Sales of structured products have greatly increased in the last several years as investment professionals began to introduce these products, which were designed for institutional investors, into the retail market. Such structured products include equity linked notes, i.e. securities issued by a brokerage firm and traded in secondary markets like stock. Such investments can be too complex for retail investors and even for registered representatives to understand. In addition to being very complex, they often offer benefits to investors that are already available in the form of less risky, less complicated and less costly investments.

Certain equity linked notes provide protection of principal in exchange for limited participation in upside gains. For example, the securities may yield the original issue price at maturity plus an additional amount depending on the appreciation in the value of the underlying stock or stock index. Other types of equity linked notes may pay additional yield compared to ordinary bonds and are also subject to downside risk in the underlying stock or stock index. These instruments resemble in their operation a combination of fixed income investments and options thereon. Examples of these sorts of investments are Merrill Lynch’s S&P 500 Market Indexed Target Term Securities, called MITTS, and J.P. Morgan’s Capped Quarterly Observation Notes. A related example is Bear Stearns Equity Derivatives forward purchase contracts which are structured like institutional transactions, employing an ISDA a agreement, purporting to lock in current value of a stock, while preserving potential for appreciation under certain circumstances.

FINRA has recently issued notices to members concerning such non-conventional retail investments, emphasizing the obligations of registered representatives to fully explain these products to customers, make sure customers understand them and that they are suitable for customers. Because of the complexity of the products and how the investment professionals are compensated (which is often over and above a more conventional investment alternative) such products are ripe for abuse.

Over-the-Counter Commodity Derivatives Markets

Closely akin to structured products issued by securities brokerage firms are over-the-counter investments in derivatives in the commodities markets, which were also originally designed for sophisticated institutional investors, but are now being sold to unsophisticated retail type customers. This practice raises many of the same issues of customer understanding of the nature and risk of complex products as in the securities arena described above. In recent years such derivatives have been offered to unsophisticated and/or retail customers through unregistered affiliates of registered commodities firms trying to insulate themselves from regulation and liability. The offering of such “off exchange” institutional investments to retail or unsophisticated customers through unregistered entities is an emerging area in securities and commodities litigation.