The International Swaps and Derivatives Association and a group of financial lawyers sponsored by the Federal Reserve (the Financial Markets Lawyers Group) have backed a Bear Stearns’ court appeal. In February this year, Bear Stearns was deemed liable for $125 million that fraudulent hedge fund the Manhattan Investment Fund, had deposited in the prime brokerage account it held at the investment bank before it filed for bankruptcy. The bankruptcy court concluded that Bear Stearns was liable for the deposits as their "initial transferee".
Isda and the Lawyers Group have submitted a brief to the district court in support of an appeal against the court judgement by the bank. The brief claims that "creditors were not harmed by the transfer of the money to the prime brokerage account, but rather by the fund’s unprofitable trading activities". The fund, the Manhattan Investment Fund, was established in 1996 and is said to have been running a strategy that involved the shorting of technology stocks. When the fund soon became unprofitable, its losses were covered up. Bear Stearns itself reported the fund to the SEC, which resulted in the investigation leading to the hedge fund’s closure.
The involvement of the two senior bodies indicates the extent of concerns in the industry about the ramifications should the court ruling not be overturned. Kimberly Summe, general counsel for Isda, says: "We feel that this decision has a much broader impact. There is $1 trillion posted to collateralize OTC trading. Does this mean every time one of those customers engages in fraud that the banks will be responsible? It imposes disproportionate responsibility."
Sylvie Durham, a partner at law firm Greenberg Traurig in New York, agrees that if the judgement is not reversed, it will be a "catastrophe" for Wall Street. "This decision does not just affect prime brokers, but any firm that extends credit to hedge funds. Essentially the judge is saying that anyone extending credit to a hedge fund is a guarantor against fraud committed by that hedge fund.
"It will change the way everyone on Wall Street works with hedge funds if they are suddenly required to act like an insurance company."
Summe says it is unclear how long the judges will take to consider the appeal and the supporting brief.