The Securities Litigation Expert Blog

Jack Duval Quoted on Wells Fargo AWC over Complex Investments

Posted by Jack Duval

Aug 7, 2015 1:26:06 PM


Accelerant Managing Partner Jack Duval was quoted in a Thomson Reuters Regulatory Intelligence article.  The article can be found on the Thomson Reuters Risk website here.  (Behind a paywall.)  For thost without access, the entire article is copied below:



Wells Fargo Fined Over Investment Product Too Complex for Brokers, Clients

Aug 05 2015 Richard Satran, Regulatory Intelligence

The sale of an investment that the U.S. securities industry regulator found too complicated for the amount of training and preparation on the part of Wells Fargo's sales team has generated a long tail of fees and legal costs for the broker dealer.

The Financial Industry Regulatory Authority said Tuesday it had reached an agreement with Wells Fargo on a censure and fine of $500,000 for the broker dealer's failure to educate and train brokers on the risk of the complicated floating-rate loan fund first sold in 2008 by the company's predecessor, Wachovia.

"This is one of those cases where complexity itself is the risk," said Jack Duval, managing partner of Accelerant, a securities litigation consulting firm. "The complexity comes back to bite everybody -- first at the client level and then at the broker level. Many investments have gone wrong because brokers misunderstood what they were selling." 

FINRA already has awarded restitution and assessed fines against Wells Fargo for the selling "unsuitable" investments in the case of the floating rate securities it calls STRATS, an acronym that stands for Structured Repackaged Asset-Backed Trust Securities.

Clients were sold on the STRATS for their safe, enhanced yield by brokers who were not made aware risks of the products, FINRA said in the action announced Tuesday. The STRATS were constructed from bonds whose fixed income interest payments were swapped for floating rate swap agreements. Far from simple, conservative securities, the STRATS were structured products loaded with fees for early termination and a capital security whose value fluctuated in the market.

The brokers "were generally not familiar" with the investments they were selling and the firm did not provide the training and supervision to sell them. In its investigation, FINRA reviewed internal marketing collateral and found that brokers would have "no reasonable basis for recommending the STRATS to retail customers."

The case shows how costly and time consuming a complicated financial offering can become. The broker has paid out some $10 million in fines and restitution for fund sales of only $12 million. While it pales compared with the $5.42 billion Wells reported for its quarterly profit last month the case generated untold legal costs over five years, along with reputational damage. Wells Fargo said it does not comment on FINRA cases.

In the latest action this week, Wells Fargo was still paying out for the complex investments that were initially packaged by Wachovia, a firm it acquired in a government supervised distress sale in 2008. In addition to the half-million dollars in new fines, the new agreement required new restitution of $241,974.34 in 2012 to pay customers for unexpected costs at the final redemption for those who held the securities issued six years ago. FINRA found that holders were not made aware of the risk that they would lose part of the principal on their investment on account of a termination fee.

"At the time of the STRATS termination many customers holding the STRATS received less and in some cases significantly less, than they paid for the STRATS." For Wells Fargo, the costs have also mounted for an ostensibly conservative trading instrument that kept on claiming time and money.


Learn more about complex investment expert Jack Duval.

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Topics: Structured Products, Complex Investments, Compliance, Investment Complexity, Complex Investment Expert, Wells Fargo, FINRA Regulation, STRATS, AWC

Increasingly Complex Investments for Retail Investors

Posted by Jack Duval

Feb 3, 2014 8:14:00 AM

This blog post continues our expert analysis of complex investments.

The Increasing Complexity of Retail Investments

The number of investments available to retail investors[1] has expanded at an exponential rate over the past 30 years.  In the 1970s, the typical retail investor was presented with a very short menu of investment options: individual stocks and bonds and mutual funds.  Investments such as hedge funds, private equity funds, and venture capital funds were a small industry and the exclusive domain of institutional investors and the very wealthy.  Index funds, structured products, and ETFs had not yet been invented.

Retail investors invested directly in stocks and bonds and institutional investors invested through intermediaries.

In 2013, that has all been reversed.  Now only a small fraction of the trading volume on the stock exchanges is done by retail investors. [2]  Instead, they are investing through intermediaries such as mutual funds, separate account managers, index funds, ETFs, structured products, and hedge funds, to name a few.

Investing through products or intermediaries may seem a benign or even superior method for individuals to invest, but it carries with it a risk that is typically not recognized:  complexity.

