Minibonds: no small affair
By Pádraig Walsh
Amid all the outwash from the financial tsunami, perhaps the most significant outpouring of regulatory interest in Hong Kong has been the fallout from the sale of Lehman Brothers-backed minibonds to Hong Kong investors. This story is a microcosm that represents the ultimate intersection between Wall Street and Main Street, and highlights how the convergence of social, political and business interests and needs can shape regulation.
First, the facts as they presently appear to be with regard to Lehman Brothers. The "minibond" product was a basket of collateralised debt obligations and credit default swap contracts, which Lehman Brothers guaranteed. A number of banks and financial institutions distributed the investment product to the Hong Kong public. Around 40,000 investors in Hong Kong who purchased these "minibonds" have suffered losses as Lehman Brothers has now filed a petition under Chapter 11, and is unlikely to be able to meet its obligations as guarantor in respect of the investment product. The present regulatory reviews are focusing on whether investors were properly apprised of the nature of the investment product and the corresponding risk.
There is one unarguable fact. Investors have made losses, many of whom are general members of the Hong Kong public, and not sophisticated investors. This has led to a public outcry and a political response. The Hong Kong government has intervened and agreed to buy back the minibonds. This will not fully compensate investors as market price is now significantly lower than original acquisition price. Nonetheless, the move has been broadly accepted as an appropriate political response to the social concern that losses were suffered by an unsuspecting public.
Let us assess issues from a legal, and then a regulatory, perspective. The primary contract was between the investors and Lehman Brothers. Lehman Brothers is in Chapter 11. Investors' losses are unsecured. Chances of recovery are slim or distant. The next port of call is the distributors of the minibonds. Any civil claim by investors against the distributors of the minibonds will be grounded in the laws that relate to misrepresentation and negligence.
A misrepresentation occurs when a person makes an untrue statement of fact or law which induces another to enter into a contract, and upon which he relies, and in consequence of which he suffers loss. A fraudulent misrepresentation requires proof that the misrepresentation was made knowingly without belief in its truth, or recklessly with indifference to its truth — this is difficult to prove.
A negligent misrepresentation, based on the Misrepresentation Ordinance, is more claimant-friendly. The claimant must prove that a misrepresentation of fact was made, that the misrepresentation continued to the point of the contract, and that the
fact was incorrect at the time of the contract. Once the party who has suffered the loss proves, however, that the representation was, in fact, false, then the onus is upon the party who made the representation to prove that he reasonably believed in the accuracy of the statement up to the time the contract was entered into.
What, however, was the misrepresentation? This boils down to issues of mis-description. This may appear to involve statements of opinion, rather than fact, but the courts have moved to a view that a statement of opinion is actionable if it contains the implicit represe
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