Commerce Commission investigating 'alleged misleading representations' on Credit Sails' 'characteristics and risk'

By Gareth Vaughan

The Commerce Commission has confirmed it’s investigating the Forsyth Barr managed, NZX listed and Credit Agricole organised Credit Sails bonds which raised NZ$91.5 million from the public in 2006 before crashing in value spectacularly during the global credit crisis.

A Commerce Commission spokeswoman told interest.co.nz the consumer watchdog was conducting an investigation under the Fair Trading Act into “alleged misleading representations made as to the characteristics and risk” of the Credit Sails product.  

“Forsyth Barr was the lead manager and underwriter of Credit Sails,” she added. “As the investigation is underway the Commission will make no further comment.”

A Securities Commission spokesman declined to comment on whether it was also involved in the investigation.

Neil Paviour-Smith, Forsyth Barr's managing director, said his understanding was that the Commerce Commission was looking into various products issued in recent years that investors had referred to the Commission along with "various allegations."

"No doubt the Commission will be dealing with these as it would any complaint or any allegations forwarded to them. And no doubt that with any failed security there will be allegations that there were misrepresentations of other wrongdoings," said Paviour-Smith.

Cayman Islands link

The Credit Sails bonds were issued by the Cayman Islands-registered Credit Sail Ltd and directors provided by another Cayman Islands company, Maples Finance.

Among the 1566 Credit Sails investors, enticed by the prospect of 8.5% annual interest over the six and a half year life time of the notes and an AA credit rating from Standard & Poor's (S&P), were several charities and community groups including the Hospice Southland Charitable Trust, the New Zealand Methodist Trust Association, the Youth Development Endowment Trust, the Roman Catholic Bishop of the Diocese of Dunedin, the Congregational Christian Church in Samoa and Dunedin Orphan's Club. Investors' had to stump up a minimum of NZ$5,000.

Greg Wright, executive officer of the Methodist Trust Association which is facing a six figure loss on its Credit Sails investment, told interest.co.nz that he welcomed the Commerce Commission investigation. A representative from the consumer watchdog had already attempted to contact him and he was interested to see what questions the Commerce Commission had.

The Methodist Trust Association would "obviously" welcome any recovery on its Credit Sails investment.

"We don’t make our investments in the expectation of not getting our capital back," Wright said.

A French bank, CDOs, swaps and big losses

The proceeds raised in the Credit Sails, or Credit Saleable Index Linked Securities, offer were invested into notes known as the Momentum CDO (collateralised debt obligations) Europe Limited Series 2006-16. Credit Sail also entered into a total return swap with Credit Agricole Corporate and Investment Bank, formerly Calyon, so it could - in theory - pass the return from any capital gain at maturity and interest, to Credit Sail.

According to Credit Sail's half-year report, French bank Credit Agricole acted as arranger of both the Credit Sails and Momentum notes issues, is counterparty to the swap, and calculation agent.

In an NZX announcement in May last year, Credit Sail's then sole director Giles Le Sueur informed investors' they'd effectively lost the shirts off their backs.

"We wish to inform you that the Calculation Agent for the Momentum Collateral Securities has sent a notice to Credit Sail Limited advising that, as of May 11, 2009, the Aggregate Loss Amount in the Reference Portfolio is equal NZ$560,611,787.32 following the occurrence of several credit events," Le Sueur wrote.

These "credit events" included the demise of several companies the Credit Sails portfolio was exposed to including Lehman Brothers and Washington Mutual, Icelandic banks Landsbanki Islands, Glitnir banki and Kaupthing banki, plus the bankruptcy of US phone directory group Idearc.

"As the Aggregate Loss Amount exceeds the Maximum Loss Amount, the nominal amount of the Momentum Collateral Securities will be reduced to zero on the Scheduled Maturity Date," Le Sueur added.

"The holders of Credit Sails will not receive their principal back and the Credit Sails will be redeemed at zero, plus the holder’s pro rata share of the residual monies, equal to NZ$1,067,239.14, plus interest which was produced upon the unwind and termination of the Credit Strategy on November 17, 2008. For each note with a denomination of NZ$1,000.00, the pro rata share of the residual monies shall be NZ$11.66, plus interest, due on the Scheduled Maturity Date."

