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FRM Part II · FRM Exam Part II · The Failure Mechanics of Dealer Banks

Which statement about the effect of a dealer bank's failure on its prime brokerage clients, as illustrated by the Lehman Brothers bankruptcy, is most accurate?

In the Lehman failure, client assets that the dealer had rehypothecated were not segregated, so clients became unsecured creditors and their funds were frozen in insolvency proceedings. This created sudden liquidity strains for hedge funds and showed the risk of rehypothecation.

  1. AClient assets rehypothecated by the dealer became unsecured claims, leaving clients exposed and freezing their fundsCorrect
  2. BClient assets were always segregated and returned within days
  3. CPrime brokerage clients had priority over repo lenders in all jurisdictions
  4. DClients could net their positions against the dealer without any delay

Explanation

Assets that clients allowed the dealer to rehypothecate were not segregated, so clients became unsecured creditors for them, and funds were frozen in proceedings, notably in the UK affiliate. The claim of guaranteed fast return is incorrect, and no universal client priority existed.

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