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A blog on all things about credit, bankruptcy, consumers, and financial institutions. We are fourteen academics who will use this space to discuss and debate issues not just for specialists but for anyone who cares about creating good policies in these areas.
Yesterday I posted about the number of religious organizations that filed chapter 11 between 2006 and 2017, and how their filings track fluctuations in consumer bankruptcy filings during those years. Non-religious non-profit organizations also file chapter 11, but in fewer numbers than religious organizations. As shown in this graph, between 2006 and 2017, a mean of 44 other non-profits filed chapter 11 per year (note: I count jointly-administered cases as one case).
In comparison, a mean of 79 religious organizations filed chapter 11 per year between 2006 and 2017. Over these twelve years, 36% of all chapter 11 cases filed by non-profit organizations were filed by non-religious non-profits.
For a bit of context, according to the National Center for Charitable Statistics, there were about 315,000 congregations operating in America in 2016. This number has remained relatively stable over the last decade. Also according to the National Center for Charitable Statistics, there were about 1.5 million tax-exempt organizations operating in the United States in 2016. This figure includes 501(c)(3) public charities (which include congregations), 501(c)(3) private foundations, and other exempt organizations (such as labor unions and farm bureaus). Removing other exempt organizations and congregations, about 815,000 other non-profits operated in the United States in 2016. Based on these figures, as a percentage of operating organizations, religious organizations filed chapter 11 in far greater (though still very small) percentages than other non-profits. (There surely are logical hypotheses as to why -- to be delved into later.)
In addition, unlike religious organizations' cases, other non-profits' chapter 11 filings track fluctuations in business chapter 11 filings. For instance, over the past few years, chapter 11 filings with predominately business debts have remained steady. Other nonprofits' chapter 11 filings likewise have remained steady, as evident in the below graph (note: business chapter 11 filing data is from the Administrative Office of the United States Courts, Table F-2 ,U.S. Bankruptcy Courts - Business and Nonbusiness Cases Filed, by Chapter of the Bankruptcy Code).
Interestingly, similar to how religious organizations' chapter 11 filing track consumer bankruptcy filings, but lagged by a year, other non-profits' chapter 11 filings seem to lag business chapter 11 filings by one year. Other non-profit's filings peaked in 2010, while business chapter 11 filings peaked in 2009. As I have done with religious organizations' chapter 11 cases, I intend to analyze data from other nonprofits' chapter 11 filings to answer questions about these cases' place within the business bankruptcy system and the non-profit sector. In short, stay tuned for more on these cases as well.
Not only are religious organizations still filing under chapter 11. As in prior years, they continue to file under chapter 11 in line with fluctuations in consumer bankruptcy filings. Find a couple graphs below to show this. But first, some background.
In my prior work, I analyzed all the chapter 11 cases filed by religious organizations from the beginning of 2006 through the end of 2013. (I define any organization with operations primarily motivated by faith-based principles as religious.) I found that these chapter 11 cases were filed predominately by small, non-denominational Christian churches, which mainly were black churches (80% of more of their members are black). And, also, that the timing of the filings tracked consumer bankruptcy cases (chapters 7, 11, and 13), not business bankruptcy filings, but lagged by one year. That is, if consumer bankruptcy filings decreased in a given year, religious organizations' chapter 11 filings decreased in the next year. I linked this result to how religious organizations' leaders came to think about using bankruptcy to deal with their organizations' financial problems.
Since my original data collection, four years has passed. I thus recently identified all the religious organizations that filed under chapter 11 between the beginning of 2014 through the end of 2017. During these four years, religious organizations continued to file, but in smaller numbers per year, as shown in this graph (note: I count a jointly-administered cases as one case).
Between 2014 and 2017, consumer bankruptcy filings declined. Chapter 11 business filings remained steady. In accordance with prior years, religious organizations' chapter 11 filings during these four years generally tracked consumer bankruptcy filings, lagged by one year. Consumer filings peaked in 2010, while religious organizations' filings peaked in 2011, as evident in the below graph (note: consumer filing data is from the Administrative Office of the United States Courts, Table F-2 ,U.S. Bankruptcy Courts - Business and Nonbusiness Cases Filed, by Chapter of the Bankruptcy Code).
Finally, a note on Catholic dioceses' cases. When people think about churches filing bankruptcy, they often first think of Catholic dioceses. Since 2006, a total of 14 dioceses have filed under chapter 11. That is about one case per year. Between 2006 and 2017, a mean of 79 religious organizations filed chapter 11 per year, including that one diocese per year.
