Alerts

The Risks Associated with Financial Counterparties

March 19, 2008

As a result of the recent turmoil in the financial markets, a number of clients have asked us questions about counterparty risk. The following is a summary of some of the key issues in dealing with financial counterparties.

The U.S. Bankruptcy Code (“Bankruptcy Code”) and the Securities Investor Protection Act of 1970, 15 U.S.C. §§ 78aaa et seq. (“SIPA”) each seek to protect “customer property” in the event of the failure, insolvency or liquidation of a broker-dealer. Neither affords customers the certainty of a 100% recovery, however. Customers thus face certain risks under either regime.

The following is a brief discussion of what a customer might expect to occur if its prime broker were to become insolvent and/or the subject of liquidation proceedings either under SIPA or Chapter 7 of the Bankruptcy Code. We then offer some suggestions to protect customer assets against the impact of such a proceeding. Finally, but equally important, we discuss a separate but related issue regarding the treatment of financial markets contracts, such as swap agreements, repurchase agreements and similar derivative contracts under the Bankruptcy Code and SIPA.