The case related to failures in the sale of structured products – namely, Lehman Brothers-related notes (LB-Notes) and Leverage Forward Accumulators (FAs).

Lehman exposure

Despite the deteriorating financial climate in summer 2008, HSBC Private Bank (Suisse) reduced its own exposure to Lehman Brothers but continued to sell LB-Notes to clients until up to two weeks before the collapse of the US investment house.

HSBC also failed to disclose to clients that the LB-Notes were issued by Lehman Brothers and did not warn them about the increasing credit risk associated with the product during the sales process.

Between January 2006 and September 2008, HSBC Private Bank (Suisse) distributed 480 LB-Notes which involved 3,961 transactions and a total nominal value of HK$12.7bn.

The gross revenue earned by the bank from these transactions was HK$94.6m.

The investigation also found that there was a risk mismatch in over 80% of the outstanding LB-Notes transactions. Clients who were categorised with “low” to “medium” risk tolerance levels were sold LB-Notes that were rated the riskiest by the bank.

SFAT determined that the bank’s culpability was “extensive, putting many clients at unnecessary risk of loss and indeed resulting in substantial losses for many”.

Private placement

The LB-Notes were sold to customers on a private placement basis, which means that only professional investors could take part.

These include:

• trust corporations with assets over HK$40m;
• any individual with an investment portfolio of not less than HK$8m;
• any corporation or partnership with a portfolio of at least HK$8m or total assets of not less than HK$40m; and,
• any corporation whose sole business is to hold investments and is wholly owned by an individual who, either alone or with any of his associates on a joint account, has an investment portfolio of not less than HK$8m.

Stern warning

The tribunal added that a fine of HK$400m is appropriate and recognises that “it is also exemplary in that for the greater protection of the integrity of Hong Kong’s financial markets, it provides a stern warning that principles of professional conduct must be adhered to”.

“Put another way, that – in future – penalties imposed for convenient avoidance of the requirements of the Code of Conduct will constitute something more severe than the mere ‘cost of doing business’,” the SFAT added.

Substantial sanctions required

Ashley Alder, SFC chief executive, said: “HSBC Private Bank (Suisse) SA’s systems and controls for selling structured products fell significantly short of the standards expected of them. In combination with flawed practices and intrinsically high-risk products, the bank’s failures magnified the risk and occurrence of significant losses for customers. Accordingly, we have decided very substantial sanctions are required.”

“The message should be clear: our standards are designed to protect all investors including clients of retail or private banks.  When breaches of these standards occur, the SFC will take action to enforce them and strive to achieve outcomes that are in the interest of the investing public,” he added.

In addition to the fine, the bank’s Type 4 regulated activity (advising on securities) has been suspended for one year and Type 1 regulated activity (dealing in securities) has also been partially suspended under the Securities and Futures Ordinance (SFO) for a year

It’s something that any investor who’s lived through a few market cycles will have a strong view on, though that doesn’t mean they necessarily know when the wheel will turn again.

It is the US where those ‘spirits’ appear strongest. In the eighth year of an equity bull market – with the S&P 500 having delivered a quite extraordinary 330% since the lows of March 2009 – there’s reason to believe the ‘greed is good’ Gekkoism has won out.

Of course, others will claim this rally hasn’t quite worked that way. After all an industry that now prides itself on the foundations of targeted return and risk-rated funds is nothing but the embodiment of the ‘cautious optimism’ mantra that’s held sway ever since the dawn rose after Lehman’s fell.

For fixed income, the good times go back even further – though, like a proud lady of an unspecified vintage, the long-running bond bull market never seems to age beyond 30.

Nick Gartside, international chief investment officer of fixed income at JP Morgan Asset Management, explains how he is harnessing optimism in terms of his exposure to US high yield – 26% of his JPM Global Bond Opportunities Fund – where he believes defaults will fall.

“There is a lot of optimism in the US through lower taxes, through an expectation of deregulation, and policies that are business friendly, and rate hikes for the right reason,” he explains.

“I’m a big believer in animal spirits driving economies because the reality is economies are collectives of us. Modelling our individual behaviour is a nightmare, and as consumers we all do very irrational things.”