More analysis--such as in which districts religious organizations mainly file and congregation demographics--to come.
Both proposals are laudably clear-eyed about some fundamental aspects of the Venezuelan debt crisis. First, if it ever made sense to view PDVSA and the Republic as separate credits, that time is long past. Second, for a restructuring plan to be feasible, it must simplify an enormously complicated debt stock and encompass more than bond creditors. Thus, while neither creates a mechanism for encompassing all of PDVSA’s liabilities, both the Lerrick and Buchheit/Gulati proposals envision a restructuring of both bond debt and the pesky promissory notes that PDVSA has issued to trade creditors. The latter instruments are especially problematic from a restructuring perspective, because they lack contract-based mechanisms for modifying their terms. Finally, both proposals recognize that something must be done to protect oil-related assets, including future receivables, from holdouts.
These shared assumptions result in similar proposals. The difference is in the details, which turn out to be important. Let’s call the Lerrick proposal Strip, Swap, Restructure.
Strip, Swap, Restructure
In a nutshell, Lerrick proposes (i) that all of PDVSA’s Venezuelan assets be transferred to the Republic; (ii) that the Republic withdraw PDVSA’S concession to exploit hydrocarbon reserves; (iii) that PDVSA bond- and note-holders be offered the opportunity to exchange their instruments for new bonds, with identical terms, issued by the Republic; and (iv) that the Republic then launch a restructuring of all of its debt. To protect oil-related assets, Lerrick suggests requiring payment and transferring title in Venezuela. Buyers will want a price discount, of course. But hey, judgment-proofing ain’t free.
Lerrick notes that holdouts will retain their claims against PDVSA. But of course, PDVSA will be not exactly an inviting litigation target. He also notes that holdouts may ask courts to treat the government as the successor to PDVSA’s debts. Lerrick dismisses this risk, opining that any holdout who won on this argument would be “in the exact same position as if it had accepted” the Republic’s exchange offer.
There is a lot to like in this proposal. Lerrick is an extremely well-respected economist, and his views will carry great weight at Treasury. I also suspect he is less interested in legal details than in the basic structure of the proposal. Still, I’m a bit hung up on the part about the holdouts.
A PDVSA bondholder who participates in the exchange offer will have a claim against the Republic under the new bonds. The Republic has no money and intends to restructure these bonds. It will presumably do that by proposing another exchange, only this time participating bondholders will also vote to modify the bonds they are exchanging in unpleasant ways. This is the classic exit consent (and Mitu, if he were here, would want you to know how much he loves exit consents!). If the new bonds issued by the Republic are otherwise identical to the exchanged PDVSA bonds, they will not have CACs and will bar any "impairment" of a non-consenting bondholder’s right to payment or to institute suit. But even if these limitations remain in place, it’s relatively easy to envision a subsequent exchange offer successfully restructuring the Republic’s bond debt.
I’m not sure I share Lerrick's confidence that holdouts will be no better off than participants in the initial exchange of PDVSA for Republic bonds. To begin with, it seems to me that this proposal essentially guarantees that courts will pierce the corporate veil and hold the Republic liable for PDVSA’s debts. Whatever one thinks about the withdrawal of the concession, the proposal envisions a straight-up transfer of PDVSA assets to the government. That’s an easy case for veil piercing.
Once PDVSA's bond liabilities are imputed to the Republic, it's hard for me to see holdouts as on equal footing with holders of Republic bonds. The modification provisions in the new Republic bonds will be useless against holdouts, who won’t own them. Nor could the Republic invoke the modification provisions in the holdouts’ own (PDVSA) bonds. Even if the Republic could claim the benefit of these provisions (possible, but not certain), who would vote in favor of a modification? Bondholders who exchange PDVSA bonds for Republic bonds that will surely be restructured signal their willingness to, well, restructure. It’s easy to imagine a majority–even a large majority–subsequently accepting a reasonable restructuring proposal by the Republic. But PDVSA bondholders who hold out are in it for the long haul. They’ll have non-restructurable claims for full principal and accrued interest against the shambling husk of PDVSA, against the government itself, and potentially against any entity that receives the oil and gas concession currently enjoyed by PDVSA. Yes, the government can take steps to shield oil-related assets from creditors, but that’s neither here nor there. PDVSA can take those steps now. And even if the government effectively shields oil-related assets, it will have to worry about holdouts lurking in the shadows every time it tries to access foreign commercial and capital markets.
