SFC Lehman Brothers Minibonds Incident Report

Dear Legco Member, Dear SFC Officer,

We are writing to you to express our questions and disagreements with the “SFC Lehman Brothers Minibonds Incident Report” (“the SFC Report”) revised version since Feb 12. We respectfully request that Legco Lehman Incidence Investigation Committee investigates questions below regarding Banks’ wrong-doing in conjunction with the sale of minibonds to retail investors, and moves towards proper compensation for minibond victims. We respectfully request that SFC addresses each question below to the Legco Committee and to the public.

The key issue with Minibond is not about if it declared “principal protected” or not. The key issue is about misrepresentation and omission of the true nature and risk of the so-called “Minibond”. Lehman bankruptcy only triggered an awakening call. It made the public and minibond holders realize that the true nature and risk of minibond was not being disclosed in the past few years.

It is not uncommon for banks to find all the possible loophole even lame excuse to hide the truth of minibond sales, in the name of the best interest of Hong Kong as Financial Center or in the name of the best interest of shareholders. The Government must try its best to protect the public's interest, especially when public does not have much legal way to†challenge†banks. A thorough investigation on the minibond sales will help to restore the tarnished trust in banks, and will be for the best interest of Hong Kong as a financial center in the long term. Even right now after SFC has proven HK banks to public in all mis-selling of Minibonds, these banks still refuse to admit their frauds with the help of HKMA old chief Joseph Yam in covering up of bank frauds which could be proven by my emails of "Joseph Yam speech in 2003" to Legco on HKMA went easy on banks in their banking practice.

Minibond

1. Minibond is “Secured collateral and Swap” per SFC summary.
- Most minibond collateral was AAA-rated securities. The AAA-rated securities were mostly AAA-rated CDO/Synthetic CDO. While Shanghai Commercial bank said that for Minibonds series 20 on my first buy that these were European market funds while the older series were Lehman bonds that were every high risks if Lehman failed.
- Swap agreements included Credit Default Swap (CDS) with 5-7 well-known companies as reference entities. While Shanghai Commercial Bank manager Thomas Lo described that these reference entities were bonds of these well-known companies. This information was also passed by me to HKMA but no actions was taken by HKMA. The bank manager informed me that these very safe bonds helped Lehman to trade in other securities that were also AAA rated and Shanghai Commercial Bank checked many securities involved.
- Most CDO collateral included CDS with 100-155 reference entities whose credit rating in the category of AAA to CCC. It was rated as AAA after enhancement and its average portfolio credit quality was usually at BBB/BBB. A CDO portfolio with 125 reference entities (Series #19 collateral), would lose 100% principal upon the 10th credit event in respect of reference entities. And Shanghai Commercial bank wrongly described these as double protection on Minibonds as a way of investment using our money paid to the Lehman bank and PIFL controlled by HSBC for more profit in these swap arrangement, only more than 12 companies failed there might be some lost to the collateral, but our money that bought the bonds should still remained.

Product Description and Disclosure

We assume that a reasonable person’here refers to persons who are not credit derivative product experts such as 黃元山，迷宗.

- As reported in news:“證監會行政總裁韋奕禮表示、證監會角色並非要監察投資產品價格是否穩定, 而是要確保所批核之投資產品, 有全面市場披露”.
(2.2) William Pearson of SFC said in 2005: “(…). We are seeing more complicated products come on to the scene, but I think as long as the disclosure is clear, accurate and not misleading, we will be happy to see that carry on”, in the Asian Structured Products Review 2005,http://www.pacificprospect.com/downloads/asian_structured_products_review.pdf )

3. The SFC Report failed to point out that the prospectuses misled retail clients with the prominent “credit-linked to 7 reference entities”.

By choosing Synthetic CDO as minibond collateral, the prospectuses should have been fully aware that minibond’s value would be greatly decided by credit risk of its collateral’s portfolio holding. However, the prospectuses never clearly stated that minibond was in fact credit linked with “7 AND MANY Other” reference entities. The prospectuses failed to†disclose where the risks truly lie.

