Investment Products
Many investors are familiar with investments in common stocks, bonds, mutual funds, certificates of deposit and other traditional investments. Losses in these investments often form the basis of a legal claim. In addition, you may have followed the advice of a financial advisor and put money into a less traditional investment, based on the promise of higher than average returns. There is a large variety of non-traditional investments, many of which are explained below.
Many less traditional or “alternative investments” pose significant risks that are hard to understand. Often investors do not understand the full risks of an investment. Often the risks are not properly explained or disclosed.
If you have recently lost money in a product you did not understand, you may have a claim for damages.
Bonds
Bonds are debt instruments or securities in which the holder (investor) is owed a debt by the issuer, generally a corporation or government. The issuer is obligated to pay interest to the holder of the bond at fixed intervals and to repay the principal at the bond’s maturity date. Bonds typically provide income to an investor throughout the term of the bond or at maturity. Credit rating agencies like Moody’s or Standard & Poor’s evaluate the credit worthiness or risk of nonpayment of bonds. Bonds that carry higher risks typically offer higher interest rates. Bonds that are rated below “investment grade” are called “high-yield bonds” or “junk bonds” and, while they pay higher yields (interest rates), they also carry a higher risk of default.
Certificates of Deposit (“CDs”)
CDs are contracts with banks or credit unions whereby the investor agrees to keep a specified amount of money on deposit for a specified time, for example three or six months or one or more years. In return, the bank or credit union agrees to pay a specified interest rate on the deposit, which is generally higher than the bank’s rate for savings accounts (which have no fixed term). Bank CDs are generally insured by the FDIC and credit union CDs are generally insured by the NCUA. While most investors are familiar with traditional bank CDs, more complex CD products exist. These products may promise higher returns, but also carry higher risks.
Commodities/Gold/Silver
Investments in commodities (such as crude oil, coal, sugar, coffee beans, wheat and other goods) and precious metals (such as gold, silver or platinum) can be made indirectly through stocks, mutual funds, ETFs, or derivatives, or directly by buying or selling the commodity or precious metal itself. Interest in precious metals has increased in recent years as the price of gold and silver has reached all-time highs. Speculating on commodities prices has inherent market risk. This risk can be increased by the risks of the investment vehicle utilized to invest in the commodity (for example derivatives and/or margin accounts). Commodities trading is regulated by the Commodity Futures Trading Commission (“CFTC”) and the National Futures Association (“NFA”).
Exchange-Traded Funds (“ETFs”)
An ETF is an investment fund, similar to a mutual fund, but it can be traded on stock exchanges throughout the trading day at a fluctuating market price, much like stocks. (A standard, open-end mutual fund may be resold by the investor directly to the mutual-fund company only at a price determined by the fund’s net asset value at the day’s end.) ETF’s generally hold stocks, bond or commodities and often track an index. ETFs gained in popularity in the U.S. following the introduction of Standard & Poor’s Depositary Receipts (“SPDRs” or “Spiders”) in 1993, which were intended to track the results of the S&P 500 Index. The number and types of ETFs has grown, including ETFs that are highly complex and that invest in less traditional strategies.
Foreign Exchange (“FOREX”)
The foreign exchange market is worldwide financial market for trading currencies. Brokers who offer investors the ability to trade foreign currencies (“FOREX” or “FX”) are regulated by the CFTC and NFA. The CFTC has warned against FOREX and precious metals scams, especially those claiming high profits and low risks. The CFTC implemented new rules for retail FOREX trading effective October 18, 2010, pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Hedge Funds
A hedge fund is a private investment fund that implements a variety of investment strategies designed to protect investors from market downturns or maximize returns during market upswings. Participation in a hedge fund is limited to accredited or qualified individual investors and certain institutional investors. Hedge fund managers often contract for substantial “performance fees” whereby the manager receives a sizable portion of the fund’s returns (say, 20% of any gains), but does not share in any of the downside risk. A hedge fund investment may include restrictions on an investor’s ability to withdraw money before a specified time.
Limited Partnerships
Limited partnerships and limited liability companies are generally private companies (i.e., companies that are not traded on stock exchanges) in which investors can buy interests similar to shares of stock in a corporation. Oil and gas investments, real estate investments and private equity funds are often offered to investors through limited partnership interests. These investments are typically sold as “private placements” under a claimed exemption to the more stringent registration and disclosure obligations applicable to public offerings. To qualify for the most common exemptions, the offeror of limited partnership interests cannot make any general solicitation or advertisement to investors, and investors must (for the most part) be “accredited” investors meeting minimum requirements of income or net worth. The investment may be in the form of interests or units in a limited partnership or limited liability company.
Promissory Notes
Promissory notes are simply contracts under which an investor loans a specific sum of principal in exchange for the promise to receive interest over the term of the note, plus return of the principal at maturity. Payment of interest and repayment of principal depend on the borrower’s creditworthiness and the security and value of the collateral underlying the note, if any. While promissory notes may sound secure, they can be quite risky.
