Posts tagged ‘structured product fraud’

Risks of Structured Products

A structured product, also known as a market linked investment, is generally a pre-packaged investment strategy based on derivatives, such as a single security, a basket of securities, options, indices, commodities, debt issuance and/or foreign currencies, and to a lesser extent, swaps.

Broker-dealers have long offered a range of structured securities to institutions and wealthy individuals. Certain structured securities products have been increasingly marketed to retail investors in recent years. Total U.S. sales of SSPs (to both retail and institutional investors) had risen from approximately $32 billion in 2004 to in excess of $100 billion in 2007.

A feature of some structured products is a “principal guarantee” function, which offers protection of principal if held to maturity. It is this feature that most often appeals to investors.  Unfortunately, it is this function that is also most often misrepresented by financial professionals to their clients simply because the financial professional doesn’t fully understand the product and its risks.

(1)   Sale of Structured Products

FINRA Notice to Member 05-59 sets forth the requirements that any broker-dealer must follow in marketing and selling a structured product.  These guidelines include the requirements to: (1) provide balanced disclosure in promotional efforts; (2) ascertain accounts eligible to purchase structured products; (3) deal fairly with customers with regard to derivative products; (4) perform a reasonable-basis suitability determination; (5) perform a customer specific suitability determination; (6) supervise and maintain a supervisory control system; and (7) train associated persons to fully understand the products.

In FINRA Notice to Member 10-09, FINRA reminded broker-dealers of their sales practice obligations with respect to reverse convertible notes (a particularly risky type of structured product).  FINRA reminded firms that sell reverse convertibles to ensure that their promotional materials or communications to the public regarding these products are fair and balanced, and do not understate the risks associated with them.  Firms are also reminded to ensure that their registered representatives understand the risks, terms and costs associated with these products, and that they perform an adequate suitability analysis before recommending them to any customer.

(2)  Brokerage Firm Requirements Prior to Recommending Any Investment

Brokerage firms and financial professionals have certain due diligence responsibilities prior to recommending any investment to a client.  These requirements are particularly significant in the context of complicated structured products, as a broker is required to fully understand any product he/she recommends.

Generally speaking FINRA requires that a broker have a reasonable grounds for believing the recommendation is suitable upon the basis of the facts disclosed by such customer as to his/her other security holdings and as to his/her financial situation and needs.  This is generally called the Know Your Customer Rule.

Securities rules further provide that recommendations violate the Know Your Customer rule if:

–  the agent’s understanding of the investment is insufficient to establish a reasonable basis for making a recommendation;

–  the agent inadequately assesses whether the recommendation is suitable for the specific investor; or

–  the level of trading is excessive in light of the customer’s investment needs and objectives.

FINRA and the SEC have routinely held that a broker is also responsible for investigating the specific characteristics of an investment.  An advisor can be responsible for making an improper recommendation when he/she fails to learn the basic characteristics of an investment and how those characteristics would affect the investment’s risks and liquidity.

Moreover, the test as to whether a broker understood a product sufficiently to recommend the product requires actual objective investigation and knowledge, rather than the rep’s personal subjective belief in the suitability of the investment. See, F.J. Kaufman & Co. of Va., 50 SEC 164, (1989) (“a broker-dealer in his dealings with customers impliedly represents that his opinions and predictions respecting a [security] which he has undertaken to recommend are responsibly made on the basis of actual knowledge and careful consideration. . . . [I]t is not a sufficient excuse that a dealer personally believes the representation for which he has no adequate basis.”);Distribution by Broker-Dealers of Unregistered Securities, Exchange Act Rel. 6721 (February 2, 1962) (“[T]he making of recommendations for the purchase of a security implies that the dealer has a reasonable basis for such recommendations which, in turn, requires that, as a prerequisite, he shall have made a reasonable investigation.”).

