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EXPERIENCED SECURITIES REGULATORY LAWYERS
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Complex Investment Products

Today’s investors have a multitude of choices among the investment products available in the securities markets. However, many times investment products created for and marketed to financially sophisticated and wealthy investors are also sold to elderly, inexperienced or small investors. These products are complex and not easily understood by many, if not most, investors. They may have significant back-end charges, large management and/or administrative fees and hard to understand risk factors (they also probably have large sales charges, which accounts for their popularity among brokers).

Frequently, these products incur losses which investors can’t understand and did not foresee, based on what they were told by their investment advisor. Below are some of the investment products currently available which investors should take a long look at before deciding to part with their hard earned savings or retirement funds.

Variable Annuities – A variable annuity is a contract with an insurance company in which the company agrees to make periodic payments to the purchaser either immediately or some time in the future. The funds used to purchase the annuity are typically invested in mutual funds. Investment selections can be changed at no cost without penalties. The principal investment grows tax-free until withdrawal.

However, early withdrawals pay a deferred sales charge and withdrawals prior to age 59 ½ are subject to tax penalties.

Features such as death benefits and guaranteed minimum values can be added to the annuity – but at a cost to the purchaser.

These are complex products which investors should be sure they fully understand prior to purchase.

Exchange Traded Funds – “ETFs” are very popular products that are comprised of a “basket” of underlying securities. ETFs operate like mutual funds in that they track the performance of their underlying assets. Unlike mutual funds their price fluctuates daily; they trade like a common stock.

However, what concerns regulators today (and what should concern investors) are leveraged and inverse ETFs. Inverse ETFs use derivatives to deliver inverse returns of the underlying securities. Leveraged ETFs use derivatives and debt to increase returns of the underlying securities.

These are very aggressive trading vehicles which are not suitable for many investors.

Real Estate Investment Trusts – “REITs” are companies that acquire income producing real property such as apartment buildings, commercial buildings, etc. REITs perform like mutual funds, are traded on national exchanges and are very liquid.

Non-traded REITs are very different from REITs. As the name implies, they do not trade on any exchanges and are therefore very illiquid. They are meant to be held several years; early redemption is very limited and will typically occur at a price well below the purchase price. The upfront fees charged for these investments are very high.

They are not suitable for many investors.

Structured Products - There are various types of structured products in the marketplace. They typically consist of an underlying security, “basket” of securities, commodities, indexes, etc. The underlying security/securities are linked to a derivative product, usually an option.

Common structured products are collateralized mortgage obligations (“CMOs”), collateralized debt obligations (CDOs”), mortgaged backed securities (“MBSs”) and credit default swaps (“CDSs).

These investments, originally designed for institutional investors, are very complex. Investors should proceed with caution in purchasing these securities.

Penny Stocks – Penny stocks, some times referred to as low priced securities, have been around for decades. They typically trade outside of the major national exchanges. These stocks are considered risky because of their lack of liquidity, large bid-ask spreads, small capitalization and limited following.

Promissory Notes –Promissory notes are legal agreements in which the issuer of the note agrees to pay a stated amount to the payee who has invested funds with the issuer. The note promises that the issuer will pay an amount equal to the principal payment plus a stated rate of interest on the principal at some time in the future. Promissory notes can be legitimate investments – but, unfortunately, are often the instruments of investment scams.

Puerto Rico Bonds – For the past two years, the saga of Puerto Rican municipal debt has roiled bond rating agencies, brokerage firms and debt holders. The combination of escalating debt, a structurally weak economy and massive unfunded pension obligations has left Puerto Rico facing bankruptcy (which, by law, is not available to the commonwealth). Holders of Puerto Rican municipal debt, or funds that hold such debt, are facing substantial losses. Those holders may only be able to recoup their losses by filing arbitration claims versus the brokers who sold them Puerto Rican debt

Oil and Gas Industry – Oil and gas prices have dropped dramatically in the past several years. While that may be good for motorists, purchasers of energy stocks that have fallen to 2008 levels have felt the pain of unmet expectations. But stockholders of oil and gas companies are not the only investors to experience losses. Investors in gas and oil master limited partnerships (“MLPs”), oil and gas private placements, exchange traded funds (“ETFs”), exchange traded notes (“ETNs”) have also experienced losses.

The list above is not exclusive. More and more complex products are being created and marketed to retail investors by the securities industry. Many of these products are unsuitable for many investors. If you have a question concerning a recent investment, or the management of your account, contact the experienced securities attorneys at Lubiner, Schmidt & Palumbo.

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