OTC Derivatives Fraud – Happens More Often Than You Think

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.