Also known as callable notes, structured notes are IOUs from an investment bank that use derivatives to create the desired exposure to one or more investments. According to the SEC, notes may enable individual retail investors to participate in investment strategies not typically offered. However, they can also be very complex and carry significant investment risks.

A note combines two elements: A bond (supposed to protect your principal) typically makes up 80% of the investment, and the rest of your money is invested in a derivative. Understanding the investments underlying structured notes is critical before investing in them.

A derivative is a security dependent upon or derived from one or more underlying assets. For example, a structured note could derive its performance from the S&P 500 Price Index, the S&P TSX Global Gold Index, or numerous others. It can also derive performance from a combination of indexes.

The bond element in structured notes can be designed to give a return equal to your initial investment if you keep the product until maturity. The derivative element can achieve higher returns than a standard deposit.

Investment banks market callable notes because they can benefit from good stock market performance while protecting against lousy market performance. Modifying the benefit covers the cost of this protection, but unfortunately, the cost usually outweighs the benefit.

List of Structured Notes

This is a list of note offerings, many of which highlight the potential risks of investing in structured notes discussed in this article.

• GLOBAL MTN FLTG RT SER A EQUITY-LINKED (AUTOCALLABLE NT) Oct-28-2020
• GLOBAL MTN FLTG RT SER A EQUITY-LINKED (PHOENIX AUTOCALLABLE NT)
• Trigger PLUS Based on the Value of the S&P 500 Index due July 3, 2025
• GLOBAL MTN ZERO CPN SER A INDEX-LINKED (AUTOCALLABLE NT) 0.000 Jun-28-2024
• Trigger PLUS Based on the Performance of a Basket of Three Indices due July 1, 2022
• $2,202,000 Buffered SuperTrack Notes due June 30, 2023
• GLOBAL MTN FLTG RT SER A INDEX-LINKED (PHOENIX AUTOCALLABLE NT) Apr-11-2024
• GLOBAL MTN ZERO CPN SER A INDEX-LINKED (BUFFERED SUPER TRACK)
• GLOBAL MTN FLTG RT SER A INDEX-LINKED (CALLABLE CONTINGENT CPN)
• 12yNC1y Step-Up Callable 07/20/21 07/22/21 07/22/33
• $4,181,700 Barclays Bank PLC Capped Buffer GEARS Jul-31-2024
• GLOBAL MTN ZERO CPN SER A INDEX-LINKED (BARRIER SUPER TRACK NT) 0.000 Jul-31-2024
• 5y SOFR Floater 08/17/21 08/20/21 08/20/26
• REVRS CV LKD 23 08/25/21 08/30/21 08/28/23
• 7yNC1y Fixed Callable 08/26/21 08/31/21 08/31/28
• GLOBAL MTN ZERO CPN SER A INDEX-LINKED (BARRIER SUPERTRACK NT)
• GLOBAL MTN ZERO CPN SER IS INDEX-LINKED (CAPPED GEARS)

Download a complete list of 3,000 structured note investments here.

Stifel Nicolaus Multi-Million Dollar FINRA Claims Involving Callable Notes Strategy 

On August 16, 2023, Advisor Hub reported that customer complaints over a noted strategy developed by a Stifel Nicolaus & Co. broker in Miami are piling up with another million-dollar claim.

According to the broker’s CRD, nine arbitrations have been filed, including the most recent one on July 21, 2023. The total damages are reportedly $24.5 million, with the individual disputes ranging from $500,000 to $5 million.

The article reports that the complaints regarding the structured notes strategy are reportedly against Stifel Nicolaus as a respondent, not the broker. They include claims of negligence, breach of fiduciary duty, and unauthorized trading. The notes were heavily weighted with a volatile biotech index or frequently traded to generate commissions.

The broker allegedly over-concentrated the notes in stocks such as Dynatrace, Pinterest, and Snapchat or to potentially volatile indexes, including the SPDR S&P Biotech ETF (NYSE: XBI), according to Advisor Hub. According to the article, investments in the structured notes suffered significant losses when the stocks and biotech index dived in late 2021.

What are the Benefits of Investing in Callable Notes?

Investment banks typically advertise that notes allow you to diversify your investment products and security types and provide asset diversification.

They also advertise that notes allow you to access asset classes previously only available to institutions or were challenging for the average investor to access. (An asset class is a group of securities that exhibits similar characteristics, behaves similarly in the marketplace, and is subject to the same laws and regulations.)

