‘100% Protected’ Isn’t as Safe as It Sounds

Article from Securities Lawyer Jake Zamansky on 100 percent principal protected absolute return barrier notes.

The New York Times : by GRETCHEN MORGENSON on May 23, 2010

BROKERS selling complex securities that they once contended were safe and sound have saddled individual investors with billions in losses since the credit bubble burst. Remember auction-rate securities? Those were peddled to investors as just as good as cash — until they no longer were after that market seized up in 2008.

Questions about how Wall Street marketed yet another complex product, sold as solid and secure, are now emerging in investor arbitration cases. The instrument is named, inaptly as it turns out, “100 percent principal protected absolute return barrier notes.”

These securities are essentially zero-coupon notes sweetened by tying the return, in part, to the performance of an equity index, like the Standard & Poor’s 500 or the Russell 2000. The securities promise to return an investor’s principal, typically at the end of 18 months, with the added gain from the index’s performance if that index trades within a certain range. Brokerage firms often issued these securities.

For an investor in one of these notes to earn the return of the index as well as get the principal back, the index cannot fall 25.5 percent or more from its level at the date of issuance. Neither can it rise more than 27.5 percent above that level. If the index exceeds those levels during the holding period, the investors receive only their principal back.

Convoluted enough for you?

Yet, these securities appear to have been sold to conservative individuals whose financial market forays were usually limited to certificates of deposit. Many of these investors, to their great misfortune, bought principal-protected notes issued by Lehman Brothers. They are now worth pennies on the dollar.

CORINNE and Gregory Minasian were two of these investors who, at the suggestion of their broker at UBS, sunk almost $100,000 — more than half of their savings — into Lehman notes in early 2008. They lost everything and have filed an arbitration case against the firm to recover their losses.

The Minasians are a retired couple who live on Long Island. They contend that their UBS broker pushed the investment when one of their C.D.’s matured. The broker failed to explain the risks in the security, the Minasians said, and did not provide them with a prospectus. They did not even know their investment had been issued by Lehman Brothers until the firm collapsed.

“I am not a sophisticated investor,” said Mr. Minasian, a former engineer who is 68. “Many years ago I dabbled in the stock market, but I learned my lessons. Over the past 10 to 15 years my wife and I invested in C.D.’s.”

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Lehman Brothers Principal Protected Notes

A post from Securities Lawyer Jake Zamansky on Lehman Brothers Principal Protected Notes.

Although this story is still relatively nascent, I have to imagine the next big scandal to engulf Wall Street will involve Lehman Brothers principal protected notes.  Lehman Brothers principal protected notes were drummed up behind Wall Street’s closed doors and used as a way to dupe investors and raise capital without diluting shareholder equity.

See, over the past few months Wall Street had trouble selling traditional bonds at attractive interest rates.  So instead, as sub-prime losses mounted, they concocted structured products that masked the risk by tying them to other securities, indexes or some other basket of stocks or bonds.  Indeed, Lehman Brothers was one of the most prodigious issuers of principal protected notes and UBS was one of the biggest brokers selling them.

The selling points of Lehman Brothers principal protected notes were that the principal was “100 percent guaranteed” and they had “uncapped appreciation potential.”  This was as close - investors were told by their brokers - to a “sure thing” that ever comes along.  But the problem was that the guarantee was only good so long as the issuer remained solvent.  And we now know how that story goes.

The market for Lehman Brothers principal protected notes and structured products is extremely large and estimated to be around $114 billion.  And much of that was created over the past year during a period when Wall Street was in dire need of capital and writing down sub-prime losses.  In the past twelve months alone, brokers sold $70 billion worth of these securities.  Naturally, three-fifths of the market was consumed by retail investors and based on the ones that have contacted Zamansky & Associates, they were risk-averse retirees who needed their savings to get by.

While holders of Lehman Brothers principal protected notes have fared the worst, we are also hearing from investors that have been left holding principal protected notes including “Suns” (Stock Upside Note Securities), “Prudents” (Prudential Research Universe Diversified Equity Notes) as well as Merrill Lynch’s “Mitts” (Merrill’s Market Index Target - Term Securities), Citigroup’s “Sequins” (Select Equity Indexed Notes) and Morgan Stanley’s Propels (Protected Performance Equity Linked Security).

Lehman Brothers principal protected note investors have experienced extraordinary losses and are filing claims for misrepresentation, omission of material facts, unsuitability and negligence.  In some cases, investors have claimed they were not even sent a prospectus.  Instead, they got a link to the SEC’s website.

Obviously, losses were severe when Lehman Brothers declared bankruptcy.  This raises some questions about one of the biggest concerns on the minds of regulators at the Federal Reserve and Department of Treasury: counterparty risk.  But who actually is considered counterparty?  Apparently financial regulators hold little regard for counterparties when they are individual investors on the other side of a Lehman Brothers transaction.

Look for Lehman Brothers principal protected notes to be a headline grabber in the weeks to come.  If you have lost money in a Lehman structured note, or principal protected note or structured product issued by another brokerage firm please call Jake Zamansky for a free consultation.  For contact information, click here.

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