FSA has today announced that it is going to review firms' sales of Lehman backed structured products (Lehman backed products) to retail investors. This raises important issues for affected investors, for firms that sold Lehman backed products, and for the structured product market as a whole.

Background

In recent years many retail providers have sought to meet investor demand for constant yield or high growth by issuing retail structured products. While varying in design, these typically offer a set income or level of capital growth over a pre-determined period of three to five years. They are generally linked to instruments purchased from an investment bank that deliver the performance that enables the provider to offer the promised benefits. The counterparty risk involved in retail structured products has only recently become a primary commercial or regulatory focus, especially after the collapse of Lehman Brothers in September 2008 resulted in significant losses for investors in retail structured products backed by securities written by Lehman Brothers.

Action by UK investors

United Kingdom investors have brought claims against the retail providers who issued Lehman backed products, and against the retail intermediaries who advised them to acquire the products. An investor may claim that he was not warned about counterparty risk, or that the adviser should have been more cautious in selecting the investment. In the first instance an investor will complain to the selling or advising firm and, if their complaint is rejected, refer the matter to the Financial Ombudsman Service (FOS) who will adjudicate the complaint (up to a ceiling of £100,000) without charge – an attractive alternative to taking court proceedings.

Action by FOS ... and now by FSA

FOS has been considering a mounting number of Lehman backed products complaints, and has been discussing this as an emerging issue with FSA under what is termed the Wider Implications Procedure. This is when FOS spots a trend and considers that while it can only deal with individual complaints, there may wider action that FSA could take to benefit investors as a whole.

FSA has today responded to FOS' referral by stating that it will now review market-wide issues connected with the sale of Lehman backed products. While no details are at present available, it is clear FSA considers that there may be systemic issues of widespread consumer detriment. It is therefore likely to undertake a thematic investigation of the way that providers constructed Lehman backed products and advisers sold them, and

  • Review whether (i) providers and advisers properly understood the risks associated with Lehman backed products, (ii) how they assessed the risks associated with Lehman Brothers as the counterparty, (iii) whether marketing material properly described the risks; and (iv) whether advised sales were suitable;
  • Determine whether firms should be required proactively to review sales of Lehman backed products and compensate investors (whether or not they have complained) where the rulebook requirements underlying issues (i) to (iv) were breached.

This is a significant use of FSA's powers to protect a whole class of investors affected by credit crunch.

FSA will draw on the results of this review to determine whether there should be additional protections for – or even restrictions on – the sales of retail structured products, although any changes would need to be consistent with the EU-wide MiFID requirements.

Implications for firms

Provider and adviser firms with significant exposure to Lehman backed products should prepare for an FSA review. This may begin with a fact-finding questionnaire and move on to a detailed document request and then management interviews. FSA's Chief Executive has today emphasised that FSA will be examining how firms' management assessed risk, and this may be one of the first examples where this new stance is put into practice.

We have extensive experience in assisting firms in connection with FSA reviews and investigations, and will be pleased to discuss how we could assist you in this matter.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

Law-Now information is for general purposes and guidance only. The information and opinions expressed in all Law-Now articles are not necessarily comprehensive and do not purport to give professional or legal advice. All Law-Now information relates to circumstances prevailing at the date of its original publication and may not have been updated to reflect subsequent developments.

The original publication date for this article was 07/05/2009.