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Securities Lawyer Jonathan Kurta
By: Jonathan Kurta Author

Structured products—also referred to as structured notes, or structured credit— are complex, hybrid products that combine a bond with a derivative component. “Derivatives” get their value from an asset, like a stock or a futures contract. According to the SEC, structured notes may comprise a blond plus equity indexes, a single equity, interest rates, commodities, and foreign currencies. Firms may advertise structured notes as products that come with upside potential and principal protection, but the reality is that these products often offer more risk than reward. 

Structured products may feature some form of principal protection, but they more often will not. The customizability of structured products often makes them overly complex for most everyday investors. They are typically offered to institutional investors and accredited investors – i.e., companies and particularly wealthy investors. They are often unsuitable for ordinary retail investors.

If your broker recommended structured investment products resulting in investment portfolio losses, you should contact a securities attorney right away. Our team at Kurta Law is ready to assist with your case.

Structured Note Maturity Dates 

Large financial institutions typically design and issue structured notes, which broker-dealers sell to their investment clients. The structured products do not represent ownership of any portfolio of assets. Instead, the structured product represents a promise to pay made by the issuer of the structured note. At the set maturity date, the investor receives some or all of the principal. 

Additionally, the investor receives a return linked to a change in the underlying asset’s value. If you hold your structured note until maturity, you will receive at least a portion of your initial investment. However, that depends on the issuer’s ability to pay back your initial investment. If your issuer falls into bankruptcy, you could lose all your initial investment.

Broker Obligations Concerning Structured Products

Sales of structured products first gained popularity with institutional investors in the 1990s. Structured products eventually targeted retail investors. The complexity and confusion surrounding structured products have influenced regulatory agencies to issue notices concerning the obligations of brokers recommending these investment products.

National Association of Securities Dealers: Notice to Members 05-59

In 2005, the National Association of Securities Dealers (NASD) issued guidance on the sales practice obligations for NASD members when selling structured products. 

  • First, the NASD emphasized the need for brokers to present a “fair and balanced picture” regarding both the risks and benefits of a structured product. 
  • Second, the NASD directed member firms to consider whether purchases of some or all structured products should be limited to investors with accounts approved for options trading. 
  • Third, the NASD reminded members of their obligation to perform a reasonable basis suitability analysis and a customer-specific suitability analysis. 
  • Fourth, the NASD mandated that members establish written supervisory procedures reasonably designed to ensure structured product sales comply with applicable securities laws and regulations.
  • Finally, the NASD required member firms to train registered personnel about the characteristics, risks, and rewards associated with each structured product before allowing the registered person to sell the products to investors.

Reasonable-basis suitability

A reasonable-basis suitability analysis requires the broker to have a reasonable basis to believe, based on reasonable diligence, that the investment or investment strategy recommended is suitable for some investors. Reasonable diligence should provide the advisor with an understanding of the risks and rewards associated with the investment product. 

Customer-specific suitability

A customer-specific suitability analysis requires the broker to have a reasonable basis to believe the recommendation is suitable for a specific customer’s investment profile. Whether an investment is suitable for a customer’s investment profile depends on several factors, including their:

  • Age;
  • Financial situation and needs;
  • Tax status;
  • Investment objectives;
  • Investment time horizon;
  • Liquidity needs;
  • Investment experience; and
  • Risk tolerance.

Advisors must take these considerations into account when deciding whether to recommend such an investment to a client.

Financial Industry Regulatory Authority: Regulatory Notice 12-03

In March 2012, FINRA issued a regulatory notice regarding the characteristics, risks, and benefits associated with structured products. The notice further addressed the use of heightened procedures that can help FINRA member firms ensure investors know the features of the investment they are purchasing. FINRA suggests firms implement formal written procedures to ensure registered representatives do not recommend a structured product before it has been thoroughly vetted. The procedures should ensure brokers know the answers to extensive questions about the product, such as:

  • Who is considered an ideal investor for this type of product?
  • Is this product unsuitable for certain investors? If so, who?
  • What is the product’s investment objective?
  • What risks does a structured product present to your investment portfolio?
  • How will the firm and registered representative receive compensation for offering this product? 
  • How does the complexity of this product affect suitability considerations or training requirements associated with the product?
  • Can I sell the structured product easily?

If a registered representative can satisfactorily answer questions about the product’s characteristics, the procedures have served their purpose.

FINRA emphasized the importance of the mandates initiated by the NASD, including having an internal procedure to review the suitability of structured products and giving registered representatives adequate training to understand the features and risks associated with structured products.

Risks Associated with Structured Notes

Structured products possess a variety of different risks that investors should know about. If your broker fails to disclose these risks when making the investment recommendation, you can hold them liable for any investment losses you suffer.

Complexity

As stated earlier, many investors encounter difficulty understanding the ins and outs of structured products. In fact, the obscure features contained in some structured products make them difficult to fully comprehend, even for investment professionals. Additionally, issuers can structure the notes any way they want. The seemingly endless possibilities can overwhelm even the most sophisticated investor. 

Uncertainty

Most structured notes utilize a complex payoff structure, making it difficult for investors to assess the value, risk, and potential for growth through the term of the structured note. Depending on the note’s structure, you could have multiple structured products using different methods. Thus, before investing in a structured product, you should carefully read the prospectus to understand how the payoff will be calculated. 

Liquidity

Structured notes present serious liquidity issues for investors, as there is no secondary market for the products. Typically, an investor seeking to sell a structured note has two potential buyers: the issuing financial institution’s broker-dealer affiliate or the broker-dealer distributor of the structured note. The issuer will typically disclaim their intention to repurchase or make markets in the notes they issue. Thus, you should hold a structured product to its maturity date if possible. Otherwise, you’ll risk selling the product at a loss.

In limited circumstances, an issuer may allow you to redeem your note before maturity. However, they will likely require payment of a penalty for redeeming the note prior to its maturity date.

Creditworthiness of the Issuer

Structured products represent the unsecured debt obligations of the issuer. That means the issuer has an obligation to make payments on the note once it reaches maturity. Just because the issuer makes these promises does not necessarily mean they will follow through. If the issuer of your structured note files for bankruptcy, there is a good chance you will lose some or all of your investment. For example, many investors who owned structured products issued by Lehman Brothers incurred heavy investment losses when Lehman Brothers filed for bankruptcy in September 2008.

Did Your Broker Recommend Structured Products Unsuitable for Your Investment Portfolio? Kurta Law Can Help

If you suffered losses as a result of unsuitable recommendations that you invest in structured products, you could initiate FINRA arbitration proceedings to recover your investment losses. FINRA rules require brokers to only recommend investments suitable for their clients. The broker can consider the investor’s age, risk tolerance, financial goals, investment horizon, and experience in their suitability analysis. Complex products like structured notes often require legwork to uncover all the characteristics and risks that could affect an investor. If your broker recommended structured products without adequately advising you of the terms, risks, and benefits of the investment, you could recover in FINRA arbitration through your broker and their broker-dealer. 

At Kurta Law, we have the experience necessary to help you determine if your broker improperly recommended structured products. Reach out to a New York investment fraud lawyer today — call 877-600-0098 or email info@kurtalawfirm.com.

 

 

Securities Lawyer Jonathan Kurta
Written by: Jonathan Kurta

Jonathan Kurta is an accomplished securities attorney and a founding partner at Kurta Law.