Interestingly, the investor’s sophistication is irrelevant when the broker fails to perform the necessary due diligence on an investment and the client relied on the broker.  See, Larry Ira Klein, 52 SEC 1030, 1037, n. 28 (1996); Hanley v. SEC, 415 F.2d, 589, 596 (2d Cir. 1969)(“The fact that [the broker’s] customers may be sophisticated and knowledgeable does not warrant a less stringent [investigation] standard.”).

These due diligence requirements will continue to be significant as more and more firms create complicated structured products and then have their advisors (individuals that do not always understand these investments) go out and sell the products to their clients.

 (3)  Structured Products To Monitor

Notwithstanding the principal guarantee function of some structured products, many of these investments have gone under over the last few years.  Investors in these products may be entitled to recover their investment losses through FINRA arbitration.  Some of the structured products that are worth monitoring include:

–           Lehman Brothers 100% Principal Protected Notes

–           Citigroup MAT Fund

–           Citigroup ASTA Fund

–           Citigroup Equity Linked Term Notes (“ELKS”)

–           Citigroup Leading Stockmarket Return Securities (“LASERS”)

–           Citigroup Portfolio Income Strategic Opportunity Notes (“PISTONS”)

–           Citigroup Premium Mandatory Callable Equity-Linked Securities (“PACERS”)

–           Reverse Convertible Notes linked to risky equities

–           UBS Bullish Underlying Linked Securities (“BULS”)

–           UBS Enhanced Appreciation Securities (“EAS”)

–           Bank of America’s Equity Appreciation Growth Linked Securities (“EAGLES”)

–           Bank of America’s Capital Protected Equity Performance Linked Securities (“CYCLES”)

–           AMPS (Accelerated Market Participation Securities)

–            ARES (Accelerated Return Equity Securities)

–            ARNs (Accelerated Return Notes)

–            ASTROS (Asset Return Obligation Securities)

–            Morgan Stanley Basket Opportunity Exchangeables (“BOXES”)

–            Morgan Stanley Broad Index Gauarded Equity Linked Securities (“BRIDGES”)

–             Morgan Stanley Commodity Indexed Preferred Securities (“COMPS”)

–             Morgan Stanley Equity-Linked Securities with Lock-In Protection (“ELIPS”)

–             Morgan Stanley High Income Trigger Securities (“HITS”)

–             Morgan Stanley Market Participation Securities (“MPS”)

–             Morgan Stanley Corporate Bond Tracers Units (“TRACERS”)

–             JP Morgan Chase Principal Protected Notes

–             JP Morgan Consumer Priced Indexed Securities (“CPIS”)

–             JP Morgan Outperformance Buffered Return Enhanced Notes

–             JP Morgan EUR 500 Million Meduim-Term Note Programme

(4)  Free Consultation

If you are concerned about a structured product investment recommended to you by your financial professional and would like to speak with an experienced securities attorney for a free consultation, please contact The White Law Group at 312-238-9650.

The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Boca Raton, Florida.

For more information on The White Law Group, visit

For more information on the risks of certain structured products, visit

Alternative Investments on the Rise, Increased Litigation Likely to Follow

According to the Investment News, more than three-quarters of retail advisers are now using alternative investments in their client’s portfolios.

Alternative investments include venture capital investments, private equity investments, hedge funds, structured products and other such investments.

While alternative investments can be appropriate in small amounts as part of a larger diversification strategy, as the amount of money pouring into alternative investments increases, so has the amount of litigation.

The downside to alternative investments is that they are often extremely complex, they are generally less liquid than traditional investments (stock, bonds, mutual funds, etc.), and they usually pay a high commission to the broker that recommends them (increasing the risk of abuse by unscrupulous brokers).

In our experience, independent advisers are the heaviest users of alternatives in part because the supervision and compliance is less stringent that at larger, more traditional brokerage firms like Morgan Stanley Smith Barney and Merrill Lynch.

If your financial advisor recommended that you invest a large percentage of your net worth in alternative investments, this may be a sign of a problem.  If you are concerned about an alternative investment recommended to you by your financial professional, please feel free to contact The White Law Group at 312/238-9650 for a free consultation.

The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Boca Raton, Florida.

