By Larry Haverkamp
BANKS sold us billions of dollars of risky structured products called 'linked notes' for short. They came with big risks, which have led to big losses.
For example:
DBS High Notes 5 are now worthless. Loss: $103 million.
Merrill Lynch Jubilee 3 are worthless. Loss: $28 million.
DBS High Notes 2 sell for 22 cents on the dollar. Loss: $55 million.
Lehman Brothers Minibonds are in limbo. Loss: unknown.
There are more.
Sales have been in the billions over the past 10 years. Banks admit to mis-selling to the elderly and uneducated. But the problem is bigger. Mis-selling extended to everyone since the prospectus mis-stated costs and risks.
Costs
Issuing banks have never disclosed their charges for linked notes. Is this serious enough to require a full refund to all investors?
A precedent exists. In the US and Europe, global banks were required to repurchase $80 billion of auction-rate notes and pay $750 million in fines. Even now, the issuing banks refuse to disclose their charges. They say the law doesn't require them to.
DBS told me: 'Pls understand that certain (pieces of) information, especially re remuneration payouts or the detailed breakdown of how a product is being calculated, are proprietary information. Where required under regulatory or statutory guidelines, we will disclose the necessary.'
Risks
Two risks are not disclosed in the prospectus.
First, default of a 'reference entity' causes the structured product to become worthless. Prospectuses show that risk is less than 1per cent for each entity. Linked notes' first-to-default structure, however, makes the risks additive. For DBS High Notes 5, it adds up to 8 per cent. No one knew the risk was so high. The prospectus never mentioned it.
Second, many linked notes are invested in AA-rated collateralised debt obligations (CDOs), which the prospectus describes as safe.
It says: 'A borrower rated 'AA' has very strong capacity to meet its financial commitments. It differs from the highest rated borrowers only in a small degree.'
While this is true for regular bonds, it is not for CDOs. Ratings are not comparable because CDOs are much riskier.
For example, the default rate of regular bonds ranked Baa by Moody's is only 2.2 per cent. CDO bonds with the same Baa ranking have a default rate of 24 per cent. Only now are we seeing effects of the high risks. Many CDOs have been downgraded. Some are near default.
It explains why banks repurchase structured products at a discount. DBS pays only 22 cents on the dollar to buy back its High Notes 2.
Is this fair? It is hard to say since investors have very little information about the underlying bonds and CDOs.
Hong Kong investors have been more aggressive. In a protest outside DBS headquarters on Oct 20, a sign in Chinese read: 'Product has poison. Asking and reprimanding DBS.' DBS gave in. It distributed a list of the CDOs for each structured product AND had a bank officer explain it.
Singapore investors also have a right to this data. DBS confirmed this when it told me: '...The list of CDOs for the respective Notes are available to clients if they asked for them.' The problem is most investors don't know what to ask for or how to interpret the list. If banks truly wanted investors to know, they could explain on their websites how they arrived at the structured product's value.
Otherwise, there is no way to know if banks are taking advantage of their information monopoly to buy back these investments at too steep a discount. Take High Notes 2. DBS buys them from investors at 22 cents on the dollar. Assuming no defaults, it can simply wait until maturity in 2011 and then redeem at 100 cents on the dollar. For the bank, it is a 350 per cent profit.
Monday, November 10, 2008
CBS Videos on derivatives, etc
Dear Mr. Tan,
Here are some links to CBS videos (10-15 mins) on derivatives, CDS, etc. They are eye openers to lay people. These derivatives are more like scams to defraud the investing public. We need to persist to get the authorities to get to the bottom of the matter. Hope you can help in this matter.
Video 1: Derivatives (July 1995)
http://www.cbsnews.com/video/watch/?id=4501762n
Video 2: Credit Default Swaps (Oct. 26, 2008)
http://www.cbsnews.com/video/watch/?id=4546583n
Video 3: Wall Street Shadow Markets (Oct. 5, 2008)
http://www.cbsnews.com/video/watch/?id=4502673n
Report 1: The Bet That Blew Up Wall Street http://www.cbsnews.com/stories/2008/10/26/60minutes/main4546199.shtml
Report 2: A Look At Wall Street's Shadow Market
http://www.cbsnews.com/stories/2008/10/05/60minutes/main4502454.shtml
Here are some links to CBS videos (10-15 mins) on derivatives, CDS, etc. They are eye openers to lay people. These derivatives are more like scams to defraud the investing public. We need to persist to get the authorities to get to the bottom of the matter. Hope you can help in this matter.
