Structured security products (SSPs) encompass a range of financial instruments, such as securities that derive their value from, and provide exposure to, various asset classes, including, among other things, a single security, baskets of securities, indices, options, commodities, debt issuances and/or foreign currencies.

SSPs are a subset of such securities products and are generally registered under the Securities Act of 1933 (“Securities Act”) in order to facilitate their offerings to retail investors.

These registered securities are generally offered to retail investors in the form of medium-term or short-term corporate debt with exposure to a variety of asset classes issued by an affiliate of a broker-dealer, and then distributed by that broker-dealer.    The issuer of the obligation is typically the parent public company of the affiliated broker-dealer underwriter.

SSPs intended for retail distribution, which are sometimes listed on an exchange, typically have some form of option or other embedded financial derivative exposure.   They may be described as offering, among other things, partial or full “principal protection,” higher interest payments, or leveraged and/or asymmetrical exposure to the underlying asset class. SSPs are often quite complex and can present wide-ranging risks and regulatory issues, including suitability and disclosure concerns, limited liquidity, comparatively opaque and often expensive fee structures, paucity of secondary market activity, and difficulty in pricing. They also pose supervisory, compliance and sales training challenges.

Total U.S. sales of SSPs (to both retail and institutional investors) had risen from approximately $32 billion in 2004 to in excess of $100 billion in 2007.  The demise of Lehman Brothers Holding Co. and its associated default on many SSPs it had issued and distributed, as well as its default on other of its structured products had a sobering effect across the SSP market in 2008.  Nonetheless, SSPs seem to have resumed an overall upward sales trend in 2009 and 2010, and SSP sales to retail investors have, on an estimated basis, risen from $34 billion in 2009 to $45 billion in 2010.

SSPs can generally be classified into five basic categories with varying payouts and risks:

The most basic category has been referred to as partial or full “principal protected” notes. Such notes typically have returns linked to broad-based equity indices, such as the S&P 500, Nikkei 225, and Nasdaq.  The basic “principal protected” SSPs might have maturities of five years or more, but they usually have a duration of 6 months to 2 years.

The next category – enhanced-income notes – typically pays a higher coupon base and has capped returns tied to the value/performance of the underlying asset and may include at least some level of “principal protection.”  The underlying assets for enhanced income notes typically include single stocks, baskets of stocks, and indices.  Enhanced-income notes with indices as the underlying reference are typically coupled with increased principal protection and have longer maturities and lower yields than others. Enhanced income notes typically have maturities of 5 years or less with the majority having maturities of 1.5-2 years.

Another category, performance/market participation notes are linked to underlying assets such as gold, or investment strategies, such as long-short strategies, that are not  otherwise easily accessed by small investors.

The fourth category is leveraged/enhanced participation notes that offer  a leveraged upside (with a leveraged risk of loss). (For example, the notes may  pay a return two to three times the return on the underlying,  usually with a cap on the return and no principal protection.

In the fifth category, these basic forms are often adjusted and/or combined with each other to form numerous other types of SSPs, most notably reverse convertible notes (“Reverse Convertibles” or “RCNs”).  With Reverse Convertibles investors are, in essence, purchasing a security with the sale of a put option embedded in it (some call option-SSPs are also offered).  The payout for a typical equity-linked reverse convertible note is a high-level interest rate plus a return of principal at maturity if the equity increases in value (or stays the same) over the term of the note.

Tomorrow’s blogticle will contain a discussion relating to life insurance.

We invite your opinions and comments by posting them below, or by calling the Panel of Experts.

Why is this Topic Important to Wealth Managers? Today we discuss foreign investment in the U.S. both private and public. The data shows a growth in the U.S. investment sector. The evaluation provides wealth managers information regarding global economic investment in the U.S.

This Treasury and Federal Reserve recently presented data and analysis regarding the latest annual survey of foreign portfolio holdings of U.S. securities. The survey measured positions as of June 30, 2010.

The annual survey measured foreign holdings of U.S. securities as of June 2010 at $10,691 billion. Of the over $10 trillion of foreign holdings $9,736 billion were holdings of U.S. long-term securities (original term-to-maturity greater than one year) and $956 billion were holdings of U.S. short-term securities.

