Jefferies Loan Syndication Deal for Harbinger Fails if CEO Falcone Charged

Jefferies Group Inc. (JEF) has been trying to spread the risk of a $190 million loan to Phil Falcone’s Harbinger Capital Partners LLC by offering a syndication deal with an unusual caveat: it defaults if Falcone is indicted.

Jefferies has been marketing all or part of the loan to other investors, said a person with knowledge of the situation. Loan documents detail the securities firm’s pitch to investors, saying it’s collateralized by $2.4 billion in assets in Harbinger’s main fund. The terms include a “key man” provision mandating the loan’s default if Falcone reduces his role, his ownership stake, or is indicted for any criminal offense.

“It’s not standard,” said Martin Fridson, global credit strategist at BNP Paribas Investment Partners, referring to the indictment clause. “Absent an ongoing investigation, companies would take offense at having such a provision in there.”

Harbinger as of November 2010 was the subject of federal probes by prosecutors and regulators into possible securities law violations, according to two people familiar with the inquiries. Falcone, 49, is Harbinger’s chairman and chief executive officer whose stake in the main fund is worth at least $850 million, according to the documents. The key man provision, one of 23 events of default listed in the loan documents, is the only one that is highlighted in the pitch book to investors.

Default Terms

Aside from the clauses that apply to Falcone, the provision specifies that that the loan will default if any other Harbinger employee is indicted for crimes tied to investment activities at the company, according to the loan documents, which were obtained by Bloomberg News.

The clause states that “events of default” that would allow “required investors” to sell collateral include “CEO of Harbinger Capital Partners LLC or president of HRG is indicted for a criminal offense.”

Such provisions are negotiated when a CEO or other official is seen as linked to a company’s performance, and could be highlighted in this case because of investigations into Harbinger by the Securities and Exchange Commission and the Justice Department, Fridson said.

Falcone, along with fund executives Omar Asali and Robin Roger, the general counsel, received notices in December from the SEC, saying the commission may sue over securities law violations. The SEC is investigating whether Harbinger gave some investors preferential treatment, and is also probing a $113 million loan Falcone took from one of his funds, according to the people familiar with the probe who declined to be identified because the matter isn’t public. The U.S. attorney’s office in Manhattan is also investigating the loan, the people said.

Preferential Treatment

John Nester, a spokesman for the SEC, declined to comment on the status of the agency’s probe of Harbinger. The U.S. attorney’s office doesn’t confirm or deny investigations, Caroline Sullivan, a spokeswoman, said.

Falcone has denied giving preferential treatment to any investors. He hasn’t been accused of any wrongdoing.

“A clause such as this is not unusual in loan documents where the borrowing financial institution is closely aligned with an individual,” said Lew Phelps, a spokesman for New York- based Harbinger, in an e-mail. “In fact, in this case, the default trigger was not included because of any pending investigation -- whether by the DOJ or the SEC. Rather, many prudent lenders would include such language even in the absence of any investigation.”

Nothing New

Phelps said with respect to the Justice Department interest in Harbinger, “there is nothing new that we are aware of.”

Richard Khaleel, a spokesman for New York-based Jefferies, declined to comment on the loan syndication, the key man provision or the probes.

Falcone, who founded Harbinger in 2001, bet millions in 2006 that securities cobbled together from subprime mortgages would collapse, making the fund $11 billion in 2007. In 2008, the fund was one of the world’s most successful hedge funds, with assets of $26 billion. Now, Falcone manages about $4 billion.

The Harbinger loan isn’t the first to be tied to the specific circumstance of a CEO, said Fridson. When MF Global Holdings Ltd. sold bonds in August 2011, there was a provision that the interest rate would rise if Chairman and CEO Jon Corzine received a federal appointment from the U.S. government.

Corzine Speculation

There had been speculation that Corzine, the former governor of New Jersey, who had previously helped run Goldman Sachs Group Inc., might be appointed Treasury Secretary or become an economic adviser to the White House, Christopher Allen, an analyst at Evercore Partners Inc. in New York, said at the time. That bond sale was managed by Jefferies.

