Why Do Investors Want Equity-Linked Notes?
An equity-linked note (ELN) is an investment product that allows investors to invest in equity as well as a fixed-income asset — usually a bond. The fixed-rate products limit the risk, while the equities give the investor the chance to see better rates of return than they would find on the stock market. Equity-linked notes are a type of structured product that banks typically offer when interest rates are low.
Unlike a traditional bond with a specified rate of return, the rate of return on an equity-linked note is determined based on the performance of the underlying equities. Equity-linked notes often offer principal protection (in most cases) with a variable interest rate. They typically do not mature for five to seven years, so they are only suitable for investors who will not need their funds in the near future.
As a financial expert told The Wall Street Journal, ELNs allow a broker to bet “on a very specific, narrowly defined outcome.” The article states that investors might be better off asking their financial advisor if a simpler product can help them accomplish the same goal. For instance, if an investor is purchasing an ELN with underlying investments in a currency, they could purchase an exchange-traded fund that invests in similar financial instruments but does not charge as high of a fee.
How Do ELNs Work?
While an equity-linked note is a debt instrument, it works more like a stock. Theoretically, the upside potential of an equity-linked note is unlimited. If the underlying equity skyrockets in value, investors can reap substantial returns. This, combined with the available principal protection, makes equity-linked notes an attractive option for many risk-averse investors.
But even when an issuer offers principal protection, this does not necessarily mean that a return of principal is guaranteed. As FINRA stated in an Investor Alert, “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.” Brokers have an obligation to accurately describe the risks associated with equity-linked notes, and investors have a right to recover their losses if they were misled.
Also, equity-linked notes may only offer partial protection. Make sure you review the worst-case scenarios with your broker.
What are the Risks of Investing in Equity-Linked Notes?
FINRA has issued a regulatory notice stating that brokerage firms should consider only recommending equity-linked notes to investors who are also approved for other risky trading strategies, like options trading. Unfortunately, many investors do not learn about the risks associated with equity-linked notes until too late. As a result, many investors end up losing substantial sums of money, often due to one of the following factors:
Equity-linked notes are designed to be held by investors until maturity. Many equity-linked notes do not mature for at least five years, and seven-year equity-linked notes are common. Investors have to consider the opportunity cost of this type of investment. What if you could generate similar returns with lower risks? While there is a secondary market for equity-linked notes, buyers will expect to receive substantial discounts. If investors need to get rid of their equity-linked notes, they may lose money in the process.
Bankruptcy and Default
Like other debt instruments, bankruptcy and credit defaults present risks for investors who put their money into equity-linked notes. If the issuer goes bankrupt or defaults under other debt obligations, investors could lose everything.
Some ELNs rely on leverage, which is borrowed money. While leverage can increase investors’ returns, it can also increase investors’ downside potential. Although issuers, brokers, and advisors are required to disclose leverage risks to equity-linked note investors, many do not provide the requisite disclosures.
Corporate Fraud and Mismanagement
Corporate fraud and mismanagement present major risks for equity-linked note investors. If the issuer engages in fraud or mismanages its equity investments, investors may suffer the consequences. Excessive fees are an issue with many ELNs as well.
Broker and Advisor Fraud
Investors can also lose money in equity-linked notes due to broker and advisor fraud. Brokers might recommend notes solely for their own benefit or simply fail to consider all relevant risks in light of their individual investor’s profiles.
Do You Have a Claim for Equity-Linked Note Fraud?
Our securities investment fraud lawyer team can help 24/7.
If you have lost money investing in equity-linked notes, you should speak with a securities lawyer about your legal rights promptly. Depending on why you suffered investment losses, you could have a claim against the issuer, or you may be entitled to recover your losses from your broker or advisor in FINRA arbitration. For a free and confidential consultation, call 877-600-0098 or contact us online now.