Pension Funds and Bondholders Revolt

The Toronto Star’s Saturday January 26th, 2008 Business section (page B3) has a couple of very interesting stories on litigation ensuing from recent major financial transactions. Both suits  will be  tests on the extent of legal liabilities in various recent financial “transactions”. The first story is about the exposue of 3 large Canadian banks to the lawsuit brought by the  New York City Pension Fund plus  Comptrollers for the City and New York State against Countrywide Financial, the primary source of subprime junkbond tainted derivative instruments.  However, the breadth and depth of that lawsuit brought by managers of huge pension funds may signal the end  of what toleration by big  investors with  financial neglect and/or malfeasance by major banks and investment houses.

Bondholders Strike Back

Just below is a story on how the purchase of Bell Canada by private equity firm Cerebrus and the Ontario Teachers Pension Fund for $52 Billion is now before the courts because Bell Canada bondholders. The story notes that “the bondholders argue that the deal requires their consent and a redemption of bonds which some estimate could top $1.5 billion. [Bondholders] claim that the takeover is unfair, giving shareholders a hefty premium while BCE[Bell Canada Enterprise] bonds have lost a quater of their value since takeover talks began last year. …lawyers representing the bondholders said that the ‘Bell Companies’ consistently assured investors they would retain low debt leverage ratios and a strong investment-grade rating for Bell’s bonds”.

The whole modus operandi for private equity firms is to find a company experiencing hard times but with a solid balance sheet with low debt to equity ratio, take it private, load up the company with $billions in additional debt, use those monies to pay themselves huge billion dollar management/investment  fees, paydown the most expensive purchase debt, and whats left over is used to “turnaround” the company. Yes, in that priority order. If the turnaround is succesful, the private equity investors will have a second huge payday, as the now much more heavily debt laden company re-enters public ownership with a”new” stock offering with huge payouts, even at a modest re-entry price, to the private equity holders.

Now this will be an intriguing case because a)its is large bondholders versus large private equity and pensions funds – not the usual finacial mismatch of smalltime investors against the Goliaths of high fincance and b)its being argued in Canadian courts where there is less of a track record on large suits like these. The nub of the case will turn on those many assurances by Bell taht they would maintain low debt to equity ratios. These assurances may have been made to avoid the complex and costly bond strictures and conditions  normally associated with much more risky bonds and “junk bond-like” instruments.

In sum, this case will surely impact debt and equity markets profoundly. Because this is another case of High Finace stiffing its own, otherwise known as Greedy Guts Itself. Already markets are reeling because trusted institutions like Moody’s and Standard and Poors have proven to be much less than  trustworthy in their ability to evaluate crucial and large investment vehicles. Likewise, the French in rescuing  fraud plagued Bank Societe General may have risked a huge stock market panic without fully informing their other European and World Central Bank colleagues.

In short, Trust is being sold short in the world of high finance – and that, in a globalized world, has depressing consequences. Does anybody have a Fifth of Trust for sale ?

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