Monday, April 11, 2011

FINRA Press Release: Principal Protected Notes

FINRA Fines UBS Financial Services $2.5 Million; Orders UBS to Pay Restitution of $8.25 Million for Omissions That Effectively Misled Investors in Sales of Lehman-Issued 100% Principal-Protection Notes

The Financial Industry Regulatory Authority (FINRA) issued a press release today announcing that
it has fined UBS Financial Services, Inc., $2.5 million, and required UBS to pay $8.25 million in restitution for omissions and statements made that effectively misled some investors regarding the "principal protection" feature of 100% Principal-Protection Notes (PPNs) Lehman Brothers Holdings Inc. issued prior to its September 2008 bankruptcy filing.
The settlement is detailed in the FINRA AWC No. 2008015443301.

FINRA has also published an investor alert informing investors of their eligibility for restitution from UBS, after it recently ordered UBS to pay $8.25 million in restitution for misstatements and omissions regarding principal protected notes issued by the now-bankrupt Lehman Brothers Holdings Inc.

Structured products are debt securities that often have unconventional and complex payoff structures. They are often linked to a security or index, such as the S&P 500 or the Russell 2000, with asset classes ranging from equity, commodities, currencies to debt. A principal protected note returns at least the face value of the note at maturity. If the reference asset – an asset to which a principal protected note is linked – increases over the term of the note, the note will return higher than the face value. Another principal protected note, branded as an absolute return barrier note, returns the absolute value of the return of the underlying index provided the index stays within pre-specified barriers during the life of the note. If the index exceeds the barriers then the note returns its initial face value.

Furthermore, structured products often have high fees, high transaction costs, and are priced well above their fair market price, see for example Henderson and Pearson (2011). Moreover, structured products depend on the solvency of the issuer, as was very clear when Lehman Brothers collapsed. SLCG has written several papers on the topic including a paper that describes structured products after the collapse of Lehman Brothers.

Investors should be careful when considering principal protected notes, for they can be quite complex and risky and their complexity can mask their riskiness to investors. Since they can be replicated by traditional securities and derivatives, investors should also consider the fees they pay for purchasing such structured products. SLCG has written a paper on principal protected absolute return notes. Investors can find other related papers and notes at our dedicated website.

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