When Wall Street lures Main Street into investing in the risky stuff known as "structured products," things don't always end well for the customer.
Last week's $19.5 million settlement between investment bank UBS (UBS) and securities regulators is just the latest example of why Mom and Pop have no business getting involved with Wall Street's most convoluted creations.
The UBS case is full of educational takeaways, so we might as well get right to it.
Lesson 1: The more complicated the financial product, the more opportunities for your brokerage firm to discreetly move money from your pocket to theirs.
The Securities and Exchange Commission said on Oct. 13 that UBS had given investors false or misleading information about the structured debt securities known as "Medium Term Securities Linked to the UBS V10 Currency Index with Volatility Cap."
Lesson 2: If you haven't figured it out already, never buy a financial product with a name that's 13 words long. We'll truncate the long-winded title to V10.
The agency said that, among other things, UBS didn't tell customers it was taking unjustified markups on hedging trades and trading for itself before making hedging transactions in the V10. The firm's actions depressed the price of the index used to calculate returns on the product by 5%, the SEC said.
UBS neither admitted nor denied the allegations. Spokesman Gregg Rosenberg said in a statement that the firm was "pleased to have resolved this legacy matter with the SEC," and that UBS is "firmly focused on the future with an unwavering commitment to upholding a culture of doing the right thing and reducing operational risks."
Now I suppose you might like to know exactly what a structured note like the Medium Term Securities Linked to the UBS V10 Currency Index with Volatility Cap is. The SEC has come up with the only definition I could find that stands a chance of making sense to someone who doesn't have a degree from the Wharton School of Business.
A structured note is "a debt security with a derivative tied to the performance of other securities, commodities, currencies, or proprietary indices," according to the SEC. If you can quickly construe how a product like that would work, and what the attendant risks might be, it's a reasonable bet you are not among the 1,900 UBS retail customers in the U.S. who put their money in V10.
Which takes us to Lesson 3: People who understand how structured products work are not usually the ones who buy them.
We all know that Aunt Agnes doesn't wake up one morning and phone her broker to say she'd like to get her hands on a debt security with a derivative tied to the performance of other securities, commodities, currencies or proprietary indices.
Then how is it that thousands of small investors like Auntie A. wind up buying Wall Street's most complicated products?
The answer is Lesson 4: Products like V10 are sold, not bought.
The sellers, of course, are the "financial advisers" who, according to the UBS Web site, "take a holistic wealth management approach to carefully understand your overall financial situation, unique needs and goals."