Small Investor Smacks Down Crony Capitalists for $3.3 Billion

Crony capitalism is when businesses form shady relationships with government officials to gain benefits through favoritism in areas such as contracting, government grants, tax breaks, or even legal rulings. Most Americans are concerned there has been a frightening expansion of this activity over the last number of years. Perhaps the most despicable form of crony capitalism has been on display in U.S. Bankruptcy Courts; where rich and powerful “vulture capital” hedge funds and their high end law firms have been able strip assets in numerous bankruptcies at the expense of minor creditors. Nate Thoma, acting as his own lawyer, fought for and won in Delaware against the vultures what could turn out to be a $3.3 billion judgment and may send some of the richest Americans who manage these hedge funds to long prison terms.



In the $327.9 billion Washington Mutual (WaMu) bankruptcy; there was $33 billion in assets and $8 billion debt after the busted bank was sold to J.P. Morgan. When WaMu filed for bankruptcy the vulture capitalist hedge funds of Appaloosa Management, Aurelius Capital, Centerbridge Partners, and Owl Creek Asset Management used their size and crony buddy-buddy knowledge of the Courts to quickly buy up depressed securities. These vultures used the size of their purchases of the distressed debt of WaMu to qualify to serve on the creditor’s committee to supposedly represent all large and small creditors.

Once on the committee, the vultures learned extremely valuable inside information about tax and litigation recoveries and settlement talks that would increase the recoveries to creditors of the bankruptcy estate. But instead of performing their fiduciary duty to represent all creditors of WaMu; the vultures used this top-secret information to trade WaMu stocks and bonds and negotiate terms for the reorganization that would generously line their pockets.

Unlike U.S. money managers that are required to report their investment activities to the SEC; hedge funds are usually set up off-shore on tax haven islands to shield disclosure of their activities. But in December 2008 a scandal broke that the Bernie Madoff hedge fund had bilked investors through a Ponzi scheme out of $64.8 billion. On March 12, 2009, Madoff was sentenced to 150 years in prison and required to pay restitution of $170 billion. In an ode to the crony capitalism’s power to corrupt, Bernard Madoff sat on the Board of Directors of the Securities Industry Association and his beautiful niece, Shana Madoff, married an SEC compliance official after a 2005 investigation gave the Madoff firm a clean bill-of-health.

Humiliated by charges of crony capitalism in Madoff; the FBI and SEC have been cracking down hard on hedge funds violation of securities laws. The $7 billion Galleon Group was raided by the FBI and SEC in 2009 and its billionaire founder, Raj Rajaratnam, was later found guilty of insider trading and his prosecutors have asked that he be imprisoned for 19 1/2 to 24 1/2 years. Over twenty-one other people have been arrested in the sprawling probe of Galleon and over twenty have pleaded guilty. Last year FBI agents made numerous raids on hedge fund offices; including Level Global Investors LP, Diamondback Capital Management LLC and Loch Capital Management LLC.

As a small dollar creditor in a bankruptcy, Nate Thoma could not afford the attorney cost to take on the legal fire-power of the billionaire vulture capitalist in bankruptcy proceedings. So Mr. Thoma represent himself as a Pro Se party and directly petition the Court that the vultures committed fraud when they traded on inside-information while sitting on the committee.

In a first ever event, Delaware Bankruptcy Judge Mary Walrath found “colorable claims” and ruled that a “claim for equitable disallowance” had been established based on violations of insider-trading rules that could strip up to $3.3 billion from the vultures. Judge Walrath stated:

“Based on the evidence presented thus far it appears that the (settlement) negotiations may have shifted towards the material end of the spectrum and that the settlement noteholders traded on that information which was not known to the public. Consequently, the court finds that the equity committee has stated a colorable claim that the (hedge funds) received material nonpublic information.”

The judge said she couldn’t discern a pattern in the hedge funds’ trading, but found that the equity committee “has made sufficient allegations and presented enough evidence to state a colorable claim that the (hedge funds) acted recklessly in their use of material nonpublic information.”

Nate Thoma never intended to be a hero to small creditors; he is just a regular guy who felt he had been cheated by powerful crony capitalists that with a wink, a nod, and a platoon of lawyers can lie, cheat and steal their way to further riches. The real hero in this story is Judge Mary Walruth; who has re-established that crony favoritism has no place in the halls of justice.

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