Securities Investor Protection in the

context of the Recent Financial Crisis

Hong Kongs Experience
2-3 November 2009
Irene Tang
Associate Director, Supervision of Markets Division
International Forum for Securities Investor Protection in the Context of Financial Crisis
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Coverage of Investor Compensation Fund (ICF)
Licensed persons authorized to deal in securities and futures
contracts irrespective of whether they are exchange participants
of Hong Kong Exchanges and Clearing Limited (HKEx) provided
that the trades relate to HKEx products

Authorized institutions trading in HKEx products

Licensed persons authorized to provide securities margin
financing in relation to HKEx products
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Definition of Default
default in relation to a specified person or an associated person
of the specified person, means
The insolvency, bankruptcy or winding up of the specified person;
or

Any breach of trust, defalcation, fraud or misfeasance committed
by the specified person or associated person of the specified
person
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Per Investor Compensation Limit
Limit of compensation :

HK$150,000 per investor for securities trading and HK$150,000
per investor for futures trading
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Collapse of Lehman Brothers Holdings Inc.
On 15 September 2008, Lehman Brothers Holdings Inc. filed a
petition under Chapter 11 of the U.S. Bankruptcy Code.
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SFC issued restriction notices on Lehman
entities in Hong Kong
On 16 September 2008, the SFC issued restriction notices on four
SFC licensed entities of Lehman Brothers in Hong Kong.
Lehman Brothers Asia Limited
Lehman Brothers Securities Asia Limited Participant of the Stock
Exchange of Hong Kong Limited
Lehman Brothers Futures Asia Limited Participant of the Hong Kong
Futures Exchange Limited
Lehman Brothers Asset Management Asia Limited

Lehman Brothers Asia Limited, Lehman Brothers Securities Asia
Limited and Lehman Brothers Futures Asia Limited were wound
up and KPMG was appointed as liquidators.
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Most Lehman clients not likely covered by ICF
Clients are mainly Lehman group companies or licensed
corporations of SFC
Qualifying client does not include a licensed corporation, a
person licensed or authorised in a jurisdiction for carrying on an
activity similar to that of the defaulting intermediary or an
associated person of the defaulting intermediary.
not qualifying clients
not qualified to claim against the ICF
So far no claims for compensation against the ICF from clients of
the Lehman entities
No broker defaults other than the Lehman-related entities during
the financial crisis.
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Minibond holders not covered by ICF
Investors suffer from the failure of Lehman because of their
investment in Lehman issued Minibonds

Minibonds are unlisted structured products arranged by Lehman

Not covered by ICF, ICF only cover defaults of SFC licensed and
registered persons in relation to trading in HKEx traded products

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Investors losses in Minibonds
Funds raised from investors were mainly used to purchase
collateral such as CDO.
The bankruptcy filing of Lehman Holdings resulted in the early
termination of the Minibonds. Under the terms and conditions of
Minibonds, in the event of early termination, investors would only
get back their share of the proceeds of sale of the collateral less
any amount which the issuer may owe to Lehman.
Value of the collateral dropped significantly in most series of the
Minibonds.
Investors suffered heavy losses.

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Complaints from investors of Minibonds
HKMA and the SFC received many complaints

Complainants alleged that the distributors (mainly banks and a few
brokers) had not properly informed them of the potential risks
involved

Lots of demonstrations and protests

Legislative Council Subcommittee to investigate the Minibonds
incident

HK Government, HKMA and SFC worked to resolve the issue
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Investigations into Minibond-related complaints
HKMA and the SFC investigated complaints relating to banks and
brokers.

The SFC adopted a top-down approach in investigation.

The SFC investigated into the brokers and banks internal
systems and controls relating to their sale of Lehman Minibonds
to clients.

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Settlement agreement between the SFC and
two licensed brokers
The SFC reprimanded two brokers. Two brokers agreed to
make voluntary offers to purchase all outstanding Lehman Minibonds
bought by clients at a price equal to the principal amount invested by
those clients,
to engage an independent audit firm to review their internal controls,
systems and procedures, etc.

329 clients fully recovered initial investments

Settlement amount about HK$90 million
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Settlement agreement between SFC, HKMA
and 16 banks
Key features of the banks repurchase agreement are:

Each bank will offer to repurchase from each eligible customer all
outstanding Minibonds at a price equal to 60% of the nominal
value of the original investment for customers below the age of
65 or at 70% of the nominal value for customers aged 65 or above
as at 1 July 2009.

Once the underlying collateral is recovered and paid to the banks,
each of them will make a further payment of initially up to 10% of
the nominal value of the Minibonds to eligible customers below
the age of 65 and, if recoveries exceed 70%, the banks will pay
the entire excess amount to eligible customers who have
accepted the repurchase offer.
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Settlement agreement between SFC, HKMA
and 16 banks (contd)
The repurchase agreement covers about 29,000 Minibonds
investors, estimated amount about HK$6.3 billion.

Up to 7 October 2009, 23,829 customers responded to the
repurchase offers (23,606 customers or 99.1% accepted the
offers).
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Lessons we learned from the Minibond
incident
Most complaints alleged mis-selling by distributing brokers and banks.

Misrepresentation the products wrongly presented as a low risk
alternative to deposits and that the risks and complexity were not
properly explained;

Complexity the products were too complex and risk disclosures
were ineffective in alerting investors;

Suitability failure of brokers and banks to do proper customer
due diligence, inexperienced retail investors were left holding
products not suitable to their investment profile.
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Measures to strengthen investor protection
On 25 September 2009, the SFC has issued a Consultation Paper
on Proposals to Enhance Protection for the Investing Public.

To solicit comments on proposals to fine-tune existing
regulations governing the sale of unlisted securities and futures
products to the public.
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Some key proposals of consultation paper
Pre-sale documentation
Criteria for authorising offer documents, including advertisements, should
be consolidated into a single SFC Handbook, which will include a new
Code on Unlisted Structured Products.
A Key Facts Statement should accompany each offer document for
retail investment products.
Disclosure at the point of sale and after
Intermediaries selling to the public should disclose their own commercial
interest (e.g. commissions, fees and other benefits) to prospective
investors.
Selling practices
Intermediaries will be required to find out their clients knowledge of
derivative products if they are selling unlisted structured products with
such elements embedded.
Post-sale cooling-off period
For longer-term products with a limited secondary market, a cooling-off
period should be given within which an investor can change their mind.
This should allow a refund of capital and related commission, but be
subject to a reasonable administrative charge and any legitimate market
value adjustment.
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Hong Kong Government is studying measures
Hong Kong Government is studying the feasibility of establishing
an Investor Education Council and a financial dispute resolution
body.
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Questions & Answers