Options Timing May Prove a Boon To Hedge Funds

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The tone of this Bloomberg story on how dozens of companies are finding that their options timing shenanigans are getting them in hot water with bondholders strikes us as a little bit one-sided. Here’s the lede, with emphasis added.

As soon as Vitesse Semiconductor Corp. said it was under investigation for securities law violations that may delay routine regulatory filings, the Camarillo, California, maker of computer chips also learned it was about to be held up for ransom in the bond market.
How Vitesse bonds and the debt of dozens of companies are being exploited by hedge funds, including Citadel Investment Group LLC, Whitebox Advisors LLC and Aristeia Capital LLC, is the story of fine print in prospectuses allowing creditors to demand immediate payment of principal when earnings reports are delayed.
At stake is as much as $36 billion of bonds that may be retired if the funds have their way, according to data compiled by Bloomberg. While no one expects that amount to be redeemed early, almost $200 million in premature payments may be made, says New York-based law firm Latham & Watkins LLP.

Briefly, here’s what seems to be happening. The companies are finding they cannot deliver financial statements on time due to questions about option timing. In a distant past they may have delivered the statements and then sought to restate them later rather than default on their bonds, but SOX requirements that the financials be certified by executives would put those executives on the line for the misstatements. So now its preferable to default than to file a timely if wrong statement.
Now this is no doubt annoying to the shareholders and managers of the companies involved. But the companies did sign on to the covenants agreeing that failure to file financial statements would amount to a default. And it’s not as if the Sarbanes Oxley requirements are new. If they wanted looser covenants, they could have sought to refinance.
Or they could have avoided playing around with the dates of their options grants.

Options Scam Lets Citadel, Hedge Funds Exploit Bonds
[Bloomberg]
Update: Paul Kedrosky has a very different take.
[Disclaimer: When John Carney was an attorney he often worked for banks and financial institutions which arranged bond issuances and most likely hold some of the bonds in question. He drafted and negotiated loan documents, including bond covenants, for clients. He worked at Latham & Watkins from 2004 to 2005.]

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