In my work forensically examining investment portfolios on behalf of endowments, foundations and pensions, I have observed an alarming trend.
Increasingly, banks serving in a fiduciary capacity, such as a discretionary or nondiscretionary trustee of a fund, are buying highly complex structured notes on behalf of clients or recommending they purchase such instruments.
This is disturbing because the notes lack virtually any of the hallmarks of a prudent investment, including such critical features as liquidity and transparency. While investing in any kind of structured note is almost never a good idea, these particular investments are by design especially unsuitable for fiduciary accounts.
To make matters worse, the structured notes I have found in bank fiduciary accounts are almost always issued or underwritten by the bank managing and acting as custodian for the portfolio.
For example, in one client’s portfolio holding 61 structured notes, the bank served as placement agent for all 61 of them. If the complexity and risk related to structured notes weren’t daunting enough, I would think banks would consider conflicts of interest and self-dealing sufficient reason to avoid recommending them to fiduciary accounts. I can only conclude that the profits derived from selling these products are compelling. Apparently that’s more temptation than many banks can resist.
Structured notes are highly customized investments created by savvy commercial and investment banks. The provisions of the notes are drafted to favor the firms and intermediaries that create and sell them and are of Byzantine complexity. Newer products add features that increase profits to issuers, making it ever more difficult for investors to evaluate the merits of the investment.
In the bizarre world of structured note investing, time-honored traditions of investor protection, such as prospectus delivery, are routinely flouted. At best, clients receive a brief “term sheet” summarizing the voluminous provisions of the offering. Not surprisingly, none of the pensions, endowments or foundations I’ve encountered that invested in these notes even knows what a structured product is. Since 2008, regulatory concern about these investor-unfriendly investments has grown as buyer complaints and tales of massive losses have surfaced. In 2010 the Securities and Exchange Commission and state securities regulators set up special task forces to police structured products.
Over the last year I have been speaking with banking regulators, as well as state and federal securities regulators, to raise awareness of the role banks play in steering these products into pension, endowment and foundation portfolios.
When you add together the conflicts of interest or self-dealing; complexity that is mind numbing; and absurd levels of risk for a rate of return that’s at best on par with what you’d expect on riskless instruments like Treasurys – it’s clear that sales of “doomed” structured notes represent a formidable liability for bank issuers.
Edward Siedle is the president of Benchmark Financial Services, an Ocean Ridge, Fla., firm that investigates money management abuses primarily on behalf of pensions. He is a former SEC attorney and later served as legal counsel and director of Compliance at Putnam Investments.
Complex Structured Notes Are a Lurking Liability for Banks
By Edward Siedle
In my work forensically examining investment portfolios on behalf of endowments, foundations and pensions, I have observed an alarming trend.
Increasingly, banks serving in a fiduciary capacity, such as a discretionary or nondiscretionary trustee of a fund, are buying highly complex structured notes on behalf of clients or recommending they purchase such instruments.
This is disturbing because the notes lack virtually any of the hallmarks of a prudent investment, including such critical features as liquidity and transparency. While investing in any kind of structured note is almost never a good idea, these particular investments are by design especially unsuitable for fiduciary accounts.
To make matters worse, the structured notes I have found in bank fiduciary accounts are almost always issued or underwritten by the bank managing and acting as custodian for the portfolio.
For example, in one client’s portfolio holding 61 structured notes, the bank served as placement agent for all 61 of them. If the complexity and risk related to structured notes weren’t daunting enough, I would think banks would consider conflicts of interest and self-dealing sufficient reason to avoid recommending them to fiduciary accounts. I can only conclude that the profits derived from selling these products are compelling. Apparently that’s more temptation than many banks can resist.
Structured notes are highly customized investments created by savvy commercial and investment banks. The provisions of the notes are drafted to favor the firms and intermediaries that create and sell them and are of Byzantine complexity. Newer products add features that increase profits to issuers, making it ever more difficult for investors to evaluate the merits of the investment.
In the bizarre world of structured note investing, time-honored traditions of investor protection, such as prospectus delivery, are routinely flouted. At best, clients receive a brief “term sheet” summarizing the voluminous provisions of the offering. Not surprisingly, none of the pensions, endowments or foundations I’ve encountered that invested in these notes even knows what a structured product is. Since 2008, regulatory concern about these investor-unfriendly investments has grown as buyer complaints and tales of massive losses have surfaced. In 2010 the Securities and Exchange Commission and state securities regulators set up special task forces to police structured products.
Over the last year I have been speaking with banking regulators, as well as state and federal securities regulators, to raise awareness of the role banks play in steering these products into pension, endowment and foundation portfolios.
When you add together the conflicts of interest or self-dealing; complexity that is mind numbing; and absurd levels of risk for a rate of return that’s at best on par with what you’d expect on riskless instruments like Treasurys – it’s clear that sales of “doomed” structured notes represent a formidable liability for bank issuers.
Edward Siedle is the president of Benchmark Financial Services, a firm which investigates money management abuses primarily on behalf of pensions. He is a former SEC attorney and later served as legal counsel and director of Compliance at Putnam Investments