“This is such a hot potato,” said Mark T. Williams, a risk-management expert teaching at Boston University who isn’t involved in the Harbinger loan deal. Williams said the provision is unusual, as is its prominent placement in Jefferies’ pitch of the loan to investors, and may be related to the ongoing federal probes.

Jefferies is charging Harbinger a 15 percent interest rate, showing that lenders regard Harbinger as risky and that Jefferies has a need for immediate fee income, Williams said.

While the fund’s assets are estimated to be $2.4 billion, they’re mostly illiquid, and Harbinger’s reputation is an issue considering the recent notices from the SEC, Williams said.

Risky Deal

“Usually you’d line up the syndicate right away,” Williams said. He also noted that a loan should be marketed based on an investment’s cash flow, not its collateral. “It’s a very risky deal. Jefferies should be in a mode of strengthening its reputation,” he added, referring to the company’s sale of sovereign debt risk in November.

Jefferies, whose stock dropped by almost half in 2011, published a breakdown of its sovereign bond holdings after MF Global Holdings filed for bankruptcy on Oct. 31, and later sold about three-quarters of the holdings to prove they were liquid.

Harbinger Capital Master Fund’s 19.5 percent stake in Ferrous Resources Ltd., an iron ore developer based in Belo Horizonte, Brazil, will be “marketed to investors immediately,” with proceeds used to repay the notes, according to the documents. Jefferies can liquidate collateral for the loan if shares in Harbinger Group Inc. (HRG), a publicly traded company that is 50 percent-owned by the hedge fund, trade below $2.81 a share for five consecutive days, according to the documents.

Shares Fall

Shares fell as much as 8 percent on the news and closed little changed at $4.86 yesterday.

Jefferies’s loan to Harbinger, signed on Jan. 30, is collateralized by assets including $1.07 billion of equity and debt in LightSquared Inc., Harbinger’s wireless network venture. It’s due Oct. 31, and has two scheduled prepayments, $47.5 million due April 30 and $47.5 million due July 31. Given that Harbinger is receiving only $160 million in net proceeds from the loan, the fund is paying an effective rate of 24 percent, more than four times what the riskiest corporate borrowers pay.

The Obama administration said LightSquared’s wireless venture would cause interference to global-positioning systems that can’t be mitigated.

LightSquared’s proposed deployment would disrupt navigation gear including equipment used by aircraft, Lawrence Strickling, administrator of the National Telecommunications and Information Administration, said in a letter yesterday to the Federal Communications Commission, an independent agency.

Loan Collateral

Other collateral for the loan is $469 million in common stock of Harbinger Group; $486 million of equity in Ferrous Resources; a $42 million loan to TMCI Holdings Inc., also known as Manischewitz Co.; a $120 million equity investment in Asian Coast Development Ltd., a casino resort in Vietnam; and an $88 million equity investment in Augere, a telecom startup based in Bangladesh.

All proceeds from sales of Ferrous Resources, Harbinger Group, TMCI Holdings and equity interests in LightSquared will also go to repay the loan’s principal or fund an interest reserve account, according to the documents.

Balanced against the loan’s assets are $276.8 million in liabilities, including the $190 million loan, a $38.9 million tax payable and other items, according to the documents.

Harbinger lost 47 percent for investors in its main hedge fund last year as Falcone was forced to cut the value of LightSquared by more than half; the Reston, Virginia-based company has been stymied by arguments that its systems will emit signals that disrupt GPS gear guiding cars, tractors, boats and aircraft. It’s seeking clearance from the Federal Communications Commission as regulators weigh test results on the disruptions.

To contact the reporters on this story: Tiffany Kary in New York at tkary@bloomberg.net; Katherine Burton in New York at kburton@bloomberg.net

To contact the editors responsible for this story: John Pickering at jpickering@bloomberg.net; Christian Baumgaertel at cbaumgaertel@bloomberg.net

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