- October 7, 2024
- Structured Products
Structured products provide retail investors access to specialized asset classes as well as the possibility of returns linked to market shifts. Due to this, they are popular with investors who are looking to diversify their portfolios quickly or those in search of higher returns.
At the same time, structured products come with real risks that are often not disclosed to the average investor. Many people do not realize that these complex investments have been linked to recurring legal issues for misleading investors. Structured products are not suitable for every portfolio because of issues regarding their liquidity, credit quality, pricing, and performance. Retail investors, especially inexperienced and conservative ones, can be easily misled by a financial advisor or broker to purchase structured products or notes not suited to their needs.
If you are seeing consistent losses, unexplained fees, or are generally worried that your portfolio may have been inappropriately structured, a structured products attorney can help you. Many investors are either unable to spot whether they have been exploited, or are unsure if their case qualifies for a FINRA complaint. We are here to speak up on your behalf.
What Are Structured Products?
Structured products are pre-packaged financial instruments that offer retail investors easy access to derivatives. Structured products and notes are linked to the performance of an underlying equity asset, like a stock, bond, ETF, mutual fund, option, or foreign currency, but they do not involve ownership of any real asset. They may include options for additional derivative categories like swaps, forwards, or futures. The issuer of these products pays a return upon maturity, which is based on an underlying formula that is sometimes highly complex.
One example of how a return is calculated is by a “point-to-point” method. In this method, the return is based on the difference between point A of the index or asset—the starting level, which is usually the closing value of the index on the pricing date—and point B—the final index level, which is usually the closing value of the index on a date specified at purchase. Thus, the underlying formula might look like this:
(final index level – starting index level) / starting index level
Some more conservative structured notes include underlying principal protection, meaning that at maturity, the investor receives their initial payment back. These are referred to as “principal protected notes” (PPNs). However, most structured notes do not include this protection in order to allow for the possibility of receiving higher returns than a simple one-for-one rate. Even PPNs carry some risk, as in some cases the issuer is allowed to redeem your note before its maturity, resulting in possible gains or losses.
Are Structured Products Debt Investments?
Structured products emerged in the 1990s and grew in popularity in the European, Asian, and American markets until the 2008 financial crisis. Structured products were widely driven by the need to finance cheap debt. However, unlike a collateralized debt investment, they are not backed by anything other than the issuer’s creditworthiness. Structured products are considered contingent payment debt instruments by the IRS, meaning that taxes are due on them every year regardless of their maturity.
Benefits of Structured Products
One of the reasons that structured products are so appealing to some investors is because they are highly customizable. One common technique is to include the option for a lookback, meaning that the value of the underlying asset is not taken at one point in time (usually the note’s expiration) but instead as an average of values over a set term. This allows some insulation against radical pricing shifts and market volatility, especially in times of inflation.
Structured products also allow retail investors a gateway to derivatives and expanded investment options that they might not otherwise be able to access. For instance, a rainbow note offers exposure to multiple asset classes, making this kind of structured product a shortcut to a more diverse profile.
Finally, structured products are often sold to investors because they have the potential for high returns. When investors are willing to sacrifice principal protection, they may be able to lock in more favorable rates and bank on market shifts that can earn them significant payouts when correct.
Risks of Structured Products
Structured products carry many risks that can be easily concealed from the average investor. They have been subject to heightened scrutiny under the FINRA because they are often aggressively marketed without full disclosure to consumers. Additionally, they have been flagged by the European Systemic Risk Board (ESRB) for being consistently marketed to lower-income households despite their increased risks, rising complexity, and lower ex-post performance. Structured products can be more profitable to the banks that distribute them than they are for the investors who sink money into their complex formulas in the hope of a payout.
Examples of risks of structured products include:
Market/Counterparty Risk
Structured products are subject to both market and counterparty risks. Market risk refers to the possibility of normal market fluctuations leading to a decline in the value of an investment. Counterparty risk refers to the possibility of the structured product issuer failing to meet its obligations. Structured products may involve unsecured debt, and only some of them are FDIC-insured. In other words, non-FDIC-insured structured products will have no issuance of an underlying certificate of deposit, meaning the investors face a higher risk of loss in the event of a bank failure.
Liquidity Risk
Structured products are highly illiquid, meaning they are difficult to quickly convert to cash. This makes them unsuitable for investors with high monthly payments or those who require access to their investments on short notice. They often lock up investor funds over a longer time horizon than a similar exchange-traded option. They can also be difficult to buy or sell since they are bespoke products, increasing the investor’s reliance on a broker who may or may not be taking advantage of the situation.
Early Redemption Risk
Some structured products and PPNs include a call option that may be concealed from the investor. This means that they can be redeemed early by the issuer, leading to some risk of loss. Thus, the investor may lose their principal or stop receiving coupon payments if the debt is redeemed early.
