Many will suffer at the hands of Lehman Brothers. That is the verdict by white-shoe law firm Wachtell, Lipton, Rosen & Katz – a firm I had the pleasure of working with during my previous life in finance. They are very good. Apparently, the bankruptcy laws will not be a protection for creditors as clent assets were comingled with Lehman’s own.
Now that Lehman is bankrupt those assets may not be recovered.
Wachtell, Lipton, Rosen & Katz, the boutique New York law firm, sent a memo to clients Tuesday covering some of the initial lessons learned from the bankruptcy. It said that many of Lehman’s counterparties thought they were somehow protected form such a disastrous outcome — but were actually not protected at all.
“The Bankruptcy Code’s special provisions simply let counterparties avail themselves of their contractual rights; they do not create protections where none otherwise exist,” Harold S. Novikoff, a partner at the firm, said in the memo.
The law firm identified two main areas where investors have been burned so far. The first involves investors posting collateral with Lehman. Hedge funds and other market players that executed trades through Lehman’s prime brokerage unit had to put up cash that was held in a Lehman account to cover losses.
That collateral, it turns out, was “comingled” with the rest of Lehman’s cash, as opposed to being kept in a lockbox. As a result, the bankruptcy of the company meant that those funds were not protected — as many clients had thought — and were frozen when the company went down.
Without their collateral, many hedge funds that depended on Lehman to execute their trades have been forced out of the business. For example, Oak Group, a small investment firm in Chicago with $25 million in assets, said it would have to shut its doors because the majority of the firm’s capital was locked up in Lehman.
MKM Longboat Capital Advisors, based in London, said it was forced to close its $1.5 billion multistrategy fund in part because of assets stuck at Lehman, according to a letter to investors obtained by Bloomberg News.
Foreign exchange trading was the second major area where some of Lehman’s clients were caught off guard. In a foreign exchange transaction, the payments “are never truly simultaneous,” the law firm said, meaning that “the party who pays first runs the risk that its counterparty will fail to pay thereby leaving the first payer with an unsecured claim for the entire failed payment — potentially a major loss.”
All of this makes it readily apparent why Goldman and Morgan Stanley had to become bank holding companies. Equally, it is apparent why Paulson and Bernanke should never have let Lehman fail in the way that it did. They had no contingency plan and now we are all paying for it.
Wachtell Lipton’s Lessons from Lehman – Deal Book