“Look out for yourselves” is Wall Street’s message to investors in the arcane securities known as derivatives. Under voluntary industry guidelines announced last week, investment firms do not have to spell out the risks of these complex investments unless expressly asked to do so by investors.
Of course, “investor beware” is good advice when it comes to any investment. However, derivatives are especially risky, and their potentially costly downsides have been experienced firsthand by many, most notably the now bankrupt Orange County. Even some of the most sophisticated and best advised corporations in the country have suffered huge losses with these volatile investments.
Derivatives are financial contracts that derive their value from some other underlying asset or index, such as gold or interest rates. They can be valuable financial tools, but if things go awry--a not infrequent happenstance--derivatives can result in catastrophic losses.
The voluntary guidelines, drafted by six Wall Street industry groups with the help of the Federal Reserve Bank of New York, assume that investors in derivatives know whether they are sophisticated enough to take on risk. Unless parties in transactions agree in writing beforehand that the securities dealer is acting as an investment adviser, investors are responsible for their own decisions.
All this sounds like a marketing gimmick to sign up clients. Leave it to Wall Street to leave Main Street out on a limb.