Structured Notes Benefits Touted by Investment Banks

• Possibility of customized payouts and exposures
• Possibility of an investment return with little or no principal risk
• Some notes offer a high return in range-bound markets with or without principal protections
• Some notes declare alternatives for generating higher yields in a low-return environment

Derivatives allow notes to align with any particular market or economic forecast. Their inherent leverage also enables returns to be higher or lower than those of the underlying asset from which they derive.

According to Citibank, structured note investments can offer the best of both worlds: growth potential and the ability to protect your initial investment, provided they are held until maturity and subject to the issuer’s credit risk.

The Risks of Structured Notes

Pricing is questionable. Callable notes rarely trade after being issued, so pricing is doubtful. Prices are calculated using a matrix, which means the issuer determines the value.

According to PlanSponsor, the investor must take the time to understand how the structured notes are priced. The fees paid to the issuer and dealer on structured notes can be as little as 40 basis points or more than 100. The costs are difficult to isolate since they are hidden in the bid-ask spread.

At the same time, the average plan sponsor simply does not have the resources to reverse-engineer the more complex instruments to determine their pricing. An investor who does not call several dealers to price the same structure may never know if the pricing is fair.

–Structured Notes are illiquid investments. Notes cannot quickly be sold or exchanged for cash without a substantial loss in value. If you need to exit early for some reason, your only option may be from the original issuer at whatever price they are willing to pay, if any. Note terms are generally between 18 months and six years, and it is essential that you can afford to tie up your money for that period because your principal is only protected when structured notes are held for their full term.

–There is a market risk with structured notes. Some callable notes provide for the repayment of principal at maturity, often called “principal protection.” This principal protection is subject to the credit risk of the issuing financial institution. Many notes do not offer this feature. For notes that do not provide principal protection, the performance of the linked asset or index may cause you to lose some or all of your principal, according to an alert aimed at those who have invested in structured notes issued by the SEC. Depending on the nature of the linked asset or index, the market risk of the note may include changes in equity or commodity prices, changes in interest rates or foreign exchange rates, or market volatility.

–There is a credit risk with callable Notes. Since notes are an IOU from the issuer, you are left holding the bag if the investment bank forfeits the debt. The protection of the principal is subject to the creditworthiness of the issuer. Structured Notes holders may lose up to 100% of their investment upon the issuer’s bankruptcy, even if the reference asset’s value is favorable. The issuer’s creditworthiness may change during the note’s term. You are taking a market risk by investing in structured notes and a credit risk.

–Notes may have complicated payoff structures. It can be difficult for you to accurately assess their value, risk, and potential for growth through the term of the structured note. Determining the performance of each note can be complex, and this calculation can vary significantly from note to note, depending on the structure. Notes can be structured in a wide variety of ways. Payoff structures can be leveraged, inverse, or inverse-leveraged, which may result in more significant returns or losses for you.

Tax treatment can be tricky. Some investors may be at risk from a tax liability, so consider consulting with a tax advisor before investing in structured notes. The tax treatment of structured notes is complicated and, in many cases, uncertain.

Questions to Ask Before Investing in Callable Notes

• What underlying asset or index is the note linked to, and how does it perform?
• What is the maturity date of the structured note, and what happens if you need to sell it before maturity?
• What is the minimum investment required, and what are the associated fees and costs?
• What is the coupon rate or yield of the note, and how is it calculated?
• What is the credit rating of the note’s issuer, and how does this affect the investment risk?
• What is the likelihood of the structured note being called early, and how would this affect your investment returns?
• What are the potential tax implications of investing in notes?
• How does the payoff structure of the note work, and what are the potential risks and rewards of investing in structured notes?
• Are there any potential conflicts of interest between you and the note’s issuer?
• How does the performance of the note correlate with your overall investment strategy and risk tolerance?

FINRA Regulations 

The Financial Industry Regulatory Authority (FINRA), the self-regulator that oversees brokers and brokerage firms, has established regulations that govern the sale of structured notes to investors. These regulations are designed to protect investors and ensure that they are provided with adequate information to make informed investment decisions.

FINRA Rule 2330 requires broker-dealers to reasonably obtain information about the investor’s financial status, tax status, investment objectives, and other relevant information before recommending a callable note. This information determines whether the investment is suitable for the investor.

FINRA Rule 2111 requires broker-dealers to have a reasonable basis for believing that a recommended transaction or investment strategy involving a structured note is suitable for the investor based on the information obtained through the broker-dealer’s reasonable diligence.

