- June 1, 2020
- Structured Products
The Wolper Law Firm, P.A. is pursuing FINRA arbitration claims on behalf of investors who experienced losses in structured products, including Auto-Callable Structured Notes, in February and March 2020.
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 were purchased in Claimants’ accounts under the guise of them being straightforward and traditional “bonds.”
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, including Respondents, 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.
During the market downturn, many Auto-Call Notes broke through their protective barriers when the underlying securities or indices declined. When the underlying securities or indices declined a certain percentage, the prospectus of the Auto-Call Notes permits the issuer to cease paying income. This further caused a decline in principal. Some Auto-Call Notes reached termination barriers, which resulted in a complete loss of principal.
Financial Advisors have a fiduciary duty to explain the characteristics and risks of each investment they recommend. To the extent a Financial Advisor failed to adequately explain the characteristics or risks of Auto-Call Notes prior to recommending them to an investor, and the investor experienced losses, he or she may be entitled to a recovery of investment losses.
Financial advisors also have a legal and regulatory obligation to recommend only suitable investments that are appropriate for their clients’ needs and objectives. Their employing brokerage firm has a legal and regulatory obligation to supervise the Financial Advisors’ sales practices and dealings with clients. To the extent any of these duties are breached, the customer may be entitled to a recovery of his or her investment losses.
Reasonable basis suitability requires that a recommended investment or investment strategy be suitable or appropriate for at least some investors. Reasonable basis suitability requires an advisor to conduct adequate due diligence so that he or she can determine the risks and rewards of the investment or investment strategy.
Quantitative suitability requires a brokerage firm or financial advisor with actual or de facto control over a customer’s account to have a reasonable basis for believing that a series of recommended transactions – even if suitable when viewed in isolation – is not excessive and unsuitable for the customer when taken together in light of the customer’s investment profile. No single test defines excessive activity, but factors such as the turnover rate, the cost-equity ratio, and the use of in-and-out trading in a customer’s account may provide a basis for a finding that a member or associated person has violated the quantitative suitability obligation.
Customer-specific suitability requires that a member or associated person have a reasonable basis to believe that the recommendation is suitable for a particular customer based on that customer’s investment profile. Among the criteria that a financial advisor must evaluate to satisfy his or her customer-specific suitability obligations include the investor’s:
• Other investments
• Financial situation and needs
• Tax status
• Investment objectives
• Time horizon
• Liquidity needs
• Risk tolerance
• Any other information disclosed by the customer
The Wolper Law Firm, P.A. represents investors nationwide in securities litigation and arbitration on a contingency fee basis. Matt Wolper, the Managing Principal of the Wolper Law Firm, P.A., is a trial lawyer who has handled hundreds of securities cases during his career involving a wide range of products, strategies and securities. Prior to representing investors, he was a partner with a national law firm, where he represented some of the largest banks and brokerage firms in the world in securities matters. We can be reached at 800.931.8452 or by email at firstname.lastname@example.org.