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Siding with banks, NY court rules loans are not securities

A district court on May 22 granted a motion to dismiss a controversial case against arranging banks including JPMorgan Chase & Co. and Citigroup Inc. for violating securities law in connection with a 2014 term loan transaction for Millennium Laboratories.

Millennium was a San Diego-based provider of diagnostic testing of urine samples for physicians. As its 2014 term loan was being arranged, Millennium was under investigation by the U.S. Justice Department for physicians' over-billing Medicare, Medicaid and other federal healthcare programs for their testing services and providing compensation to physicians in return. In May 2015, Millennium disclosed that it had agreed in principle to a $256 million global settlement with the Justice Department, and by Nov. 10, 2015, Millennium defaulted on its recently arranged term loan and filed a bankruptcy petition.

The plaintiffs in the case, Kirschner vs. JPMorgan Chase Bank et al., are term lenders to Millennium, which have alleged that arranging banks "are liable for negligent misrepresentation and securities law violations ... [and] abandoned their obligations to perform due diligence concerning (1) Millennium’s exposure to liability, damages, and penalties in connection with the DOJ investigation; and (2) the artificial inflation of Millennium’s financial results stemming from the company’s unlawful sales and marketing practices."

The arranging banks filed a motion to dismiss on the basis that syndicated term loans are not securities, and thus securities law would not apply.

On May 22, Judge Paul Gardephe of the Southern District of New York agreed with the banks. Most importantly, the court ruled that the minimum participation threshold of $1 million referred to a small subset of sophisticated investors and that even though hundreds of investment managers were solicited to participate in the loan, that constituted "a relatively small number compared to the general public."

The ruling is a victory for many in the loan market who wanted to protect the asset class from the typical disclosures that securities issuers are required to furnish to potential investors. The reclassification also would have complicated U.S. banks' abilities to hold CLO assets on balance sheet and remain in compliance with the Volcker rule.

"The ruling is a victory for the flow of capital to American businesses," said Elliot Ganz, general counsel and chief of staff for the Loan Syndications and Trading Association. "Declaring syndicated term loans to be securities would have upended the expectations of borrowers and lenders and wreaked havoc in the large, and vitally important, market for those loans. We are pleased that Judge Gardephe declined to go down this path."

The plaintiffs in Kirschner have the right to appeal the dismissal of the securities claims to the Second Circuit Court of Appeals.

This article was written by Alexander Saeedy, who covers CLOs and leveraged finance for LCD.

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