Another significant operational risk faced by investment banks is from litigation following deals or public securities issuance that turned sour. In such cases, bankers, along with accountants, are frequent targets for blame. How can this risk be effectively mitigated?
What Is the Risk?
The cost of litigation faced by investment banking, most commonly on the equity and loan underwriting side, is one of the highest potential costs from operational risk across an investment bank's key lines of business. That is because when a company fails, investors who bought into the most recent stock or debt offering will naturally feel aggrieved at the unexpected turn of events and the resultant loss they suffered. In their grief they will ask questions and sometimes take the view, like it or not, that were it not for the incompetence of the bankers, they would still be whole.
A conspicuous number of the litigation settlements of the past few years are related to actions stemming from the 2008 Financial Crisis because of the sudden collapse of many firms due to the onset of the crisis. A firm that has collapsed is an inherent danger to its bankers as it lashes out in its final death throes. The common complaint from an investment bank's risk managers is that they are typically targeted as a result of having deep pockets rather than due to any wrongdoing on their part (see Table 10‐1).