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Criticisms of Structured Securities

Criticism of structured securities is growing as fast as the demand. FINRA, the financial regulatory agency, has looked carefully at how these instruments are designed and marketed. Several published papers have warned investors about complexity, expense, and suitability. Some of the products are so misunderstood that investors are completely unaware of what they own or how much they could lose.

In 2008, many investors were burned. Structured products that were supposedly “principle-protected” were not. Investors at firms such as UBS, Merrill Lynch, and Morgan Stanley learned that their securities bought to earn income had overnight been “converted” into depreciated stocks. The losses were huge and unexpected.

In a Forbes article, “When will FINRA stop this insanity?” Seth Lipner says structured products are too complicated for ordinary investors to understand.

  • They are, in reality, exotic derivatives... Isn’t it clear by now that these newfangled financial products exist just to enrich Wall Street at the expense of naive investors? Isn’t it enough already?xy4

Other criticisms center not on the danger, but on the fact that they don’t add anything that investors can’t get through simpler and less expensive instruments. One report concluded:

  • These products add nothing to retail investors’ portfolios that can’t be acquired from investments already available in the market in the form of less risky, less complicated, or less costly products.5

Because these products “add nothing,” they may fail even the most basic regulatory “reasonable basis” rules for suitability to sell to retail investors.

Despite the criticism, the trend is clear. Investors don’t want the roller coaster that investing has become in the last decade. Financially engineered products are not going away, nor is the demand for people who can build them and explain them.

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