Securities Fraud Attorney Blog

Over-the-counter (OTC) derivatives can be scary. Derivatives may pose an unsuitably high amount of risk for non-institutional investors yet are being sold by dealers around the world to investors who do not clearly understand the products.

According to Reuters yesterday, U.S. Representative Stephen Lynch said that “taking a ‘soft approach" to regulating OTC derivatives would be a mistake, but that appears to be the direction lawmakers are leaning.” Representative Lynch further said "by allowing a significant part of the derivatives market to just go off unregulated ... we're setting ourselves up to fail."

After the meltdown of 2008 and 2009, now is the opportunity to address the concerns related to OTC derivatives. Hopefully, Representative Lynch’s perspective will prevail and public investors will be further protected.

Over-the-counter (OTC) derivatives are very complicated investments. OTC derivatives are sometimes defined as contracts that are traded (and privately negotiated) directly between two parties, without going through an exchange or other intermediary. They include swaps (such as credit default swaps (CDS)) and interest rate, currency and commodities contracts. The OTC market is supposedly made up of banks and other highly sophisticated parties such as hedge funds. Then why have OTC derivatives been sold to less sophisticated investors? Good question.

The U.S. Secretary of the Treasury, Tim Geithner, announced last week the Obama Administration’s broad plan on regulatory reform of OTC derivatives. Much of the news coverage focused on the systemic risk portions of Mr. Geithner’s memo. However, the last section of the memo stated that Treasury’s objective is also “ensuring that OTC derivatives are not marketed inappropriately to unsophisticated parties.” This is a very important mandate.

Our firm represents investors who were improperly sold various over-the-counter derivatives without the requisite risk disclosure made by the parties selling them. OTC derivatives fraud cases have become more and more prevalent as the OTC market mushroomed to greater than $600 trillion in notional amount in 2008. There is no room for fraudulent misrepresentations in this extremely complex market. Investors should be wary. Let’s hope the government follows through on its objectives and protects investors from the risks posed by OTC derivatives.