Structured products, generally, are investment vehicles based on or derived from a single security, a basket of securities, an index, a commodity, a debt issuance and/or a foreign currency. Structured products have a fixed maturity date and are designed to offer specific risk-return tradeoffs, which pre-set formulas for both the potential risk and potential return. These calculations are complex and well beyond the capabilities of a retail investor. Structured Products come in many varieties, including Auto-Call Notes, Market-Linked Notes, Steepener Notes, and Structured CDs. Many of these investments are sold to investors under the guise of them being straightforward and traditional “bonds.”
One of the most common types of Structured Products are Auto-Call Notes. An Auto-Call Note is a complex synthetic investment product created and issued by financial institutions and sold to retail brokerage customers. While every issuer of Auto-Call Notes uses different verbiage within their offering materials, the mechanics of the Auto-Call Notes are the same. The investor purchases the Auto-Call Note, which typically offers an above-average income stream, sometimes upwards of 10%. This is known as a “teaser” rate.
The Auto-Call Notes have a fixed maturity date upon which an investor, in theory, will receive a return of principal. However, both the income stream and the ability of the investor to receive a return of principal are correlated to either underlying stocks or indices referenced within the prospectus of the Auto-Call Note. To the extent the underlying stock or index depreciates in value below a certain threshold, often times referred to as a “barrier,” the income stream may be eliminated, and the principal value lost.
Importantly, most Auto-Call Notes can be “called” or redeemed by the issuer prior to the maturity date. The impact of this is immense. If the Auto-Call Note happens to perform in a way that is advantageous to the investor, the issuer may, at its election, redeem the investment so that it does not have to continue paying the higher interest rate. In other words, the house always wins. Auto-Call Notes are lucrative for Financial Advisors. Brokerage firms have incentivized Financial Advisors by offering them selling commissions of approximately 3%-4%. This commission structure further underscores the economic inefficiency of these products for retail customers.
The Wolper Law Firm has extensive experience handling claims involving Structured Products. If you believe that you were improperly sold a Structured Product, such as an Auto-Call Note, Market Linked Note or Market Linked CD, please contact the Wolper Law Firm for a free consultation and case evaluation.