The 24% Bond and the Pensioner
Mr. Nwosu, 68, has retired as a civil servant and received a gratuity of NGN 18 million. He needs about NGN 450,000 each month for at least three years and describes himself as conservative; he has never bought a bond or a share. His sponsored individual recommends a five-year subordinated bond issued by Northern Star Projects Limited, paying a 24% coupon, callable after two years, with a minimum subscription of NGN 10 million. The offering memorandum calls the bond 'secured, risk-free, and backed by government contracts.' The issuer's latest audited accounts show revenue down 38%, negative operating cash flow of NGN 2.1 billion, a qualified audit opinion over NGN 7.4 billion of receivables, and a going-concern note. The SI's firm is a co-underwriter and earns a 2.5% selling concession; the SI's annual bonus is volume-based. When Mr. Nwosu asks whether he can get his capital back after one year, the SI says: 'The coupon covers everything. You cannot lose.'
1. Assess the suitability of the Northern Star bond for Mr. Nwosu.
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The bond is unsuitable. Mr. Nwosu is 68, retired, and needs NGN 450,000 per month for at least three years. That requires capital preservation and liquidity. The Northern Star bond is a five-year, subordinated, callable instrument with a NGN 10 million minimum - over half his gratuity in one issuer - and no secondary market. Subordination means he ranks behind senior creditors in a default; the call feature means the issuer can repay early if rates fall, leaving him to reinvest. A 24% coupon does not compensate for going-concern risk.
The suitability assessment should match the product to his objectives, risk tolerance, horizon and liquidity needs. The product fails on liquidity and credit risk. Suitable alternatives might include short-dated government securities, a diversified money market fund, or insured deposits, with clear disclosure that returns may be lower. The SI should document the advice and not execute the bond purchase.
2. What are the disclosure and misrepresentation issues in the offering memorandum and the SI's statement?
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The offering memorandum's description - 'secured, risk-free, and backed by government contracts' - is misleading. 'Risk-free' is an absolute claim that is false for a subordinated bond with going-concern doubt; 'secured' and 'government contracts' need legal verification and disclosure of the security, ranking and enforcement rights. The memorandum should disclose the qualified audit opinion, the NGN 7.4 billion receivables, negative operating cash flow, subordination, call risk, illiquidity and use of proceeds.
The SI's statement - 'The coupon covers everything. You cannot lose' - is a guarantee that no one can give. It is a misrepresentation and a breach of conduct rules. The SI must correct it immediately in writing, provide the audited accounts and a balanced risk summary, and ensure the client understands that capital is at risk. The issuer and underwriters may also bear liability for misleading disclosure. The correction should be documented.
3. How should the SI handle the conflict of interest and the client's insistence on proceeding?
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The SI's firm is a co-underwriter earning a 2.5% selling concession, and the SI's bonus is volume-based. That is a material conflict: the advice to buy is directly profitable to the firm and the SI. The conflict must be disclosed in writing, and the firm should manage it by separating advice from sales incentives, requiring an independent suitability review, and ensuring the client knows the firm is an underwriter.
If the client insists after full and corrected disclosure, the SI must document the advice, the client's reasons, and the suitability mismatch. The firm may still decline to execute if the product is clearly unsuitable, especially given the client's age and liquidity needs. Compliance should sign off on any exception. The SI should not receive the volume bonus on a sale that breaches suitability - that would compound the conflict.