In the first big government action against a seller of the financial instruments known as derivatives, the Federal Reserve Board said yesterday that it had reached a settlement with Bankers Trust Co. that requires the bank to increase the disclosure of risks its customers face.
At the same time, two other federal agencies, the Securities and Exchange Commission and the Commodity Futures Trading Commission, are expected to reach a joint settlement against Bankers Trust in the next few weeks.
Taken together, these actions will substantially expand the government oversight of derivatives, which are financial instruments with a value linked to the performance of an underlying asset or index, such as a government bond, a stock or an index of stocks. The outline of new requirements for Bankers Trust could become a de facto standard for the entire industry.
Under the new guidelines, Bankers Trust will have to detail the risks of certain volatile derivatives before they are bought. After the purchase, the bank has to report the value of those derivatives to the customer every day. Before yesterday, the bank made such information available only if it was requested by the customer.
Until now, the derivatives market has been largely unregulated but has made headlines all year because of the sharp losses blamed on these complex financial instruments. They can be volatile and can expose investors to sudden losses not often considered when the derivative was bought.
Bankers Trust has been among the nation's most prominent dealers of derivatives. Several of Bankers Trust's corporate clients have said they suffered substantial losses on derivatives deals that went bad after interest rates rose earlier this year.
The bank has been sued by Procter & Gamble Co. and Gibson Greetings Inc. It settled with Gibson last month.
Mutual funds and municipalities around the country also have attributed sudden and unforeseen losses to derivatives. Several mutual fund sponsors have had to cover their funds' losses with infusions of cash. In Orange County, Calif., Treasurer Robert L. -- Citron resigned yesterday, after the county disclosed last week that its investment fund is facing potential losses of $1.5 billion, much of it due to trading in derivatives. Securities and Exchange Commission officials have launched an investigation of the trades.
The Federal Reserve's action in the Bankers Trust case is called a "written agreement," the second strictest form of disciplinary action, which is rarely applied to the nation's largest banks.
Unlike the more common "Memoranda of Understanding," written agreements, which essentially are formal promises by the bank to take certain actions, are made public and can be enforced in court.
The Fed appears to be signaling that it found disturbing practices at Bankers Trust, although it did not detail any specific rule violations.
The SEC and the CFTC are negotiating a joint consent agreement with Bankers Trust, people familiar with those negotiations said. Such an agreement would probably include a promise by the bank to follow certain practices, as it does in its deal with the Fed.