As I mentioned, Lerrick may not be wedded to the details of his proposal. He is primarily interested in protecting oil-related assets and in simplifying the debt stock before a restructuring. The plan is elegant and may well provide the framework for a successful restructuring. But I’m not convinced that it effectively counters the risk of holdouts.
Pledge, Swap, Restructure
To understand the Buchheit/Gulati proposal, just replace “Strip” with “Pledge.” To mitigate the risk of holdouts, Lee and Mitu take a deep dive into PDVSA’s bond contracts. My first-year law students sometimes enter my Contracts class believing that contracts exhaustively specify the parties’ rights and obligations, leaving few gaps to fill or ambiguities to interpret. I spend much of the semester teaching them otherwise, when I’d really just like to introduce them to Lee and Mitu. The drafters of PDVSA’s bonds probably didn’t envision quite this scenario, but Lee and Mitu proffer an entirely reasonable interpretation of a particular clause. Actually, sub-part 23 of that clause. The clause defines Permitted Liens (i.e., liens that PDVSA can create despite the negative pledge clause in the bond) to include:
(23) Liens in favor of the Venezuelan government or any agency or instrumentality … to secure payments under any agreement entered into between such entity and the Issuer …”
Like Lerrick's proposal, the Buchheit/Gulati proposal envisions that PDVSA bondholders will swap their bonds for new ones issued by the Republic. To encourage participation, they too want to turn PDVSA into an uninviting litigation target. But rather than strip away its assets, they propose that PDVSA grant the Republic a security interest in everything it owns. With the Republic assuming much of its debt, PDVSA will promise to repay whatever the Republic spends. (Whether it actually repays is another question, but of course failure to do so will make the arrangement look a bit of a sham.) The pledge of security will back that promise, while also creating a senior lien to effectively prevent holdout creditors from seizing PDVSA assets.
Arguably, not much distinguishes the Lerrick and Buchheit/Gulati proposals. Isn’t this asset stripping by another name? Well, perhaps not. By finding express contractual authority for their transaction, Lee and Mitu may mitigate the risk that the Republic will be treated as PDVSA’s alter ego. Moreover, the transaction bears at least some resemblance to an ordinary commercial loan.
On the other hand, if a court views PDVSA’s reimbursement obligation as a pretense, existing only to justify the lien, will it really allow the subordination of PDVSA’s bond creditors? More generally, if a court concludes that PDVSA is Venezuela’s alter ego, won’t it simply disregard the lien? Lee and Mitu recognize this risk and, to mitigate it, suggest that Venezuela should “promptly restore a degree of independence to PDVSA.” That seems like good advice, for all kinds of reasons. Like, for instance, creating a functional oil company. But when it comes to defeating the claims of PDVSA's current creditors, I worry that the horse is out of the barn.
PDVSA’s creditors argue, with some force, that Venezuela has used its control as shareholder (and regulator) to enrich itself at their expense. Examples include requiring massive contributions to social programs, orchestrating large debt-fueled dividend payments, and other shenanigans. If these acts are problematic, it isn’t clear to me that Venezuela can protect itself by reforming its relationship to PDVSA now. To be sure, the decision to disregard a corporation’s separate legal status is an equitable one. If Venezuela starts acting more like an ordinary shareholder, perhaps the equities will weigh less heavily in favor of imputing PDVSA’s liabilities to the Republic. This may be what Lee and Mitu have in mind, and I acknowledge that the argument has some force.
But it’s quite easy to see matters differently. Courts tend to disregard the corporate veil when a shareholder uses its control over the corporation to elevate itself in priority over corporate creditors. If you ask a creditor like Crystallex, that’s just what Venezuela has done. Indeed, the argument retains force even if a large majority of PDVSA bondholders participate in the swap envisioned by Lee and Mitu. Perhaps Venezuela’s abuse of the corporate form has left them with few better options. If that’s so, I don’t see why it should matter if Venezuela suddenly decides to straighten up and fly right.
Of course, I’m telling the story in the light most favorable to creditors; I don’t mean to prejudge the merits of the veil piercing arguments. The point is only that Lee and Mitu don’t fully engage with the risk that a court might view this transaction as a sham or might disregard the corporate partition separating PDVSA from Venezuela. I worry that the risk is a substantial one. The fact that they bury this discussion in a footnote (on p. 5) makes me wonder whether they feel the same way.