For Octave Notes series 6,10,15 and Constellation notes , all the banks I knew of involved in selling these products such as Shanghai Commercial Bank and Bank of China never gave me the two pages brochures for me to read first for these brochures were quit easy to read and Shanghai Commercial Bank did all Octaves Notes sales thru telephone in order not to let me to read these brochures. I later found out from Legco sessions, and my wife brochures of Octave Note series 20,21 there these products were high risk and these were listed in brochures. These banks were hiding out these products were high risks by not letting me to see the brochures before the sales and they all pretended these products were low risk bonds and these bonds should be safe and this was a complete lie. In Legco session, I also found out listening legco sessions that the detail prospetus and documents of Octave Notes listed these entities as low risk and very safe but in brochures that these products were listed as high risk. This should be the reason the banks did not want to give out these Octave Notes brochures that they could not lie to customers that Octave Notes were bonds.

Why did the SFC Report fail to find the prospectuses not meeting SFC’s “Clear, Accurate, No misleading” requirement?

4. The SFC Report Section 16.3.1 made biased observation on the prospectuses.

The SFC Report quoted the declaration of “not principal protected”. But the SFC Report failed to notice the following statements in the page 9 (of Series #27) of the Issue Prospectus:

“Are our Notes principal protected?

Our Notes are not principal protected: if a credit event happens to any one of the 7 reference entities before the maturity date, you will lose part, and possibly all, of your investment”.And for Shanghai Commercial Bank, in Minibonds 20 the bank manager said to us (me and three others clients of SCB that did not bought the Minibonds) that this only meant that only 1/7 of the minibonds were lost, and for Octave Notes and Constellation, this proved to be wrong)

Above statements effectively suggested that the “not principal protected” was conditioning on the credit event of 7 reference entities. Banks staff did not offer any other advise on such understanding.

What was the reason that the SFC Report did not identify above inaccurate and misleading statement?

Why were most (or all) banks staff having the similar misunderstanding on the condition of “not principal protected”?

5. The SFC Report Section 16.3.2 made biased observation on the prospectuses.

The SFC Report quoted “Our Notes are not suitable for everyone. (…). Before applying for any of our Notes, you should consider whether our Notes are suitable for you in light of your own financial circumstances and investment objectives. If you are in any doubt, get independent professional advice.” from the Prospectuses.

However, the SFC Report failed to notice the following statements in the Issue Prospectus (Series #20,21):

“Who should buy our Notes? Are they suitable for everyone?
Our Notes are not suitable for everyone. (…).
Our Notes are only suitable for investors who are:†
looking for fixed rate quarterly interest income (…),
confident that none of the 7 named reference entities will be affected by a credit event. (….)”.

Above statements in plain English clearly suggested (to retail clients) that, if you were confident on the 7 reference entities, the Notes was for you.

What was the reason that the SFC Report did not identify above misleading and inaccurate statements in the prospectuses?

6. A prospectus must disclose where the money would be invested into and where the interest and repayment of principal would be coming from. The SFC Report failed to identify that the Prospectuses never clearly disclosed such information. Why did the SFC Report consider the prospectuses disclosure as sufficient and acceptable?

The prospectuses only stated that “We use the money which you invest in our Notes to buy a package of assets.” (page 19, “What happens to my money? How can Pacific International Finance Limited pay me back? and so Shanghai Commerial Bank manager could use all kind of lies to mislead customers”).

The brand name of minibond and the term “credit linked to 7 reference entities” gave retail clients false illusion that the minibond money would be invested into debt/loans of 7 reference entities as told by Shanghai Commercial bank manager that these money were buying bonds. The truth was that, the Minibond†money was not invested inhto the 7 reference entities or any of the undisclosed 100+ reference entities that comprised of the minibond CDO collateral.There were no such things as double protection of the money invested into Minibonds that made Minibnds lower risk than bonds as Shanghai Commercial Bank said. There were no corporate bonds sold in most HK local smaller banks in order to lure customers mainly retiree with sum of USD100,000 or more to buy these Minibonds to replace bonds sales and HKMA was also intentionally to cover this up as told by HKMA Choi in Legco session that these minibonds were first intended for customers with less than USD100,000 capital and would willing to take higher risk to buy minibonds for more interest and I had sent these information to Legco on HKMA voodoo economics team members. These minibonds paid less interest 4.8% than corporate bonds 6-6.5%. The only way to stop bonds sales on market were all smaller banks joined together to stop bonds sales in order to push these high risk low yield Minibonds.

