Introduction

“Big-Boy Letters” are often used as a tool to limit an issuer’s or broker-dealer’s potential liability in connection with a private sale of securities. In these letters, the investor represents that, as a “big boy,” it is a sophisticated party that can fend for itself. Often, these letters also contain an explicit waiver of all claims against the inside party arising from the nondisclosure of non-public information, including violations of Rule 10b-5 under the Securities Act of 1933.

“Big Boy Letters” serve several useful purposes for both the inside and outside parties as they can:

  • increase the execution speed of time-sensitive transactions;
  • reduce the costs and risks of potential claims and liability from frustrated counterparties; and
  • facilitate the contractual allocation of risks between sophisticated parties.

These letters can be particularly useful in connection with private sales of sophisticated structured products to institutional investors. For example, the security may have particularly complex terms, and/or an affiliate of the issuer may possess material non-public information that relates to the security, such as business or financial information about the stock linked to the structured note.

Are They Enforceable?

The enforceability of “Big-Boy Letters” has been the subject of dispute.1 This uncertainty stems from tension between the “sanctity of a contract,” on the one hand, and Section 29(a) of the Securities Exchange Act of 1934, which states that waivers of liability for securities fraud are void as a matter of public policy. However, a recent U.S. District Court decision has articulated a means to honor the contractual relationship created by “Big-Boy Letters” without characterizing their effect as a waiver of securities fraud liability and thus as void as a matter of public policy. 

Pharos Capital

In Pharos Capital Partners, L.P. v. Deloitte & Touche, LLP, plaintiff Pharos Capital Partners (“Pharos”) filed suit alleging fraud in connection with its $12 million equity investment in National Century Financial Enterprise, Inc. (“NCEF”)—an investment that lost its full value when NCEF proceeded to file for bankruptcy.2 Pharos claimed that defendant Credit Suisse Securities, LLC (“Credit Suisse”), acting as co-placement agent in connection with the offering, failed to disclose material information while also materially misrepresenting NCEF’s business operations. Credit Suisse’s defense rested primarily on the existence of a “Big-Boy Letter,” in which Pharos acknowledged that it was a “sophisticated institutional investor” who was “relying exclusively” on its own due diligence and would bear the risk of an “entire loss” of its investment.3

Rather than treating the “Big-Boy Letter” as a waiver of liability, the court focused on its effect on a crucial element of successful fraud claims. In granting summary judgment in favor of defendant Credit Suisse, the court noted that common law claims for fraud and negligent misrepresentation require the aggrieved party to have justifiably relied upon the alleged misrepresentation or omission. The court then went on to cite the clear language of the “Big-Boy Letter” to hold that any reliance on the part of Pharos was unjustifiable and thus does not support a claim for fraud or negligent misrepresentation.4 In other words, the existence of a well-crafted “Big-Boy Letter” does not waive liability for securities fraud; rather, it may eviscerate the underpinnings of such a claim.

Pharos demonstrates the value to underwriters of furnishing “Big-Boy Letters” in connection with the offering of complex structured products. However, the existence of such a letter, on its own, may not be sufficient to shield underwriters from liability. Underwriters should also have reason to believe that the investor can in fact protect itself. Obtaining this level of comfort requires reasonable know-your-customer procedures, providing access to any relevant requested materials upon which the investor can rely, and negotiating the content of the “Big-Boy Letter” to evidence an arm’s length transaction between two sophisticated parties.