Hedge Funds Threatening Option-Scam Defaults Win Case

Date: Friday, October 6, 2006
Author: Caroline Salas, Bloomberg.com

Oct. 6 (Bloomberg) -- Hedge funds won the support of a New York court in their battle for early repayment of bonds from companies that miss financial-reporting deadlines.

A New York Supreme Court decision against consulting firm BearingPoint Inc. will help investors get their money repaid faster or win concessions from dozens of companies being probed for the manipulation of stock options used to compensate executives, according to lawyers for bondholders.

Hedge funds say companies ranging from UnitedHealth Group Inc., the biggest U.S. health-insurance provider, to computer chipmaker Vitesse Semiconductor Corp., are defaulting on their debt because the options investigations are forcing them to delay the filing of financial results. The companies have as much as $36 billion of bonds, data compiled by Bloomberg show.

``The majority will recognize this obligation,'' said Jeff Ross, an attorney at Anthony Ostlund & Baer PA in Minneapolis who represented Whitebox Advisors LLC and other hedge funds in the BearingPoint case. ``As for the others, I refer you to the title of Bob Woodward's book: `State of Denial.'''

The court in Manhattan ruled Sept. 18 that BearingPoint, a McLean, Virginia-based management consultant that was once part of accounting firm KPMG LLP, defaulted by missing a filing deadline. The company is appealing the ruling. In New York, the Supreme Court is the lowest state court. BearingPoint's delay isn't related to the options probe.

Notice of Default

Hedge funds such as Whitebox seek to profit by enforcing so- called covenants that protect creditors. If a company violates the terms of its borrowing agreements, bondholders have the right to demand immediate repayment of the bonds. Hedge funds are private pools of capital that allow managers to participate substantially in the gains on investments made on behalf of clients.

UnitedHealth said in an Aug. 28 filing it was notified of a default. Minnetonka, Minnesota-based UnitedHealth's $500 million of 4.875 percent notes due in 2015 trade at about 96 cents on the dollar to yield 5.5 percent, according to Trace, the bond-price reporting system of the NASD. The bonds have investment-grade ratings of A2 from Moody's Investors Service and A from Standard & Poor's.

Investors would get a 4.12 percent return if UnitedHealth were forced to repay the debt at face value, or 100 cents on the dollar. That compares with a 3.2 percent total return on the average investment-grade corporate bond so far this year, according to Merrill Lynch & Co. index data.

`Tortured Parsing'

In its ruling, the court found that BearingPoint violated the terms of its $200 million of 2.75 convertible notes due in 2024 when it didn't report financial results. BearingPoint missed deadlines after audits found accounting errors.

The company argued it wasn't in default because its obligation to report results to bondholders was contingent upon submitting earnings statements to the U.S. Securities and Exchange Commission, which it didn't do, according to a Sept. 29 Barclays Capital report.

The company's ``tortured parsing'' of its bond covenant to claim SEC filings are optional violated an obligation ``to provide information to the investors so that they may protect their investment,'' the court said.

``We respectfully but strongly disagree with the decision,'' Harry You, chief executive officer of BearingPoint, said in a Sept. 26 statement. ``It is important to note the court did not order an acceleration of the debentures nor grant the request to award damages.''

The SEC is investigating at least 135 companies for defrauding shareholders by backdating stock-options grants to executives. The BearingPoint ruling may make it more difficult for companies to fend off hedge-fund challenges, according to Barclays.

Setting a Precedent

``While the cause of the delay was not option related, we believe the precedents set by this decision could help influence the outcomes of UnitedHealth and other companies for which the interpretation of their indenture language is up for debate,'' Barclays analysts Melody Vogelmann, Stanton Nelson and Bill Nonneman wrote in a Sept. 28 report.

``If this interpretation stands, it makes UnitedHealth's stance that it is not in default more difficult for the company to defend.''

Whitebox, Fore Research and Management LP and Linden Advisor LP own about $91 million of the BearingPoint notes, according to the court ruling. Whitebox also owns debt of UnitedHealth and Camarillo, California-based Vitesse, according to regulatory filings and an interview with a Whitebox official last month.

Andy Redleaf, the founder of Minneapolis-based Whitebox, didn't return a call seeking comment. Mark Lindsay, a spokesman for UnitedHealth, didn't respond to a call and e-mail seeking comment.

Side Payments

Hedge funds are being lured by millions of dollars in side payments to waive their claims of defaults.

Sanmina-SCI Corp., Amkor Technology Inc. and Medarex Inc. have offered bondholders payments in the last two months to give them more time to meet deadlines. San Jose, California-based Sanmina; West Chester, Pennsylvania-based Amkor and Princeton, New Jersey-based Medarex are all being investigated for stock- options, which resulted in filing delays.

Amkor, the world's second-largest packager of semiconductors, on Sept. 28 increased the special payment it is proposing to bondholders, saying it will pay one fee for more time to present its statements and another if it doesn't meet a deadline.

The company is threatening to file for Chapter 11 bankruptcy protection if bondholders try to force it to immediately repay its debt, the Wall Street Journal said today, citing people familiar with the negotiations. Amkor and its creditors aren't close to reaching an agreement to waive the default, the newspaper said.

Medarex, Sanmina

Sanmina, the world's second-largest maker of electronics for other companies, in August offered investors holding $1 billion of its bonds $12.5 million.

Medarex, a biotechnology company, on Sept. 22 said it would pay $2.50 per $1,000 face amount to investors holding $150 million in convertible bonds if they'd give the company more time to file its earnings. It offered to pay $10 per $1,000 face amount if results aren't submitted by the close of business on Oct. 24, according to the company's statement.

The federal Trust Indenture Act of 1939 requires companies with public debt to file financial statements and provide them to bondholders, said J. Andrew Rahl, an attorney at Anderson Kill & Olick PC, who represented bondholders pressing Navistar International Corp. to accelerate payments on its debt after failing to publish financial results since September 2005.

The BearingPoint ruling ``certainly vindicates the position that bondholders have been taking,'' he said in an interview from his New York office.

To contact the reporter on this story: Caroline Salas in New York at csalas1@bloomberg.net