Enough about veil piercing and holdouts. But while I’m on a roll… One of the best features of the Lerrick and Buchheit/Gulati proposals is that they are simple, easy-to-explain solutions to an extraordinarily complex problem. That’s no faint praise. Any restructuring will require significant creditor buy-in, and creditors aren’t likely to buy in if they can barely understand the mechanics of what the government proposes. Complexity also works to the advantage of holdouts, who can exploit ambiguities in a lengthy, convoluted restructuring process.
Yet Venezuela has created such a mess that many questions remain unanswered. Here’s one of them: Rumor has it that many PDVSA bonds and promissory were issued with principal amounts that were … a bit on the high side? The so-called Hunger Bonds are an example, but there are reportedly others. In any event, the principal purportedly due at maturity bears little relation to the amount actually paid at issue. It’s reasonable to suppose a number of these wound up in the hands of likely holdouts. What will happen to these bonds? If ever there were an argument for treating sovereign debt as illegitimate, or for disallowing claims for the difference between the face value and the issue price, it applies here. But it’s an open question whether courts applying New York law will recognize the difference between these bonds and others issued under normal market conditions. Does it matter whether a new Venezuelan government is in place? Will creditors holding these bonds be treated differently in a restructuring? My sense is that many market participants are ignoring questions like these for now, but that they may become more important when restructuring negotiations begin in earnest.
The US Trustee's office just prevailed in a sanctions case against a law firm with a most creative fee scam. To oversimplify (and leave out certain other issues of bad behavior), the law firm steered debtors who owned cars in which they had zero equity into an arrangement in which the debtor's car would be towed for an (unpaid) fee by an affiliated firm and then stored in Indiana. The existing auto lender would never be notified of any of this. The affiliate would then assert a warehouseman's lien for the unpaid fee and foreclose on the car, and use the sale proceeds to pay back the fee and pay the debtor's bankruptcy filing fee to the law firm, with the auto lender getting nothing.
Now you might be wondering how this is possibly an acceptable foreclosure sale distribution. The problem, it seems, is not that the warehouseman's lien primed the auto lender's lien. It turns out that the choice of Indiana might not be coincidental. UCC 9-333 says that a possessory lien has priority over other security interests unless "the lien is created by a statute that expressly provides otherwise." The UCC has a warehouseman's lien provision, UCC 7-209, but that provision expressly states that the warehouseman's possessory lien is normally subordinate to existing liens. So if the lien were under UCC 7-209, then existing auto lender's lien would ride through the foreclosure and the existing auto lender would still be able to foreclose on the car (if it could locate it).
But Indiana has another warehouseman's lien statute (actually two of them, at least): one for warehousemen, and one for the towing and storage of motor vehicles. I assume the latter is the applicable statute as it is more specific, but it doesn't really matter as neither of them provides that the lien is subordinate to an existing security interest. (The same would be true if there were a common law lien.) So I think the effect of the foreclosure sale was to wipe out the auto lender's subordinate lien.
The matter doesn't end there, however. Even though the junior lien gets wiped out in the foreclosure sale, it should still be entitled to share in the distribution if there are more funds than necessary to repay the senior (warehouseman's) lien. Or at least I think, as that's the way it works everywhere, but I haven't been able to find the relevant Indiana foreclosure sale distribution statute. In other words, the problem isn't so much that the scam stripped the existing auto lender of its lien (although there are certainly some equitable argument to be made there), but that the excess funds from the foreclosure sale went to pay the law firm for the bankruptcy fees, rather than to the auto lender.
All told, it's a scam that only a secured credit nerd could love. Makes me think that some lawyers were paying very close attention in their secured credit class, but missed the ethics discussion.
The CFPB is out with its Strategic Plan for FY 2018-2022, also known (without any apparent irony) as The Five Year Plan. Lots to chew on in this doozy, starting with this:
If there is one way to summarize the strategic changes occurring at the Bureau, it is this: we have committed to fulfill the Bureau’s statutory responsibilities, but go no further. Indeed, this should be an ironclad promise for any federal agency; pushing the envelope in pursuit of other objectives ignores the will of the American people, as established in law by their representatives in Congress and the White House. Pushing the envelope also risks trampling upon the liberties of our citizens, or interfering with the sovereignty or autonomy of the states or Indian tribes.
