SEC, Finra warn retail investors about notes with principal protection

By Angela McDaniels

Tacoma, Wash., June 2 - The Securities and Exchange Commission and the Financial Industry Regulatory Authority issued an investor alert about the risks of structured notes with principal protection.

"The retail market for these notes has grown in recent years, and while these structured products have reassuring names, they are not risk-free," the SEC said in a news release.

The alert noted that some of these products guarantee as little as 10% of par back at maturity and that any guarantee is subject to credit risk. It also pointed to the cap sometimes placed on the upside exposure to the underlying and potential issues with liquidity.

"Structured notes with principal protection contain risks that may surprise many investors and can have payout structures that are difficult to understand," Lori Schock, director of the SEC's Office of Investor Education and Advocacy, said in the news release.

"This alert is a 'must read' for investors considering these products, especially those with the mistaken belief that these investments offer complete downside protection."

Finra senior vice president for investor education John Gannon said, "The current low interest rate environment might make the potentially higher yields offered by structured notes with principal protection enticing to investors. But retail investors should realize that chasing a higher yield by investing in these products could mean winding up with an expensive, risky, complex and illiquid investment."

The investor alert suggested that investors ask the following questions:

• How do I know whether this product is appropriate for me given my overall investment objectives?

• What is the level of principal protection offered?

• Are there conditions to the principal protection?

• What are the fees and other costs?

• How long will my money be tied up?

• Can I sell or liquidate before the maturity date?

• Is there a call feature?

• Are potential gains limited?

• What are the tax implications?

• How does the payout structure work?

• What unique risks will I take on as a result of being exposed to the underlying asset, index or benchmark?

• What is the credit risk of the note?

• What other risks are associated with this particular product? and

• What other investment choices are available to me?

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