SEC Investigates Sales of So-Called “Principal Protected” Notes


The U.S. Securities and Exchange Commission is investigating misleading marketing by Wall Street banks of so-called “principal protection” notes, according to a recent Bloomberg article by Zeke Faux and Joshua Gallu. The investigation focuses on notes issued by now-bankrupt Lehman Brothers that prominently featured the words “principal protection” or “principal protected” in brochures provided to investors and that were sold as safe investments. Safety-minded investors were shocked when Lehman Brothers went bankrupt and the value of the notes collapsed. Investors had never been told that the notes were really options combined with an unsecured obligation of Lehman Brothers.

These products are essentially zero-coupon notes linked, in part, to the performance of an equity index, like the Standard & Poor’s 500 or the Russell 2000, or some other basket of securities. In some cases, there is a trap door in the linkage, however. If the index falls 25.5 percent or more, or rises more than 27.5 percent, the investors are promised a return of principal but no additional return in exchange for their loan.

Individual investors in the U.S. bought $34 billion of structured notes in 2009, according to, a database used by the industry.
The SEC’s Division of Corporation Finance is reportedly in the beginning stages of examining whether and how the selling firms described the risks and whether the use of the term “principal protection” was deceptive and misleading. Findings made by that division may be referred to the enforcement division, which investigates fraud, according to the article. The brokerage firms mentioned in the article include Citigroup, Barclays, Morgan Stanley and Bank of America. UBS is another firm known to have sold Lehman Brothers Principal Protected Notes.

Applicable laws and rules require firms to fully disclose of all important risks when marketing a product. Oral presentations as well as marketing materials must fairly present all important risks, and firms cannot escape that requirement by putting disclosures in the prospectus while glossing over them in sales pitches.

Kenneth Lench, head of the SEC’s Structured and New Products enforcement unit, was quoted saying: “You’ve got these long disclosure documents, but oftentimes there are marketing materials and those have to be accurate as well.”

There is at least one lawsuit seeking class-action alleging that UBS brokers provided “misleading” information when using the term “100 percent principal protection” to market the notes.

While class actions lawsuits are appropriate avenues of recovery for investors seeking low-percentage recoveries of losses that are too small to justify individual arbitrations, many investor who lost significant amounts have engaged counsel to seek recovery in Financial Industry Regulatory Authority (FINRA) arbitration cases.

UBS is facing many arbitration claims across the country relating to these products. A FINRA arbitration panel recently awarded one investor $432,000.00 in compensatory damages, which was 100% of the amount of compensatory damages claimed, plus an additional $53,000.00 in attorney’s fees, plus another $5,610.00 as reimbursement for expert witness fees.

The Claimants in that case were represented by Seth E. Lipner. According to Mr. Lipner, the documents introduced into evidence at the hearing showed that UBS knew that there were huge problems at Lehman in early 2008 when it sold the products to investors, but that UBS representatives failed to disclose how Lehman’s problems could affect the structured product investments sold to those investors. “Senior executives of UBS tried to explain away the failures that took place at UBS,” Mr. Lipner said, “but the arbitrators obviously did not buy it.”

“We continue to receive inquiries from investors who acquired Lehman structured notes as a result of UBS’s misrepresentation of it as a ‘principal protected’ investment,” said J. Boyd Page, a 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. ??The brokers who sold the Lehman structured notes are not targets of investor claims.

Page Perry, a law firm based in Atlanta, Georgia, is co-counsel with Mr. Lipner and his Garden City, New York law firm, Deutsch & Lipner, in representing a number of investors in Lehman structured note cases.