Structured Notes with Principal Protection

Seemingly in spite of the lessons we thought we learned about overly complex financial products during the Financial Crisis just a few years ago, a new raft of investment products have made their way onto the market and into investors’ portfolios. The most important question for any investor whose brokerage accounts contain complex financial products is whether they are suitable. (Suitability comes into play in several forms - for more on this issue, please visit our page dedicated to suitability issues.)

While the names of these products often indicate some form of guaranteed return of the investment’s principal, there is no such guarantee.

Structured notes with principal protection are one of several new generation financial products that have become increasingly common among retail investors in the past few years. Since they are difficult to understand and often contain more risk than their reassuring names suggest (and more risk than brokers selling them to clients tend to indicate), they have been the subject of numerous alerts and regulatory notices by securities industry regulators like the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA).

What are Structured Notes?

The term refers to a somewhat broad category of structured securities which combine a bond with a derivative component. Like a bond, these products usually offer a full or partial return of the principal at maturity (hence the “principal protection”). These products may also be described as “capital guaranteed,” “absolute return,” “minimum return,” and so on. According to FINRA:

Structured products in general do not represent ownership of any portfolio of assets but rather are promises to pay made by the product issuers. Structured notes with principal protection typically reflect the combination of a zero-coupon bond, which pays no interest until the bond matures, with an option or other derivative product whose payoff is linked to an underlying asset, index or benchmark. The underlying asset, index or benchmark can vary widely from commonly cited market benchmarks to foreign equity indices, currencies, commodities, spreads between interest rates or "hybrid" baskets of various asset types.

What Are the Hidden Risks Associated with Structured Notes?

While the names of these products often indicate some form of guaranteed return of the investment’s principal, there is no such guarantee. As always, the issuer of the promise to repay you may not be creditworthy or may go bankrupt. In these cases, you could lose some or all of your money. In addition, many structured notes only offer partial protection of your principal, so that even if you are attached to a worthy issuer, you could still lose your principal.

Structured notes also contain higher than normal liquidity risk, since the derivative component within the security may be tied to assets which do not trade on the secondary market (or trade infrequently). In other words, if you need to redeem your note before the maturity date, this may not be possible since the assets underlying it may not be able to be exchanged and/or the issuer may refuse the transaction. Finally, even if a secondary market for your product does exist, the note’s illiquidity may also still result in a significantly diminished sale price relative to your purchase price.

Brokers Are Required to Match Investors to Investments

If you found that hard to grasp, you’re not alone. However, it is not the duty of retail investors to fully understand the complex products contained in their portfolios. After all, you are probably a novice when it comes to complex financial matters. Your financial advisor, on the other hand, must not only understand the product he or she is selling to you, but he or she must also ensure there is a suitability match between you as an investor and the investments in your accounts. Structured notes are not for everyone.

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Pennsylvania & New Jersey Securities Litigation Law Firm

If you or someone you know has suffered financial loss due to structured notes or any other form of investment fraud or broker misconduct, please contact our experienced team of securities attorneys immediately to protect your legal rights by calling 1-855-462-3330 or by using our online contact form.