FINRA Rule 2210 requires that all communications related to the sale of notes be fair, balanced, and not misleading. Communications must also provide a sound basis for evaluating the facts regarding the investment and disclose any material risks associated with the investment in structured notes and other complex investment products.

FINRA also requires broker-dealers to disclose the fees associated with purchasing a structured note, including any commissions, markups, or markdowns. In addition, FINRA requires broker-dealers to provide investors with a prospectus that contains detailed information about the note, including its terms, risks, and fees.

FINRA and SEC Sanctions Involving Callable Notes

There have been cases where FINRA has disciplined broker-dealers for the sale of notes. FINRA has taken disciplinary action against broker-dealers for various reasons, including failing to disclose the risks associated with structured notes, making unsuitable investment recommendations to clients, and supervising the sale of notes.

On July 30, 2021, Herbert J Sims & Co., a registered broker-dealer based in Fairfield, CT, paid $250,000 for allegedly making unsuitable recommendations for specific highly complex and high-risk variable interest rate structured products.

From January 2015 through April 2018, thirteen registered representatives from Herbert J. Sims’ Boca Raton, Florida branch office purportedly recommended variable interest rate notes and other structured products to forty-five customers. Considering their financial situations and needs, these customers reportedly considered such investments unsuitable and posed a needless risk.

In September 2019, FINRA censured and fined Newbridge Securities for allegedly failing to establish and maintain a supervisory system and procedures concerning the sale of complex securities, such as callable notes, and leveraged, inverse, and inverse-leveraged exchange-traded funds that were reasonably designed to achieve compliance with FINRA’s suitability rule.

One notable structured notes case involved UBS Financial Services, fined $15 million by FINRA in 2011 for allegedly making unsuitable investment recommendations for Lehman Brothers notes to some clients. The notes, which were linked to the firm’s performance, lost value significantly when the firm declared bankruptcy in 2008. UBS was also required to pay restitution to customers who had sustained losses due to the unsuitable recommendations.

Another case involved Wells Fargo Advisors, which FINRA fined $3.25 million for allegedly making unsuitable client recommendations regarding specific notes and other structured products. FINRA found that Wells Fargo failed to train its representatives properly on the risks of these products and that some representatives made unsuitable recommendations.

These cases highlight the importance of broker-dealers complying with FINRA’s regulations when selling callable notes and the potential consequences of failing to do so. Investors should also know the risks associated with structured notes and carefully evaluate the investment before deciding.

Brokers’ Duty of Due Diligence 

Brokers often pitch structured products as providing “downside protection” against losses to a related index while allowing modest upside gain potential. However, investors in note find that the protection offered is limited and insufficient to ward off enormous losses.

Brokerage firms are required to perform adequate due diligence on any product they recommend, including structured notes. They must also ensure that all recommendations suit their clients based on age, investment experience, net worth, income, and investment objectives.

If a brokerage firm fails to perform adequate due diligence or makes an unsuitable investment recommendation, the firm can be held responsible in a FINRA Arbitration claim.

The following is a detailed list of structured products sold by financial advisors:

Structured Notes

Free Consultation with a Securities Attorney

If you suffered losses investing in structured notes with your financial advisor and would like to discuss your litigation options, please call The White Law Group at 888-637-5510 for a free consultation.

The White Law Group, LLC is a national securities fraud, securities arbitration, investor protection, and securities regulation/compliance law firm with offices in Chicago, Illinois, and Seattle, Washington.

Our firm represents investors in securities-related claims, including claims involving stock fraud, broker misrepresentation, churning, unsuitable investments in structured notes, selling away, and unauthorized trading.

With over 30 years of securities law experience, The White Law Group has the expertise to help investors defrauded in securities, investment, and financial business transactions attempt to recover their investment losses. The firm reviews securities fraud cases nationwide with offices in Seattle, Washington, and Chicago, Illinois.

Frequently Asked Questions

Are notes FDIC-insured? 

One factor worth considering when assessing whether structured notes are a good investment for you is the likelihood of you recovering your investment if your bank goes out of business. Unlike bank deposits, notes are not FDIC-insured. If your bank fails, you will lose your investment.

Are gains from an investment in structured notes taxable? 

Unlike other securities, taxable notes are viewed as debt instruments and thus taxed as regular income rather than capital gains. Therefore, you may pay more taxes on profits from structured notes than with other investment products.

How are structured notes taxed?

In certain cases, structured notes can be taxed before they mature. This includes instances when the asset’s owner has not yet received cash. This should be considered before investing in structured products.

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