Certificates gained inglorious reputation in 2008 by the bankruptcy of U.S. investment bank Lehman Brothers. Its Dutch subsidiary went on the German market with numerous differently structured certificates that became practically worthless in a bankruptcy of the Lehman Brothers group. The investors will only receive the insolvency rate, the exact amount of which has not yet been determined. But also certificates issued by other issuers partly pose dangerous risks for the invested capital.
What are certificates?
A certificate is a derivative financial product that is regularly traded as security at the stock exchange. Derivative means that the security derives its price from the value of other assets, eg from stocks and stocImprintk indices, such as the DAX. This value is called the underlying asset. There are certificates that only trace exactly this value, with other certificates special functions are added that shall minimize the risk or increase returns. There are numerous variations and combinations (some examples can be found in our glossary).
If the investor has opted for a certificate, he pays a sum of money to the issuer that the issuer must repay according to the agreed rules. The redemption sum or amount repayable may differ greatly from the amount originally paid. The holder of a certificate whose value depends on the value of a share is not a shareholder himself, but receives a payment claim against the issuer.
Legally, a certificate is defined as a so-called bearer bond § 793 BGB. The owner of the certificate is therefore creditor of the issuer. This also means that the investor bears the issuer risk: In case of the issuer's insolvency there is a risk of total loss of his investment, so the creditworthiness of the issuer is of particular importance in this type of investment.
Investor- and investment-oriented counseling
Whether there are claims for damages against the advisory bank primarily depends on whether an investor- and investment-oriented counseling has taken place. Any matters that may be of essential relevance to his purchase decision have to be pointed out to the investor. Depending on the particular type of certificate the following points should be informed about:
- The risk of insolvency of the issuer and possibly the guaranteeing bank
- The lack of deposit insurance,
- The risk of total loss which is possibly due to the structure of the certificate
- The term, the market price risk and the possible lack of fungibility,
- Special features for the termination conditions for the Issueron the one handand for the investoron the otherhand.For somecertificatesthis can also resultin the risk of total lossif the prepayment amount is based eg on a fair market price of which deductions are performed and whose concrete calculationis at the discretionof a calculation agent.
The precise content and extent of information obligations varies from case to case. Ultimately, the bank may only recommend an investment that meets the investor's needs and interests (eg a fixed deposit account for a very security-oriented investor).
The bank must indicate the higher risk for recommendations that do not fundamentally match the investor profile. The bank is liable for any damages suffered by the investor through proven incorrect advice (eg if a conservative investor loses his entire assets invested into a single, extremely risky investment upon the recommendation of the bank) and has to compensate any damages incurred.
Kick-backs and similar conflicts of interest
For certificates the flow of rebates, better known as "kick-backs", is rather rare. Instead, the advisory bank usually receives commissions or a profit margin for the successful completion of business it recommended. It is not uncommon that different kinds of compensation are combined. While the Federal Court of Justice is unambiguous on rebates, the question of information obligations regarding commissions is partly disputed. Regarding the profit margins collected in fixed price business the obligation to inform is denied by a predominant part of jurisdiction so far. However, whether or not there is an information obligation in regard to external products sold in fixed-price business has still not been clarified by the highest court. Unlike with own products, the profit motive is not obvious.
The conflict of interest of the advisory bank is independent of the legal type of remuneration - on one hand the bank is supposed to only advise in the interest of the investor, but on the other hand it receives a benefit from the sale of the certificate. The investor is only able to assess whose interest may weigh more heavily in his case when he knows the actual amount of this benefit. Against this backdrop he can then take his own investment decision.