing some power to get it back. It could also complicate financial reporting.
"Normally stockholders are last on the list," said Orie Barron, an accounting professor at Penn State's Smeal College of Business. "You've made it less clear by doing this."
On the whole, though, analysts don't see Sarbanes-Oxley's impact on bankruptcies as earth-shattering. WorldCom presents a unique set of characteristics. It involved massive fraud, and the firm still had many of its assets intact when it filed for bankruptcy. So there was plenty to fight over.
There won't be many cases like WorldCom, analysts note. But shareholders are already paid ahead of creditors in many cases.
Some three-quarters of bankruptcies violate the absolute priority rule, or APR, which puts creditors ahead of shareholders. So says Harlan Platt, a professor at Northeastern University in Boston. He's also a consultant with Chicago's Huron Consulting Group, an adviser to United Airlines as it goes through Chapter 11.
Parties involved in the bankruptcy, not the SEC, must decide to break the priority rule. But even if shareholders get priority, they typically aren't given any money. Instead, they get warrants to buy stock at a future date.
These warrants are not usually assigned a dollar figure, Platt says, though you could use a formula called Black-Scholes to calculate their worth. That formula is typically used to find the value of tradable options.
"It's considered theoretical, so most people don't put a dollar amount," he said. "Normally, for every 10 shares the party would get one warrant."
But the payment doesn't have to be in cash or stock. Airlines have given discount coupons to placate shareholders during bankruptcies.
Why would creditors agree to violate the APR? For one thing, says Platt, the move often appeases parties who may otherwise slow down the process.
In the WorldCom case, of course, shareholders are getting a lot more than travel coupons. That's upset some creditors, who say they're getting the shaft. MCI spokeswoman Julie Moore says the company won't discuss its relationships with its creditors.
But MCI would be paying a fine regardless -- even if no cash or stock went to shareholders. The firm puts the value of fraud committed by its prior managers at $11 billion. WorldCom filed for bankruptcy in June 2002.
Barron says you could argue that Sarbanes-Oxley is unfair to creditors. The law didn't exist when creditors established their relationships with WorldCom. "You're changing the rules of the game as you go along," he said.
Of course, this is only an issue for unsecured creditors, Barron notes. Secured creditors can seize collateral to get their loans repaid.
In the future, unsecured creditors may have to do more legwork in checking out prospective customers. The same goes for suppliers, which can lose out in a bankruptcy.
"There will be a cost there in doing business for the firms," said Barron, referring to the use of resources to investigate a potential customer.
New Order?
It's hard to say whether the Sarbanes-Oxley provision will have far-reaching effects on creditors. Already, says Barron, "Unsecured creditors are happy to get 10 or 25 cents on the dollar."
The WorldCom case was perhaps rare in that there was still lots of loot left to divvy up. In many bankruptcies, claimants wouldn't have as much to fight for.
Sarbanes-Oxley could -- in theory, at least -- change the nature of balance sheets. Claimants are listed there in order of priority. But now that's slightly harder to define.
Another question is whether the SEC will begin to play a more active role in bankruptcies. Until recently, it took a hands-off approach, Platt says. But in the distant past, it was very active. "Decades ago, they got involved in every bankruptcy of size," he said.
