Report on the Lehman-related Securities (9)

( II. Dissecting the ‘Piggybacked Structure’....... continued)

It should be noted that while most of the Lehman-related securities are fixed rate product, the
security (because of the inherent volatility) is designed to generated variable rate return. In
order to enable Lehman to benefit from the potential higher return without having to assume
the risks embedded in the synthetic CDO, Saphir would enter into swap agreement with
another Lehman-controlled entity (the ‘swap counterparty’) whereby return generated from
the portfolio would be paid by the former to the latter in exchange for a sum equivalent to the
interest payable to the victim investors. In other words, the victim investors of each series of
Lehman-related securities were asked to underwrite an extremely complicated portfolio of
derivatives for a meager return because they were not informed of the risk at the time of the
investment. The bulk of benefit flowing from the portfolio went to Lehman, secretively
through the hidden component in the ‘piggybacked structure’.

Although the swap between Saphir and the ‘swap counterparty’ is all within the control of
Lehman, Saphir had to use the money received from Pacific to purchase collateral in order to
give the arrangement the respectability in the eye of the more regulated world. After all, the
Saphir notes are subject to the relevant European regulations governing disclosure. With
more transparency, there are few anomalies. The exact opposite happens in Hong Kong. Such
latent sense of lawlessness, fostered by the frequent disregard of the law by the government,
encourages or even causes the fraudsters to conceive and implement the scam here.

The very contrived nature of this ‘piggybacked structured’ is also manifested in the
misstatement that the investors’ money was used to purchase the security as if it is something
of value. The security, as explained above, is also a credit-linked note embedded with a swap
arrangement between Saphir and another Lehman entity similar to a SPE. The swap
agreement is a private bilateral contract the value of which depends to a large measure on the
collateral selected by the parties to back up their mutual promises. In other words, to describe
the ‘security’ (i.e. Saphir notes) as ‘collateral’, which is what Pacific does in its prospectuses,
is a misstatement for the simple reason that there is ‘real collateral’ underlying the Saphir
notes. With regard to the Saphir notes series 2008-8, the ‘real collateral’ is USD61,000,000
Principal amount floating rate note issued by Landesbank Baden-Wurttemberg. It is to the
purchase of this ‘real collateral’ that the fund of investors of minibond series 12 has gone.
The existence of this ‘real collateral’ is kept hidden from the investors because the term
‘collateral’, together with its conceptual significance, has been misappropriated to apply to
the ‘hidden component’ (the Saphir note).

to be continued......
Extract From: "Exposure - the Truth About Lehman-HSBC Fraud"

Report on the Lehman-related Securities (8)

( II. Dissecting the ‘Piggybacked Structure’....... continued)


To sum up, the ‘piggybacked structure’ consists of two layers:

(a) The first layer could be a CLN featuring well-known corporations for the purpose of
deceiving the investors into believing that their investment would be safe so long as those
corporations are solvent.

(b) The second layer of synthetic CDO masquerading as ‘collateral’ so as to justify only
very sketchy information is given about it in the prospectuses.


For those readers who are interested in getting a quick grasp of the gist of the scam, they are
recommended to turn to Appendix C where they would find a comparison of the table of
contents of the following two prospectuses:

(a) The above-mentioned HSBC CLN prospectus dated 8th April 2005; and

(b) The issue prospectus of minibond series 19 dated 25th April 2005.


These two prospectuses are meant to describe two very different products – a simple CLN in
one case and an unprecedented contrivance of ‘piggybacked structure’ in the other. Despite
the vast differences, the two prospectuses look astonishingly alike in contents and length. At
this point, the reader should bear in mind that:

(a) Pacific Finance is controlled by HSBC in the sense that HSBC holds all the issued
shared capital of Pacific Finance and provides its employees as directors of the SPE.

(b) The same law firm, the Linklaters, provided legal advice in respect of these two
prospectuses.

