Open Accessibility Menu

Investors Seeking Safe Income from Bonds Lose Out on Structured Notes

David P. Meyer, Esq.

Retirees and other investors seeking safe, stable returns typically invest in bonds. A bond is essentially a loan from an investor to a company or government in exchange for a promise of repayment (the principal borrowed plus a predetermined interest rate) on a set date (also know as the maturity date).
Investors generally view bonds as risk-free products offering a stable return. Unfortunately, this has enabled unscrupulous brokers and sales agents to mislead investors seeking safe income into purchasing complex securities they don't understand.

84-year-old Leona Miller is one such investor. Two years ago, while in the market for "safe and steady income from bonds," Miller was persuaded by her broker to purchase a structured note paying 9% interest, according to a September 22 Bloomberg article by Zeke Faux. Within 6 months she had lost 30% of her $20,000 investment.

Structured notes are bonds bundled with derivatives. Sales to investors like Miller have increased structured note offerings 58% over the previous year, according to the Bloomberg article. The low rate for overnight loans between banks set by the Federal Reserve combined with the complex nature of the notes has contributed to their rising popularity.

"Brokers are paid more to sell structured notes than some other financial products because the securities aren't standardized, making it difficult for buyers to shop around," said the managing director and co-founder of the research firm Institutional Risk Analytics, Christopher Whalen, to Bloomberg. Regulators and industry professionals see this as a problem. Over the past year, the SEC has begun investigating the sale of structured products, particularly to individual investors.

"We're concerned about the sale of complex structured notes to retail customers because people don't always understand the risks they're exposed to," said Kenneth Lench, head of the SEC's Structured and New Products unit, in the article. Miller, whose Wachovia Corp. broker sold her the structured product, is now involved in an arbitration proceeding with Wells Fargo & Co. Wells Fargo acquired Wachovia in 2008.