Individual Investors Duped by Derivatives

Leona Miller, an 84-year-old retired beautician, says she was seeking safe and steady income from bonds two years ago when she bought securities recommended by her Wachovia (WFC) broker, Robert Baldacci, paying 9 percent interest. Within six months, Miller lost about 30 percent of her $20,000 investment, and the bonds were converted into shares of Merck (MRK) in a falling stock market. "I just wanted him to make some money for me, like anybody else," says Miller, who lives in San Diego. "I still don't understand too much about it."

Miller had bought a structured note—a bond combined with a derivative. In her case, it was a reverse-convertible note with a knock-in put option tied to Merck stock. The option meant the security could offer a relatively high interest rate. It also added risk, as Miller learned too late. A decline in the drugmaker's shares, to below 32 from 40 when Miller bought the notes, triggered the put option. That allowed the note's issuer, the Oslo-based export-credit agency Eksportfinans, to pay Miller off with Merck shares, then trading at 26. Kathryn Ellis, a spokeswoman for San Francisco-based Wells Fargo (WFC), which acquired Wachovia in 2008, and Baldacci, who no longer works for the bank, declined to comment.