If there was any hope that some on Wall Street had turned a corner and was going to start acting more ethically and fair, it was dashed last night as a motion was granted to have a hearing at 3pm on Friday June 12th in Delaware about a proposed IPO of Hertz (HTZ) stock to investors which would be managed by the investment bank Jefferies LLC.

My last post discussed the completely illogical run up in bankrupt Hertz shares as well as nearly bankrupt Chesapeake Energy (CHK) which were both beaten back down since then. You can now add Whiting Petroleum (WLL) and Nikola (NKLA which doesn’t expect revenue until 2022) to the list of insolvent or worthless companies that are seeing a rally. Hertz fell from as high as $5.61 on Monday to a close of $2.06 per share on Thursday but this is still up from the $0.56 the shares traded at on May 26. All this has confounded market watchers who don’t understand why worthless shares are all of the sudden seeing a rally driven by retail investors from apps like Robinhood.

This IPO is essentially a money grab by Hertz to transfer wealth from unlucky or unknowing retail investors to creditors. In a typical bankruptcy, the bankrupt company issues a debtor in possession (DIP) loan which is senior to all the existing debt. The pre-petition debt which is impaired, is partially or fully rolled into post petition equity which can then be sold on the open market after restructuring the company. The prior shares are canceled and end up worthless. This is of course, if the company is not completely liquidated and the assets are sold off for the creditors to get what they can. If the company does emerge from the bankruptcy in tact, then the new shares can be floated on the open market by the creditors to try and recoup their losses on the debt.

Hertz and Jefferies have decided that with the run up in the current shares gaining attention, they have a unique opportunity to try and raise cash via these worthless shares which are likely to be cancelled in the process of bankruptcy. Where would this money go? Initially it would go 2 places: the coffers of Hertz, which will use the money to satisfy its DIP loan as well as put it towards some of its existing debt, and it would go to the pockets of Jefferies, which is likely charging massive fees to the company since I doubt that many other firms would be willing to touch this type of filing.

The process can be lengthy and litigious. This creates a lot of uncertainty which drags down the value of the debt. In addition, many institutional investors are not allowed to hold bankrupt company debt so the value of the bonds tends to drop like a stone in bankruptcy. Currently, bonds due in October 2022 are trading at 35 cents on the dollar.

Source: Zero Hedge

Who Stands to Profit

Besides the obvious, that Jefferies and Hertz creditors stand to profit from this, it could provide a short term trade for those that have recently bought any bonds or loans of Hertz. Knowing that the debtor could suddenly have an influx of free cash to pay creditors with may bump up bond and loan prices and provide some opportunities for these buyers (likely hedge funds) to make a short term profit, especially if they don’t want to go through the bankruptcy process.

So if this goes through as planned, small retail investors who likely aren’t rich and likely don’t know anything about the process or how bankrupt companies operate, will end up transferring their wealth to a bunch of bankers, lawyers, accountants, consultants and hedge funds.

Short term speculators in these shares may stand to profit again on Friday as the word of this potential IPO leaked. Pre-market activity of Hertz has the shares up almost 35% at the open, Chesapeake is looking to open 19% higher.

Source: Yahoo

Could Jefferies Be Putting Itself at Risk?

There is a clear ethical issue here. If this motion is approved, Jefferies will be earning hefty fees from the IPO. They would then distribute the shares to unknowing or greater fool believing, retail investors that have piled into the stock recently. Hertz and the investment bank know that these shares will likely become worthless yet they are willing to do it anyway.

In a society where everyone is looking for a scapegoat rather than take any responsibility for their own actions, I could easily see a scenario where a group of investors falls victim to this swindle and ends up suing Hertz, Jefferies and Robinhood, should they let their investors buy the shares.

The likely defense they will try to invoke will be written in any prospectus and filings just like they are for any other IPO saying that “the common stock could eventually become worthless” except that in this case, they already are worthless and everyone knows it.

Don’t count on the management of Jefferies to step in and put ethics and the well being of small retail investors before greed. The newly Instagram loving CEO of Jefferies, Rich Handler, counts convicted fraudster Michael Milken as one of his mentors.

Source: Instagram

Who Could Prevent This

The SEC would be the obvious choice but it has become clear in recent years that they only choose to step in after the fact when the damage has already been done and even then, they likely don’t get any strong convictions that disuade this type of behavior.

It will likely come down to the decision of bankruptcy judge Mary Walrath who is set to decide in Wilmington Delaware today as to whether this sale can go through. Markets will definitely be keeping an eye on this to see how it plays out and whether this fluke in bankrupt share prices will lead to a real opportunity for Hertz and their creditors to swindle retail investors.

Update: The sale of the shares was approved by the bankruptcy judge. The train of thought is that “they’ve been warned” meaning investors have been told that the stock may become worthless so they would buy at their own risk. I will be curious to see how these funds actually get used in the process of the bankruptcy and who ends up holding the bag when shares are canceled.

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