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When derivatives go bad

THUD! That’s the sound a busted derivative trade makes when it lands at the courthouse steps.

Drake Capital Management, once a highflying hedge fund manager that is now winding down its operations, claims it’s still owed some $102 million on a derivatives trade that went kablooie when Lehman Brothers filed for bankruptcy. Like most of Lehman’s thousands of creditors, the New York hedge fund hasn’t been paid a penny.

So Drake has filed a weighty 543-page document in bankruptcy court to press its point. A close look at the Drake filing shows why the Obama administration’s proposal to regulate and rein in these often exotic financial instruments may be easier said then done.

Only five pages of the filing are devoted to the so-called proof of claim, where Drake co-founder Steven Luttrell explains why the hedge fund is still owed money. Most of the remaining 538 pages are what constitutes the actual derivative — the various contractual agreements spelling out the terms of the trades between Drake and Lehman. The agreements date back to August 2004.

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