MAS report on sales & marketing of structured notes

On 7 July 2009, Monetary Authority of Singapore (MAS) has issued a report titled:
Investigation report on the sale and marketing of structured notes linked to Lehman Brothers

The press release provides a good summary.

10 distributors (banks/finance companies and stockbroking firms) of structured notes linked to Lehman Brothers:
(i) ABN AMRO Bank N.V. Singapore Branch (ABN)
(ii) CIMB-GK Securities Pte Ltd (CIMB)
(iii) DBS Bank Ltd (DBS)
(iv) DMG and Partners Securities Pte Ltd (DMG)
(v) Hong Leong Finance Ltd (HLF)
(vi) Kim Eng Securities Pte Ltd (KESPL)
(vii) Malayan Banking Berhad Singapore Branch (MBB)
(viii) OCBC Securities Pte Ltd (OSPL)
(ix) Phillip Securities Pte Ltd (PSPL)
(x) UOB Kay Hian Pte Ltd (UOBKH)

Structured notes linked to Lehman Brothers concerned: (with $ amount sold to retail investors)

• Minibond series 1 to 10 (except series 4): $508 million, 7800 retail investors
• High Notes 5, arranged by DBS Bank: $104 million, 1000 retail investors
• Series 3 LinkEarner Notes/Jubilee Notes, arranged by Merrill Lynch: $18 million, 350 retail investors
• Series 9, 10 Pinnacle Notes, arranged by Morgan Stanley Asia: $25 million, 650 retail investors

Findings on individual distributors in the PDF file above are indeed eye-opening.
Highlights of some of the findings (cases from individual institutions) from the report: (I tried to classify them into categories)
1. No due diligence on products sold

• did not conduct any formal product due diligence on product

2. Wrong classification of risks of products

• failed to sufficiently distinguish the Minibond Notes from bonds and in fact informed its RMs that the Minibond Notes were suitable for clients who wanted to diversify their portfolio with bonds.
• "low to medium" risk classification for the Minibond and Pinnacle Notes was inconsistent with the prospectuses

3. Communication errors or improper communication

• mis-communicated the risk as conservative to relational manager (RM); reclassifications were solely by way of email to RM
• did not expressly communicate its internal product risk rating to its RMs;
  instead relied on a general understanding among RMs, as communicated during training for other products, that non-capital protected products were to be rated "Growth".

4. Improper training system and training management system

• did not however monitor whether RMs who missed the arranger’s briefings were briefed at the branch level.
• not all RMs who sold the products attend training and take the test.
• not provide sufficient guidance to its RMs on how to factor in a structured note into client’s portfolio

5. Improper risk profiling of clients

• question in risk profile questionnaire erroneously scored.
• not allocate a numerical score to the client’s investment time horizon, experience and diversification needs towards computing that client’s risk profile and suitability to purchase an investment product, nor were alternative forms of guidance provided to the RMs on how to factor in such information.

The report’s Annex 2 shows settlement outcomes of these affected structured products.

The ban on selling structured products will eventually be lifted when the ban period is over. As investors, we should always bear in mind the lessons learnt in this whole saga. Buyer beware ! Be extra careful when dealing with financial institutions, particularly before you are signing on the dotted line. We have seen how ridiculous the financial institutions can be in doing due diligence, classifying risk of products, communicating within the institutions, training staffs and doing risk profiling of clients. Just wonder how to justify the high remuneration/bonus paid to the financial institutions’ top management and board of directors.

Report from Center for Public Integrity - Subprime 25: Who’s Behind the Financial Meltdown ?

On 6 May 2009, Center for Public Integrity has published a investigation report titled :
Who’s Behind the Financial Meltdown – the top 25 subprime lenders and their Wallstreet Backers

This Subprime 25 Interactive List is cool.
You can click on the sheets (#1 to #25) to see name, status of company, its CEO, total high interest loans.
Click on "Read More" for more "interesting" information for e.g history, summary, parent companies, bailout money, political contributions etc..

The Subprime 25
These are the top 25 subprime lenders, responsible for 7.2 million "high interest" loans made from 2005 through 2007 (72% of high-priced loans reported).

