SFC, HKMA and The Royal Bank of Scotland N.V. reach agreement on Lehman Brothers-related equity-linked notes

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18 Jul 2013

SFC, HKMA and The Royal Bank of Scotland N.V. reach agreement on Lehman Brothers-related 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 The Royal Bank of Scotland N.V. (RBS), formerly known as ABN AMRO Bank N.V., (ABN Amro) in relation to the sale of Lehman Brothers-related equity-linked notes (LB-ELNs) to retail clients between July 2007 and May 2008 (Notes 1, 2 & 3).

RBS has agreed, without admitting any liability, to make a repurchase offer to all eligible customers holding outstanding LB-ELNs sold by the bank (including those sold by ABN Amro in Hong Kong before the acquisition by RBS of ABN Amro’s retail and commercial banking business) at 100% of the principal value of each eligible customer’s investment in the LB-ELNs. Today’s resolution provides them an opportunity to reverse their purchase of the outstanding LB-ELNs.

The SFC estimates about 540 customers are eligible for the repurchase offer under this resolution which, if accepted by all, will lead to payments totalling approximately $513 million.

The eligible customers are retail customers holding outstanding LB-ELNs who were assessed to have a risk tolerance level that was more conservative than the risk rating assigned to the LB-ELN purchased by the customer.  The risk profiling process in issue in this case was developed by ABN Amro prior to RBS’ acquisition of ABN Amro’s retail and commercial banking business.  

The repurchase offer will not be offered to professional investors. The SFC’s investigation into the handling of professional investors by RBS in respect to LB-ELNs is continuing (Note 4).

RBS will also make top-up payments to retail customers with whom RBS has entered into settlement agreements in respect of their holding of outstanding LB-ELNs but would otherwise have been eligible to receive a repurchase offer to ensure these customers are treated in the same way as other customers participating in the repurchase scheme.

The offer price will exclude the amount of coupon already paid to eligible customers and any recovery by the eligible customers in respect of the relevant LB-ELNs out of the bankruptcy of Lehman Brothers Holdings Inc. or its related entities. The offer price will include an additional amount representing the interest that would have been earned if the amount invested in the LB-ELNs had been invested with the bank on a savings deposit (Note 5).

During the course of the SFC’s investigation, the SFC raised a number of concerns with RBS regarding the risk assessment and the risk matching process used by the bank at the time, in particular:

  • Each customer was provided with a risk profiling questionnaire in which answers were scored. The customer’s ultimate risk score determined their risk profile or tolerance level which, in turn, was used to assess the relative suitability of LB-ELNs for each customer. However, the scores assigned to two out of 12 questions in the risk profiling questionnaire were weighted erroneously which led to some customers’ risk tolerance level being assessed as higher than it should have been if the correct weighting had been applied (Note 6);
  • Further, the bank classified all series of LB-ELNs, except for two, as high risk products under its three-level risk rating system.  However, the LB-ELNs were sold to customers who were assessed to have a medium or low risk tolerance level without proper records of justification for so doing (Note 7).

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

  • there is no distributable collateral for the LB-ELNs. As such, there is less chance for LB-ELN customers to receive any substantial payment or dividend in the Lehman Brothers bankruptcy proceedings (Note 8);
  • the repurchase scheme will enable eligible customers to receive 100% of the principal value invested in the LB-ELNs without the costs and risks of separate legal proceedings;
  • the processes that caused concern for the SFC were not devised by RBS which inherited these issues following its acquisition of ABN Amro’s retail and commercial banking business;
  • RBS will review complaints lodged by LB-ELN customers who are not eligible for the repurchase offer under its enhanced complaint handling procedures. The case by case enhanced complaint handling procedures should address any other possible irregularities in the sale of the LB-ELNs to customers with high risk tolerance level under RBS’ risk profiling processes;
  • this outcome could not have been achieved through the imposition of disciplinary sanctions by the SFC against RBS 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 RBS and those customers who participate in the repurchase scheme.

