Commerce Commission says Forsyth Barr's promotion of 'capital protected' Credit SaILS was "both misleading and deceptive"; shouldn't have been marketed to retail investors

By Bernard Hickey

The Commerce Commission has published a full investigation into the marketing of Credit SaILS 'capital protected index-tracking notes' to retail investors and found the French investment bank CALYON that built the notes and the New Zealand brokerage firm Forsyth Barr that promoted the notes made representations that were 'both misleading ad deceptive'.

Forsyth Barr is one of the retail brokers promoting Mighty River Power to retail investors.

"The description of the product as being 'protected' was misleading. The collateral that 'protected' the product was in fact its greatest risk," the Commission said, noting that the capital was eventually lost.

"The product was not suitable for retail investors, but retail investors were targeted," the Commission said. "The companies held information that confirmed that the Credit SaILS product was complex and unsuitable for the average investor," it said.

"The companies knew or ought to have known that Credit SaILS were unsuitable for the average retail investor."

During May and June 2006 Calyon and Forsyth Barr sold NZ$91.5 million of the 'capital protected AA-rated index tracking notes' to 3,000 retail investors in New Zealand. Several charities and community groups were among the buyers.

Marketing material sent to investors promised interest of 8.5% per annum paid quarterly with an average total return of 10%. Once issued and listed, the Credit SaILS paid 8 quarterly interest payments before being suspended in September 2008.

By November Credit SaILS notified there would be no more interest payments. The so-called "Momentum Reference Portfolio" upon which the notes were based included exposure to derivatives linked to collapsed Icelandic banks Landsbankski, Glitnir and Kaupthing, as well as to US banks Lehman Bros and Washington Mutual, both of which went bankrupt.

By May 2009 Credit SaILS had notified the underlying assets had been wiped out, leaving investors with NZ$11.66 for every 1,000 Credit SaILS held.

The Commerce Commission calculated the losses of capital to investors at around NZ$70.66 million out of the NZ$91.5 million invested.

After complaints from investors, the Commerce Commission began an investigation in December 2011 and it settled with Calyon and Forsyth Barr in December 2012. They agreed to pay NZ$60 million into a trust fund to be paid out to investors in exchange for not admitting any guilt. The Commission said it chose to settle rather than risk a delay of two to three years in legal action, given many of the investors were elderly and suffering from the capital and interest losses.

Incriminating emails

The Commission's included a selection of emails and evidence collected during the course of the one year investigation costing NZ$900,000 that show Forsyth Barr pushed back against attempts by the Companies Office and Calyon to tone down the claims in the marketing material.

It also shows the Credit SaILS were so complicated that many of Forsyth Barr's own brokers didn't understand it.

Interesting sections in the report include:

Paragraph 52, page 10 - Several brokers, financial advisors and banks decided not to promote Credit SaILS to their customers because they didn't consider them suitable for retail investors, given the risks and complexity. 

Paragraph 54, page 11 - Calyon only promoted Credit Sails to retail investors in 2 out of 21 countries, including Taiwan and New Zealand. 

Paragraph 56, page 11 - One Forsyth Barr executive commented in May 2006 that Forysth Barr had actually pushed Calyon to open it up to retail investors. Here's the email, which Forsyth Barr has said is the view of just one executive:

“Did they knock on our door. Not really, the courting went the other way and it took considerable effort to get them to entertain doing a retail issue in NZ. Other than ABN this is the only major international bank to promote such a structure for retail. This structure is not new, ANZ “inflicted” exactly the same deal on its middle market & institutional clients last year. We consider that an endorsement of the structure as these types of investors are sophisticated….the key guy running things is the Calculation Agent Calyon. They run the strategy”

Paragraph 64, page 12 - A Forsyth Barr email in response to Calyon requests to take out some of the 'sizzle' in the marketing material. 

Calyon has made further changes to the offer document which in my view detract from the "sizzle" of the offer. I would like your views on whether we should hang tough on their reinsertion. On page 5 we have some language talking about modern yacht design.. blah blah blah making an analogy with Credit SaILS, stating "... Credit SaILS! an AA principal rated investment producing 8.5% interest payments." This was big and bold but has been removed by Calyon so there is now no reference in this page to the returns. In the "What are Credit SaILS" there was an analogy between the Credit Strategy and fire insurance. Calyon have removed this. I felt (as author) this was very useful in understanding how credit swaps work and how the income and risks are generated through a comparison with normal household insurance. However I understand that not all parties agree. Are you happy with its deletion?

