FINANCIAL 

COMPANY 

BANKRUPTCIES

Need to Further 

Consider Proposals' 

Impact on Systemic 

Risk

Report to Congressional Committees

July 2013

GAO-13-622

United States Government Accountability Office
United States Government Accountability Office

Highlights of GAO-13-622, a report to 

congressional committees

July 2013

FINANCIAL COMPANY BANKRUPTCIES

Need to Further Consider Proposals’ Impact on 

Systemic Risk 

Why GAO Did This Study

The Dodd-Frank Wall Street Reform 

and Consumer Protection Act (DoddFrank Act) mandates that GAO report 

on an ongoing basis on ways to make 

the Code more effective in resolving 

certain failed financial companies. This 

report examines advantages and 

disadvantages of certain proposals, 

based on those identified in GAO’s first 

report, to revise the Code for financial 

company bankruptcies—specifically, 

proposals (1) to change the role of 

financial regulators in the bankruptcy 

process; (2) affecting funding of 

financial company bankruptcies; and 

(3) to change the safe-harbor 

treatment of QFCs. For this report, 

GAO held two expert roundtables in 

which participants evaluated the 

proposals using criteria for orderly and 

effective bankruptcies that GAO 

developed in earlier reports. The 

criteria are minimizing systemic risk, 

avoiding asset fire sales, ensuring due 

process, maximizing value, and limiting 

taxpayer liability. GAO identified these 

criteria by reviewing literature and 

interviewing government officials, 

industry representatives, and legal and 

academic experts. 

What GAO Recommends

FSOC should consider the implications 

for U.S. financial stability of changing 

the role of regulators and the treatment 

of QFCs in financial company 

bankruptcies. FSOC agreed that a 

disorderly financial company 

bankruptcy could pose risks to financial 

stability, but stated that it would be 

premature for FSOC to consider 

proposals to change the Code. GAO 

reiterated that its recommendation was 

consistent with FSOC’s statutory role 

and responsibilities. 

What GAO Found

Because the Bankruptcy Code (Code) does not specifically address issues of 

systemic risk, experts have proposed giving financial regulators a greater role in 

financial company bankruptcies. However, according to experts at a GAO 

roundtable, such proposals may have limited impact and raise certain 

implementation issues. For example, a proposal to require notification before 

bankruptcy depends on when (number of days) notification would be required 

and with whom (which regulators). Experts noted financial companies may not 

know that they will declare bankruptcy even a few days before the event and 

could have many regulators to notify. Experts also noted ways regulators already 

can compel financial companies to declare bankruptcy, and that changing the 

Code to allow regulators to place firms in bankruptcy involuntarily could 

temporarily place a firm in an uncertain legal status, eroding firms’ values and 

endangering market stability. Other options, such as having regulatory standards

forcing the firm into bankruptcy, could improve the likelihood of an orderly 

resolution, according to these experts. Although the proposals reflect the need to 

minimize systemic effects of financial company bankruptcies, the Financial 

Stability Oversight Council (FSOC)—charged with responding to threats to 

financial stability—has not considered changes to the Code. Consideration could 

improve FSOC’s ability to address such threats in a timely and effective manner. 

Experts emphasized that funding is needed to facilitate orderly and effective 

financial company bankruptcies. They generally agreed that prohibiting all federal 

funding or guarantees of private funding likely would lead to fire sales of assets. 

They agreed that fully secured funding should be used only to provide short-run 

liquidity and not for bailouts of insolvent firms’ creditors. Experts suggested a 

private-sector fund could be created for this purpose. Such funds could be

collected voluntarily, through routine assessments (before a bankruptcy), or 

through a facility similar to the one created for the Orderly Liquidation Authority, 

which allows federal funding at the time of a bankruptcy and later recovery of 

funds through an industry assessment. Experts noted some difficulties 

associated with these proposals, including determining whether a firm was 

insolvent or needed liquidity, and identifying permissible types of collateral.

Generally, experts did not agree on advantages or disadvantages of proposals to 

change the safe-harbor treatment of qualified financial contracts (QFC). The 

Code exempts QFCs, such as derivatives, from the automatic stay that generally 

prevents creditors from taking company assets in payment of debts before a 

case is resolved. It also exempts QFCs from provisions that allow bankruptcy 

judges to “avoid” contracts entered into within specified times before a filing. 

Proposals to change QFC treatment—subjecting all or some contracts to the 

automatic stay on a permanent or temporary basis and removing the avoidance 

exemptions—might address issues raised by extensive contract terminations in 

the early days of financial company bankruptcies. Experts said it was unclear 

what lessons should be learned from those experiences. Many noted that 

narrowing the exemptions would reduce the size of derivative markets, but views 

varied about whether such narrowing would increase or decrease systemic risk. 

Some experts said that the current safe harbors decrease systemic risk, while 

others said they increase it by making firms more dependent on less-reliable 

short-term financing. 

View GAO-13-622. For more information, 

contact Alicia Puente Cackley at (202) 512-

8678 or cackleya@gao.gov.
Page i GAO-13-622 Financial Company Bankruptcies

Letter 1 

Background 3

Experts Agreed That Changing Regulatory Involvement May Have 

Varying Impacts and Needs Further Consideration 12

Experts Considered Funding Mechanisms Essential for 

Bankruptcies of Large Financial Companies 21

Experts Had Varying Views on Advantages and Disadvantages of 

QFC Proposals 27

Conclusions 37

Recommendations for Executive Action 38

Agency Comments 38

Appendix I Objectives, Scope, and Methodology 42

Appendix II Experts, Background, and Agendas for Expert Roundtables 47

Appendix III Safe-Harbor Treatment of Certain Financial Contracts under 

the Bankruptcy Code 58

Appendix IV Comments from the Department of the Treasury 66

Appendix V GAO Contact and Staff Acknowledgments 68

Table

Table 1: Assets and Liabilities of Global Systemically Important 

Banking Institutions Headquartered in the United States, 

Fourth Quarter of 2007 and 2012 23

Figures

Figure 1: Chapter 11 Process, 2013 5

Contents 
Page ii GAO-13-622 Financial Company Bankruptcies

Figure 2: Primary Dealer Repurchase Agreements and Global Overthe-Counter Derivatives Markets, 2000 to 2012 29

Figure 3: Expert’s Evaluation of How QFC Proposals Would Affect 

Orderliness and Effectiveness of Financial Company 

Bankruptcies, 2013 30

Figure 4: QFC Termination and the Netting of Obligations 64

Figure 5: Completion of Bilateral Repurchase Agreement and 

Collateral Liquidation 64

Abbreviations

AOUSC Administrative Office of the U.S. Courts

Federal Reserve Board of Governors of the Federal Reserve System

CFTC Commodity Futures Trading Commission

DIP debtor-in-possession

Dodd-Frank Act Dodd-Frank Wall Street Reform and Consumer 

 Protection Act

FDIC Federal Deposit Insurance Corporation

FSOC Financial Stability Oversight Council

LBHI Lehman Brothers Holdings, Inc.

LBI Lehman Brothers, Inc.

NAS National Academy of Sciences

NAIC National Association of Insurance Commissioners

OLA Orderly Liquidation Authority

QFC qualified financial contract

SEC Securities and Exchange Commission

SIPA Securities Investor Protection Act

SIPC Securities Investor Protection Corporation

TARP Troubled Asset Relief Program

Code U.S. Bankruptcy Code

Treasury U.S. Department of the Treasury

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Page 1 GAO-13-622 Financial Company Bankruptcies

441 G St. N.W.

Washington, DC 20548

July 18, 2013

Congressional Committees:

The 2007-2009 financial crisis and the failures of large, complex financial 

companies led some experts to question the adequacy of the U. S. 

Bankruptcy Code (Code) for effectively reorganizing or liquidating these 

companies without causing further harm to the financial system.1

Questions raised about the effectiveness of the Code have prompted 

some financial and legal experts—sometimes working in interdisciplinary 

groups—as well as government officials and members of Congress to 

propose changes to the Code, or to the supervisory process leading to a 

bankruptcy filing.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (DoddFrank Act) mandates that we study, at first annually and then at specified 

intervals, issues including the effectiveness of the Code in facilitating the 

orderly liquidation or reorganization of financial companies and ways to 

make the orderly liquidation process under the Code for financial 

companies more effective.2 In July 2011, we issued our first report, which 

addressed the mandate’s requirements and included proposals for 

revising the Code to improve the orderliness and effectiveness of financial 

company bankruptcies.3 In July 2012, we issued our second report that 

addressed actions taken to implement the Orderly Liquidation Authority 

(OLA) created by the Dodd Frank Act. OLA authorizes the Secretary of 

the Treasury to appoint the Federal Deposit Insurance Corporation 

(FDIC) as a receiver when, among other things, the failure of a financial 

company would have serious adverse effects on financial stability in the 

 

1

Insured depository institutions and insurance companies may not file for debtor protection 

under the U.S. Bankruptcy Code, and broker-dealers qualify for liquidation, but not 

reorganization. 

2

Dodd-Frank Wall Street Reform and Consumer Protection Act, Pub. L. No. 111-203, § 

202(e), 124 Stat. 1376 (2010). 

3

See GAO, Bankruptcy: Complex Financial Institutions and International Coordination 

Pose Challenges GAO-11-707 (Washington, D.C.: July 19, 2011).

 
 

Page 2 GAO-13-622 Financial Company Bankruptcies

United States and taking action under OLA would avoid or mitigate such 

adverse effects.4

We focus in this report on the advantages and disadvantages of 

proposals from experts, government officials, and legislators to change 

the Code to make bankruptcies of financial companies (especially those 

that pose systemic risk to the financial system) more orderly and 

effective. Specifically, this report examines the advantages and 

disadvantages of proposals (1) to change the role of financial regulators 

and the Department of the Treasury in financial company bankruptcies; 

(2) affecting the funding of financial company bankruptcies, and (3) to 

change the safe-harbor treatment of certain financial contracts—including 

derivatives and repurchase agreements.5

To address these objectives, we reviewed our earlier work under the 

mandate and that of the Administrative Office of the U.S. Courts 

(AOUSC) and the Board of Governors of the Federal Reserve (Federal 

Reserve), which have similar mandates.6 For this engagement we 

reviewed more recent literature to update the proposals we earlier 

identified for modifying the Code. We relied on criteria for orderly and 

effective bankruptcies that were developed during our earlier work. These 

criteria included minimizing systemic risk, avoiding fire sales, maximizing 

value, promoting due process, and limiting taxpayer liability. To evaluate

the proposals relative to these criteria, we conducted two expert 

roundtables in which participants evaluated the proposed changes to the 

role of regulators and the safe-harbor treatment of certain financial 

contracts in financial company bankruptcies. These roundtables were 

conducted with the assistance of the National Academy of Sciences 

 

4

See GAO, Bankruptcy: Agencies Continue Rulemakings for Clarifying Specific Provisions 

of Orderly Liquidation Authority GAO-12-735 (Washington, D.C.: July 12, 2012).

5

Such contracts are often referred to as qualified financial contracts because they qualify 

for safe harbor treatment—that is, they are not subject to the automatic stay in bankruptcy 

proceedings that generally stops most lawsuits, foreclosures, and many other collection 

activities against the debtor.

6

See GAO-11-707; GAO-12-735; AOUSC, Report Pursuant to Section 202(e) of the 

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, (Washington, D.C.: 

July 2011) and Second Report Pursuant to Section 202(e) of the Dodd-Frank Wall Street 

Reform and Consumer Protection Act of 2010, Pub. L. No. 111-203 (2010), (Washington, 

D.C.: July 2012); and Federal Reserve, Study on the Resolution of Financial Companies 

under the Bankruptcy Code (Washington, D.C.: July 2011).
 

Page 3 GAO-13-622 Financial Company Bankruptcies

(NAS). Roundtable participants included bankruptcy judges, practicing 

attorneys, financial regulators, industry representatives, and academics. 

We chose the roundtable participants based on their publications 

demonstrating an expertise in bankruptcy and financial regulation, input 

from regulatory bodies and industry groups, and suggestions from NAS. 

Roundtable participants discussed the proposals in relation to the criteria 

of orderliness and effectiveness, potential outcomes of implementing the 

proposals, and how impediments to implementing them might be 

overcome. During our work, we also met with officials from AOUSC, the 

Commodity Futures Trading Commission (CFTC), FDIC, the Board of 

Governors of the Federal Reserve System (Federal Reserve), Financial 

Stability Oversight Council (FSOC), U.S. Department of Justice, National 

Association of Insurance Commissioners (NAIC), Securities and 

Exchange Commission (SEC), and U.S. Department of the Treasury 

(Treasury). See appendix I for more information on our scope and 

methodology and appendix II for more information on the expert 

roundtables.

We conducted this performance audit from October 2012 to July 2013, in 

accordance with generally accepted government auditing standards. 

Those standards require that we plan and perform the audit to obtain 

sufficient, appropriate evidence to provide a reasonable basis for our 

findings and conclusions based on our audit objectives. We believe that 

the evidence obtained provides a reasonable basis for our findings and 

conclusions based on our audit objectives.

Bankruptcy is a federal court procedure conducted under the Code. The 

goals of bankruptcy are to give individuals and businesses a “fresh start” 

by eliminating or restructuring debts they cannot fully repay and help 

creditors receive some payment in an equitable manner. The filing of a 

voluntary bankruptcy petition operates as an “automatic stay” that 

generally stops lawsuits, foreclosures, and most other collection activities 

against the debtor, allowing the debtor time to eliminate or restructure its 

debts. In bankruptcy, equitable treatment of creditors means that all 

creditors with substantially similar claims shall be classified similarly and 

receive the same treatment.7 For example, a class of secured creditors —

 

7

This treatment is also called pari passu, meaning “on equal footing,” and in usage often 

refers to treating things equally, without showing preference. In the context of bankruptcy, 

it refers to creditors of the same class receiving the same prorated (or pro rata) share of 

payment, according to the amount of the claim.

Background 
 

Page 4 GAO-13-622 Financial Company Bankruptcies

those with liens or other secured claims against the debtor’s property—

will receive similar treatment. Secured creditors are more likely to get 

some debt repaid than general unsecured creditors, and creditors 

generally receive payment of their debts before shareholders receive any 

return of their equity in the failed company.

Business debtors that are eligible for protection under the Code may 

qualify for liquidation, governed primarily by Chapter 7 of the Code, or 

reorganization, governed by Chapter 11.8 Proceedings under both 

Chapters 7 and 11 can be voluntary (initiated by the debtor) or involuntary 

(generally initiated by at least three creditors). However, in an involuntary 

proceeding, the debtor can defend against the proceeding, including 

presenting objections within 21 days of being served the summons of the 

proceeding. The judge subsequently decides whether to grant the 

creditors’ request and permit the bankruptcy to proceed, dismiss the 

request, or enter any other appropriate order.

