Feb 3, 2009

The Saga of the Structured Notes - What Next for the Suffering Investors? (Part 2)

Laymen and judges think differently about the law. Here is one of the differences.

A customer is angry with his bank. He takes the bank to court. The customer feels that in some way, the bank has treated him unfairly. The customer has come to the court to present his case and to seek some form of redress or compensation.

The customer is really just thinking about his own problem. However, the judge has to think deeper than that. Achieving justice and fairness result in this particular case will not be the judge's only consideration.

The judge also has to think about public policy. The way that he handles this one case will affect all similar future disputes between banks and their customers. The way that he handles the case will even influence the future direction of the retail banking business as a whole.

FIDREC is not a court. But the way it handles the structured note disputes will similarly have an important effect, above and beyond the actual cases. Banks and retail investors alike are watching the FIDREC cases. The eventual outcomes will influence:

(1) the way banks make decisions about the type of products they sell to the retail public;
(2) the way banks manage their selling process; and
(3) the level of confidence that Singaporeans have in their banks.

When FIDREC starts hearing its cases, it should bear in mind the wider context of these disputes. Worldwide, many events in the global financial crisis have exposed serious flaws and weaknesses in the ways that banks are being regulated and managed. Many of the old ways just don't work any more.

FIDREC must be wary of mechanically following and adopting the old ways of thinking. FIDREC needs to boldly push its cases in the new directions towards which the banks ought to evolve.

Back to my previous post - where I had discussed the customer risk-profiling process. Here we have a very basic, very fundamental problem. In Singapore, the risk-profiling process is carried out by the very same salesperson who's going to try to sell you some structured product.

In other words, there's a conflict of interest. Suppose I am a bank salesperson. I will get a big commission from selling riskier products. However, I can only sell riskier products to customers who have a more "aggressive" risk rating. At the same time, I am the person who hands the questionaire to the customer and guides him through all the questions. The customer is not a financial expert and may not fully understand the questions and their implications. Therefore I am in the position to influence the answers that he gives.

And of course, it is to my own benefit to influence the customer to give answers that lead to a more aggressive risk rating. Then I can make more money by selling him riskier products.

(Apparently the Hong Kong Monetary Authority has recently caught on to this problem. It was reported that HKMA is now preparing a new set of regulations. One of the new rules is that the the customer risk-profiling process should be carried out not by the salesperson, but by another bank officer who will not stand to gain any fee or commission. The salesperson is allowed to meet the customer only after the risk-profiling process is completed).

As mentioned in my previous post, it appears that a few banks have decided not to compensate investors, on the basis that they had been classified "Moderately Aggressive". The bank's position would be that the structured notes were suitable for such investors.

I don't agree with this. Among other things, the banks' risk classification of these investors as "Moderately Aggressive" must be treated with suspicion. After all, this classification was the result of a process that is fundamentally flawed (because of the conflict of interest).

As a matter of public policy, FIDREC must be wary about allowing a bank to defend itself on the basis of its own flawed processes. The bank would be disincentivised from improving and cleaning up those processes.

As for the retail investors, think back to the time when you did that questionaire at that bank. Did you really pay attention to what was being asked? Did you understand the questions? Were they properly explained to you? Did you really know the significance of the questionaire, or were you led to think it was just some kind of not-very-important formality? Were you just happy to go along with the answers that the RM suggested you should be happy to go along with?

Do consider whether you were fairly treated, during the risk-profiling process. If not, go to FIDREC and challenge your "Moderately Aggressive" rating.


Anonymous said...

Interesting thought.

Mr Wang, I hope you are not blogging your way out of a job :) Good luck.

bbqchickenwings said...

the customer may have a moderately aggressive risk profile, i.e. he is willing to put much more money in stocks and equities with a long term view, but certainly he expected the structured notes to be SAFE products. Banks are finding the easy way out by ignoring this fact and compensate people based on risk profiling.

