The Basics of “Secured Notes”

Investors should always be skeptical about complicated-sounding investments that promise to minimize or eliminate risk. One such type of investment is known as a “structured note.” This describes any hybrid security that includes multiple financial products.

Structured Notes

Structured notes are linked to some other index or security. Here is a simple example of how this might work. You purchase a structured note for $1,000 from a bank. The note has a term of 24 months. During this time, the value of the note is indexed to the Dow Jones Industrial Average. So if at the end of 24 months the Dow is up, the bank pays you the original $1,000 plus the gain in the Dow. But if the Dow is lower than it was at the beginning of the note’s term, you would still get your original $1,000 back.

This is a very simple example provided for illustrative purposes only. Most structured notes are far more complex. In fact, unlike the example above, many structured notes do not guarantee a return of principal. This means you could lose your entire investment based on the performance of the indexed asset connected to the note. And even structured notes that do offer “principal protection” depend on the creditworthiness of the financial institution that issued the note. Like bonds and similar securities, structured notes are an unsecured debt held by the issuer. If the issuer defaults or goes bankrupt, you may be left with nothing.

Another thing to look for in a structured note is whether there is a “call provision.” This means the issuer may unilaterally call in or redeem the note before its stated maturity date. If that happens, you may not be able to reinvest under the same terms as the original note.

But the most important thing to look for in any structured note is the actual payoff terms. In the example above, the structured note was indexed to the Dow Jones Industrial Average. So if the Dow rises 10% over 24 months, you would get a 10% return on your note. But in practice, many structured notes are not that simple. For example, the note might have a capped rate of return, say 5%, in which case you would not get the full benefit of the increase in the indexed asset. Or, on the other side of the ledger, the note might have a “knock-in feature,” which is a specified level below which the indexed asset cannot fall without penalty. So if the Dow were to decline 10%, the note might reduce your return of principal to compensate.

These are just some of the issues you need to consider before investing in a secured note. Frankly, if you do not completely understand the terms of such a note, it is best not to invest in it. The Securities and Exchange Commission, FINRA and other financial regulators have published information for consumers thinking about secured notes. And it is always best to work with a qualified and licensed investment professional before making any such investment.

Reach Out to an Attorney for Help

Before a broker recommends any investment, especially something as complicated as a structured notes, he/she must determine if that investment is suitable for you. If you have purchased a structured note and are not sure if it was suitable for you, contact Florida securities fraud attorney Gregory Tendrich, P.A., today.