Fraud Is as Fraud Does

Many of you read the Wall Street Journal article today on Adelphia's creditors. Its pretty good as a short context of the fight over the auction proceeds winds down. On one side are Arahova creditors (an operating company acquired by Adelphia pre-petition) and on the other side are the senior holdco creditors at Adelphia. The article briefly describes the intercompany claim which senior holdco creditors assert entitles them to be paid out first (essentially, they argue THEY are Arahova creditors to the tune of $1.9B). The article then says that Arahova noteholders assert the whole intercompany payable is a result of fraud (which everyone knows was pretty substantial at pre-petition Adelphia).

Here is what the article didn't say. Just before filing bankruptcy, Adelphia (the holding company) filed consolidated financial statements in their scheduled SEC disclosure. In this statement, Adelphia listed a $1.9B note receivable from Arahova. Just after this, they filed chapter 11. The receivable had no note, no explanation, no discussion in the MD&A section. Generally speaking, an almost $2B receivable gets a little mention somewhere in the company's statements. It was pretty clear to everyone then, as it is now, that receivable was bull. No one can point to anything which would justify the intercompany claim. Adelphia was likely cooking the books, as they did before, to make themselves appear to be a creditor to the operating companies where value still existed.

Recently though, the spread between senior holdco bonds at Adelphia and the Arahova notes has tightened. The market seems to be impressed with the defense holdco creditors are mounting, and feel a deal is in the works. This may be, I have no way of knowing for sure. However, as respecting the law, it seems clear to a lot of us that in a chapter 11 case where the financial statements prior to the petition were fraudulent, the party arguing for the veracity of those statements bears the burden of proof. If you unwind the transactions and tranfers between Arahova and the other Adelphia opcos at the time (this is a favorite point of those arguing the holdco creditor position) you have a hard time meeting this burden. In fact, it doesn't even pass the smell test. Markets need to know that when they see fraud, its going to stay fraud, absent proof to the contrary. Unless a silver bullet appears, I don't think the holdco creditors have much by way of proof. (note: if there was a silver bullet, it probably would have already appeared). If I had a few million to play with, I'd go long Arahova and short Adelphia holdco notes.