The packaging of investments into products adds a significant level of complexity to investing.  This is simply because the investor not only has to understand the characteristics of the underlying investments, but also those of the investment vehicle itself.

A simple example of this is of an equity mutual fund.  In order to understand an investment in an equity mutual fund, the investor has to understand the what an equity is as well as how a mutual fund works.

This adds a layer of complexity and requires more analysis and a much broader range of knowledge on the part of the investor.  Table 1, below, shows the difference in elements that factor into reviews of individual equities and equity mutual funds.

Table 1.  Comparison of Elements Involved in Investment Evaluation 

Individual Equity Equity Mutual Fund
Business Model Size/Style/Sector/Country Dynamics

Economic/Sector Outlook

Economic Outlook
Stock Valuation Market Valuations
  Investment Discipline/StrategyManagement Tenure and Turnover
  Fund Strategy Risk Level
  Fee Structure
  Liquidity Constraints

While there are certainly additional items that could be added to both columns, Table 1 gives a sense of the difference in the additional elements required to understand an equity mutual fund as compared to an individual equity. 

This example is particularly telling because most investment professionals would place an equity mutual fund on the simple side of the complexity continuum.  However, to the layman, mutual funds can be beyond their understanding.

The Complexity of Structured Products

As mentioned above, structured products did not exist 30 years ago, but now they represent a large and growing market.  There are three broad categories of structured products, each with there own risks and payoff structures.  I have listed them below.

Table 2.  Broad Structured Product Categories[3]

Certificates Maximum Return Capital Protection
Index Discount Vanilla
Basket Reverse Convertible Asian
Bonus Step Ladder

From the retail client perspective, structured products are exotic and opaque.  In order to understand them one must understand options and futures pricing, which involves some advanced mathematical aptitude.  This fact alone puts structured products beyond the grasp of most retail investors.

However, the potential investor must not only understand the risk and payoff structure of the embedded options or futures in the structured product, they must also evaluate a host of risks that are inherent to the investment vehicle itself.  Some of these risks include:

  •       Credit (Issuer)
  •       Liquidity
  •       Leverage
  •       Interest Rate

Finally, the investor must also undertake an analysis of the underlying investment, just as they would if they were going to invest in it directly.

Thus there are multiple analyses that must be completed in order to evaluate and understand a structured product, including: options/futures pricing and payoff structure; vehicle risks; and underlying investment.

While any one of these tasks requires substantial financial expertise, taken together they require professional level knowledge.  Furthermore, because of the complex nature of a structured product, it may be impossible to fully comprehend how different scenarios would affect its price.

For example, a rise in interest rates would effect the embedded option, the issuer, and the underlying investment in different ways and magnitudes.  Even an experienced professional would be hard pressed to predict the net effect of such a move on the structured product price.

Indeed, many investment professionals do not fully understand complex investments and have sued their own broker-dealers after having been sued by their clients.  (See our coverage of this phenomenon here.)


The Accelerant roster of securities experts with complex investment backgrounds includes:

Steve Pomerantz, Ph.D., Tom Boczar, Esq., CFA, Tom Brakke, CFA, Gerry Guild, CFA, and John Duval, Sr.

You can find the complete roster here.


[1]         I use “retail investors” to distinguish individual investors from institutional investors.  Importantly, retail investors include high net worth investors, because the mere fact of having money does not convey understanding or sophistication about investments.  This fact is sadly borne out by the great many high net worth investors who have lost their fortunes on bad investments or swindles.

[2]         Davis, Alicia J. "A Requiem for the Retail Investor?" Va. L. Rev. 95, no. 4 (2009): 1105-29.  “The American retail investor is dying.  In 1950, retail investors owned over 90 percent of the stock of U.S. corporations.  Today, retail investors own less than 30 percent and represent a very small percentage of U.S. trading volume… recent New York Stock Exchange data reveal that trades by individual investors represent, on average, less than two percent of NYSE trading volume for NYSE-listed firms.”  (Notes omitted.)

[3]         Structured Products in Wealth Management, Steffan Tolle, Hunter, Ruthemann, and Wohlwend; John Wiley & Sons, 2008; Kindle Edition; 1333-1759.



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Topics: Structured Products, Complex Investments, Securities Expert

IOSCO Publishes "Regulation of Retail Structured Products" Report

Posted by Jack Duval

Apr 30, 2013 2:51:00 AM

This blog post continues our expert analysis of complex investments and their regulation.