For more information on The White Law Group, please visit our website at

SEC Issues Warning Regarding Structured Products and Reverse Convertible Notes

Broker-dealers have been engaging in sales practices for structured securities products that hurt retail investors, according to a Securities and Exchange Commission report recently released.

In sweep examinations of 11 broker-dealers, the SEC found that the firms may have steered clients into the complex products even though they were not suitable for their portfolios.

The SEC also noted instances where broker-dealers charged prices that were too high, did not adequately disclose risks related to them and misrepresented them on customer account statements.

The agency recommended that broker-dealers improve disclosure about structured securities products, establish procedures and controls to prevent abuses in the secondary market and conduct specialized training for their representatives who sell the instruments.

Structured securities products are derivatives whose value is based on other securities, baskets of indexes, options, commodities, debt issuances and foreign securities. Sales to retail investors rose to $45 billion in 2010 from $34 billion in 2009, as customers have been seeking higher returns in a market characterized by low interest rates and uneven growth.

One of the riskiest structured products, according to the SEC report, is a reverse convertible note, which is a security with an embedded put option.
The SEC report follows a recent warning to investors from the Financial Industry Regulatory Authority Inc. to be careful when considering the purchase of complex investment products.

Although the report does point out deficiencies in sales practices for structured instruments, it doesn’t indicate the scope of the problem.

If you have questions about a structured product or reverse convertible note sold to you by your financial professional, the securities attorneys of The White Law Group may be able to help. For a free consultation, please contact The White Law Group at 312-238-9650.

The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Boca Raton, Florida.

For more information on The White Law Group, visit

Risks of Structured Notes With Principal Protection

The retail market for structured notes with principal protection has been growing in recent years. While these products often have reassuring names that include some variant of “principal protection,” “capital guarantee,” “absolute return,” “minimum return” or similar terms, they are not risk-free. Any promise to repay some or all of the money you invest will depend on the creditworthiness of the issuer of the note—meaning you could lose all of your money if the issuer of your note goes bankrupt. Also, some of these products have conditions to the protection or offer only partial protection, so you could lose principal even if the issuer does not go bankrupt. And you typically will receive principal protection from the issuer only if you hold your note until maturity. If you need to cash out your note before maturity, you should be aware that this might not be possible if no secondary market to sell your note exists and the issuer refuses to redeem it. Even where a secondary market exists, the note may be quite illiquid and you could receive substantially less than your purchase price.

While structured notes with principal protection have the potential to outperform the total interest payment that would be paid on typical fixed interest rate bonds, these notes also might underperform a typical fixed interest rate bond and could earn no return for the entire term of the note, even if you hold the note to maturity. Their terms and structures also can be more complex than traditional bonds, making them more difficult for investors to evaluate. Finally, as with structured products generally, structured notes with principal protection may have hidden or imputed costs that can be relatively high and difficult to understand.

FINRA and the SEC’s Office of Investor Education and Advocacy are issuing this alert to make investors aware of these risks and to help them better understand how structured notes with principal protection work. The alert includes questions investors should ask when considering structured notes with principal protection and provides links to helpful resources, including a recent FINRA Regulatory Notice on these products. In particular, the terms related to any protections to or guarantee of your principal require a careful review.

What Are Structured Notes With Principal Protection?

For the purposes of this alert, the term “structured note with principal protection” refers to any structured product that combines a bond with a derivative component—and that offers a full or partial return of principal at maturity. Structured products in general do not represent ownership of any portfolio of assets but rather are promises to pay made by the product issuers. Structured notes with principal protection typically reflect the combination of a zero-coupon bond, which pays no interest until the bond matures, with an option or other derivative product whose payoff is linked to an underlying asset, index or benchmark. The underlying asset, index or benchmark can vary widely from commonly cited market benchmarks to foreign equity indices, currencies, commodities, spreads between interest rates or “hybrid” baskets of various asset types. For example, a note might be based on the performance of an equally weighted basket composed of the Russell 2000, an exchange-traded fund tracking a real estate index, the Brazilian Real-U.S. Dollar exchange rate and the price of copper. These products are designed to return some or all principal at a set maturity date—typically ranging up to 10 years from issuance. The investor also is entitled to participate in a return that is linked to a specified change in the value of the underlying asset.