A reorganization proceeding under Chapter 11 allows debtors, such as 

commercial enterprises, to continue some or all of their operations as a 

way to satisfy creditor claims. The debtor typically remains in control of its 

assets, and is called a debtor-in-possession (DIP). The court also, under 

certain circumstances, can direct the U.S. Trustee to appoint a Chapter 

11 trustee to take over the affairs of the debtor.9 As shown in figure 1, a 

firm going through a Chapter 11 bankruptcy generally will pass through 

several stages.

 

8

A liquidation proceeding—under Chapter 7—is a court-supervised procedure by which a 

trustee takes over the assets of the debtor’s estate, reduces them to cash, and makes 

distributions to creditors in accordance with the Code’s priority scheme. This report 

discusses in depth Chapter 11 reorganization.

9

If certain conditions are met, the court directs the U.S. Trustee to appoint a Chapter 11 

trustee upon request of the U.S. Trustee, certain other parties, or on its own motion. 

Bankruptcy Proceedings
 

Page 5 GAO-13-622 Financial Company Bankruptcies

Figure 1: Chapter 11 Process, 2013

a

Potential outcomes also include dismissal of the case or conversion to a Chapter 7 liquidation. A 363 

sale refers to that section of the Code which applies to sales that are free and clear of creditor claims.
 

Page 6 GAO-13-622 Financial Company Bankruptcies

Each stage of the Chapter 11 process has key attributes:

First-day motions. The most common first-day motions relate to 

the continued operation of the debtor’s business and involve 

matters such as requests to use cash collateral—liquid assets on 

which secured creditors have a lien or claim—and obtaining 

financing, if any. They may include a motion to pay the 

prebankruptcy claims of critical vendors—those deemed vital to 

the debtor’s continued business operations.

Disclosure. The disclosure statement filed after the bankruptcy 

petition filing must include information on the debtor’s assets, 

liabilities, and business affairs sufficient to enable creditors to 

make informed judgments about how to vote on the debtor’s plan 

of reorganization and must be approved by the bankruptcy court.

Plan of Reorganization. A debtor has an exclusive right to file a 

plan of reorganization within the first 120 days of bankruptcy.10

The court may not confirm the plan unless a sufficient proportion 

of allowed creditors has accepted the plan or would not be 

impaired by the plan. The court’s approval also depends on 

whether there are dissenting classes of creditors. If a plan has not 

been filed by the debtor within 120 days or accepted by a 

sufficient number of creditors after 180 days, any interested 

party—including creditors—may file a plan. The plan divides 

creditors into classes, prioritizing payments to creditors.

Reorganization. Possible Chapter 11 outcomes, which can be 

used in combination, include (1) sale of the company (in whole or 

in part), which is sometimes called a section 363 sale because 

that section of the Code applies to sales that are free and clear of 

creditor claims and interests; (2) liquidation of the company’s 

assets with the approval of the court through means other than a 

363 sale; and (3) actual reorganization of the company in which it 

 

10Also, there are many other findings a court must make in order to confirm a plan of 

reorganization, aside from acceptance or lack of impairment. For example, the court must 

find that the plan is feasible. Additionally, the 180-day rule allowing third parties to file a 

plan is tied to voting (i.e., acceptance of the plan by a sufficient number of impaired 

creditors) on a plan filed by the debtor and not just court approval. See Code section 

1121(c)(3).
 

Page 7 GAO-13-622 Financial Company Bankruptcies

emerges from bankruptcy with new contractual rights and 

obligations that replace or supersede those it had before filing for 

bankruptcy.11

The debtor, creditors, trustee, or other interested parties, may initiate 

adversary proceedings—in effect, a lawsuit within the bankruptcy case to 

preserve or recover money or property to subordinate a claim of another 

creditor to their own claims, or for similar reasons. Furthermore, the 

Chapter 11 trustee or others may bring a preference action (a type of 

avoidance action) challenging certain payments made by a debtor to a 

creditor generally within 90 days prior to the bankruptcy filing.12 In 

addition, fraudulent avoidance actions generally can be taken on transfers 

made within 2 years prior to a bankruptcy if payments are determined to 

be fraudulent. As such, an avoidance action can question the payment as 

a preferential or fraudulent transfer of assets and require payments to be 

returned to the debtor.

Large, complex financial companies that are eligible to file for bankruptcy 

generally file under Chapter 11 of the Code. Such companies operating in 

the United States engage in a broad range of financial services including 

commercial banking, investment banking, securities and commodities 

trading, derivatives transactions, and insurance. Many of them are 

organized under both U.S. and foreign laws. The U.S. legal structure is 

frequently premised upon the ownership by a parent holding company of 

various regulated subsidiaries (such as depository institutions, insurance 

companies, broker-dealers, and commodity brokers) and other 

nonregulated subsidiaries that engage in a variety of financial activities. 

Many of these businesses have centralized business lines and operations 

that may be housed in a holding company or in one or more subsidiaries. 

Smaller banking institutions also are organized as holding companies, but 

many of these hold few, if any, assets outside a depository institution and 

generally engage in a narrower range of activities.

 

11Potential outcomes also include dismissal of the case or conversion to a Chapter 7 

liquidation. 

12A preference action can be asserted for payments made to an insider within a year prior 

to the bankruptcy filing. 

Financial Companies and 

the Bankruptcy Code
 

Page 8 GAO-13-622 Financial Company Bankruptcies

Certain financial institutions may not file as debtors under the Code and 

other entities face special restrictions in using the Code:13

• Insured depository institutions. Under the Federal Deposit 

Insurance Act, FDIC serves as the conservator or receiver for insured 

depository institutions placed into conservatorship or receivership 

under applicable law.14

• Insurance companies. Insurers generally are subject to oversight by 

state insurance commissioners, who have the authority to place them 

into conservatorship, rehabilitation, or receivership.

• Broker-dealers. Broker-dealers can be liquidated under the 

Securities Investor Protection Act (SIPA) or under a special 

subchapter of Chapter 7 of the Code. However, broker-dealers may 

not file for reorganization under Chapter 11.15

• Commodity brokers. Commodity brokers, also known as futures 

commission merchants, are restricted to using only a special 

subchapter of Chapter 7 for bankruptcy relief.16

 

13Financial companies that the Secretary of the Treasury determines meet the conditions 

specified under OLA—including that their failure and resolution under otherwise applicable 

federal or state law would have serious adverse effects on financial stability in the United 

States—may be resolved under an FDIC receivership, broadly similar to that currently 

used to resolve insured depositories. 

1412 U.S.C. § 1821(c). 

15Chapter 7 of the Code contains special provisions for the liquidation of stockbrokers. 11 

U.S.C. §§ 741-753. Under SIPA, the Securities Investor Protection Corporation (SIPC) 

initiates a liquidation proceeding, the primary purpose of which is to protect customers 

against financial losses arising from the insolvency of their brokers. Once a protective 

decree has been applied for, any other pending bankruptcy proceeding involving the 

debtor stockbroker is stayed, and the court where the application is filed has exclusive 

jurisdiction over that stockbroker. SIPC participation can displace a Chapter 7 liquidation 

pending the SIPA liquidation, but provisions of the Code apply in a SIPA liquidation to the 

extent they are consistent with SIPA. See 15 U.S.C. §§ 78eee(b)(2)(B), 78fff(b). Because 

the stockbrokers discussed in this report are also dealers registered with SEC as brokerdealers, we generally use broker-dealer rather than stockbroker in this report. 

16Chapter 7 of the Code contains special provisions for commodity broker liquidation (11 

U.S.C. §§ 753, 761-767), and CFTC’s rules relating to bankruptcy are set forth at 17 

C.F.R. § 190.01 et seq. 
 

Page 9 GAO-13-622 Financial Company Bankruptcies

Regulators often play a role in financial company bankruptcies. With the 

exception of CFTC and SEC, the Code does not explicitly name federal 

financial regulators as a party of interest with a right to be heard before 

the court. In practice, regulators frequently appear before the court in 

financial company bankruptcies. For example, as receiver of failed 

insured depository institutions, FDIC’s role in bankruptcies of bank 

holding companies is typically limited to that of creditor. CFTC has the 

express right to be heard and raise any issues in a case under Chapter 7. 

SEC has the same rights in a case under Chapter 11. SEC may become 

involved in a bankruptcy particularly if there are issues related to 

disclosure or the issuance of new securities. SEC and CFTC also are 

involved in Chapter 7 bankruptcies of broker-dealers and commodity 

brokers. In the event of a broker-dealer liquidation, pursuant to the SIPA, 

the bankruptcy court retains jurisdiction over the case and a trustee, 

selected by the Securities Investor Protection Corporation (SIPC), 

typically administers the case. SEC may join any SIPA proceeding as a 

party.

The Code does not restrict the federal government from providing DIP 

financing to a firm in bankruptcy, and in certain cases it has provided 

such funding, as it did in the bankruptcies of General Motors and Chrysler 

with financing under the Troubled Asset Relief Program (TARP).17 The 

authority to make new financial commitments under TARP terminated on 

October 3, 2010. In July 2010, the Dodd-Frank Act amended section 

13(3) of the Federal Reserve Act to prohibit the establishment of an 

emergency lending program or facility for the purpose of assisting a single 

and specific company to avoid bankruptcy. Nevertheless, the Federal 

Reserve may design emergency lending programs or facilities for the 

purpose of providing liquidity to the financial system.18

The federal government also has provided financial support to companies 

who later declared bankruptcy. For example, CIT Group, Inc. received 

funding from TARP in 2008. CIT subsequently declared bankruptcy under 

Chapter 11 in 2009 and was reorganized.

 

17In a bankruptcy proceeding, creditors often provide financing for the debtor to have 

immediate cash as well as ongoing working capital during a reorganization process. This 

financing is called DIP financing.

18Dodd-Frank Act, Pub. L. No. 111-203, § 1101(a). 

Current Role of Financial 

Regulators in Bankruptcy 

Proceedings
 

Page 10 GAO-13-622 Financial Company Bankruptcies

Although the automatic stay generally preserves assets and prevents 

creditors from taking company assets in payment of debts before a case 

is resolved and assets are distributed in a systematic way, it is subject to 

exceptions, one of which can be particularly important in a financial 

institution bankruptcy. Commonly referred to as a safe harbor, this 

exception pertains to certain financial and derivative contracts, often 

referred to as qualified financial contracts (QFC).19 The types of contracts 

eligible for the safe harbors are defined in the Code. They include 

derivative financial products, such as forward contracts and swap 

agreements that financial companies (and certain individuals and 

nonfinancial companies) use to hedge against losses from other 

transactions or speculate on the likelihood of future economic 

developments.20 Repurchase agreements, collateralized instruments that 

provide short-term financing for financial companies and others, also 

generally receive safe-harbor treatment.

Safe-harbor treatment was first added to the Code in 1982 for forward 

contracts, commodity contracts, and securities contracts.21 In a recent 

change, the Code’s definition of repurchase agreements was expanded 

(in 2005) to include, among other things, agreements for the transfer of 

mortgage related securities, mortgage loans, interests in mortgagerelated securities or mortgage loans, and government securities issued by 

countries that are members of the Organisation of Economic and Cooperation and Development, thereby expanding the scope of contracts 

subject to the safe-harbor treatment. According to the legislative history, 

the purpose of these safe harbors is to maintain market liquidity and 

 

19The term “qualified financial contract” is not used in the Code. 

20A swap is a type of derivative that involves an ongoing exchange of one or more assets, 

liabilities, or payments for a specified period. Financial and nonfinancial firms use swaps 

and other over-the-counter derivatives to hedge risk, or speculate, or for other purposes. A 

futures contract is a contract that is standardized and traded on an organized futures 

exchange, while a forward contract is privately negotiated among the buyer and seller. 

21In general, a commodity contract is a contract between two parties where the 

commodities buyer agrees to purchase from the commodities seller a fixed quantity of a 

commodity at a fixed price on a fixed date in the future. A “forward contract” is a contract 

for the purchase, sale, or transfer of a commodity with a maturity date more than two days 

after the contract is entered into. A securities contract generally refers to a contract 

defining a financial agreement between counterparties. A securities contract includes 

contracts for the purchase and sale of various financial products such as a group or index 

of securities, mortgage loans, certificates of deposit, and extensions of credit for 

settlement purposes. See appendix III for more information on securities contracts.

Current Safe-Harbor 

Treatment for Financial 

Contracts under the Code
 

Page 11 GAO-13-622 Financial Company Bankruptcies

reduce systemic risk, which we define as the risk that the failure of one 

large institution would cause other companies to fail or that a market 

event could broadly affect the financial system rather than just one or a 

few companies.

Under the safe-harbor provisions, most counterparties that entered into a 

qualifying transaction with the debtor may exercise certain contractual 

rights even if doing so would otherwise violate the automatic stay.22 In the 

event of insolvency or the commencement of bankruptcy proceedings, the 

nondefaulting party in a contract may liquidate, terminate, or accelerate 

the contract, and may offset (net) any termination value, payment 

amount, or other transfer obligation arising under the contract when the 

debtor files for bankruptcy. That is, generally nondefaulting counterparties 

subtract what they owe the bankrupt counterparty from what that 

counterparty owes them (netting), often across multiple contracts. If the 

result is positive, the nondefaulting counterparties can sell any collateral 

they are holding to offset what the bankrupt entity owes them. If that does 

not fully settle what they are owed, they are treated as unsecured 

creditors in any final liquidation or reorganization.

Safe-harbor provisions also generally exempt certain payments made 

under financial contracts from a preference action seeking to recover any 

payment made by a debtor to a creditor generally within 90 days of filing 

for bankruptcy. In addition, they exempt fraudulent transfers made to 

financial contract counterparties generally within 2 years prior to a 

bankruptcy unless the payments are determined to have been 

intentionally fraudulent. Trustees cannot question the payment made in 

connection with these contracts as a preferential or fraudulent transfer of 

assets and cannot require the payments to be returned to the debtor. See 

appendix III for more information on the current safe-harbor treatment for 

derivative and repurchase agreement contracts.

 

22A contractual right includes a right set forth in the rules or bylaws of, among others, a 

derivatives clearing organization, a multilateral clearing organization, a national securities 

exchange or association, or a securities clearing agency. 
 

Page 12 GAO-13-622 Financial Company Bankruptcies

Experts at our roundtables evaluated proposals to change the roles of 

regulators in financial company bankruptcies. Specifically, they discussed 

proposals to require firms to notify and consult with regulators prior to a 

bankruptcy; allow regulators to commence an involuntary bankruptcy; 

provide regulators with standing or a right to be heard in bankruptcy court; 

and have regulators determine how subsidiaries might be consolidated in 

a bankruptcy. The experts noted that the proposals could have varying 

impacts on the bankruptcy process. For example, they viewed most of the 

proposals as having limited impact because regulators already have 

similar roles in bankruptcies, whereas efforts to consolidate subsidiaries 

in a bankruptcy would undermine key legal and regulatory constructs. 

