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Financial Engineering: The Evolution of a Profession by Cara M. Marshall, Tanya Beder

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Chapter 26

Legal Risk

Jordana Krohley

INTRODUCTION

Legal risk is not simply a concern for lawyers. Whether you are a CEO, CFO, COO, compliance officer, supervisor or regulator, shareholder or bondholder, chances are that legal risk is more a part of your life than ever. Parties recently impacted by the realization of legal risk include investors who bought a Collateralized Debt Obligation (CDO), entered swaps to hedge an Auction-Rate Security (ARS), invested capital with Bernie Madoff, had Lehman Brothers or AIG as a counterparty, owned General Motors equity or debt, had a derivative contract with the subsidiary of a bank that was nationalized in another country, had an Icelandic credit default swap, held super senior credit default swaps “insured” by MBIA, or had a financially engineered transaction with one of the many regional banks that failed during the financial crisis. Accordingly, the analysis of legal risk is one of the critical due diligence concerns of any participant in the financial markets; a party that neglects this province may suffer civil and criminal penalties, be unable to enforce its contract against a counterparty, or discover that it has an unforeseen liability to another party.

Regrettably, the lack of consensus within the financial industry on how to define legal risk is a fitting indicator of the ambiguity and complexity that characterizes the topic. Legal risk can be conceptualized in different ways for different purposes, often overlapping with other ...

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