I've written about envelope pushing and Mick-Mulvaney-Think previously, but there's two new things here. First there's the claim that going beyond the Bureau's statutory responsibilities violates the will of Congress. (Note the unusual addition of "the White House" to the formulation.) Narrowly that's uncontroversial, but the way Mulvaney-Think approaches the Bureau's statutory responsibilities, if there isn't a statutory clearly and directly prohibiting something, then there's no prohibition. Standards-based regulation is gone, even if that is exactly what Congress (and the White House when the bill was signed into law) demanded.
Second, there is a curious solicitousness for the rights of states and Indian tribes. The CFPB has never previously been accused of trampling the rights of states, but the inclusion of states is all the more confusing given the Bureau's newfound commitment to protecting the sovereignty of Indian tribes. The only relevance of Indian tribes to the CFPB is that a few of them partner with "fintechs" in rent-a-tribe schemes to avoid state regulation, particularly state usury laws. It would seem that upholding state sovereignty and rights would require cracking down on rent-a-tribe schemes; the idea that a tribe has immunity for commercial activities extending outside of tribal lands is clearly wrong--were it so all of federal law could be subverted. It looks like someone forgot to remove the "states rights" talking point from the usual GOP talking points deck because someone didn't realize that it conflicts with the new tribal rights talking point. Oops.
But let's turn the the actual plan itself, not just the opening rhetoric. I'm only going to focus here on item number 1: more financial education. This might qualify as Worst. Consumer. Protection. Idea. Ever.
Now wait, Levitin, what are you possibly talking about? You're going to write a screed against "education"? Isn't that an admission against interest from a professor? Who could possibly oppose eduction? And anyhow, didn't Congress, in its in its deep and infinite wisdom required that the CFPB have a financial education mission and mandate a Consumer Education and Engagement Office in the Bureau?
I've got nothing against education generally. But regulators should pursue strategies that are calibrated to the problems that actual exist in the markets they regulate and likely to fix those problems. Viewed this way, financial education is largely worthless for most (but not all) consumer finance issues. In most cases it's going to be as helpful as one of Gwyneth Paltrow's coffee enemas (a/k/a 21st century Carbolic Smoke Balls). Here's why:
First, financial literacy only matters when there is a possibility of consumer choice in a market. That's not the case with several key consumer financial product markets: debt collection, loan servicing, and credit reporting. The consumer doesn't pick the service provider in these markets. Critically these are the markets with the most consumer complaints filed with the CFPB. So
Second, given the poor state of American numeracy, the idea that we're going to achieve financial literacy of any material sort is silly. When folks can't do simply arithmetic operations, it doesn't matter much if they understand theoretically what compound interest means.
Third, some things are in fact complicated and hard, so that even very numerate, very financially literate folk don't intuitively understand them. Try amortization schedules: can you explain the Rule of 78s? Do you really think that you can teach people to understand it readily? (And yes, it still applies to some auto loan transactions.) I've taken classes of very bright first year law students through credit cardholder agreements and asked them to explain what the agreements mean. They can't. That should given anyone who preaches financial literacy and education some pause.
Fourth, even if consumers were financially literate, they regularly encounter transactional settings that discourage careful consideration of options. Examples here are when the consumer is told the terms of the deal over the phone or when the consumer goes to a car deal and is given the hard sell in the F&I office after having sunk a few hours into picking a car, negotiating a price and a trade in, etc. Likewise, for a small dollar transaction, how much time is a consumer rationally going to sink into evaluating and comparing options?
Fifth, businesses have incentives to interfere with consumer understanding--if the consumer perceives a price as being lower than it is, the consumer will overconsume, which is what the business wants--more sales. Don't think businesses do this? Look at the CFPB's own complaints. CFPB & FDIC entered into a consent order with Discover Bank that alleged, among other things, that Discover sales reps started speaking real fast when it came time to disclose material terms. That's a pretty crass way of doing things, but it doesn't seem so different than using fine print or a hard-to-read font or burying information in long, prolix disclosures.
Sixth, literacy doesn't help with fraud or deception. Nor does it help when a financial institution doesn't act in good faith once a deal has been made. Those are the situations that UDAAP is supposed to police. Those are what virtually every CFPB enforcement action has been about. Yet that seems to be precisely what Mick Mulvaney says the CFPB won't be doing--UDAAP actions are entirely discretionary--the CFPB isn't required to bring any UDAAP enforcement actions or undertake any UDAAP rule makings, and "unfair, "deceptive," and "abusive" are, to some degree, in the eye of the beholder. The Mick Mulvaney-administered CFPB seems to have a declared policy of extreme myopia--see no evil, hear no evil, but a healthy does of financial literacy enemas.
