As the price of Apple (symbol: AAPL) common stock rose dramatically during a four-year bull run beginning in early 2009, brokerage firms including J.P. Morgan Chase, (symbol: JPM), Morgan Stanley (symbol: MS), UBS (symbol: UBSN.VX), and Barclays (symbol: BARC.LN) collectively sold hundreds of millions of dollars of various structured investment products linked to Apple common stock. These so-called equity-linked notes included single-observation reverse convertibles, reverse convertibles and auto-callable notes linked to Apple’s stock price. The notes transferred the downside risk of owning Apple stock to investors but capped the upside at somewhat more than corporate bond yields.
These products are essentially bonds that can turn into stocks of other companies, in this case Apple common stock. They pay high interest, typically monthly, for one year or less. If the stock the products are tied to rises or stays close to its price at the time the products were issued, investors get all of their money back when the bonds come due. But if the stock falls more than a certain percentage, investors are given shares of the fallen stock rather than a return of their principal at the due date. Under those circumstances, investors may receive substantially less than the face value of the bonds. In the case of Apple equity-linked notes, investors are expected to suffer tens of millions of dollars in losses. The implosion of these Apple equity-linked notes is a reminder that there is no such thing as high yield with low risk. Complex investments generally favor the seller, not the buyer.
As typically is the case with the complex products that Wall Street sells to investors, brokerage firms were motivated to sell these products. Simply, the Apple-linked products gave brokerage firms a cheap way of betting that Apple’s stock price would decline. Now, in many cases, they can dump the fallen stock on the investors who thought they were buying conservative investments.
Many brokers were not properly trained about these products and they consequently often misrepresented and failed to explain the significant risks of these complex structured products to investors. In some instances the SEC has barred brokers from the securities industry for failing to properly advise investors of true nature and risks of equity-linked notes. Investors in Apple equity-linked notes now are facing tens of millions of dollars in losses as a result of being sold these investments without being properly informed of the true risks.
