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"

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(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 (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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Letter to Commissioner of Police Mr. Tang King Shing

 Mr. Ian Grenville Cross, SC, JP

Director of Public Prosecutions 
Mr. Ian McWalters, SC 
Deputy Director of Public Prosecutions 
Mr. Lee Ka Chiu, Director of Crime & Security, HKP 
Mr. Chan Yiu Kwok, CSP (Crime Commercial Bureau), HKP 
Sirs, 

The most important message of this letter is to inform you that your inaction and foot-dragging tactic is being exploited by the banks to carry out a second fraud against the victim investors defrauded by them. These victims were deceived by the banks as to the true nature of the Lehman-related securities when they were induced to make the purchase and now, courtesy of your inaction, they are subject to a second round of deception regarding their legal rights. Before you resort to the cliché that the victims should seek their own legal advice, they as well as the wider public are entitled to know what the government generally, and the relevant departments inclusive of yours in particular, have done.

2. What has happened in the last several months is an artificial environment created by you and other officials, with varying degree of intent, indifference, and culpability; to enable the banks to coerce the victims to agree to the so-called settlement. We are informed by some victims that the bank staff has adopted an intimidating attitude to: 
(a) induce the victims to agree to settle on terms dictated by the banks; 
(b) mislead the victims into believing that the terms of settlement would be harsher with the passage of time thereby putting pressure on the victims to surrender their rights to whatever terms offered to them; 
(c) deny the victims the right to be accompanied by relatives or friends in the settlement process; 
(d) deny the victims the right to have a full written record of the terms and conditions of the settlement. 

3. The risk that a majority, if not all, of these settlements are reached under duress is substantial and real. The HKMA and the SFC have the profiles of the victims and they know how many and who are vulnerable to duress or misrepresentation. The senior officials of these two bodies are by far the most culpable for allowing the banks this ‘window of opportunity’ to perpetrate the second fraud. 

4. It is not disputed that the extent to which this second fraud is properly so characterized is dependent on whether the original complaint of fraud is well-grounded in our jurisprudence. It is therefore apposite to recount in summary form what is known and what evidence is at hand. We are only a handful of victims not having legal or financial expertise, nor do we have any privileged right of access to information not available to the public, yet we have been able to unearthed the following within months after the fraud came to light. This convinces us that you undoubtedly are in possession of sufficient evidence, and information that will lead to further evidence, that would satisfy any reasonable police officers and prosecutors that criminal prosecution against the suspects is fully justified. 

5. The evidence we rely on to demand immediate intensification of investigation and prosecution is as follows: 
(a) The prospectuses in pursuance of which the Lehman-related securities were sold (the ‘Lehman prospectuses’) are incapable of describing the nature of the products or explaining the risks inherent therein by a massive margin. 
(b) The Lehman-related securities feature a ‘piggybacked structure’ with a façade, typically a first-to-default credit-linked note (the ‘FTD’) concealing a hidden component varyingly referred to as ‘security’ or ‘collateral’ in the Lehman prospectuses. At least in majority of cases, the ‘hidden component’ is synthetic floating rate notes that are the sine qua non of the Lehman-related securities. This hidden component will be referred to as ‘Security’ below in order to distinguish it from the ‘real collateral’ the existence of which is not disclosed in the Lehman prospectuses.
(c) Structure note resembling the FTD in every material aspect was sold by HSBC Bank in Hong Kong (the ‘HSBC notes’) during the material time when the Lehman-related securities were sold. The issuer of HSBC notes and issuer of ‘minibond’ are almost identical in the sense that the individuals sit on these two boards of directors during the material time are almost the same. If the corporate veil is lifted, both issuers are clearly controlled by the same unit or department within the HSBC group. 
(d) The law firm Linklaters advised the two issuers in respect of the two different products – the relevant Lehman-related securities known as ‘minibond’ and the HSBC notes. Despite the enormous differences between the two – one a ‘piggybacked structure’ while the other is just a FTD, the two prospectuses concerned are almost identical in structure, content and layout. 
(e) Structure notes resembling the ‘Security’ in every material aspect were sold by Lehman Brothers in Australia during the material time through an entity under its control – Mahogany Capital Limited. The Mahogany prospectuses provide a rough but insightful estimate of what and how extensive details about the ‘Security’ were withheld from the Lehman prospectuses. 
(f) Numerous victims defrauded by this fraud have enquired the banks concerned about the training to which the relevant staff involved in the sales of the Lehman-related securities had been given. The responses received all indicate that training for the Lehman-related securities was provided by the Sun Hung Kai Financial (the ‘SHKF’). In the past two months or so, we have repeatedly invited SHKF to admit or deny whether it has anything to do with the training of staff of other distributor banks regarding the sales of the Lehman-related securities. So far, all replies from SHKF have been evasive refusing to address its role over the training issue. 