In the previous survey as of June 30, 2009, total foreign holdings amounted to $9,641 billion.  The increase over the 12-month period from June 2009 to June 2010 – $1,050 billion – more than reversed the decline in total foreign holdings of U.S. securities in the 2009 survey.  Foreign holdings of equity rose $562 billion to $2,814 billion.  The increase in part reflected the rebound in stock prices between the 2009 and 2010 survey dates, but even so, foreign holdings of U.S. equity remained below the level recorded in 2008 (value of holdings is determined at fair market).  Foreign holdings of U.S. long-term debt securities rose $681 billion over the same period.  This increase was more than accounted for by a record increase in holdings of long-term Treasury securities, which rose $739 billion to reach a level just above $3.3 trillion.

In contrast, foreign holdings of long-term agency securities decreased further from the peak recorded in June 2008.  Foreign holdings of long-term corporate securities edged up slightly over the 12-month period.  Foreign holdings of U.S. short-term securities decreased $193 billion to $956 billion.  Foreign holdings of U.S. Treasury bills and certificates, short-term U.S. agency securities and short-term corporate debt securities all declined.

At $9,736 billion, foreign holdings of U.S. long-term securities continue to be considerably larger than U.S. holdings of foreign securities, estimated at $5,175 billion as of end-June 2010.  Moreover, foreign holdings of U.S. long-term securities increased $1,244 billion during the 12-month interval between the 2009 and 2010 surveys, more than the $560 billion that U.S. holdings.

Foreign securities are estimated to have increased over the same period.  As a result, the ratio of U.S. holdings to foreign holdings decreased to 0.53 and the net position in long-term securities holdings widened further to -$4.6 trillion.  In June 2010, foreign holdings of U.S. long-term securities exceeded the previous peak recorded in June 2008, but U.S. holdings of foreign securities were estimated to be still below the peak recorded in June 2007.

The data show that at $1,611 billion, total holdings attributed to mainland China exceeded those attributed to any other country, surpassing holdings by Japan ($1,393 billion) for a second year.  Holdings attributed to residents of the United Kingdom were third at $798 billion.  The United Kingdom had been one of the top two investing countries in U.S. securities since country-level data became available (1978), but the United Kingdom fell into the third position behind the rapidly growing stock of holdings of China in the 2006 survey.  The United Kingdom remained the largest holder of U.S. equity in 2010, while China remained the largest holder of debt securities.

Long-term U.S. Treasury securities held by China amounted to $1,108 billion, up from $757 billion a year ago.  In addition, $4 billion of the $5 billion in short-term securities held by China were U.S. Treasury bills and certificates, bringing China’s total holdings of U.S. Treasury securities to $1,112 billion.  Notably, China has reduced its holdings of short-term debt since June 2009 by $155 billion but has increased its holdings of long-term Treasuries.  Japan was the second largest holder of U.S. Treasury securities, with total holdings of $799 billion, of which $737 billion were long-term Treasury securities and $62 billion were short-term securities.

Since the 2004 survey, China’s holdings of U.S. securities have more than quadrupled.

Tomorrow’s blogticle will continue to discuss tax and market issues relating to wealth management.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

Why is this Topic Important to Wealth Managers? Today we continue our series on “Wealth Management in Today’s Economic Environment”. The series is designed to address the specific question many wealth managers are currently asking: “what are the best investment, retirement and financial planning tools given the current global financial position?” We explore alternatives from “safe” to “risky” from “traditional” to “emerging” to discover and discuss the most relevant wealth management tools and techniques available today. We look forward to presenting this discussion and think you will find the information quite valuable. Please note that this series is presented in continuation. That being said each blogticle resumes discussion from the previous day.

As was discussed yesterday, one option investors may currently consider seeking is U.S. government debt. However, ten-year note yields bottomed out at 3.05 percent last week.[1] Clients are being advised that they “should think twice” about treasures, that’s because consumer inflation continues to outpace those yield figures.” [2] Treasury yields are stupidly low,” says Robert Auwaerter, head of the fixed-income group at Vanguard Group. [3]

Are there any other U.S. government options that provide reasonable rates of return? Given the national debt issues and current low Fed rate will inflation play a part? Presented below is one option that may help clients hedge against inflation.

