Ordinary People Face Big Loss From Lehman Collapse

Thousands of ordinary people looking for low-risk investments were sold extremely complex `structured products', underwritten by Lehman Brothers, via independent financial advisors.

These investors could now potentially lose all of their money. They're stuck in the queue of creditors seeking a payout from Lehman Brothers administrators PricewaterhouseCoopers (PwC).

Yet the structured products were marketed as low risk.

One provider, NDF Administration, said in its literature that the investment was "100% capital secure", emphasising twice that: "Your initial capital investment will be returned to you in full at maturity." What's more, NDF didn't mention Lehman in its brochure.

So what are structured products?

Structured products are investment products that typically offer specified returns if certain hurdles are met. Normally, financial instruments called derivatives are used to provide the return for the investors.

Amongst UK private investors, guaranteed equity bonds are a well-known form of structured product.

Structures vary between bonds, but one popular approach is to offer investors a guarantee that they will get all of their initial investment back at the end of a five-year period. That's regardless of what happens to global stock markets.

And if stock markets do well, investors receive some of the gains.

The idea sounds great at first - especially in troubled times - but there are several drawbacks to these schemes. Perhaps the biggest is that investors don't normally receive any of the dividends from the underlying shares in the bond.

There are other drawbacks too and that's why we've never been fans of guaranteed equity bonds at The Fool.

But we never imagined that some investors in these bonds could end up losing all of their money. But that may now be the outcome for some unfortunate people.

This disastrous outcome is due to 'counterparty risk', also known as 'default risk'.

The problem is, for most of these products, the actual guarantee is not provided by the plan provider (for example NDF) but by a third party. If the third party goes bust, then your investment is worthless - assuming nothing can be obtained from the third party's administrator.

Sadly, Lehman Brothers, which hit the rocks in September, has guaranteed several such products in the UK markets.

Here they are:

* Prima 9 is now backed by BNP Paribas, Prima 3 is now backed by Merrill Lynch.

Were investors warned about the risks?

Looking at NDF's Capital Secure Fixed Growth Plan April 2008, wherever it states there will be "full repayment of your capital at maturity", the risks are not highlighted.

It is not until you flick further through the documentation that the investment risks are stated. Even then, they are unclear.

In fact, all it says is 'there is a risk that the Issuer may fail to meet its obligations'. Exactly what these risks might be are not clarified in any way.

For this reason, investors who feel they have been misled may be able to seek redress from the Financial Services Ombudsman.

What can investors do?

According to a spokesperson for the Financial Ombudsman Service (FOS), customers believing the risks were not stated clearly enough in the plan documentation could have a case for compensation.

Investors who feel they have been misled by plan documentation, because they thought they were taking out a low-risk investment, should contact the firm they believe is responsible in the first instance, and if nothing is resolved within eight weeks, they should then contact the Financial Ombudsman Service itself.

However, investors cannot claim compensation from the Financial Services Compensation Scheme (FSCS).

Why not?

The FSCS only covers a default on behalf of the plan providers and not the investments themselves.

According to a FSCS spokesperson, had the investments been directly through Lehman Brothers, investors could have claimed compensation, but because they invested through an plan provider and that plan provider is still trading, no one can claim.

What about the administrator?

The plan providers are currently trying to recover their investors' losses from Lehman Brothers' administrator, PwC.

As soon as they get information from PwC, they say they will inform all those involved.

In the meantime, investors are advised to check the websites of their plan providers for updates, as well as the website for PwC.

Frustratingly, no one is currently able to say whether investors will be able to get any of their money back, or how long it will take to resolve.

So have the involved companies changed their ways?

I thought it would be interesting to see whether the documentation for NDF Administration's new plans has been revised now that the above problems with Lehman Brothers have come to light.

Looking at the Capital Secure Fixed Growth Plan August 2008, the risk warning was slightly changed.

The amended plan stated: 'There is a risk that the Issuer may fail to meet its obligations and it is you, the Investor, that faces this risk rather than the Plan Manager.' (My Italics.)

But it still did not state clearly enough exactly what the risks were.

The August Plan is no longer available (it closed on 17 October) and there is now no plan called 'Capital Secure Fixed Growth Plan' listed on the NDF website.

However, all remaining NDF plans do now clearly state on the front of the documentation that 'your capital is at risk so you must be prepared to lose some or all of your capital.' The majority of the plan documents point out that the investments are exposed to an AA- rated financial institution with a note to look further into the document for more details.

Then the documents state that 'the Plan is not the same as a bank or building society account and the investment does not include the security of capital which is afforded under a deposit with a bank or building society.'

And once again the documentation stipulates in the risks section that 'there is a risk that the Issuer of the Preference Share Securities may fail to meet its obligations and it is you, the Investor, that faces this risk rather than the Plan Manager.'

We want justice!

Here at The Fool, we're pleased that NDF has made the situation clearer in its latest documents.

That said, we want justice for the investors affected by the collapse. Investors deserve better from regulated firms.

We also want to make sure that all providers of these products properly highlight the risks to their customers.

But what do you think? Have you been affected? Are you aware of similar plans? Share your thoughts with other Fools using the comment boxes below.

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