• Investment Banking: Prepare for Economic Cycles to "Stress-Test" New Products
  • September 8, 2005
  • Law Firm: Nixon Peabody LLP - San Francisco Office
  • A broad slate of new rules stemming from Sarbanes-Oxley and the spring's $1.4 billion biased-research settlement have created a legal minefield for investment banking counsel to navigate, while a wave of shareholder lawsuits continues to pound the industry. Seemingly battered on all sides, counsel can focus on the following issue to help make sense of the new world of Wall Street.

    Many innovative financial products developed during the recent low-interest rate, benign-credit environment have yet to be "stress-tested" in less friendly times. For example, the remedial provisions of complex Collateralized Debt Obligation securities or popular "second-lien" financings have not been fully tested in real-life conditions. If history is any lesson, there will be surprise risks in store for product providers and transaction participants.

    To contain these risks proactively:

    1. Create a risk management team, which includes "fresh eyes" who will question base assumptions of the transaction.

    2. Ensure the team has the right skill sets, including product management, credit and legal. The legal adviser must have access to expertise in securities law, bankruptcy/insolvency and bank regulation. When appropriate, include access to knowledge about cross-border legal issues as well as a litigator to challenge the team's Panglossian assumptions about "how this will turn out in court."

    3. Once a problem is identified, strong initial due diligence will pay big dividends by identifying key issues early and eliminating costly "do-overs." Procure all the relevant documents as soon as possible, as they often vary remarkably from the transaction participants' recollections of "how it is supposed to work."

    4. Counsel your clients to keep finger pointing to a minimum.

    5. Don't flinch. Once the problem has been analyzed, encourage clients to commit to a resolution strategy. Things rarely get better if left to drift, and the indirect costs (including diversion of valuable talent) of a prolonged crisis usually far exceed the savings that the parties hope will emerge if they "wait and see."