SEC, FINRA Warn Retail Investors About Investing in Structured Notes With Principal Protection

WASHINGTON — The Securities and Exchange Commission's (SEC) Office of Investor Education and Advocacy and the Financial Industry Regulatory Authority (FINRA) have issued an investor alert called Structured Notes with Principal Protection: Note the Terms of Your Investment to educate investors about the risks of structured notes with principal protection, and to help them understand how these complex financial products work. The retail market for these notes has grown in recent years, and while these structured products have reassuring names, they are not risk-free.

Structured notes with principal protection typically combine a zero-coupon bond — which pays no interest until the bond matures — with an option or other derivative product whose payoff is linked to an underlying asset, index or benchmark. The underlying asset, index or benchmark can vary widely, from commonly cited market benchmarks to currencies, commodities and spreads between interest rates. The investor is entitled to participate in a return that is linked to a specified change in the value of the underlying asset. However, investors should know that these notes might be structured in a way such that their upside exposure to the underlying asset, index or benchmark is limited or capped.

Investors who hold these notes until maturity will typically get back at least some of their investment, even if the underlying asset, index or benchmark declines. But protection levels vary, with some of these products guaranteeing as little as 10 percent — and any guarantee is only as good as the financial strength of the company that makes that promise.

"Structured notes with principal protection contain risks that may surprise many investors and can have payout structures that are difficult to understand," said Lori J. Schock, Director of the SEC's Office of Investor Education and Advocacy. "This alert is a 'must read' for investors considering these products, especially those with the mistaken belief that these investments offer complete downside protection."

"The current low interest rate environment might make the potentially higher yields offered by structured notes with principal protection enticing to investors," said FINRA Senior Vice President for Investor Education John Gannon. "But retail investors should realize that chasing a higher yield by investing in these products could mean winding up with an expensive, risky, complex and illiquid investment."

FINRA and the SEC's Office of Investor Education and Advocacy are advising investors that structured notes with principal protection can have complicated pay-out structures that can make it hard to accurately assess their risk and potential for growth. Additionally, investors considering these notes should be aware that they could tie up their principal for upwards of a decade with the possibility of no profit on their initial investment.

Structured Notes with Principal Protection: Note the Terms of Your Investment also includes a list of questions investors should ask before investing in these products.

The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation. The SEC's Office of Investor Education and Advocacy provides a variety of services and tools to address the problems and questions that individual investors may face. The Office conducts educational outreach, assists with investor complaints and inquiries, and facilitates individual investors in bringing their perspectives to the Commission and its staff. For more information, please visit www.investor.gov or www.sec.gov/investor.

FINRA, the Financial Industry Regulatory Authority, is the largest non-governmental regulator for all securities firms doing business in the United States. FINRA is dedicated to investor protection and market integrity through effective and efficient regulation and complementary compliance and technology-based services. FINRA touches virtually every aspect of the securities business – from registering and educating all industry participants to examining securities firms, writing and enforcing rules and the federal securities laws, informing and educating the investing public, providing trade reporting and other industry utilities, and administering the largest dispute resolution forum for investors and registered firms. For more information, please visit www.finra.org.