Retail investors in structured products that were sold as safe and secure investments have lost at least $113 billion, according to a report by the nonpartisan policy center Demos and The Nation Institute. “In my three decades of Wall Street experience, I have not seen any other product as absurdly destructive as retail investments linked to structured products,” securities arbitration consultant Louis Straney wrote in the report.
Structured notes issued by Lehman Brothers and sold by UBS are emblematic of an array of structured products that have been described as “absurdly destructive.” See InvestmentNews article by Liz Skinner entitled “Structured products ‘absurdly destructive’ for retail investors: Report.” Lehman Brothers structured notes were falsely named and sold as providing “100% Principal Protection.” Despite that representation, investors lost most of their principal when Lehman Brothers filed for bankruptcy in September 2008.
Yet brokerage firms are apparently ramping up the sales of structured products, which pay higher commissions than ordinary fixed income investments. They reportedly sold more than $52 billion last year, often to senior citizens, as a way to earn more interest while protecting principal.
The Financial Industry Regulatory Authority (FINRA), which regulates broker-dealer sales practices, filed an enforcement action against UBS alleging that UBS misled investors by failing to inform them that the Lehman notes (like virtually all such structured notes) were unsecured obligations of the issuer, in this case Lehman Brothers, which could be extinguished by a bankruptcy filing. UBS settled that case by agreeing to pay $10.7 million in fines and restitution.
But the FINRA settlement leaves out many investors who purchased Lehman notes. It only covers the “100% Principal Protected” notes (not the notes that promised partial or contingent principal protection), and it only applies to those investors that UBS coded as having either a conservative or moderate risk tolerance (those coded as moderate are only eligible to receive 50% of their losses out of the FINRA settlement).
Lehman note investors who have not already consulted with an attorney with experience in handling these matters should do so promptly. Investors who have filed securities arbitration cases against UBS to recover losses on Lehman principal protected notes have won or achieved a substantial settlement in every case so far. But the passage of more time could lessen the possible recovery.
The article also alluded to, but did not mention specifically, another “absurdly destructive” structured product ? reverse convertibles. Reverse convertibles are also high-yield, short-term structured notes linked to a reference asset. They are sold to customers with a wide variety of investment objectives and risk tolerances, including seniors who cannot make ends meet with the interest from CDs.
The key feature of reverse convertibles that can make them so “absurdly destructive,” which is not explained or understood by most advisors or investors, is that they contain an embedded put option ? a Trojan Horse, if you will. The payout at maturity is dependent on the performance of a reference asset or basket of assets. If the price of the reference asset falls below a certain point, instead of receiving a return of principal at maturity, the investor receives the depressed reference asset. Because of the embedded put option, FINRA has notified broker-dealers that they should “consider” only selling reverse convertibles to investors who are properly approved for options trading.
Structured products are so complex and opaque that the brokers who sell them do not understand them. This has been repeatedly demonstrated in arbitration hearings as the broker, though prepared by attorney for the firm, cannot accurately explain how they work or how they are valued. According to experts who have examined them, structured products are both over-priced and extremely illiquid.
Structured products were originally sold to sophisticated investors, but in recent years, an increasing number of them have been sold to unsophisticated retail investors.
“There’s no doubt that structured products are targeted toward older folks,” director of Alabama’s securities commission, Joe Borg, wrote in the Demos report, adding: “There’s the issue of outliving their money when it is tied up in low-yielding CDs and bonds. They’re a scared group.”
Page Perry is an Atlanta-based law firm with over 125 years collective experience representing investors in securities-related litigation and arbitration. While past results are not indicative of future success, Page Perry’s attorneys have recovered over $1,000,000 for clients on more than 45 occasions. Page Perry’s attorneys have extensive experience in representing investors in cases involving principal protected notes, reverse convertibles and other structured products. For further information, please contact us.