How Do These Notes Protect My Investment?

If you hold a structured note with principal protection until maturity, you typically will get back at least some—and perhaps all—of your initial investment, even if the underlying asset, index or benchmark declines. Be aware that protection levels may vary. While some products return 100 percent of principal at maturity, others return as little as 10 percent. In some cases, the principal protection does not apply unless some contingency is met—sometimes called “contingent protection”—so it may provide no protection at all, even if the sales materials suggest otherwise.

Also, any guarantee that your principal will be protected—whether in whole or in part—is only as good as the financial strength of the company that makes that promise. In other words, the principal guarantee is subject to the creditworthiness of the guarantor, which is generally the securities firm that structures and issues the note. In the event the issuer goes bankrupt, investors who hold these notes are considered unsecured creditors and might recover little, if anything, of their original investment. This is what happened to investors who purchased structured notes with principal protection issued by now bankrupt Lehman Brothers Holdings.

How Do Structured Notes With Principal Protection Calculate the Return on My Investment?

Some structured notes with principal protection make periodic interest payments while others don’t. The return on your investment—over and above any principal guarantee and assuming you hold the note to maturity—will depend on a host of factors, including the method the issuer uses to calculate gains (or losses) linked to the performance of the underlying asset, index or benchmark (the “market-linked” returns), the note’s participation rate and any minimum guaranteed return.

Market-linked gains (or losses). As with other complex financial products, there can be varying and often complicated methods of calculating a market-linked gain or loss. For example, one product might compare the change in an index at two discrete points in time, such as the beginning and ending dates of the note’s term (point-to-point). Another product might look at the index value at various points during the life of the investment, for example at annual anniversaries, and then compare the highest value with the value of the index level at the start of the term (high water mark). Some products base your return on the number of days during the holding period that the underlying index stayed above (or below) a pre-specified level (accrual)—or within a range of pre-specified levels (range). And still others use complex, conditional formulas that allow you to participate in some or all of the index’s gain up to a set level—but significantly limit your return if, at any time during the holding period, the index rises above that level (shark fin).

Participation rates. A participation rate determines how much of the gain in the underlying asset, index or benchmark will be credited to the note. For example, if the participation rate is 75 percent, and the asset, index or benchmark increases 10 percent, then the return credited to your note would be 7.5 percent.

Minimum guaranteed returns. If a structured note with principal protection offers a “minimum guaranteed return,” be sure to carefully read the prospectus to understand how the issuer defines that term. In some instances, the term includes not only the principal guarantee but also a fixed overall investment return. For example, a note with 100 percent return of principal at maturity and a 2 percent minimum guaranteed return would pay out 102 percent of your initial investment at maturity, regardless of how the underlying asset, index or benchmark performed. In other cases, however, an issuer might use the term to refer only to the level of principal protection.

The bottom line for investors is that structured notes with principal protection can have complicated pay-out structures that can make it hard to accurately assess their risk and potential for growth. In addition, depending on how the note is structured, the distinct possibility exists that you could tie up your principal for upwards of a decade with the possibility of no profit on your initial investment. While your principal might be returned at maturity, that might be all you get back after this lengthy holding period—and, in the meantime, inflation could erode your purchasing power.


Can I Get My Money When I Need It?


Potential lack of liquidity is one of the disadvantages of structured notes with principal protection. These products tend to be longer-term investments, tying up your money for several years. Some issuers might allow investors to redeem their notes before maturity under certain circumstances, such as expiration of a “lock-up period” (a period of time during which you cannot access your funds), payment of a redemption fee or both. Other issuers might (but are not obligated to) provide a secondary market for certain notes. However, depending on demand, the notes might trade at significant discounts to their purchase price and might not return the full guaranteed amount. In addition, the value of the note before maturity might be difficult to calculate and can vary depending a wide array of factors (including prevailing interest rates and the volatility of the underlying asset, index or benchmark). You might also have to pay a penalty for early redemption, further reducing any return of your principal.

