Equity Linked Notes
Equity linked notes are generally fixed income securities that usually pay above market rate of interest, based upon the price or performance of a particular equity or index of equities. However, such rates are usually capped at a certain amount, should the price of the underlying security or the rate of return increase above a certain value, and in addition, should the price of the underlying security or index decrease in value, these securities are also associated with a put option, meaning that instead of receiving either interest or principal as payment for the note, the investor just gets the underlying security, which by definition has already decreased in value. Sort of “the heads I win, tails you lose” investment manufactured by Wall Street.
For example, a brokerage firm may underwrite the $100 million offering of the Proctor & Gamble 8% Equity Linked Notes. In this particular case, the broker-dealer and its sales persons may realize up to 4.5% or $4.5 million simply from the sale of the underwriting. According to the prospectus, all investors get at a minimum 8% return on their investment based upon the value of Proctor & Gamble’s common stock, up to a stated percentage or cap. So if Proctor & Gamble common stock increases by 15%, the investors may get a 15% return, but if the price of Proctor & Gamble’s common stock increases by 30%, the investors still only get 15% because the investors return is capped at 15%. Any increase above this amount, in addition to management fees, generally belongs to the fund manager. However, should the price of Proctor & Gamble’s common stock decrease by let us say 20%, the party is over, the investors do not get back their principal investment. Instead, they get their Note paid off with Proctor & Gamble common stock at market value or some previously stated conversion rate.
Equity Linked Notes Can Be a Lose-lose for Investors
The result is a win, win, win, for everyone except the customer. The brokerage firm and its sales persons earn commissions from the underwriting and sale to the public. If the underlying investment goes up too much, investor returns are limited. If the underlying investment goes down to much, the firm’s downside risk is limited, and all along the way, the generally affiliated investment managers and related broker-dealers executing transactions for these managers, make money. Often the customer, who thought they were buying a note or fixed income investment is stuck with owning the common stock of some company, worth substantially less than the amount of their original investment.
Guiliano Law Group
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AboutNicholas J. Guiliano
Nicholas J. Guiliano has more than 25 years of securities related experience, and has represented more than 1,000 public customers in claims against brokerage firms for fraud in connection with the sale of securities principally in arbitration before the Financial Industry Regulatory Authority (“FINRA”) Dispute Resolution, Inc. (formerly known as The National Association of Securities Dealers (“NASD”) Dispute Resolution, and the New York Stock Exchange (“NYSE”) Department of Arbitration.LEARN MORE