AA rated securities 'demolished'

Wright said the Methodist Trust Association bought its Credit Sails notes through Craigs Investment Partners subsidiary Greenslades. He feels S&P has much to answer for.

"In the specifics of Credit Sails you really need to say that how can it be that something that is rated at that level is so susceptible to a demolition?"

The Commerce Commission's Credit Sails investigation comes after it secured a NZ$45 million payout to thousands of investors in the ING Diversified Yield Fund and the ING Regular Income Fund which were marketed by ING and the ANZ. The settlement, reached in June, followed an investigation into alleged breaches of the Fair Trading Act.

Wright said there was a similarity between Credit Sails and the ING funds in the sense both were sold as being robust fixed interest products.

"Neither proved to be robust fixed interest products and at an AA rating you’d expect it to be an extremely robust fixed interest product," said Wright.

'Getting the grandma's their money back'

Greg Marshall, of Wanaka-based Logic Fund Management, says his firm is representing about 850 Credit Sails investors. Although Logic wasn't involved in the marketing or selling of Credit Sails, Marshall says his number one objective is to "get the grandmas their money back."

He knew of an Auckland man, who after making NZ$1 million from selling a property, invested NZ$500,000 in Credit Sails, NZ$250,000 into South Canterbury Finance preference shares and NZ$250,000 in Strategic Finance preference shares and lost the lot.

Marshall says he believes Credit Sails was mis-sold, failed to properly disclose the buyback of some of the notes, and securities laws were potentially "busted" in the way the product was built and sold. Logic's research suggests about NZ$19 million worth of Credit Sails were exchanged via the NZX in 2007 at 93.6 cents in the dollar, although no filing was made to the NZX and nor did Credit Sail disclose this in its annual report.

The latest Credit Sail monthly report records a "nominal amount" of NZ$66.54 million worth of Credit Sails notes, excluding those held by Credit Agricole.

Wright said questions needed to be asked about how investors were treated on a equitable basis given some apparently had the opportunity to sell and others didn't.

'Not our fault'

Meanwhile, Paviour-Smith said Forsyth Barr's role as lead manager and underwriter of the Credit Sails issue were "completely separate" to the involvement of the firm's advisers in discussing the securities with their clients, and how they represented the security offering to their clients. This was the same as how other brokers discussed and marketed Credit Sails.

"That means that if broker XYZ misrepresented Credit Sails to a client it does not mean Forsyth Barr is at fault just because we were the lead manager," Paviour-Smith added.

"As regards the offer documents etc these were all the responsibility of the issuer/promoters IE Calyon Bank."

In an interview for an article I wrote in The Independent last year, Paviour-Smith said Forsyth Barr's involvement with Credit Sails came via the Hong Kong branch of Calyon. Other New Zealand firms involved were auditor BDO Spicers and trustee New Zealand Permanent Trustees Ltd, a Public Trust subsidiary.

"Essential to us was the credit rating," says Paviour-Smith.

The rating, from Standard & Poor's, was "AA" meaning the credit rating agency viewed Credit Sail as having "very strong" capacity to meet financial commitments.

However, S&P's rating was only on the probability of investors getting their principal investment back. It did not cover the likelihood of them receiving interest payments.

As to whether Credit Sail was the type of investment that should have been promoted to community groups and retail investors, Paviour-Smith says it's impossible to comment on individual investor's decisions.

"But generally speaking the AA credit rating was the primary reason I think a lot of people invested in it."

This meant Credit Sail was one of the highest-rated debt securities in the market.

"That's a principal driver of why people were willing to invest in it and why we were happy to be involved with it," says Paviour-Smith.

Clearly it's "disappointing" it hasn't come to fruition.

"But I guess there's always an element of risk."

S&P now rates the Credit Sails principal CC, meaning it's "currently highly vulnerable". S&P says investors' should keep in mind that credit ratings aren't advice or an indication of investment merit. Instead they are "opinions on aspects of an investment decision - creditworthiness and likelihood of default."