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Washington Mutual Shareholders Seek Info On Hedge-Fund Trades
Peg Brickley | 19 January 2011

Shareholders of Washington Mutual Inc. are demanding information from Appaloosa Management LP and three other hedge funds they suspect engaged in insider trading during the bank-holding company's bankruptcy case.

In a filing late Tuesday with the U.S. Bankruptcy Court in Wilmington, Del., lawyers for the official shareholders panel referred to a court ruling that twice cited the allegations of improper trading, which remain unproven.


They say an investigation is required to get to the bottom of allegations aimed at Appaloosa, Aurelius Capital Management LP, Centerbridge Partners LP and Owl Creek Asset Management LP, hedge funds in line for huge profits under the Chapter 11 plan for Washington Mutual, former parent of Washington Mutual Bank, or WaMu.

The allegations first surfaced during a confirmation contests that ended in defeat for Washington Mutual's Chapter 11 plan, raised by an unhappy investor, Nate Thoma. Judge Mary Walrath said the allegations against the hedge funds, while hearsay, made her reluctant to shield the investors from lawsuits over the role they played in negotiating the Chapter 11 plan.

Lawyers for the hedge funds called the allegations of insider trading "baseless" and said shareholders didn't bother to question their trading activity in time for confirmation hearings, which concluded in December 2010. There's no need for an "extraordinary" emergency probe now, with Washington Mutual busy revising its Chapter 11 plan, the hedge funds contend.

If proven, the insider-trading claims could cost the hedge funds some of the interest they are in line to collect under Washington Mutual's Chapter 11 plan, the judge suggested in the Jan. 7 ruling. In the aggregate, the four hedge funds own more than $2.5 billion worth of securities issued by Washington Mutual. About $1.7 billion of the securities are in line for payment in full with interest under the Chapter 11 plan. Other holdings will be paid at 74 cents on the dollar and entitle Appaloosa, Aurelius, Centerbridge and Owl Creek to control the reorganized company.

Shareholders who are being left with nothing in Washington Mutual's bankruptcy on Wednesday appealed parts of Walrath's decision that found the fundamental settlement at the heart of the bank-holding company's Chapter 11 plan is sound.

But they seized on the judge's references to possible improper trading and launched an investigation into the activities of the four hedge funds. Besides a cut in the interest rate, shareholder attorneys say insider trading could be even more costly. Proof of impropriety by the hedge funds could form the basis of an "equitable subordination" claim. A rarely imposed remedy for improper creditor behavior, equitable subordination pushes the offender down the ranks of the payment priority scheme.

The premise of the insider-trading allegations is that Appaloosa and other members of the noteholders' group were at the bargaining table when Washington Mutual hammered out the terms of its Chapter 11 plan, a $7 billion-plus distribution scheme. Information gained at the bargaining table - such as the interest rate Washington Mutual intended to pay, or the likely timing of a settlement - would have been invaluable in knowing when to buy and sell the company's debts.

If they are able to prove the allegations, shareholder attorneys believe they could persuade the judge to slash the profits the hedge funds stand to make under Washington Mutual's plan. Funds not paid to the creditors would trickle down the payment-priority scheme, perhaps reaching preferred shareholders.

Product of the biggest banking collapse in U.S. history, Washington Mutual's bankruptcy turned out to be a bonanza for those prepared to gamble in the fall of 2008, when the U.S. financial system looked shaky. Court filings indicate the four hedge funds pounced on Washington Mutual's debt soon after regulators stripped the company of its prized thrift, WaMu, which was bought by J.P. Morgan Chase & Co.

Owl Creek was the first to jump in, buying senior notes Sept. 25, 2008, the day the Office of Thrift Supervision marched in and seized the shaky thrift. The hedge fund paid as little as a fraction of a penny for debt that will be paid in full, with interest, under Washington Mutual's plan, court records show.

Appaloosa and Centerbridge started buying the next day, Sept. 26, 2008, which saw the once-staid Seattle bank holding collapse into bankruptcy. Aurelius started buying October 3, 2008, still in time for bargain-basement prices on the debt.

The four hedge funds filed summary trading records with the court in May 2010, two months after Washington Mutual unveiled a key plan settlement, followed by a Chapter 11 plan. Negotiations continued for months until the Chapter 11 plan was in final form, but the essential outline of who was getting what was public by the end of March 2010.

The summary trading records indicate Appaloosa did most of its trading in 2008, traded in a few issues in 2009, and did no trading in 2010. Owl Creek traded through the end of 2009, with one issue traded in 2010. Centerbridge and Aurelius continued trading through May 2010.


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