Hedge Funds Could Face Insider-Trading Lawsuit In WaMa Bankruptcy

Sep 15 2011 | 1:02pm ET

Four hedge funds may have to defend themselves against insider-trading charges after a federal judge for the second time blocked Washington Mutual's bankruptcy plan.

U.S. Bankruptcy Judge Mary Walrath in Wilmington, Del., found that the collapsed bank's shareholders had established a "colorable" case that the four hedge funds, known as the "settlement noteholders," had violated insider-trading laws during their involvement in WaMu's Chapter 11 plan negotiations. But, while ruling that the shareholders produced enough evidence that "the settlement noteholders knowingly traded with knowledge that the debtors were engaged in global settlement negotiations… of which the trading public was unaware" to sue the hedge funds, she blocked any immediate litigation, ordering the parties to mediation.

Walrath, who said she was concerned that "the case will devolve into a legal morass," did reject the shareholders' allegations that the hedge funds, Appaloosa Management, Aurelius Capital Management, Centerbridge Partners and Owl Creek Asset Management, controlled WaMu, meaning the Chapter 11 plan was negotiated in bad faith. Instead, she wrote that "the actions of the settlement noteholders appear to have helped increase the debtors' estates."

All four hedge funds have denied any wrongdoing.

Nor did Walrath reject the main points of the bankruptcy plan, although she ordered that senior debt holders would have to settle for a lower rate of interest.

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