Banking on Bankruptcy

Bad news is good news when you know what you're doing.

Hipster Battles Hedge Funds

Nate Thoma stood up in a Delaware bankruptcy court last December in a sharkskin suit and delivered a 24-minute argument that changed the course of one of the largest bankruptcies in U.S. history.

The 33-year-old Washington Mutual investor, with no legal experience, delivered what people in the courtroom called an unusually eloquent speech, helping persuade the judge to investigate trading by some of the nation's biggest hedge funds and to reject a plan for the bank's exit from bankruptcy.

The net result was a settlement between small investors and the hedge funds, which included Appaloosa Management and Centerbridge Partners. That deal has paved the way for the bank to exit from bankruptcy and gives the little guys a chance of recovering some of their losses.

Mr. Thoma's court appearance added new drama to an already contentious case, which began when the U.S. government seized the bank in September 2008. The court-ordered probe riled hedge-fund managers, who said they did nothing wrong, and made Mr. Thoma a folk hero among Washington Mutual's legions of small investors.

Mr. Thoma, who had traveled from Queens, N.Y., to lodge his objections in person, came across as "intense and smart," though "somewhat lacking in experience in the legal arena," says Edgar Sargent, a lawyer representing Washington Mutual's shareholder committee.

Sitting in a Greek tavern in Astoria, N.Y., on a recent afternoon, sporting a hipster-perfect scruffy beard and dressed in a plaid shirt and jeans, Mr. Thoma recalls thinking Judge Mary Walrath would cut him off after a few minutes.

"But halfway through, I noticed she was paying attention," he says. "I realized she was going to let me go on, and I went for broke."

Mr. Thoma, who gave up computer programming to become a trader in 2005, estimates he probably made 10 times his money in Washington Mutual, in part because he bought up cheap securities that will get a payout.

Mr. Thoma spent as many as 10 hours a day analyzing various pieces of the Washington Mutual case before appearing in court, and presented 33 pages of documents. In her written opinion, Judge Walrath cited Mr. Thoma's arguments six times, though she pointed out that much of his evidence was inadmissible.

"Some things were wide of the mark," concedes Mr. Thoma. "But it's my first bankruptcy."

No wrongdoing by the hedge funds was proved by the investigation ordered by Judge Walrath. Appaloosa and Centerbridge, as well as Aurelius Capital Management and Owl Creek Management, were ordered to divulge trading records and answer questions from lawyers for common shareholders.

The funds declined to comment, as did Washington Mutual's attorney.

While Mr. Thoma's impact on the case could inspire other small investors, they probably won't get as loud a voice. Judge Walrath was particularly attentive to smaller shareholders during the Washington Mutual case, in part because of the number of individuals hurt when the bank was seized, according to people involved in the case.

Soft-spoken and with about $500,000 in investments, Mr. Thoma is an unlikely agent for change in the halls of American finance and an even more unwelcome adversary for the hedge funds involved. His actions infuriated the likes of David Tepper, head of Appaloosa. They also served as a call to arms for small investors in the case, many of whom lavished him with accolades on Yahoo message boards.

When Appaloosa responded to Mr. Thoma's claims with demands for research, correspondence and trading records, shareholders, many of them from Europe, rallied to Mr. Thoma's defense, flooding the Delaware court with more than 150 objections. "Apparently, I'm big in Switzerland," he says.

Mr. Thoma, who didn't finish college, says he taught himself to trade, much like he taught himself computer programming. He is also following in the footsteps of his grandfather, who actively traded and retired early on his stock-market investments.

"When I was little, he would show me stock charts, but it didn't register," Mr. Thoma says. "Years later, it occurred to me, 'I can do this.'"

His transformation from small-time investor to activist shareholder began following the seizure of Washington Mutual. Mr. Thoma's shareholding in the bank was wiped out. He spent weeks in front of his Scottrade account, trying to figure out how to recoup money he had lost.

"I started looking at the capital structure, and I saw an opportunity to make back my investment," Mr. Thoma said. He bought trust preferred securities, a hybrid of debt and equity, which rank above common and preferred shares. That enabled him to essentially jump ahead in line for any money distributed from the bank's estate.

It also put him in the same pool as Appaloosa, Aurelius, Centerbridge and Owl Creek, which were snapping up the same securities.

Those securities were quoted at around one cent in November 2008, when Mr. Thoma first started buying—they are now at 16 cents—but they rarely traded and were hard to buy through his online brokerage account.

In the following months, Mr. Thoma bought in lots of 500 or 1,000 units. But he noticed other investors were occasionally able to buy them in much larger amounts, at one point as many as six million units in a day.

"I was envious," he said. "They were like whales passing in the night."

Mr. Thoma suspected the buying was being made by hedge funds, which already owned the bank's bonds. Owning large chunks of both classes of securities would help them control the bankruptcy's course, he figured. While this practice is standard in most bankruptcies, in the case of Washington Mutual, the hedge funds' strategies affected thousands of retail investors, who still owned the bank's securities.

In his December objection, Mr. Thoma said he thought it was unfair that hedge funds were able to eventually negotiate on behalf of trust preferred holders, seeing as they were also bondholders and involved in settlement talks. He questioned whether they were acting in all of the preferred holders' best interests.

Judge Walrath listened, and ordered the probe into the buying.

Mr. Thoma says he is still obsessed with the case, and his wife has banned Washington Mutual from household conversations.

But this battle is likely to be his last. He says that despite his success, his experience has left him disillusioned.

"The thrill is gone," he says. "It's such a big game, [individuals] just can't compete. I'm picking up freelance Web work again."