IOSCO has published a consultative piece on the regulation of retail oriented structured products.  (Press Release, Paper)  As you can read, there is much confusion about structured products, even at this level.  For example:

    • There is no clear definition of a "retail client";

    • There is no clear definition of "structured product"

There are some things that are clear though:

    • The products are complex;

    • There is a large amount of issuance;

    • There have been many blowups of structured products in the recent past

Investors and advisors alike should be wary of structured products because of their complexity and high costs.

Our previous coverage of structured products can be found here, here, and here.

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Topics: suitability, investments, Structured Products, Complex Investments, Compliance, IOSCO, Complexity

New Financial Assets Increase Market Risks

Posted by Jack Duval

Apr 23, 2013 4:49:00 AM

This blog post continues our expert analysis of complex investments and their regulation.

A new paper from Alp Simsek of MIT makes an argument that financial innovation always increases market risks.  (See the WSJ article on the paper here, and the paper here.)  Essentially, the argument boils down to this:

    1. New financial products create new disagreements about valuations and outcomes;

    1. These products are new and therefore disagreements are bound to be wide;

    1. New products amplify speculation on existing disagreements;

    1. They also allow traders to purify their bets (and speculate on more narrow outcomes) or in economic terms, the traders opportunity set has increased;

    1. When traders are able to make purer bets, they make larger bets

The traditional argument for financial innovation is that it allows for risk sharing, and that those who don't want to take certain risks can trade them to others who want them.  This paper is interesting because it shows that aggregate risks are increased by the endogenous introduction of new financial products (by amplifying old disagreements and introducing new disagreements).
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Topics: investments, CDS, Structured Products, financial innovation, RMBS, CDO, risk, Complexity

Bubble Alert - Student Loan Defaults up 36% Y/Y

Posted by Jack Duval

Mar 27, 2013 3:02:43 AM

One of the biggest bubbles in history is beginning to show signs of distress.  Reuters reports a sharp increase in Student Loan defaults.  (Reuters)  Here's your money quote:

Delinquencies have spiked in the last eight years, with about 17 percent of the nearly 40 million student loan borrowers at least 90 days past due on their repayments, a February report from the New York Federal Reserve Bank showed.

This is the sub-prime loan debacle all over again.  Lenders give loans to anyone who can fill out an application, the loans are ultimately guaranteed by FFELP, or some other government agency, creating the same perverse incentives and agency problems as with RMBS.  Which gives us the maxim of our age:

All lenders with no skin in the game eventually blow up.

For you traders out there, there is a way to short the student loan bubble.  See this Zero Hedge article on the SecondMarket platform.  (ZH)

New York Federal Reserve analysis can be found here.

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Topics: Student Loan Bubble, bubble, investments, FFELP, SecondMarket, Structured Products, fixed income

Risks of Structured Products

Posted by Jack Duval

Mar 22, 2013 2:53:00 AM

This blog post continues our expert analysis of complex investments and their regulation.

While structured products are often marketed with one-page fact sheets, they are usually highly complex.  Some of this complexity can be seen in the multitude of risks that can be found in most structured products.  Some of these risks include:

    • Credit (Issuer)

    • Reference Security

    • Liquidity

    • Maturity

    • Interest Rate

    • Leverage/Embedded Option

    • Concentration

Evaluating these risks is beyond most investors and many securities sales personnel, leading to portfolios which can be much more risky then either intended.

Compliance and supervisory staff should be extra vigilant of portfolios with high concentrations of structured products.  Portfolio risk assessment by supervisory staff and subsequent frank discussions with registered representatives and clients is a must to avoid excessive and unknown risk-taking.

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Topics: FINRA, Investment Advisors, investments, supervision, Structured Products, risk, Complex Investments, Compliance, Complexity

Protecting Senior Investors - Finra Product Focus Areas

Posted by Jack Duval

Mar 19, 2013 6:15:00 AM

This blog post continues our expert analysis of complex investments and their regulation.

Finra has delineated a number of products to focus on regarding sales to senior investors.  (NTM 07-43)  Some of these include:

    • Any products with withdrawal penalties, including: Variable Annuities, Variable Life Settlements, Equity Indexed Annuities, REITs, and Limited Partnerships;

    • Complex Structured Products

    • Home Equity Lines of Credit

    • Early Retirement (Rule 72T Withdrawals)

Compliance officers and supervisors should take note of these as the Baby Boom generation moves into the senior investor category.