6. The above points (a) to (f) are factual and they are grounded on documentary evidence and the following are reasonable inferences that we believe also to be factual: 
(a) The façade and the Security are products capable of and are being sold as stand-alone products. They were sold separately by Lehman Brothers. 
(b) The purpose of ‘piggybacking’ a façade on the Security is solely for deception purpose. There is no other economic or legitimate commercial purpose. 
(c) SHKF as coordinating distributor either knew, or recklessly indifferent of, the true nature of the Lehman-related securities. In its training provided to the bank staff responsible for selling the securities, it put emphasis only on the façade as if it is the be all and end all of the products. This is a misrepresentation of the true nature of the Lehman-related securities, but the Lehman prospectuses are designed and organized in such a way to facilitate such misrepresentation. At any event, the Security level of synthetic derivative notes would be too complicated for the bank staff and the prospective investors. 

7. The fraud is commonplace in terms of its modus operandi, namely by means of misstatement of facts. It is unusual in terms of the parties involved and their status, namely almost two dozens of banks and financial institutions ranging from global dominant players to local runners-up are implicated. The amount of money involved is also unprecedented by local history. A further dimension of complexity is that the same ‘piggybacked structured’ financial products marketed by the same modus operandi was adopted by another, or other, major financial institutions. Because the suspects are too powerful and well-connected with the political leadership, the criminal law is halted right at doorstep of the banks. The latent privileges, including potential immunity from the law, enjoyed by the banks and the well-connected (such as the Linklaters) crystallize which turns law enforcement into a consensual matter in so far as these suspects are concerned. 

8. Is there any reason why the police and the DPP are indulging in this wait-and-see trick? Already in their brief should be the following ingredients sufficient for bringing the suspects to court: 
(a) Indictment: fraud contrary to section 16A of the Theft Ordinance (Cap. 210 of the Laws of Hong Kong). 
(b) Defendants: (i) HSBC Bank and its individual employees serving on the boards of directors of the issuers authorizing the issuance of the Lehman-related securities. 
(ii) SHKF and the distributor banks 
(iii) Lehman Brothers Asia Limited and Mr. Leon Hindle. 
(c) Evidence: (i) the Lehman prospectuses; (ii) testimonies of the victim informants who have lodged complaints with the police. 
(d) Points of law that may be disputed: the nature of Lehman-related securities.
The reports produced by the HKMA and SFC contain numerous misstatements of facts, especially in respect of the securities. There are also articles appear in locally based professional periodicals purported to explain the fraud in a misleading way. This is reminiscent of burning the Reichstag by Hitler in 1933. Is it not a concerted effort to whitewash the fact and paint over it with fiction? 

9. In the recently adjudicated case of HKSAR v HO Ka Keung (Criminal Appeal No. 196 of 2007), the defendant, a professional insurance broker, was charged with the same offence as abovesaid. It was held that recklessness suffices to found a conviction and the personal attributes of the defendant were ‘obviously relevant’ to the question of guilt. In paragraph 51 of the judgement, the learned judge endorsed the observation of the trial judge as to the state of knowledge of the defendant. In this connection, the defendant was held at the trial that he ‘knew that commission was to be paid ... at a very attractive level and, quite clearly, he knew that the whole purpose ... was churning through insurance forms without any attempt ... to ensure that they were honest, truthful and complete’. The same description could properly be applied to the distributor banks and the HSBC Bank. The defendant in this case had been found guilty and his appeal was dismissed. If what he did is unlawful, so is the conduct of the suspects identified above. 

10. According to professor Alastair Hudson of Queen Mary, University of London, actionable loss arising from the context of financial derivative products could generally be classified into two categories: ‘failure of model’ and ‘suitability failure’. HSBC Bank and Mr. Hindle knew the model is doomed to disaster for the retail investors but they decided that their personal gains override the concern that the model is fraudulent. The ‘suitability failure’ follows inevitably from it. (See ‘The Law on Financial Derivatives’ 2nd Ed., (Sweet & Maxwell, 1998)). 

11. In our polity, it is the judiciary that decides whether the suspects are guilty. The refusal of the police and the DPP to prosecute this crime rigorously verges perilously on perverting the course of justice. If the refusal of the suspects to cooperate is a reason for delay, the public should be informed of this fact and decide for themselves their best course of action. 

Yours faithfully 
The Alliance of Lehman Brothers Victims in Hong Kong 

From: http://www.lbv.org.hk/content/pages/posts/letter-to-director-of-public-prosecutions2733.php