Silver Point Capital’s Not-So-Great Wall
Some investment advisers are simple. Clients ask for investment advice, and the advisers give it. The clients pay them one way or another. Others are more complex. They might be hedge funds. They’re larger and have multiple lines of business. Sometimes those lines bring material, nonpublic information about public companies into the adviser’s metaphorical tent.
But regardless of size or shape, Advisers Act Section 204A says all advisers have to have written policies and procedures that are reasonably designed to prevent the MNPI at their firms. These policies and procedures must take into consideration the nature of the adviser’s business, including the circumstances under which the adviser receives MNPI. This is a lot easier to do that at the first kind of adviser versus the second!
We learned all about it last month when the SEC sued Silver Point Capital, L.P.[i]
Silver Point Capital’s Distressed Debt Business
So . . . Silver Point Capital, L.P. is a hedge fund manager based in Greenwich, Connecticut, with over $28 billion under management. Suffice it to say that it’s the more complex kind of investment adviser. Its business model is heavily focused on investing in distressed debt. For the last 20 years, Silver Point has divided its business between a “public side” and a “private side.”
The public side invests in the debt markets for the funds that Silver Point manages. It consists of (1) analysts that research distressed entities and makes recommendations to buy and sell securities issued by those same entities, (2) a group that considers and approves the trading recommendations, and (3) traders that execute the trades.
These distressed entities frequently engage in confidential negotiations aimed at crafting repayment plans or restructuring. Once Silver Point holds debt in one of those entities, it often sends representatives from its private side to join creditors’ committees to participate in those negotiations. The private side reps advocate for advantageous recoveries for Silver Point’s debt.
These creditors’ committees routinely become aware of MNPI during these confidential negotiations. For these restructuring proceedings, the parties’ negotiating positions, proposed settlement terms, or the debtor’s financial condition can all amount to material, nonpublic information. The creditors aren’t allowed to trade on it.
Silver Point’s Information Barrier
Meanwhile, Silver Point purported to maintain an information barrier between its public and private sides, with the idea that the public side could actively trade the debt of a distressed entity while the private side simultaneously participated in confidential negotiations regarding the same entity. This wall was critical to upholding its obligations to establish written policies and procedures preventing the misuse of MNPI. Silver Point also had a policy that required that all of its personnel be designated as either public, private, or administrative, which then determined the level of oversight warranted to prevent leaking MNPI.
For example, some communications between public and private Silver Point employees were subject to enhanced monitoring by Compliance. The core requirement of the barrier policy was pre-approval for “wall-crossings”. That is, any employee who wanted to communicate with staff on the other side about any investment-related matter must first inform Compliance, regardless of any MNPI. Under this policy, the employee seeking preapproval would document the communication participants, the issuer to be discussed, the discussion topics, any information disparity between the public and private sides, and whether the private side intended to share confidential information. The barrier policy and Silver Point’s “professed practice” also required Compliance to maintain a log of all wall crossings.
The barrier policy also required Compliance to maintain a “watch list” and a “restricted list” to track the firm’s investments and knowledge levels. Compliance placed an issuer on the restricted list when the public side learned MNPI about that issuer. Silver Point was prohibited from trading in those issuers’ securities. The watch list included issuers about which only the private side had confidential information. This list was only accessible to Compliance because even the fact that the private side was working on a particular deal might amount to MNPI.
The barrier policy also dictated physical separation between the public and private sides within Silver Point’s office space, complete with separate key card access.
Chaim Fortgang
A fun part of this post was learning about legendary bankruptcy lawyer Chaim Fortgang. Fortgang was a bigshot at Wachtell, Lipton, Rosen & Katz for 30 years, but left under at least somewhat acrimonious terms in 2002 and set up his own shop. He died in 2021, but this WSJ article about his departure from Wachtell almost reads like an obituary 19 years before his death. As the SEC’s complaint says, Fortgang ‘had a reputation for being aggressive and uncompromising while advocating on behalf of his clients.” That is to say, one time he threatened to rip out another lawyer’s tongue (though didn’t actually do it).
Anyway, in 2004 Fortgang began consulting for Silver Point, which paid him a flat, monthly consulting fee of $183,333 along with a potential annual bonus. (The SEC includes all this detail to make Fortgang look like an employee and not just a random consultant.) Fortgang gave advice on both Silver Point’s public side and its private side. At times, he was copied on trading recommendations made by Silver Point’s public side analysts. He was also often Silver Point’s sole representative on on the creditors’ committees discussed above.
But what about that information barrier? Did the wall run straight through Fortgang? Well, Silver Point’s barrier policy did not clearly require the same oversights and controls for consultants like Fortgang as it did for its private side employees. Instead, the SEC says “Silver Point’s barrier policy was, at best, ambiguous—stating only that consultants like Fortgang may be designated as private employees, without providing any criteria for Compliance to use to determine when to do so.” Fortgang wasn’t designated as strictly public or private, so he operated in this weird void where he was neither. So Fortgang’s interactions with the public side went largely unpoliced by Compliance, even though he was routinely exposed to MNPI as Silver Point’s creditors’ committee rep, and had contact with members of the public side all the time.
