Derivatives Expert Witness: An Introduction to Derivatives

Stephen Gomez

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— Updated on June 22, 2020

derivatives expert witnessIn finance litigation, many elements turn on the specifics of the case. In cases involving derivatives, the complexity of the elements, usually stemming from the different financial instruments involved, coupled with numerous parties, is leading to the increase employment of a derivatives expert witness. They are used to explain the various practices that financial parties should follow when trading.  Here are three examples of a derivatives expert witness that may be needed during litigation.

Securities and Exchange Commission Expert Witness

A Securities and Exchange Commission (SEC) expert witness is useful for ensuring that firms are in compliance with SEC regulations. This is especially important for any case involving an alleged violation of either the Securities Act of 1933 or the Securities Exchange Act of 1934. Additionally, this type of expert is increasingly important due to the Sarbanes-Oxley Act of 2002 and the even more recent Dodd-Frank Wall Street Reform and Consumer Protection Act. As a result of these laws, additional reporting requirements were placed on financial institutions.

Publicly held companies have to comply with an ever-increasing amount of regulatory mandates.  Compliance expert witnesses can opine on the necessary procedures and standards within their industry for dealing with derivative contracts. Typically they have a substantial amount of experience in the over-the-counter securities market and broker-dealer sales practices. They also have experience with the SEC and New York Stock Exchange (NYSE) where derivatives are traded. Additionally, an individual familiar with the SEC may also be able to opine as a conflict of interest expert witness. The may comment on the standard that individuals should adhere to when engaging in the field.

Broker – Dealer Expert Witness

A broker-dealer expert witness is useful in litigating cases involving derivatives. They frequently trade with this type of financial instrument. Derivatives can be traded either over-the-counter- or on an exchange floor and broker-dealers will deal with both types of transactions. The broker-dealer is charged with “making a market.”. This means they make competitive bids on the derivative contracts when the client is selling, or offers when the client is buying. Broker-Dealers are familiar with the regulations surrounding the exchanges and the laws governing regulated derivatives contracts. Because the over-the-counter (OTC) market is relatively unregulated, broker-dealers are familiar with the industry standards and practices for these types of transactions as well. With the enactment of the Dodd-Frank Act, broker-dealer expert witnesses must be familiar with reporting and clearing requirements for derivatives contracts and other standards that may be applicable.

Credit Rating Expert Witness

A credit rating expert witness is another type of expert witness that is frequently used when litigating a derivatives claim. A credit derivative is any number of various techniques that are used to separate and transfer the credit risk of default or partial default by a corporate or sovereign borrower. They then transfer it to an entity besides the lender or debt holder. These financial assets include forward contracts and swaps. They may even include options where the price is determined by the credit risk of a private investor or government. It is traded over-the-counter and allows for institutions to manage their credit risks by synthetically creating or eliminating credit exposure. Credit rating expert witnesses are familiar with credit default swaps, total return swaps, and credit linked notes for minimizing and eliminating risk. They can opine on the regulations and procedures within their industry regarding these types of transactions.

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