Do Structured Notes With Principal Protection Have Fees?

Yes, even if the sales materials suggest otherwise. Virtually every investment has either implicit or explicit fees, whether they are described as selling commissions or concessions, management fees, structuring fees, early redemption fees or by some other term.

What Other Costs or Tradeoffs Are Involved?

Depending on their terms and the way they are put together, structured notes with principal protection can have hidden or imputed costs, which in some cases may be relatively high. These stem from the way a product is “bundled” or “packaged.” At issuance, any given note will have an estimated fair value based on its structure. The issuer generally raises this value by a spread to arrive at the offering price of the product, which captures costs to the issuer associated with the note over its life, such as costs of hedging, as well as the issuer’s profit. The hidden costs of purchasing virtually any structured product include the possibility that you could have assembled a similar bundle of investments on your own at a lower cost—and potentially with higher returns. The maximum return of any particular structured note with principal protection will typically reflect (and account for) the issuer’s costs of manufacturing and maintaining the note as well as its own profit margin. These costs generally are not transparent to investors.

Other costs of investing in structured notes with principal protection include the opportunity cost involved with sacrificing a potentially higher yield to obtain some downside protection. It is also important to note that the principal protection generally relates to nominal principal and does not offer inflation protection. And, for any underlying investment that would ordinarily pay dividends, structured notes, like other equity or index-linked investments, typically exclude dividends.

How Are These Products Taxed?

In most cases, if you invest in a structured note with principal protection, you must pay federal taxes while you own the product, even before maturity or during any lock-up period and even if you haven’t received any cash payments. This can occur if the interest on the product’s zero-coupon bond holdings (resulting from the principal guarantee) is considered to be imputed interest for federal income tax purposes. You should read the tax consequences description in the prospectus and consult your tax advisor to know how a particular structured note might be taxed and when you must report any income or loss.

What Questions Should I Ask Before Investing?

When you evaluate a structured note with principal protection, be sure to do your research to find answers to the following questions, among others, or ask your investment professional:

  • How do I know whether this product is appropriate for me given my overall investment objectives?
  • What is the level of principal protection offered? There is a big difference between 100 percent return of principal and 10 percent return, or something in between. Know your protection percentage.
  • Are there conditions to the principal protection? For example, is the protection contingent on the occurrence of specified events?
  • What are the fees and other costs? Products offering principal protection can be expensive. You should pay particular attention to the fees of any product you invest in, including those that offer principal protection. Ask your investment professional to explain all of the fees and costs associated with the investment.
  • How long will my money be tied up? Structured notes with principal protection are meant to be held to maturity and are often designed for long-term investors. If you need your money back early, you could pay a significant penalty. Furthermore, any downside protection offered might only kick in after a long lock-up period—or it might require you to hold the note until maturity.
  • Can I sell or liquidate before the maturity date? While it is easy to turn many investments into cash, liquid markets for some structured products might not exist. If you need to sell your structured note with principal protection before it matures, you might have to do it at a price less than the amount you paid for it, or you may not be able to sell it at all. This is true even if the product has a ticker symbol or has been approved for listing on an exchange.
  • Is there a call feature? If so, be sure you understand what can trigger the call and when is the earliest the investment may be called. You will also want to ask your investment professional what might be your game plan in the event your note gets called.
  • Are potential gains limited? Some structured notes with principal protection may have limits or caps on the gains you can earn based on the performance of the underlying asset, index or benchmark.
  • What are the tax implications? You might wish to consult with a tax advisor to understand the consequences of any particular investment, including imputed interest and any foreign tax consequences.
  • How does the pay-out structure work? Is it possible to lose money, or not have any gain at all, even if the underlying asset, index or benchmark goes up? Purchasing a structured note with principal protection does not guarantee positive returns. For example, the underlying asset, index or benchmark might not increase in value—or even if it does, there may be conditions, which in some cases can be counterintuitive, that limit your gains. And, if the entity backing the principal protection at maturity goes bankrupt, you could lose your entire principal.
  • What unique risks will I take on as a result of being exposed to the underlying asset, index or benchmark?
  • What is the credit risk of the note? Remember that any principal guarantee is subject to the creditworthiness of the guarantor, which is generally the securities firm that structures and issues the note. Be sure to find out as much as you can about the financial condition of the issuer and read its disclosures as carefully as you would for any other bond investment.
  • What other risks are associated with this particular product? Be sure you understand how the derivative component of the note impacts the pay-out structure—and ultimately your return.
  • What other investment choices are available to me? Carefully consider what might be a good fit for you, and whether there are alternatives to the product you are considering.