Although experts broadly supported regulatory involvement in financial 

company bankruptcies, they said the proposed changes raise several 

implementation issues, such as determining the number of days prior to a 

bankruptcy that a company would be required to notify regulators and 

which regulator(s) to notify. As a result, the proposals require further 

consideration. FSOC, which is charged with identifying and responding to 

risks to financial stability that could arise from the failure of large financial 

companies, has been identified in some proposals as a regulator that 

should be notified.23 However, FSOC has not yet considered implications 

of changes to the role of regulators in the bankruptcies of financial 

companies.

Several proposals have been made by financial and legal experts, as well 

as government officials, to further involve regulators in financial company 

bankruptcies. The experts at our first roundtable discussed four such 

proposals we identified in our 2011 study.24

 

23The Dodd-Frank Act does not assign FSOC a direct role in deciding whether a company 

should go through OLA. 

24We provided the experts with another proposal on granting regulators the right to file 

reorganization plans and motions for sale of property but experts spent almost no time 

addressing it so it is not included in this discussion. 

Experts Agreed That 

Changing Regulatory 

Involvement May 

Have Varying Impacts 

and Needs Further 

Consideration 

Proposals to Further 

Involve Financial 

Regulators in Financial 

Company Bankruptcies
 

Page 13 GAO-13-622 Financial Company Bankruptcies

Require debtors to notify and consult with regulators 

(primary, functional, Financial Stability Oversight Council, 

foreign, or other) in advance of filing for bankruptcy.25

Bankruptcy-related proposals introduced in the 111th Congress 

included a notification period.26 In prior work, we found that the 

notice period was intended to provide the regulator with some time 

to facilitate actions to minimize the systemic impact of the 

bankruptcy.27 During that time, the regulator might be able to find 

ways to maintain critical functions, facilitate an asset sale, identify 

potential creditors that would provide financing for the debtor, or 

determine if a proceeding under OLA would be more appropriate. 

This extra time for preparation could help to maintain the value of 

the institution and reduce systemic disruptions to the wider 

economy.

Allow regulators to commence an involuntary bankruptcy if 

the firm is insolvent or in imminent danger of becoming 

insolvent. This proposal was included in the proposal made by 

the Hoover Institution resolution project group to have a separate 

bankruptcy chapter in the Code—Chapter 14—for large financial 

companies.28 The authors of that proposed chapter noted that 

under the existing Code, an involuntary bankruptcy proceeding 

can commence when a firm generally is not paying its debts as 

they become due unless the debts are subject to a legitimate 

dispute. For large financial companies, allowing involuntary 

 

25The Gramm-Leach-Bliley Act defines a federal functional regulator as (a) the Board of 

Governors of the Federal Reserve System, (b) the Office of the Comptroller of the 

Currency, (c) the Board of Directors of FDIC, (d) the Director of the Office of Thrift 

Supervision (no longer existent), (e) the National Credit Union Administration Board, and 

(f) the Securities and Exchange Commission. 

26Bankruptcy Integrity and Accountability Act, Senate Amendment 3832, 111th Cong., 2nd 

sess., Congressional Record (May 5, 2010): S3620-3624 and Consumer Protection and 

Regulatory Enhancement Act. HR 3310, 111th Cong., 1st sess., Congressional Record

(July 24, 2009): E1964-E1967.

27See GAO-11-707. 

28The Hoover Institution resolution project group was established in 2009 under the 

auspices of the Working Group on Economic Policy at the Hoover Institution at Stanford 

University. The group has proposed that a new chapter—Chapter 14—of the Code be 

created to address bankruptcies of large financial companies. For these proposals see 

Kenneth E. Scott and Thomas Jackson, eds., Bankruptcy Not Bailout: A Special Chapter 

14 (Stanford, Calif.: Hoover Institution Press, 2012).
 

Page 14 GAO-13-622 Financial Company Bankruptcies

bankruptcies in response to balance sheet insolvency may allow 

regulators to initiate a bankruptcy at a time when they could still 

limit the spread of damage to other financial companies. The 

Chapter 14 proposal specifically provides primary regulators 

power to commence an involuntary case against a financial 

company in the event that the firm’s assets are less than its 

liabilities, at fair valuation, or the firm has unreasonably small 

capital.

Allow regulators of the debtor or its subsidiaries to have 

standing or a right to be heard in the courts to raise issues 

relative to regulation. Proposals introduced in the 111th 

Congress contained a provision to allow certain financial 

regulators the right to be heard during a bankruptcy case.29 The 

proposals granted the functional regulator, Financial Stability 

Oversight Council, Federal Reserve, Treasury, and any agency 

charged with administering a nonbankruptcy insolvency regime for 

any component of the debtor the right to be heard on any issue in 

a bankruptcy case.30 Experts have contended that regulated 

institutions have more complicated legal structures and products 

than others; thus, having regulatory expertise would provide more 

timely information to the judge and could lead to resolutions that 

better preserve asset value.31

Consider the role of regulators in determining what 

subsidiaries should be included in a bankruptcy proceeding 

and the extent to which complex firms might be consolidated 

in bankruptcy. This proposal would give regulators a role in 

determining whether the court should consider the filing of a 

financial company as a whole under processes similar to the 

doctrine of substantive consolidation—a rarely used procedure. In 

substantive consolidation, the intercompany liabilities of related 

companies are eliminated, the assets of these companies are 

pooled, and the companies’ liabilities to third parties are paid from 

 

29See Bankruptcy Integrity and Accountability Act Senate Amendment 3832, and 

Consumer Protection and Regulatory Enhancement Act. HR 3310.

30The House proposal included an entity with a similar conceptual function to FSOC, 

which it called the Market Stability and Capital Adequacy Board. 

31See GAO-11-707. 
 

Page 15 GAO-13-622 Financial Company Bankruptcies

the single pool of assets. The proposal also would give regulators 

a role in determining whether existing bankruptcy exclusions for 

insurance companies, broker-dealers, or commodity brokers 

should be maintained. The Hoover Institution resolution project 

group noted that these exclusions can complicate the resolution of 

a major financial institution, because the bankruptcy court can 

deal only with pieces of the firm.

The experts at the first roundtable generally supported three of the four 

proposed changes to the role of regulators in bankruptcy proceedings, but 

noted that these proposals might have limited effects. None of the experts 

who responded to written questions indicated that requiring notice and 

consultation with regulators or granting regulators a right to be heard in 

bankruptcy court would greatly change the existing bankruptcy process. 

The experts noted that regulators already play these roles in financial 

company bankruptcies.

• In response to the proposal to require notice to regulators, the experts 

generally agreed that regulators and financial companies usually have 

a great deal of communication and involvement, particularly when an 

institution is experiencing financial difficulties. One expert worried that 

requiring notice to the regulator before filing for bankruptcy might 

allow regulators to prevent the debtor from filing and adversely affect 

recoveries for creditors.

• In relation to regulatory authority to compel involuntary filings, the 

experts who specifically addressed this proposal said that regulators 

already have ways of forcing a financial company to file for bankruptcy 

through their existing regulatory powers. A few experts said that 

regulators can use the threat of placing the firm into FDIC receivership 

under OLA if the firm does not file voluntarily for bankruptcy.32 One 

expert expressed the view that once living wills are in place, 

regulators may compel a financial company to execute its resolution 

 

32NAIC and state insurance officials noted that generally state insurance regulators place 

insurance companies into receivership. However, insurers can voluntarily request to be so 

placed. Under OLA, state insurance regulators retain this right. However, if an insurance 

company or subsidiary has been designated through OLA to go through the state’s orderly 

resolution for insurance companies and the state insurance regulators have not taken 

action within 60 days of the designation, FDIC can stand in place of the insurance 

regulators to place the company into orderly liquidation under the state’s laws. 

Experts Noted Limited 

Effects on Regulator Roles 

from Most Proposals and 

Trade-offs Relating to 

Orderliness and 

Effectiveness
 

Page 16 GAO-13-622 Financial Company Bankruptcies

plan by filing for voluntary bankruptcy.33 Regulators also can take 

other actions. For example, under the statute, the Federal Reserve 

and FDIC may jointly take corrective action, including ultimately 

requiring the divestiture of certain assets, if they jointly determine that 

a firm has not been able to submit a plan that meets the statutory 

criteria.34 Under SEC and CFTC rules, an undercapitalized securities 

broker-dealer or commodity broker cannot operate and must therefore 

be liquidated. One expert with whom we spoke said that even if 

regulators were given an explicit right to place a firm in involuntary 

bankruptcy, they would be unlikely to use that authority.

• In response to the proposal to give regulators an explicit right to be 

heard, experts who addressed the issue said regulators are routinely 

heard by the court in bankruptcy proceedings. And as noted 

previously, SEC and CFTC already have legal standing in some 

cases. Court officials said they were not aware of an instance in which 

a regulator was denied the right to be heard by the court. However, 

experts also said making this an express right might have benefits, 

which we discuss later in this report.

Although experts favored most of the regulatory proposals, they were 

opposed to having regulators decide whether a firm should be resolved 

on a consolidated basis and noted that these changes would undermine 

key legal and regulatory constructs. One expert noted that the idea 

undermined the concept of having corporate separateness for 

subsidiaries. Corporate separateness is generally the principle that a 

parent corporation is not liable for actions taken by its subsidiaries. 

Another expert noted that encouraging substantive consolidation as 

determined by the regulator could have a negative impact on the 

predictability and transparency of the bankruptcy process, detracting from 

 

33Under the living wills provision of Title I of the Dodd-Frank Act and the implementing 

regulations, certain large complex financial companies must provide the Federal Reserve, 

FDIC, and FSOC with plans that detail how they could be resolved under the Code (or 

other applicable non-OLA regime) in a way that substantially mitigates the risk that the 

failure of the company would have serious adverse effects on financial stability in the 

United States. See Dodd-Frank Act § 165(d), 12 C.F.R. § 381.2(o). 

34Dodd-Frank Act, Pub. L. No. 111-203, § 165(d)(5). If the Federal Reserve and FDIC 

determine that the plans are not credible or would not facilitate an orderly resolution under 

the Code, the agencies may impose more stringent capital, leverage or liquidity 

requirements or restrictions on the growth, activities, or operations of the company until an 

acceptable plan is submitted, or require divestiture of certain assets if no acceptable plan 

is submitted within 2 years.
 

Page 17 GAO-13-622 Financial Company Bankruptcies

the orderliness and effectiveness of that process. A third expert noted that 

treating the legal entities of a financial company in bankruptcy on a 

consolidated basis would conflict with the U.S. regulatory structure, which 

is designed around separate legal entities, such as depository institutions, 

broker-dealers, and insurance companies. However, companies continue 

to manage themselves along business lines that cut across legal entities. 

A regulatory expert said that removing the exemption for securities 

broker-dealers and commodity brokers from bankruptcy could undermine 

the purpose of the regulatory construct applied to those entities and the 

ability of regulators to protect customers’ assets. An expert noted that 

overriding state insurance regulators could lead to intensive litigation. 

Additionally, NAIC and state insurance officials said that the priority 

structure for bankruptcy is inappropriate for insurers because the primary 

goal in the resolution of an insurance company is to protect the 

policyholders. Because of this, policyholders generally receive priority 

over creditors in an insurance receivership beyond any claims supported 

by collateral.

Experts at our roundtables also broadly discussed the proposals in 

relation to criteria for orderly and effective bankruptcies (including 

minimizing systemic risk and promoting due process). Most 

fundamentally, these experts had differing views on whether bankruptcy, 

as currently construed, was an appropriate vehicle for minimizing 

systemic risk. Some participants at the roundtable raised issues about 

whether the court could act quickly enough to stem systemic spillovers 

from the debtor company to other companies and markets. They noted 

other potential trade-offs. For example, to act quickly in cases involving 

large and complex financial companies, courts might need to shorten 

notice periods and limit parties’ right to be heard, which could 

compromise due process and creditor rights. Similarly, one participant 

said that if the goal was to turn the Code into an effective resolution tool, 

the fundamental balance of power among debtor, creditor, and regulator 

might need to be altered. Another was concerned that if regulators 

become more involved in bankruptcy cases, courts might defer to them 

over other parties, undermining the ability of creditors to argue their 

cases. However, a legal expert at the roundtable doubted that the courts 

would be overly solicitous to regulators. Another legal expert noted that 

regulators could enhance due process by educating the court and 

providing a method for verifying information provided by the financial 

institution. One of these participants noted that standards for an 

involuntary bankruptcy initiated by the regulator might require a new 

definition for insolvency that would consider both regulatory and systemic 

interests.
 

Page 18 GAO-13-622 Financial Company Bankruptcies

Nevertheless, many of the experts indicated that regulatory involvement 

in bankruptcies was consistent with minimizing systemic risk. These 

experts said that regulators do and should have influence in times of 

crisis and that commencing a bankruptcy without regulatory involvement 

could be problematic. Additionally, some of the experts at the roundtable 

noted that regulators ought to have the power to compel a financial firm to 

file for bankruptcy because, as one regulatory expert said, allowing a 

financial firm to continue to do business when it is in vulnerable financial 

condition would likely add to concerns for systemic risk.

Although experts generally supported proposals to change the roles of 

regulators, they said implementing the proposals relating to notice and 

involuntary proceedings could be difficult. Experts at our roundtable said 

that determining the correct number of days for notification to the 

regulator would be difficult. For example, requiring a financial institution to 

provide notice to and consult with regulators 10 days in advance of filing 

for bankruptcy—the number of days specified in proposals introduced in 

the 111th Congress—might not work in practice. One expert said that 10 

days can be a long time in a financial crisis. Another noted that the firm’s 

need to file for bankruptcy might arise very quickly and that a firm might 

only be able to notify its regulator a day or two in advance of its filing. As 

an example, an expert noted the rapid collapse of the investment firm 

Bear Stearns and Co. In 2008, senior management of Bear Stearns gave 

the Federal Reserve Bank of New York a 1-day notification, saying that 

the company would file for bankruptcy protection the following day unless 

it received an emergency loan. In the failure of Lehman Brothers, the 

abruptness of the company’s bankruptcy did not allow much time for 

attorneys to prepare for filing. Another expert said that a requirement to 

“notify and consult” with the regulator before entering bankruptcy should 

not interfere with the ability of a company to file for bankruptcy.

Determining which regulators to notify also may be difficult. Complex 

financial companies and their subsidiaries may have many regulators 

domestically and internationally. As a result, determining which regulator 

a bank holding company or nonbank financial company would notify if a 

domestic or foreign subsidiary were nearing insolvency is not clear. One 

expert noted that because large financial companies have many 

regulators, before a firm could file for bankruptcy it would be important to 

identify in advance which regulators to notify. Proposals introduced in the 

111th Congress would have required that a nonbank financial company 

consult with its functional regulator, FSOC, and any agency charged with 

administering a nonbankruptcy insolvency regime for any component of 

Experts Generally Agreed 

That Proposals Need 

Further Consideration
 

Page 19 GAO-13-622 Financial Company Bankruptcies

the debtor firm, which could be a large number of regulators.35 The 

proposals define functional regulator as the federal regulatory agency 

with the primary regulatory authority, such as an agency listed in section 

509 of the Graham-Leach-Bliley Act. Some roundtable experts said that 

prebankruptcy consultation should be with the firm’s primary regulator, 

although none of them defined this term.

