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Financial Product Failures

During the past 20 years, brokerage firms and their brokers have become more and more focused on selling “products” as opposed to the actual selling of individual stocks and bonds. Some of these products are easily understood and explained, such as equity or bond mutual funds, but problems arise when the firms and their brokers attempt to supplement what was supposed to be just a simple investment. Examples of this are the Morgan Keegan RMK Funds and the Schwab YieldPlus Funds, both of which were touted and promised to investors as being “safe and secure” investments, which instead suffered unacceptable losses for such products. The impetus for these financial product failures was largely due to an investment called “derivatives” which were added to the funds as a means of bolstering their returns. The brokerage firms and their brokers would advertise the superior returns on these products as if such returns were a result of the firm’s market acumen. In reality, the only thing that was accomplished for investors was an increased risk taken in the product, while still being advertised to them as relatively safe.

Other products are simply gross misrepresentations of the very nature of the product. One such glaring example is the Principle Protected Note (“PPN”), which by the name alone would lead a reasonable investor to understand that the principal was somehow protected and guaranteed. In reality, many brokers were actually misled into promising that to investors by their firm’s own marketing materials on the product. A current product that is popular amongst brokers is the Securities Backed Loan (“SBL”), or basically a brokerage firm credit line. The firms and brokers extoll the upsides of these products, painting them as a win/win investment. However, unlike a traditional bank line of credit, which is collateralized against real property, the SBL is collateralized against the assets in your portfolio. And unlike a bank, when the value in your portfolio decreases, the brokerage firm will sell off assets in your portfolio to offset those drops in value. By doing so, your portfolio is robbed of any potential increases in value in its other assets.

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