To Trade or Not to Trade: Can Claim Traders Sit on Creditors’ Committees and Trade in Securities
of the Debtor?
By Anna C. Palazzolo¹

Oftentimes in large chapter 11 cases the Office of the United States Trustee (the “U.S. Trustee”) will appoint claim traders to the committee of unsecured creditors, and such members may seek to continue to trade in the debtor’s securities.² Such appointment may seem to run afoul of committee member fiduciary duties to the unsecured creditors they represent,³ however the U.S. Trustee, the Securities and Exchange Commission and bankruptcy courts have upheld the right of claim traders to serve on creditors’ committees and trade in the debtor’s securities, so long as certain precautions are taken to preserve the committee member’s fiduciary duties.

In In re Federated Department Stores, Inc., 1991 WL 79143 (Bankr. S.D. Ohio), for example, Fidelity Management & Research Company (Fidelity), a member of the Official Bondholders’ Committee, sought to trade in securities of certain debtor and related non-debtor entities during the pendency of the bankruptcy cases. In order to protect its claims from potential disallowance, subordination, or other penalty, Fidelity sought an order determining that trading in the debtor and non-debtor securities would not violate Fidelity’s fiduciary duties as a committee member. The bankruptcy court ordered that trading in the debtor and non-debtor securities would not be in violation of Fidelity’s fiduciary duties “provided that Fidelity employs an appropriate ‘[screening] wall’ that is reasonably designed to prevent Fidelity trading personnel from receiving any nonpublic committee information through Fidelity committee personnel and to prevent Fidelity committee personnel from receiving information regarding Fidelity’s trading in securities of the debtors... in advance of such trades.” In re Federated Department Stores, Inc., 1991 WL 79143 at * 1.

The bankruptcy court ordered that the “Screening Wall” must include the following procedures:

1. Execution of a letter by the committee members acknowledging that they may receive nonpublic information and that they are aware of the “screening wall” procedures;


2. No sharing of nonpublic information with other Fidelity employees (except for legal counsel, who also will not share such information);


3. Storage of all files containing nonpublic information in cabinets inaccessible to other employees;


4. No receipt by committee members of information regarding Fidelity’s trades in advance of such trades, (except that committee members may receive reports on Fidelity’s ownership of the securities once a month);


5. Review of Fidelity’s trades in the debtor and related non-debtor entities by compliance department personnel to confirm that such trades were made in compliance with the screening wall procedures, and maintenance of records regarding the same.

Although courts have permitted committee members to trade in the debtor’s securities (upon the establishment and implementation of certain blocking procedures), such permission may be granted only upon an appropriate factual record and a sufficiently detailed request. In the recent case of In re Spiegel, 292 B.R. 748 (Bankr. S.D.N.Y. 2003), the proposed creditors’ committee counsel sought entry of an order determining that the members of the committee, including a non-voting ex officio member, will not violate their fiduciary duties as committee members by trading in the debtor’s securities during the pendency of the bankruptcy case, provided that the committee member establish, implement, and adhere to certain blocking procedures (collectively referred to as the screening wall) that are approved by the U.S. Trustee or that are consistent with other blocking procedures established by the court in other bankruptcy cases. In re Spiegel, 292 B.R. 748, 749 (Bankr. S.D.N.Y. 2003).

The bankruptcy court for the Southern District of New York found the committee’s request deficient, and refused to enter an order approving the same. Specifically, the bankruptcy court found that the committee’s motion failed to provide an adequate factual basis regarding the request (such as a description of the committee member’s business, its fiduciary duties to its clients, and the specific harm that would result if the committee member did not receive the relief requested) and that screening wall procedures must be in place prior to approval of such procedures. The bankruptcy court also questioned the propriety of committee counsel seeking a blanket order on behalf of the committee “where the relief requested benefits a limited number of committee members to the potential detriment of the unsecured creditor body as a whole.” Id. at 751.⁴

In re Spiegel instructs that a request for authorization to trade in the debtor’s securities should be specific to the particular committee member and adequately describe both the factual basis for the request and the screening wall procedures that have been established. Other suggestions for a motion seeking authorization to trade in the debtor’s securities include:

1. Filing a declaration of the individual committee member that (a) the individual will comply with the screening wall procedures established, (b) that an individual or a committee has been designated to monitor compliance with the screening wall procedures, (c) that the individual will disclose any increase or decrease in its position in the debtor’s securities, (d) that the individual will file periodic reports with the bankruptcy court that it has reviewed its procedures and the screening wall remains effective.


2. Preserving the bankruptcy court’s right to take any action it deems necessary in the event that a breach of fiduciary duty has occurred.

It is important to note that whether a court will authorize a particular committee member to trade in the debtor’s securities remains a decision that the court will base on the facts and circumstances of each request. However, following the suggestions described above should strengthen the likelihood that a court will grant such requests.

¹ Anna C. Palazzolo is an associate in the New York office of Dechert LLP.
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² Under the Bankruptcy Code, security includes, in part, “note,” “stock,” “treasury stock,” “bond,” “debenture,” “collateral trust agreement,” “transferable share,” and “other claim or interest commonly known as ‘security’.” See 11 U.S.C. §101(49)(A).
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³ It is well established that committee members are fiduciaries to the class of creditors they represent. See e.g.; Woods v. City Nat’l Bank and Trust Co. of Chicago et al., 312 U.S. 262, 268-269, 61 S.Ct. 493, 85 L.Ed. 820 (1941).
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⁴ The court also stated that even upon the appropriate factual record and proper notice, it “would not be inclined to grant the relief” requested by the committee, and would “hold the committee to full and strict compliance with its fiduciary obligations.” In re Spiegel, 292 B.R. 748 at 751. However, despite this position, the U.S. Trustee continues to appoint creditors trading in claims to committees (subject to the creation of appropriate “Screening Wall” procedures). See Lisa L. Lambert and Greg M. Zipes, Creditors’ Committee Formation Dynamics: Issues in the Real World, AMERICAN BANKRUPTCY LAW JOURNAL, Spring 2003.
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