WASHINGTON -- The Securities and Exchange Commission has become a party to the Orange County, Calif., bankruptcy proceedings so it can weigh in on issues affecting the municipal bond market, such as how the bankruptcy laws affect repurchase agreements, the SEC's top lawyer said yesterday.
"We want to be in a position where, if we decide that we should present our views to the court, we know we'll have the right to do that," Simon Lorne, the SEC's general counsel said in an interview.
The SEC officially joined the bankruptcy proceedings, he said, when it filed "notice[s] of appearance" last Friday in two bankruptcy cases pending before the U.S. Bankruptcy Court for the Central District of California in Santa Ana.
Orange County and its investment pool each filed for bankruptcy under Chapter 9 of the bankruptcy code earlier this month.
The filings were made after the county's $7.5 billion investment pool lost about 20% of its value and suffered liquidity problems from derivatives and leveraged investments. The bankruptcy filings are the largest ever made by a local government.
Lorne said that it is not clear yet how active the SEC will be in the case or on what issues the commission might want to comment.
However, the SEC is closely watching a dispute about whether broker-dealers had the right under federal bankruptcy laws to liquidate the securities they held as collateral for their repurchase agreements with the county after the county filed for bankruptcy, Lorne said.
In a repurchase agreement, a broker-dealer finances a customer's purchase of securities but holds the securities as collateral.
The county has sued Nomura Securities International, Inc. and its parent company in the bankruptcy proceedings, charging the firm violated federal bankruptcy laws when it liquidated about $900 million of bonds and structured notes that were collateral for repurchase agreements after the county filed for bankruptcy.
"I think there are public interest issues in that litigation that are broader than this particular case," said Lorne. He declined to comment further, saying the SEC has not yet developed a position on the issue.
Bankruptcy law experts say the SEC may be worried that a court ruling against Nomura could kill the use of repurchase agreements in the municipal market, with disastrous consequences.
"It's a market-integrity issue," said James Spiotto, a bankruptcy expert with the law firm of Chapman and Cutler in Chicago.
But Spiotto said the SEC probably is also worried about investors and "has an interest on both sides of the issue."
Other lawyers agreed.
One of the key roles of the SEC is to protect the markets and investors in the markets and to make sure there is a clear understanding about securities, another lawyer said.
The dispute between the county and Nomura is the result of ambiguity in the federal bankruptcy laws, several lawyers said.
Congress overhauled the bankruptcy code in 1978 and put an automatic stay provision in Chapter 9, the section of the code that deals with municipal bankruptcies. Under that provision, if a municipality files for bankruptcy, creditors are automatically prevented from filing suit, liquidating collateral, or taking other actions that could hurt the municipality.
In 1984, with the growing use of repurchase agreements in the corporate market, Congress amended Section 362 of the code and exempted these instruments from the automatic stay provision.
"That was to provide market assurance that, in doing a repo transaction, you have the ability to set off [or take possession of and liquidate] even if the counterparty went into bankruptcy," said Spiotto.
Congress made clear, in Section 559 of the code, that the securities underlying a repurchase agreement could be liquidated in the event of bankruptcy. But this section was never incorporated into Chapter 9 which deals with municipal bankruptcy.
"In 1984, no one anticipated that municipalities would be doing repurchase agreements," said Spiotto.
As a result, broker-dealers contend that they can liquidate the securities underlying repurchase agreements under the exception to the code's automatic stay provision.
"The whole purpose behind the 1984 changes in the bankruptcy code were to recognize the special nature of repurchase agreements and the need to freely sell collateral in just these situations," said Micah Green, executive vice president of the Public Securities Association.
But the county claims the securities can not be liquidated because Congress never explicitly provided for that in the chapter on municipal bankruptcy.
Another issue is whether the repurchase agreements meet the bankruptcy code's definition of a repurchase agreement, Spiotto said.