What Does a Defective Securities Product Look Like? Example: GWG Holdings L Bond

Today, very few products use asbestos, an abundant and inexpensively produced heat-resistant mineral once common in a wide array of construction materials, auto parts, and firefighter equipment, to name a few. Its use was rampant until studies revealed that asbestos causes various forms of cancer—clearly a defective product, use of asbestos is now scarce and regulated by the government.

Defective securities products are no different. Brokerage firms often develop complex securities products that promise to beat the market but instead result in catastrophic financial losses to investors. If this sounds familiar to you, you need to contact a New York Defective Securities Law Firm, like Malecki Law. Touted as the next big thing since sliced bread, some defective securities are so complex that even the brokers who sell them do not understand how the product works. Some other such products are easier to understand, but their viability is misrepresented, or their attendant risks are downplayed. The GWG Holdings L Bond is of the latter kind.

A few years ago, GWG Holdings Inc. created what they called the L bond, a speculative, unrated, high-risk, and high-yield investment instrument. GWG issued the bond to raise funds to purchase life insurance policies from insureds with the intention to collect the policies’ payouts upon their deaths. Each L Bond was priced at $1,000 principal with a minimum buy-in of 25 units ($25,000) and offered to investors with varying maturity terms and corresponding interest rate incomes. Given the investment’s high risk and price tag, the L Bond was deemed suitable only for wealthy investors. Nevertheless, brokers fraudulently sold it to the elderly, retirees, and other relatively inexperienced people with conservative to moderate risk tolerances and limited resources. If your broker sold you high-risk investments and failed to disclose or explain their inherent risks, you should have an experienced Defective Securities Lawyer in New York, like the lawyers at Malecki Law, review your portfolio. Based on the foregoing, it is clear this story does not have a happy ending; but before getting there, a word on the L Bond’s defective nature is apropos.

Compared to the complexity of other defective securities products—cue commodities futures speculation by average investors, which is about as recommendable as petting a wild tiger—the L Bond was nothing to write home about. At its most basic, the L Bond was a junk bond: a bond that compensated for its higher risk of default by offering a higher interest rate return. However, the L Bond was an especially defective securities product not only because investors lacked any guarantee that the life insurance policies would pay out the full amount, or at all; but also due to the L Bond’s illiquidity and automatic renewal, junior priority to GWG’s and its subsidiaries’ other substantial debts, and broker misconduct, among other things, vis-à-vis the previously mentioned types of investors who bought it. Let’s talk about what that means below.

The first index of the L Bond’s defectiveness is that GWG could not tap into its investment—could not get the life insurance policies’ proceeds—absent the insureds’ compliance with the policy terms and only after the insureds died, events out of GWG’s control. The strategy was necessarily predicated on the insureds’ conduct, investor patience, and GWG’s ability to continue selling the L Bond so it could run operations and pay interest to existing investors. Relatedly, GWG also faced exposure should an insurance company that issued policies in its portfolio went under. Secondly, no secondary market was available for investors to resell their bonds. The L Bond was an illiquid alternative investment offered via a private placement which by its terms bound investors to it until maturity, unless: the investor died, went bankrupt, suffered total disability, or GWG agreed to redeem the bond at the extra cost of a 6% redemption fee. Conversely, GWG reserved the right to repurchase the L Bond at its discretion. Thus, investors had little recourse to minimize their losses should the product underperform but GWG could repossess it on favorable terms should it need to, any adverse effects to the investors notwithstanding. Did you face adverse effects and/or substantial losses due to defective securities in your portfolio? Did an advisor recommend that you purchase these defective securities? You should reach out to a New York Defective Securities Attorney, like the attorneys at Malecki Law, who are happy to review your account holdings for free. Loss of the total investment was a possibility; and should GWG go under, L Bond debt was subordinated to substantial senior loans with institutionalized lenders. Meanwhile, brokers selling the L Bond were netting unreasonably high commissions. Investors were never the priority.

High-yield high-risk is a much harder sell than merely high-yield. Thus, the impetus for the fraudulent sales. Thus, irrespective of the very real risks to retail investors, GWG sold defective securities which resulted in serious financial losses to the buyers—who now must traverse a legal maze to recover. SEC investigations and other issues caused GWG to stop the sale of the L Bond, a circumstance that prompted a cascade of problems that landed the L Bond issuer in bankruptcy. Apropos of GWG’s inability to tap its portfolio, it needed to continuously bring in new investors to pay interest to the old; but once that stopped, it could no longer afford operations or its obligations to investors. Sounds familiar, Ponzi? In bankruptcy, GWG disclosed $2 billion in liabilities, of which $1.3 billion correspond to L Bonds; yet, secured GWG lenders will be accorded senior priority and therefore recover before any L Bond investor can.

The L Bond is a defective securities product that has ruinously affected the lives of countless investors. Investors looking to recover face a legal maze. You can avoid this by consulting with a Defective Securities Law Firm in New York, like Malecki Law, to provide you with guidance based on its experience with defective securities.


Contributions by Nelson O. Melgar Martinez, NYLS Securities Arbitration Seminar and Field Placement Extern

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