FSOC—which under the Dodd-Frank Act is charged with identifying and 

responding to risks to U. S. financial stability—was included as a 

regulator in the notification and consultation proposal.36 Treasury officials, 

including those who support FSOC, interpret the Dodd-Frank Act as 

having a preference for resolving financial companies through bankruptcy 

and said that FSOC has focused its activities on implementing its 

responsibilities under the act. Furthermore, in its annual reports FSOC 

has described the role that resolution plans are supposed to play in 

fostering orderly resolutions under the Code. Specifically, under the 

Dodd-Frank Act, bank holding companies with total consolidated assets 

of $50 billion or more and nonbank financial companies designated by 

FSOC for enhanced supervision by the Federal Reserve are required to 

submit resolution plans to the Federal Reserve, FDIC, and FSOC. 

FSOC’s 2013 Annual Report included a recommendation that the Federal 

Reserve and FDIC implement their resolution plan authorities in a manner 

that better prepares firms and authorities for a rapid and orderly resolution 

under the Code.37

However, in our discussion with Treasury officials, including those who 

support FSOC, they noted that FSOC does not routinely evaluate 

 

35Bankruptcy Integrity and Accountability Act, Senate Amendment 3832, 111th Cong., 2nd 

sess., Congressional Record (May 5, 2010): S3620-3624 and Consumer Protection and 

Regulatory Enhancement Act. HR 3310, 111th Cong., 1st sess., Congressional Record

(July 24, 2009): E1964-E1967. Both proposals provided FSOC, or an entity with a similar 

conceptual function, the right to a prebankruptcy petition consultation. The House 

proposal referred to the similar agency with the conceptual function similar to FSOC as 

the Market Stability and Capital Adequacy Board. 

36We have reported and testified before Congress on FSOC’s management structure and 

mechanisms for meeting its mission. See GAO, Financial Stability: New Counsel and 

Research Office Accountability and Transparency of Their Decisions GAO-12-886

(Washington, D.C.: Sept. 11, 2012) and Financial Stability: Continued Actions Needed to 

Strengthen New Counsel and Research Office GAO-13-467T (Washington, D.C.: Mar. 14, 

2013).

37See FSOC, 2012 Annual Report (Washington, D.C.: July 2012).
 

Page 20 GAO-13-622 Financial Company Bankruptcies

proposals that could alter the role of regulators in the bankruptcy process 

or other changes to the Code that might reduce systemic risk, such as 

narrowing the safe harbor treatment of QFCs. While current law does not 

specify a role for FSOC related to the potential filing of a bankruptcy by a 

systemically important financial company, when MF Global declared 

bankruptcy, FSOC met in emergency session to monitor the event and 

subsequently reported that the MF Global bankruptcy had not roiled 

markets.38 Treasury officials and staff that support FSOC said that FSOC 

is focused on implementing provisions in the Dodd-Frank Act. Since 

helping to develop rules to implement OLA is explicit in the Dodd-Frank 

Act, FSOC has described activities related to these provisions and made 

recommendations—but has not considered the implications of changing 

the role of regulators under the Code. Although the Dodd-Frank Act does 

not amend the Code or explicitly call for FSOC to consider such changes, 

changing the role of regulators could potentially impact FSOC’s ability to 

identify and respond to systemic risks in a timely fashion.

The roundtable experts noted that allowing financial regulators to initiate 

an involuntary bankruptcy for financial companies raised a number of 

implementation questions including appropriate time frames and 

standards. These experts generally agreed that lengthy time frames 

included in the rules for an involuntary bankruptcy filed by a creditor could 

reduce the value of a systemically important financial institution and 

endanger market stability.39 However, one expert expressed concern over 

the possibility of regulators acting too quickly to place an institution in 

bankruptcy, especially during a financial crisis in which asset valuations 

might be in dispute. A legal expert noted that considering what the 

appropriate standard for placing a financial institution in bankruptcy would 

be was important. The expert noted the difficulty of distinguishing 

between an insolvent company and one experiencing temporary liquidity 

needs. Another expert proposed that a bankruptcy initiated by the 

regulator should require a standard similar to the standard in place for 

 

38MF Global Holdings Ltd. and MF Global Finance USA Inc. filed on a consolidated basis 

for relief under Chapter 11 bankruptcy protection on October 31, 2011. The jointly 

registered broker-dealer and commodities broker subsidiaries of MF Global Holdings, 

operating as MF Global Inc., entered liquidation proceedings under SIPA. 

39Debtors can defend against an involuntary proceeding including presenting objections 

within 21 days of being served the summons.
 

Page 21 GAO-13-622 Financial Company Bankruptcies

placing a firm in FDIC receivership under OLA.40 The regulators at the 

roundtable thought that a regulatory framework that required firms to 

meet certain standards or be placed in bankruptcy—as currently exists for 

commodities brokers and securities broker-dealers—might alleviate some 

of the disadvantages posed by the creditor rules and would not 

necessarily require a change in the Code.

One criterion for an effective bankruptcy or resolution process is to limit 

taxpayer liability. Legislators have made proposals to limit the ability of 

the Treasury or the Federal Reserve to help finance bankruptcies of 

financial companies. For example, proposals introduced in the 111th 

Congress specifically would have forbidden the U.S. Treasury and 

Federal Reserve from participating in bankruptcy financing. However, 

some proposals recognize the difficulty of financing bankruptcies of large 

financial companies, especially during a crisis. The Chapter 14 proposal 

made by the Hoover Institution resolution project group would allow the 

government to provide subordinated DIP financing to companies with 

assets greater than $100 billion (subsidiaries included) with a hearing and 

the court’s approval and oversight.41 Experts at our roundtable discussed 

the appropriate role of the government in providing financing for firms in 

bankruptcy.

 

40The factors to be addressed are set forth in section 203(b) of the Dodd-Frank Act. 

Before the Secretary of the Treasury, in consultation with the President, makes a decision 

to seek the appointment of FDIC as receiver of a financial company, at least two-thirds of 

those serving on the Board of Governors of the Federal Reserve System and at least twothirds of those serving on the Board of Directors of FDIC must vote to make a written 

recommendation to the Secretary of the Treasury to appoint FDIC as receiver. In the case 

of a broker-dealer, the recommendation must come from the Federal Reserve and SEC, in 

consultation with FDIC, and in the case of an insurance company from the Federal 

Reserve and the Director of the Federal Insurance Office, in consultation with FDIC.

41The DIP financer usually requires that its loan be secured with collateral and paid as an 

administrative expense of the estate, giving it priority over all prepetition creditors of the 

firm. Occasionally, such a loan is given priority over other administrative expenses. Such 

an arrangement is called a super priority. In contrast, a subordinated loan to a DIP would 

receive payment only after administrative expenses, other DIP lenders, and other creditors 

are paid. 

Experts Considered 

Funding Mechanisms 

Essential for 

Bankruptcies of Large 

Financial Companies
 

Page 22 GAO-13-622 Financial Company Bankruptcies

Experts at our roundtables emphasized that many of the proposals to 

make the bankruptcy process more orderly and effective depend on 

having an adequate funding mechanism. As a result, experts at the first 

roundtable generally agreed that changing the Code to prevent any 

federal funding of these bankruptcies would not be consistent with orderly 

and effective resolutions. In their written responses to a question asking 

what the most important changes would be to achieve most of the 

elements of an orderly and effective bankruptcy, experts most 

consistently responded that proposals to provide adequate funding, rather 

than to restrict it, were the most important changes that could be made. 

All but one of the eight experts responding put providing a funding source 

as the most important change to avoid fire sales. Experts said that 

support for federal funding rested on two propositions. First, voluntary 

private funding likely would be unavailable to finance the bankruptcy of a 

systemically important financial company. Second, the government 

should distinguish between funding for a bailout and funding that provided 

short-term liquidity.

Experts did not think that voluntary private funding would be available to 

finance a systemically important financial company because these 

companies are large and some of them grew substantially over the 

course of the financial crisis (see table 1). Solutions that were possible 

during the crisis, such as JPMorgan Chase providing funding for Bear 

Stearns, or Barclays’ purchase of parts of Lehman, would be unlikely in 

the future because some firms have gotten much larger. Experts also 

noted that obtaining funding would be especially difficult during a period 

of general financial distress when firms large enough to provide funding 

might be experiencing difficulties themselves. 

Experts Considered Fully 

Secured Federal or 

Industry Funding 

Mechanisms Essential for 

Orderly and Efficient 

Bankruptcies 
 

Page 23 GAO-13-622 Financial Company Bankruptcies

Table 1: Assets and Liabilities of Global Systemically Important Banking Institutions Headquartered in the United States, 

Fourth Quarter of 2007 and 2012

(U.S. dollars in millions)

Banking institutions

2007 2012

Assets Liabilities Assets Liabilities

Bank of America Corp. $1,720,688 $1,571,489 $2,212,004 $1,974,902

Bank of New York Mellon, Corp 197,839 168,269 359,301 321,858

Citigroup, Inc. 2,187,631 2,068,725 1,864,660 1,673,663

Goldman Sachs Group, Inc. 1,119,796 1,076,996 938,770 862,546

JPMorgan Chase & Co. 1,562,147 1,438,006 2,359,141 2,154,273

Morgan Stanley 1,045,409 1,014,140 780,960 711,223

State Street Corp. 142,937 131,628 222,229 201,358

Wells Fargo & Co. 575,442 527,528 1,422,968 1,264,057

Total $8,551,889 $7,996,781 $10,160,034 $9,163,880

Source: GAO analysis of SEC and Federal Reserve data.

Note: These U.S. banking institutions were designated by the Financial Stability Board as of 

November 1, 2012. The board defines systemically important financial institutions as financial 

institutions whose distress or disorderly failure, because of their size, complexity and systemic 

interconnectedness, would cause significant disruption to the wider financial system and economic 

activity. Data are from December 2007 and December 2012 except for the 2007 assets and liabilities 

for Goldman Sachs Group, Inc. and Morgan Stanley. These data were reported in November 2007.

Several experts noted that any government funding would need to 

distinguish between bailing out an insolvent company, which they 

opposed, and providing short-term liquidity for a solvent company 

providing collateral, which they generally supported. One of the legal 

experts defined a bailout as the government putting in equity capital to 

support existing creditors. Legal and academic experts at our roundtables 

compared the provision of fully secured, liquidity funding with providing 

lender-of-last resort funding. They referred specifically to the Federal 

Reserve providing short-term liquidity through its discount window to 

solvent depository institutions with eligible collateral to secure the loan. 

The Federal Reserve accepts a very broad range of collateral to secure 

such loans.42 Our roundtable experts generally agreed that funding for 

liquidity needs was essential and noted that in a period of financial 

distress the federal government might be the only entity with enough 

resources to provide such funding.

 

42See Federal Reserve, Federal Reserve Collateral Guidelines, 

www.frbdiscountwindow.org/FRcollguidelines.pdf, accessed on May 7, 2013.
 

Page 24 GAO-13-622 Financial Company Bankruptcies

Although experts at the roundtables did not think voluntary private funding 

likely would be available for financing or other liquidity support during the 

bankruptcy of a large financial company, they did consider whether the 

industry as a whole might provide such support. They noted several 

options for such funding.

• The industry could create a fund or mechanism for providing liquidity 

to firms that needed it.

• The government could assess companies prior to a bankruptcy as it 

does for the deposit insurance fund.

• The government could raise funds through postbankruptcy 

assessments, while meeting immediate needs through temporary 

federal funding as with the Orderly Liquidation Fund under Title II of 

the Dodd-Frank Act. Under OLA, the Treasury may make funds 

available through an Orderly Liquidation Fund to FDIC as the receiver 

of a covered financial company.43

A few of the experts noted that some government guarantees might 

facilitate private-sector financing.

As with many of the proposals, our roundtable experts noted that 

implementing a proposal to allow fully secured federal funding for liquidity 

needs raised some difficulties. First, they noted the difficulty of 

distinguishing between an insolvent company and one experiencing 

temporary liquidity needs. This distinction is particularly difficult in a 

period of financial stress when valuation of assets may be difficult. For 

example, the value of some of Lehman Brothers Holding, Inc.’s (LBHI) 

real estate assets has increased since the time of its bankruptcy in 2008.

Second, experts at the first roundtable noted that the Dodd-Frank Act 

amendments to section 13(3) of the Federal Reserve Act might apply to 

some Federal Reserve funding related to a bankruptcy.44 This provision 

 

43If income from the liquidated assets of the financial company is insufficient to repay the 

borrowings, the FDIC may, if necessary, impose assessments on certain financial 

companies. 

44Section 1101 of the Dodd-Frank Act provides that these emergency lending programs 

under section 13(3) of the Federal Reserve Act are not available to borrowers that are 

insolvent, which is defined to include entities that are in bankruptcy. See 12 U.S.C. § 

343(B)(ii). 
 

Page 25 GAO-13-622 Financial Company Bankruptcies

restricts the Federal Reserve from providing funding to a single distressed 

company but would allow it to provide funding to the financial system. 

Similar funding provided under the Primary Dealer Credit Facility in 

September 2008 (prior to the Dodd-Frank Act amendments), allowed 

Lehman Brothers, Inc. (LBI)—the broker-dealer and commodity broker 

subsidiary of LBHI—to remain a going concern after LBHI declared 

bankruptcy, thus facilitating the transfer of some assets to Barclays later 

that week. The remaining parts of LBI were liquidated in a SIPA 

proceeding. Under the terms of the loans provided through the Primary 

Dealer Credit Facility, the Federal Reserve Bank of New York became a 

secured creditor of the firm, giving it higher priority in the event of a 

bankruptcy. We found in 2011 that LBI and Barclays had repaid their 

overnight loans with interest, according to Federal Reserve officials. One 

legal and financial expert suggested that the Federal Reserve would be in 

compliance with the amendments to section 13(3) if it set up a fund for 

firms being resolved under the Code for large financial companies.

Third, experts noted that determining what types of assets firms could use 

to collateralize government or industry funding might be difficult. Although 

the Federal Reserve had accepted assets with significant tail risk (the 

probability of a rare event occurring that would result in great losses) as 

collateral during the crisis, experts noted that such risky assets might not 

be acceptable in the future.