Treasury Inflation-Protection Securities

Treasury Inflation-Protected Securities, or TIPS, provide protection against inflation. The principal of a TIPS increases with inflation and decreases with deflation, as measured by the Consumer Price Index. When a TIPS matures, clients are paid the adjusted principal or original principal, whichever is greater. This provision protects clients against deflation.

TIPS pay interest twice a year, at a fixed rate. The rate is applied to the adjusted principal; so, like the principal, interest payments rise with inflation and fall with deflation.

TIPS are marketable securities whose principal is adjusted by changes in the Consumer Price Index. With inflation (a rise in the index), the principal increases. With a deflation (a drop in the index), the principal decreases.

The relationship between TIPS and the Consumer Price Index affects both the sum clients are paid when the TIPS matures and the amount of interest that a TIPS pays every six months. As stated above, TIPS pay interest at a fixed rate. Because the rate is applied to the adjusted principal, however, interest payments can vary in amount from one period to the next. Thus otherwise stated, if inflation occurs, the interest payment increases. In the event of deflation, the interest payment decreases.

But according to the returns on TIPS they may not offer investors growth relative to the security they desire. For example the TIPS due February 2041 are currently yielding only 1.774%. [4] Moreover, interest on tips is generally subject to federal tax unlike some other government issued debt.

For more in-depth discussion on treasuries, see AdvisorFX: U.S. Treasury and Government Agency Securities.

Our series continues next week with a discussion of municipal bonds, cash accounts, commodities, international investment and more.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

Series Author: Benjamin Terner

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[1] Reuters. “Treasuries-Gov debt prices fall on profit taking”. May 27, 2011.  http://www.reuters.com/article/2011/05/27/markets-bonds-idUSN274758020110527. Last Accessed 5/30/2011.

[2] Chris Farrell. Safe Investing in a Troubled Economy. Bloomberg Businessweek. September 25, 2008.

[3] Id.

[4] Wall Street Journal. Friday, May 27, 2011. Market Data Center- Treasury Inflation-Protected Securities. http://online.wsj.com/mdc/public/page/2_3020-tips.html.

Brokers’ disciplinary histories are now prominently displayed for the web savvy public; they’re no longer filed away at the Financial Industry Regulatory Authority (FINRA), where only the most diligent investors will find them. FINRA has made your disciplinary history freely and easily available to the public by launching a web-accessible discipline database.

Whether the easy accessibility of the information is a positive or negative will depend on a broker’s history. Those with a clean record will undoubtedly benefit from the easy accessibility of the information and the ease with which clients and prospects can canvass their record and compare it to others. Those with a negative history, whether deserved or not, may now find themselves on the defensive with prospects more often.

Read this complete analysis of the impact at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

For previous coverage of FINRA complaint and disciplinary procedure in Advisor’s Journal, see FINRA Rule 45-30: Expansive New Complaint Report Requirements (CC 11-96) & Broker Bonus Arbitration Bottleneck Forces FINRA to Reconsider Arbitrator Qualification Standards (CC 11-08).

Why is this Topic Important to Wealth Managers? Presents discussion on a common financial product that investor clients can incorporate into planning strategies, if not already.

Today’s blogticle takes a look at one topic of international intrigue and high finance—debt issued by the United States Federal Government.  Generally United States “securities are debt instruments issued by the U.S. Treasury to raise money needed to operate the federal government and to pay off maturing obligations.” [1] The “paper” is backed by the “full faith and credit of the United States government guarantees that interest and principal payments will be paid on time, and thus, these securities are considered very safe investments.” [2]

Treasury bills, or T-bills, “are short-term government securities with maturities ranging from a few days to 52 weeks.” [3] The Bills are generally sold at a discount from the par value or face amount of the bill.  An example, an investor may pay $990 for a $1,000 bill.  When the bill matures, the investor is paid the full $1,000.  The discount or difference between the purchase price and the redemption price is interest.   T-Bills are sold direct by the Treasury department, or can be purchased through banks and brokers.

