SFC, HKMA and Citibank reach agreement on Lehman Brothers-issued market-linked notes and equity-linked notes

The Securities and Futures Commission (SFC) and the Hong Kong Monetary Authority (HKMA) announced today that an agreement has been reached with Citibank (Hong Kong) Limited (Citibank HK) in relation to its distribution of market-linked notes (MLNs) and equity-linked notes (ELNs) issued by Lehman Brothers (collectively referred to as "LB Notes") between March 2007 and June 2008 (Notes 1, 2 & 3).

Without admitting any liability, Citibank HK has agreed to make a repurchase offer to eligible customers holding outstanding LB Notes distributed by Citibank HK at a price equal to 80% of the total value of each eligible customer's investment in the Notes (Note 4).

The total value of Citibank HK's repurchase offer is estimated to be about HK$1.06 billion, covering about 92% of Citibank HK customers holding outstanding LB Notes (Note 5).

The offer price will exclude the amount of coupon already paid to eligible customers but include an additional amount representing the interest that would have been earned if the amount invested in LB Notes had been invested with Citibank HK on a fixed term deposit (Note 6).

Although Citibank HK's written guidelines to staff in relation to the sale of securities were comparatively sound and provided a foundation for compliance with key regulatory requirements, the SFC had a number of concerns regarding the bank's implementation and supervision of those guidelines and associated procedures and controls which posed risks that regulatory requirements would not be met.

Specifically, the SFC had concerns in the following areas:

• the adequacy of disclosure of credit risk of Lehman Brothers to customers;
• the sufficiency of the assessment of customers' experience and some customers' level of tolerance to risk for LB Notes, including risk profiling procedures before the purchase of LB Notes; and
• the overall monitoring of the sale process of LB Notes.

Under the repurchase scheme, Citibank HK will also pay top-up payments to those customers of outstanding LB Notes with whom Citibank HK has already entered into settlement agreements but would otherwise have been eligible to receive a repurchase offer to the extent that such payments are needed to ensure those customers are treated in the same way as other customers participating in the repurchase scheme.

In entering into this agreement under section 201 of the Securities and Futures Ordinance, the SFC has taken into account:

• Citibank HK's comparatively sound and detailed written guidelines and procedures in respect of risk disclosure and suitability assessment;
• LB Notes were less complex than credit-linked notes;
• there is no distributable collateral for the LB Notes. As such, there is less chance for LB Notes customers to receive any substantial payment or dividend in the Lehman Brothers bankruptcy proceedings (Note 7);
• the repurchase scheme will enable the great majority of LB Notes customers to receive a reasonable portion of what they invested without the costs and risks of separate legal proceedings;
• this outcome could not have been achieved through formal disciplinary action by the SFC against Citibank HK and/or its staff, even if such action was successful; and
• the agreement will bring the matter to an appropriate end for the benefit of Citibank HK and those customers who participate in the repurchase scheme.

"While sound internal guidelines dealing with what is required and expected in the sale of investment products is an essential compliance tool for intermediaries, adequate guidelines alone are not sufficient. Good controls and supervision together with sound experience and judgement are needed to ensure recommended investment products are suitable for customers," the SFC's Acting Chief Executive Officer, Mrs Alexa Lam said.

"This outcome is a demonstrably good one for affected customers and brings the matter to an appropriate conclusion," she added.

Mr Arthur Yuen, Deputy Chief Executive of the HKMA, said, "The HKMA welcomes the resolution. The HKMA believes that this resolution is a reasonable and practical one and is in the interests of investors and in the public interest. Eligible customers are encouraged to consider the offers positively."

In view of the repurchase scheme, the SFC will not impose disciplinary sanctions against Citibank HK and its current or former officers or employees in relation to the distribution of LB Notes, save for any acts of dishonesty, fraud, deception or conduct that is criminal in nature.

The HKMA has also informed Citibank HK that it does not intend to take any enforcement action against their executive officers and relevant individuals in connection with the sale of LB Notes to customers who have accepted the repurchase offers or the top-up payments under the repurchase scheme, except for any acts of dishonesty, fraud, deception or conduct that is criminal in nature.

End

Notes:

1. Citibank HK is a registered institution under the Securities and Futures Ordinance (SFO) to carry on business in Type 1 (dealing in securities) and Type 4 (advising on securities) regulated activities.
2. MLNs and ELNs were issued by Lehman Brothers Treasury Co. B.V. and guaranteed by Lehman Brothers Holdings Inc. They were distributed by Citibank HK on a private placement basis with a minimum subscription amount of HK$500,000.
3. MLNs were structured notes offered in USD/HKD/AUD/NZD with a tenor from 2.5 to 4.75 years. The potential return of MLNs was linked to the performance of the underlying equities, which might be a basket of stocks traded in Hong Kong, or some market indices. MLNs were principal protected, i.e. the issuer will pay back 100% of the principal amount to the investor at the maturity date.

   In respect of ELNs, they were structured notes offered in USD/HKD/GBP with a tenor from eight months to one year. The potential return of ELNs was linked to the performance of a basket of stocks traded in Hong Kong. They were not principal protected and at maturity, they might be redeemed by the physical delivery of the worst performing stock at the strike price upon certain triggering events.

   Both ELNs and MLNs were senior and unsecured debt obligations of the issuer. They were not backed by any collateral and subject to the credit risk of the issuer/guarantor.

4. Eligible customers are Citibank HK customers who have open position(s) in the LB Notes purchased through Citibank HK. Eligible customers will not include professional investors, corporate/non-individual investors and experienced investors, meaning Citibank HK customers who, in the three years preceding their first purchase of the LB Notes, executed five or more transactions in structured products and leveraged products or a combination of these products (please refer to the attached FAQ). The definition also excludes those customers who have previously settled claims in relation to LB Notes with Citibank HK.
5. Between March 2007 and June 2008, Citibank HK distributed 19 series of MLNs and 52 series of ELNs of which US$204.7 million (equivalent to approximately HK$1.60 billion) worth remains outstanding. The outstanding LB Notes are held by over 1,400 customers.
6. The calculation of the interest is based on the full nominal value of the customer's total investment in outstanding LB Notes, using the average of counter rates from Citibank HK on a 12-month USD time deposit for the period between the issue date of the relevant LB Notes and 30 June 2011, to be paid up to 30 June 2011.
7. In the unlikely event that it is determined at a later date that a customer accepting a repurchase offer would have received a greater amount as an unsecured creditor in the Lehman Brothers bankruptcy proceedings, Citibank HK has agreed to pay the difference to that customer, such that no customer shall be disadvantaged by participating in the repurchase scheme.
8. For enquiries, please contact:
   Securities Futures Commission:
   Ernest Kong at 2840 9335 or Jonathan Li at 2283 6808

   Hong Kong Monetary Authority:
   Rhonda Lam at 2878 1480 or Queenie Yip at 2878 1687