Credit Quality of Issuer
Structured notes are only as reliable as the underlying issuer. When brokers fail to conduct due diligence into the issuer behind a structured note, they put their clients in jeopardy. In the event of a default, a holder of a structured note only recovers value alongside other creditors. For instance, the September 2008 Lehman Brothers meltdown left investors with over $18.6 billion of worthless debt that had been marketed as “low-risk” investments. This kind of dangerous financial engineering was done largely through an increase in the issuance of structured products that left credit risk purposefully not priced into the debt.
Pricing Considerations
Structured products are often more expensive than other investments with lower risk profiles. While they can be customized, many of them are associated with higher fixed costs, which makes them less accessible to the average retail investor. The pricing behind many structured products is complex, and sometimes purposefully so.
Questionable Sales Practices
Structured products are often profitable to the banks and firms that issue them without necessarily passing on those benefits to the investor. Some investors may be able to gain an advantage from structured products, but they should be aware of the costs and risks, which may not be fully explained to them by a broker. Investors can easily find themselves in a situation where they never see returns or see returns that are too low for their investment goals.
What Your Investment Advisor Isn’t Telling You About Structured Products Risks
Structured products involve many risks like volatility, credit risk, foreign exchange rate risk, yield curve risk, call risk, and interest rate risk. They are also difficult to value appropriately because their payouts depend upon market performance and a complex internal formula.
The suitability of structured products for retail investors has long been a subject of debate, further fueled by their connection to the 2008 financial crisis. There has been significant research into whether these financial instruments truly benefit consumers by providing access to more diverse derivative options or simply obscuring their dangers and raising prices.
There are many alternatives to structured products with lower risk profiles that may be more suited to the average investor. If your financial advisor has not discussed these with you, then they may be banking upon your lack of knowledge to increase their commissions and fees.
Here are other factors you should know about structured products in your portfolio:
- Performance considerations: High payouts are not guaranteed with any kind of investment product. Structured products are subject to market risk as well as counterparty risk.
- Lack of liquidity: The bespoke and highly customizable nature of a structured product may work against you when it comes to reselling it on the market.
- Lack of training: Not every financial advisor is qualified to sell structured products, as they involve increased complexity. If you are uncertain your advisor has done due diligence in assessing the creditworthiness of an issuer, contact an investment loss lawyer.
- Conflicts of interest: The main issuers of structured products are banks, leading to a possible conflict of interest between the broker and the issuer. This can expose an investor to increased counterparty risk.
- Hidden costs: Most structured products are more expensive than other investment options. Consider whether there are lower-cost, lower-fee choices that may make more sense in your portfolio.
- Tax implications: Not only are structured products subject to taxation each year, regardless of whether or not they have matured, but any gains from their sale may be treated as ordinary income and thus subject to income tax.
Has your broker discussed all of these elements with you? Are you having trouble contacting them, or are you seeing higher fees and commissions than expected? If your portfolio is losing money, or if you are worried it is not suitable for your needs and goals, you may want to review your investments with an experienced structured products lawyer. Seeking out third-party counsel is one of the most important steps you can take in case you suspect your advisor is not telling you the whole truth about your investments.
How to Avoid Broker Fraud or Negligence in Structured Product Investments
Investors should be aware of the limited regulatory oversight, lack of transparency, difficulty in valuation, illiquid and expensive nature of structured products, as well as the other risks that they carry. Consider taking the following steps as you assess your portfolio and the state of your investments:
- Understand your risk appetite: Not all investors are willing to put up with the same amount of risk on the market. Depending on the scope of your investment, your timeline, long- and short-term goals, and overall financial security, you will naturally have specific needs for your portfolio.
- Understand the underlying assets: Know what kinds of investments you are making and whether or not they are securitized. Evaluate the risks from issuers as well as what is being agreed upon in exchange for your principal.
- Evaluate performance history: Structured products and other alternative investments often do not involve the same amount of pricing data and transparency in reporting. Because of this, it can be difficult to evaluate whether or not they match your goals and risk appetite.
- Consult with a structured products attorney: When in doubt, speak with an experienced third party trained to spot fraud, market scams, and suitability concerns.
When Should I Contact a Structured Products Attorney?
A financial advisor is supposed to help you make informed decisions about managing your money. If you believe they are not doing so, or they are withholding information you need, you might want to seek legal advice. There are mechanisms in place that can protect you as well as hold negligent financial advisors accountable for their actions. Our law firm may be able to help you file an investment loss lawsuit or a FINRA complaint to potentially recover lost funds.
Concerned About Fraud or Negligence? Speak To a Structured Products Lawyer Today
Alternative investments carry a natural degree of risk. However, your advisor should always keep you well informed about what you are putting your money into. You do not have to accept losses from structured products that were offered to you without due regard to your financial needs, investment goals, and risk tolerance.
At Wolper Law Firm, we have a 99% success rate at recovering our clients’ funds. We stand up for investors who have been misled by financial professionals, whether maliciously or through ineptitude, and help win their money back. If you have questions or concerns, or are worried about unsuitable investments, contact Wolper Law Firm for a confidential consultation.