And also, a lot of risk profiles are influeneced by RMs and financial advisers. Things can get ugly if we go down to the nitty gritty. Will it result in the RMs and FAs facing lawsuits as well? After all, they just want to make a living and probably had no idea that the structured products were so unsafe.

Whichever smart aleck in the banks decided to introduce such products into the market should be held responsible. They should pay the price together with the banks.

Anonymous said...

Mr Wang,

Fully agreed with your arguments.

The whole thing needs an overhaul. When something is wrong at the root, the whole thing must be pulled out,remove and rebuilt. But this is going to be very painful for the banks because they have to compensate everybody fully. Is the MAS prepared to enforce this? Judging from the outcome, they took a middle path. Even this middle path is not very clear as to the actual figure value of the total), rather than percent of cases compensated.

As an analogy, one might think the PAP scored very high number of votes in elections by getting 98% of the seats in Parliament. But in actual fact they only got 66 % of the votes!

Similarly it may be possible that 58% of the investors are fully or partially compensated but the amount may be only 2% of the total amount invested!

Anonymous said...

correct me if I am wrong, but the mini-bonds etc is marketed as a low risk product back then.. slightly higher than FD returns but safe, ideal for retirees??

Anonymous said...

eh the blogging association died liaoz!

Anonymous said...

Excellent Analysis. How I wish you are the Minster in charge.


Onlooker said...

Conflict of interest on the Bank's RM part.
I once heard,forgot where, that the notion that the structured note are based on is that the customer trust and confidence in the financial institution/vehicles.
What actually happen is that this trust/goodwill become a mirror of sort.
When everything is fine,Everything is reflecting off of each mirror as okay in a kaleidoscope. That is until the thing which image was being reflected begin to decompose.
The kaleidoscope will amplify the effect.
(!slightly off topic)
What Bushy did wrong among all thing is to let the situation get out of hand due to personal interest.
What their republican did wrong even now is the fact that they filibuster Obama bailout just to introduce clauses that are profitable to themselves.But that being said Obama's Bailout also have some very minor flaw that can be exploited (which they never noticed because they are stuck to the old,tried and proven method exploitation of less developed countries).
What the whole world need is for them to resolve the problem quickly.So that the confidence is restored.
Banks also need our confidence to operate,That why when Someone told me very bad news about a bank Where I hold a current account so that I will switch bank.
My first thought is will this person benefit from my switching?
Given that the worst depression (ever) is exacerbated by bank runs,My logical conclusion is to keep my money at the bank.(foolish maybe but what happened in Britain can happen anywhere due to lack of basic understanding of the situations)
My next action is to cut back on unnecessary spending via credits(esp recreational trips to nearby countries that I will not specify .Why boost other country economy first? Business trips is lesser now) and to open another saving account in another bank(kiasu perhaps but it is my backup plan egg in different basket).
That is my way to cope.Due to anonymity is like virginity,
I can't send you an email previously.

Anonymous said...

Mr Wang,

Your analysis is nothing new at the present stage.

Mr Wang Says So said...

I'd be interested to see any old analysis, actually.

I'm not aware that anyone so far has argued that as the general risk profiling process is flawed in principle, the bank should not be allowed to raise a risk classification defence in any specific cases.

In other words, I'm inviting Fidrec to take the following position -

"We don't care whether this particular RM did or did not say the right things or wrong things to this particular customer ... We don't care whether the customer had actually signed the form or not ... As a matter of principle, since the risk classification process in every case is flawed, therefore in every case we reject any attempt by the bank to defend itself on the basis of how it had classified the customer."

Note: It's still open to the bank to raise other types of defences. But what I'm trying to do here is kill off the entire "risk classification" defence at one go.

Anonymous said...

