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Lending Facility Concerns

While many investment advisors are recommending structured products to their clients, many investors are left wondering what structured products are. These are highly complex derivatives with pitfalls and risks that are inadequately disclosed.

Structured products, also known as structured notes, are now being used by major brokerage firms to turn their own client base into a lending facility. The underlying concept for structured products is disturbing in that your trusted financial advisory firm or wealth management firm is advising you, the client, to loan money to it – or one of its brethren on Wall Street – on an unsecured basis.  These same firms summarily fire individual financial advisors who solicit loans from their clients. Similarly, regulators such as FINRA, the Financial Industry Regulatory Authority, regularly investigate and punish individual financial advisors who borrow money from a client. The fairness of the terms and return is immaterial, financial advisors are forbidden from soliciting loans from their own customers.

However, FINRA and the brokerage houses turn a blind eye when it is the firm that solicits the loan.  There is an industry-wide willingness to disregard the massive conflict of interest created by a brokerage firm borrowing money from its own clients on a widespread basis that is embedded in these structured note products.

When investors buy a structured note issued by their own brokerage firm, the money is essentially an unsecured loan for that brokerage firm to use for operations or however it sees fit.   Why would the major brokerage firms borrow money from you instead of going to a bank or institutional lender?  In our opinion, they aren’t doing this to provide you with a wonderful investment opportunity, but rather they’re doing it because they can get much better loan terms from you than they could get from a banker or professional lender.

In the March 2012 issue of AARP Magazine, Vernon Litigation Group co-founder, Chris Vernon, succinctly explained the problems with structured products when he was quoted as saying “The financial industry is effectively using structured products to borrow billions of dollars from Main Street investors with no collateral.”

The Lehman bankruptcy graphically illustrated the dangers associated with structured products. Beyond the fallout of the Lehman bankruptcy, at Vernon Litigation Group we remain concerned about the promotion and sales of Structured Notes (which are still being heavily sold to retail investors in our home city of Naples and throughout the country by the big financial institutions).