When ‘Principal Protected’ Doesn’t Really Mean an Investor’s Principal is Protected


The Securities and Exchange Commission and the Financial Industry Regulatory Authority (FINRA) continue to warn that the so-called “principal protection” feature of structured notes is misleading, according to an InvestmentNews article by Liz Skinner entitled “Principal-protected notes don’t always protect principal, regulators warn.”

This is particularly true for structured notes issued by Lehman Brothers Holdings. UBS Financial Services sold a huge quantity of these notes in late 2007 and 2008, offering “100% principal protection” or “partial protection,” but the advertised protection vanished when Lehman Brothers filed for bankruptcy on September 15, 2008. Investors in such notes suddenly, without any warning from UBS, found themselves holding near-worthless pieces of paper.

In April, UBS Financial Services agreed to pay $10.75 million in fines and restitution to settle FINRA charges that UBS misled clients about the “principal protection” feature of structured notes issued by Lehman Brothers Holdings Inc. In particular, FINRA charged UBS with failing to inform investors of the crucial fact that the “100% Principal Protected” Notes were really just the unsecured obligation of Lehman Brothers, not UBS, and that investors could lose their entire principal despite the advertised “100% principal protection.”

The FINRA settlement, however, does not address or provide any compensation for many other structured products sold by UBS, including other varieties of Lehman Brothers principal protected notes that were improperly sold by UBS. FINRA’s sanction only addresses the so-called “100% Principal Protected Notes” issued by Lehman and sold by UBS.

In addition, the settlement leaves out investors who purchased these notes before March 17, 2008 or after June 30, 2008. UBS issued extremely critical and highly negative reports on Lehman Brothers as early as the Fall of 2007 but continued selling the Lehman-backed notes as “100% Principal Protected.” Lehman declared bankruptcy on September 15, 2008.

The amount of restitution is further limited to investors who were coded by UBS as having conservative or moderate risk tolerances, even though UBS miscoded many investors to make it appear that they had a higher risk tolerance than they actually had. Those investors whom UBS coded as moderate will only receive 50% of the purchase price paid for a product that was completely unsuitable for all but the most aggressive and speculative investors, and despite UBS’s misrepresentation of the product as “100% Principal Protected.”

According to the article, UBS said it was pleased to have the matter resolved. But the matter is far from resolved. UBS faces a multitude of FINRA arbitrations by Lehman principal protected note investors. UBS has lost or settled all of them.
Most recently, a Financial Industry Regulatory Authority (FINRA) arbitration panel awarded $2,200,000.00 ? 100% of the compensatory damages requested ? to the Chairman and CEO of CNA Financial Corp. (Motamed v. UBS, decided December 2010). This award “shows that even a seemingly sophisticated investor ? at a disadvantage in arbitration ? can win back his or her money.” ??

“Every time UBS loses one of these cases, the phones light up again,” said Seth E. Lipner, of Deutsch & Lipner in New York, who is co-counsel with Page Perry in Atlanta on Lehman structured note cases. In earlier cases (Edelson v. UBS, decided November 2010; Severi vs. UBS, decided in December 2009; and Marcus et al. v. UBS, decided April 2010), arbitration panels ordered UBS to buy back the Lehman principal protected structured products from investors at their original cost.

J. Boyd Page, the senior partner of Page Perry, noted: “This collection of arbitrator awards confirms just how egregious UBS’s activity was. Investors in these toxic notes are urged to take action if they haven’t already done so. Some investors were sold these Lehman notes in 2007 and 2008 are beginning to reach, or may have already reached, the four year anniversary of the purchase date. Further delay could result in time bar issues.”

Arbitrators are obviously not buying UBS’s main defense that all three rating agencies had an investment-grade rating on Lehman up to the bankruptcy. “UBS knew that Lehman was in trouble as far back as October 2007, but they continued to sell Lehman structured products anyway, ignoring the ever-growing risk,” Mr. Page observed, adding: “Not only weren’t they candid with the public, they weren’t candid even with their own brokers.” ??”These are highly complex products; they are too complex for ordinary investors to evaluate. We have obviously been successful in proving that,” Mr. Lipner noted.

Fortunately for aggrieved investors, UBS has and will continue to have the financial wherewithal to pay all such awards of compensation.

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 investors in Lehman structured note cases.