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I. Background

On 15 September 2008, Lehman Brothers Holdings Inc. (LBHI) filed for bankruptcy protection under Chapter 11 of the US Bankruptcy Code. Subsequently, eight Lehman companies have been put into liquidation in Hong Kong. As a result of this, investors who had purchased Lehman retail investment products suffered huge losses and blamed banks or brokers for “mis-selling” Lehman “minibonds” to them.


Some investors may regard the term “minibonds” as misleading in that these investment products are not actually “bonds”, but are “structured products”. These are products which, in addition to an exposure to the credit or default risk of the issuer (or guarantor where applicable), contain an exposure to an underlying asset, opportunity, or risk that is usually unrelated to the issuer or the guarantor. These so-called “minibonds” are in fact credit-linked notes with payment of interest and redemption payout at maturity linked to the credit of specified reference entities (these reference entities are generally well-known companies) for each series of “minibonds”. The exact mechanism and nature of these products are very complex and may not be comprehensible to ordinary citizens (especially senior citizens) unless they are seasoned investors having in-depth knowledge of the financial market.


For most of these products, the issuer also entered into swap arrangements with a swap counterparty whose obligations were guaranteed by Lehman Brothers Holdings Inc. (LBHI). Under these swap arrangements, the amounts received in respect of the collateral are swapped for amounts payable by the issuer under the credit-linked notes. On some occasions, the issuer also entered into a credit default swap with the swap counterparty under which the swap counterparty paid a premium in return for the issuer’s agreement to deliver the collateral to the swap counterparty upon the occurrence of a specified credit event.


To put it simply, these structured products were tied to LBHI’s credit risks. They were sold as a way for the company to generate revenue, and that revenue was lost during the sub-prime mortgage crisis.


When purchasing “minibonds” at the recommendation of bank officers or brokers most investors did not see it as a bundle of derivatives that had the potential to turn into a ticking time bomb. Very often, an investor bought the “minibonds” after hearing only a brief presentation from the bank officer or broker in person, or even after hearing only a brief presentation over the telephone.


Some investors complained that they were told the products were “principal-protected” or “100% principal protected notes”, which were "like a time deposit". These products were sold as “a safe alternative to buying stocks” and “a low risk investment”. The investors would be entitled to the “promised annual interest”. Contrary to what the investors were led to believe, after LBHI filed for bankruptcy, the “minibonds” devalued to such an extent that the investors saw their principal investment sum vanish into thin air.


The banks and brokers, on the other hand, argued that the investors were all supplied with advertising brochures which stated very clearly that these products were not principal-protected and that they were "linked to the credits" of various companies including LBHI. The banks and brokers also argued that they provided investors with prospectuses that contained clear risk disclosures.


However, as previously stated, the mechanism and nature of these products are highly complex. Most investors would not be able to understand how they work even after reading the prospectus.