Margin Accounts
A margin account is a brokerage account in which the broker-dealer or securities firm loans money to its customer to buy investments. The securities firm generally holds the investments (and other assets) as collateral for the loan. Margin accounts give investors “leverage” (additional, borrowed funds) to buy more investments than they otherwise could, using the firm’s money. The investor is charged interest on the borrowed funds. In addition, if the value of the collateral (the investments bought on margin) declines, the investor will receive a “margin call” requiring the customer to deposit additional collateral (cash or other investments) or sell the investments bought with the borrowed funds, often at a loss. Thus, buying investments on margin creates additional risk because, if the value of the investments declines, the leverage will work against the investor. In this event, the investor will end up taking a loss on the investment and owing the firm the amounts borrowed on margin, plus interest. These amounts can often be several times more than the investor’s starting capital. By the same token, if the investment increases in value, the margin account will have enabled the investor to reap greater gains due to having more capital to buy more of the investment. So long as the gains are greater than the margin interest, the investor is ahead. Thus, margin accounts increase risk and can magnify both gains and losses.
Mutual Funds
Mutual funds have dramatically gained in popularity since the 1970s. Mutual funds are professionally managed collective investments that pool the money of several investors. Instead of directly owning a stock, bond, or other security, investors in mutual funds buy ownership in a trust or company that then invests the pooled funds consistent with the fund’s stated investment objectives. Mutual funds are regulated by the SEC under the Investment Company Act of 1940. There are thousands of mutual funds in the U.S., holding trillions of dollars in assets. Mutual funds present a wide range of investment objectives, management styles, and fee structures. Oil & Gas Investments/Mineral Interests/Royalties – In Texas, the right to payment from oil or gas production is usually divided between the landowner (the owner of the mineral rights below the surface), who is entitled to receive a fraction of the production (or its cash equivalent) as a royalty, and the operator/lessee, who drills and operates the well. Oil and gas investments in Texas are regulated by the Texas State Securities Board. Oil and gas investments are often offered to investors through interests in partnerships or limited partnerships by way of private placements.
Options/Derivatives
Options are one of the most common types of derivative investments available to individual investors. Derivative investments are contracts that derive their value from another, underlying investment (e.g., a stock, bond, or commodity). A stock option, for example, may give its holder the right (but not the obligation) to buy or sell shares of stock at a specified price. An option that gives the holder the right to buy something at a specified price at or before a future date is known as a “call.” An option that gives the holder the right to sell something at a specified price at or before a future date is known as a “put.” Many options are traded on the Chicago Board Options Exchange (“CBOE”). Sometimes options are used for hedging (offsetting potential losses in another investment) or employee compensation (employee stock options). When used for speculation, options and other derivatives can present very high levels of risk.
Penny Stocks
In the U.S., shares trading for less than one dollar are known as penny stocks. Their low valuation and low trading volumes make them susceptible to price manipulation schemes.
REITs
A “real estate investment trust” (“REIT”) may be a trust, corporation, or association that owns (and sometimes operates) real estate. Ownership in a REIT takes the form of transferable shares or “certificates of interest.” Owners expect to receive periodic distributions of income from the REIT. The shares in many REITs are publicly traded. REITs can also be privately held and sold through private placements. REITs provide a structure for investing in real estate similar to the structure mutual funds provide for investing in stocks. The value of an investment in a REIT will be heavily affected by the REIT’s underlying real estate assets and operating costs.
Stocks
Stocks provide an investor with equity ownership in a company. Each share of stock is a unit of ownership in the company. Shares of major U.S. companies are typically traded on well-known stock exchanges like the New York Stock Exchange (“NYSE”) or the NASDAQ. Stocks may provide income in the form of dividends, or may be traded (bought and sold) for a profit or loss. Companies offering publicly traded stock in the U.S. must file periodic reports with the Securities and Exchange Commission (“SEC”). Publicly traded stocks are one of the most heavily regulated types of investment.
Variable Annuities
Variable annuities are an insurance product, a contract between you and an insurance company. They combine the features of an annuity (a guaranteed single or periodic payment from an insurance company) with the possibility of market gain (or loss) depending on the performance of an underlying investment strategy (the “variable” part of the investment), similar to a mutual fund. Thus, the insurance company guarantees a minimum payment and any remaining payments can vary depending upon the performance of the underlying investments. Common drawbacks to variable annuities include substantial penalties for early withdrawal, the potential for substantial fees and expenses, and the addition of credit risk (the risk that the insurance company might default on its contractual obligations to you) to the market risk of your chosen investment strategy.
Securities Arbitration & Securities Fraud Claims
The sale of a life insurance policy before the death of the insured is a viatical. An investor who buys viatical purchases the right to receive all or a fractional portion of the death benefit from a life insurance policy insuring someone else’s life. These contracts are also known as “life settlement” contracts. The seller (policyholder/insured) receives a cash payment during his lifetime of less than the policy’s death benefit. The investor/buyer then receives the right to payment of the death benefit at the insured’s death.