As explained above, this outline of the synthetic CDO will be brief as the primary tactic of
the scam is to conceal the importance of it. By playing down its importance, there is hardly
any disclosure about it in the relevant prospectuses – not even the existence of another swap
arrangement between the issuer of ‘security’ and another Lehman-controlled entity. Take the
example of the synthetic portfolio floating rate notes (series 2008-8) issued by Saphir as
example. The notes were purchased by Pacific as ‘security’ of minibond series 12. The value
of the notes is credit-linked to a portfolio of over 100 swap agreements (known as Credit
Default Swap) whose value, individually or collectively, is dependent to a large extent on the
sentiment of the international credit market. Whether, and if so the extent to which, the
investors are able to monitor this financial derivative market is not mentioned in the relevant
prospectuses. What is disclosed is the ‘publicly available information’ about the well-known
corporations at the façade level as if this is all that the investors need to know or to keep
abreast of. Where there is only partial disclosure when full disclosure is mandated, and where
what is not said would render what is said false and misleading; as it happens in the relevant
prospectuses, a case of criminal fraud is capable of being established, at least on a prima facie
basis.

to be continued......
Extract From: "Exposure - the Truth About Lehman-HSBC Fraud"

Report on the Lehman-related Securities (7)

( II. Dissecting the ‘Piggybacked Structure’....... continued)


The Mahogany Notes are relevant to this scam not only because they were sold under the
supervision of Lehman, but also because they are based on notes issued by another
Lehman-controlled SPE known as Saphir Finance plc (the ‘Saphir’). For those victims who
have received notices from the trustee (HSBC USA NA), they may recall Saphir is one of the
companies that supplied security to Pacific Finance for the minibond. In other words, Pacific
used money received from the victim investors to purchase ‘security’ (that is, the hidden
component) from Lehman-controlled SPE and Saphir is one of the security suppliers.

At this stage, more perceptive readers would notice some anomalies. The façade, which is a
CLN, requires collateral to back up the swap agreement. But why should the parties agree to
use the very risky and very complicated synthetic CDO as collaterals. This is entirely
contrary to the logic inherent in the role of collateral because when compared with the façade,
the ‘security’ is inherently more volatile. The only way to make this ‘piggybacked structure’
less absurd is to reverse the roles played by the CLN and the synthetic CDO. That is to say,
the synthetic CDO should be shown to the world as façade of the product, because it is a lot
more risky and is capable of generating higher return. By the same token, the CLN whose
basket of reference entities are among the most powerful corporations in the world with
known political connection with the most powerful governments, it is more logical to be the
collateral if only because of the little likelihood that any one of them would default.

.....to be continued.
Extract From: "Exposure - the Truth About Lehman-HSBC Fraud"

Report on the Lehman-related Securities (6)

( II. Dissecting the ‘Piggybacked Structure’....... continued)

The CLN issued by HSBC Structured Notes (Cayman) Limited is particularly relevant to this
scam because the directors of this special purpose entity (‘SPE’) are almost the same as the
Pacific International Finance Limited (the ‘Pacific Finance’) – the issuer of the minibond. In
addition to common directorship, there are more sinister signs suggestive of fraud perpetrated
by the HSBC Bank to be detailed below. Suffices it to note at this stage that the CLN sold by
the HSBC-controlled SPE, known as USD Callable Basket Credit Linked Notes (the ‘HSBC
CLN’), does not require the backing of ‘collateral’ because it is guaranteed by the HSBC
Bank. Therefore, the money received by HSBC Bank from investors of the HSBC CLN is
declared in the prospectus as applied by the Bank to its general banking business. As will be
elaborated below, despite the vast differences between the HSBC CLN and the
Lehman-related securities, the prospectuses of the two are almost identical in terms of
organization, contents, and layout. Given the common directorship, Pacific Finance has to be
taken to know its prospectuses are seriously defective as they are definitely inadequate for the
purposes of explaining the intricacies of the products and gravity of the risks involved.

The second component is hidden behind the façade because it is a very risky and complicated
product known as ‘synthetic collateralised debt obligation’ (Synthetic CDO). Any attempt to
provide a simplified explanation of this product runs the risk of misleading instead of
enlightening. However, a brief outline of it will appear after an exposition of the heart of the
scam. One can have a firm grasp of the scam and the complicity of the HKMA and SFC in it
by considering the sales of ‘Mahogany Notes series I and II’ by Mahogany Capital Limited in
Australia. The Mahogany Notes are essentially synthetic CDO-based products and the sales
of them in 2004 and 2006 were controlled by Lehman. To meet the statutory disclosure
requirements then in force in Australia, the Mahogany prospectuses contain detailed diagrams,
tables, charts, analyses, and the like to explain the nature and the risks of the notes.

.....to be continued.
Extract From: "Exposure - the Truth About Lehman-HSBC Fraud"

Report on the Lehman-related Securities (5)

II. Dissecting the ‘Piggybacked Structure’

The ‘piggybacked structure’ is made up of two separate and independent components. They
are intended to operate in tandem, but independently. They carry risks of different kinds and
of different magnitude.

