Tan Kin Lian's Blog: Was there an attempt to cheat?

Friday, July 03, 2009

Was there an attempt to cheat?

Let us discuss this hypothetical case.

1. An investment bank was able to buy several credit default swaps (CDS) and collateralised debt obligations (CDOs) from the market to produce a return of 50% over 5 years.

2. It introduced an "innovative product" that pays an interest rate of 5% a year over 5 years, totalling 25%. It set aside 10% to pay a top legal firm to draft the prospectus and pay distributors to sell the products to its retail customers. The investment bank was able to keep a profit margin of 15% to sell the product. It planned to sell $100 million of the product, yielding a profit of $15 million to the investment bank.

3. The prospectus was drafted to be legally correct, but totally incomprehensible, even to the knowledgable people. The prospetus was "registered" with the regulatory authority, giving the impression that the product has been approved by the regulator.

4. The "genuis" who created this product wrote in the prospectus that the issuer had the right to choose the underlying assets after the launch of the product. This allowed the investment bank to select riskier assets (so long as they fit the credit rating) that produced a higher profit margin for the invsetment bank.

Does this hypothetical product sound familiar to you? Was the investment bank cheating the public?

Are these actions considered as "cheating"?
a) writing a prospectus that does not fairly describe the product or the underlying assets to the retail customer?
b) failing to disclose the expenses and profit margin, which are relevant for an analysis of the product?
c) giving a misleading description of the product in the advertisements?
d) knowing that the distributors (who are ignorant) are giving incorrect verbal statements of the product?

We do not know the real yield of the underlying assets and the profit margain made by the product issuer. If the profit margin is excessive, then the intent to cheat is more credible. If the profit margin is fair, the intent is harder to prove.

Only the regulatory authority, with the power to investigate and get evidence, can find out. "Lesser mortals", like the misguided investors and me, do not have this power. So sad.

Tan Kin Lian

13 comments:

Anonymous said...: "3. The prospectus is drafted to be legally correct, but totally imcomprehensible, even to the knowledgable people."
The above is the tricky part. If the prospectus is totally incomprehensible to many people, including the knowledgable financial experts, what is the use/purpose of it?
Out to cheat?
This is akin to playing a game where the rules/penalties are only known to a side, the players on the other side do not know much at all.

starlight; July 03, 2009 8:07 AM
Redstar said...: I always like this quote from Stephen Frey, "Behind every fortune, there is a CRIME". He is a famous US author on financial espionage, and former employee of JP Morgan. He lives in Princeton, New Jersey.; July 03, 2009 8:59 AM
Unknown said...: The man-made laws in a country's legal system are a reflection of the values and character of its citizens and leaders.

The way a country treats its weakest and most defenceless citizens is one of the best ways of determining national character. (And whether a country or people is worth a footnote in the history of mankind).

It is cheating if the majority of the citizens stand up and say it is. That the existing laws do not represent or reflect Singaporean values. And the existing laws need to be changed, modified or enhanced.

It is not cheating if we accept the status quo of the existing laws.

The law is the visible manifestation/reflection of our hidden/non-visible national values.

Don't blame the law. Take a good long look in the mirror. Start with the man in the mirror.

I took a good look a few years ago. I did not like what I saw.; July 03, 2009 9:21 AM
Solomon said...: MAS work too closely with FIs in the inestigation of CLNs. That make me think the investigations were skewed and in favor of FIs.; July 03, 2009 9:40 AM
Anonymous said...: Tan Kin Lian's "hypothetical" case is a true case of what happened to the products. To prove it is so simple really - but in a court. Howver, to do so is not so simple because the lawyers want to charge at least $1-1.2 mln to do the case. Conceptaully, that is not difficult to raise - say $2000/= max. per investor and we have a legal fund of $4 mln to bring it to court. Win - there will be at least 50% refund of the fee. Lose - that is the max.

The case is so strong that we can only win in fact in a court of law as the law is clear as to what a propsectus is to do and NOT to do.

The Pinnacle Action Grop is in the process of organizing such a legal suit and hopes that it will get the support of investors.; July 03, 2009 10:03 AM
Anonymous said...: Latest exciting update from Hong Kong. If the banks are compensating all investors in Hong Kong, hope our MAS will also take up responsibility to ensure that Singapore investors also get the same fair deal.

New deal to settle minibond buyback

(EXCLUSIVE)
Sixteen banks which sold Lehman Brothers minibonds will pay most investors 60 percent of the principal as settlement - and no more.

Katherine Ng

Friday, July 03, 2009

The Standard

Sixteen banks which sold Lehman Brothers minibonds will pay most investors 60 percent of the principal as settlement - and no more.

Investors aged 65 and above will receive about 70 percent of their investment.

In a formal proposal made to the Securities and Futures Commission yesterday, the banks said they will cap the total payable sum at 60 percent and will not repay the difference if collaterals are sold at a higher price in the future.

The move, which came a day after the July 1 protest, was a follow-up to the "touch base" meeting that representatives of the banks had with the SFC on Monday, in which no specific settlement plan was tabled.

