SEC Investigating Securities Fraud Related to the Issue and Sale of “Principal Protected” Notes

According to a recent Bloomberg article, the Securities and Exchange Commission (SEC) is investigating misleading marketing by Wall Street banks of so-called “principal protection.” The investigation focuses on notes issued by now-bankrupt Lehman Brothers that prominently featured the words “principal protection” or “principal protected” in brochures provided to investors and that were sold as safe investments. Safety-minded investors were shocked when Lehman Brothers went bankrupt and the value of the notes collapsed. Investors had never been told that the notes were really options combined with an unsecured obligation of Lehman Brothers.

These products are essentially zero-coupon notes linked, in part, to the performance of an equity index, like the Standard & Poor’s 500 or the Russell 2000, or some other basket of securities. In some cases, there is a trap door in the linkage, however. If the index falls 25.5 percent or more, or rises more than 27.5 percent, the investors are promised a return of principal but no additional return in exchange for their loan.

The SEC’s Division of Corporation Finance is reportedly in the beginning stages of examining whether and how the selling firms described the risks and whether the use of the term “principal protection” was deceptive and misleading. Findings made by that division may be referred to the enforcement division, which investigates fraud, according to the article. The brokerage firms mentioned in the article include Citigroup, Barclays, Morgan Stanley and Bank of America. UBS is another firm known to have sold Lehman Brothers Principal Protected Notes.

Applicable laws and rules require firms to fully disclose of all important risks when marketing a product. Oral presentations as well as marketing materials must fairly present all important risks, and firms cannot escape that requirement by putting disclosures in the prospectus while glossing over them in sales pitches.

Kenneth Lench, head of the SEC’s Structured and New Products enforcement unit, was quoted saying: “You’ve got these long disclosure documents, but oftentimes there are marketing materials and those have to be accurate as well.”

There is at least one lawsuit seeking class-action alleging that UBS brokers provided “misleading” information when using the term “100 percent principal protection” to market the notes. While class actions lawsuits are appropriate avenues of recovery for investors seeking low-percentage recoveries of losses that are too small to justify individual arbitrations, many investor who lost significant amounts have engaged counsel to seek recovery in Financial Industry Regulatory Authority (FINRA) arbitration cases.

Call Jeffrey Wittenberg at 877-352-2010 if you have questions about principal protection notes or about any of your investments.