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The bankruptcy reform bill that passed the Senate earlier this month would not only restructure the federal bankruptcy code, but also significantly shift the landscape for advisers involved in corporate bankruptcies. The legislation would repeal an existing provision that prohibits investment banks from advising a company in bankruptcy if that company had been an underwriting client within three years of its Chapter 11 filing — something that affected mostly Wall Street firms. The restrictions on investment banks have existed in the code since 1938. The change “will presage the end of Western civilization as we know it,” groused Jeffrey Werbalowsky, senior managing director at Houlihan Lokey Howard & Zukin, who opposes the repeal. “In a world that is more and more conflict conscious, this goes the other way.” Wall Street investment banks such as CIBC, Citigroup Inc., Credit Suisse First Boston, Lehman Brothers Inc., Merrill Lynch & Co., Morgan Stanley and UBS Investment Bank do serve as bankruptcy advisers, but they are largely “conflicted” out of such lucrative fee-generating work because of the three-year time frame. The House must still vote on the bill. Investment banks say that finding a client they can represent requires onerous work, including looking at all of the firm’s entities and those of the prospective bankrupt client. The investment banks must also examine all their outstanding securities and their selling syndicates to make sure there are no conflicts. The conflict-of-interest rule is part of the bankruptcy code’s disinterestedness test that mandates a professional in a bankruptcy must not have an interest materially adverse to the interest of the estate. In particular, the rule pays special attention to Wall Street investment bankers, saying a disinterested person can’t be a creditor, equity holder, insider or investment banker for any outstanding security of the debtor in the three years before a bankruptcy petition. Nor is anyone who’s been a director, officer or employee of the company within two years of the bankruptcy petition considered to be disinterested. The bill in no way changes the disinterestedness test, asserts the Securities Industry Association, an industry trade group. Instead, the bill “will put investment banks on a level playing field with accountants, attorneys and management consultants,” Richard Hunt, SIA senior vice president for federal policy, said in a statement. “This change will broaden the pool of eligible candidates, thereby increasing competition and lowering the cost of advisory services.” Furthermore, a bankruptcy judge still has the authority to determine a certain investment bank may not be an appropriate choice to act as an adviser, the SIA said. Yet restructuring advisory firms such as Blackstone Group, Gordian Group, Houlihan Lokey Howard & Zukin, Lazard and Rothschild have been up in arms about the change. Sen. Paul S. Sarbanes and Patrick J. Leahy, the highest-ranking Democrats on the Senate Banking and Judiciary committees, respectively, have joined them. The two lawmakers offered an amendment to restore the legislation back to the existing language. Securities and Exchange Commission Chairman William H. Donaldson, a Bush appointee, supported the amendment, which was defeated on the Senate floor. “The big firms have never been precluded from providing financial advisory services to companies in bankruptcy,” said Peter Kaufman, head of restructuring and distressed M&A at Gordian Group, and co-chair of the American Bankruptcy Institute’s committee on investment banking. “It’s a sad day for anyone interested in reducing rather than increasing the potential for egregious conflicts of interest,” Kaufman said. “This is the worst public policy decision with respect to corporate governance that I have ever seen.” Said Werbalowsky: “It is unclear to me if this will materially change our business as we know it, but time will tell.” The Senate voted overwhelmingly in favor of a bankruptcy reform bill, with all Republicans, plus 18 Democrats and one independent, voting for the bill. President Bush has said he would sign it. Copyright �2005 TDD, LLC. All rights reserved.

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