Even the simplest sounding products can be pretty complex. Always read a product’s prospectus or disclosure statement carefully. If you can’t understand how the product works, ask your investment professional for help. If you still can’t understand the product, you should think twice about investing in it.

This information which is publicly available on FINRA’s website has been provided by The White Law Group, LLC.  To speak with a securities attorney, please call the firm’s Chicago office at 312/238-9650.

The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Boca Raton, Florida.

For more information on The White Law Group, please visit our website at


Have you suffered losses in a Structured Product Investment?

If so, the securities attorneys of The White Law Group may be able to help.

Structured notes and other derivatives products have been marketed by Wall Street as safe and secure investments. Of course, there’s safe and then there’s safe. Retail investors of all stripes have lost at least $113 billion by purchasing these purportedly safe instruments, according to a new study conducted by the nonpartisan policy center Demos and The Nation Institute, a media think tank.

That’s worrisome, considering financial institutions appear to be ramping up the sales of these products. Last year, banks and brokers sold more than $52 billion in structured notes, according to the study. In the past, the notes were sold strictly to sophisticated institutional investors. In recent years, however, structured notes have been repackaged and sold to retail investors — often, senior citizens —as a principal protection tool.

Indeed, structured notes with principal protection are among the most popular products being pitched to income-oriented investors, the study said. These investments combine a zero-coupon bond and an option whose payoff is linked to an underlying asset, index or benchmark, or a basket of benchmarks. The notes, which pay off based on the performance of the linked index, can provide reasonable returns and upside potential — certainly attractive given today’s puny money market and CD rates.

But as the name implies, structured products can be complex. Last week, regulators warned investors that structured notes with principal protection often come with confusing terms, low guarantees and can tie up money for as long as a decade. The alert from the Securities and Exchange Commission and the Financial Industry Regulatory Authority Inc. stressed that the investments are not risk-free.

The SEC said principal-protected notes vary wildly by issuer and that investors tend to ignore or don’t understand what is spelled out in prospectuses. Also, the commission warned that principal-protected notes do not always protect principal.

Some issuers of principal-protected notes guarantee only a certain amount of the principal — in some cases, as little as 10%. Sometimes, the principal is protected only if a contingency stipulated in the prospectus is met.

Other sellers of the notes do guarantee 100% of principal. But even that’s not a lock. If the issuer of the note goes bankrupt, the investor likely will lose all or most of the money invested.

In April, for example, UBS Financial Services Inc. agreed to pay $10.7 million in fines and restitution to settle Finra allegations that its advisers misled investors about the “principal protection” feature of structured notes issued by Lehman Brothers Holdings Inc. that it sold a few months before that firm collapsed.

In its complaint, Finra said that some UBS advisers didn’t understand the complexity of the 100% principal-protected notes that Lehman issued and failed to tell investors that they were unsecured obligations.

In settling the case without admitting wrongdoing, UBS said that it was pleased to have the matter resolved and that most structured-product sales had been done properly.

If you have questions about your investment in a structured product, the securities attorneys of The White Law Group may be able to help.  To speak with a securities attorney, please call the firm’s Chicago office at 312/238-9650.

The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois and Boca Raton, Florida.

For more information on The White Law Group, please visit the firm’s website at