We asked the experts at our first roundtable to discuss the advantages 

and disadvantages of the proposal made by the Hoover Institution 

resolution project group that calls for using subordinated government debt 

to provide payments to certain short-term creditors early in a bankruptcy 

proceeding. Such subordinated loans would be repaid with a lower priority 

than that of other creditors. The proposal further proposes a “claw-back” 

procedure if the preferred creditors have received more than they were 

entitled to when the reorganization or liquidation is finalized. The proposal 

was made to stem systemic concerns—the failure at one financial 

company spreading to others because short-term creditors would not 

have access to funds. Reliance on short-term funding exacerbated the 

Roundtable Experts Were 

Concerned about Using 

Federal Funding for 

Preferences to Some 

Creditors 
 

Page 26 GAO-13-622 Financial Company Bankruptcies

financial crisis of 2007-2009.45 And as has been noted by some Federal 

Reserve officials, regulatory reform has not yet addressed the risks to 

financial stability posed by short-term wholesale funding.46

Legal experts at the roundtable agreed that such payments could be 

made by treating certain short-term creditors as critical vendors during 

first-day motions. However, experts who discussed this issue at the first 

roundtable said that making decisions about providing funding to certain 

short-term creditors during a bankruptcy was not the best way to address 

systemic concerns associated with short-term liquidity. They noted that 

such a proposal would increase uncertainty for creditors during a 

bankruptcy proceeding. Two experts noted that they would not want to 

use subordinated federal funding. Another explained that the point of 

subordinating the funding is to help ensure that the government uses 

such funding to address concerns about liquidity rather than to defray 

certain creditors’ losses. However, such funding would expose taxpayers 

to potential liability.

Instead, those experts who discussed this proposal at the first roundtable 

said that changing the Code to give an explicit priority to short- over longterm creditors would be preferable. They noted that an explicit priority 

would be a better option in that it would help to address systemic risk and 

lead to a more predictable bankruptcy process. In addition, such a priority 

might provide an incentive for firms to continue to provide short-term 

funding when a financial company experiences distress. One legal expert 

noted that the special bankruptcy laws for railroads had a provision that 

any creditor providing funding in the 6 months leading up to a bankruptcy 

 

45For example, in GAO-11-707, we found that Lehman faced a liquidity crisis just prior to 

declaring bankruptcy when banks refused to lend money for its brokerage and other 

services. As a result, Lehman had difficulty rolling over borrowings of about $100 billion 

dollars every day to pay off maturing commercial paper and other commitments. More 

generally, when questions about the quality of subprime mortgages arose, investors 

became unwilling to make loans secured by a wide range of assets. When they could not 

borrow to meet their obligations, financial institutions were forced to sell assets, putting 

additional downward pressure on asset prices. As a result, some financial institutions had 

to put up more collateral and further mark down asset values leading to further intertwined 

downward spirals in asset and funding markets. 

46Daniel K. Tarullo, “Evaluating Progress in Regulatory Reforms to Promote Financial 

Stability, (speech at the Peterson Institute for International Economics, Washington, D.C., 

May 3, 2013) and William C. Dudley, “Fixing Wholesale Funding to Build a More Stable 

Financial System,” (speech at the New York Bankers Association’s 2013 Annual Meeting 

and Economic Forum, New York, N.Y., Feb. 1, 2013). 
 

Page 27 GAO-13-622 Financial Company Bankruptcies

had priority over other creditors in that bankruptcy proceeding. This type 

of provision might have created an incentive to provide funding to a 

railroad experiencing short-term financing issues and thus, might have 

prevented a bankruptcy. However, a legal expert at our second 

roundtable said that this would create unfair treatment for creditors 

providing long-term financing, because long- and short-term creditors 

were members of the same creditor class.

While a priority for short- over long-term creditors might reduce the 

incentive to withdraw funding leading up to a bankruptcy and reduce the 

likelihood of systemic issues associated with liquidity shortages during a 

bankruptcy, it could have additional consequences. For example, such a 

priority would provide more of an incentive for creditors to provide shortrather than long-term funding. If there were less likelihood that these 

short-term creditors would lose their funds in the case of a default 

because they had priority over other creditors, they might be less likely to 

monitor the credit-worthiness of borrowers. As a result, the market might 

be less likely to discipline companies that take on excessive risk. 

Although promoting market discipline is not among the criteria we 

identified for orderly and effective bankruptcies, it is a goal of the DoddFrank Act.

Experts at our roundtables evaluated proposals to change the treatment 

of certain QFCs relative to criteria for orderly and effective financial 

company bankruptcies. Specifically, they discussed the effects of 

proposals for removing all safe harbors for QFCs; partially rolling back 

safe harbors on specific contracts; implementing a temporary stay for all 

or certain contracts; and allowing trustees to “avoid” contracts entered 

into within specified periods prior to the bankruptcy filing if they are 

determined to be preferential or fraudulent.47 The experts generally 

agreed that limiting safe-harbor treatment would affect derivative and 

repurchase agreement markets and could limit short-term funding options 

for financial companies especially in periods of distress. However, the 

experts had differing views on the advantages and disadvantages of the 

 

47Trustees can avoid contracts entered into in the 90 days prior to a bankruptcy if they are 

determined to be preferential; up to two years prior to a bankruptcy if they are determined 

to be fraudulent. We provided the experts with another proposal—keeping contracts open 

after bankruptcy with revaluations determined by the courts—but experts did not address 

it, so it is not included in this discussion. 

Experts Had Varying 

Views on Advantages 

and Disadvantages of 

QFC Proposals
 

Page 28 GAO-13-622 Financial Company Bankruptcies

proposals, and those views are still evolving as lessons learned from the 

treatment of these contracts during the Lehman Brothers bankruptcy 

remain unclear.

The roundtable experts generally agreed that limiting the safe-harbor 

treatment—removing it all together or providing it to a more limited set of 

contracts—would reduce the use of derivatives and repurchase 

agreements. Some experts have noted that these markets grew 

substantially after additional types of contracts were granted safe-harbor 

treatment in 2005 (see fig. 2). However, one expert we spoke with noted 

that in his opinion the industry has tended to overstate the impact that 

limiting the safe harbors would have on the size of the markets, which the 

expert thought would likely be minimal.

Experts Generally Agreed 

That Limiting Safe-Harbor 

Treatment of QFCs Would 

Affect Markets and 

Funding Availability
 

Page 29 GAO-13-622 Financial Company Bankruptcies

Figure 2: Primary Dealer Repurchase Agreements and Global Over-the-Counter Derivatives Markets, 2000 to 2012

Several of the roundtable experts thought that if downsizing these 

markets was a goal, it should be done directly through regulations rather 

than through changes in the Code. For example, the experts noted that 

derivatives markets have been undergoing vast change as a result of 

requirements in the Dodd-Frank Act (such as requiring certain contracts 

to be tracked more effectively and traded on exchanges). However, 

another expert noted that it would be good if the Code were consistent 

with regulatory goals. Limiting the safe harbors would reduce the 

availability of short-term funding for financial companies. Short-term 

funding for financial companies creates flexibility, but, at the same time, it 

sets the stage for potential runs on firms.
 

Page 30 GAO-13-622 Financial Company Bankruptcies

As figure 3 shows, there was little consensus in written responses 

provided by our roundtable experts on how, if at all, changes in QFC 

treatment under the Code would affect the orderliness and effectiveness 

of financial company bankruptcies (see app. II for more detailed 

information on the proposals).48 However, most of our roundtable experts 

responded that removing all of the safe harbors would detract from 

orderliness and effectiveness and none of them responded that this would 

greatly enhance orderliness and effectiveness. For the other proposals, 

the experts were split fairly evenly in their written responses between 

those who thought the proposal would enhance the orderliness and 

effectiveness and those who thought it would detract from orderliness and 

effectiveness. Many of the experts who thought allowing trustees to 

“avoid” contracts would detract from orderly and effective bankruptcies 

chose “greatly detract.” Generally, those experts representing industry 

interests noted that the proposals would detract from orderliness and 

effectiveness, and those in favor of adopting certain proposals thought 

that industry opposition would be difficult to overcome.

Figure 3: Expert’s Evaluation of How QFC Proposals Would Affect Orderliness and 

Effectiveness of Financial Company Bankruptcies, 2013

a

Trustees’ generally can “avoid” contracts entered into in the 90 days prior to a bankruptcy if they are 

determined to be preferential; up to 2 years prior to a bankruptcy if they are determined to be 

fraudulent.

 

48We provided the experts with another proposal on keeping contracts open after 

bankruptcy with revaluations determined by the courts but experts spent almost no time 

addressing it so it is not included in this discussion.

Experts Held Varying 

Views on Proposal Impacts 

Relative to Orderliness and 

Effectiveness
 

Page 31 GAO-13-622 Financial Company Bankruptcies

Experts at the roundtable noted that even if there was high-level 

agreement on what changes to the Code were needed, legal experts 

might disagree on the precise details. For example, with regard to the 

safe-harbor exemptions from avoidance actions—trustees’ ability to 

“avoid” transfers entered into in the 90 days prior to a bankruptcy if they 

are determined to be preferential or up to 2 years prior to a bankruptcy if 

they are determined to be fraudulent—some legal experts at the second 

roundtable said that the courts were giving preferential treatment to 

contracts that in principle should not be receiving it. Specifically, they said 

that the courts were interpreting section 546(e) of the Code in a way that 

allows contracts that otherwise might be considered preferential or 

fraudulent to remain in force.49 As a result, they noted that changes to the 

Code might be made to tighten that section. For example, a roundtable 

expert said that section 546(e) of the Code should be changed so that 

fictional transactions, such as Ponzi scheme payments, would not receive 

such treatment.50 Another legal expert cited a number of cases in which 

contracts entered into within 90 days prior to the bankruptcy filing, which 

would be considered preferential without the safe-harbor exemption, were 

being given safe-harbor treatment. For example, in the bankruptcy case 

of communications company Quebecor, insurance companies that held 

private placement notes that qualified for safe-harbor treatment had 

received 105 cents on the dollar while other unsecured creditors received 

 

49Section 546(e) states, with certain exceptions, the trustee may not avoid a transfer that 

is a margin payment or settlement payment made by or to a commodity broker, forward 

contract merchant, stockbroker, financial institution, financial participant, or securities 

clearing agency, or that is a transfer made by or to one of the entities listed above in 

connection with a securities contract, commodity contract, or forward contract made 

before the bankruptcy. 

50See for example, Picard v. Katz, 462 B.R. 447, 451-52 (S.D.N.Y. 2011). 
 

Page 32 GAO-13-622 Financial Company Bankruptcies

a fraction of a dollar.51 The expert and others said that it might be useful 

to allow a judge to make decisions relative to some contracts. However, 

one expert at the roundtable noted that this could be a very long, complex 

process. In addition, allowing the judge to decide which contracts would 

get safe-harbor treatment when counterparties defaulted would increase 

the uncertainty attached to those contracts.

Our roundtable experts also varied in their evaluations of the proposals 

relative to some of the specific criteria we had identified for orderliness 

and effectiveness such as limiting systemic risk, avoiding fire sales, 

maximizing value, and preserving due process.

When explicitly asked, some experts responded that limiting the safe 

harbors would increase systemic risk, while others responded that limiting 

them would reduce it. Such a dichotomy could result from differences in 

the way the experts viewed markets.52 Having the safe harbors likely 

increases dependence on short-term funding and thus increases the 

chance for a run if questions arise about a company’s financial 

soundness. In addition, needing to sell off assets because of a lack of 

funding could lead to a spiral of falling asset prices. However, safe 

harbors are also thought to limit systemic effects before and during a 

bankruptcy. According to an expert at the second roundtable, if 

counterparties are certain about the safe-harbor treatment of their 

contracts, such treatment may limit runs prior to bankruptcy because 

counterparties know they will be able to terminate or liquidate their 

 

51In September 2012, the District Court upheld a Bankruptcy Court ruling that Quebecor’s 

payment of more than $376 million to purchase and redeem a series of private placement 

notes that an affiliated company had issued years earlier were settlement payments. In re: 

Quebecor World (USA) Inc., 480 B.R. 468 (S.D.N.Y. 2012). By being deemed settlement 

payments, the money was protected by the § 546(e) safe harbor which prevented the 

bankruptcy estate from pulling the money back into the estate and permitted the note 

holders to retain the money they had been paid. This decision was based on an earlier 

decision in the Enron case. In the June 2011 Enron decision, the Appeals Court 

determined that Enron’s payments to certain companies to retire specific commercial 

paper prior to its maturity was within the § 546(e) safe harbor because they were 

settlement payments. Thus, Enron’s trustees could not have the commercial paper 

holders return that money to the Enron estate. In re: Enron Creditors Recovery Corp., 651 

F.3d 329 (2011). The Quebecor District Court decision was upheld by the Appeals Court 

in June 2013. In re: Quebecor World (USA) Inc., 2013 U.S. App. LEXIS 11615 (2d App., 

June 10, 2013). 

52Mark J. Roe, “The Derivatives Market’s Payment Priorities as Financial Crisis 

Accelerator,” Stanford Law Review, Vol. 63, no. 3 (March 2011). 

Limiting Systemic Risk and 

Avoiding Fire Sales 
 

Page 33 GAO-13-622 Financial Company Bankruptcies

positions in case of default. In addition, the safe harbors primarily exist to 

limit market turmoil during a bankruptcy—that is, they are to prevent the 

insolvency of one firm from spreading to other firms and possibly 

threatening the collapse of an affected market. Although FSOC has 

reported on threats to financial stability from derivative and repurchase 

agreement markets, as with proposals to change regulators’ roles under 

the Code, they have not considered the implications of potential changes 

to the safe-harbor treatment of these contracts during bankruptcy.

The roundtable experts made a number of specific points relative to the 

impact of QFC treatment on systemic risk and fire sales of assets. One 

expert at the second roundtable noted that during the early days of the 

Lehman Bankruptcy, he thought that the QFC terminations would lead to 

a systemic event in derivatives markets, but that did not happen. The 

expert questioned whether the lack of a systemic event reflected 

Lehman’s small share of the market—5 percent—or the safe-harbor 

protection. In contrast, the commercial paper market did experience a 

systemic event—becoming illiquid after the Lehman bankruptcy. 

However, another participant noted that it was not the claims process in a 

bankruptcy that caused systemic risk; it was the uncertainty, the effect on 

counterparties, and market reactions. Roundtable participants also 

discussed the likelihood that safe-harbor treatment or bankruptcy in 

general could create asset fire sales. One expert noted that fire sales 

were more likely to occur in the period leading up to bankruptcy rather 

than after the bankruptcy was filed. Another industry expert noted that 

some unpublished research suggests that fire sales of Lehman’s assets 

that might have resulted from the treatment of QFCs did not take place 

following the bankruptcy filing. Instead, counterparties terminated only 

those contracts that had maintained their value.

Roundtable experts noted that conflicts might arise depending on whether 

the goal of a bankruptcy proceeding was to maximize value for the 

economy, for the debtors, or for the creditors. One legal expert noted that 

in a time of financial crisis, balancing market expectations and needs 

against the needs of an individual company was difficult. Debtors usually 

are expected to fare best when companies can be reorganized under 

Chapter 11. Under Chapter 11, the purpose of the automatic stay is to 

preserve the value of companies while debtors consider their options. 