Treasury notes, or T-notes, are “issued in terms of 2, 3, 5, 7, and 10 years, and pay interest every six months until they mature.”  [4] Further, the notes may be sold at a discount (for less than face value), at a premium (for more than face value) or for face value.  When the note matures, the investor is paid full face value, in addition to the interest payments received.

A few of the key features of T-notes include:

• The yield on a note is determined at auction.
  • Notes are sold in increments of $100. The minimum purchase is $100.
  • Notes are issued in electronic form.
  • An Investor can hold a note until it matures or sell it before it matures. [5]

Treasury bonds are issued for terms of 30 years and pay interest every six months until maturity. When a Treasury bond matures, the investor is paid its face value.

“The price and yield of a Treasury bond are determined at auction.” [6] Like a T-note, a T-bond, may be issued at a discount, premium or face value.  T-bonds “exist in either of two formats: as paper certificates (these are older bonds) or as electronic entries in accounts.”   Today, Treasury bonds are issued exclusively in electronic form.

Total current outstanding debt issued by the Treasury in bills, notes, bonds and other evidence of indebtedness is approximately 13.8 Trillion dollars, as of the end of November 2010. [7]

For more in-depth discussion on T-bills, notes and bonds, see AdvisorFX: U.S. Treasury and Government Agency Securities.

Clients can purchase T-bills, notes, and bonds from the Treasury Department at the following link: http://www.treasurydirect.gov/indiv/products/products.htm. 

Tomorrow’s blogticle will present some interesting new topics.

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] AdvisorFX.  AUS Main Libraries ,  Section 22.2  Investment Vehicles, B—U.S. Treasury and Government Agency Securities. http://www.advisorfx.com/articles/f22-2_1_13_3760.aspx?action=13.  Last Accessed 11/29/2010.

[2] AdvisorFX. U.S. Treasury and Government Agency Securities.

[3] Untied States Department of the Treasury.  Treasury Direct-Treasury Bills.  http://www.treasurydirect.gov/indiv/products/prod_tbills_glance.htm.  Last Accessed 11/29/2010.

[4] Untied States Department of the Treasury.  Treasury Direct-Treasury Notes.  http://www.treasurydirect.gov/indiv/research/indepth/tnotes/res_tnote.htm.  Last Accessed 11/29/2010.

[5] Untied States Department of the Treasury.  Treasury Direct-Treasury Notes.

[6] Untied States Department of the Treasury.  Treasury Direct-Treasury Bonds.  http://www.treasurydirect.gov/indiv/products/prod_tbonds_glance.htm.  Last Accessed 11/29/2010.

[7] Damian Paletta.  The Wall Street Journal.

Debt-Panel Chairmen Work to Gain Support.  November 29, 2010.  http://online.wsj.com/article/SB10001424052748703785704575643111128016590.html.  Last accessed 11/29/2010.; see also Untied States Department of the Treasury.  Treasury Direct.    http://www.treasurydirect.gov/NP/BPDLogin?application=np.  Last Accessed 11/29/2010.

Author: William H. Byrnes & Benjamin S. Terner

Why is this Topic Important to Wealth Managers? Provides wealth managers with information relating to client transactions and reporting to the Internal Revenue Service beginning next year.

The Energy Improvement and Extension Act of 2008 created new laws requiring most regulated securities transactions occurring after December 31, 2010 to be subject to cost basis reporting by securities brokers to the IRS. [1] Currently, brokers are required to report the gross proceeds from the sale of a security on Form 1099. [2] The new law will add reporting of client’s adjusted basis of the security, and whether the gain is a short or long-term.  [3] Mutual fund cost basis reporting is to start a year after regulated securities reporting, and options and debt contracts are to follow a year after mutual funds.  The reports are to be filed on a Form 1099-B, Proceeds from Broker and Barter Exchange. [4]

Why is it important to know that the IRS will be receiving information about the values of securities of clients?

