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Structured Product Claims as Part of FINRA Arbitration

In recent years the sale of structured products by Wall Street firms to retail and institutional investors has skyrocketed.  Since most investments were delivering poor returns, brokerage firms pushed complex and opaque structured products.  These products, in theory, offer an opportunity for larger returns and many of them purport to protect principal, but they present hidden risks and can cause substantial losses.

The sale of structured products, in theory, offers an opportunity for larger returns and many of them purport to protect principal, but they present hidden risks and can cause substantial losses.

- Jacob H. Zamansky

What are Structured Products?

Structured products are complicated and difficult for the average retail investor to understand. Brokerage firms rarely provide investors with “plain English” disclosure documents outlining the features, risks and details of the structured product. These products are not suitable for all investors, particularly retirees and other conservative, low-risk investors.

Structured Notes. The most common structured product is a “structured note” which is a combination of a bond and a derivative, such as a call or put option, on a particular index, such as the S&P 500. The structured note is a “debt” or IOU from an investment bank, using derivatives to create the desired exposure to one or more investments. The investor’s return and potential loss varies depending on the structure of the note, the amount of “principal protection” available, and the performance of the index over time.

Reverse Convertibles. Other common structured products include “reverse convertibles,” which are short-term notes with principal repayment linked to the performance of a stock or a group of stocks. If the underlying stock’s price falls below a pre-specified level during the term of the note, investors may receive substantially less than the face value of the notes. Reverse convertibles tend to pay higher coupon rates than traditional notes, but investors risk large losses should the price of the stock drop sharply.

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The Risks of Structured Products

It is often said that no one “buys” structured products but, rather, they are “sold” to individual investors. A rational investor would never seek to buy a risky and costly derivative security with limited upside potential and plenty of downside risk. Most investors prefer to buy relatively risk-free stocks based on the simple investment principle of “buy low, sell high.”  Brokers, however, earn paltry commissions on buying and selling stocks. They prefer to sell investments that generate higher fees, such as structured products, which often place their clients at risk for substantial losses.

The most significant “risk factor” in purchasing a structured note involves the “credit risk” of the issuing investment bank. Because structured notes are debt obligations from the “issuer,” an investor bears the risk that the investment bank may default on its debt. Consider, for example, when Lehman Brothers filed for bankruptcy in September 2008. Investors who owned Lehman structured products incurred near-total losses on their investment. This “issuer risk” is the most notable risk and is present regardless of the performance of the underlying or referenced index or security.

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Another substantial risk in purchasing structured products involves the liquidity or illiquidity of the structured note. Structured products rarely trade after they are issued and therefore are functionally illiquid. There is typically no active “secondary” market in which an investor could sell a structured product before maturity. It is possible that the original issuer could repurchase the note, or that the brokerage firm which sold the note would arrange a sale to another buyer. However, under these circumstances, an investor is likely to take a large discount on the purchase price to sell the note before maturity.

There is also a risk for an investor regarding the questionable “daily pricing” of the note and the value as it appears on the monthly account statement issued by the brokerage firm holding the note. Since most structured notes never trade after issuance, pricing is usually a guess or an estimate by the firm. Thus, pricing often does not reflect the “actual” value which the note would receive in the secondary market.

Until recently, Apple bonds and structured notes were the second leading “reference” index or security following the sale of structured products linked to the S&P 500. JPMorgan & Co. was the largest issuer of these products, selling $65.5 million. The value of these structured products, often called reverse convertibles, is linked to the performance of Apple stock. With the plummet of Apple’s stock price, investors are now facing the painful possibility of steep financial losses.

Our Investment Arbitration Lawyers Can Provide Legal Advice and Assistance

Investors who have been led to believe that structured products are a safe and suitable investment and have suffered losses can recover damages through the FINRA arbitration process. Zamansky LLC has recovered millions of dollars in stock broker fraud and securities arbitration cases against investment firms. If you have sustained a structured product loss, our FINRA arbitration attorneys will thoroughly investigate your claim and develop the best tactics and strategies to recover your losses. Our firm handles all types of structured product cases, including:

To learn more about how our securities fraud law firm can assist you with a structured products matter, contact us today to schedule a free, no-obligation consultation.

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