The majority of Lehman-related securities are labeled as ‘minibond’ while others are
variously named as ‘equity-linked note’ and the like. The label is less important than the
structure because the scam is based on using one component to conceal the other. The former
performs the function of a façade in order to hide what is underneath. It is apt to characterize
that component a façade because prominence is given to it by the fraudsters in the marketing
materials.

The façade component (the ‘façade’) could be a first-to-default credit-linked note (the ‘CLN’)
featuring a few corporations well-known to the public of Hong Kong. It is intended to
provide the reassurance that the product is safe and solid.

By purchasing a CLN, the investors run the risk of losing part or all of their investment if any
one of the specified reference entities (that is, the well-known corporations) suffers a credit
event as defined in the prospectus. Because an issuer of CLN can be a special purpose entity
(a company without substantive business or asset but was created solely for the purpose of
issuing structured notes), it will use the fund received from the investors to purchase
collateral in order to enter into swap arrangement with another party (known as ‘swap
counterparty). The swap is intended to be a mutually beneficial exchange whereby the CLN
issuer is likened to an insurer underwriting the financial health of the reference entities. In
exchange for this protection, the swap counterparty agrees to pay at regular intervals a fixed
or variable sum to the CLN issuer just as an insured would do in paying premium to its
insurer. The collateral serves to protect the interest of parties to the swap agreement by
ensuring that fund for the performance of their respective obligations is readily available.
Given this ‘safety net’ function, the parties to a swap agreement normally select sound and
solid assets whose value is likely to remain stable during the term of the agreement as
collaterals.

.....to be continued.
Extract From: "Exposure - the Truth About Lehman-HSBC Fraud"

Report on the Lehman-related Securities (4)

(1. Introduction ....... continued)

There is evidence showing that from 2003 to 2008 the HKMA had kept on asking the banks
to adhere to the codes, presumably without any sign of success despite repeated attempts year
after year. No regulator can perform its statutory duties by exhortation alone. We have no
reason to believe that the HKMA has ever been so hamstrung during the material time as to
render it impotent to police the banks. This being the case, one cannot help wondering why
HKMA should tolerate the banks to indulge in malpractices inclusive of taking no heed of the
warnings from the regulator. Hong Kong has a shameful history of pervasive corruption on a
massive scale. We should not entertain the implausible and groundless assertion of the
HKMA that it has performed its duties diligently. Deeds usually speak louder than words, and
this is truer in law enforcement than in other circumstances. The fact that HKMA is incapable
of moving beyond mere words speaks volume of the insincerity of its statements.

More in-depth analysis on the responsibilities of the HKMA and SFC in the scam will appear
in the pages to follow. In Chapter II, the ‘piggybacked structure’ will be explained in greater
detail in order to prepare the uninitiated for the following two chapters where the crucial
questions relating to the total regulatory failure will be discussed.

In sum, the Lehman-related securities are not caused by the recent credit market crisis, or the
‘mis-selling’, or the design of the ‘piggybacked structure’ alone. Rather it is the banks
implicated in the scam together with the ‘regulatory capture’ that bring about the tens of
thousands of tragic stories of the victims. Looking further afield, one could justifiably say
that the scam is symptomatic of the socio-political malaises that enable the banks to disregard
the regulators, and in turn the regulators to disregard the public. What is outrageous is not
only that the regulators failed in their statutory duties over the last few years, but also their
persistent refusal to respond to reasonable requests, whether they are for information or
action, from the victims of this scam. These are the grounds on which we found our
accusation of abdication against these two bodies.

Extract From: "Exposure - the Truth About Lehman-HSBC Fraud"

Report on the Lehman-related Securities (3)

(1. Introduction ....... continued)

Briefly, the Lehman-related securities feature a structure that is made up of two components each of which is capable of being, and was, sold as stand-alone product by Lehman Brothers as well as other financial institutions. Lehman put these two components together but described the combined product in the prospectuses as if one is more important than the other.

Apparently, the intent to given prominence to one component in the marketing materials is to induce the investors to believe that it is what the product is all about. But nothing could be further from the truth.

By devoting more than 90% of the coverage in the prospectus to only one component, Lehman and HSBC Bank clearly did not intent the prospective investors to have a correct understanding about the product. No legitimate reason for such intent is conceivable and none is forthcoming despite our enquiries with the regulators and the banks.