The Puerto Rico Bonds
In 2015, Puerto Rico suffered a financial collapse and defaulted on a lot of its debt. Two years later a federal bankruptcy court appointed a panel of federal judges to mediate between Puerto Rico and its creditors to reach resolve recoveries for creditor bondholders. From at least September 2019 through February 2020, Silver Point participated in the mediation as a member of an “ad hoc” creditors’ committee.
The mediation was supposed to be confidential. The court order appointing the mediators specified that it would be, and Silver Point signed onto a mediation agreement that (1) said the same thing and (2) noted the securities laws restricting trading while possessing MNPI.
Fortgang was Silver Point’s sole representative for most of the mediation. He attended mediation sessions and participated in calls with other creditors, the mediator, and representatives of Puerto Rico, offering Silver Point’s perspective on the economic terms of any deal and serving as its primary negotiator. He also received settlement proposals and other information about Puerto Rico’s financial position – much of which constituted MNPI and was marked that way.
By assigning Fortgang and not a public side analyst, Silver Point’s idea was that it could continue to trade Puerto Rico bonds while the mediation was ongoing. Silver Point sort of relied on its information barrier policy to let Fortgang play both private and public sides, but they didn’t really enforce it as to him.
For example, on September 17, 2019, Fortgang attended the first Puerto Rico mediation session and received MNPI about the risks associated with Puerto Rico’s fiscal plan. Compliance added Puerto Rico to Silver Point’s watch list based on Fortgang’s receipt of MNPI. Still, Fortgang had a seven-minute call with a member of Silver Point’s public side during that first session (the first session!). The barrier policy required that Compliance be alerted to the call, but it wasn’t, and Compliance was unable to determine whether it needed to be monitored and entered on the wall crossing log. Later that day, Silver Point’s public side pulled the trigger on buying $14.5 million in Puerto Rico bonds.
On September 19, 2019, Fortgang was allowed to roam around the public and private sides of Silver Point’s Greenwich office even sat next to the traders while they placed trades (why?) despite the barrier policy requiring physical separation between the two sides.
On September 20, Compliance took the Puerto Rico bonds off the watch list, and didn’t added them back until October 25th. Silver Point made 11 purchases of Puerto Rico bonds totaling over $46 million during that 5½ week period.
Lots of Calls
Except for about eight days in October, Fortgang had MNPI about the Puerto Rico bonds from September 17, 2019, until February 9, 2020. He learned about seven different settlement offers exchanged by the parties and attended in-person mediation sessions where MNPI was exchanged. Through that period, Fortgang had over 500 calls to Silver Point’s public side staff, including calls with the analyst and executive who recommended and approved trades in Puerto Rico bonds.
Here’s how one series of these calls went: On December 3, 2019, Fortgang made two calls to Silver Point’s public-side Puerto Rico analyst. Later that afternoon, the analyst sent a draft trading recommendation to his boss. Fortgang spoke with the analyst the next day for four minutes. A few hours later, the analyst circulated a final trading recommendation, and over the next nine days Silver Point bought more than $54 million in Puerto Rico bonds.
Fortgang again came to Silver Point’s office on December 12, 2019, when the Puerto Rico analyst circulated a “TIME SENSITIVE” recommendation to buy more Puerto Rico bonds. Silver Point then bought $18 million more the next day.
None of these calls – and certainly none of the in-person meetings – were monitored or logged, so nobody knows exactly what was said during them.
Not every hedge fund participating in the Puerto Rico mediation handled it this way! Others flatly prohibited their employees from trading in Puerto Rico bonds when they had MNPI from the mediation.
The Upshot
First, for its part Silver Point says, “We have refused to settle a matter in which there was neither any wrongdoing nor any deficiency in our information barrier policies or our compliance program.” So they’re going to fight! Meanwhile, the SEC notes that it can’t establish whether Fortgang in fact ever passed MNPI to Silver Point’s public side “precisely because of Silver Point’s failures.”
But one of the reasons Silver Point says it was fine to handle Fortgang this way was because he was a lawyer (presumably with the attorney-client privilege attaching to all of his Silver Point communication). They say, “Mr. Fortgang acted for Silver Point solely as an attorney and therefore should have been treated no differently than any other outside counsel where chaperoning, by all accounts, is not required.” I think that may not work, though? Was he really giving legal advice to Silver Point’s public-side Puerto Rico analyst? Was he collecting information so he could advise the private side? Can an investment adviser immunize itself as to Section 204A by putting a lawyer in the middle of its public/private communications? Doesn’t a court have to have some sort of in camera review of the communications to determine that? Here, because none of the communications have been reduced to a writing, it seems like the analyst and supervisor on the public side have to be deposed in camera. I guess I have more questions than answers on this one.
If the SEC’s administrative court program had not been reduced to rubble by this point, I almost guarantee it would rather have filed this case before an ALJ instead of in federal court. Maybe a judge in Connecticut will recognize the importance of this prophylactic rule. But maybe not!
[i] All of the “facts” that follow are really just allegations. This is especially so because Silver Point is not settling the case and vows to fight it, so we don’t know if any of what follows is actually true.