Airbags - Unsafe at any Speed

Attorney Advising Disclaimer

"Airbags" are a new twist on the old reverse convertible structured product. We are beginning to see investors bringing in account statements and materials related to these types of products. To date, we have had the privilege to study Airbags issued by UBS (United Bank of Switzerland), RBC (Royal Bank of Canada), and Deutsche Bank, and are preparing claims against the firms and brokers which sold these products.

One main issuer of Airbags, UBS, describes structured products as "…designed to provide alternative exposure to traditional, direct investments. Structured investments possess unique risk-return profiles and are linked to the performance of underlying securities such as individual equities, broad-based equity indices, commodities, interest rates or currencies."

The "Old" Reverse Convertible

The "old" reverse convertible is a combination of a short-term debt instrument ("promissory note") linked to a put option on a stock which gives the issuer the right to "put" the underlying stock to the investor if the price of the stock declines to a certain predetermined level called the limit price or "knock-in" price during the term of the investment. On the promissory note's maturity date, the investor either receives the return of his principal or if the price of the stock fell beneath the limit price during the term of the reverse convertible (or in other instances fell below and remained below the limit price at the time of maturity), the issuer "puts" the stock to the investor and the investor must accept the stock in lieu of receiving his principal.

The Airbag

The Airbag is a far cry from the basic reverse convertible using a lone put option as its main component. Financial alchemists from Wall Street's UBS, RBC, and Deutsche Bank, among other firms, assemble a combination of options linked to a promissory note issued usually by a financial institution to create an Airbag.

We found one website which, in one sentence, explained the options which constitute an Airbag structured product's linkage between the promissory note and the underlying stock. explains an Airbag's linkage as "…constructed using a long zero-strike call ratio, a short call ratio and a long at-the-money strike call."

If you did not understand the prior sentence, you are not alone. How a broker explains these complex options to a client in a sales presentation is something we are curious to hear in testimony., with a few more sentences discusses how Airbags work for investors.

"Airbag certificates fully participate to the upside price performance of an underlying asset and have a certain amount of downside protection down to which the investor doesn't incur any losses. In other words, as long as the underlying asset doesn't lose more than a predefined level, the capital is 100% protected. That level is called the airbag, named after the automobile safety system placed in the steering wheel that lessens the injuries in case of an accident. Below the airbag level, the product starts to decrease in value at a leveraged pace compared to the underlying asset. However, it stays above the underlying asset until the asset loses all value" Still confused? An analogy may help.

In our opinion, the leverage component of an Airbag structured products makes the investment even more dangerous. If a car hit a tree, the airbag would deploy and the driver would escape relatively unscathed. The leverage component in the UBS Airbag keeps the car driving, through the tree, across the field, and potentially over the cliff. The lack of a secondary market keeps the driver tightly belted into the car for the entire ride. An Airbag investor can keep losing money until the ride ends.

Where Did My Money Go?

Airbags have one other sneaky "gotcha," the sum of the individual components of an Airbag do not equal the cost of the product! Securities Litigation Consulting Group ("SLCG") analyzed a number of Airbags issued by UBS and made this surprising finding: "[i]nvestors purchasing these reverse convertibles effectively sell put options to UBS and post the note's issue price as collateral to secure satisfaction of the investors' obligations under the option contracts. UBS pays investors a 'coupon' that is part payment for the put options and part interest on the investors' posted collateral. This reverse convertible is fairly priced if and only if the difference between the reverse convertible's 'coupon rate' and interest paid on UBS's straight debt equals the value of the put option investors are giving to UBS."

In the case of a Facebook Airbag (CUSIP No. 90272E325), SLCG found for each $1,000 unit of the Facebook Airbag purchased, the sum of the individual components, a zero-coupon note issued UBS (the promissory note), the short out-of-the-money cash-or-nothing binary put option (option #1), a short out-of-the-money put option (option #2), and the present value of all future coupons was only $901.14.

UBS discloses the differential as "[t]he issue price you pay for the Notes exceeds their estimated initial value as of the trade date due to the inclusion in the issue price of the underwriting discount, hedging costs, issuance costs and projected profits." Said another way, UBS takes 10% off the top!

From the moment the Facebook Airbag was purchased, investors were already down 10%. To break even, an investor had to see a 10% return. In today's low interest rate environment, a 10% return is a reflection of massive risk. That leads to one question: at a 10% purchase cost, coupled with the issuer risk and reference security risk, who exactly are these products suitable for?

What to do if you Lost Money on Airbags

If an advisor or stockbroker sold you Airbag structured products, which resulted in the stock being put to you for a loss, please call The Law Offices of Jonathan W. Evans & Associates at (800) 699-1881 for an investigation and consultation. As always, each case is individual to its own set of facts and our successful resolution of prior cases is no guarantee your case will be resolved on such favorable terms.

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