ALLEN & OVERY WHAT are the costs of legal risk? ambiguity/lack of clarity unenforceability of the contract senior management time front/back office time legal fees punitive/consequential damages public exposure of internal policy reputation
ALLEN & OVERY Current Anomalies Barings Liquidators vs. Deloitte & Touche tens of £ millions in legal fees vs the £13,000 fee for two audits
ALLEN & OVERY WHY are the legal risks of derivatives unique from traditional commercial/investment banking products?
ALLEN & OVERY Derivatives Involve Mutual two-way exposure Potentially unlimited exposure Increased cross-border issues Barely 20 year product Uncertain regulatory/tax status Out-of-court settlements Evolving markets Old law/new products
ALLEN & OVERY HOW are the claims brought? Statute of Frauds Lack of Capacity Lack of Authority Common Law Fraud Breach of Fiduciary Duty Negligent Misrepresentation Regulatory Violation Contract Based Claims Procedural Violations
ALLEN & OVERY Modelling Legal Risk? Qualitative vs. quantitative
ALLEN & OVERY The Efficient Portfolio of Legal Risks there is an optimum amount of legal risk for your firm risk management generally does not have as an objective the elimination of risk, but rather, the development of a framework for managing and understanding the risk
ALLEN & OVERY The Legal Bullet Return Risk x x Rf
ALLEN & OVERY The Model LR = f(D,R,L,J,C,P,I,Lo,T,E,S,Cr,St,Ch) where: D = documentation R = regulation L = your lawyers J = judicial decisions C = type of counterparties P = type of products I = initial mark-to-market Lo = location of counterparties T = technology E = exposure to counterparties S = your staff Cr = your credit St = your corporate structure Ch = choice of law/legal environment
ALLEN & OVERY WHICH variables are controllable? Direct (D,L,C,P,I, Lo, T,E,S) Indirect (Cr, Ch) Uncontrollable? (R,J)
ALLEN & OVERY WARNING!!!!!! If your firm leads the industry in: types of counterparties, types of products, location, exposure
ALLEN & OVERY A legal risk limit? If there are credit risk ratings, why not legal risk ratings Why not weight each legal risk factor, as well as have a maximum limit for each factor?
ALLEN & OVERY The Volatility of Legal Risk 1980’s - low 1990s - high 2000-2010 - moderately high beyond 2010 ?????
ALLEN & OVERY 1980’s - Derivatives Litigation Time Line Interest /Currency Rate Transactions Statute of Frauds Tax Withholding Regulatory Characterisation
ALLEN & OVERY 1990’s - Derivatives Litigation Time Line Leveraged Products Capacity/Authority Suitability Negligent Misrepresentation Fraud Regulatory Characterisations Contract Based Claims
ALLEN & OVERY 2000’s - Derivatives Litigation Time Line Credit Derivatives/Insurance “Incorrect/Ambiguous” Documentation Contract Based Claims
ALLEN & OVERY WARNING WHAT YOU ARE ABOUT TO SEE IS NOT A COMPLETE LIST
ALLEN & OVERY Derivatives Litigation Time Line 1991 Decision H of Lords Hammersmith & Fulham lack of power/authority 1994 Filed Lehman v Minmetals breach of contract counterclaim lack of capacity lack of authority securities fraud (d) breach of fiduciary duty negligencemisrepresentation mark up fraud (d) $53.5MM 1987 Decision Homestead vs. Life Savings anticipatory breach of contract good faith/fair dealing affirmative defense Statute of Frauds $6.2MM 1992 Decision Salomon Forex vs. Tauber breach of contract affirmative defense Statute of Frauds counterclaim illegal futures gambling laws bucket shop laws $26MM Drexel vs. Midland Contract Based, 353M
ALLEN & OVERY Derivatives Litigation Time Line 1995 BT vs. Dharmala lack of capacity suitability misrepresentation P& G vs. BT Ohio regulatory (SEC,CEA) laundry List SEITA vs. SBIL regulatory fraud fiduciary duty lack of capacity 1996 1998
ALLEN & OVERY Derivatives Litigation Time Line 2002 Filed Eternity vs. Morgan Guaranty breach of contract breach of good faith fraud negligent misrepresentation consequential damages $14MM,$6MM 2000 Filed Korea Life vs. Morgan Guarantyfraud negligent misrepresentation breach of contract violations of Korean law violations of NY gambling laws $90MM Peregrine vs. Robinson Contract Based $78MM ANZ vs. Soc Gen Contract Based, $8MM Griffin vs. Citibank, Tax 2001 Caiola vs. Citibank regulatory