“This was a time consuming investigation that involved our investigators combing through tens of thousands of documents and listening to hours of telephone recordings. The problems caused by the errors in ABN Amro’s processes should send a warning to all intermediaries who seek to automate suitability processes with matching systems. An automated process cannot replace governance disciplines and professional judgement in assessing whether an investment advice or recommendation is reasonably suitable for the customer,” the SFC’s Chief Executive Officer, Mr Ashley Alder said.  

Ms Meena Datwani, Acting Deputy Chief Executive of the HKMA, said, “This agreement with RBS represents the outcome of the investigatory efforts by the two regulatory authorities.  The HKMA considers the agreement to be in the interests of the investing public as it allows eligible customers to recover the money they invested without the need to go through lengthy and costly legal processes. ”

In view of the repurchase scheme, the SFC will not impose disciplinary sanctions against the bank and its current or former officers or employees in relation to the sale of the LB-ELNs to RBS’ retail customers (other than professional investors), save for any acts of dishonesty, fraud, deception or conduct that is criminal in nature. 

The HKMA has also informed the bank that it does not intend to take any enforcement action against their executive officers and relevant individuals in connection with the sale of LB-ELNs 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. RBS is a registered institution under the SFO to carry on business in Type 1 (dealing in securities), Type 4 (advising on securities) and Type 6 (advising on corporate finance) regulated activities. RBS acquired ABN Amro’s retail and commercial banking business in October 2007 during the period in which the SFC’s concerns arose. However, the resolution agreement is with RBS and RBS is responsible for implementing and performing the repurchase agreement.
  2. Between July 2007 and May 2008, the bank sold to its customers equity-linked notes issued by Lehman Brothers Treasury Co. B.V. and equity-linked notes issued by Allegro Investment Corporation of which Lehman Brothers Holdings Inc. was one of the referenced entities.  The LB-ELNs were sold by RBS on a private placement basis. 
  3. Among the LB-ELNs sold by the bank to its customers, 44 series were outstanding at the time Lehman Brothers Holdings Inc. filed for bankruptcy on 15 September 2008. The total principal value of the outstanding LB-ELNs is approximately $784 million.
  4. Professional investors are those customers who: (a) fall under paragraphs (a) to (i) of the definition of “professional investors” in Part 1 of Schedule 1 of the SFO; or (b) fall under section 3 of the Securities and Futures (Professional Investor) Rules (Cap. 571D) and classified by the bank and agreed by the customers to be treated as such in accordance with paragraphs 15.3 and 15.4 of the Code of Conduct at the time they purchased the relevant LB-ELNs. Based on evidence gathered to date, there are about 10 professional investors who purchased LB-ELNs from the bank that remain outstanding.
  5. The calculation of the interest is based on the full nominal value of the eligible customer’s total investment in outstanding LB-ELNs using the bank’s savings deposit rates for the period from the issue date of the relevant LB-ELNs up to today’s date.
  6. Under ABN Amro’s scoring system, a lower score indicated a higher tolerance of risk.  Two questions were scored incorrectly with one question giving customers with less investment experience a lower rather than a higher score and another question giving a lower rather than higher score to customers who wished to invest lower proportion of assets in other than risk free deposits.  About 80 out of 1,115 transactions were affected by this issue.  The scoring errors were rectified by the bank in June 2008. In determining whether the client is eligible for a repurchase offer, the client’s risk tolerance level will be computed based on the rectified scores.
  7. Among the 44 outstanding series of the LB-ELNs, two series were principal-protected, i.e. the issuer will pay back 100% of the principal amount to the investor at the maturity date.  The bank had rated these principal-protected LB-ELNs as “Balanced” product. The rest of the outstanding series were not principal-protected and the bank had rated these non-principal protected LB-ELNs as “Growth” product. 
  8. 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, RBS has agreed to pay the difference to that customer, such that no customer shall be disadvantaged by participating in the repurchase scheme.
  9. Please follow this link for a set of questions and answers about the Repurchase Scheme.
  10. For enquiries, please contact:

Securities and Futures Commission
Jonathan Li at 2231 1808 or Ernest Kong at 2231 1335.

Hong Kong Monetary Authority
Queenie Yip at 2878 1687 or Yokee Wong at 2878 1213.

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Last revision date : 18 July 2013