Obviously there are some places where some greater financial literacy helps. It helps for a consumer to understand the risks inherent with particular products. What happens if I can't refinance this mortgage when the rate resets? What happens if I co-sign a loan and the other co-signor dies? Etc. But I don't think this is what the CFPB means in terms of financial literacy.
Still, let me end with a positive recommendation. If the CFPB wants to do one simple thing that will help American consumers, it will engage in a very proactive advertising campaign to let people know that they should get pre-approved for a car loan before going to look for a car at a dealership. If you go into the dealership without an alternative offer, you've just walked into a monopoly market, where the dealer is not incentivized to find you the cheapest loan term. Some folks are smart enough to get offers from third-party lenders before they go shopping for a car. Everyone should or at least everyone should know that they should. If the CFPB takes financial literacy and education seriously, this is a very concrete, easy step to take.
Golden Valley Lending, Inc. is a payday lender that charges 900% interest on consumer loans sold over the internet. Golden Valley relies on the dubious legal dodge of setting up shop on an Indian reservation and electing tribal law in its contracts to evade state usury laws. In April 2017 the Consumer Financial Protection Bureau filed an enforcement action asserting that Golden Valley and three other lenders were engaged in unfair debt collection practices because they violated state usury laws, and also failed to disclose the effective interest rates, violating the federal Truth in Lending law (enacted in 1969).
A few days ago, Mark and I put up a post on the possibilities of using Chapter 15 bankruptcy for Venezuela's state-owned company, PDVSA. In response, we received a number of terrific comments, both via email and in the comments section.
One of the particularly interesting points that was made to us (both in email and in one of the comments), that we had not raised was the following:
PDVSA is not just a Venezuelan company; it is the Venezuelan company -- the company responsible for generating 95% of the foreign currency earnings of the entire country. Placing the fate of PDVSA into the hands of a bankruptcy judge poses an existential risk to the economy and to the government as the sole owner of the company unless, of course, the government can control the outcome of the insolvency proceeding. But insolvency proceedings in which the equity owner of the bankrupt enterprise can control the outcome are not proceedings likely to be recognized or enforced by foreign courts.
Catch Veinte Dos?
The foregoing also brings up a slightly different question that Bob Rasmussen asked when he was visiting us last week, which was whether the bankruptcy proceeding could be conducted in a manner such that the 100% equity holder (who would normally have to turn over control to the debt holders in an insolvency) could retain all or almost all of the equity. After all, it does seem clear that Venezuela is not going to accept giving up full control of PDVSA. Bob did have some very interesting thoughts as to how this might be done in a purely domestic context. The question that remained though was whether something similar could be engineered for the foreign state-owned company context that wasn't going to give up any control of the process. But more on this later
Donald Trump came into office promising, among other things, to “drain the swamp” and get rid of all that corruption. One year in, how are things looking in terms of swamp draining?
The following is based on work with my super co author, Stephen Choi, of NYU Law School.
To answer (at least partially) the question posed at the start, we have analyzed data on Securities and Exchange Commission (SEC) enforcement actions under the Foreign Corrupt Practices Act – the primary U.S. statute that gets at, among other things, bribes to influence foreign officials with payments or rewards.
We report data that compares SEC enforcement actions against U.S. public companies and subsidiaries of public companies under the FCPA from both the final year of the Obama administration and the first year of the Trump administration. We focus on U.S. public companies and subsidiaries of public companies because these are the larger economic actors that affect the economy. The Department of Justice also has authority to bring actions, but there were 0 actions brought by the DOJ against U.S. public companies and subsidiaries of public companies during the period we examined (although the DOJ has brought several actions against non-U.S. reporting issuers including a number of prominent foreign companies).
Figure I, we think, speaks for itself. On the graph, actions brought during the Trump months (from January 20, 2017 to January 31, 2018—roughly Trump’s first year) are in red, those during the Obama months (January 1, 2016 to January 19, 2017) are in blue. As compared to SEC enforcement activity under the Obama administration, the SEC under the Trump administration, appears to have taken a pause from FCPA swamp cleaning activities. For those who saw our report on partial year information (up to the end of September 2017) here, some months ago – the story has only become clearer with the passage of more time).
