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Home > Cases > Structured Investment Products > A Primer On Structured Investment Products

A Primer On Structured Investment Products

The names may be different - from Lehman Brothers Principal Protected Notes to Pinnacle Series 9 and 10 to DBS High Notes 5 - but for many investors of these complicated structured finance products, the end result is the same. Their investments have been wiped out. Structured finance products are generally described as securities mixed with other derivatives and whose repayment value is linked to the performance of the underlying assets. Those assets can include a single security, a pool of securities, stock, bonds, debt issuances, foreign currencies or swaps.

The products themselves have become increasingly complex in recent years; only about 10% are actually listed on exchanges. Despite their complexity, the financial institutions that offer structured products often tout the window of opportunity they provide to markets that otherwise would be off limits to investors. And while that may be true, structured finance products also can carry considerable levels of risk - risks that many investors often do not clearly understand.

In the past five years, structured product sales have skyrocketed. In 2007, $114 billion worth of structured investment products were issued, up from $64 billion in 2006. By comparison, sales stood at $28 billion in 2003. As of November 2008, nearly $34 billion of structured products had been sold to small U.S. investors.

In recent months, there have been a number of news reports documenting the potential pitfalls of structured investment products. In theory, a structured investment product is designed to guarantee full or partial protection on the principal of the investment at maturity, plus a share of any gains that might occur depending on how the product is set up. The key words, however, are “might occur.” If a structured product is linked to a stock that plummets in value or to a company that becomes insolvent such as in the case of Lehman Brothers, investors could lose their entire investment.

The following articles and white papers offer a primer on structured investment products, examining both the potential risks they may pose to investors and the challenges facing lawmakers and regulators to raise the standards of protection.

  • Policy Issues Raised by Structured Products discusses the reasons behind the explosive growth in the structured products market and the underlying issues that investment banks and regulators must address to ensure investors understand the complicated payoff structure of the products. The paper is part of Harvard's John M. Olin Discussion Paper Series and can be viewed at: http://www.law.harvard.edu/programs/olin_center/.
  • Another 'Safe' Bet Leaves Many Burned from the Wall Street Journal examines the variations of structured investment products and the impact of the credit crisis and the fallout of Lehman Brothers bankruptcy on investors holding structured products. The Nov. 11, 2008, article can be viewed at: http://online.wsj.com/article/SB122636312365215727.html?mod=googlenews_wsj
  • Structured Investments Nomenclature Standardization Proposal from the Structured Products Association suggests that the numerous acronyms and descriptions used to reference similar structured finance products only adds to the confusion for prospective investors, as well as increases the likelihood for unsuitable sales. One possible solution is to adopt a standardization naming model. To read the entire June 2007 white paper, go to: http://www.structuredproducts.org/img/catfiles/36/i0/42_SPA_Nomenclature_Standardization_-_Final.pdf.
  • Structured Products on the Rise by Susan L. Hirshman. In 2007, more than 2,300 new structured products were introduced in the United States. Yet, only 15% of affluent investors actually are knowledgeable about these products, according to the consulting firm Spectrem Group. This article discusses the need for additional education about structured investments, and the steps brokers can and should be taking to help clients assess whether the products are a good fit for their portfolio. The full article can be read at: http://www.structuredproducts.org/img/catfiles/36/i0/44_investment%20advisor.pdf.
  • Best Practices for Reviewing New Products from the National Association of Securities Dealers (NASD) outlines a series of best practices designed for financial institutions to improve internal procedures when determining what constitutes a new structured investment product, as well as the kinds of questions to consider before a new product is offered for sale to investors. For NASD's complete summary, go to: http://www.finra.org/web/groups/industry/@ip/@reg/@notice/documents/notices/p013755.pdf.

Our affiliation of securities lawyers is actively involved in advising individual and institutional investors in evaluating their legal options when confronted with subprime and other mortgage-related investment losses.

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