III. Disclosure-based Regulation
In December 2008 the SFC submitted to the Financial Secretary a report (the ‘Report) purportedly to address the causes and consequences of the scam. What is emerged is a shame and the shoddiness of the report should convince any perceptive and fair-minded person how corrupt (at least morally and intellectually) the government is and how individuals of decency and integrity will not want to associate themselves with such an administration.
The Report is titled ‘Issues raised by the Lehmans Minibonds crisis’ (available at: www.sfc.hk/sfc/doc/EN/general/general/lehman/Review%20Report/Review%20Report.pdf). Could the ‘Lehmans’ be just a typo? Computer-users would have no difficulty in appreciating how hard for this error to happen without the person performing the task noticing it. Another piece of damning evidence of shoddiness is the decision to use the label ‘Minibonds’ to describe what the SFC has been saying all along, namely ‘Lehman Brothers-related retail structured products’. Could the use of label ‘Minibonds’ be merely a casual mistake? To answer this question properly, one needs to bear in mind the deflection tactic used by the SFC to preclude public discussion about the deceptive disclosure statements in the relevant prospectuses. By invoking the label ‘minibond’, the SFC may be trying to keep alive the emotional debate about the propriety of the label among the less educated victims. To the extent that the label is relevant, it is peripheral to the core issues surrounding the blatantly misleading disclosure in the marketing materials – the very documents that were approved by the SFC.
It is understandable why the SFC wants to avoid such terms like ‘retail’ and ‘structured’. Typically a prospectus for structured product resembling the afore-mentioned Saphir notes would run to some 100 pages in length. The sheer number of entities in a typical portfolio and the complexity of contractual provisions governing the swap arrangement dictate that the prospectus has to be lengthy and peppered with tables, diagrams, charts, and other visual aids to help readers to understand the intricacies of the product.
Given the complicated structure of the product, the only way to ensure that every purchase is based on informed consent is by full and fair disclosure in the marketing materials. But the effectiveness of disclosure, however full and fair, is doubted by many respectable professional opinions for reason that such complicated products are inherently unsuitable for retail investors. Their lack of access to market information and lack of knowledge to assess the significance of it are some of the major handicaps disadvantaging the retail investors.
The existence of proper disclosure in a prospectus is only an essential pre-condition of preventing fraud or other ‘mis-selling’ from taking place. Equally important are the willingness and ability of the distributor to understand the product, as well as the ability of its sales team to have such understanding that enables them to explain the details to the prospective investors. Thus, it is a two-stage suitability assessment. The first stage concerns the suitability of the distributor itself to sell the product. And only when the distributor who has reason to believe its staff is capable of explaining the product and assessing the suitability of any particular prospective investor that it should involve in the sales of the product.
The sales of these Lehman-related securities for six years unmistakably demonstrate the complete breakdown of these safeguards. The abdication by SFC of its duty to know the products and assess adequacy of disclosure is matched by the same culpability of HKMA to let the distributor banks to disregard the suitability assessment.
Does the SFC have anything to say about its jurisdiction over disclosure in the Report? In paragraphs 24.3 and 24.4 of the Report, the SFC argues that (i) verification of accuracy of what is disclosed; and (ii) assessment of suitability of the products, should not be the duties of SFC. The practices of its counterparts overseas are used by the SFC to justify this argument.
This is just another deflection tactic. About half of the total victim investors of this Lehman-related securities scam are elderly and individuals with little education or otherwise suffering from handicap of one form or the other. The profiles of these victims are known to the two regulators but they persistently refuse to release it for no good reason whatsoever. To the extent that the demand for verification and assessment is genuine in the sense that it was made by some of the victims, the SFC should know better that these are not the key issues. One of the real issues that the SFC should have addressed but again it has failed to do, in the Report as well as in the media; is whether the SFC is required to detect inadequacy, inconsistence, or discrepancy in the documents submitted for approval.
Misstatement in a document could be a result of negligence or fraud. The possibility of this should always be in the mind of those SFC staff responsible for vetting the prospectuses. Yet the Report clearly reveals a conscious effort to steer clear from this simple and evident aspect of the SFC work. The ‘piggybacked structure’ could be hard for the uninitiated to understand but the SFC is staffed by professionals well remunerated by any standards; and it has never been mentioned that these officials were constraint by any shortage of resources. In the circumstances, it is reasonable for the public to expect them to perform their duties to a high standard of excellence.
The shoddy Report proves how much the public is short-changed by the SFC. But that is not all. As the scam is about the Lehman-related securities, one would expect to find in the Report some detailed analysis of the products. Instead of any analysis, one can only find a 2-page (pages 33-34) shameless copying from the prospectuses masquerading as answer to the self-imposed question ‘what is a minibond?’ By relying almost exclusively on the prospectuses, the SFC is tantamount to vouchsafing the compliance of the prospectuses with statutorily required standard. The LBV has written to the SFC on 27th February 2009 requiring an explanation of its conclusion that disclosure is adequate and requesting a constructive dialogue on our queries over its assertions. The letter to SFC is re-produced in full in appendix A of this report.
The SFC is a member of the International Organization of Securities Commissions (IOSCO), an international standard setting body created in 1983. So far, the SFC has not been able to summon up the courage to answer pertinent questions raised by some of the more knowledgeable victims. This is a fact of crucial public importance because, if the SFC is content to hide behind its own illusory reality, the foundation of our financial system will turn into quicksand sooner than we could expect. The fact that this city was selected for this scam, and the conduct of the regulators in the last six months, reveal what kind of future is in store for us.
to be continued......
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