Video 1: Derivatives (July 1995)
http://www.cbsnews.com/video/watch/?id=4501762n
Video 2: Credit Default Swaps (Oct. 26, 2008)
http://www.cbsnews.com/video/watch/?id=4546583n
Video 3: Wall Street Shadow Markets (Oct. 5, 2008)
http://www.cbsnews.com/video/watch/?id=4502673n
Report 1: The Bet That Blew Up Wall Street http://www.cbsnews.com/stories/2008/10/26/60minutes/main4546199.shtml
Report 2: A Look At Wall Street's Shadow Market
http://www.cbsnews.com/stories/2008/10/05/60minutes/main4502454.shtml
Obama's Speech at Election Night
Please click here to see President-elect Obama's
speech on Election Night:
http://my.barackobama.com/page/community/post/stateupdates/gGx3Kc
Barack Obama and Joe Biden are hopeful about the opportunities and
clear-eyed about the challenges our nation faces. They look forward to
working with all Americans, regardless of who they voted for, in the great
project of American renewal. Enlisting the energy and ingenuity of the
American people is the only way we will create the changes that so many
people want to see, so we hope you'll be involved.
speech on Election Night:
http://my.barackobama.com/page/community/post/stateupdates/gGx3Kc
Barack Obama and Joe Biden are hopeful about the opportunities and
clear-eyed about the challenges our nation faces. They look forward to
working with all Americans, regardless of who they voted for, in the great
project of American renewal. Enlisting the energy and ingenuity of the
American people is the only way we will create the changes that so many
people want to see, so we hope you'll be involved.
Did the RM explain "first to default" ?
Dear Mr Tan,
Thank you for taking the time and effort to help the unfortunate minibond investors.
I am disheartened to find out that some of our banks have "thrown out" many cases. Perhaps the "vulnerable" investors could not effectively submit a proper case. Perhaps they could not effectively present the argument that they were misled by the Managers (Relationship) of the banks.
The argument I am presenting is based on the structure of the minibond product, not the companies (i.e, Lehman Brothers) underlying it.
In such cases whereby the minibond investors attempted to demostrate that they had been misled in buying high risk would likely be countered by bank's argument like "Have our sale staffs explain the risks to you?", "The rating of the companies behind minibonds has been AAA, AAB, therefore this is a very safe investment". Indeed, the staffs might have taken efforts to explain the risks but what were the exact risks explained? Who is to argue a rating of AAA and AAB is not safe? And who is to argue a 100+ year old investment bank has no firm foundation? As such, when banks present such facts, how can one not deduce that the minibond is a safe investment?
The case of the minibond is not a case on the companies behind the structured product sold. The high risk was the structure / architecture / design of the minibond itself. This is the risk: FIRST TO DEFAULT BASIS. This means any of the eight underlying entitles fails, the minibond will be terminated and investor receives zero payout in the worst case scenario. This is the reason why it is a risky investment.
So what can the minibond investors do now? Perhaps what they can do now is to answer these 2 questions:
> Had the Relationship Manager explained clearly the risks due to the structure / architecture / design of the minibond?
> Had the Relationship Manager fully and clearly explained the worst case scenario?
If the answers to both questions are "No", the investor may possibly have a better case. The "higher" risk came from the structure / architecture / design of the minibond and not the underlying companies.
Mr Tan, much has been discussed about the fate of the minibond and their investors, I do have a question. What happened to the $500 million dollars (cold hard cash) invested in the minibond?
Regards,
REPLY
The financial institutions are only interested to find any excuse to reject the claim, so as to avoid paying any compensation.
The Monetary Authority of Singapore has asked them to treat their customers fairly. Unfortunately, MAS has not provided specific guidelines and leave it to the discretion of the financial institutions. The outcome is to be expected.
Thank you for taking the time and effort to help the unfortunate minibond investors.