Could it be the case that the SFC was not aware of this patent anomaly in the relevant prospectuses? Being a regulator of the local securities market, the SFC should be duty bound to keep itself abreast of what happens in the market including vetting the statutorily required marketing materials for accuracy and comprehensiveness. The performance of these basic duties necessitates a good understanding of the kinds of securities in the market that fall within its jurisdiction. The Lehman-related securities had been actively marketed for six years before the scam was exposed. During this period of time, both the SFC and those behind the marketing of these securities had, on several professional or other occasions, responded to queries regarding the propriety and suitability of selling highly risky and highly complicated derivatives products to the retail investors. Their responses, as reported in the professional publication, suggest that no such complicated product was being sold to the public. At any event, it was said that such sales should be preceded by proper and sufficient education to the retail investors to help them understand the complexity of risks involved. None of these statements is true. The Lehman-related securities are about the most complicated products one could imagine given the ‘piggybacked structure’ mentioned above. During the years when they were sold by deceptive means in Hong Kong, no education of any kind that could have equipped the investors to prepare for what they were about to confront was provided by the SFC, or Lehman and its associates.

In addition to disclosure, the banks in Hong Kong dealing with securities are required to observe specific ‘codes of practice’ governing, among others, the obligation on the banks to assess the suitability of the products for sales by their respective staff and the suitability for particular customers to whom sales of the products are intended.

......to be continued.

Extract From: "Exposure - the Truth About Lehman-HSBC Fraud"

Report on the Lehman-related Securities (2)

I. Introduction

This report is for the purpose of exposing why the Hong Kong Monetary Authority (the ‘HKMA’) and the Securities and

Futures Commission (the ‘SFC’) should bear the primary responsibilities for the scam. This is not to say that Lehman Brothers Asia (the ‘Lehman’) and the HSBC Bank, respectively the controller and accomplice of the scam, are any less culpable than the regulators. Rather the total and inexplicable failure of the regulators to do anything during the six years when the

scam was allowed to rampage through our banking system and to deceive the ordinary members of this community raises serious questions about the competence and integrity of these statutory bodies whose raison d'être is to protect the public interests. Protecting the public interests is exactly what the HKMA and SFC failed, and continue refuse, to do. The

following pages set out the grounds why these bodies deserve condemnation.

Since the scam was exposed in September of 2008 in the wake of the collapse of Lehman Brothers, the HKSAR Government and the two regulators have been maintaining that the questionable Lehman-related securities are all about ‘mis-selling’. They want the public and the media to focus solely on the distributor banks, which in turn means, the frontline staff

who would be the ideal scapegoats for the wrongs committed by those who have authority over them in their organizational hierarchy.

Having looked into the scam very closely including literature research and consulting knowledgeable professionals in the industry, we come to the conclusion that the scam could only be implemented as it did with the courtesy of the regulators who dutifully turned a blind eye to it at the behest of the banks. Their subservience is amply exemplified by their persistent refusal, without any reason whatsoever, even to consider that the disclosure about the products in the prospectuses may be problematic.

....to be continued.

Extract From: 'Exposure - the truth about Lehman-HSBC Fraud'

Report on the Lehman-related Securities (1)

Note on English Version

The reader who understands both Chinese and English will notice the differences between the two versions in this Report. There is no more profound reason for it than the fact that the two versions are written by different writers (some of whom are victims of this scam) and they approach the issues with somewhat different emphases that inevitably reflect their diverse educational and research background.

Aside from persona idiosyncrasies, the writers are mindful of the needs of their audiences. Most of the victims with whom they come into contact after the scam was exposed are elderly with no or little education.

This Report aims to help them understand what the banks have done to them so that they could better make informed decisions, whether the scam is to be dealt with properly according to the law or just swept under the carpet as this government is inclined to do in difficult circumstances.

Given its colonial past and its finance-dominated economy, Hong Kong has multifarious ties with the rest of the world. The interest of international audiences is likely to extend beyond the deceitful products and the regulatory failure, to the more deep-rooted causes of global financial malaise of which the Lehman-related securities are symptomatic.

Oftentimes, major financial scams are concocted by international banks and exploited at national level where they are attracted by the existence of regulatory loopholes and regulatory capture.

The English version of this Report aims to set the scam in broader perspective querying if the defeat of rule of law is largely responsible for the current crises.

Legality does not command strong respect in this city and it is defeated internationally when the major developed countries acquiesced to the demands of the banks to leave the derivatives market unregulated. Obviously important lessons are to be learned, and sadly in some cases, re-learned.

......to be continued. Extract From:

'Exposure - the truth about Lehman-HSBC Fraud'

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