These have been an extraordinary three days in the financial industry. As we continue to absorb the events surrounding Lehman Brothers and AIG and reports of new issuers that may be troubled, as well as money market fund pricing problems, we want to provide you with some insight as to some of the considerations that may be relevant to you in connection with your mutual fund and/or hedge fund operations during this particularly volatile period. In no particular order, they are as follows:

  •  Counterparties to Derivatives Transactions: Consider whether a distressed entity deals with your fund as a counterparty to options, swaps or other derivative transactions. If so, it may be appropriate to consider alternative arrangements, including any industry-sponsored programs such as those that may be offered through the International Swaps and Derivatives Association (ISDA).
  •  Securities Lending Agents: Consider the parties with whom you are dealing with respect to your securities lending relationships. If an entity that borrows fund securities becomes insolvent, there is a risk that the borrower may not return the security or that it will not honor its obligation to return securities. If a distressed entity is serving as your securities lending agent, your securities lending program may not function properly or at all. If your securities lending collateral is invested in a money market fund or a “2a-7- like” private fund, you will want to consider the strength of the assets in the money market fund or private fund.
  •  Repurchase Agreement Counterparties: Consider whether a distressed entity is acting as a repurchase agreement counterparty for your fund. Insolvency proceedings, in particular, could interfere with the administration of such arrangements, and you may want to consider other alternative counterparties.
  •  Credit Agreements: Consider whether a distressed entity is serving as a lender to your fund. A distressed entity’s obligations to continue lending may be terminated or disrupted if it becomes subject to insolvency proceedings. It may be appropriate to consider other lenders, if available.
  •  Insurance Arrangements: Consider whether a distressed entity provides liability insurance or fidelity bond insurance to your fund either as a primary or excess lender. It may be appropriate to explore any available alternatives with your insurance broker.
  •  Broker/Dealer Counterparty: Consider whether distressed entities should be removed from your approved broker/dealer list.
  •  Pricing Arrangements: Consider whether a distressed entity is providing pricing to your fund on any of its portfolio securities. If so, alternate pricing arrangements may be appropriate.
  •  Index Providers: Consider whether any distressed entity provides indexes that your fund may track (if an index fund) or use as a benchmark will continue to be available.
  •  Prime Brokerage/Custodial Relationships: Review and analyze any custodial or prime brokerage arrangements with distressed entities to determine whether they should be retained.
  •  Other Service Provider Relationships: Advisers may want to consider whether a distressed entity services their fund and whether insolvency proceedings might disrupt the orderly administration of back-office accounting services, transfer agency or other services.
  •  Affiliate Issues: Consolidations among financial services (e.g., Bank of America and Merrill Lynch) create new affiliations and potentially new conflicts of interest that should be considered by fund compliance personnel. New independence issues also may be presented for disinterested directors.
  •  Pricing Issues: Market volatility, unprecedented governmental takeovers and sudden consolidations have created some uncertainty in the pricing of securities of issuers involved in these transactions. Pricing services and broker/dealers are challenged under current conditions to provide accurate pricing. It may be appropriate to review fund pricing procedures, as well as prices supplied by pricing services, to ensure that prices are challenged if they do not appear to be appropriate or accurate.
  •  Investments in Other Funds: Consider the strength of other funds in which your fund is invested.