However, one roundtable expert noted that with the rapid dissolution of 

value for a financial company as a result of the safe harbors, liquidation is 

a more likely outcome than reorganization. Another expert noted that 

even if QFCs were stayed, value could dissipate quickly in financial 

company bankruptcies because that value rests on the confidence of the 

Maximizing Value
 

Page 34 GAO-13-622 Financial Company Bankruptcies

debtors’ counterparties. In addition, one expert raised concern about the 

impact of the safe harbors on the remaining value for creditors after QFC 

positions were terminated. In a bankruptcy, creditors compete with 

counterparties to derivative contracts and repurchase agreements for a 

firm’s assets. Allowing the QFCs to be terminated while other debts are 

stayed means there are fewer assets available for those creditors. 

However, since creditors know that they are less well protected in 

bankruptcy, they should command a higher price for the risk they are 

taking when they provide credit. So, determining whether creditors are 

being disadvantaged overall is difficult.

Roundtable participants also discussed whether a temporary stay for 

QFCs would enhance the value of a financial company; however, as 

noted earlier, they were split on whether this would contribute or detract 

from the overall orderliness and effectiveness of financial company 

bankruptcies. For example, while several experts said that a temporary 

stay might facilitate a sale of a company’s derivatives to a third party, the 

sale would increase concentration in the market and ultimately contribute 

to greater overall systemic risk. Other experts agreed that a temporary 

stay would be useful only to the extent that an exit strategy, such as 

selling to a third-party buyer, was available or a bridge company—which 

is a temporary company used to maintain the failed company’s 

operations—could be constructed. These experts cited the case of 

General Motors as an example of what they were suggesting. However, 

the newly formed company in the case of General Motors was not 

temporary. In contrast, one expert presented a hypothetical example that 

did not involve a sale of the whole entity to a third party or the 

construction of a bridge company. In this example the judge would have 

from a 10 to 12 day stay, which might allow the judge to dispose of pieces 

of the company, leaving a small enough entity that its assets could be 

liquidated through normal bankruptcy proceedings. However, other 

experts noted that it might be difficult to determine what the appropriate 

number of days for a temporary stay might be.

Several of the experts at our roundtables questioned whether bankruptcy 

reforms designed to deal with systemically important financial companies 

would adequately protect due process given the need to move quickly in 

such a bankruptcy. They suggested that due process might be 

compromised or would depend on the ability of counterparties and 

creditors to take action after regulators or courts make decisions (as is 

the case with OLA). For example, if preferences were given to some 

counterparties or creditors during a temporary stay, other counterparties 

or creditors would have the right to take action to recover value or “claw 

Maintaining Due Process and 

Providing Certainty 
 

Page 35 GAO-13-622 Financial Company Bankruptcies

back” value later in the process, as opposed to having a judge consider 

the views of all of the parties prior to making any decisions.

Roundtable experts noted that some changes to the Code relative to the 

treatment of QFCs could create uncertainty in the process. Specifically, 

counterparties need certainty about bankruptcy treatment when they 

enter a contract. To provide that certainty, several experts agreed that 

changes should be detailed in the terms of the contract rather than 

determined at the time of the bankruptcy. However, one of the experts 

noted that even with provisions specified in the Code, counterparties 

might still be uncertain for some time about how certain contracts would 

be treated. Although the Code had been amended in 2005 to extend safeharbor treatments to more types of repurchase agreements, that expert 

said that uncertainty as to how the courts would treat repurchase 

agreements contributed to the Lehman Brothers bankruptcy. Leading up 

to the bankruptcy, counterparties were unwilling to extend new short-term 

funding because of the uncertainty—essentially precipitating a run on the 

firm.

Our roundtable experts noted other issues that would arise relative to 

making any changes in the Code, such as whether contracts that already 

existed would be processed under the Code at that time or under the new 

Code. One expert said that contracts should be grandfathered, while 

another pointed out that the grandfathered contracts might be around for 

another 30 years, creating other difficulties. While it is difficult to assess 

how many contracts would be long term, key contracts are thought to be 

used for overnight funding. When the 2005 changes were made to 

expand the contracts receiving safe-harbor treatment, the new treatment 

applied to all contracts, including those that had been entered into prior to 

that time. Some roundtable experts further suggested that not knowing 

which judge will have a case and how that judge will make decisions can 

introduce additional uncertainty into the treatment of certain contracts.

Not knowing whether a qualified financial contract would be subject to the 

Code or OLA creates further uncertainty about how a contract will be 

treated. Under the latter, FDIC becomes the receiver of the company and 

QFCs are stayed for 1 business day. During that day, FDIC has an 

opportunity to transfer a company’s derivatives to a third-party or bridge 

company. Under OLA, FDIC can choose to transfer contracts with one 

company to the bridge company while choosing not to transfer those with 
 

Page 36 GAO-13-622 Financial Company Bankruptcies

another company. However, if FDIC chooses to transfer a contract with a 

specific company, it would have to transfer all of the contracts with that 

company.53 There was some presumption among roundtable participants 

that very large systemically important institutions would be resolved under 

OLA rather than through bankruptcy. However, FDIC officials testified 

before the Subcommittee on Oversight and Investigations of the House 

Committee on Financial Services in April 2013 that under the Dodd-Frank 

Act, bankruptcy is the preferred resolution framework in the event of a 

failure of a systemically important financial company.54

Experts at our roundtable said that the lessons learned from the Lehman 

bankruptcy that might be applied in considering changes to the safe 

harbors are still unclear. Early reports and statements about the LBHI 

bankruptcy said that in the first 5 weeks after LBHI filed for bankruptcy, 

approximately 80 percent of its derivatives counterparties terminated 

contracts that were not subject to the automatic stay.55 However, some of 

the initial counterparty claims have been found to have been overstated. 

Two experts at our second roundtable specifically noted that the large 

initial loss in value was, in part, the result of LBHI counterparties’ initially 

overstating their claims against LBHI, and subsequently some of these 

claims have been overturned in adversary proceedings. For example, 

Swedbank AB, a Swedish bank, that was a creditor of LBHI, sought to 

offset Lehman’s payment obligations under prepetition swaps with 

deposits Lehman had made at Swedbank after filing for bankruptcy. The 

Bankruptcy Court of the Southern District of New York ruled against 

Swedbank, holding that the post petition deposits could not be used to 

offset prepetition swaps.56 In another proceeding involving the Lehman 

 

53If FDIC chooses not to transfer a contract with a specific company, none of the contracts 

with that company may be transferred. 

54FDIC, Statement of Federal Deposit Insurance Corporation on Who Is Too Big To Fail? 

Examining the Application of Title I of the Dodd-Frank Act (Washington D.C.: Apr. 16, 

2013).

55See appendix III for information on how qualified contracts may be liquidated, 

terminated, or accelerated under the Code. 

56In re Lehman Bros. Holdings, Inc., 433 B.R. 101(Bankr. S.D. N.Y. 2010) (“Memorandum 

Decision Granting Debtors’ Motion Pursuant to Sections 105(a) and 362 of the Bankruptcy 

Code for an Order Enforcing the Automatic Stay Against and Compelling Payment of 

Post-Petition Funds by Swedbank AB”). The decision said that the payments lacked 

mutuality. 

Experts Noted That 

Lessons Learned from 

Lehman Bankruptcy Are 

Still Unclear
 

Page 37 GAO-13-622 Financial Company Bankruptcies

bankruptcy, a lender, Bank of America, seized the debtor’s account funds, 

which were unrelated to any safe-harbor transaction, to set off certain 

contracts that could receive safe-harbor treatment. The court ruled that 

the bank’s use of the funds to set off the transactions violated the 

automatic stay.57 Further, some experts no longer supported proposals 

they had originally made in response to Lehman’s early perceived losses.

As a result, experts continue to weigh whether changes to the treatment

of derivatives and repurchase agreements under the Code are needed. 

The Hoover Institution resolution project group continues to discuss their 

proposals and plans to issue additional publications on their Chapter 14 

proposals. The American Bankruptcy Institute has a Commission to Study 

the Reform of Chapter 11 and has appointed advisory committees to 

consider various aspects, including the treatment of QFCs. Its work is 

expected to continue for some time. Throughout the roundtable 

discussion, the participants noted that changes to the Code should not be 

made without considering ongoing changes in the broader legal and 

regulatory environment for derivatives. Specifically, they noted that the 

Dodd-Frank Act calls for a number of significant changes in the regulation 

of derivatives that are still being implemented, and the industry is looking 

at potential changes to derivatives contracts. Finally, experts noted the 

need to make changes consistently across international borders, 

especially in the United States and United Kingdom. During the Lehman 

Brothers bankruptcy, differences in the treatment of various contracts 

caused courts in the United States and United Kingdom to rule in 

opposing ways on the same contracts.

The financial crisis and the failures of some large financial companies 

raised questions about the adequacy of the Code for effectively 

reorganizing or liquidating these companies without causing further harm 

to the financial system. Although the Dodd-Frank Act created OLA, an 

alternative resolution process, filing for bankruptcy under the Code 

remains the preferred resolution mechanism even for systemically 

important financial companies. Some proposals to modify the Code 

recognize that currently the Code may not adequately address threats to 

financial stability. Some proposals—changing the role of regulators in the 

 

57Bank of America, N.A. v. Lehman Brothers Holdings, Inc., 439 B.R. 811 (Bankr. S.D. 

N.Y. 2010). 

Conclusions 
 

Page 38 GAO-13-622 Financial Company Bankruptcies

bankruptcy process, creating funding mechanisms, and limiting the safeharbor treatment of qualified financial contracts—may address this 

potential shortcoming. However, experts are not ready to recommend 

specific changes to the Code and the proposals require further 

consideration. FSOC—which was established under the Dodd-Frank Act 

to identify and respond to threats to financial stability—has not specifically 

considered changes to the role of regulators in bankruptcy or the 

treatment of QFCs. Although the Dodd-Frank Act does not explicitly 

require FSOC to assess changes to the Code, it is well positioned to take 

a broad view of potential changes within the context of other regulatory 

and market changes prescribed by the act. It is also well positioned to 

decide the appropriate level of attention such changes merit. Such 

attention to the systemic implications of financial company bankruptcies 

could improve FSOC’s ability to take timely and effective action to identify 

and respond to threats to U.S. financial stability.

To fulfill FSOC’s role under the Dodd-Frank Act to identify and respond to 

threats to financial stability, we recommend that the Secretary of the 

Treasury, as Chairperson of FSOC, in consultation with other FSOC 

members, consider the implications for U.S. financial stability of changing 

the role of regulators and narrowing the safe harbor treatment of qualified 

financial contracts in financial company bankruptcies.

We provided a draft of this report to AOUSC, CFTC, FDIC, the Federal 

Reserve, NAIC, the Departments of the Treasury and Justice, and SEC, 

for review and comment. CFTC, FDIC, NAIC, and SEC provided technical 

comments, which we have incorporated as appropriate. AOUSC, the 

Federal Reserve, and Department of Justice did not provide comments. 

Treasury’s Under Secretary for Domestic Finance, on behalf of the 

Chairperson of FSOC, provided written comments, which are reprinted in 

appendix IV. 

In commenting on our draft report, FSOC said that it shares our concern 

that a disorderly financial company bankruptcy could pose risks to 

financial stability. However, FSOC stated that it would be premature for 

FSOC to prioritize the consideration of proposals to amend the Code until 

the Dodd-Frank Act is fully implemented or there is evidence of risks that 

cannot be adequately addressed within existing law. FSOC added that 

the Federal Reserve Board and FDIC are currently implementing 

provisions of the Dodd-Frank Act requiring designated financial 

companies to submit resolution plans ("living wills") to facilitate their 

Recommendations for 

Executive Action

Agency Comments
 

Page 39 GAO-13-622 Financial Company Bankruptcies

orderly resolution under the Code. FSOC also noted that it is facilitating 

communication and coordination on the implementation of OLA and living 

will requirements. FSOC noted further that the council is engaged in a 

variety of other actions to address risks to financial stability posed by the 

failure of one or more financial companies such as the designation of 

nonbank financial companies.

We acknowledge FSOC’s efforts to implement the Dodd-Frank Act and 

the actions they have taken to address risks to financial stability, including 

some actions related to implementing OLA. However, rather than 

considering changes to the Code after the Dodd-Frank Act is fully 

implemented, our recommendation is intended to encourage FSOC to 

actively address such changes in conjunction with these efforts—

particularly as some suggested changes would affect regulators’ and 

ultimately FSOC’s ability to respond to the failure of a large complex 

institution. First, changing the role of regulators in a financial company 

bankruptcy could be critical for effective resolution. For example, the point 

at which regulators become aware of an impending or actual financial 

company bankruptcy could be critical to determining whether its living will 

could be used to improve the orderliness and effectiveness of the 

bankruptcy. Similarly, timing could be critical in determining whether to 

use OLA, which is to be used if a bankruptcy under the Code were

determined to have serious adverse effects on U.S. financial stability. 

Second, narrowing the treatment of QFCs could also have implications for 

limiting systemic risk. As some members of the council have stated

publicly, bankruptcy remains the preferred method for resolving failing 

financial companies. Given that preference and FSOC’s charge to identify 

and respond to risks to U.S. financial stability, our recommendation—that 

FSOC consider the implications for U.S. financial stability of changing the 

role of regulators and narrowing safe harbor treatment of QFCs in 

financial company bankruptcies—is consistent with its statutory role and 

responsibilities.

We are sending copies of this report to the appropriate congressional 

committees, the Director of the Administrative Office of the U.S. Courts, 

Chairman of the Commodity Futures Trading Commission, Attorney 

General, Secretary of the Treasury, Chairman of the Federal Deposit 

Insurance Corporation, Director of the Federal Judicial Center, Chairman 

of the Board of Governors of the Federal Reserve System, Chief 

Executive Officer of the National Association of Insurance 

Commissioners, Chairman of the Securities and Exchange Commission, 
 

Page 40 GAO-13-622 Financial Company Bankruptcies

and other interested parties. The report also is available at no charge on 

the GAO website at http://www.gao.gov. 

If you or your staff members have any questions about this report, please 

contact Alicia Puente Cackley at (202) 512-8678 or cackleya@gao.gov. 

Contact points for our Offices of Congressional Relations and Public 

Affairs may be found on the last page of this report. Major contributors to 

this report are listed in appendix V.

Alicia Puente Cackley

Director

Financial Markets and Community Investment
 

Page 41 GAO-13-622 Financial Company Bankruptcies

List of Committees

The Honorable Tim Johnson

Chairman

The Honorable Mike Crapo

Ranking Member

Committee on Banking, Housing, and Urban Affairs

United States Senate

The Honorable Patrick J. Leahy

Chairman

The Honorable Charles E. Grassley

Ranking Member

Committee on the Judiciary

United States Senate

The Honorable Jeb Hensarling

Chairman

The Honorable Maxine Waters

Ranking Member

Committee on Financial Services

House of Representatives

The Honorable Robert W. Goodlatte

Chairman

The Honorable John Conyers, Jr.

