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Danimark Investment Bank has decided to structure and market a new securities product to its clients. The securities are collateralized debt obligations (CDOs) directly tied to a reference portfolio of credit-card-backed securities (CCBS). CDOs are zero-sum investments, so one partys gain is always the other partys loss. Anthony Karol is the managing partner responsible for the launch of the new securities. He knows that Danimarks client Nelipern & Co., a large hedge fund, will play a significant role in selecting the securities in the reference portfolio. Karol also knows that the investors interests in the portfolio will be averse to Neliperns interests. While Nelipern has shorted the equity of the CDOs (so Nelipern will make money if their value falls), the counterparties will hold a long position on the portfolio, so they will lose money if it performs badly.

Question:

Does Danimark have a legal duty or an ethical obligation to disclose Neliperns role in the selection process to potential investors? Is it enough if Danimarks marketing materials disclose that Nelipern helped select the portfolio, or should Danimark also disclose Neliperns adverse interests in the performance of the portfolio?

Is this situation any different from a transaction in which an investment bank sells stock belonging to one client to another client?

Now suppose that the largest long-term investor in the portfolio, I-Analytics International, has the privilege and responsibility of independently approving the selection of the CCBS in the portfolio. If I-Analytics uses its own methods and approves the CCBS in the portfolio, how, if at all, should that affect Karols analysis?

Should it matter whether the offering circular states that I-Analytics selected the portfolio?

Should it matter that Danimark plans to buy the securities for its own firm account?

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