Generally, gain determination for the sale or exchange of a capital asset is the sales price minus what the asset was acquired for, or the cost basis. [5]

Until now, gain determination, which directly effects tax liability, has largely been a task for accountants.  The new law fundamentally changes how gains will be calculated by the Treasury;  going forward, it will have all the information it needs to calculate tax liabilities for taxpayers from transactions occurring on capital markets. [6]

Now, under Form 1099 reporting by brokers—“basis, sales price, and type of gain, the IRS can track” what was paid for the stock, what the stock was sold for, and whether the gain is short term or long term. [7] There is now little room for error for individuals purchasing securities to correctly report gains from transactions on stocks.  If the IRS receives information from the broker that does not match information on the client’s tax return, “the mismatch should trigger an IRS inquiry.” [8]

The effort is part of the Federal initiative of finding “innovative ways to reduce the tax gap and improve compliance.” [9] Internal Revenue Service Commissioner Shulman states the new law “will go a long way to reducing [miscalculated gains] and making things easier for investors.” [10]

Also, the requirements for reporting continue—a broker who transfers custody of a security to another broker must include an accompanying written statement with information to determine basis. [11] Moreover, once an issuer of stock takes an organizational action such as a stock split, merger, or acquisition that affects basis, an issuer must report to the Service and to each stockholder or nominee a description of any such action and the quantitative effect of that action on basis. [12]

The Commissioner relates to the issue personally, “I don’t know about you, but I have spent far too much time digging through old records, trying to find the basis for securities I sold.  I think investors…and I count myself one …will welcome getting this new, easy-to-understand information from their brokers.” [13] Others may disagree with the Commissioner but, time should tell.

Our Blogticles will continue Friday.  From the staff and experts at National Underwriters – we wish you a Happy Thanksgiving!

We invite your questions and comments by posting them below, or by calling the Panel of Experts.

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[1] Section 403 of the Energy Improvement and Extension Act of 2008, Div. B of

Pub. L. No. 110-343, 122 Stat. 3765, enacted on October 3, 2008, added sections

6045(g), 6045A, and 6045B to the Code. Section 6045(g) 6045(a); Notice 2010-67.  http://www.irs.gov/pub/irs-drop/n-10-67.pdf.  Last Accessed 11/7/2010.

[2] 26 U.S.C. § 6045.

[3] Id.

[4] See  26 U.S.C. § 6045; 26 CFR § 1.6045-1.

[5] See generally, 26 U.S.C. §§ 1001, 1011, 1012.

[6] Arden Dale.  The Wall Street Journal.

Cost Basis to Come on 1099B’s.  http://online.wsj.com/article/SB10001424052748704763904575550461405074090.html.  October 14, 2010.  Last Accessed 11/22/2010.

[7] Robert W. Wood.  “Forms 1099 For Cost Basis: What, Me Worry?”.  Forbes-The Tax Lawyer.  Oct. 20 2010.  http://blogs.forbes.com/robertwood/2010/10/20/forms-1099-for-cost-basis-what-me-worry/.  Last Accessed 11/22/2010.

[8] Robert W. Wood. Forbes-The Tax Lawyer.

[9] Internal Revenue Service Commissioner Douglas Shulman.   Prepared Address to The American Payroll Association’s and American Accounts Payable Association’s 28th Annual Congress. IR-2010-68.  May 27, 2010, Washington, D.C.

[10] Douglas Shulman.  IR-2010-68.

[11] 26 U.S.C. § 6045(g).

[12] 26 U.S.C. §  6045B.

[13] Douglas Shulman.  IR-2010-68.

Brokers and mutual fund companies will soon be required to report to their customers and the IRS on the basis of securities sold from customers’ accounts and whether any gain on the sale is a short or long-term capital gain. IRS Commissioner Doug Shulman praised the new rules, saying that “[i]nvestors will now receive the information they need to more easily and accurately report their gains and losses.” Easy access to basis information will save many investors time and money when filling out their tax returns and ensure that the IRS is given accurate information by investors who make securities sales.

The new basis reporting requirements will be burdensome for brokers; the IRS has estimated that the average broker will spend eight hours annually to comply with the requirements. And this year, brokers have the challenge of implementing the systems necessary to comply with the basis reporting requirements by January 1, 2011. We will keep you posted if the IRS releases any additional guidance.

Read this complete article at AdvisorFX (sign up for a free trial subscription with full access to all of the planning libraries and client presentations if you are not already a subscriber).

We invite your questions and comments by posting them below or by calling the Panel of Experts.