The Lehman Principal Protected Notes Disaster: Will Others Follow?

Although structured products like Lehman notes are very complicated products, at their essence they are nothing more than the following:  Illiquid and unsecured loans to the now-bankrupt Lehman that were packaged up and purchased at wholesale prices by UBS (i.e. underwritten) and then immediately sold by UBS to its own retail clients.

UBS provided its financial advisors with incentives to sell Lehman structured notes to UBS retail clients and these financial advisors didn’t fully understand the flaws, risks, and costs of the product they were pitching to UBS customers.  This was an “underwriting assembly line.”

Structured products, like the Lehman notes and similar notes constitute illiquid and unsecured loans to UBS, Merrill Lynch, and other financial institutions that are now having significant financial problems. These structured notes are like many products before them: Like the limited partnerships of the late 1980s and early 1990s, these products are formerly complex institutional-type financial instruments that are packaged up and oversold to main street investors — at great profit to the seller and issuer.

Unlike, the tech wreck earlier this decade, banks and brokerage firms sold these structured products to investors who sought to avoid risks — rather than investors who sought to maximize returns.

Historically, structured products are a broad category of products that have been popular in Europe and, more recently, heavily sold to retail investors in the United States and elsewhere around the world.  According to Bloomberg, investors held more than $8 billion in Lehman structured notes alone as of September, with $2.8 billion of those sold in 2008.

Typically, and in the case of the Lehman notes, derivatives (i.e. options, etc.) are used to morph a basic debt instrument with a fixed maturity into something purportedly better.   In reality, these are very complex products.  In fact, based on our investigation thus far on behalf of investors, it appears that many of the financial advisors selling these products for firms such as UBS didn’t understand what they were selling to their customers. In some cases, financial advisors appear to have been misled by their own brokerage firms as to the risks and complexity inherent in these products.

The banks and brokerage firms that sold these products — primarily UBS (UBS), Merrill Lynch (MER), Barclays (BCS), and Wachovia (WB) — misrepresented the safety of these Lehman notes and neglected their duties to investors.

We’re finding the following in the portfolios of investors who’ve contacted us about legal representation: misrepresentations evidenced by inaccurate sales pitches that downplay or deceive investors regarding credit and liquidity risks, and inappropriate concentration levels in accounts that lack diversification.

In sum, sales pitches to investors misrepresented the safety of principal and upside opportunities of these notes, which in turn led to a lack of diversification and overconcentration in these products. Much like the siren song for equity index annuities — principal protection and an upside opportunity to participate in market returns — conservative investors proved to be an easy sell on these products.

Although the harm to investors is most clear with respect to the Lehman notes in light of the Lehman bankruptcy (as mentioned in a previous article, according to a spokesman from SecondMarket, Lehman principal-protected notes are selling for 10 to 14 cents for every dollar of principal invested), investors’ concerns shouldn’t be limited to Lehman notes.

Chris Vernon, attorney at law

Vernon Litigation Group

(239) 319-4434, e-mail:

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