The articles and glossary from the report are extremely good reads to understand root causes of the subprime crisis.

The "Data" are informative. (Click on Data)
Maps show regions of high interest loans of different percentage points above treasury securities);
Charts & Graphs are really interesting. There are charts showing increasing % of income goes to housing; increasing financing of Mortgage-Backed Securities (MBS) and the top underwriters.

Then there are the interesting parts:

• charts showing political contributions by securities and investment companies, real estate companies to parties (Democrats or Republicans) and
• top recipients of contributions by securities and investment companies, real estate companies for 2003-2004 and 2007-2008;
• top recipients of contributions by AIG in 2008 Election Cycle.

Guess who was the top recipient: 2003-2004 George W. Bush; 2007-2008 Barack Obama.
Haha, wonder what the analysts are trying to imply here :-)

I put the Widget of Subprime 25 on my blog for a limited period :-)

2009 World’s Most Ethical Companies - by Ethisphere

2009 World’s Most Ethical Companies by Ethisphere
website

99 companies made it into the "World's Most Ethical Companies" list (available in the website).

Some highlights of selected winners are available. It will be good if the questionaires used to evaluate the ethical quotient are available.

Its methodology:
Corporate citizenship and responsibility: 20%
Corporate governance: 10%
Innovation that contributes to public well being: 15%
Industry leadership: 5%
Executive leadership and tone from the top: 15%
Legal, regulatory and reputation track record: 20%
Internal systems and ethics/compliance program: 15%

Does it pay to be ethical ?
According to the graph (in the webstie) that compare "WME vs S&P" growth% over past 5 years, it is a strong YES.

There are other interesting lists and ratings in Ethisphere, for e.g:
100 Most Influential Peoples in Business Ethics;
50 Codes Rated;
Global Anti-corruption Quotient 2009.

I place its blog into my "Investment bloglist". This blog will help in showing fraud prevention insights and ethical practices that will help in preserving investment value.

Fraud prevention – information from Commercial Affair Department Singapore

Commercial Affair Department Singapore’s website has a lot of useful information on fraud prevention. I’m amazed with the many types of scams/frauds.

Some resources:

Crime alerts
Examples of scams/frauds:
Job Application Scam
Lottery/Lucky Draw scam
Kidnap scam
Impersonation scam
Elderly gold scam
Apple scam
Government welface scam
Counterfeit currency/credit card scam
Renovation scam
Rental scam

Crime prevention advice
The PDF files at the bottom are good reads.
More frauds/scams..

Press releases on scams/frauds

Other information:
links to MAS’s MoneySense – Protect Yourself Against Bogus Investment Opportunities
link

Singtel *127 Crime Alert SMS. (Wonder what is the cost ?)
link

Many of these scams/frauds are operated internationally. Therefore, it is good to explore internationally on other countries’ regulators/legal enforcers’ website for information on scams/frauds.

Really scary.. The real world is like "a jungle out there". Equip yourself with fraud prevention knowledge.

Fraud prevention – don't take risk dealing with unlicensed financial operators: Singapore

Singapore is a financial hub.
It has many financial institutions doing different kinds of transactions.

Licensed financial institutions and services that they are licensed to provide.
You can click on "all institutions (alphabetical order)" to search for a particular company.
However, they are also unlicensed financial institutions that are doing businesses in Singapore, often disguised themselves as operating in Singapore or have names similar to licensed financial institutions.

The names can be deceiving. They can be sophisticated sounding (International, Consultancy, Wealth Management, Asset Management). Don't be deceived by the names.

Investor Alert List – not authorised companies
The list is not exhaustive. Choose to transact only with the regulated ones, rather than with the ones not in the alert list, for better fraud prevention.

These advices are good read. Very useful in preventing fraud.

Regulations & Licensing of Singapore financial institution
Useful if you want to know the legislation guidelines.

A licensed/regulated companies and an approved investment product cannot replace due diligence. Due diligence and self-assessment of risks are still of utmost importance at all times when investing in any investment product.