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The US investment bank collapsed in 2008, leading to derivative products linked to Lehman brothers becoming worthless.

The fine was levied against the bank in July 2015, with HSBC Private Bank announcing in October that it intended to appeal. 

Details of the case were not previously made public, and were first revealed at the hearing at the Securities and Futures Appeals Tribunal on Wednesday. 

There were failings in HSBC’s know-your-client (KYC) procedures, in which customers did not fully understand the risks of the investment products, according to Ming Pao Daily.

The hearing is expected to run until 12 May.

Defence

Former SFC chairman Anthony Neoh, the lawyer representing HSBC, argued at the hearing that the penalty was excessive, according to WSJ and Bloomberg reports.

The risk appetite of private banking clients is higher than those of retail customers, he said, and the investment tools are considered traditional “vanilla-type” structured products.

He said the SFC should not consider the private bank as it would a retail bank.

One of the products, equity–linked notes (ELN), can have the contracts cancelled any time, and there were no reasons at that time to refuse selling Lehman Brothers products, he said.

HSBC Private Bank holds type 1 and type 4 licenses in Hong Kong to operate business for dealing and advising on securities respectively.

The fine is the largest imposed by the Securities and Futures Commission.

Burkhart held roles at Goldman Sachs and Deutsche Asset Management before joining Lehman Brothers in 2004 as managing director of senior relationship management in Europe.

After Lehman, he held roles at PricewaterhouseCoopers and Nomura International.

Saunders worked in the Department for Business, Innovation and Skills for over 35 years before becoming the chief executive of the Competition Commission in 2009. He retired from this role in March and currently stands as a special adviser at Europe Economics.

Martin Wheatley, chief executive of the FCA, said: “Both David and Gunner come with impressive experience in their respective areas, which will be a valuable resource for the teams as they look at competition and wholesale issues.”

In September 2008 Lehman Brothers filed for Chapter 11 bankruptcy following the loss of its clients and stocks and the devaluation of its assets by credit rating agencies. This represented the largest bankruptcy filing in US history and is often cited as a key factor in the recent global financial crisis.

Immediately after the collapse, Barclays agreed to purchase Lehman’s North American investment-banking and trading divisions along with its New York headquarters building. A week later, Nomura Holdings announced that it would acquire Lehman Brothers franchise in the Asia-Pacific region as well as its investment banking and equities businesses in Europe and the Middle East.
 

In a statement, the SFC said that according to the bank’s records, outstanding LB-ELNs were held by 12 professional investors, nine of which would have otherwise been eligible for a repurchase offer under a repurchase scheme on 18 July 2013 if they had not been classified as professional investors.

To “bring a satisfactory conclusion for eligible professional investors”, the bank has made repurchase offers to these identified professional investors at 100% of the principal value of each eligible professional investor’s investment in the LB-ELNs, the statement added.

The SFC said that in view of the agreement reached it will not impose disciplinary sanctions against the Royal Bank of Scotland and its current or former officers or employees in relation to the sale of LB-ELNs to professional investors, “save for any acts of dishonesty, fraud, deception or conduct that is criminal in nature”.

The Royal Bank of Scotland will further review complaints lodged by professional investors who are not eligible for the repurchase offer under its enhanced complaint handling procedures.

The Hong Kong Monetary Authority has also informed the bank that it does not intend to take any enforcement action against the bank’s executive officers and relevant individuals in connection with the sale of LB-ELNs to professional investors who have accepted the repurchase offers, except for any acts of dishonesty, fraud, deception or conduct that is criminal in nature.

In May 2011, Core Pacific-Yamaichi International (CPYI) repurchased Lehman Brothers-backed structured products worth HK$9.6m from investors, after reaching an agreement with Hong Kong’s Securities and Futures Commission.

Take a look at International Adviser’s recent profile of the Independent Financial Advisors Association, which had as one of its first challenges the issue of dealing with the local scandal that involved the sale of high-risk ‘mini-bonds’ backed by Lehman Brothers to thousands of ordinary retail investors.