Structured Note Sales Booming, But Do Investors Understand The Risks?

Sales of structured investment products are bigger than ever. The problem is many brokers are selling structured notes to investors without first disclosing the considerable risks involved or, for that matter, how the financial instruments work in the first place.

Take the case of 84-year-old Leona Miller. According to a Sept. 30 article by Bloomberg Businessweek, the retired beautician got into structured notes after looking for an investment that could provide a safe and steady source of income. On the recommendation of her Wachovia broker, Miller bought $20,000 worth of bonds. Within two months of her purchase, Miller had lost about 30% of her $20,000 investment, and the bonds were converted into shares of Merck in a depressed stock market.

“I just wanted him to make some money for me, like anybody else,” said Miller in the article. “I still don’t understand too much about it.”

What Miller had purchased was actually a structured note, i.e. a bond that is combined with a derivative. In Miller’s case, the investment was a reverse-convertible note (also known as a principal-protected note) that contained a “put option” on Merck stock. The option meant that the security could offer a relatively high interest rate.

It also meant more risk for Miller. A decline in the drug maker’s shares triggered the put option, which in turn allowed the note’s issuer, Oslo-based export-credit agency Eksportfinans, to pay Miller off with Merck shares.

Sales of structured notes jumped to nearly $32 billion through August 2010, nearly a 60% increase from the same period last year, according to data compiled by Bloomberg and StructuredRetailProducts.com.

Sales of structured notes – and the potential risks they hold for retail investors – have garnered attention from federal regulators. In July, the Securities and Exchange Commission (SEC) announced the formation of a special task force to investigate disclosure policies of asset-backed securities and other structured products.

If you’ve suffered losses in Reverse Convertibles, please contact our securities fraud team. We can evaluate your situation to determine if you have a claim.