Think Lehman Brother’s Minibond and related products.

Fraud prevention – don't take risk dealing with unlicensed financial operators (Malaysia)

In this time of financial crisis/recession,
be extra careful of frauds.
For recession survival, beware of frauds.

Bank Negara Malaysia has some useful information which is useful to prevent potential financial fraud.
From its "Hyperlink",
we can find lists of licensed :
banking institutions,
insurance companies & Takaful operators,
dealers of foreign currency,
money changers,
non-bank remittance operators,
issuers of credit cards, charge cards, e-money, remittance services providers,
loss adjusters,
insurance brokers, Takaful brokers,
financial advisers.

Be very vigilant of having transactions with unlicensed financial operators.
Though they may not necessarily fraudsters, don’t take the risk.
It’s a matter of "what if".

Consumer may be more legally protected when he is dealing with licensed ones.
However, due diligence is still needed, especially if large amount of money is involved.


Bank Negara Malaysia’s website has also
"Financial Consumer alerts".

Check occasionally on Financial Consumer Alerts.

Among the ones mentioned:
Unauthorised withdrawals,
Misuse of BNM’s name,
Get-Rich-Quick schemes,
Warnings about companies, for e.g. G-Gold Gallery, PureInvestor.com Inc., Swiss Cash/Swiss Mutual Fund.

Check also on press release.
You will be able to see, for examples:
Sunshine Empire charged for illegal deposit taking;
Walton International Property Group raided..

These advices may save us from potential frauds.

ACRA Singapore - area of concern in financial statement audit in current economic environment

Just saw in newspaper ACRA (Accounting and Corporate Regulatory Authority) Singapore has come out with a list of areas of concern in financial statement audit in current economic environment.

link

The PDF file in the link is a good read.

Areas of concern:
1. Planning and fraud considerations
2. Cash at banks
3. Going concern
4. Valuation of financial instruments held at fair value
5. Impairment of assets
6. Deferred tax asset recognition
7. Provision for onerous contracts and restructuring
8. Disclosure in financial statements, off-balance sheets items
9. Communication with those charged with governance

Refer to the PDF file in the link for details.
It even mentions the references/standards applicable to the areas of concern.

To improve on how to spot frauds, maybe we should learn from these references/standards.


Note:
Do check out my other related posts on Singapore investment, financial crisis and
fraud prevention.

Lehman Brother’s Minibond victims – associations, groups, blogs

Many Hong Kong, Singapore and Taiwan’s investors are affected by Lehman Brother’s Minibond or related products.

Some associations, groups, blogs are created to seek justice for the Minibond victims.

Among the groups, some main ones are listed below:

Hong Kong :
雷曼苦主大聯盟 (Hong Kong)
website
Read 苦主心聲 for the victims’ views.
There are many useful links inside related to Minibond groups/blogs.

Singapore:

Tan Kin Lian's blog

website

Taiwan:
连动债受害人权益促进会
website

The useful links of websites above will lead to more associations/groups/blogs.

House Committee on Financial Services - on Bernard Madoff's Ponzi scheme

Found this website of US’s House Committee on Financial Services.
website
This committee oversees all components of the nation's housing and financial services sectors including banking, insurance, real estate, public and assisted housing, and securities.
(refer to "Who we are" for more details)

US House Committee on Financial Services had a meeting to discuss and assess Bernard Madoff’s Ponzi scheme and the need for regulatory reform.

link

Quite a good read. There are testimonies from representatives from SEC, Securities Investor Protection Corporation (SIPC), Bernard Madoff’s investor and some academics.

Some info from the opening statement:
red flags raised by others on Bernard’s investment:
1. outsiders like Mr. Markopolos could not create a model that matched the results of Mr. Madoff’s purported strategy
2. Others published articles as early as 2001 raising questions about Mr. Madoff’s firm.
3. unrealistically steady investment returns
4. auditor the size of a mouse examining a fund the size of an elephant.

agency’s enforcement unit is chronically understaffed:
1. 433 people in the office of compliance and examinations looking at 8,000 advisers two years ago, today it has 400 people looking at 11,000 advisers and thousands of mutual funds:
2. number of investment advisers subject to the Commission’s oversight has doubled since 1997
How will they "restructure the regulatory system for the financial services industry and enhance investor protection" ?