Paragraph 64.3, page 12 - In another email in response to a Calyon deletion:

… [The external legal adviser] has forwarded me the last night’s version with further deletions and changes made by you. One of the deletions we feel is harmful to the marketing of this offer. Remember we catch more flies with honey than vinegar! On screen 7 this is pure marketing spiel. We want the retention of some statement here about the returns. This is entirely consistent with the offer and makes an eye catching initial statement which we think is very important as investors seldom read in detail beyond the first few pages.

Paragraph 64.3, Page 12 - In an email responding to Calyon's insertions, Forsyth Barr said:

We would very much wish for the section on back testing to be removed the graphs in particular show a large number of incidences were the returns are materially lower than we expect which is a big marketing negative, and there is no obligation for you to include this information anyway.

Paragraph 65, Page 12 - Around May 9, 2006 the Companies Office told Forsyth Barr that references in the prospectus to the words 'guarantee' and 'assured' and 'protected' should be treated with caution. Later Calyon and Forsyth Barr removed most, but not all, of the references to 'capital protection' and 'principal protection.'

Then Forsyth Barr had an internal debate in which it was argued it could make the changes suggested and then use other channels such as the media to convey the message of capital protection and high returns.

“Here is the marked up version of the advertisement, basically reflecting the CO’s required comments, as you can see, they don’t look good.”

“I say we flag the advertising and work on media interviews and articles to convey the message.”

“[The] suggestion is to take out the 8.5% to get rid of the negative language and go with a smaller schedule (maybe two placements?) A further alternative is to replace the language relating to 8.5% with the marketing spiel at the front of the offering document.”

“Why can't we put the 8.5% in there with a tiny (1) next to it and then at the bottom in tiny text next to the (1) we put all their dumb language? This would be workable. We're not selling bloody cigarettes!”

Paragraph 74, Page 15 - Forsyth Barr made numerous statements and presentations separate to the prospectus implying or stating that Credit SaILS was 100% capital protected and 'as safe as a bank term deposit.'

Paragraph 89, Page 21 - Calyon bought NZ$20.8 million of the Credit SaILS notes in July and October 2007 and only some Forsyth Barr investors were advised they could sell to Calyon. Emails from one investor complaining about missing out on the chance to sell were included in the report. 

. I would appreciate an explanation of why we were not included in this buyback in Oct when we had clearly advised that we wanted to sell after you had contacted us in July ??? I await your comments and as you are aware we still hold FB responsible for the situation we find ourselves in and intend to pursue any avenue open to us to recover this amount.

Paragraph 104.4, Page 25 - One retiree told the Commission they were only interest in low risk investments with no risk to capital and had been told by Forsyth Barr Credit SaILS was suitable and not told of its complex or derivative based nature.

Forsyth Barr advisor confirmed later she did not understand structure or risks of the product.

Paragraph 106.1, Page 25 - The Commission gave examples of what some investors thought they had invested in and why they thought it was capital protected:

“The flyer said ‘AA rated capital protection’ and this was the key thing for me. I thought it was capital guaranteed by CALYON. I understood this to mean that I would at least get my capital back. [My advisor] reinforced that view by saying that the investment was as safe as investing in Westpac Bank.”

Forsyth Barr later published a statement on the Commerce Commission website, saying it did not agree with parts of the report, which it said contained "factual errors and statements taken and presented out of context".

Here is the full statement:

Forsyth Barr acknowledges the publication of the Commerce Commission's Investigation Closure Report. We note the Commission’s statement that it was restrained to only presenting information that had been obtained from Forsyth Barr and that this may create an imbalanced impression as to our role and responsibilities with Credit Sails. While we do not agree with parts of the report, which contains factual errors and statements taken and presented out of context, we have taken on board the Commission’s feedback and comments. It is important to reflect carefully on any negative outcome and the lessons learnt. Financial markets have undergone tremendous change since the global financial crisis.

The report refers to the issue of Credit SaILS notes back in 2006. Since then there have been sweeping changes in the financial and investment advisory industry with new regulators established and a new regime for financial advisers. As noted by the Commission in the Settlement Agreement entered into in December 2012, Forsyth Barr fully cooperated with the Commission’s investigation. We were pleased to have been involved in achieving a good settlement outcome for investors considering the losses that had been experienced.

(Updated with link to full report, details and quotes from report; also response from Forsyth Barr published on Commerce Commission website)