(Staff post from The SINGAPORE INFOPEDIA in August 2023.)
Lehman Brothers Minibond saga: The Lehman Brothers
Minibond saga refers to the chain of events resulting from the Lehman Brothers’
bankruptcy filing in September 2008.
Following the collapse of the Lehman Brothers,
about 10,000 retail investors in Singapore lost their investments totalling
over S$500 million in structured investment products linked to the American
investment bank. The financial institutions that distributed the products were
accused of having mis-sold these relatively high-risk products to investors,
many of whom were elderly and less educated.
This prompted government investigations, which led to penalties being imposed on 10 financial institutions, and tighter supervision of the industry.
Minibond are not bonds, but financial
derivatives based on credit default swaps (CDS), which are high-risk financial
investment products. They were a brand name for a series of structured
financial notes issued in Hong Kong and Singapore under control of Lehman
Brothers. The name MINIBOND was also used for other likewise structured Notes,
namely Constellation Notes and Octave Notes, respectively issued in Hong Kong
under the direction of DBS Bank and Morgan Stanley.
Some countries prohibit or restrict the
sale of CDS to non-professional investors. However, in many regions in Asia,
banks sell them on behalf of others. In addition, banks to sell products to
retired people, familiar neighbors, etc. in order to gain sizable commissions
leading to possible misselling. Most investors do not read the terms of sale in
detail and get the impression that mini-bonds are capital-guaranteed and
low-risk investments.
In 2008, these Minibonds led to the Lehman
Brothers mini-bond affair, where as a result of Lehman Brothers bankruptcy the
value of its minibonds plummeted, and problems gradually emerged for its
investors.
Background
The investment products in question were the
Minibond Notes, High Notes 5, Jubilee Series 3 LinkEarner Notes and Pinnacle
Series 9 and 10 Notes.3 For each of these products, the investor was paid a
regular stream of interest or coupon until maturity, at which point the
investor was entitled to a redemption amount as described in the terms and
conditions of the product.
Pegged to considerably higher interest rates than
fixed deposit rates, the notes were eagerly taken up by investors. As the notes
had multiple risk exposure, there was no guarantee that investors would get
back their principal when the notes were redeemed, either upon or before
maturity.
Unwinding of products
On 15 September 2008, news broke that Lehman
Brothers had filed for bankruptcy in the United States, which sent shockwaves
across the world and worried investors who had bought its Minibond Notes.
Lehman Brothers had arranged all nine series of Minibond Notes. It was also the
swap counterparty, which meant that its collapse would cause the notes to
default on their scheduled interest payments. This would, in turn, lead to an
early redemption of the notes and liquidation of the underlying assets.
Shortly after, investors who had bought High Notes
5 (arranged and issued by DBS Bank) and Jubilee Series 3 LinkEarner Notes
(arranged by Merrill Lynch) discovered that the collapse of Lehman Brothers had
also triggered a mandatory early redemption of their notes.
They could get nothing from the forced sale of the
underlying collateral, as the values of these assets had fallen drastically
amid the global credit crisis then. Their worst fears came true in October
2008, when it was announced that investors would not receive any payout from
the unwinding of the two products.
The hopes of Minibond Notes investors were raised
in October 2008 when some financial institutions expressed interest to take
over as the swap counterparty, thus avoiding an early redemption. However, this
option was ruled out in December 2008 because of legal challenges by Lehman
Brothers’ lawyers in the United States.
As the legal issues had to be cleared first, the
investors were also told that the underlying assets could not be sold for at
least another two years. Fortunately, this happened earlier than expected, and
the process of liquidating the assets began in October 2009. In February 2010,
investors received their share of the proceeds, with payouts ranging from 21.5
to 70.8 percent of the amount invested.
In November 2008, investors of Pinnacle Notes
Series 9 and 10 were informed that their notes would be unwound, and that they
could lose almost all of their original investments. The event was triggered by
the failure or near-bankruptcy of five underlying assets, namely Lehman
Brothers, two mortgage giants in the United States, Freddie Mac and Fannie Mae,
and Icelandic banks Kaupthing and Landsbanki.