I am disheartened to find out that some of our banks have "thrown out" many cases. Perhaps the "vulnerable" investors could not effectively submit a proper case. Perhaps they could not effectively present the argument that they were misled by the Managers (Relationship) of the banks.
The argument I am presenting is based on the structure of the minibond product, not the companies (i.e, Lehman Brothers) underlying it.
In such cases whereby the minibond investors attempted to demostrate that they had been misled in buying high risk would likely be countered by bank's argument like "Have our sale staffs explain the risks to you?", "The rating of the companies behind minibonds has been AAA, AAB, therefore this is a very safe investment". Indeed, the staffs might have taken efforts to explain the risks but what were the exact risks explained? Who is to argue a rating of AAA and AAB is not safe? And who is to argue a 100+ year old investment bank has no firm foundation? As such, when banks present such facts, how can one not deduce that the minibond is a safe investment?
The case of the minibond is not a case on the companies behind the structured product sold. The high risk was the structure / architecture / design of the minibond itself. This is the risk: FIRST TO DEFAULT BASIS. This means any of the eight underlying entitles fails, the minibond will be terminated and investor receives zero payout in the worst case scenario. This is the reason why it is a risky investment.
So what can the minibond investors do now? Perhaps what they can do now is to answer these 2 questions:
> Had the Relationship Manager explained clearly the risks due to the structure / architecture / design of the minibond?
> Had the Relationship Manager fully and clearly explained the worst case scenario?
If the answers to both questions are "No", the investor may possibly have a better case. The "higher" risk came from the structure / architecture / design of the minibond and not the underlying companies.
Mr Tan, much has been discussed about the fate of the minibond and their investors, I do have a question. What happened to the $500 million dollars (cold hard cash) invested in the minibond?
Regards,
REPLY
The financial institutions are only interested to find any excuse to reject the claim, so as to avoid paying any compensation.
The Monetary Authority of Singapore has asked them to treat their customers fairly. Unfortunately, MAS has not provided specific guidelines and leave it to the discretion of the financial institutions. The outcome is to be expected.
Sued for misleading investors
Nov 10, 2008
Suit against Lehman, UBS seeks an order certifying it as a class-action.
LEHMAN Brothers Holdings Inc's Chief Executive Officer Richard Fuld and UBS AG's US brokerage were accused in a lawsuit of misleading investors who bought Lehman's 'principal protected notes' before its September bankruptcy.
The complaint, filed on Nov 6 in federal court in Manhattan, claims Mr Fuld and 10 other past and current Lehman directors deceived investors about the risks of buying notes that are now almost worthless, Bloomberg news reported on Monday.
The suit seeks unspecified damages and an order certifying it as a class-action, or group lawsuit, on behalf of other investors.
Sales documents for the securities 'contained untrue statements of material fact and omitted other material facts', according to the complaint filed by Girard Gibbs LLP in San Francisco.
Lehman didn't disclose that repayment of the debt might be threatened by 'exposure to losses from its real estate and mortgage portfolio', and UBS Financial Services should have 'diligently' investigated the disclosures before helping sell the notes, the complaint said.
Mr George Sard, a spokesman for Mr Fuld, didn't respond to a message seeking comment.
Suit against Lehman, UBS seeks an order certifying it as a class-action.
LEHMAN Brothers Holdings Inc's Chief Executive Officer Richard Fuld and UBS AG's US brokerage were accused in a lawsuit of misleading investors who bought Lehman's 'principal protected notes' before its September bankruptcy.
The complaint, filed on Nov 6 in federal court in Manhattan, claims Mr Fuld and 10 other past and current Lehman directors deceived investors about the risks of buying notes that are now almost worthless, Bloomberg news reported on Monday.
The suit seeks unspecified damages and an order certifying it as a class-action, or group lawsuit, on behalf of other investors.
Sales documents for the securities 'contained untrue statements of material fact and omitted other material facts', according to the complaint filed by Girard Gibbs LLP in San Francisco.
Lehman didn't disclose that repayment of the debt might be threatened by 'exposure to losses from its real estate and mortgage portfolio', and UBS Financial Services should have 'diligently' investigated the disclosures before helping sell the notes, the complaint said.
