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SEC Looking at the Sale of Principal Protected Notes
The Securities and Exchange Commission (SEC) is reviewing how financial companies market principal protected notes (PPNs), according to Bloomberg news. The SEC’s inquiry is focused on how companies describe the products’ risks and whether the term “principal protected” is misleading and implies that the investment is guaranteed not to fall in value.
UBS had sold more than $1 billion of PPNs, described as safe investments backed by Lehman Brothers that were “guaranteed” against loss of principal. Au contraire, following Lehman Brothers' bankruptcy filing on September 15, 2008, the PPNs are now in default causing the holders of these PPNs to become senior unsecured creditors in the Lehman bankruptcy proceeding. Practically speaking, these investors are left with virtually worthless investments.
FINRA Holds UBS Liable to Lehman Brothers Principal Protected Notes Investors
A FINRA arbitration panel in New York last week ordered UBS to pay $432,000 to two of its brokerage clients who purchased Lehman Brothers principal protected notes. UBS was also ordered to pay the investors’ attorneys’ fees of $53,000, plus other expenses.
This is yet another success for investors in a series of awards against UBS for its sale of Lehman Brothers principal protected notes. These securities were typically recommended by UBS as safe investments. Many investors allege they were not warned of the risks of the “100 percent principal protected notes'' that are now almost worthless as a result of the Lehman Brothers bankruptcy.
The Lehman Brothers Collapse – The Writing Was On the Wall (So Why Didn't UBS See It?)
One of the big issues concerning Lehman’s collapse—and UBS’ role in selling toxic securities to its clients—concerns what UBS knew about Lehman’s spiraling out of control and when it knew it.
Beginning in the summer of 2007, the cost of insuring short-term obligations (a/k/a, credit default swaps) for Bear Stearns and Lehman Brothers began to increase steadily. The rise reflected the growing concern over solvency of such companies, particularly on the part of those entities who traded with them or loaned them money. Lehman in particular was highly leveraged, owing an inordinate amount of money to third parties and collateralizing it with mortgage-related assets. In fact, Lehman was one of the largest underwriters of mortgage-backed securities in 2007.
FINRA Expresses Concern about Principal Protected Notes
FINRA issued a regulatory notice this month to remind brokerage firms of their sales practice obligations relating to the sale of principal protected notes. The executive summary provides:
The retail market for principal-protected notes (PPNs) has grown in recent years, in part because they are often marketed as combining the relative safety of bonds with a potential for growth not available with traditional fixed income products. However, these products are not risk-free, and their terms and structures can be complex. Firms must ensure that their promotional materials or communications to the public regarding these products are fair and balanced, and do not overstate either the level of protection offered or an investment's potential returns. Firms also have a duty to ensure that their registered representatives understand the risks, terms and costs associated with these products, and that they perform an adequate suitability analysis before recommending them to a customer.
Investor Awarded in FINRA Arbitration Against UBS Over Lehman PPN
On December 4, 2009, the Wall Street Journal reported that a FINRA Arbitration Panel awarded an investor $200,000.00 against because the broker inappropriately sold her risky Lehman Brothers principal protected notes.
The securities law firms Blum & Silver, LLP (www.stockattorneys.com) and Sallah & Cox, LLC (http://www.sallahcox.com) are representing investors in FINRA arbitration claims who suffered losses at UBS as a result of losses in Lehman principal protected notes and Lehman preferred shares. These securities were typically recommended as safe investments. However, many investors allege they were not warned of the risk and suffered extraordinary losses as a result.
What the NASD Warned Firms About When Selling Structured Products is Everything the Average Investor Was Never Told
For a long time, structured products were sold by European brokerage houses to primarily sophisticated investors, typically institutions. Because of their organization, intricate “structure” - no pun intended - and multiple moving parts, they were often considered too complex for typical individual, retail investors. Nevertheless, by 2005, after almost $50 billion of the products were sold, the NASD (now known as FINRA), decided to issue at least two Notices to Members (“NTM”) that warned brokerage firms that they should pay careful attention to whom they were marketing and selling such products. Notice to Members 05-26 states, in part:
In the current investment environment, investors and brokers are increasingly turning to alternatives to conventional equity and fixed-income investments in search of higher returns or yields. Such products, including … structured notes… are often complex or unique features that may not be fully understood by the retail customers to whom they are frequently offered, or even by the brokers who recommend them. Some appear to offer benefits to investors that are already available in the market in the form of less risky, less complicated, or less costly products, prompting concerns about suitability and potential conflicts of interest.