BMA kicks off campaign to improve due diligence

The association is canvassing members with a view to forming a set of guidelines

The Bond Market Association has held the first of what promises to be a series of meetings with its member firms to discuss whether it should develop a set of best practice guidelines for due diligence in underwriting bonds.

The initiative comes just weeks after Wall Street firms shelled out a record $6 billion to WorldCom bondholders to settle a class action lawsuit which accused WorldCom’s underwriters of failing to adequately examine the telecom company’s financial health. WorldCom later filed for bankruptcy protection after revealing accounting fraud, leaving investors with huge losses.

Judge Denise Cote ruled that underwriters in the case were obligated to conduct a “reasonable investigation” into WorldCom’s finances, rather than simply relying on the company’s audited financial statements or a comfort letter from WorldCom’s auditor Arthur Andersen.

Bondholders recovered nearly 40% of their claimed losses in the WorldCom case, although past cases of this sort only recovered around 6% on average, according to Brad Hintz, a brokerage analyst at Sanford Bernstein. But now that the precedent is set, analysts say that investment banks will be held to a high standard of liability. Hintz estimates that underwriters could face nearly $1 billion in underwriter liability from future defaults on bonds floated in 2003 and 2004.

The potential for greater liabilities has raised concern among Wall Street firms over what level of due diligence is required in such offerings, but what shape any formal guidelines might take is as yet unclear.