Mr George Sard, a spokesman for Mr Fuld, didn't respond to a message seeking comment.
Sunday, November 9, 2008
Joseph Stiglitz
Joseph Stiglitz shared the Nobel prize in Economics in 2001 for helping to develop a theory of assymetrical information which showed that only under exceptional circumstances are markets efficient.
Prof Stiglitz argued that inadequate regulation has caused the global financial crisis. He argued for stronger regulation relating to corporate governance, pay, lending practices, etc.
Here are some of his remarks in a debate organised by the Economist magazine.
> The current crisis is caused, in part, by inadequate regulation.
> Financial crisis has occurred quite regularly in recent decades. They have occured in developed and developed countries. The only countries that have been spared so far are thsoe with strong regulatory frameworks.
> In each case, the crisis has affected not just the lenders and borrowers, but also innocent bystanders. Workers have been thrown out of jobs. Governments had to intervene.
> Regulations are necessary to restore confidence.
Prof Stiglitz argued that inadequate regulation has caused the global financial crisis. He argued for stronger regulation relating to corporate governance, pay, lending practices, etc.
Here are some of his remarks in a debate organised by the Economist magazine.
> The current crisis is caused, in part, by inadequate regulation.
> Financial crisis has occurred quite regularly in recent decades. They have occured in developed and developed countries. The only countries that have been spared so far are thsoe with strong regulatory frameworks.
> In each case, the crisis has affected not just the lenders and borrowers, but also innocent bystanders. Workers have been thrown out of jobs. Governments had to intervene.
> Regulations are necessary to restore confidence.
Quality of financial advice and fact find
Sunday Times 9 Nov 2008
Under the Financial Advisers Act (FAA), financial institutions and their representatives or financial advisers (FAs) are required to have a reasonable basis for recommending investment products to their customers.
The Act states that an FA must collect and document from the client information such as his financial objectives; risk tolerance; employment status; financial situation including assets, liabilities, cash flow and income; and current investment portfolio.
However, clients may choose not to provide the above information or choose to opt out from receiving advice. In such cases, the FA has to highlight to the client that it is the latter's responsibility to ensure that the product selected is suitable.
The FA may then proceed with his request for the transaction.
The Monetary Authority of Singapore (MAS) has encouraged the industry to improve the quality of advice and extent of fact-find.
It also expects FAs to have additional safeguards when dealing with clients with limited knowledge of investment products and who may find it difficult to understand the features of complex investment products.
Whether there is a breach of the FAA would depend on the facts and circumstances of a particular case.
Breaches of the FAA are punishable by a range of actions, including fines and imprisonment.
In particular, Section 27 of the Act provides that an FA is liable to pay damages to an investor who suffers loss or damage arising from advice that was not supported by a reasonable basis for recommending a certain product.
In addition, MAS may also take other regulatory actions such as issuing a prohibition order to bar the contravening person from providing financial advisory service for a fixed period.
Under the Financial Advisers Act (FAA), financial institutions and their representatives or financial advisers (FAs) are required to have a reasonable basis for recommending investment products to their customers.
The Act states that an FA must collect and document from the client information such as his financial objectives; risk tolerance; employment status; financial situation including assets, liabilities, cash flow and income; and current investment portfolio.
However, clients may choose not to provide the above information or choose to opt out from receiving advice. In such cases, the FA has to highlight to the client that it is the latter's responsibility to ensure that the product selected is suitable.
The FA may then proceed with his request for the transaction.
The Monetary Authority of Singapore (MAS) has encouraged the industry to improve the quality of advice and extent of fact-find.
It also expects FAs to have additional safeguards when dealing with clients with limited knowledge of investment products and who may find it difficult to understand the features of complex investment products.
Whether there is a breach of the FAA would depend on the facts and circumstances of a particular case.
Breaches of the FAA are punishable by a range of actions, including fines and imprisonment.
In particular, Section 27 of the Act provides that an FA is liable to pay damages to an investor who suffers loss or damage arising from advice that was not supported by a reasonable basis for recommending a certain product.
In addition, MAS may also take other regulatory actions such as issuing a prohibition order to bar the contravening person from providing financial advisory service for a fixed period.
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