The Myth of “100% Protected” Securities

As Gordon Gecko (Michael Douglas’s infamous character in the movie “Wall Street”) said, “Greed is good.” Well, not for everyone. Greed on the part of stockbrokers, financial advisors and bankers is allegedly responsible for the loss of billions of dollars invested in so-called “100% principal-protected” notes. Recent arbitration, court, and regulatory proceedings brought against UBS, one of the world’s largest financial services companies, and other issuers of principal protected notes have thrust these complicated securities into the spotlight. More than $1 billion of principal-protected notes that UBS sold as safe investments were backed by Lehman Brothers Holdings. But when Lehman Brothers filed its landmark bankruptcy in September 2008, investors in the securities became nothing more than unsecured creditors in Lehman Brothers bankruptcy proceeding. As a result, these investors expect to lose virtually their entire investment.

Principal protected notes (PPNs) are securities that allegedly combine the safety generally associated with fixed-income securities and the growth potential often associated with equity investments. These securities are often linked to a single equities index or a group of several indices. PPNs allegedly were designed to protect investors’ principal funds while seemingly taking the risk out of investing in the stock market; they were seen as a fail-safe product that was purposely structured to shield invested monies from potential downward fluctuations of stock prices that could result in a loss. In reality, PPNs lulled many investors into a false sense of security.

The notes, touted by many as a sure-fire investment, are now worth pennies on the dollar. Their dramatic drop in value has resulted in an as-yet-undetermined number of investors losing most or all of their retirement funds and savings. Many of the investors, including a number who already have filed arbitration claims against UBS, allege that they had no idea that Lehman Brothers was in such poor financial condition and that Lehman Brothers PPNs subjected them to such enormous risk of loss. These same investors have alleged that UBS, on the other hand, knew very well that Lehman Brothers was poised for financial disaster at the time that UBS was recommending that investors purchase the Lehman Brothers securities. Even many UBS brokers claim that UBS misinformed them about the significant risk associated with the Lehman Brothers PPNs. Indeed, it even has been reported that UBS was eliminating its own financial exposure to Lehman Brothers during the time that it was recommending that investors invest their savings in Lehman Brothers securities.

How Did This Happen?

Financial records show that UBS alone sold $1 billion worth of these securities to investors, to the tune of $17.5 million in commissions for UBS brokers, some of whom allegedly told investors not only that principal protected securities were 100 percent safe, but also that there were no commissions on their purchase or sale.

These products, famously marketed by a number of financial powerhouses like JP Morgan, Barclays, Citibank and UBS, were named and marketed in such a way as to entice investors to purchase them in lieu of Treasury Inflation Protected Securities (TIPS) or CDs. With descriptive titles like “Principal Protected Notes” and “100% Principal Protection Notes,” many investors bought them, swayed by the advice of a brokerage firm.

When Lehman Brothers filed for bankruptcy in late 2008, its stock price plummeted and it defaulted on all of its PPNs, causing a chain reaction of falling market values that threw the United States and world economies into turmoil. The effects have been so widespread that the global credit crisis continues nearly two years later.

What Can Be Done?

Some investors whose principal protected notes were backed by now-defunct companies like Lehman Brothers have brought securities arbitration cases against brokerage firms, most notably UBS, to recover their losses. The underlying allegation of these arbitrations is that brokerage firms like UBS acted not in the interest of their clients, but instead in a self-serving manner, selling these notes even after obvious signs arose that the companies backing them were in danger of collapse. The first several arbitrations against UBS that were filed with the Financial Industry Regulatory Authority (FINRA) have proven successful, with investors recovering most or all of their losses, and many more arbitration claims are expected.

If you have lost investment money as a result of now-worthless principal protected notes, you may have a claim against the individual brokerage firm that recommended and sold the PPN to you. To increase your chances of succeeding at a FINRA arbitration, arrange a consultation with an attorney who has an active securities arbitration practice.