Investor activism and compensation
Soon after the affected investors found out that
they could lose their entire capital, the local media began carrying stories on
the plight of those who claimed they were misled into buying the investment
products. The unhappiness stemmed from the way these risky products were
marketed and sold as safe investments.
A large number of the investors were elderly and
less educated. They were not proficient in English or had little financial
knowledge, and thus would have found it difficult to fully understand the risks
of these complex structured investments. Questions were raised on why the
products had been offered to these investors in the first place.
Public anger was directed at the institutions that
sold them the products. Adding to the debacle was news that eight town councils
run by the ruling People’s Action Party had S$16 million invested in various
products linked to Lehman Brothers.
Thousands of complaints were sent by affected
investors to the 10 financial institutions that distributed the notes: DBS
Bank, ABN Amro (now Royal Bank of Scotland), Maybank, Hong Leong Finance,
CIMB-GK Securities, DMG and Partners Securities, Kim Eng Securities, OCBC
Securities, Phillip Securities and UOB Kay Hian.
Some who were dissatisfied with the responses they
received from the financial institutions took their cases to the Financial
Industry Disputes Resolution Centre. Many investors also joined public protest
rallies, petitioned to the Monetary Authority of Singapore (MAS), and/or
initiated collective legal action against the distributors.
As of 31 May 2009, DBS Bank, ABN Amro, Maybank and
Hong Leong Finance received 5,551 complaints. Of the 5,352 cases decided on,
3,607 (67 percent) received settlement offers, of which 85 percent were
accepted by the investors. The compensation offered totalled S$104.6 million or
32 percent of the amount invested in the cases decided.
The six brokerages, which received 952 complaints,
offered compensation for 33 percent of the 889 cases decided on. The offers, of
which 70 percent were accepted, totalled S$2.74 million or 5.6 percent of the
amount invested in the cases decided.27 All settlements were offered without
admission of liability.
The first lawsuit arising from the Minibond saga
was by a group of 204 investors. They sued DBS Bank in July 2009 for the S$17
million they lost from investing in High Notes 5.
Government response
While reminding investors that they were ultimately
responsible for their own financial choices and should understand what they
were investing in, the MAS took an active role in helping those affected.
Besides telling the distributors to handle all
complaints fairly and prioritise vulnerable investors such as retirees with
little education, the MAS also ordered them to appoint independent parties to
oversee the investigations into mis-selling and the complaints handling
procedures.
In addition, the MAS drew up a timeline that
distributors had to follow in the handling of customers’ complaints, requiring
them to complete their review of each complaint within four weeks of receiving
it.
After looking into the sales practices of the 10
distributors, the MAS’s findings led to sales bans being imposed on them
starting from 1 July 2009. Hong Leong Finance received the heaviest penalty – a
two-year ban – while DBS Bank, Royal Bank of Scotland and Maybank were given
six-month bans.
The six brokerages were handed bans of six months
or one year and could not resume selling structured notes until their internal
processes were strengthened to the MAS’s satisfaction. Hong Leong Finance has
since said that it would not sell such products in the future. The bans on the
three banks were lifted with effect from 12 February 2010, while the six
brokerages had theirs lifted with effect from 24 August 2010.
In a move to keep rules updated and relevant, the
MAS reviewed the regulatory framework for marketing investment products and
proposed several measures to better safeguard the interests of retail
investors. For example, financial institutions have to provide a user-friendly
product highlights sheet describing the key features and risks of an investment
product, and investors have a seven-day window during which they can cancel
their investments without incurring sales charges or commissions.
Other proposals put forth by the MAS included
measures to raise the competency of individuals selling complex investment
products. Having sought public feedback in early 2009 and early 2010, the MAS
also published an online consumer guide titled Making Sense of Structured
Products to help investors make more informed decisions regarding such
products.
