Structured Financial Products: a Legal Defense Guide for U.S. Issuers

The fundamental architecture of a structured financial product involves combining one or more derivative instruments with a reference asset or basket of assets to create a return profile that would be unavailable through a straightforward investment in either component alone, and ISDA agreement counsel who advise on derivative documentation for structured financial products must confirm that the product's underlying documentation accurately describes the payoff formula, the reference asset, and all conditions under which the product's return could be reduced or eliminated, including barrier events, early redemption triggers, and issuer call rights.

Defining the risk-return profile of a structured financial product requires a careful balance between the investor's desire for enhanced yield or principal protection and the issuer's need to hedge its exposure through offsetting derivative transactions, and structured investment products counsel advising on product design must evaluate whether the product's stated principal protection or return enhancement features are achievable under the hedging arrangements available at the time of issuance and whether the product's complexity makes it suitable only for sophisticated investors who can evaluate the risks independently.

The most significant source of investor litigation risk in structured financial products is the allegation that the offering documents or sales presentations did not accurately describe the product's risks, the circumstances under which the investor could lose principal, or the issuer's conflicts of interest in structuring the product. Securities fraud defense counsel handling structured financial products misrepresentation claims must evaluate whether the product's offering documents contained all material information required by the Securities Act of 1933 and whether the alleged misrepresentation was made with the scienter required for securities fraud liability.

Broker-dealers and investment advisers that recommend structured financial products to retail customers must satisfy suitability requirements under FINRA rules and, where applicable, the best interest standard under Regulation BI, and a failure to document the suitability analysis before recommending a structured product is one of the most common bases for regulatory enforcement and private arbitration claims. Investment advisory services attorneys advising financial intermediaries on suitability compliance must confirm that each recommendation is supported by a documented analysis of the customer's investment objectives, risk tolerance, time horizon, and liquidity needs and that the documentation in the customer file accurately reflects the suitability analysis performed before the recommendation was made.

A structured financial product that is offered publicly in the United States must be registered with the SEC unless the offering qualifies for an exemption, and the registration statement must contain a prospectus that discloses all material information about the product's terms, risks, and the issuer's financial condition in a manner that a reasonable investor would consider important when making an investment decision. SEC regulations counsel advising issuers on structured financial product registration must evaluate whether the product's prospectus accurately describes each scenario in which the investor could lose principal and whether the risk factors section is sufficiently specific to put investors on notice of the product's key risks.

FINRA's rules governing communications with the public and sales practices require that any materials used by a broker-dealer to market or sell structured financial products be fair, balanced, and not misleading, and that the product's risks be presented with equal prominence to its potential benefits. Capital markets and securities attorneys advising broker-dealers on structured product distribution compliance must assess whether the product's marketing materials satisfy FINRA's content standards for member communications and whether the firm's pre-use filing requirements for structured product marketing materials have been satisfied.

The foundation of a defensible structured financial product offering is a complete and accurate set of offering documents that clearly explain the product's terms, risks, and the circumstances under which the investor's return could be less than expected, and structured finance counsel who prepare structured product documentation must verify that the pricing supplement accurately reflects the final terms of the product as executed and that all risk factors material to a reasonable investor's decision are disclosed in plain language that retail investors can understand.

When a structured financial product fails to perform as investors expected and claims begin to emerge, the quality of the firm's documentation, its suitability analysis, and the accuracy of its disclosures determine whether the claims can be resolved efficiently or will require extended litigation. SEC enforcement defense counsel handling structured financial products investor claims and regulatory investigations must evaluate whether the product's offering documents provide an adequate defense against allegations that the product was misrepresented and whether the distributor's suitability records are sufficient to rebut claims that the product was recommended to unsuitable investors.