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Enron Ruling Could Harm Liquidity Of Bankruptcy Claims

Three industry trade groups have banded together to protest a recent ruling that subordinates claims of Enron debt holders who bought loans from parties the company said committed fraud.

Three industry trade groups have banded together to protest a recent ruling that subordinates claims of Enron debt holders who bought loans from parties the company said committed fraud. The Loan Syndications and Trading Association, theBond Market Association and the International Swaps and Derivatives Association have filed amicus brief to support an appeal that is being filed on behalf of the investors.

Elliot Ganz, executive v.p., president and general counsel of the LSTA said the ruling is "tantamount to saying the claims have no value." Enron claims some of its banks committed fraud in their dealings with the company. Judge Arthur Gonzalez ruled that debt bought from those banks should come below all other loans. Summing up his argument, the judge argued that this would ease the administrative burden on the debtor by allowing him to subordinate claims rather than sue those alleged of wrongdoing to recover losses. He also argued it would prevent wrongdoers from avoiding having their claims subordinated by trading the claims away.

The court showed little sympathy to those who bought Enron bankruptcy claims for value, arguing they should be aware of the risks and uncertainties of buying claims associated with post-petition debtors, including the possibility of claims being subordinated.

Those appealing the decision said it would have been impossible for investors to do the necessary due diligence to determine whether the person they bought claims from was guilty of wrongdoing. "They should be aware of the risks," said Ganz. "But there is no way to determine whether the seller engaged in bad acts. The lawsuit was filed after they bought the loans. It was not a risk they could have avoided even if they did do due diligence."

Loans are not the only instruments affected by the court's decision. In his summary, the judge also said that buyers of bonds or credit default swaps should not be treated differently. Craig Goldblatt, counsel for ISDA, argued that many of those accused of wrongdoing in the Enron bankruptcy are large banks and that it would have been difficult to determine whether they had done anything wrong. "It is absolutely impossible to satisfy yourself that the seller has committed fraud. You can't do due diligence on a major financial institution," said Goldblatt.

The BMA is concerned that the judge's decision will harm the liquidity of bonds of bankrupt companies. "It raises the question of how vulture investors will value these securities," said Marjorie Gross, senior v.p. and regulatory counsel for the BMA. "It will definitely affect what people are willing to pay for bonds of bankrupt companies." She added that many buyers of bonds do not know the identity of the person they are buying from because many transactions are done through dealers.

Gross added that the large number of buyers in the bond market means the ruling would affect a lot of people compared the loan market, which is smaller and less liquid. "The judge should have limited his opinion to loan trading. Bonds are much more liquid than loans. They are more likely to be traded to a large number of smaller institutional investors than loans which are traded to a smaller classification of people," she said.

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