The Perils of Global Banking

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In Belgium: The Rubers lost $200,000 invested in Lehman notes Ed Alcock

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JA Solar bought $100 million worth last summer, at the urging of its Lehman bankers. It says the bankers pitched the notes (which paid a little interest each quarter if a certain commodity index registered a gain) as no riskier than a money market fund. JA Solar says it was told that at worst the investment would come out flat. "We did not anticipate [the notes'] coming even close to risky," says Anthea Chung, JA Solar's chief financial officer.

Now the company is reeling. It has written off the entire $100 million on its books. Its stock, which is traded in New York, is down 66% since Lehman filed for bankruptcy. JA is becoming one of the pioneers of de-globalization, preferring to keep its financial deals closer to home. "For the near future, we are quite comfortable with Chinese banks," says Chung. "They are backed by the Chinese government."

Lehman also tapped retail banks, including Citigroup and UBS (UBS), to hawk the Amsterdam notes, which were part of an enormous market. All told, Wall Street has sold more than $640 billion of structured notes to small investors around the world, according to StructuredRetailProducts.com—most of them from overseas units. That's about the size of the market for subprime collateralized debt obligations (CDOs), which brought on the global crisis. "[Lehman's notes] were sold directly by the banks to their retail customers," says Erik Bomans, a partner at Deminor, an advisory firm specializing in investor protection. Deminor, based in Brussels, is working with attorneys representing buyers of Lehman notes sold in Belgium, Italy, and the Netherlands. To date, the firm says, it has been contacted by 1,600 investors. "You can't even call them investors—they were savings bank customers," says Bomans.

The Rubers are among those who claim they were misled. Rene Ruber says a banker at a Citigroup office in Belgium sold him and his son about $200,000 of Lehman notes, promising an annual return of up to 6%. He says the notes were presented as a risk-free savings tool. "In plain English, we were screwed," says Rene. "I was lied to. They are not honest bankers." His son Cedric says some of his lost money had been earmarked for a new home, and some for college savings for his two children.

UBS says it "properly sold these investments to its clients. The offering materials clearly identified Lehman as the issuer and discussed all the relevant risks." A Citi spokesman in Belgium says the bank "is committed to helping affected customers retrieve as much of their original investment as possible through Lehman's bankruptcy proceedings in the U.S. and the Netherlands."

In Britain it's a somewhat different story. Most of the notes sold there were marketed under the names of various London-based brokerages. Investors say they never knew that Lehman originated the bonds or guaranteed them. "If people knew it was Lehman, many wouldn't have bought them," says Howard, the retired British schoolteacher, who purchased notes in February 2008. "Many [American banks] were having a sticky time back then."

Howard, 58, is trying to organize U.K. investors to recoup their money. Working from his home in Wantage, in Oxfordshire, he has spoken with about 100 people so far, he says. "The average age is 65," says Howard. "Most of them took some of their pension money and invested in these notes." He says he has been talking to members of Parliament to get them to pressure brokerages to reimburse investors. In the next few weeks, his grassroots group, SPIRIT—short for Structured Products Investors Recovery & Information Team—plans to launch a Web site to draw more attention.

Similar stories abound in Asia, where investors have taken to the streets in Hong Kong several times since Lehman collapsed. The government says the Hong Kong Monetary Authority received more than 20,800 complaints about the notes, called minibonds there. Government officials on Apr. 28 alleged that some banks sold minibonds to mentally ill investors, although more details couldn't be obtained.

The minibonds were similar to the Amsterdam notes except that they weren't "principal protected." Instead, a marketing leaflet said the minibonds were "credit-linked to a basket of well-known international financial institutions," such as ­JPMorgan Chase (JPM). In fact, they were tied to a CDO. The leaflet said the minibonds were safe and that returns "may reach 48.4%." But they were no more secure than Lehman's ability to pay back the cash. That risk was buried in the fine print, below icons for gifts—digital cameras, LCD TVs, even grocery coupons.

Gordian Knot

Now investors are trying to get their money back. —We feel totally cheated,— says Alex Chow, 51, who lost about $130,000 and is organizing more protests. "The bank stole our money," he says. Two firms that distributed Lehman minibonds have agreed with regulators to repay investors. About 6,000 investor claims are being settled, says the Hong Kong government.

Meanwhile, in Amsterdam, the untangling of Lehman Brothers Treasury is just beginning. Rutger Schimmelpenninck, a partner with law firm Houthoff Buruma who is serving as the bankruptcy trustee, is daunted by the task. His exasperation came through in an Apr. 16 report in which he complained that "almost all the notes are governed by English law, while the validation of debt…is under Dutch bankruptcy law. … Obligations under the notes are governed by New York State law [and claims] have to be calculated and filed in accordance with the bankruptcy law of the United States." There's no clean way to slice through the Gordian knot of contracts, he tells BusinessWeek: "The legal practices for resolving disputes in bankruptcy situations around notes with embedded derivative elements have not yet developed."

Regulators have worried about that sort of problem for years. "Insolvency proceedings from one country to another are completely different," says Michael H. Krimminger, special adviser for policy to FDIC Chairman Bair.

Despite the mess in Amsterdam, new deals are hatching in Europe. On Feb. 11 Goldman registered a plan in Ireland to sell notes that seem similar in structure to the ones sold by Lehman in Amsterdam. The notes will be issued by an Irish unit called Goldman Sachs Financial Products Europe, according to the prospectus. Like Lehman's notes, some of Goldman's will be backed by the parent company in New York. Goldman declined to comment.

Ireland, like Amsterdam, has become a favorite place for global banks to set up subsidiaries to sell financial instruments. A recent Government Accountability Office report listed Ireland among more than 30 nations where U.S. companies have established units to take advantage of easier regulation.

Goldman's operation is similar to Lehman's in another way. Two of the subsidiary's directors are executives with Deutsche International Corporate Services, a unit of Germany's Deutsche Bank (DB) that provides trustee and securities services to scores of investment vehicles set up by Goldman and others. The mailing address for Goldman's Ireland subsidiary? It's the one used by the Deutsche operation.

If more structured notes go sour or if bank bailout burdens grow, the biggest loser could be globalization itself. Josef Ackermann, chairman of Deutsche Bank, warned of the consequences of financial protectionism in a recent speech at the London School of Economics. "Market integration, for goods and services and for capital, is the bedrock of our prosperity," he said. But by selling risky instruments to unwitting investors around the world, Wall Street is placing that prosperity in jeopardy.

Henry is a senior writer at BusinessWeek. Goldstein is a senior writer at BusinessWeek. With Theo Francis in Washington and Bruce Einhorn in Hong Kong

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