by Bob Van Voorhis and Scott Carpenter
JPMorgan Chase & Co. has ruled in a federal appeals court that its $1.8 billion loan in the court case was not a security, a victory for the banking and private equity industries.
The ruling by the Second Circuit US Court of Appeals in Manhattan came Thursday in a securities fraud lawsuit brought by a trustee for note buyers in a 2014 syndicated loan deal led by JPMorgan. Soon after the notes began trading, the borrower, drug-testing company Millennium Health, ran into legal troubles and filed for bankruptcy the following year.
Debt notes are not currently considered securities, so a ruling against JP Morgan will have a wide-ranging impact on the regulation of the leveraged debt market. If the loans were securities, borrowers would be required to submit additional disclosures and produce more financial data, and any subsequent trades would need to be settled much more quickly than at present.
The court ruling is welcome news for banks as well as private equity firms, which often use leveraged debt in buyout deals. They may become less attractive if a court rules that they must comply with securities laws.
The trustee, Mark Kirshner, declined to comment on the decision. JP Morgan did not immediately respond to a request for comment.
“It’s a huge relief for the market because it avoids a major disruption,” said Elliot Ganz, head of advocacy for the Loan Syndications and Trading Association, an industry group that lobbies in favor of the banks.
Advocates of reclassifying leveraged loans have argued that regulating the loans as securities would bring long-needed transparency to a notoriously opaque part of the financial markets. Industry observers say that decades ago, large-scale loans were excluded from securities laws because at the time companies typically borrowed from only one bank, which, unlike the syndication and trading common in today’s market, managed their entire debt. kept the loan with him for the period. ,
Without regulation under the securities laws, “disclosure requirements become weak and anti-fraud rules difficult to enforce,” according to a January report from researchers at the advocacy group Americans for Financial Reform.
A lower court had previously dismissed Kirshner’s fraud claims on the grounds that the notes were not securities. The appeals court agreed, finding that the purchasers of the debt notes themselves became the lenders.
“The district court did not err in dismissing plaintiffs’ state-law securities claims because plaintiffs failed to suggest that the notes were securities,” Circuit Judge Jose Cabrenas wrote on behalf of the three-judge appellate panel.
In March, an appeals court asked the Securities and Exchange Commission to give its opinion on whether syndicated debt notes are securities under the 1990 Supreme Court decision. In July, the SEC declined to consider the question.
The LSTA lobbied the SEC heavily throughout the spring and early summer, holding more than 10 meetings with SEC staff and three of its five commissioners. The SEC met with both sides in the case and consulted with other federal agencies. Her decision not to submit a brief came as a surprise, and was widely seen as making it less likely that the court would overturn the status quo.
Kirshner claimed that JPMorgan and other banks withheld critical information that would have exposed investors to Millennium’s troubles. The company announced in May 2015 that it had reached a $246 million settlement with the Justice Department and other parties on billing fraud charges.
The trustees represented the interests of 70 groups of investors, made up of approximately 400 mutual funds, hedge funds, and other institutional investors.
In its ruling, the appeals court found that the notes failed to meet three of the four factors set forth by the Supreme Court to determine whether an investment constitutes a security under US law: They are available to the general public. were unavailable, the buyers were sophisticated institutional investors and were secured by collateral.
The case is Kirshner v. JPMorgan Chase Bank, 21-2726, 2nd US Circuit Court of Appeals (Manhattan).