Et tu Schwab?

June 12, 2009

Discount brokerage Charles Schwab may be facing a Lehman-sized headache.

It appears some Schwab brokers were actively selling so-called structured notes–derivative-like investments–that were issued by the now bankrupt Lehman Brothers. The structured notes were pitched as principal protected, meaning investors might not make a lot of money if a strategy failed, but they wouldn’t lose their initial investment either.

The only problem with the sales is pitch that the Lehman issued structured notes were guaranteed by Lehman. The notion that an investors’ prinicipal investment was 100% protected went out the window when the Wall Street firm filed for bankrupty last fall.

Lehmans’ collapse is proof that unless an investment is backed by the federal government there really is no such thing as a “100% principal protected” note.  In other words, there are no free lunches for investors on Wall Street.

Seth Lipner, a New York securities lawyer, says he’s on the verge of filing an arbitration claim against Schwab on behalf of a Florida couple who purchased Lehman structured notes through Schwab. He claims Schwab “misrepresented” the risks associated with these notes. Lipner’s clients invested $60,000 in these now all-but-worthless notes. But Lipner suspects Schwab peddled Lehman notes to many other customers.

Schwab wasn’t immediately available for comment. But if they call back, I’ll update with their response.

Up until now, UBS was the biggest known seller of Lehman structured notes in the US. In fact, New Hampshire securities regulators, earlier this month, filed a cease and desist notice against UBS over the sale of Lehman structured notes. Regulators claim UBS brokers “exaggerated” the safety and security of the notes.

Structured notes, which use a derivative to give investors exposure to a wide range of asset classes, long have been a big seller in Europe and Asia. In fact, a Lehman entity in Amsterdam issued some $30 billion of these notes to overseas investors. Regulators across Europe and Asia are investigating the sale of these notes and some are agitating for reforms.

Of course, it’s a wonder why anyone needs to buy a structured note in the first place. Buying an index fund or a basket of stocks or commodities will often get an investor the same kind of asset exposure as a structured note.

All structured notes do is just give banks another way to rake in fees and dupe investors into buying something they really don’t need.

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