Red flags in Bernard Madoff’s fund

Found 2 articles (see below) on red flags in Bernard Madoff’s fund.
We can get a glimpse of which portion of due diligence can uncover the red flags in Madoff’s case.

Some insights:
1. whether volatility, returns are tally with investment strategy claimed; backtesting using investment strategy and compare

2. "literature" study: whether others have due diligence check and result; news of feeder fund’s shutdown

3. trading records, regulatory filings to compare with trading (volume) claimed

4. corporate governance : comptroller, auditor of firm, feeder funds; independence of comptroller/auditor/compliance officer etc.

Article: The Red Flags In the Madoff Fund's Past (from CNBC)
link to CNBC's article
Who: Aksia, a firm that does due diligence on investment advisers
What: investigation for client
When: Apr 08

Red flags:
excerpt:
[1. The Madoff investment strategy, called "split-strike conversion," is known to be very volatile; it involves trading huge positions around options expirations. Despite that volatility, its returns over the past decade were an amazingly stable 8-10 percent.

2. Aksia discovered a 2005 letter to the Securities and Exchange Commission from a financial advisor who supposedly studied Madoff's operations. That letter asserted Madoff was running a Ponzi scheme. There was also a Wall Street Journal story at the time about one of the Madoff's associated "feeder funds" getting shut down in 1992.

3. Madoff's strategy was bizarre: He said he would move $13 billion in various trades at once, yet Aksia couldn't find traders who saw his trades. There were also no regulatory filings. And family members were running the firm.

4. The comptroller of the firm was based in Bermuda. Most mainstream hedge fund investment advisers have their comptroller in-house. Madoff's so-called feeder funds, meanwhile, were audited by respectable auditors. That gave the impression that Madoff had a professional operation. But the central investment action wasn't with the feeder funds, but in Madoff's New York City headquarters. And those activities were audited by a smaller, lesser known firm.

5. Madoff sent out accounting statements by mail. Most hedge funds email statements and allowed them to be downloaded via computer for easier analysis by investors.]
(but I haven’t figured out what’s wrong with this)

Advice:
[….warned clients not to do business with Bernard Madoff's investment fund.]

Article: European banks tally losses linked to Madoff (from International Herald Tribune)
link to IHT's article
Who: Société Générale
What: routine due diligence audit
When: early 2003

Some findings:
[…strategy consisted of balancing holdings in large Standard & Poor's funds with options to buy and sell shares, known as puts and calls;….. when Société Générale back-tested the strategy, it could not match the results that Madoff claimed to have produced.
…troubled by the fact that Peter Madoff, Madoff's brother, was the chief compliance officer.]

Advice:
[…..Société Générale immediately put Bernard L. Madoff Investment Securities on its internal blacklist, forbidding its investment bank from doing business with him, and also strongly discouraging wealthy clients at its private bank from his investments]

Linked Notes, structured debt (2) - Malaysia

Linked Notes that are linked to Lehman Brothers have caused big losses to investors in Hong Kong, Singapore and other more financially advanced countries.

Caveat Emptor (buyer bewares) is often the rule. However, information asymmetry often disadvantaged the investors, especially when the investors are of lower educational level, not knowing English and under excessive sales gimmicks..

Sellers had the advantages. Sales pamphlet’s facts may be selectively presented; prospectus may be available only after the sales; high risk product (like LNs) be recommended to low risk investors etc..

I just wonder whether these Linked Notes are marketed in Malaysia to the general public and what the regulator’s standpoint on Linked Notes.

Found this "Guidelines on the offering of structured products" (2007) from Securities Commission of Malaysia:
PDF file

The above guidelines are applicable to :
Equity LN, Bond LN, Index LN, Currencies LN, Interest Rate Linked Notes, Commodity LN, Credit LN etc..

