Washington Mutual Decision Offers Key Lessons on Treatment of Confidential Information

Since Judge Walrath issued in September 2011 her now (in)famous decision in the Washington Mutual chapter 11 cases pending in the US Bankruptcy Court for the District of Delaware, much has been written about the current and potential impact of that decision.  Recent developments in that case have cast doubt on whether there will in fact be a significant long-term impact.  However, it remains clear that Judge Walrath’s decision does contain several key lessons with respect to treatment of confidential information that are well worth remembering, regardless of the fate of other aspects of that decision.

First, a brief note regarding the most recent developments in the WaMu case.  In December of 2011, the dissenting shareholders reached a settlement with the creditors allowing the Court to ultimately move forward with this (seventh!) plan of reorganization.  Then, last week, Judge Walrath confirmed the plan of reorganization, withdrawing a portion of her September ruling which granted equity holders the opportunity to pursue claims against certain major noteholders (which happened to be four large hedge funds which specialize in distressed debt investing) (the “Funds”) on the theory of insider trading.

Now, a look at the September 2011 decision.  The (rather complicated) facts which gave rise to Judge Walrath’s September decision are, very briefly, as follows.  WaMu and JP Morgan Chase (“JMP”) were engaged in on-going settlement discussions regarding the ownership of certain $4 billion held by JPM.  These settlement discussions took place over the course of some 12 months.  The Funds were directly involved in many of the discussions, and, periodically, were subject to confidentiality agreements in connection with these discussions, which restricted the Funds’ trading activities with respect to the Debtor’s securities (unless appropriate ethical walls were established).  The Funds’ understanding was that, upon the expiration of each such period of restriction, the Debtor would publicly disclose all material information, thereby allowing the Funds to become unrestricted and continue their trading activities.

In practice, however, the Debtor, upon at least two occasions when settlement talks with JPM broke down, did not release to the public either the fact that such settlement discussions had taken place or any details of those discussions to which the Funds had been privy.  On the other hand, several of the Funds (who had not established any ethical walls) resumed their trading activities, on at least two such separate occasions, with the understanding that (a) the applicable confidentiality agreements had expired and (b) the material information regarding the settlement discussions had been disclosed to the public by the Debtor.

Based on these facts, Judge Walrath found that there were sufficient allegations that the Funds (which did not restrict their trading) may have traded on the basis of material non-public information in violation of applicable securities laws to warrant further discovery.  The Court further ruled that the little-known remedy of equitable disallowance could be imposed to disallow the claims of the Funds if the facts supporting insider trading claims were established (vs. equitable subordination, which the Court ruled was not available as a remedy).  The Court also specifically rejected the Funds’ contention that, having strict internal policies prohibiting insider trading, the Funds acted in reliance on JPM’s obligation under the confidentiality agreements to disclose the material non-public information at the conclusion of each of the confidentiality periods.

What, then, given the recent confirmation of the Chapter 11 plan, and Judge Walrath’s withdrawal of the insider trading aspect of her September 2011 decision, are the lessons of this case?  There are certain notable aspects of Judge Walrath’s rulings with respect to bankruptcy law which may arguably have some lasting effect in bankruptcy proceedings (or, at least, academic interest) (such as her ruling regarding the availability of equitable disallowance or that the Funds may have owed a duty to other members of the two classes of the Debtor’s debt structure in which the Funds held blocking positions).  However, the indisputable lessons of this case pertain to the treatment and use of confidential information and the administration of confidentiality agreements and the attendant obligations.  In particular, the WaMu case reminds us that

  1. Having policies in place is necessary but not sufficient – the key is in the implementation of those policies. Whether the answer is to have ethical walls to prevent the confidential information from reaching the traders (which, admittedly, is practicable for only the largest organizations) or to restrict all trading activity pertaining to a particular name, the policy on appropriate use of confidential (i.e., non-public) information must be vigilantly enforced.
  2. When acting on the basis of (or just with the knowledge of) confidential (read “inside”) information, one takes the risk of that information being material in the eyes of the SEC or a court.  Here, the Funds were apparently of the opinion that the information regarding the ongoing settlement discussions with JPM was not material to the Debtor / plan of reorganization.  Judge Walrath found otherwise.
  3. It is a fine idea to provide in an NDA that, on the expiration or termination of the NDA, the disclosing party will make public the confidential information provided, thereby “cleansing” the recipient and enabling the recipient to trade the relevant securities.  However, just having that contractual right (or even obligation on the part of the disclosing party) is not necessarily sufficient. The recipient must then confirm that the relevant confidential (or inside / non-public) information has actually been made public by the disclosing party prior to placing any trades.  Indeed, contractually, the recipient may additionally want to obtain the right to disclose publicly the relevant information in the event that the disclosing party fails to do so in a timely fashion or, as seems to have been the case in WaMu, there is a difference of opinion as to what portion of the confidential / non-public information should be made public.

Beyond Confidentiality: the private equity bidders’ experience with Yahoo!

A lesson from the recently reported Yahoo! sale process: carefully review and negotiate your NDAs!  As Yahoo! illustrates, confidentiality agreements can reach well beyond mere confidentiality and can affect not only the process but the potential outcome of a sale.

Confidentiality agreements, as we all know, are the life blood of private equity and, generally, M&A transactions.  In a typical NDA, the recipient agrees to keep information confidential and to limit its use to the transaction under consideration.  However, not infrequently, the disclosing party will include additional restrictions on the recipient which go well beyond confidentiality.  Common examples include non-circumvention (e.g., with respect to a particular target or subject), non-solicitation of employees, and no contact with the acquisition target (or borrower, if the transaction involves debt) as well as its customers, suppliers, vendors, etc.

These restrictive provisions are designed to protect the legitimate business interests of the target company by preventing, for instance, damaging rumors and employee and customer defections.  They may also serve to protect the interests of the broker or introducing party with respect to a particular opportunity. Occasionally, however, the disclosing party may seek to include in the NDA a provision which is primarily designed to influence the sale process.  As has been widely reported, Yahoo! included just such a provision—no “cross talk” as it has been described—into the NDAs circulated to potential private equity bidders.  

As reported, this no cross-talk provision precludes the potential bidders from speaking to each other regarding the potential transaction (presumably, whether or not confidential information is disclosed in the course of such conversations).  What is Yahoo!’s possible motivation for including such a provision in the NDA?  It is, almost certainly, a business consideration – the desire to influence the bidding process and, indeed, the likely outcome of the sale.  Given Yahoo!’s market capitalization of $20 billion, if the bidders are not able to discuss potential co-investment agreements, it makes it much less likely that any private equity bidder would be able to make an offer for 100% of the equity.  Not surprisingly, many potential private equity bidders balked at this restriction.  The one private equity sponsor who has reportedly agreed to this restriction in the NDA is TPG Capital which, as reported, is specifically interested in a minority stake.

From our perspective, as buy-side counsel, we strongly encourage our private equity and hedge fund clients to review and negotiate all NDAs, whether in M&A, private equity, distressed debt, real estate or other contexts.  As this case amply illustrates, the restrictions contained in many confidentiality agreements go well beyond confidentiality and may significantly impact one’s ability to evaluate and consummate a potential transaction (and, indeed, influence what kind of transaction or bidder is likely to succeed).