Published October 15, 2008
Time to make sellers beware, not just buyers
By R SIVANITHY

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IS IT enough for the financial community to disclose important information in the fine print, or to bury material data inside prospectuses, or to put all sorts of legal disclaimers on broking reports or offer documents, and then to hide behind the maxim of caveat emptor (buyer beware) when things go belly-up and the finger- pointing starts?
Where exactly should the boundaries of caveat emptor extend to and, more importantly, what recourse is there for parties hurt by failure to read or understand the fine print?
Take the fiasco involving Lehman's Minibond Notes that were sold to retail investors about 18-24 months ago and are now the subject of some dispute because the risks, true nature of the product and Lehman's role were not highlighted at the point of purchase.
Some have argued that caveat emptor should apply because most - not all - of the relevant information was there for all to see in the prospectus, even if some of it was in the fine print and the rest was couched in technical jargon.
Others have said that even if Lehman's role as the central player behind Minibond was highlighted, investors would still have bought the product because no one at the time could have foreseen the coming financial meltdown. This being so, there is no basis for claims of compensation. How valid are these assertions?
Here we have essentially an insurance policy taken out by Lehman Brothers via its own special-purpose vehicle named Minibond to protect its exposure to six prominent banks known as 'reference entities' or REs. The money invested by the Singapore and Hong Kong public formed the insurance payout should any of the six have failed over the period in question, and in return for use of the public's money, Lehman paid the public an attractive annual coupon of 5 per cent which was, in effect, an insurance premium.
It was brilliant in its conception, simplicity and execution: Lehman transferred its risk of loss from any RE failure to the public but structured the deal and its sale documents to give the impression this was a desirable arrangement.
If caveat emptor is to be reasonably used as a defence (or a criticism of the retail investing public for not reading or understanding the offer documents), then the cover of the prospectus should have had a description of the exact nature of the product as an insurance policy, the fact that Minibond was Lehman, the financial standing of Lehman, Lehman's reasons for needing the insurance and that the risk of loss was not limited to one of six banks failing but, in fact, seven.
Since this was not the case, there must surely be grounds for claims that disclosure was poor, possibly even misleading and that a defence of caveat emptor is not good enough. If buyers were to beware, then there should have been full and proper disclosure of all essential elements in the proper fashion.
What about the case of FerroChina, which dropped a bombshell last week, saying it was unable to service its loans and so had to temporarily shut down some of its manufacturing operations? Analysts were all caught by surprise, saying FerroChina's management gave no sign of impending trouble at recent meetings. Caveat emptor, again?
Here we have another incidence of purportedly weak disclosure that ultimately led to investors losing money. Is there any liability if the management should have disclosed (but didn't) its loan problems earlier? The situation is slightly different because the recipients of the allegedly poor disclosure were sophisticated parties - namely, analysts, who in turn produced reports that led to clients possibly losing money.
Yet sophistication or not, the outcome is the same as in the Minibond failure: parties have been injured by absent/lacking/below-par disclosure.
By the same token, is it good enough for brokers to include ridiculous disclaimers on the cover of reports to the effect that those reports may be biased because the broker may have a business relationship with the company being covered?
What all this illustrates is that the local market has gone overboard in its eagerness to institutionalise a disclosure- based regime and to cement the maxim of caveat emptor as a guiding pillar of that regime.
Banks have been allowed to sell all sorts of dubious structured products to naive buyers without sufficient safeguards, brokers have been allowed to sell possibly biased research and companies whose disclosure may be lacking are not penalised hard enough.
In the US, the hazards of putting too much faith in caveat emptor have been painfully obvious - the entire financial crisis is because of poor regulation that allowed investment banks to indulge in financial jiggery-pokery of the highest order.
It's time the authorities here had a fundamental rethink of the entire philosophy relating to how markets are regulated and to not only make buyers beware - but also sellers.