(7.1) Plenty of credit rating information on the 7 reference entities was disclosed. The prospectuses mentioned the AAA-rating on the CDO. But there was no mentiotraning on the credit rating information/or guideline on the reference entities that comprised of CDO collateral. The Prospectuses at least should be able to state clearly about credit linked to many other referen ce entities, and to disclose some guideline on the criteria for selection of the reference entities such as the expected number of reference entities and the expected percentage of reference entities below BBB/or BB /or B-/etc.In Minibond series 6 and older versions, there were informations about these CDO sold by six HK smaller local banks, and these informations were hide away in Minibonds 7 by these six banks and SHK agents that issued these brochures and later on these were issued by PIFL For Constellation Notes and Octave Notes, these Notes listed high risk in brochures but the bank - Shanghai Commercial Bank use telephones calls to sell these products so their customers had no chance to look at these brochures.

(7.2) The prospectuses at least should be able to disclose that a Synthetic CDO usually would experience 100% principal loss when 8% (or less) of the reference entities has default event. It does not need 10% or more of the reference entities to have default event for the 80%-100% principal loss.

The prospectuses did not provide “sufficient information” on minib on, and obviously were way off the “Clear, Accurate and non misleading, Disclosure (全面市場披露 )” requirements. We contend that the prospectuses consistently omitted material fact and gave misleading statement, so that a reasonable person would not be properly informed of the true nature and risk of minibond.

Why did the SFC Report consider the prospectuses disclosure as sufficient and meeting SFC requirements?

Code of Conduct at Point of Sale

The SFC Report Section 2.5 listed requirements on regulated body (banks) or HKMA/SFC registered staffs.

8. The SFC Report failed to identify that banks provided clients with incomplete material information.

The CDO collateral information held the most important material information on the Minibond. The diminished collateral value also proved the critical of such collateral information. The prospectuses were only part of minibond information. Detailed Information about the collateral, including evidence of the rating and the terms and conditions of the collateral, would have provided Minibond buyers with a 2nd chance to know what the Minibond was really comprised of.

Such collateral information was not available to minibond purchaser when they signed the purchase agreement. However, such collateral information usually would be made available prior to the issue date. Banks should have requested such information after offer closed. Banks should have sent such CDO collateral information documents /or notice of such documents’ availability to minibond purchasers. Banks are required to provide clients with relevant material information for derivative products, according to SFC’s Code of Conduct. But Banks failed to do so. Why was this not mentioned in the SFC Report? In fact, the bank manager informed us that structure products were not derivative products, but another type of new products similar to funds and much more safer than bonds for the low risk bonds might lost some of the values if the companies or US government had no money to pay back the money,what he meant put structure products were near zero risk as some of the 0% lost protection funds or insurrance products.

9. The SFC Report failed to identify that Banks’ due diligence was insufficiently thorough over the past few years’ minibond sale. Evidence is as follows:

- Banks should have cautioned us that minibond was not invested into any debt / bonds issued by any of the 7 reference entities.

- Banks should have cautioned us that AAA-rated securities (or AAA-rated CDO), may not be the same as AAA-rated conventional bond, and should have cautioned†us about the nature and risk related to CDO collateral. $10 million cash or cash equivalent is very different from $10 million worth of combined asset value of cash / stock /commercial real estate / residential real estate / machinery

- It was never mentioned to us what CDO was comprised of and what kind of risk CDO may have.

- It was never pointed out to us that the key asset of CDO collateral was CDS with many entities, and its value was decided by the credit risk or default event of its portfolio holding.

- It was never mentioned to us that† a†AAA-rated Synthetic CDO may have average portfolio credit quality at BBB/BBB-.

- We were never told to be aware that minibond was, in fact, not only credit linked with 7 reference entities, but also credit-linked with many other entities at various rating categories from AAA to CCC. A 8% (or less) default rate in the CDO collateral would result 100% principal loss.

