Caveat Emptor - Understand What you Invest In !

With the recent bankruptcy of Lehman Brothers, there has been much controversy over the structured products which have been sold (through various financial institutions and brokerages) to retail investors. One of them is the DBS High-Notes, while another contentious product are the Lehman Brothers Mini-Bond Series. When a major event such as a credit event occurs, these products are rendered virtually useless for the retail investor and many are now questioning the amount of risk they took up (unknowingly) and whether there was any mis-representation on the part of bank officers who sold them such products.

Deep in the heart of such controversy lies the term "Caveat Emptor", which means "buyer beware" in Latin. Essentially, it means that purchasers of securities and investment products should understand what they are buying before they plunge in, or suffer the consequences of their lack of understanding. While the flip side for this argument is that the "pushers" if such securities ought to be more informed and provide better clarity on the structure of such products; the reality is that sometimes the sellers of such products themselves may not fully understand the consequences or ramifications of obscure events such as "credit events" or "default".

If sufficient appropriate disclosure of risks had been made, perhaps the issue would not have blown up in the media to the extent that it is (in Hong Kong, and now in Singapore). I have read reports that showed retirees who invested their life savings (6-digit sum) into such derivative products, believing that the risk was low and that the product was principal-guaranteed. THe 5% interest rate seemed a little too good to be true, as bank savings rate was only a paltry 0.25% ! I guess as the saying goes - if something is too good to be true, then sometimes it isn't true. Apparently, such high returns were a form of "insurance premium" which the banks paid to ensure that there was no default on any of the underlying securities; and the retail investors were the ones who had to pay out the "insurance" when one of the firms went bust. Essentially, these investors were in the dark about being used as vehicles for insurance, while the issuer of such securities paid off these premiums to them every year. Though the risk of default at the time of issuance was low, this does not preclude the fact that the product was in itself risky and complex.

The Edge Magazine's Personal Wealth section reported that even Mr. Leong Sze Hian (who is president of the Society of Financial Service Professionals in Singapore and has 4 Masters Degrees) had problems understanding the inner workings of such products. He had to read it a few times and in depth before he could unravel the risks and characteristics of such products. So the irony is that if such an accomplished and experienced professional such as Mr. Leong finds it hard to understand such products, what about the uneducated retail investor who simply seeks a safe haven to park their retirement monies ? The banks and brokerages have a fiduciary duty to the general public to ensure that ALL the risks and rewards of ALL the products they offer are clearly and explicitly stated, and not just using glossy marketing brochures to advertise the rewards in large fonts while keeping the risks portion at font size 6.

The reason why I feel strongly about this issue even though I do not know anyone personally affected by this saga is because I feel for the people who have "invested" their life savings into such risky products, all the while thinking that their retirement nest egg was safe, only to be told now that almost all their money will go up in smoke. It could happen to your parents, uncle, aunt or a relative; so imagine the number of extra years one has to slog just to make back the money - and all because of salespeople who may be pushing the wrong product and not being able to explain such products clearly enough.

I welcome comments from readers who have something to say about this saga, and to voice your opinions on how you think this can be prevented in future.