Ranking Member

Committee on the Judiciary

House of Representatives
Appendix I: Objectives, Scope, and 

Methodology

Page 42 GAO-13-622 Financial Company Bankruptcies

Section 202(e) of the Dodd-Frank Wall Street Reform and Consumer 

Protection Act (Dodd-Frank Act) mandated that we report on the 

orderliness and efficiency of financial company bankruptcies every year 

for 3 years after passage of the act, in the fifth year, and every 5 years 

thereafter.1 This report, the third in the series, examines the advantages 

and disadvantages of certain proposals to modify the Bankruptcy Code 

(Code) for financial company bankruptcies. Specifically this report 

examines the advantages and disadvantages of proposals (1) to change 

the role of financial regulators in the bankruptcy process; (2) affecting the 

funding of financial company bankruptcies; and (3) to change the safeharbor treatment of qualified financial contracts (QFC), including 

derivatives and repurchase agreements.

To address all of our objectives, we reviewed relevant laws, including the 

Code and the Dodd-Frank Act as well as GAO reports that addressed 

bankruptcy issues and financial institution failures. We specifically 

reviewed the reports we issued during the first 2 years of the mandate as 

well as reports written under the same or similar mandates by the 

Administrative Office of the United States Courts (AOUSC) and the Board 

of Governors of the Federal Reserve System (Federal Reserve).2 We also 

updated our review of published economic and legal research on the 

effectiveness of bankruptcies that we had originally completed during the 

first year of the mandate. For the original search we relied on Internet 

search databases (including EconLit and Proquest) to identify studies 

published or issued after 2000 up through 2010. We reviewed these 

articles to further determine the extent to which they were relevant to our 

engagement, that is, whether they discussed criteria for effectiveness of 

the bankruptcy process, key features of the bankruptcy process, or 

 

1

Pub. L. No. 111-203, § 202(e). The Administrative Office of the U.S. Courts (AOUSC) is 

also required to address Pub. L. No. 111-203, § 202(e) on the same time frame. The 

Board of Governors of the Federal Reserve System (Federal Reserve) was required to 

address a similar mandate—Pub. L. No. 111-203, § 216—in July 2011. 

2

GAO, Bankruptcy: Complex Financial Institutions and International Coordination Pose 

Challenges, GAO-11-707 (Washington, D.C.: July 19, 2011) and Bankruptcy: Agencies 

Continue Rulemakings for Clarifying Specific Provisions of Orderly Liquidation Authority, 

GAO-12-735 ((Washington, D.C.: July 12, 2012); AOUSC, Report Pursuant to Section 

202(e) of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, 

(Washington, D.C.: July 2011) and Second Report Pursuant to Section 202(e) of the 

Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010, Pub. L. No. 111-

203 (2010), (Washington, D.C.: July 2012); and Federal Reserve, Study on the Resolution 

of Financial Companies under the Bankruptcy Code (Washington, D.C.: July 2011).

Appendix I: Objectives, Scope, and 

Methodology 
Appendix I: Objectives, Scope, and 

Methodology

Page 43 GAO-13-622 Financial Company Bankruptcies

proposals for improving the bankruptcy process. We augmented this 

Internet search with articles provided by those we interviewed or obtained 

from conferences. In addition, we reviewed a number of prior GAO 

reports on financial institutions and the financial crisis. For this report, we 

replicated the literature search for 2011 and 2012. Further we met with 

officials at the following federal government agencies: AOUSC; the 

Commodity Futures Trading Commission; Federal Deposit Insurance 

Corporation; Department of Justice; Department of the Treasury, 

including officials who support the Financial Stability Oversight Council 

(FSOC); Federal Reserve; and Securities and Exchange Commission. In 

addition we met with officials of the National Association of Insurance 

Commissioners and members of insurance departments in Illinois, Iowa, 

and Texas.

We relied on our earlier work and the updated literature review to 

establish criteria for orderliness and effectiveness and to develop a list of 

proposals related to the role of regulators in the bankruptcy process or 

the role of government in financing bankruptcies, as well as proposals to 

change the safe-harbor treatment of certain financial contracts. In our 

earlier work, we analyzed the results of the literature review and expert 

interviews to determine criteria for orderliness and effectiveness of 

financial company bankruptcies. These criteria are minimizing systemic 

risk, avoiding fire sales, maximizing value; preserving due process, and 

minimizing taxpayer liability. In that work, we also used the literature 

review to determine the range of proposals that had been made to reform 

the bankruptcy process for financial institutions. We categorized some of 

the proposals into groups, such as those that included a role for the 

regulators or modified the treatment of qualified financial contracts, and 

then asked the experts looking at these categories and specific proposals 

to tell us which they considered had merit and should be included for 

further consideration and why. We also updated the literature review to 

determine whether earlier proposals had evolved, proposals had been 

subject to critical review, or additional proposals had been made. As we 

had for our earlier work, we surveyed relevant government agencies for 

information on newer studies they had or were conducting or were aware 

of related to our objectives.

To obtain expert views on existing proposals and how these proposals 

might be improved, we convened two roundtables to discuss the 

advantages and disadvantages of specific proposals. The roundtables 

were held at the National Academy of Sciences (NAS) and staff at NAS 

assisted with determining who would sit on the roundtables. Generally, 

roundtable members were chosen for their expertise on bankruptcy and 
Appendix I: Objectives, Scope, and 

Methodology

Page 44 GAO-13-622 Financial Company Bankruptcies

financial institutions and markets. We also discussed potential experts for 

our roundtables with the relevant government agencies listed previously. 

Specifically, we relied on a list of experts compiled for the first report 

under this mandate. These experts represented a wide range of interests 

including academics, industry representatives, judges, and practicing 

attorneys. The experts had made proposals, written extensively on 

bankruptcies or financial institutions, or were recommended by relevant 

government agencies. In addition, relevant government agencies and 

NAS suggested additional potential participants for our roundtables, 

whom we considered using our original criteria and the balance of the 

experts at the roundtables. Final participants for the roundtables were 

chosen for their expertise and to ensure that a number of interested 

parties were included. These included academics, industry 

representatives, judges, practicing attorneys, and regulators. To ensure 

that participants represented a broad range of views and interests and 

that we fully understood those interests, we required that participants 

complete a conflict of interest form. See appendix II for a list of 

participants in each roundtable, as well as background materials and 

agendas.

Participants at the first roundtable held on April 1, 2013, discussed the 

role of regulators in the bankruptcy process for financial companies and 

how those bankruptcies might be financed.3 The proposals discussed 

were:

1. Require the debtor to notify and consult with regulators (primary, 

functional, Financial Stability Oversight Council, foreign, or other) in 

advance of filing for bankruptcy.

2. Allow regulators (primary, functional, Financial Stability Oversight 

Council, foreign, or other) to commence an involuntary bankruptcy in 

the event that the firm is insolvent or in imminent danger of becoming 

insolvent.

3. Allow regulators (primary, functional, Financial Stability Oversight 

Council, foreign, or other) of the debtor or its subsidiaries to have 

standing or a right to be heard in the courts to raise issues relative to 

regulation.

 

3

We provided the experts with another proposal on granting regulators the right to file 

reorganization plans and motions for sale of property but experts spent almost no time 

addressing it so it is not included in this discussion. See appendix II. 
Appendix I: Objectives, Scope, and 

Methodology

Page 45 GAO-13-622 Financial Company Bankruptcies

4. Consider the role of regulators (primary, functional, Financial Stability 

Oversight Council, foreign, or other) in determining what subsidiaries 

should be included in a bankruptcy proceeding, the extent to which 

complex firms might be consolidated in bankruptcy, including the 

possibility of revoking the exclusion from bankruptcy for insurance 

companies and the exclusion from Chapter 11 for stock and 

commodities brokers.

5. Restrict U.S. Treasury and Federal Reserve from participating in 

bankruptcy financing.

6. Allow the government to provide subordinated debtor-in-possession 

financing to companies with assets greater than $100 million 

(subsidiaries included) with a hearing and the court’s approval and 

oversight.

Similarly, participants in the second roundtable, held on April 10, 2013, 

discussed proposals to change the safe-harbor treatment of certain 

financial contracts such as derivatives and repurchase agreements.4 The 

proposals discussed during this roundtable were:

1. Removing all safe harbors for qualified financial contracts.

2. Partially rolling back safe harbors on specific contracts; such as

a. allowing only contracts traded on an exchange to have safeharbor treatment;

b. limiting collateral sales of repos by counterparties to cash-like or 

highly marketable securities; or

c. allowing roll backs with approval of the Financial Stability 

Oversight Council or the courts.

3. Implementing a temporary stay for all or certain contracts.

4. Exercising certain “reach back” avoiding powers for qualified financial 

contracts.

In both cases participants discussed the advantages and disadvantages 

of the proposals relative to our criteria for orderly and effective 

bankruptcies. In addition they discussed impediments to implementing 

proposals and how these impediments could be addressed. The agendas 

 

4

We provided the experts with another proposal on keeping contracts open after 

bankruptcy with revaluations determined by the courts, but experts spent almost no time 

addressing it so it is not included in this discussion. See Appendix II.
Appendix I: Objectives, Scope, and 

Methodology

Page 46 GAO-13-622 Financial Company Bankruptcies

for the roundtables are included in appendix II. To meet our objectives, 

we also interviewed some experts that were not able or did not choose to 

participate in the roundtables on their views about the proposals.

We used regulatory data to provide context for some expert statements.

For expert statements on the growth of large financial institutions since 

the 2007-2009 financial crisis, we used data from the Federal Reserve 

and SEC to provide measures of the growth of global systemically 

important banks from 2007 to 2012. For expert statements about the 

growth of markets for repurchase agreements and derivatives related to 

changes in the Code in 2005, we used data from FSOC’s 2013 Annual 

Report, which is signed by the principals of 9 federal agencies and the 

independent member with insurance expertise, and the Bank for 

International Settlements to provide measures of the growth of 

repurchase agreements and derivatives from 2000 to 2012. 

We conducted this performance audit from October 2012 to July 2013 in 

accordance with generally accepted government auditing standards. 

Those standards require that we plan and perform the audit to obtain 

sufficient, appropriate evidence to provide a reasonable basis for our 

findings and conclusions based on our audit objectives. We believe that 

the evidence obtained provides a reasonable basis for our findings and 

conclusions based on our audit objectives.
Appendix II: Experts, Background, and 

Agendas for Expert Roundtables

Page 47 GAO-13-622 Financial Company Bankruptcies

This appendix includes a list of the experts who participated in our 

roundtables, background information that was provided to the experts 

prior to the roundtables, and the agendas for the roundtables discussions.

Donald Bernstein, Davis Polk & Wardwell

Robert Bliss, Wake Forest University

Patrick Bolton, Columbia University

Josh Cohn, International Swaps and Derivatives Association

Christine M. Cumming, Federal Reserve Bank of New York

Marcia Goldstein, Weil, Gotshal & Manges

Allan Gropper, U.S. Bankruptcy Court, Southern District of New York

Randall Guynn, Davis Polk & Wardwell

Kevin Kelly, JPMorgan Chase & Co.

Michael Krimminger, Cleary Gottlieb Steen & Hamilton

Christopher LaRosa, Securities Investor Protection Corp.

Stephen Lubben, Seton Hall University

Carter McDowell, Securities Industry and Financial Markets Association

Thomas McGowan, Securities and Exchange Commission

Knox McIlwain, Cleary Gottlieb Steen & Hamilton

James Millstein, Millstein & Co.

Edward Morrison, University of Chicago

James Peck, U.S. Bankruptcy Court, Southern District of New York

Mark Roe, Harvard University

Paul Saltzman, The Clearing House

Kenneth Scott, Stanford University

Bruce Tuckman, New York University

David Wall, Federal Deposit Insurance Corp.

Mary Walrath, U.S. Bankruptcy Court, District of Delaware

Robert Wasserman, Commodity Futures Trading Commission

Appendix II: Experts, Background, and 

Agendas for Expert Roundtables

Expert Participants
Appendix II: Experts, Background, and 

Agendas for Expert Roundtables

Page 48 GAO-13-622 Financial Company Bankruptcies

Background Information-Roundtable 1
Appendix II: Experts, Background, and 

Agendas for Expert Roundtables

Page 49 GAO-13-622 Financial Company Bankruptcies
Appendix II: Experts, Background, and 

Agendas for Expert Roundtables

Page 50 GAO-13-622 Financial Company Bankruptcies
Appendix II: Experts, Background, and 

Agendas for Expert Roundtables

Page 51 GAO-13-622 Financial Company Bankruptcies
Appendix II: Experts, Background, and 

Agendas for Expert Roundtables

Page 52 GAO-13-622 Financial Company Bankruptcies

Background Information-Roundtable 2
Appendix II: Experts, Background, and 

Agendas for Expert Roundtables

Page 53 GAO-13-622 Financial Company Bankruptcies
Appendix II: Experts, Background, and 

Agendas for Expert Roundtables

Page 54 GAO-13-622 Financial Company Bankruptcies
Appendix II: Experts, Background, and 

Agendas for Expert Roundtables

Page 55 GAO-13-622 Financial Company Bankruptcies
Appendix II: Experts, Background, and 

Agendas for Expert Roundtables

Page 56 GAO-13-622 Financial Company Bankruptcies

Roundtable Agendas
Appendix II: Experts, Background, and 

Agendas for Expert Roundtables

Page 57 GAO-13-622 Financial Company Bankruptcies
Appendix III: Safe-Harbor Treatment of Certain 

Financial Contracts under the Bankruptcy 

Code

Page 58 GAO-13-622 Financial Company Bankruptcies

Financial derivatives derive their value from an underlying reference item 

or items, such as equities, debt, exchange rates, and interest rates. 

Parties involved in financial derivative transactions do not need to own or 

invest in the underlying reference items, and often do not. These products 

are agreements that shift risks from one party to another—each 

commonly referred to as a counterparty. Such shifting of risks may allow 

companies to offset other risks—hedging—or to take advantage of 

expectations of obtaining an economic gain due to changes in the value 

of the underlying reference items—speculation. Although some 

transactions are bilateral in that they involve only two counterparties, 

derivatives can be used to structure more complicated arrangements 

involving multiple transactions and parties.

Financial derivatives are sold and traded on regulated exchanges or in 

private, over-the-counter markets that allow highly customized 

transactions specific to the needs of the counterparties. A master netting 

agreement sets out the terms governing contractual actions between 

counterparties with multiple derivative contracts. This agreement provides 

for the net settlement of all contracts, as well as cash collateral, through a 

single payment, in a single currency, in the event of default on or 

termination of any one contract. Generally counterparties net payments to 

each other under the contract, and, if a counterparty defaults, the 

nondefaulting counterparty can immediately close-out open contracts by 

netting one against the other. It can also receive payment under what is 

called set off, which is the discharge of reciprocal or mutual obligations to 

the extent of the smaller obligation. For example, a nondefaulting bank 

can take funds from a defaulting party’s bank deposit held by the bank as 

payment for what the bank is owed on a contract it has with the defaulting 

party as long as the deposit existed prior to the default.

