Investors Beware -- SEC and FINRA Caution Structured Notes With Principal Protection Carry Risks
A recent investor alert issued jointly by FINRA and the SEC's Office of Investor Education and Advocacy is directed at informing the public about the risks of structured notes -- even when they carry principal protection. In the investor alert that is entitled, Structured Notes with Principal Protection: Note the Terms of Your Investment, investors are warned that these investments are not as secure as they might seem given their "reassuring names."
Calling them "complex financial products," the SEC/FINRA alert states that these investments combine a zero-coupon bond that does not pay interest until maturity with either an option or other derivative product. One major concern is that the underlying asset value can vary and may be tied to assets, benchmarks or an index that could also carry a cap or limitation on the upside exposure.
If held to maturity, most investors will receive back some of their investment regardless of whether there is a reduction in value of the underlying asset, index or other benchmark. However, due to the fact that these products have varying levels of protection, the alert warns that "any guarantee is only as good as the financial strength of the company that makes that promise."
The concern about these complex investments is that the "payout structures" can be difficult for investors to fully understand. Lori J. Schock, Director of the SEC's Office of Investor Education and Advocacy, stated in the joint press release on this matter that the alert "... is a 'must read' for investors considering these products, especially those with the mistaken belief that these investments offer complete downside protection."
As investors look for higher yields, the concern is that investors might be drawn to these investments not knowing that in fact their investment could in fact be "expensive, risky, complex and illiquid investment," in the words of FINRA Senior Vice President for Investor Education John Gannon.
One of the major concerns for investors is that both the risk assessment and the growth potential are not easily assessed. It is important that investors review the alert before investing in these products.
Given the focus on these products by the SEC and FINRA, we suggest that broker-dealers carefully assess their current marketing materials and risk disclosures to their investors. When these entities jointly issue an investor alert, it is possible that these products will also be targeted for enforcement scrunity.
The New York securities regulation and enforcement attorneys at Gusrae Kaplan Nusbaum PLLC represent broker-dealers in regulatory and enforcement matters. Our lawyers advise clients and defend industry members in matters involving a broad spectrum of issues including compliance with regulatory requirements and rules. Contact our law firm to consult with one of our attorneys.