It's quite an attractive argument. From Fidrec's point of view, if there are too many cases, and too few adjudicators, this approach helps to save a lot of time. No need to investigate and decide what exactly did this Bank RM really say to that customer Mr Tan.
Or to customers Lim; Chan; Lee; Wong; Leong; Toh; Cheong; Lam; Lum; Soh .... and a few thousand others.

And the public policy argument feels strong too.

Anonymous said...

Mr Wang, you're really writing this post for Fidrec to read, aren't you?

Anonymous said...

I am glad you are looking at this more closely. Initially I got the impression when you first commented on the minibond issue, that you were leaning towards the caveat emptor approach so espoused by you know who...Or was I wrong and totally misreading you then?

Mr Wang Says So said...

I think that the man in the street (ie retail customer) must be treated differently from the sophisticated FI clients. And also from the high-net worth individuals.

But I will elaborate on this, in Part 3 or 4.

Anonymous said...

You can frame the argument in the style of a Turquand's indoor management argument as well. It would go something like this.

1. The customer provided PQR information about himself.

2. Based on this information, the bank classified the customer as Moderately Aggressive, and considered Minibonds to be suitable for him.

3. But we don't have to care. Internally the bank can classify the customer as whatever it likes, and can consider whatever kind of bonds as suitable for the customer. This doesn't mean that Fidrec has to accept any of the bank's views as correct.

Anonymous said...

but your line of reasoning (ie conflict of interest because of flawed process) would open up a can of worms.

I mean if any court were to agree with you, this would mean that anyone can file a copycat lawsuit to say that they suffered investment losses because of conflict of interest, that the investment product was not suitable because of improperly conducted risk profiling.

Mr Wang Says So said...

My view:

1. The COI in itself should not be sufficient for the customer to show that the product was unsuitable. For example, a bank might profile you wrongly, yet end up selling you a suitable product.

So the client's unsuitability argument should not be based on COI, but on other grounds. The onus is on the customer to demonstrate those grounds. Such as the product being too difficult for the client to understand; or being inappropriate for the client's financial needs (I will elaborate on this, in the next part of this series).

2. If the customer does make those unsuitability arguments, then the bank will have to defend itself. Now, here is where the COI comes in. I am saying that at this stage, the COI argument could be enough to stop the bank from raising a defence based on its own risk classification process.

Anonymous said...

ok now I can see your line of legal argument.

But I'd still pity the plaintiff's lawyer.

Consider this:
1) Our financial system regulation is based on full disclosure (seller disclose all risk factors in a prospectus) and caveat emptor (You're a O-level graduate but can't understand the financial jargon, tough luck, becoz you still understand English, don't you? BTW, why are you buying something that you don't understand? A reasonable man wouldn't buy something that he don't understand)

2) the MAS does look at the internal process of the FIs very closely. So I don't see how your COI argument would carried the day.

BTW, does Accredited Investors (A.I.) count as sophisticated investors? I'm hearing that the sales process for complex products to AIs have been tightened up considerably.

Anonymous said...

Question - What was the rating of the Minibond and related instruments in the first place?

We all know after the fact that it was risky, because it was not based on the risk of the actual assets itself.

In fact, if I remember correctly, it was sold as something relatively safe since it was backed by strong companies. Given the fixed returns, it would also seem like a more conservative instrument.

If so, it would have been strange that compensation is denied to investors who are anything in the "aggressive" range, even if banks are relying on / can rely on this as justification.

Anonymous said...

My own experience in purchasing some unit trusts from a local bank few yrs ago. The RM explained all the goodies and perks of the product and got me interested. Then very casually and nonchalantly I was told i need to fill up something very quickly. The RM just asked a few questions (less than 5) and filled up the questionnaire booklet for me in less than 5 mins and ask me to sign. That's it.

Xtrocious said...

IMHO if the HKMA wants to do a proper job, then the risk profiling should be done by an independent party - not another bank employee...

True, he may not get any direct commission or fee from the product sale but at the end of the year, if the bank does well, he will be rewarded with good bonuses...