- And, we were never and even wrongly and criminally explained about the First-To-Default with the 7 reference entities, nor the credit event redemption amount. Constellation is an example about how crucial to understand such terms prior to purchase. In fact for example Minibond series 6 did listed that if one of the 7 entities failed, the values of the minibonds might go to zero, these informations were hidden intentionaly in series 20 where the bank manager, Thomas Lo told me that if one reference entities failed, I would still have the values of the remaining entities hold inside Minibonds that made Minibonds safer than coporate bonds, that proved to be wrong for related Minibonds such as Octave Notes and Constellation notes. '

- Shanghai Commercial Bank had promise before they knew about collateral information for it was one of the six banks that sold Minibonds series one to series 6 that had collaterial informations printed in the documents and in fact banks did not disclose any collateral information for they themselves are looking closely into them as they said that these are their responsibilty to look into collateral information for customers and no need for us to fear the risk of these so called (bonds) and are still checking these collateral information. Shanghai Commercial Bank has just called to inform me about Victory Peak International finance Ltd. Octave Notes 6 that because of default of Nortel Network and Smurfit-Stone Contaier enterpries. The bank said that these 7 reference entities owned these (bonds, stocks) that I should sell these notes at 60% loss. These banks are still lying to customers for they knew what was behind these minibonds, octave notes, constellation series before the sales and still are lying to customers about CDO and CDS.

We contend that, instead of exercising due diligence, Banks† in fact collaborated, we would suggest fraudulently, with the minibond issuer, hiding the risk of the Synthetic CDO from the bank's retail clients since Minibonds series 7 for the hiding of the information raised Shanghai Commercial Bank sales of Minibonds much more than 10 times , refusing to sell bonds such as Hutchison bonds to retail clients, with the objective of increasing the sale of the minibonds.(according to my source in KCR/HK procecutors that used HSBC and from UBS that the two public bank that had Hutchison bonds for sold was HSBC and CitiBank) and Banks such as Shanghai Commercial bank / Wing Hang Bank /etc, rated the inibond as “Low to Medium Risk”, considerably downplaying the product’s risk level, is another proof of banks’ faulty due diligence. In the only customer risk profiling form done by the bank done on 13Dec 05, the bank destroyed my original low risk bonds buying requests with three others customers requesting bonds sales requests from bank in customer risk profiling against rule of SFC, fill the profiling form themselves, and asked me to come to bank to sign the new form saying they were required by their top management from central, mostly directors that required them to commit this criminal acts of bank frauds. I had told this to HKMA on their first telephone call to me, and HKMA is still covering this up with no investigating and put my complaints as 3B.

The SFC Report failed to identify this, and so SFC should study this informations once more for more severe punishments against the banks.

10. What was the SFC Report’s conclusion on the banks minibond sales related training and procedures?

- (10.1) What was the understanding of banks staffs regarding all the risks listed in the SFC Report Section “16.4”? Did banks staff explain all these risks to their clients at the point of sale, other than credit-linked to 7 reference entities and no liquidity / long lockup period?

- (10.2) The SFC Report Section 2.3.1 stated “2.3.1 ..... Intermediaries were still under an obligation pursuant to the Code of Conduct to explain the nature and risks of the product they were selling and ensure it was suitable". Does SFC consider that the mentioning of “credit-linked to 7 reference entities and no liquidity / long lockup period” was sufficient for fulfilling such requirements?

- (10.3) The SFC Report Section 2.5.2 stated“2.5.2. The Code of Conduct also imposes obligation on intermediaries to ensure their staff are properly trained and supervised”. To what extent, was this demonstrated by SFC’s investigation? In fact, after finding wrong doing during the sales of Minibonds, SFC had started 30 training lessons for 300 banks and stock trading staffs each.But for Shanghai Commercial bank, the banks not only did not warned their customers about mis-selling, but continue with more mis-selling thru telephones just to hide away these mis-selling for the banks had to hide away further HKMA inspections of mis-selling by using telephones sales. In 2006,2007,2008 most sold of Lehman derivatives notes were thru telephones or in offices of bank customers.