The data is from the Securities Enforcement Empirical Database (SEED),a collaboration between NYU and Cornerstone Research. It tracks SEC FCPA actions from January 1, 2016 to January 31, 2018. SEED defines a public company as a company with stock that trades on the NYSE, NYSE MKT LLC, NASDAQ, or NYSE Arca stock exchanges at the start date of the SEC enforcement action.
There, of course, are caveats as to what else might be going on.
First, maybe the comparison of the final year of the Obama administration to the first year of Trump’s administration is not the right one. Maybe administrations take some time to get their ducks in order before they can begin swamp cleaning, and we should compare the first years of each. Figure II, therefore, reports year 1 for Obama (January 20, 2009 to January 31, 2010) to compare with Trump’s first year (January 20, 2017 to January 31, 2018). We obtain data on FCPA enforcement against public companies and subsidiaries of public companies from the SEC’s website. We find basically the same story. There were 10 SEC enforcement actions against public companies or subsidiaries of public companies in the first year of the Obama administration, five times the number in the first year of the Trump administration.
Second, maybe the sloth during the Trump years is really the fault of the Democrats, who have been slowing down the nominations of key Trump swamp cleaning officials. There certainly are indications that filling positions has been slow. The Commission at the SEC only achieved the full complement of five Commissioners on January 11, 2018. The question though is why. Is it because the Democrats have thrown up too many road blocks or because the Trump administration has different priorities? After all, the Trump administration seems to be getting nominations through at a remarkable pace where it wants them. In particular, check out the federal judiciary where Trump managed to appoint four times as many federal appeals court judges in his first year as Obama did in his first year; see here. Maybe FCPA swamp cleaning is just an area that the Trump administration is not as committed to? We will need more data to answer this, and we plan to be collecting and reporting it. We note that Charles Cain was appointed by the SEC as head of the FCPA Unit in November 2017 (after serving as Acting Chief of the FCPA unit since April 2017). So perhaps the SEC’s FCPA enforcement numbers will pick up over the first half of 2018. We will see.
Third, maybe the SEC is focused on different areas of the swamp (domestic rather than foreign perhaps?). Best we can tell from other analysis of SEC enforcement activity though, the story of dramatically diminished enthusiasm for enforcement against public companies seems to be a general one (see here, here and here, for somewhat different perspectives).
Lastly, perhaps the SEC during the last year of the Obama administration was particularly zealous in its FCPA enforcement, clearing out many cases in the pipeline. And it will take some time for the SEC to develop new cases. One study found that the time from the initial disclosure of an informal SEC investigation to the conclusion of a SEC enforcement action can take 2 to 3 years. We don’t know how many active SEC investigations the Trump administration inherited so it’s hard to judge the pipeline argument. As time passes, however, into 2018, we think the pipeline argument becomes less plausible.
Twelve senators have just writtento Education Secretary Betsy DeVos questioning why the Education Department continues to award lucrative contracts to debt collection firms, and criticizing the seriously misaligned incentives embedded in those contracts.
While most federal student loan borrowers deal with loan servicing companies like PHEAA, Navient and Nelnet, defaulting borrowers in an unlucky but sizeable minority (roughly 6.5 million) have their loans assigned to debt collectors like Collecto, Inc., Pioneer Credit Recovery, and Immediate Credit Recovery Inc. Borrowers assigned to collection firms immediately face collection fees of 25% added on to their outstanding debt. The collection firms harvest hundreds of millions of dollars in fees, mostly from federal wage garnishments, tax refund intercepts, and new consolidation loans borrowers take out to pay off old defaulted loans. Wage garnishments and tax refund intercepts are simply involuntary forms of income-based repayment, programs that could be administered by servicers without adding massive collection fees to student debt. Similarly, guiding defaulted borrowers to consolidation loans, and putting them into income-driven repayment plans, are services that servicing contractors can and do provide, at much lower cost. In short, the debt collector contracts are bad deals for student loan borrowers and bad deals for taxpayers.