It also came ahead of SFC chief Martin Wheatley's scheduled third meeting with a Legco panel today.

Explaining the cap, a source told The Standard that the banks will now lose as much as HK$1.5 billion rather than the HK$800 million as reported earlier by local media.

Some Lehman minibonds have lost all their value and a few are worth at most 20 percent of their original value.

Reports that the receiver of Lehman Brothers assets in Singapore will soon sign a deal offering the local liquidator an extra 20 percent to 30 percent of the collateral values of minibonds does not bode well for local investors, a banking source said.

"Investors may only get back less than 40 percent of their invested sum [rather] than the 53 percent Ernst & Young originally offered," the source said.

Possible litigation in the United States may also affect what Hong Kong investors retrieve.

The liquidator of Lehman assets has claimed that it has the right to own the collateral of all Lehman-related products globally.

This may compel distributor banks to go to court in the United States, where Lehman Brothers was based, and reduce any settlement with local investors.

Another source noted that the local investors' group - Allied Victims of Lehman Products - is avoiding the fact that few lenders have settled cases with a payback ratio higher than 60 percent to 70 percent and those payments were not retrospective.

The banking industry could lose up to HK$4.2 billion if the Lehman products' valuation drops to 26 percent of the original price, and up to HK$7.5 billion if they are worth nothing.

Lehman-related products worth HK$12 billion were sold in Hong Kong by 19 banks, according to the Hong Kong Monetary Authority.

Eleven of the banks were found to be involved in misconduct in the sale of those products, the SFC told lawmakers last week.

An SFC spokesman declined to comment on the banks' proposal.

But at last Friday's meeting at the Legislative Council, Wheatley said the SFC welcomed all proposals as long as they deterred misselling practices.

Meanwhile, the SFC said brokerage firms Sun Hung Kai Investment and KGI Asia have both completed their voluntary repurchase of Lehman Brothers minibonds, according to agreements they had with the regulator.

SHKI and KGI separately undertook to repurchase all outstanding Lehman Brothers minibonds subscribed, at a price equal to the principal amount, from eligible clients following the SFC's investigation into their sale of Lehman Brothers minibonds.

These agreements helped 329 clients recover their initial investments in full.

Last month, BOC Hong Kong (2388) - the largest vendor of Lehman minibonds - offered a similar payback ratio of 60 percent to 70 percent to investors plus a top-up for future collateral sales.; July 03, 2009 10:25 AM
Anonymous said...: Investors,
If you worry about money and legal fees why not talk to Lockton companies (singapore) for the After The Event insurance (ATE).
Let them assess your case and chance of winning .If you strongly believe that you have been mis-sold Lockton will insure you and take up the case .. No upfront fees or payment. Talk to them directly or ask your lawyer to talk to them. Details below

Address:
36 Robinson Road #16-01 City House
Singapore 068877
Telephone:
(65) 6221 1288
Fax:
(65) 6225 0682
Email:
Website:
http://www.alexanderforbes.com; July 03, 2009 12:03 PM
Concerned said...: Anonymous: July 03, 2009, 10:25 a.m

The problem here is that all these happenings in Hong Kong are not reported in the main media. Only a small faction of the people read Tan Kin Lian's blog. How to get this out so that the vast majority of Singaporeans will learn of discrepancy in compensation between HK investors and Singapore investors.; July 03, 2009 12:03 PM
Anonymous said...: Re: Legal Expenses Insurance

We thank anonymous for mentioning Lockton. The Pinnacle Action Group has been in touch with Lockton and may apply for insurance. But there is no gurantee we will get insurance even if we apply. Hence the need to build our own full legal fund or perhaps about $4mln to cover experts' fees, Senior lawyer's fees, disbursements and the contingency that we lose the case , despite the merits of it.

Thanks.; July 03, 2009 2:39 PM
Anonymous said...: I think the 3rd July news of 60% to 70% compensation is a good thing. Since it only comes out today, I believe the main papers will report tomorrow.

Such payment goes to show the FIs admit fault in product as well as selling. MAS report is coming out soon, hopefully next week during parliment sitting. What will MAS say this time? It will be interesting as they use to pride themselves doing better than HK-MAS. Let's see how they match up with HK-MAS success.

Regards; July 03, 2009 2:53 PM
Anonymous said...: HK-MAS (HK Monetary Authority) has always been only helping FI's (cover-up). If anything, they get in the way of HK victims. They hate HKMA, they took to the street on 1 July to demand the HK Chief Executive to step down.

The victims' self-organized efforts are the primary reason why FI's finally pay, if they pay.; July 04, 2009 6:36 AM
Anonymous said...: Thank you Mr. Tan for yr efforts in writing these articles.; July 04, 2009 8:50 AM
Anonymous said...: Hi 2:53PM,

If MAS Chairman GCT can make such a misleading speech, how can we expect much from the impending MAS report.
Not surprise it will be full of bullshit again!; July 06, 2009 11:05 PM