Hence it will ultimately be in his own interest to help his colleagues sell the more "lucrative" product...

And it could also give rise to "under table money" incidents where the assessor will mark up the risk profile so that his colleagues sell a more lucrative product and channel some fee back to him...

But with a truly independent party, an investor can get a risk profile done and then go to any FI of his choice - there is less risk of any kickbacks and COI...

On the issue of COI - it is legally okay to have it as long as it is made known to the customer

Anonymous said...

Aiyah, there's no such thing as conflict of interest in Singapore LAH. Have'nt we all learnt by now?

蝴蝶思语 said...

I'm not financially savvy but this is a personal experience. I went to a local bank to open an FD account around the period when the minibonds thing unraveled. The sales person kept encouraging me to take up a higher return product. I naively asked if returns are "guaranteed" like FD and she kept repeating that the product had always performed well. She could have just told me a simple no. I signed up and it was only then that she administered the risk assessment questionnaire! To her it was just a hassle for the customer and she breezed through it. I made a u-turn and cancelled on the spot ;) Imagine all the aunties and uncles who go through such deceptive tactics.

Anonymous said...

On the one hand, there is so much deliberation in assessing if an investor should be compensated or not. On the other hand, there is the Jobs Credit scheme where ALL companies, regardless of whether they are profitable or not, regardless of whether they have any intention of retrenching staff or not, are given 12% jobs credit, costing tax-payers $4.5b. It's a MAD MAD MAD MAD world!

Victor said...

I support risk profiling be done by an independent party who is not related to the bank. This is analogous to the current property valution process, i.e. the independent valuer has no COI with either the propective buyer nor the seller.

Most people would not mind having to pay a small fee to obtain this risk profile report which should be valid for a predetermined period (e.g. 1 year) during which they could use it to purchase any financial product from any seller.

Anonymous said...
This comment has been removed by a blog administrator.
Mr Wang Says So said...

One post deleted for irrelevance. It had nothing to do with structured notes.

Anonymous said...
This comment has been removed by a blog administrator.
Anonymous said...

I attended an interview with Philip Securities recently. I discovered that no risk profiling was done when I purchased the minibonds. The interviewer claimed that risk profiling is not required for such transaction in 2007.

Is this true and what is the impact on this on my claims for mis-selling by the brokerage?


Anonymous said...
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Anonymous said...

while there is a flaw in the system the whole problem lies in the misrepresentation of risk involved. Even aggressive investors can have low risk products in their investment portfolio. I am not an expert in investment but high risk investors don't just have a high risk portfolio and low risk investors doesn't mean they just have 'safe' products. The financial advisor is suppose to advise accordingly.

The measure should still be whether there is misrepresentation involved and not the risk assessment. People with high risk appetite could buy a low risk bond to add to their portfolio. If the intent was for the investor to buy something 'safe' then that should be the gauge not their risk profile. Of course that is difficult to prove and not possible to measure.

Besides the low 5% return for the risk involved is bad deal for any investors. There are probably better products for the kind of risk involved. The risk vs benefits just does not match. The institution should never have sold this product. The bank took a hugh risk betting that there will not be bank collapsing and sold the instrument. They should take the responsibility of clearing up the mess. The high profit for the instrument must also present high risk for the distributor. It is time for them to take some responsibility and not pass the losses to the innocent consumers.

Mr Wang Says So said...

2 more irrelevant comments deleted.

To that commentator, please use your brains.

My post does not even criticise the Singapore government. It is addressing a dispute between some investors and a bank.

So please do not make stupid comments like how criticising the government will lead to our evil, hostile neighbours like Indonesia invading us etc.

Have you considered that the Singapore government might actually be GRATEFUL for my post, since it may help the senior citizens etc who have lost their money to the bank?

Mr Wang Says So said...

Unless, of course, you're suggesting that DBS *is* the Singapore government, LOL.

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Anonymous said...
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