This past week, Bob Rasmussen of USC Law gave a talk at Duke on “Puerto Rico and the Netherworld of Sovereign Debt Restructuring.” Luckily for us, he also took a detour to UNC to talk to our International Debt students about whether PDVSA might use Chapter 15 of the Bankruptcy Code to restructure its debts. Our foil for that discussion was a recent paper by Rich Cooper (Cleary Gottlieb) and Mark Walker (Millstein & Co.) proposing Chapter 15 as a possible solution to PDVSA’s woes. This is one of a number of extant restructuring proposals for Venezuela and PDVSA; Lee Buchheit (working with Mitu) has published several others (here, here, and here). The Cooper and Walker proposal is the only one to explore the Chapter 15 possibility in detail, and it thoughtfully makes the case for that restructuring option. In very condensed form, the proposal is for Venezuela to pass a new bankruptcy law governing PDVSA and other public sector entities, for PDVSA to restructure its debts using that process, and then for PDVSA to ask courts in the U.S. to recognize that bankruptcy under Chapter 15.
One way to frame an analysis of this proposal is to ask what Chapter 15 offers that other restructuring tools—like Exit Consents—do not. Cooper and Walker detail a number of advantages, but it seems to us that the key ones are a stay of litigation by creditors and the ability to bind dissenting creditors (including non-bond creditors). We suspect it would be fairly easy for PDVSA to obtain a temporary stay of creditor litigation, as courts have discretion to stay creditor enforcement actions while working out preliminary matters in a Chapter 15 case. But a relatively short stay, while valuable, probably isn’t worth enough to justify the effort of enacting a new bankruptcy law. For a longer stay, and to give effect to a plan of reorganization, PDVSA would have to satisfy the eligibility criteria for Chapter 15, and the Venezuelan bankruptcy law would have to earn “recognition.”
In our Chapter 15 session with Bob, several fundamental questions surfaced, only one of which is squarely addressed by the Cooper and Walker proposal. One question has to do with political feasibility. To pass muster under Chapter 15, Venezuela’s new bankruptcy law will have to be administered by a credibly independent institution in that country. PDVSA will also have to submit to a certain amount of oversight by bankruptcy courts in the U.S. and elsewhere. It isn’t clear to us that any Venezuelan government—and certainly not the present one—will accept these costs. Cooper and Walker allude to this, and they seem to envision a new government implementing the plan. At least in the near term, however, it seems a major barrier.
A second question, which they do discuss at length, concerns PDVSA’s eligibility for Chapter 15 relief. PDVSA can’t reorganize under Chapter 11, because an instrumentality of a foreign government is not a “debtor” eligible to use that Chapter. A relatively recent case from the Second Circuit (In re Barnet, 737 F.3d 238) implies that the definitions in Chapter 11 might control eligibility in Chapter 15 as well, but Cooper and Walker lay out the counter-arguments in some detail.
Viewed purely as a question of statutory interpretation, the eligibility question might be a toss-up. But we do wonder whether U.S. courts will be disinclined to accept PDVSA’s arguments. That’s true on eligibility, but especially on questions of recognition. It’s one thing for a US bankruptcy court to recognize a well-established foreign bankruptcy regime, even one that departs in some ways from U.S. practice. But a brand new bankruptcy regime, with no track record at all (much less a track record of independence), enacted to benefit an entity not eligible to reorganize using U.S. bankruptcy law? That’s a big ask. And what if the U.S. government opposes recognition, if only to protect U.S. bondholders from having restructuring terms imposed against their will? (Recall that PDVSA’s bonds give each bondholder the right to reject a proposed modification to payment terms.) We suspect a bankruptcy judge would take that opposition very seriously.
Recognizing these concerns, Cooper and Walker propose an alternative. This route is more complicated. The first step involves the use of Exit Consents (and Mitu loves Exit Consents!). PDVSA would secure the approval of a majority of bondholders to change the governing law of the bonds from New York law to English law. Then, PDVSA would seek to reorganize through a so-called “scheme of arrangement,” in which 75% of creditors can impose restructuring terms on dissenters. Finally, PDVSA could seek recognition of this proceeding in the U.S. But of course, the threshold question of eligibility remains. Moreover, the use of Exit Consents will trigger scrutiny, both under New York and English law. PDVSA would have to explain how it can permissibly use this technique to accomplish the very thing it promised not to do in the bonds: impair a holder’s right to receive payment and to bring suit to enforce that right.
We have gone on long enough. The short version of our critique is simply that the Walker and Cooper proposal leaves us wanting more. It’s a provocative proposal by two extremely experienced restructuring professionals. But we remain skeptical that Venezuela can use such maneuvers to effectively cramdown bondholders. And while the issues are somewhat different, we are left with similar questions about other creditors, like those pursuing alter ego claims against PDVSA based on expropriation by Venezuela.
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