FINRA CEO Richard Ketchum recently stated that structured products are “areas of concern” for the Financial Industry Regulatory Authority (“FINRA”), according to a Bloomberg article by Jesse Hamilton and Alexis Leondis entitled “Finra’s Ketchum Says Structured Products Are ‘Areas of Concern.'” If FINRA is concerned, it better act fast. “Sales of structured products rose 46 percent last year to a record $49.5 billion,” according to the article, citing data compiled by Bloomberg.
Structured products are complex, option-driven financial products that are marketed to people in need of better yielding investments, often senior citizens on a fixed income. Frequently, a bank customer complains about low interest rates being offered on certificates of deposit or money market funds, and is referred to the bank’s brokerage arm for a solution to that problem. That is the first time many investors are introduced to higher-yielding investments that are marketed as safe and secure, but are not. The consequences to many seniors who have been sold these structured products have been disastrous.
Structured products are notes whose value at maturity are tied to the value of a “reference asset,” such as a stock, an index, or a basket of currencies. They are generally structured as a combination of a note and a derivative (often an option) on the reference asset. Examples include Lehman Brothers “principal protected” notes sold by UBS, and a group of products known generally as reverse convertibles and sold by UBS as “Yield Optimization Securities.”
Structured products are usually unsecured obligations of the issuer, which creates significant credit risk in addition to the risk of fluctuations in the reference asset. If the issuer goes belly-up, investors lose their entire principal. When Lehman Brothers went bankrupt in September 2008, investors in so-called “principal protected” Lehman notes lost all their entire investment. If that risk had been explained, seniors seeking safe and secure income would never have bought such a product.
Structured products are also sold to investors at extraordinary markups, and tend to be extremely illiquid if there is a secondary market for them at all.
In the past, structured products were generally sold only to institutions and sophisticated investors. Because of their option component, they are just too complex for ordinary investors and brokers to understand. Indeed, a Nobel Prize was awarded to the finance expert who first explained the model (Black-Scholes) for evaluating whether an option is fairly-priced. One would need a complex application of the Black-Scholes model to determine whether a structured product is fairly-priced.
FINRA has warned that structured products should not be sold to retail investors who are not appropriately approved to buy and sell options. However, in today’s low-interest rate environment, brokerage firms have disregarded FINRA’s warning as they seized an opportunity to retailize structured products. Structured products are simply too lucrative for brokerage firms to pass up, with commissions ranging from 3% to 10% – far higher than they would receive on the sale of an ordinary bond or bond fund.
Mr. Ketchum’s announcement that structured products are an area of concern implies that FINRA is contemplating doing something about the problem. “Brokers can’t rely on firm approval alone to satisfy their suitability obligations,” Ketchum was quoted as saying, adding: “This is particularly important with the proliferation of increasingly complex financial products, and at a time when certain investors are tempted to chase yield in today’s lower interest rate environment.”
The problem with that is that experts say these products require a Ph.D. in finance to understand, and most retail brokers and customers lack that background.
The article points out that a Securities and Exchange Commission study mandated by the Dodd- Frank Act recommended broker-dealers instead be subject to a fiduciary standard as rigorous as that which requires investment advisers to act in clients’ “best interests.”
If FINRA really wants to address the problem of retail sales of structured products, then why do “we also have FINRA spending money on Capitol Hill to really decimate any chance of a meaningful Investment Advisers Act fiduciary standard that would inure to the benefit of individual investors in this country,” according to Denise Voight Crawford, Texas Securities Commissioner and President of the association of state securities regulators known as the NASAA?
“We continue to receive inquiries from investors who acquired Lehman ‘principal protected’ notes, ‘Yield Optimization Securities,’ and other structured products as a result of misrepresentations of them as safe and secure investments, said J. Boyd Page, the senior partner at Page Perry in Atlanta. “Our legal team continues to investigate and pursue arbitrations on behalf of investors who purchased these products,” he added.
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 structured product cases. For further information, please contact us.