Liability of Derivatives Dealers
HAL S. SCOTT
The OTC derivatives market is huge. The 1995 International Swaps and Derivatives Association ( ISDA) survey indicates that there was $11.5 trillion in contracts outstanding at the end of 1994. This activity has produced, by some accounts, at least 30 multimillion dollar derivative suits in the United States by customers against major securities firms that advised them about derivatives or entered into derivatives transactions with them in the 1990s. Gibson Greetings v. Bankers Trust Co., 1 involved a claim for $32 million in compensatory damages and Proctor & Gamble v. Bankers Trust Co., 2 involved a claim for $195 million. Gibson was settled for approximately $14 million in 1994. The real blockbuster was Orange County Investment Pool v. Merrill Lynch & Co., 3 in which Orange County sued for $3 billion in damages.
Although there is great variety in the derivative transactions behind the different litigations, many of the transactions were swaps reflecting bets that interest rates would stay constant during 1993 and 1994. The P&G and Gibson derivatives were complex interest rate swaps where either a rise in short term or long term rates would very quickly put the parties in the red. Orange County involved structured notes called inverse floaters which represented a direct bet that interest rates would stay constant or decline.
The complaints in these litigations are based on a combination of common law and statutory claims that can be broken down into four main categories: ultra vires, fraud, suitability and contract. This Chapter examines each theory, as well as the exposure of dealers to regulatory sanctions.
The basic ultra vires claim is that the customer corporation was prohibited by law from engaging in a particular transaction. For example, Orange County claims that the transactions it entered into with Merrill Lynch were____________________