Our previous coverage of senior investors can be found here, here, and here.

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Topics: FINRA, NTM 07-43, Investment Advisors, Senior Investors, investments, SEC, Structured Products, Compliance, regulation., Complexity

Structured Products - Some Definitions

Posted by Jack Duval

Mar 18, 2013 3:15:20 AM

Due to the great variety of types of structured products, there is no one definition.  However, there are a number of traits that are common between them, including the use of a reference security or index and the use of derivatives.  Here are four definitions:

  1. Finra NTM 05-59, Structured Products:  "Structured products are securities derived from or based on a single security, a basket of securities, an index, a commodity, a debt issuance and/or a foreign currency."

  2. SEC Rule 434: "Securities whose cash flow characteristcs depend upon one or more indices or that have embedded forwards or options or securities where an investor's investment return and the issuer's paymet obligations are contingent on, or highly sensitive to, changes in the value of underlying assets, indicies, interest rates or cash flows."

  3. Structured Products in Wealth Management by Tolle, Hutter, Ruthemann, and Wohlwend: "The meaning of the term "structured products" as it is used in specialist literature is not the same everywhere.  This book defines structured products as combindations of derivates and traditional financial instrments, such as stock and bonds.  The various components are combined into a single financial instrument and securitized.  The inclusion of derivative components gives the structured product itself the characteristics of a derivative."

  4. Wikipedia:  "In finance, a structured product, also known as amarket linked investment, is generally a pre-packaged investment strategy based on derivatives, such as a single security, a basket of securities, options, indices, commodities, debt issuance and/or foreign currencies, and to a lesser extent, swaps.The variety of products just described is demonstrative of the fact that there is no single, uniform defnition of a structured product.."

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Topics: FINRA, NTM 05-59, Swaps, SEC Rule 434, Senior Investors, investments, SEC, Structured Products, fixed income

Goldman Sachs to Make Structured Products Available to Investment Advisors

Posted by Jack Duval

Mar 8, 2013 1:45:07 AM

Goldman Sachs is teaming with CAIS to offer structured products to registered investment advisors.  (GS)  From the press release:

 According to the terms of the agreement, pre-qualified CAIS Member Firms will have access to the Goldman Sachs structured products capabilities. Advisors that use CAIS will benefit from the efficiency of a centralized calendar offering and automated indications of interest. Additionally, all CAIS Member Firms will have direct access to Goldman Sachs’ resources to create customized offerings.

You can find our previous coverage of structured products here, here, and here.
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Topics: Investment Advisors, CAIS, investments, Structured Products, Goldman Sachs

Independent Valuations of Structured Products from EDI

Posted by Jack Duval

Mar 6, 2013 1:36:00 AM

This blog post continues our expert analysis of complex investments and their regulation.

Here's an overdue idea: independent valuations of structured products.  Exchange Data International and Derivative Partners are teaming up to do just that.  (EDI) Here's the press release:

Exchange Data International (EDI), a well-established provider of Security Reference and Corporate Actions data, today announced its partnership with Derivative Partners, a leading provider of independent risk management and valuation services of structured products, to provide valuations for a wide range of structured products and complex derivative instruments.

The current service covers result sets combining various asset classes including equity, indices, FX and commodities, payoffs and pricing models.

Derivative Partners operates a scalable architecture for providing daily independent valuations, currently calculating over 200,000 instruments using an independent database and proprietary state-of-the-art valuation models. In combination with a flexible approach for integrating new payoffs and pricing models this allows to meet the intensified regulatory demands for transparency that clients are faced with.

Jonathan Bloch, CEO at EDI says: "We have noticed an increased demand from our clients for independent portfolio valuations and more especially for complex financial derivatives and structured products over the last years. We are very pleased to have partnered with Derivative Partners and provide our clients with a reliable and impartial valuation solution that will help them meet the transparency standards."

Andreas Kropf, Managing Director of Derivative Partners Research, adds: "We have been continuously developing and enhancing our coverage of complex derivative instruments. The partnership with EDI allows us to bring our valuation capabilities to a larger audience."  (Emphasis added.)

 See our previous coverage of structured products here, here, and here.
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Topics: Exchange Data International, valuation, complex products, investments, Structured Products, fixed income, Derivative Partners, regulation., Complexity

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