New York State amended its commercial code last month to solidify the legal standing of oral financial agreements, a common practice in the derivatives market.
Derivatives transactions such as swaps are contractual arrangements, not securities trades. As such, before the code was changed, an oral agreement could have been challenged under laws designed to prohibit fraudulent contracts.
Frequently, traders will agree to enter a swap over the telephone. In New York, under the amended law, most such arrangements will not be subject to the antifraud rules.
On July 20, Gov. Mario Cuomo signed into law an amendment to Sections 1-206 and 2-201 of the state's uniform commercial code and Section 5-701 of the general obligations law that creates an exception for "qualified financial contracts." The amendment, which will take effect 60 days after the signing, is similar to a bill last year that did not reach the governor's desk.
The amendment states that oral agreements will be exempt from the antifraud rules if the parties involved have previously agreed in writing to be bound by such agreements.
Market participants said the amendment is consistent with existing practices.
At J.P. Morgan Securities Inc., for example, derivatives professionals follow up agreements on the telephone with written confirmation.
"It's nice to see that way of business has been validated in New York," said Shaun Rai, vice president and head of municipal swaps at the firm. "We were 99.9% sure before. Now they've taken care of that last little bit."
"Passage of this amendment to the New York statute of laws fulfills one of the key recommendations of the Group of 30," said Denis Forster, an attorney at Baker & McKenzie who coordinated the International Swaps and Derivatives Association's efforts on behalf of the amendment.
"The bill modernizes New York law and brings it current with today's technology," he said. "It provides needed legal certainty and thereby reduces risk."
Other attorneys who have studied the amendment also welcomed the change, but warned that it does not apply to all transactions and that some significant loopholes remain.
"We feel this goes a long way to alleviate concerns that people had," said Linda B. Klein, a partner at Debevoise & Plimpton. "But there still are important categories of market participants who are not covered by this or who are covered by special statutes such as the Federal Deposit Insurance Act."
For example, the amendment does not apply to oral contracts with "natural persons." That means a firm's dealings with a wealthy individual would not be covered, Klein said. However, oral foreign exchange transactions with individuals who are considered "merchants" are already exempted under a previous law, she said.
Some market participants are covered by other laws that create problems for oral agreements.
"An agreement with a U.S. federally insured financial institution cannot serve as the basis for a claim against the Federal Deposit Insurance Corp. in a receivership or conservatorship proceeding involving the financial institution unless certain writing and other requirements of the Federal Deposit Insurance Act are satisfied," Klein wrote in a memo about the amendment.
Klein also suggested that firms examine their master agreements to ensure that their oral transactions will qualify for the new amendment's exemption.
The International Swaps and Derivatives Association's sample master agreement doesn't require that all transactions between parties that have signed a master agreement automatically fall under the agreement, she said.
The amendment also expands the definition of written signing to include text produced by telex, fax, computer retrieval, and other electronic means.
