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Bankruptcy Filings Rare in Brokerage Industry With PM-Drexel, Bjt

February 14, 1990

NEW YORK (AP) _ The broker-dealer arm of Drexel Burnham Lambert Group Inc. is not seeking bankruptcy court protection because federal law bars firms that deal in securities from reorganizing under Chapter 11.

The parent company of onetime braggart securities firm Drexel Burnham Lambert Inc. filed for Chapter 11 protection from creditors Tuesday in what is believed to be the largest bankruptcy plunge in securities industry history.

Under the law, firms that underwrite stocks or bonds or handle securities transactions with the public are not eligible for Chapter 11, where companies can attempt reorganization without fear of creditors’ claims.

Brokerages can seek to liquidate their holdings under Chapter 7 of the code, a move that the Drexel unit has not made. Drexel could try to liquidate outside of bankruptcy court, though.

″It was thought by Congress too difficult to have a true reorganization where you have customer claims for securities that are in the possession of the stockbroker,″ said New York bankruptcy attorney Richard Lieb. ″What’s really needed is to liquidate the positions.″

But Lieb said it was rare for a securities firm to survive a bankruptcy filing by its parent. ″I am unaware of a successful reorganization out of bankruptcy or by other means of a stock brokerage firm,″ he said.

Securities firms typically hold and use securities owned by other parties. Because firms control but don’t own such assets, it is difficult to determine who gets what in a reorganization.

Instead, brokerage firms that go belly-up are protected under a federal agency known as the Securities Investors Protection Corp., established about 10 years ago.

The corporation appoints an independent trustee who administers the liquidation and a federal insurance fund to protect customers of an insolvent brokerage firm. The fund is supported by contributions from securities firms.

Experts compare the agency with the Federal Deposit Insurance Corp., which protects commercial bank deposits.

Typically, the net proceeds of the securities on hand are pooled and distributed among the various holders of a security.But since brokerages manage their holdings actively, often there isn’t enough of the security to go around.

In the case of the shortage, the federal insurance fund can cover at least some of the difference, bankruptcy experts said.

There have been two bankruptcy court filings by brokerage parents in the last year. L.F. Rothschild Holdings Inc., whose subsidiary was severely damaged in the 1987 stock market crash, sought Chapter 11 protection last June.

Earlier this month, J.T. Moran Financial Corp., parent of a 3-year-old over-the-counter brokerage, filed amid a shortage of capital and a host of legal problems.

The largest near collapse was by E.F. Hutton & Co., the retail brokerage that faced a damaging credit downgrade after the 1987 crash before it was resuced by what is now Shearson Lehman Hutton Inc.

Drexel’s filing is believed to be the largest on record. Bankruptcy experts could come up with no other filing that would compare.

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