In my opinion, the requirement that makes a difference and gives investors’ extra protection are the "suitability and fair dealing requirements".

Excerpts of some of the notable points inside (refer to the PDF file for details):
(bracketed text below is my comment)
1. ....primary seller shall adopt fair dealing best practices when dealing, marketing and selling structured products to investors…. (this puts the responsibility to the seller)

2. ....different standards of fair dealing in relation to institutional investors and investor individuals…
(this sets a more stringent requirement to sales to investor individuals)

3. ...giving an investor individual who invests in structured products during an offer period, the option to obtain a full refund of his principal investment sum within three working days of such investment or the remaining offer period
(a cooling off period; good for investors who are bombarded with sales gimmicks)

4. A primary seller should endeavour to make an investor understand the risks in relation to investing in structured products before marketing and selling structured products to that investor.
(this again puts the responsibility to the seller)

i. know your client: ……primary seller should take all reasonable steps beforehand to assess the client’s financial position, investment experience and investment objectives.
(not only puts responsibility to the seller, it also sets the proper sequence of the sales process)

ii. duty of care: …..financial risks and potential losses that may arise from investing in structured products are fully explained to clients before the client makes his investment decision

iii. sales personnel: …. specifically identified personnel who have a financial background and possess adequate knowledge and understanding of structured products, particularly when dealing with investor individuals….. (only peoples with adequate product knowledge can sell)

iv. provided risk disclosure statement: …..risk disclosure statement is to be provided separately from the application form or other document constituting a contract between an Eligible Issuer and the investor, and is to be furnished to the potential investor together with other promotional and sales documents, before any binding contract is entered into by the investor….

v. confirmation of disclosure by client: …..primary seller should invite the client to read the risk disclosure statement, ask questions and take independent advice if the client so wishes….client should be requested to sign a confirmation..

vi. investors individual: …primary seller should ensure that a higher standard of diligence is exercised when dealing with investor individuals… (this sets a higher standard for sales to investor individuals)

I hope these guidelines have helped reducing/eliminating misrepresentation in LN sales in Malaysia and Malaysian investors are not affected by these LNs.
If that is the case, special thanks should be given to the Securities Commission. It has safeguarded the investors’ interest.

Professional Skepticism - Beware of financial reporting fraud !

One of the important pillars of investment analysis is company analysis.

Let's say we analyse the account, we find that the account is audited by some famous audit firm. Everything points to a "strong buy". Can it be wrong ?

Yes, it can go wrong, even extremely wrong too.
We will be surprised by how many cases of accounting frauds that are uncovered (not counting those that are not surfaced yet).

Areas of reporting most susceptible to fraud
report pursuant to section 704 of Sarbanes-Oxley Act of 2002

In this SEC study, areas of reporting most susceptible to fraud, inappropriate manipulations and earnings management mentioned are:

• improper revenue recognition,
• improper expense recognition,
• improper accounting in connection with business combinations,
• inadequate disclosure in MD&A & elsewhere,
• failure to disclose related party transactions,
• inappropriate accounting for non-monetary & rountrip transactions,
• improper accounting for foreign payments,
• improper use of off-balance sheet arrangement,
• improper use of non-GAAP financial measures.

The number of cases in the report can shock you. Real cases for different types were mentioned.

Fraud risk factors
Frauds take time to be uncovered.

Often when it is uncovered, it is already too late for the investors. Share price plummets, "trapped" investors suffer big losses.

It is better to avoid them in the first place.

Look for the warning signs and red flags.
If we see the warning signs and red flags, if we are in doubt, avoid the firm.

3 conditions generally present when financial reporting fraud occur:

• incentives/pressures
• opportunities
• attitudes/rationalizations

Refer to Appendix (page 300-7 onwards) of the following document for list of fraud risk factor.
"(AICPA SAS 99) Consideration of fraud in financial statement audit"

(AICPA is American Institute of Certified Public Accountants.)

Though "areas of reporting most susceptible to fraud" and "fraud risk factors" are mentioned, be always aware that the list is not exhaustive. New instruments, new environment, make possible new ways of frauds. Buyer bewares !