Scoring investment risk

The Bank for International Settlements is thinking the right way in calling for a global standard of ranking financial instruments based on their risk and suitability for different kinds of investors.

The BIS Annual Report argues that financial instruments, markets and institutions all require reform if a truly robust system is to emerge. For instruments, it means a mechanism that rates their safety, limits their availability and provides warnings about their suitability and risks.

One way to do that would be to require investment houses to slap a Surgeon General cigarette-style warning on every exotic security that gets peddled to retail investors.  This warning would be attached to every piece of marketing material for a financial product, disclosed by brokers everytime they pitched the security and prominently displayed on every investor account statement.
For instance, the warning on a structured note could read something like this: “Even though this security is marketed as principal protected, you could still lose everything if the bank that issued it goes bust. Additionally, structured notes generate fat fees for the both the issuing bank and the bank that sells them. In many cases, an investor could achive the same asset exposure by buying a basket of stocks, commodities etc. on his or her own.”
Let’s hope this idea from BIS is adopted by the SEC and the new consumer financial protection agency the Obama administration wants to create.


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Structured notes investors hope MAS report will boost claims

INVESTORS caught out by the structured notes fiasco hope the official report slamming the sale processes used by financial institutions might bolster their legal claims for compensation.
But lawyers maintained yesterday that an investor's chances of success will improve if individual sales staff are found to have mis-sold the Lehman-linked structured notes.They also expressed hope that the findings on this point from the Monetary Authority of Singapore (MAS) will be released soon.
The MAS said on Monday that it is still investigating complaints of mis-selling against individuals - sales representatives, relationship managers or financial advisers - and may take action.
Its comments came as it released its report documenting how the 10 financial institutions that sold complex structured notes had failed to ensure a robust sales and advisory process.
About 9,900 retail investors lost around $520 million invested in structured notes such as Lehman Minibonds and DBS High Notes 5.
The institutions have since been banned from selling similar products. The bans range from six months to two years.
Investors hope that the bans have strengthened their case that the sellers were at fault.
However, the MAS had made it clear that the institutions' failings and the penalties handed out do not automatically mean they will be liable to investors.
Some investors say the report will not help them, but one lawyer said the report offers 'one more piece of evidence in the investor's favour but that alone may not win the case, though it does help bring the investor closer to the finishing line, or help him cross it'.
Another lawyer in corporate litigation said: 'The report generally helps the investors prove that there was really a systemic problem, especially in how the relationship managers were trained.
'If the relationship managers were untrained, then it is unlikely they can fulfil their duties under the Financial Advisers Act.'
The role which sales staff played remains crucial for investors in trying to prove that they were mis-sold, said lawyers.
Investors will typically need to relate what exactly they were told and what information they relied on from the staff before they decided to invest in the notes.
The challenge investors face with such cases of mis-selling or misrepresentation is one of proof, but most information related by sales staff is done verbally so there would not be any records.
'This is where the credibility of the staff is crucial and if it is known that he has already been singled out by the authorities for inappropriate behaviour during the sale process, then that may tip the scales in favour of the investor,' said another lawyer.
That is why if details of the investigation into individuals are released, they may help the legal proceedings.
Meanwhile debate continues on whether investors have received fair compensation as the settlement amounts released by the MAS appear surprisingly low.
For example, brokerages DMG & Partners and UOB Kay Hian were out of pocket by only $20,000 and $90,000 respectively, a small fraction of the total sums their clients invested in the notes.
DBS Bank paid out $7.6 million, about a tenth of the $70 milion to $80 million it had set aside to compensate investors in Singapore and Hong Kong.
The MAS said the different compensation sums were determined by each institution's customer profile and business model. Brokerages, for example, mostly perform transactions instructed by clients without necessarily giving advice, so the cases of mis-selling may have been fewer.
DBS said that most of its customers were relatively sophisticated - two out of three DBS High Notes 5 clients were priority banking customers, while 80 per cent of the customers were below the age of 60.
MAS had noted earlier that most of the 'vulnerable' investors - the elderly or those with little income, low levels of formal education or little investment experience - had been offered 'full or partial settlement'. For the 'few cases' among this group who did not receive any settlement offer, the financial institutions had provided 'good grounds' for their decisions.

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