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The Cover Up

November 12, 2010

The Cover Up?

Please click here to download a PDF of The Cover Up


We believe an initial cover up for Credit Sails may have begun as soon as the potential ramifications of the mortgage collapse in the United States became known within the New Zealand market in December, 2006.   The failure of Ownit Mortgage Solutions Inc., a California-based home lender part-owned by Merrill Lynch & Co., was perhaps the most pertinent signal and even some savvy retail investors realised they should sell Credit Sails.  We have been led to believe that this and the following events put Calyon under increasing pressure to buy-back Credit Sails from customers.


The second significant sell signal occurred on 10 January, 2007, when Credit Sails was initially placed on Credit Watch Negative.  While recently reviewing market data through individual note holders, we noticed a pick up in selling from the local arranger Forsyth Barr.  On a number of occasions these trades do not appear to have been reported on the NZ stock exchange[1] and in one case in particular, the product was sold at a price to the customer that we cannot reconcile with the reported price.[2] To our knowledge and to those note holders to whom we refer, this was not disclosed.


By July, 2007 Credit Sails had been placed on Negative Credit Watch three more times and the weakness in US institutions continued to contribute to the desperate situation.  This may have influenced Forsyth Barr to cause Calyon to buy back a block of Securities because of customer demand to sell.[3] It appears only select customers were offered the chance to get out.  One client received this e-mail from Forsyth Barr Christchurch adviser, Liz Douglas, on 11 July, 2007:


We are concerned about Credit Sails and the quality of the capital guarantee via the CDO and have arranged for a weekly buy back from the French Investment Bank who arranged this investment.  I will sell your 40,000 into this facility to preserve capital…at the expense of one year’s interest we can take away the current risk to your capital.


Credit Sails was placed on Credit Watch Negative again in late August and the collapse of Lehman Brothers in September caused the suspension of quarterly payments for the duration of the Credit Sails investment.  This may have been a key influencing factor to the second buy-back in October.


Just over $19m was redeemed by October, 2007 and as stated in the Buy-back report, a number of advisers were unaware of the involvement of their firm in this transaction.  From this period onward the requests to sell continued to intensify and we have been led to believe that Forsyth Barr may have failed to execute client orders to sell. 


In late February, 2008, Credit Sails issued its annual results through 31 December, 2007 and did not disclose any returns to shareholders via buybacks.  This appears to be a breach of the regulations set out by the NZ Stock Exchange.  In a July, 2009 letter to a Forsyth Barr client, Neil Pavouir-Smith stated:


…We arranged with Calyon for them to buy a block of securities at the time to facilitate the selling requirements of the clients.


In a Business Day article interviewing Mr. Pavouir-Smith in July, 2010, we see a perspective on Forsyth Barr’s involvement with Credit Sails in hind sight.  In reference to the product design he referred to Calyon as having responsibility and Forsyth Barr as being merely the organising broker and lead manager in New Zealand.  He justified their role by stating:

There is a limit to how much you will get involved in completely reviewing every single facet of every single investment.


Later in the same article, Mr Pavouir-Smith discussed the structure of the product and their advice to Calyon as to what would sell best in the NZ Market:

The feedback we had from brokers was they didn’t want a portfolio that could be modified afterwards, potentially reducing the credit quality.  We said to Calyon that based on the market feedback a static portfolio would be preferable to a dynamic portfolio. And if it was a dynamic portfolio they would have less interest and there would be less interest from us.


What we find interesting is that this static structure was one of the reasons why the product failed.


As the full extent of the loss hit newspapers many aggrieved clients began writing to advisers and directors of Forsyth Barr as well as NZ Regulatory Bodies to try and find the potential reasons for the total loss and what these organizations were doing to investigate it.  In an excerpt from a July, 2009 letter, Neil Pavouir-Smith responds:


I would also like to advise you that in recent times we have been undertaking a thorough and comprehensive review of all the facets of this security and the operation of Credit Sails to ensure that at all times, all aspects of the security were complied with.  We have been in communication with the trustee, credit rating agencies and Calyon in order to obtain confirmations in this respect.  Please be assured that if we become aware of any matter which suggests a breach of any of the requirements, we will be pursuing the matter fully and seeking appropriate redress.


In the letters we have reviewed, Forsyth Barr continues to state messages like the one above.  We believe this to be far from the truth because we have not seen any response from any of the parties mentioned, other than after significant probing by Logic Fund Management.  In the July, 2010 article interviewing Mr. Pavouir-Smith, he states further:

It would be wonderful for Calyon to come out and say here are the answers to all these questions. We would welcome that, like everybody would, because then there’s a full disclosure of information and you need to address your questions with them as to why they wouldn’t adopt that approach.  But the question is who is best placed to get answers to questions? and the answer to that is [Credit Sails trustee] Public Trust, because I know they have corresponded with Calyon with specific questions and have received answers. I don’t see that correspondence but they have assured us in relation to certain questions they have had satisfaction.  If you or me or whoever go to Calyon and ask questions we get frustrated with responses, but the trustee must be responded to.


After reading this, one could deduce that Calyon has ceased communication with Forsyth Barr, and Forsyth Barr has aimed to direct the responsibility of the probe to the trustee.  The trustee has issued a multitude of letters since the failure of Credit Sails, but when Logic Fund Management asked the Public Trust to clarify what exactly they were investigating, the trustee was unable to respond.  Tim Hunter, from New Zealand Business Day received a similar response.  In their most recent letter dated 28 October, 2010, they claim that they have carried out their duties and could find no breach in the trust.  Although we do not have access to the same information as the Public Trust, the data we have reviewed and evaluated by other maket experts leads us to believe that the manner in which the Credit Sails portfolio was managed did not conform to expected market practice.


This deviation from market practice appears to have spiraled throughout the Credit Sails process and one case involving the removal of Credit Sails from Forysth Barr privately managed portfolios in the second quarter of 2010 is now under investigation by the NZX.  We acknowledge that Credit Sails have dropped in price tremendously, but all investors are due approximately $11.50 per 1,000 notes at the end of the term.  This example highlights the fact that there is information yet to be investigated and we believe a disaster such as Credit Sails should not be swept under the carpet.


Those who were involved with the manufacturing, designing and selling of Credit Sails have not taken appropriate responsibility for their actions and those regulatory bodies who supervise the industry are only just beginning to take the appropriate steps to investigate these matters further.  We continue to pursue this matter and ensure that these facts will remain in front of those regulatory bodies whose main function is to protect investors.





[1] Client A – 11 December, 2006 – $25,000 / Client B – 12 December, 2006 – $13,500 / Client C – 10 January, 2007 – $20,000

[2] Client D – 23 January, 2007

[3] Business Day, 15 July, 2010, An interview with Neil Pavouir-Smith, by Tim Hunter


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