Financial derivatives receive special treatment under the Code and thus 

are sometimes called qualified financial contracts (QFC).1 The Code 

includes five categories commonly considered QFCs, which include 

various types of derivatives. Contracts may fall into more than one 

category. The Code includes specific definitions of the agreements and 

transactions covered. In addition, to have protection under the Code, the 

counterparty with the debtor also must meet specified definitions. The 

 

1

The Code does not define a QFC or use this term specifically. 

Appendix III: Safe-Harbor Treatment of 

Certain Financial Contracts under the 

Bankruptcy Code

Overview of Financial 

Derivatives

Contracts Qualified for 

Special Treatment under 

the Code
Appendix III: Safe-Harbor Treatment of Certain 

Financial Contracts under the Bankruptcy 

Code

Page 59 GAO-13-622 Financial Company Bankruptcies

types of derivatives qualifying for special treatment are generally 

described as follows:

Securities contract. Securities contact is a broad term defining a 

financial agreement between counterparties and may include 

contracts for the purchase and sale of various financial products 

such as a group or index of securities, mortgage loans, certificates 

of deposit, and extensions of credit for settlement purposes.2

Margin loans are one type of extension of credit through a 

financial intermediary for the purchase, sale, carrying, or trading of 

securities. Margin loans do not include other loans secured with 

securities collateral.3 Securities contracts also include options to 

purchase and sell securities, or other financial products. Options 

give their holders the right, but not the obligation, to buy (call 

option) or sell (put option) a specified amount of the underlying 

reference item at a predetermined price (strike price) at or before 

the end of the contract.

Commodities contract. In a commodities contract the 

commodities buyer agrees to purchase from the commodities 

seller a fixed quantity of a commodity at a fixed price on a fixed 

date in the future.4 Commodities can consist of agricultural goods, 

metals, and goods used for the production of energy such as 

crude oil. For example, to hedge against the risk of rising oil 

prices, oil refineries can enter a commodities contract to fix a price 

today for a future supply shipment.

Forward contract. A “forward contract” is a contract for the 

purchase, sale, or transfer of a commodity with a maturity date 

 

2

See 11 U.S.C. § 741(7).

3

H.R. Rep. No. 109-031.

4

See 11 U.S.C. § 761(4). Commodity is defined by cross-referencing the Commodity 

Exchange Act, which defines commodity to include agricultural products and “all services, 

rights, and interests in which contacts for future delivery are presently or in the future dealt 

in.” A “commodity contract” includes purchases and sales of commodities for future 

delivery on, or subject to the rules of a contract market or board of trade. Olympic Natural 

Gas, 294 F. 3d 737.741 (5th Cir. 2002).
Appendix III: Safe-Harbor Treatment of Certain 

Financial Contracts under the Bankruptcy 

Code

Page 60 GAO-13-622 Financial Company Bankruptcies

more than 2 days after the contract is entered into.5 Under the 

Code, a forward contract can include, but is not limited to, a lease, 

swap, hedge transaction, deposit, or loan.6 As an example, a firm 

may want to limit risk to fluctuations in service costs, such as 

electricity prices. The firm may enter into a forward contract with 

an electricity provider to obtain future service at a fixed rate.

Swap Agreement. A swap involves an ongoing exchange of one 

or more assets, liabilities, or payments for a specified period. 

Swaps include interest rate swaps, commodity-based swaps, and 

broad-based credit default swaps. Security-based swaps include 

single-name and narrow-based credit default swaps and equitybased swaps.7 As an example, interest rate swaps allow one party 

to exchange a stream of variable-rate interest payments for a 

stream of fixed-rate interest payments. These products help 

market participants hedge their risks or stabilize their cash flows. 

Alternatively, market participants may use these products to 

benefit from an expected change in interest rates. A credit default 

swap is generally a contract between two parties where the first 

party promises to pay the second party if a third party experiences 

a credit event such as failing to pay a debt. Credit default swaps 

are contracts that act as a type of insurance, or a way to hedge 

risks, against default or another type of credit event associated 

with a security such as a corporate bond.

Repurchase agreements are also qualified to receive special treatment 

under the Code and are thus considered to be a QFC. In a repurchase 

agreement one party sells a security, or a portfolio of securities, to 

another party and agrees to repurchase the security or portfolio on a 

specified future date—often the next day—at a prearranged price.8

 The 

 

5

See 11 U.S.C. § 101(25). The definition of “forward contact” in the Code has been found 

to include four elements: (1) a contract for the sale of a commodity; (2) with a delivery date 

more than two days after execution; (3) by a forward contract merchant; and (4) that is not 

otherwise subject to the rules of a board of trade. See In re MBS Management Services, 

Inc., 432 B.R. 570 (Bankr. E.D. La. 2010), aff’d 2010 WL 1899764 (E.D. La. 2011).

6

Outside of the Code, a forward contract has been referred to as a contract whereby the 

forward buyer agrees to purchase from the forward seller a fixed quantity of the underlying 

reference item at a fixed price on a fixed date in the future. 

7

See 11 U.S.C. § 101(53B).

8

See 11 U.S.C. § 101(47). 
Appendix III: Safe-Harbor Treatment of Certain 

Financial Contracts under the Bankruptcy 

Code

Page 61 GAO-13-622 Financial Company Bankruptcies

security, or portfolio of securities, serves as collateral for the transaction. 

In a reverse repurchase agreement, a security is purchased with the 

agreement to resell on a specified future date. Repurchase agreements 

have been used to provide financial institutions with funding for 

operations.

A bilateral repurchase agreement—a repurchase agreement solely 

between two counterparties—can be viewed as two subtransactions 

referred to as initiation and completion.9 A repurchase agreement is 

similar to a loan secured by collateral. A firm will lend cash to a 

counterparty at an interest rate in exchange for assets provided by the 

counterparty as collateral. In a repurchase agreement, a cash provider 

willing to invest cash will agree to purchase securities from a collateral 

provider, or repurchase agreement dealer. Repurchase agreement 

dealers are typically distinguished as the counterparty selling securities, 

or providing collateral, at initiation. The market value of the securities 

purchased will typically exceed the value of cash loaned to the dealer. 

When a repurchase agreement matures, securities are sold back to the 

collateral provider and cash plus interest are returned to the cash 

provider. Collateral providers or dealers are generally large financial 

institutions, such as subsidiaries within bank holding companies. Cash 

providers are firms such as, but not limited to, other large financial 

institutions, hedge funds, and money market funds. Under the Code, U.S. 

Treasury debt securities, agency debt issues, mortgage-backed 

securities, and other assets can be used as collateral in repurchase 

agreement transactions.

For most of the debtor’s assets, the Code provides an automatic stay, or 

freeze, when the bankruptcy petition is filed. That is, the filing generally 

stops lawsuits, foreclosures, and most other collection activities against 

the debtor allowing the debtor or a trustee time to eliminate or restructure 

debts. For example, set-off of any debt owed to the debtor that arose 

before the filing against any claim against the debtor is prohibited.10

Additionally, in certain situations debtors may not terminate or modify an 

 

9

Triparty repurchase agreements include three parties: the borrower, the lender, and a 

triparty agent that facilitates the repurchase agreement transaction by providing custody of 

the securities posted as collateral and valuing the collateral, among other services.

1011 U.S.C. § 362(a).

Treatment of QFCs under 

the Code
Appendix III: Safe-Harbor Treatment of Certain 

Financial Contracts under the Bankruptcy 

Code

Page 62 GAO-13-622 Financial Company Bankruptcies

executory contract at any time after the bankruptcy is filed solely because 

of a provision in the contract that is conditioned on the insolvency or 

financial condition of the debtor or the filing of bankruptcy or the 

appointing of a trustee.11 However, the QFC’s described previously 

receive safe-harbor treatment that generally exempts them from the 

automatic stay. Instead, the contractual rights—to liquidate, accelerate, or 

terminate—of nondefaulting counterparties conditioned on the insolvency 

or financial condition of one of the counterparties or the filing of 

bankruptcy or the appointing of a trustee, such as netting and setoff, are 

activated.12 Counterparties with claims against the debtor’s property are 

typically referred to as creditors.

Some contracts that are generally considered QFCs may not be eligible 

for safe-harbor treatment or may be otherwise limited. For example:

• Repurchase agreements, where the debtor is a stockbroker or 

securities clearing agency, and securities contracts that are resolved 

under the Securities Investor Protection Act of 1970 (SIPA) or any 

statute administered by Securities and Exchange Commission 

(SEC).13

• Certain commodity contracts involved in a commodity broker’s 

liquidation under Chapter 7. For example, a commodity broker creditor 

may not net or offset an obligation to a commodity broker debtor.14

• Repurchase agreements are treated differently from some other 

contracts in that any excess of the market prices received on 

liquidation over the amount of the stated repurchase agreement price 

and all expenses in connection with the liquidation of the repurchase 

 

1111 U.S.C. § 365(e)(1). In bankruptcy, an executory contract is one in which both parties 

to the contract have future performance obligations that, if unperformed by either party, 

would result in a material breach. See Regen Capital I, Inc., v. Halperin, 547 F. 3d 484 (2d 

Cir. 2008); Olah v. Baird, 567 F. 3d 1207 (10th Cir. 2009).

12See 11 U.S.C. §§ 555, 556, 559, 560. Note that the phrase “liquidate, terminate and 

accelerate” was added to the Code through amendments in 2005. Previously, the right to 

liquidate was provided for securities contracts, commodity contracts, forward contracts 

and repurchase agreements, while the right to terminate was provided for swaps. H.R. 

Rep. No. 109-031.

1311 U.S.C. § 555; 11 U.S.C. § 559.

1411 U.S.C. § 561(b)(2). 
Appendix III: Safe-Harbor Treatment of Certain 

Financial Contracts under the Bankruptcy 

Code

Page 63 GAO-13-622 Financial Company Bankruptcies

agreement must be deemed property of the debtor’s estate, subject to 

the available rights of setoff.15

• For master netting agreements, the right to terminate, liquidate, or 

accelerate is only applicable to the extent it is permissible for each 

type of QFC.16

After entities exercise their rights of netting for individual QFCs and under 

master netting agreements, some debtors still may be indebted to the 

creditor. Generally, the creditors’ remaining claims will receive the same 

treatment accorded other unsecured creditors.17

The figures below illustrate the safe-harbor exemption from the automatic 

stay in simplified, yet practical scenarios:

Figure 4 illustrates a bilateral contract, in which two counterparties are 

able to net opposing obligations of a contract, or, stated otherwise, net 

payments under a single master netting agreement. In this example, 

under current market conditions of an existing QFC, Firm A owes $100 to 

Firm B while Firm B owes $120 to Firm A. If Firm B files under the Code, 

the QFC is not stayed due to the safe harbor and Firm A receives the net 

proceeds of $20 ahead of Firm B’s other creditors. However, Firm A has 

no guarantee of recouping the total value from the QFC due to other 

factors, such as a change in market conditions. Without the safe harbors, 

Firm A would not have been able to terminate the transaction and could 

have been exposed to further market risk.

 

1511 U.S.C. § 559.

1611 U.S.C. § 561(a).

17See 11 U.S.C. § 753; 11 U.S.C. § 767.
Appendix III: Safe-Harbor Treatment of Certain 

Financial Contracts under the Bankruptcy 

Code

Page 64 GAO-13-622 Financial Company Bankruptcies

Figure 4: QFC Termination and the Netting of Obligations

Figure 5 depicts the typical completion of a repurchase agreement 

transaction along with the possibility that the creditor liquidates collateral 

in certain situations. In the case of a repurchase agreement, if a dealer 

files under the Code after the initiation but prior to completion, the cash 

provider at initiation will be left with the collateral provided by the dealer. 

Under the safe harbor, the cash provider has the option to terminate the 

transaction with the insolvent dealer. As illustrated in figure 4, the cash 

provider may terminate the transaction and sell the collateral in the open 

market to a third party. Without the safe harbor, concerns have been 

raised that a stay on the overnight repurchase agreement market could 

result in adverse market impacts due to simultaneous sales of collateral.

Figure 5: Completion of Bilateral Repurchase Agreement and Collateral Liquidation
Appendix III: Safe-Harbor Treatment of Certain 

Financial Contracts under the Bankruptcy 

Code

Page 65 GAO-13-622 Financial Company Bankruptcies

QFCs are generally also exempt from avoidance or claw back provisions 

under the Code. These provisions generally require that the trustee may 

avoid, or take back, any payments made during the 90 days before the 

filing of a bankruptcy petition if those payments are preferential or 2 years 

before the filing of the petition if those payments are fraudulent.18 But, for 

QFCs, a trustee may not recover certain transfers made by or to a swap 

participant, repurchase agreement participant, commodity broker, forward 

contract merchant, stockbroker, financial institution, financial participant, 

or securities clearing agency in connection with securities contracts, 

commodity contracts, forward contracts, repurchase agreements, or 

swaps that were done before the bankruptcy filing.19 Also, a trustee may 

not recover transfers made by or to a master netting agreement 

participant or any individual contract covered by a master netting 

agreement that was made before the bankruptcy filing.20 Since many 

QFCs are short term, and likely to be agreed to well within the 90 day 

window, these exemptions provide protection to many QFCs including 

those under master netting agreements.

 

1811 U.S.C. § 547; 11 U.S.C. § 548.

1911 U.S.C. § 546(e), (f) and (g).

2011 U.S.C. § 546(j). For both 11 U.S.C. § 546(e), (f), (g) and (j), the protection from pull 

back is not provided if the transfer was done based on fraud under 11 U.S.C. § 548(a)(1). 

For the master netting agreements it cannot be more than the extent that the trustee could 

otherwise avoid the transfer made under an individual contract covered by the master 

netting agreement. 11 U.S.C. § 546(j).
Appendix IV: Comments from the Department 

of the Treasury

Page 66 GAO-13-622 Financial Company Bankruptcies

Appendix IV: Comments from the 

Department of the Treasury
Appendix IV: Comments from the Department 

of the Treasury

Page 67 GAO-13-622 Financial Company Bankruptcies
Appendix V: GAO Contact and Staff 

Acknowledgments

Page 68 GAO-13-622 Financial Company Bankruptcies

Alicia Puente Cackley, (202) 512-8678 or cackleya@gao.gov

In addition to the contact named above, Debra Johnson (Assistant 

Director), Nancy S. Barry, Rudy Chatlos, Risto Laboski, Marc Molino, 

Barbara Roesmann, Jessica Sandler, and Jason Wildhagen made 

significant contributions to this report. Other assistance was provided by 

Janet Eackloff and Walter Vance.

Appendix V: GAO Contact and Staff 

Acknowledgments 

GAO Contact

Staff 

Acknowledgments 

(250692)
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