- (10.4) How would SFC define banks / banks staff’s Honesty and Fairess, Care to their Clients? Should it be defined as:

"For a complex credit derivative product like minibond, the responsibility of Bank's staff is limited to: passing the Issuer Prospectus to the client after the sales few weeks later, hide away the brochures if there were high risk products listed so customers could think these products were low risk, and telling clients with wrong information, misrepresenting and misleading on true nature and risk of the product, stole the coupons after the sales as Bank of China did to my Octave Notes 15”? SFC require proper training and qualified bank staffs to sell the Minibonds. But Shanghai Commercial Banks Jenny Cheung promised in telephone calls in selling Octace Notes and Constellation to come to explain the new products as Insurrance agents did for trust funds but she never came and added false informations to all sales document after the sales thru mails.All the customer risk profile were added later by banks as B.G. by the bank. Before signing, these were blanks and I called Jenny Cheung to ask why this were blank and not filled in by me, and she lied that this were for bank use only. In fact, any add on items will falsfied the documents in Insurrance agents training and Jenny Cheung Should be trained in this.Right now only police CID in HK waterfront central station hasd files on this customer risk profile form.

notes:
2.6 根據Saphir在零八年推出的2008-8合成CDO的銷售章程顯示，雷曼把超過100家企業組成一個投資組合，如果該組合中的企業出現財政困難，雷曼 將會減少向Saphir投資者派發的利息，當出現財困的企業超過一定數目，Saphir投資者將失去所有本金，只能索回該投資組合的企業某種指定債權的市 值。換言之，這類合成CDO妨如把一連串的信貸違約掉期(CDS)組合而成的CLN。由於Saphir集資所得不會直接購買該投資組合，資金將會購買一些 例如市場基金等抵押品。(參考圖2)

2.7 正如第一種信貸衍生工具，投資者既要承擔投資組合內的100家企業的信貸風險，亦要承擔抵押品的風險。投資者從中換取利息回報。

2.8 迷你債券系列10至36把上述兩種產品合而為一。方法是利用第一種衍生工具集資所得購買第二類衍生工具，並以此作為迷債的抵押證券(參考圖3)。

2.9 換言之，迷債投資者購買這種二合一產品後，要承擔三重風險，包括：第一層結構中指定企業(一般是6家較知名的企業)的信貸風險、第二層結構中超過100家指定企業的信貸風險，以及第二層結構中的最終抵押品的信貸風險。

2.10 當我們比較HSBC CLN系列12、Mahogany票據，及雷曼迷債系列19的產品結構及銷售章程，即能看見雷曼迷債披露資料方面的嚴重缺失。

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雷曼產品本身就有很大的欺騙性｡ 若說迷你債券是一個騙局, 亦非虛言｡ 迷你債券(簡稱「迷債」)本身名稱的設計就是要引君入局, 令買者以為這是將債券拆細, 或將大戶專用的債券拆細為適合散戶的債券｡ 由於迷債名稱的誤導, 令三萬多個散戶紛紛墮網｡ 是以當證監會總裁韋奕禮說: 「迷你債券只是品牌」, 全港輿論嘩然, 以為韋氏是外星人, 要驚動特首澄清說「迷你債券不是債券」｡香港這個「亞洲世界之都」, 一時間時光倒流, 返回二千多年前「白馬非馬」、「飛矢不動」的詭辯世界中｡

迷債表面上與六、七間大公司, 甚至中國國債作信貸掛鈎(Credit-linked), 銀行的銷售單張都以此作為招徠｡ 前線銷售人員千篇一律, 異口同聲說: 「即使其中一間大公司信貸破產, 買主只損失七份一｡」 實際上並非如此, 其中一家破產, 則本金可能全失｡ 而且, 更大的禍害, 隱藏在所謂墊底証券(underlying securities), 有時則乾脆稱為抵押品(Collaterals), 與超過一百間公司的CDS(Credit Default Swap 信貸違約掉期)掛鈎, 成為所謂的合成 CDO (Synthetic Collateralized Debt Obligation抵押債務責任)｡ 只要其中六、七家公司發生信貸事件, 亦足以令投資者本金全軍盡墨｡ 這個隱藏的禍害, 並無如實的披露, 稱之為包藏禍心, 實不為過｡